S&P To Triple in 2018

If you read our Quarterly Letter you know that the overriding question is at what level will bond yields begin to hurt stocks? Well, courtesy of “Bond King” Jeffrey Gundlach we have a number. Gundlach held his yearly January conference call this week which is always fascinating and filled with thought provoking ideas. In his conference call Gundlach stated that the 2.63% level on the 10 year is going to be a very important level and at which stocks may begin to suffer. The 10 year closed the week at 2.55% but touched a high of 2.597%.

I have spent the better part of the weekend in the office reading interviews with investing mavens and re-listening to conference calls, much to the chagrin of my wife. This week we heard from Jeffrey Gundlach, Bill Gross and Jeremy Grantham, all of whom we value highly in their opinions. If you have time check out Grantham’s latest missive titled “Bracing Yourself for A Melt Up”.  We, of course, agree with Grantham as we have been calling for a melt up in the markets since November 2017 and its subsequent 30% mark up. He makes what we believe are salient points in regards to his concept of bubbles and his feeling that one critical component is the acceleration of prices. Turning points in markets happen very quickly. That is why we stay invested. This melt up could run much further, higher and faster than any of us can predict. That is why we stay invested and simply recalibrate our allocations.

Another reason we have spent so much time in the office this weekend is that we believe that we are on the cusp of a regime change in markets. That regime change could spell the end of the bond bull market of the last 30 odd years and see a reemergence of inflation. Jim Paulsen, Chief Investment Strategist from the Leuthold Group had this to say back in November on the regime change.

“As financial markets are weaned off the juice they have been drinking for almost a decade, investors should prepare for a very different bull market in the balance of this recovery,” he said. “Without a chronic injection of financial liquidity, the stock market may struggle more frequently, overall returns are likely to be far lower, and bond yields may customarily rise.”

To be sure, Paulsen is not predicting a market collapse. Instead, he suggests investors will need to shift strategy away from the cyclical U.S.-centric approach that has worked for most of the past 8½ years, due to the likely contraction of money supply compared to nominal GDP growth.

That means value over growth stocks, international over domestic, and inflationary sectors, like energy, materials and industrials, over disinflationary groups like telecom and utilities.

Here is what Dr. Ben Hunt at Epsilon Theory had to say on inflation and QE back in July of last year.

(As the Fed slowly raises rates) It will force companies to take on more risk. It will force companies to invest more in plant and equipment and technology. It will force companies to pay up for the skilled workers they need.

In exactly the same way that QE was deflationary in practice when it was inflationary in theory, so will the end of QE be inflationary in practice when it is deflationary in theory.

My view: as the tide of QE goes out, the tide of inflation comes in. And the more that the QE tide recedes, the more inflation comes in.

Dr. Ben Hunt Epsilon Theory

The timing on Trump’s tax reform is a bit late in the cycle and may end up exacerbating inflationary pressures. Central bankers have been pouring gasoline on the pyre for years with no effect. Pushing on a string. Higher rates (and tax reform) may be the match and with too much gasoline on the fire inflation may be the result.

(the economy) “will be getting an extra boost in 2018 and 2019 from the recently enacted tax legislation” which could lead to overheating. In which case, it would be necessary for the Fed to “press harder on the brakes”  –

NY Federal Reserve President William Dudley

The combination of higher rates, the end of QE and tax reform may push the market and economy into overheating. Late stages of bull markets tend to be very kind to commodity plays and we are beginning to see movement in the typical commodity plays. Transports are off to their best start since 1983. The S&P is off to its best start since 1987 while the Dow is off to its best start since 1997.At its current rate so far in 2018 the S&P 500 will triple by the end of the year. Not entirely likely. According to one of the many sentiment indicators that we follow the bulls are partying like it is 1987. It is starting to feel more like 1998-99. Watch for price acceleration.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

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Paradox

 The catch is, a boat this big doesn’t exactly stop on a dime.

Seaman Jones – Hunt for Red October

 Whenever you find yourself on the side of the majority, it is time to pause and reflect. ~ Mark Twain

Paradox

The word of the year just might be paradox. In a normal year the market is full of conflicting information and contradictory conclusions. 2018 and its historical asset valuations may set a new bar when it comes to investing paradox. A recent Bank of America Global Fund Manager survey shows a record high number of managers feel that stocks are overvalued yet cash levels continue to fall. The upshot is that even though managers feel that markets are overvalued they are forced to chase the market ever higher and deploy their cash holdings. An explanation for this data point is that managers act in this way in an effort to provide themselves with insurance against career risk. Chasing markets higher can be, in itself, just an effort to assuage investors who see the market returns and expect the same despite manager’s historical models telling them to act more cautiously.

