Chill in the Air

God, I love Fall. There is a Chill in the air, college football on television and the stock market gets really interesting. A chill wind blew through the markets this week. If you read our Quarterly Letter last week you know that we said that the selloff could come at any moment and come quickly. We will file that under the blind squirrel theory. We are not saying that we predicted it. No one can predict the market but what we were saying is that all of the elements were there for a sharp selloff. We didn’t know which grain of sand would cause the avalanche but we knew that we were due.

Having said that, we are now sitting in what appears to be a very large trading range on the S&P 500 of 2600-2850. 2600 was support back in early 2018 and we may get a chance to revisit that level. On Friday we closed right on the all important 200 Day Moving Average (DMA). Why is the 200 DMA important? Many investors base their bull/bear debate on where we are in reference to the 200 DMA.  A sustained break below the 200 DMA could bring further selling pressure on stocks. The 200 DMA has become even more important in recent years as the quants have taken over. These markets are now controlled by computers and those computers are programmed by math guys. Things like standard deviations and moving averages make up the major building blocks of those lines of computer code. A break below the 200 DMA could produce more selling. It’s just math.

We came within 44 points on the S&P from 2666. If you remember our previous writings we have written a bit on the levels that the S&P has struggled at 2x, 3x and now 4x the low of 666 in 2009. 4x 666 is 2664. We have typically spent 9-18 months struggling at those levels. Is the market still digesting 2666 (Level 4x)? If so, we are in month 11. Read it here.

Right now the pundits are saying that there is a complete disconnect between what the stock market is doing and what the economy is doing. They are correct. The economy is flying on deregulation, tax cuts and fiscal stimulus so the Fed is raising rates and tightening policy. That’s the way it works. They are taking away the punch bowl as the party is getting a little too rowdy. The Fed knows it needs to raise rates and shrink its balance sheet so that it has some weapons to combat the next crisis. What we need to know is how much pain is the Fed willing to endure as asset markets re-price in the new landscape? We would have to say that, given the lack of commentary this week from the Fed on that subject, the line in the sand at which they will defend the stock market is lower than here.

This is probably the most important chart on Wall Street right now. This is where the S&P should be priced based on the world’s central bank balance sheets. The chart seems to be telling us that the S&P 500 should be a bit lower at 2500. As the world’s central bank balance sheets are reduced so will the S&P 500 reduce.

Global Central Bank Balance Sheet Oct 2018

I could go into so many reasons for last week’s 4% drop in the markets. At the end of the day it doesn’t matter. What matters is where are we going next and how to profit? We think that we have entered a very large trading range between 2600-2850. Markets are short term oversold and due for a bounce but there seems to be a reluctance on the part of investors to jump in here. Markets are still sporting sky high valuations and the bulls will want to see new highs before committing more capital. Keep your wallet on your hip and look both ways. We could see a bounce but I think that investors will be raising cash. We could give back 20% and still only be back to where we were in mid 2017.

 

 

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.

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Alchemy – Bulls into Bears

So  much to say and so little space. I guess a chunk will have to wait for my quarterly letter next month.

Bulls into Bears

Some of the most visible market pundits that I term as permanent bulls have turned bearish of late. In fact, in my almost 30 years of doing this, these are people that I have never seen anywhere remotely close to bearish – so this is news. Perhaps it just has to do with how late we are in the cycle but I couldn’t help but notice. Prof. Jeremy Siegal, Abby Joseph Cohen, Leon Cooperman and now Ben Bernanke have all turned bearish in the last few weeks and they all seem to be pointing to how difficult 2019 is going to be. To us, that means, the trouble could start as early as July of 2018 in anticipation of a tough 2019. 

From Jeremy Siegal 

Caution is going to be the word here. 

This is a great year for earnings, no one argues with that. But the tax cut is front-loaded which means that the write-offs on capital equipment are going to accrue to 2018 and not nearly as much in 2019. 

The major threat of the market is higher interest rates going forward. Too many people read the FOMC minutes as being too dovish. –Prof. Jeremy Siegal

From Leon Cooperman

I would be a reducer on strength, not a buyer on strength. I think the market is adequately valued.

I’m sympathetic to the idea that sometime in the next 12 to 24 months, there will be events that will catch the market. In other words, … I think that inflation and interest rates will catch up to the market as we normalize. –Leon Cooperman  Omega Advisors

From the Did He Really Say That Dept?

The stimulus “is going to hit the economy in a big way this year and next year, and then in 2020 Wile E. Coyote is going to go off the cliff,”
– Ben Bernanke,  former Fed Chairman, June 7

 While not a perma-bull the most direct and information laden warning came from the largest hedge fund in the world – Bridgewater Associates.