One data point that simply jumps off of the page from the fund manager survey is that close to 70% of fund managers believe that tax reform will lead to higher stocks in 2018. If 70% of managers feel that tax reform will lead to higher stock prices, and the stock market is a discounting mechanism, then shouldn’t that idea already be factored into stock prices? In a world where for every buyer there is a seller 70% is practical unanimity.

Here is yet another paradox. Low rates are a commonly ascribed reason as to why equity valuations are so high. Doesn’t everyone expect rates to rise in 2018 including the Federal Open Market Committee (FOMC)? The FOMC itself has stated that they expect to raise rates three times in 2018.  If it is widely expected that rates will rise and low rates are the reason for expensive equity valuations then shouldn’t equities be falling? We are left with the idea that the current market is in melt up mode due to the twin engines of human psychology and market structure.

New Regime

Current market structure is built on self reinforcing algorithms engineered by computers. Computers run by market makers see buy orders and place other buy orders ahead of clients in order to implement more liquidity into the system. Market makers, by design, restrict themselves as to how much capital they put at risk. At a certain level, dictated by management, a market maker will cover their short or dispose of their long in order to manage risk. A high and rising market will lead to a market maker buying more and a lower market will lead to a market maker dumping their position into a falling market. That leads to self reinforcing loops. We now find ourselves in an era with lower volatility and grinding markets with self reinforcing feedback. While we believe that the lower volatility regime is partly a response to the lower human emotional component of investing the emotions are still present and impactful.  Investors currently find themselves chasing the market ever higher as their models have told them to reduce their allocations to stocks but yet stocks push ever higher and clients demand higher returns. Hence, another self reinforcing feedback loop.

“…algorithmic traders and institutional investors are a larger presence in various markets than previously, and the willingness of these institutions to support liquidity in stressful conditions is uncertain.”- Janet Yellen FOMC Chair Jackson Hole 8/25/17

We are currently seeing record low volatility with continued rising asset valuations, all while being in an era of experimental monetary policy attempted globally for the first time in history. After conducting their experiment of adding liquidity to ward off the greatest financial crisis since the Great Depression central bankers have now begun to drain liquidity and lift interest rates.

Prices of bonds and stocks continue to advance further away from median historical valuations. That tells us that there is too much money in the system and it needs to be drained. The Fed and BIS (Bank of International Settlements) see that too and are anxious to drain or, at the very least, stop adding liquidity. That tipping point of global central bank balance sheets draining liquidity instead of adding may happen sometime in the summer of 2018 if markets allow.

Central bankers have never attempted this before and will now, in the next six months, begin to attempt the most difficult part of their act. In the face of this never before attempted trick by central bankers we find investors are taking on even more risk.  Are investors waiting to see who runs for the door first in an elaborate game of chicken? “Prices are still rising. I can’t sell. I will miss out. I will get out before the other guy.” It will be a small door when the music stops. It’s like the boiled frog. A frog will jump out of a hot pot but put him in a cool pot that slowly boils he won’t perceive the danger until it’s too late. Investors are the frog as central banks slowly raise interest rates and drain liquidity. They won’t know what hit them. Note the following quotes (courtesy of ZeroHedge) from Jerome Powell, the newly appointed Chair of the FOMC, from the FOMC Minutes in October of 2012.

[W]hen it is time for us (the Federal Reserve)to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. – Jerome Powell FOMC Committee Minutes October 2012

 

Moral Hazard

I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. – Jerome Powell FOMC Chair FOMC Minutes Oct 2012

Since the election of Donald Trump in November of 2016 we have postulated that we were on the precipice of a melt up in stocks. Since that time we have seen the S&P 500 rally by over 28%. It was not the election of Trump that led to that thought process it was an amalgamation of set points that had come together at that instant to provide the fuel for the rally. The election released the Animal Spirits of the market. We felt that investors would be spurred by the idea that deregulation, tax reform and infrastructure spending would lead an economy, which was primed and ready, to go to greater heights. But most importantly, the groundwork for this rally was put into place prior to the election by the members of the FOMC. What the FOMC had put into place was similar to kindling and gasoline looking for a spark and that spark arrived in the form of tax reform and deregulation.

The above quote from Powell deserves to be read again. By engineering QE, the FOMC took steps to actually encourage risk taking and, with that, the FOMC had created a moral hazard. Moral hazard is the idea that investors could and should count on the Federal Reserve to effectively bail them out if things went wrong. Investors have been trained to think that if there is a significant selloff in the market then the Fed will add liquidity. Perhaps even begin a new round of QE if the selloff is bad enough. That leads investors to think Why Sell? No one sells. The market just heads higher. People have adjusted to the new paradigm. Whenever the market gets in trouble the Fed bails it out. 1987. 1998. 2001. 2007. 2011.2012. 2015. That has investors asking “Why EVER Sell”?

The moral hazard of the Fed gave rise to what became known as The Greenspan Put. The put was the level in the market, which if the market ever fell to, the Federal Reserve would ride to the rescue, add liquidity and save markets from themselves. The Federal Reserve gave no reason for investors NOT to take on risk and substantial risk at that.

Another factor in the rise of animal spirits has been the parabolic rise in the price of bitcoin and the mania surrounding it. It has helped drive investors to an extreme in bullishness anticipating future investing profits. Now, bullishness in itself is not bad and, in fact, an extreme level of bullishness can portend further gains but we do believe that it sets markets up for difficult comparisons. Most major tops and bottoms in the market in recent years have what is seen as a negative divergence in its level of Relative Strength (RSI). We are currently seeing extreme levels of RSI in the broader market. Having hit this level of extreme bullishness we should see some sort of selloff or just a breather in markets rise. Having had that breather when we approach these levels again comparisons become very difficult. If those levels of bullishness do not hit prior levels investors may see that as a negative divergence and begin to take off risk. Bitcoin’s parabolic rise is a sign of mania in markets and caution should be paid. The FOMO Fear of Missing Out has investors, perhaps, getting in a little over their heads.

Giddy Up and Getting Giddy

We learn far more when we listen than when we talk so when smart people talk we listen. David Swenson is the Chief Investment Officer of the Yale Endowment. He is seen as the Michael Jordan of endowment investing. We have rarely seen interviews of him but we came across this one in November of last year at the Council on Foreign Relations. He was interviewed by Robert Rubin the former US Treasury Secretary and CEO of Goldman Sachs. My take on “uncorrelated assets” is that a good portion of what he is talking about is cash or cash like instruments that do not move with the stock market.

RUBIN: Did I hear you say that you have 32 percent now in uncorrelated assets?

SWENSEN: That’s correct.

RUBIN: More than you had in ’08, when we were in recession?

SWENSEN: Slightly more, yeah.

RUBIN: Do you think we’re in recession, or what scares you that you really want to have a recession-level of cash?

SWENSEN: Yeah. So I’m not worried about the economy so much. I have no idea what economic performance is going to be over the next five or 10 years. What I’m concerned about is valuation. I think when you look at pretty much any asset class anywhere in the world, it feels expensive. And the handful of areas that I talked about where I thought there were opportunities are kind of niche-y—short-selling, Japan, I think there’s some opportunities in China and India, although it’s hard to call either of those markets screamingly cheap either. So it’s really a question of valuation, not a question of economic fundamentals.

For now we ride markets higher. We ride them higher with lower equity exposure and lower durations but ride them we must as our clients need a return on their assets to provide for current and future liabilities.  But we grow in caution as giddy investors confidence grows with their account balances. We are concerned because valuations are historically high because interest rates are historically low. If we believe that asset valuations are a derivative of the risk free interest rate then shouldn’t valuations be falling as interest rates are rising? Or, perhaps, valuations will just drop off a cliff when interest rates hit some theoretical number? Will it be 3% on the 10 year? 4%? 5%? No one knows this theoretical number so is it not prudent to scale back your risk allocation given that higher interest rates are on the way? The frog is in the pot. The water is getting warmer. You cannot plan to get out before everyone else. We recalibrate our risk perspective. The trick is that human nature has us chasing higher and higher equity prices because we have fear of missing out.

The market is a massive naval ship running full steam ahead. It doesn’t stop on a dime. The markets could continue to rage. We recalibrate and adjust our asset allocations because when turning points come they will come quickly and seemingly come out of the blue. The Fed cannot react to every market twitch and if they are truly dedicated to reducing their balance sheet then they will have to raise their pain threshold and that makes the Fed Put lower (and more painful) in terms of the level of the S&P 500. For now we recalibrate, accept slightly lower rates of return and brace for a shock with non correlated assets as our cushion.

We continue to believe that central bank purchases will dictate asset pricing and while we can try and predict when asset flows will turn negative we cannot predict when markets will react to that reversal in flow. For now buy the dip still reigns while volatility selling strategies are de rigueur. In a self reinforcing loop the current paradigm reflects an assumption of the continuance of the status quo and trades built upon that will grow ever higher in AUM. That will make the break all the more painful and swift.

 What’s Next?

In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”– Rudiger Dornbusch

Since November of 2016 we have postulated that we were on the verge of an animal spirits led melt up and we projected that much like 1987 we would see a 30-35% rally in markets before a letdown in prices. We may have underestimated the animal spirits. A strong 2017 followed by a strong start to 2018 could lead to further gains. We may also have underestimated current market structure as it may be causing markets to have longer, less volatile regimes and that regime change may become less and less frequent.

We feel that while we are in the late stages of a bull market it is best to pull back on risk and while late stages of bull markets can see spectacular returns we nor anyone else knows when that comes to an end. So for now we are in it to win it but just a little less in.

2018 has come in like a lion. We think that a correction in 2018 is likely and how the Federal Reserve responds to that correction is likely to determine how long and how deep that correction is. Tax reform is priced in and economic news has been positive. While those positives are now baked in the cake disappointing actual results from tax reform could impact pricing. Also, impact could be felt from rising bond yields as investors seek safe haven in bonds over stocks. This week the rate on the 2 year bill rose above that of the S&P 500 yield for the first time since 2008. Investors may begin to see bonds as an alternative to equities. If a correction should come we would expect it to be sharp and scary but will set equities up for another leg higher in 2019 and beyond.  We believe it is prudent to be a bit more conservatively positioned this late in the cycle and expect lower returns in order to be prepared to profit from others panic and flawed market structure.

As investors, our job is NOT making the case for why markets will go up. Making the case for why markets will rise is a pointless endeavor because we are already invested. If the markets rise, terrific. We all made money, and we are the better for it. However, that is not our job. Our job, is to analyze, understand, measure, and prepare for what will reduce the value of our invested capital. –Lance Roberts

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein CEO of Goldman Sachs

 Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks…During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.Warren Buffett

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BitCoin

Be greedy when others are fearful and fearful when others are greedy. – Warren Buffett

The most important aspect of investing to master is the psychology of investing. If one is not aware of one’s emotions surrounding money and gains and losses one can never master the art of investing. The parabolic price rise and constant chatter surrounding the rise of bitcoin has all of the hallmarks of a mania. The bitcoin mania has pundits and media types all aflutter. That emotion works its way into mainstream investing.

We are seeing very large money flows into the market as investors see the big returns of bitcoin and want some for themselves. That reminds us of another Warren Buffett quote. “What the wise man does in the beginning the fool does in the end.” According to CNBC, ETF inflows had their second biggest week in history. We believe that the parabolic rise in the price of bitcoin and the mania surrounding it has driven investors to an extreme in bullishness. That has led to the S&P 500 becoming overbought (According to its RSI) to a level not seen since 1995. Investors are plowing money into stocks excited by bitcoin’s parabolic rise. The FOMO Fear of Missing Out has investors, perhaps, getting in a little over their heads.

For months we have mentioned the idea that the market could stall at the 2666 level on the S&P 500. We made mention of the fact that 2666 is just about 4 times the bottom print in March of 2009 of 666 on the S&P 500. Also, our thesis included that this number, and its biblical significance, would play a part in Wall Street traders psychology and in Quantitative Funds computer programs. For those of you who thought we were nuts, by way of Zero Hedge, comes a chart which shows that the market has struggled with multiples of 666 since March of 2009. The S&P 500 when hitting 2x and 3x the low of 666 has spent the next 18-24 months in a consolidation pattern. Signposts like this along the way are good spots for investors to take a respite and reflect on how far we have come and whether the trend should continue. 2018 may be a Year of Reflection.

4x 666 S&P 500

 

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Less In

One of our favorite bulls is changing his tone this week as Jim Paulsen of the Leuthold Group seems to be pouring a little cold water on this rally. In his piece titled “No More Juice” Paulsen, a long time bull, says investors should be prepared as central bankers try to wean markets off of the juice (QE). Paulsen has been spot on for years with the market rally since 2008 and when he speaks we listen. We agree with Paulsen and we do not see a market collapse but there is a need to constantly reevaluate and recalibrate where our investment money needs to be in this market.

“As financial markets are weaned off the juice they have been drinking for almost a decade, investors should prepare for a very different bull market in the balance of this recovery,” he said. “Without a chronic injection of financial liquidity, the stock market may struggle more frequently, overall returns are likely to be far lower, and bond yields may customarily rise.”

To be sure, Paulsen is not predicting a market collapse. Instead, he suggests investors will need to shift strategy away from the cyclical U.S.-centric approach that has worked for most of the past 8½ years, due to the likely contraction of money supply compared to nominal GDP growth.

That means value over growth stocks, international over domestic, and inflationary sectors, like energy, materials and industrials, over disinflationary groups like telecom and utilities.

It is our job not to predict but to contingency plan. In order to do that we look to the horizon for what could trip up our investing plans or to find what investments may benefit from changes in the environment. One of biggest worries is China. The yield curve continues to invert in China. For those of you that are new to our blog an inverted yield curve is a sign that a recession may be approaching. A recession in China would have reverberations worldwide. According to FT, Chinese debt has grown from $6T at the beginning of the crisis in 2007 to over $29T today. The government there continues to want reform but needs to proceed with caution to avoid creating a crisis. The Chinese central bank added more reserves to their system this week in one of its biggest injections of 2017 and that helped soothe markets – for now.

In another sign of the imbalances created by central banks and QE it still boggles our minds that European High Yield has less of a yield attached to it than 10 Year US Treasuries. If we have a bubble then it is certainly there. In yet another great piece by John Mauldin, in his Thoughts from the Frontline, he notes the preponderance of negative yielding government bonds. Can you believe that Italy and Spain have short term negative yielding debt? Who would want to own debt from Italy and Spain at negative yields?!  Mauldin also points to Louis Gave and their research suggesting a currency peg could cause a waterfall of problems and they are pointing to Lebanon. It is a very interesting piece. If you don’t get John’s Thoughts From the Frontline, then sign up, it is free.

Market internals continue to deteriorate and that is especially important in light of historically high valuations. The market has entered what seems to be a new pattern of opening lower and rallying back throughout the day. The S&P 500 is up 12 months in a row and has only experienced pullbacks of less than 3% in 2017. The daily range in stocks is the lowest it has been since the 1960’s. The yield curve here in the US is the flattest it has been since 2007 and the curve in China is inverted. Trees cannot grow to the sky and what cannot continue – won’t.  Volatility will return it is only a matter of when. We see the relative strength on the S&P 500 reaching historically overbought levels. When the S&P reaches this level it makes the comparisons very tough. A pullback is warranted in the S&P and when it does the next rally will not be able to surpass these overbought levels. At that time investors will see it as a negative divergence. That is when the market may begin to struggle.

We continue to fret about risk parity and volatility selling. When stocks go down we will look at bond prices. At some point they will both go down in tandem and selling will beget selling. If there is a meltdown, we believe that is where it where we will see it start.

The Warren Buffet of endowment investing is David Swenson from Yale. We were able to watch an hour long interview with the investing legend and have included a link. The interview of Mr. Swenson is from a meeting of the Council on Foreign Relations conducted by former Treasury Secretary Robert Rubin. Here is the money quote.

But when you start out, you were talking about fundamental risks in this world. And when you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling, and makes me wonder if we’re not setting ourselves up for an ’87 or a ’98, or a 2008-2009. David Swenson Chief Investment Officer Yale University

So much to say and so little space this week. Obviously, we are a bit concerned that the rally is a little long in the tooth and investors may have lost respect for the power of markets amid market’s seeming invincibility. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less and a little less in. Tax reform passage could be a sell on the news event and we are, warily, watching the turn of the calendar.  Happy Thanksgiving everyone!! No blog next week as we will be still filling up on leftovers.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

 

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Red Flag Warning

Just days after our latest blog post, Bump in The Silk Road, some very interesting comments from central bank governor Zhou Xiaochuan were posted on the central bank’s website. Here is a snippet from Bloomberg.

Latent risks are accumulating, including some that are “hidden, complex, sudden, contagious and hazardous,” even as the overall health of the financial system remains good.

 “High leverage is the ultimate origin of macro financial vulnerability,” wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure. “In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.”

 The latest in a string of pro-deleveraging rhetoric from the PBOC, Zhou’s comments were speculated to have contributed to a rout in Hong Kong shares. They signal policy makers remain committed to the campaign to reduce borrowing levels across China’s economy. Concern that regulators may intensify this drive after last month’s twice-a-decade Communist Party congress helped push yields on 10-year sovereign bonds to a three-year high. 

https://www.bloomberg.com/news/articles/2017-11-04/china-s-zhou-warns-on-mounting-financial-risk-in-rare-commentary

You can feel the pressure building in Washington DC. Republicans are scrambling and their candidate in the Alabama Senate race is in hot water. A loss to the Democrats in the Senate could make passing legislation that much more difficult. That could force Republicans to negotiate more aggressively with the Democrats if they want their tax bill passed. Complicating matters, the government’s current funding agreement expires Dec. 8. While the last agreement just punted to December the next agreement will have a lot more on the line. Also, members of Congress could be distracted by anger emanating from their constituents surrounding health insurance. The window just opened 10 days ago for 2018 and the increases are outrageous. We are hearing it from contacts looking for advice on how to proceed. The open enrollment period ends December 15th. 16 days earlier than last year. The pressure is building. It is going to be an interesting December.

The market seems a bit on edge as everybody knows it can’t just go higher EVERY day. The S&P had its first down week in 8 weeks and even BitCoin went down! Japan was up 23 out of the last 25 days. It broke. Whether the machines broke or investors broke is the question. Investor’s answer was to sell first and ask questions later. It just shows how on edge investors are with the market seemingly up every day everywhere.

We told you things can get weird when the President is out of the country. Saudi Arabia didn’t waste any time announcing their purge. That got oil and oil related stocks hopping. West Texas is at prices it has not seen in 2 years as oil remains in the mid $50 a barrel range with $60 in its sights. High yield bonds have seen huge outflows and that is a red flag warning sign for stocks. The ten year yield bounced higher late in the week to get back to the 2.4% level. The red flag there is its performance in the post Japan mini melt down. Yields jumped higher. Logically, you would think that yields would head lower in a flight to safety. Instead, it appears to be a flight to deleveraging. It is sign that there is too much risk and leverage in the system. If yields and stocks go down together that will be a problem as risk parity funds as they will be forced to cash in some bets. If there is a meltdown that is where it where we will see it start. That boat, that includes the volatility selling crew, is just too crowded.

There are rumors of more indictments when Trump gets back into town. Political uncertainty, rumors of the Saudi king abdicating over the weekend, Japanese flash crashes, and the tax cut bill seems to be DOA for now.  S&P 500 is exhibiting signs of slowing its ascent as the rally is showing some cracks. The bulls could use a time out. The animal spirits are unpredictable and still in control. Gotta be in it to win it but, maybe just a little less in.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Fear and Greed

While most of America seemed to be mired in statue controversies and rumored and real resignations we choose to focus on making money for our clients. Our focus was on the FOMC Minutes that came out this week. We think that it has real clues as to policy and market direction (i.e. making money). Here, as follows, is the garbled Fed Speak hidden deep in the minutes which we will interpret for you.

This overall assessment incorporated the staff’s judgment that, since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets…

 recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.

 According to one view, the easing of financial conditions meant that the economic effects of the Committee’s actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.

We interpret the committee’s thoughts as, while the committee likes higher stock prices, a further rise in stocks isn’t going to help much. In fact, higher stock prices may actually increase risk. No one seems to be noticing that risk is elevated and hedging accordingly which only heightens risk even further. And by the way, our (the FOMC) tighter policies (raising rates) haven’t really done much and we are going to need to tighten policy much more than we thought. Was that a warning shot across the bow? The Fed doesn’t want stocks to go up much more and tighter policy is coming.

As always, from Arthur Cashin and his sources, comes a very interesting note about the technical aspects of the market. We study technicals because it gives us insight to the psychology of the market. The numbers show where Fear and Greed reside. After Jason’s note came out earlier this week markets were repelled by the 2475 area and fell 2% from that level. Here is Jason’s note.

While they closed within hailing distance of the day’s highs, the session had some very odd aspects. Here’s what the sharp-eyed Jason Goepfert of SentimenTrader noted in his report. More lows. Despite a 1% surge in the S&P 500, its best gain in months, and being within sight of an all-time high, there were more combined new 52-week lows than 52-week highs on the NYSE and Nasdaq exchanges. This is highly abnormal. Since 1965, it has only been seen a handful of days in 1998, 1999, 2000, and 2015 -Cashin’s Comments 8/15/17

NY Federal Reserve President Dudley sees chances of a Fed rate hike higher than the market is currently forecasting in December. Chances for that rate hike are now close to 50% and rising. The market continues to reject the 2475 area on the S&P 500. As a resistance area it is growing in its importance. The bulls still have the ball but they need to get their act together.

The S&P 500 is at its 100 Day Moving Average (DMA) and the 2420-2400 area is support for now. The next support is the 200 DMA at 2350 which is down about 3% from here. If markets fell to that level that would be a 5.5% drop from the all time highs, certainly, not a major crisis. However, the bulls would need to hold the 2350 or then the bears are in charge. The S&P 500 is 2.5% from its highs while the Russell 2000 is down more than 6%. The broader market indicator failed to hold its 200 DMA this week. Not a healthy sign. Always have some dry powder on hand.

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I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

 

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

 

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

 

 

 

The Great Escape

It is a 10 year anniversary for us this week. This week marks 10 years since our move to Georgia. It also marks the 10th anniversary of the dawn of the financial crisis. Not a coincidence I assure you. Having traded through the Internet Bubble and watched Lucent Technologies, which was that bubbles’ “Darling” stock, trade from $79 to 79 cents we knew the real estate market would have also have to get as bad as it was good. And in 2006 -07 it was very good. We foresaw the real estate crisis and sold our house in New Jersey for an exorbitant price which according to Zillow it still has not climbed back to. As a side note, Lucent never got back to $79 either. We say this not to brag but as an investment lesson learned well. Trees do not grow to the sky. Know when to cut back on your risk.

Not much is being made of the 10th Anniversary of the Great Financial Crisis (GFC) but there has been a lot of consternation surrounding the Federal Reserve’s most recent decision and path going forward. If we have established that the growth in central bank balance sheets around the world has been responsible for the run up in asset prices it stands to reason that any shrinking of those balance sheets would diminish asset prices. Here is another timeless lesson of investing. Never fight the Fed. While the Fed has spent the last 10 years injecting liquidity into the system to pump up asset prices it is now talking about taking liquidity out – Quantitative Tightening (QT). Ironically, during our time on Wall Street the phrase QT was a questionable trade, an error that needed to be resolved and it usually cost you money. The question facing us now is the Federal Reserve making a questionable trade and will it cost you money?

The economy is growing, albeit slowing. That is due to the immense amount of debt on the United States balance sheet. This slow growth is now being met by a central bank that seeks to raise rates and shrink its own balance sheet. Now instead of a tailwind, the economy and markets are looking at a headwind. As we have written in prior posts, the Federal Reserve could have been acting since December with the impulse that more stimulative fiscal policy was going to come out of Washington, in the post election period. The new administration Trumpeted the advent of a new era with tax reform and deregulation at its forefront. The Fed sought to get ahead of the curve by applying tighter money policy. Well, Washington is at a standstill and has provided none of the above.

Is the Federal Reserve making the ultimate central banker mistake? Are they tightening into a slowdown? The bond market seems to think so. The yield curve is flattening which indicates that bond investors do not see inflation on the horizon and see subpar growth in the economy. Yet the stock market keeps chugging along. Who is right? Generally, we always go with the bond market.  We believe that the Fed is tightening due to financial conditions and not economic conditions. That is what the stock market is missing. As long as the market expects the Fed to stop tightening because of slowing economic conditions then the market will continue to rally and the Fed will continue raising rates. Someone is going to blink first.

We think that the animal spirits playbook is still alive. Markets have not broken down and still seem to be headed higher. Higher markets may force investors to chase it even higher.

The Federal Reserve’s thinking has two main problems. One is that the Fed believes in stock and not flow which means that the Fed believes a big balance sheet helps the market. We believe it is the flow that determines the direction of markets. Flow is the direction in which the Fed and policy are headed. The Fed also believes that the market will discount their talking points as they move towards QT. We believe that the market will change when the flow changes.

Oil continues to get pounded as it is down 20% from March highs even though things in the Middle East heat up. Oil may try to find a bottom here as oil production will slow below $40 a barrel, at least here in the US. Biotech has had a great week as investors rotate there as the pressure from Washington on that sector seems to have ebbed. Equities are still in the middle of what we anticipate to be the new range on the S&P 500. For now we see support at 2400 on the S&P 500 with 2475 providing resistance. Interest rates may have seen their interim low for awhile.

If you are not currently receiving our blog by email you can sign up for free at https://terencereilly.wordpress.com/ .

I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

You’ve Got Mail

Just when I thought I was out. They pull me back in.

 – Michael Corleone Godfather III

Was it Michael Corleone or James Comey Director of the FBI? Comey has to be thinking the same as the Godfather as Anthony Weiner’s emails have pulled Comey back into the Clinton investigation and thrown the election and markets for a loop. The S&P 500 was holding support above the 2130 level that we spoke of last week until the explosive news of a reopening of the Clinton email investigation hit the tape on Friday. Markets closed under 2130 for the second time triggering Jeffrey Gundlach’s warning. Monday is going to be a very important day for the short term direction of the market.

Mega mergers are not typically seen as very good for markets. In fact they usually serve as a warning post and signs of a potential top. We were served up with the news of three merger/takeovers last Monday morning. The largest being the ATT Time Warner deal. The AOL Time Warner deal served as the warning bell at the top of the 2000 bull market and the subsequent tech crash. When large companies have squeezed the last drop of growth out of their companies and the business cycle is near the top the playbook calls for buying growth. At the end of the business cycle the only thing left to do is acquire the growth that is not obtainable organically. ATT has recently seen a slowdown in the growth of subscribers. Is this the Hail Mary Pass for ATT? The AOL Time Warner merger is now studied in business classes as the classic failed mega merger. How will history see the ATT Time Warner merger? Better we suspect but sometimes they do ring bells at the top.

As far as the technicals go the 50 Day Moving Average (DMA) on the S&P 500 is now declining. Also, the last two weeks have seen market swoons instead of rallies at the end of the market day. Both serve as warning signs for a tired market. We are entering, which is historically, the best part of the year for stocks. The election and the Federal Reserve may have something to say about that. We are now staring at an election in chaos and a Federal Reserve committee meeting in December where they have all but promised the market that they will raise rates. Will they still raise rates if Trump wins and markets swoon? 2130 is being tested. Pass or fail?

The S&P 500 has now closed below its 100 day moving average for the third straight week. If 2130 fails then the next real level of support is the always critical 200 day moving average at 2078 on the S&P 500.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Heavyweights

Two heavyweight investors took to the airwaves this week to give their views on current markets and Federal Reserve actions. David Tepper who manages Appaloosa Management and is one of the more successful hedge fund managers noted that he is “pretty light in the market and we have a lot of cash”. He is “pretty cautious “on the market right now and he points towards the election for that caution. He feels that if the election provides a shock to the market it could put the Fed on hold. If the market is not shocked by the election we could get a relief rally. It appears that he, like everyone else, is looking for fiscal spending to ramp up.

If the market goes down because of the election, Tepper said the Federal will also be less likely to raise its benchmark federal funds rate. But if the market holds at current levels, Tepper said the central bank will likely raise rates because the economy is “at a point where they should raise rates.”

“But if you do get some sort of mixed government or something that’s near what’s going on right now … then you’ll get some relief after this election’s over. I think they have to anticipate business investment going up, especially if you have more or less of a status quo economically,” Tepper said. This would include the Republicans retaining their control over the House, he added.

http://www.cnbc.com/2016/10/17/billionaire-david-tepper-im-generally-pretty-cautious-on-the-market.html

Jeffrey Gundlach was the other heavyweight investor to weigh in this week. Gundlach manages over $100 billion at DoubleLine Capital and we find him to be the single most valuable investment opinion to follow. He has given some prescient guidance since the crisis of 2009 and we have invested with great confidence in Double Line. While Gundlach is mainly known for his bond acumen he also espouses his views on equities. He gave an interview this week noting a critical support level of 2130 on the S&P 500. We closed below that level on Monday of this week. According to Gundlach, we need a second close below it to confirm more downside to the market.

Wiki leaks continue to drip. Denial of service attacks on the East Coast put a slight chill into markets. Pressure continues to build. The S&P 500 has now closed below its 100 day moving average for the second straight week. The next real level of support is the always critical 200 day moving average at 2070 on the S&P 500. Keep an eye on 2130.

Is this long national nightmare over yet? Vote early and vote often.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

 

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

 

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.

Yellen – More Punch Anyone?

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens”.– John Maynard Keynes

Central bankers have an obsession with inflation. Inflation is the central banker’s temperature gauge for the economy. Inflation above a certain level is too hot and deflation is way too cold. The natural question is at what level is inflation too hot? Currently, the US Federal Reserve thinks that above 2% is too hot, so 2% is their target.

On Friday, in a speech in Boston, Janet Yellen, Chairperson of the Federal Reserve, stated that it might be wise to consider the upside of a “high pressure economy”. While the FOMC has targeted a 2% inflation rate it appears that they are preparing us to accept a higher than normal inflation rate in order to “heal” the economy. One is very quickly reminded of the Weimar Republic. Prophetically, our good friend Arthur Cashin from the NYSE had this to say in his blog this week.

Originally, on this day in 1922, the German Central Bank and the German Treasury took an inevitable step in a process which had begun with their previous effort to “jump start” a stagnant economy. Many months earlier they had decided that what was needed was easier money. Their initial efforts brought little response. So, using the governmental “more is better” theory they simply created more and more money.

In 1920, a loaf of bread soared to $1.20, and then in 1921 it hit $1.35. By the middle of 1922 it was $3.50. At the start of 1923 it rocketed to $700 a loaf. Five months later a loaf went for $1200. By September it was $2 million. A month later it was $670 million (wide spread rioting broke out). The next month it hit $3 billion. By mid-month it was $100 billion. Then it all collapsed.

By October of 1923 German citizens were burning cash instead of wood for heat. It was easier to get and less expensive.

In a normal environment it has been said that it is the Federal Reserve’s job to take away the punchbowl just as the party has started. On Friday, it appeared that Yellen not only doesn’t want the party to end she wants to spike the punchbowl.

We do not believe that the November meeting of the FOMC is live and that they will not raise interest rates at that time. Not days before a Presidential election. Traders are betting that there is a 65% chance that they raise rates at the December meeting. If they raise rates in December it could make for another rocky start to the New Year.

One of the most astute investors that we know is a long time friend who pops in on us time to time. He is a very patient investor and quite prescient in his market calls. He called us out of the blue this week. He senses caution and is taking money off of the table. When he speaks we pay heed.

Technical analysis, while voodoo for some, is a way of quantifying the current state of market psychology. The market has been forming what is called a wedge. A wedge is a state of an increasingly tighter price range. This tells us that the market has been forming pressure much like a volcano or earthquake fault line. The market may have broken out of that range this week. The market has been below its 100 day moving average for the last two weeks. What was once support for the market is now resistance. The next real level of support is the always critical 200 day moving average at 2070 on the S&P 500. That is about 3% lower from the close of 2133 on Friday. The market is currently up 4.6% Year to Date (YTD). Investors, and professionals who looking to keep their bonus checks, could get very anxious if this year’s gains are put at risk in an October swoon. Keep an eye on 2070.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.