2019 is setting up to be a dangerous year, as the fiscal stimulus rolls off while the impact of the Fed’s tightening will be peaking. 

We are bearish on financial assets as the US economy progresses toward the late cycle, liquidity has been removed, and the markets are pricing in a continuation of recent conditions despite the changing backdrop. ­- Daily Observations  co-CIO Greg Jensen Bridgewater Associates

The Fed is pulling back on liquidity as it is the right thing to do, however, there are many that don’t share that view. In particular, emerging markets that are beginning to submerge from Argentina to Turkey to Brazil and the ripples across the pond are becoming waves. Those waves will eventually hit these shores and the Fed will have to slow its tightening cycle. There are no problems only opportunities. We are loath to enter emerging markets but see commodities as a place to hide as inflation rears its ugly head as a handcuffed Fed is forced to slow rate hikes by Congress and external international pressure. We are already starting to see wage pressures in trucking and the oil patch. Markets are pricing in a goldilocks scenario that is ever elusive and fleeting. Change is the only constant.

We are also more bullish on the US than Europe. We are currently seeing Europe’s economy slow down while the US speeds up. Why? The US and Europe both have QE and are buying assets in the real market. The difference is interest rates. The US is raising interest rates which is creating demand. People are saying hey interest rates are going up I better, fill in the blank, buy that house, that car, or build that factory. Jobs are getting more plentiful. People can get raises, get better jobs, move, spend money. Europe is not raising rates and therefore there is no impetus or motivation for people to spend. Spending leads to more jobs with healthier pay which leads to people moving for better jobs which creates jobs and more spending. You get the picture.

QE is the kindling. Interest rates are the match. Europe just keeps pouring more gas on the fire without lighting the match. It took the US several tries before the market and economy gained confidence and then believed the Fed would continue to raise interest rates. Trump’s fiscal and tax polices helped give the Fed cover and made its story more believable. Europe needs the same. Light the match. Having said this, the fire will only burn so long. What comes next? Commodity prices will rise along with inflation here in the US. The Fed will try to continue to raise rates but the question remains will they end up behind the curve while feeding inflation? We think they will.

The market can continue to chug along to higher prices but that will become more difficult as we head into 2019 with less fiscal/tax stimulus and more QT around the world. To be sure, Cooperman cautioned that while trouble could be ahead for late next year, he isn’t ready to head to the exits just yet, saying “the conditions normally associated with a big decline are not yet present.” We agree.

Small caps continue to lead while the trade wars stay on the front burner. Keep an eye on the banks. Markets won’t get far without them. You’ll find us in the commodity space. You won’t find us in emerging markets. That’s where the trouble will surface.

We have been telling you to keep an eye on Bitcoin. It bounced slightly this week to close on Friday at $7660.66. It still has our attention. $6777 is important support for bitcoin.

The S&P closed the week at 2779 or up about 1.6% but still near our fulcrum of 2666. 2800 is resistance. Small caps and the Russell are holding their recent new highs but look a bit overbought and could use a rest. We are headed to NY/NJ to see clients and had considered taking the whole week out of the office. We think that is sufficient to confuse the trading gods and expect next week to be an active one. Whenever we are out of the office the trading gods seem to knock the hell out of the market. Next week is a busy one with summits and central bankers galore. Keep your helmets on. The bulls are still in charge and looking for a knockout punch.

pexels-photo-722664.jpeg

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.

Housing On Fire – Again

The housing market is absolutely on fire of late. We are hearing tales of bidding wars again. What short memories we have. We had an interesting conversation with some in the core housing supply chains. Their tales are more of woes surrounding supply rationing and trucker shortages. Inflation here we come. The real story is about interest rates and their effect on markets at home and abroad. We have long surmised that it was absurdly low interest rates that were holding back the economy. Our thought process is that with 0% interest rates there is no rush to go out and buy that house, that car or build that factory. Rates are low and will be for some time. Well, now the rush is on to make moves before interest rates run even higher and inflation is entering from stage left. The ironic part is that if the Federal Reserve raises rates further it may push the economy further into overdrive.

If one oversteps the bounds of moderation, the greatest pleasures cease to please. – Epictetus

For a more in depth analysis of where rates may be headed check out this blog post from our friends over at Global Macro Monitor.

As I said, it is all about interest rates. Here is what David Tepper, hedge fund legend and now owner of the Carolina Panthers (who bought the team for a mere $2.2 billion) had to say on about interest rates and the stock market earlier this month.

… a lot of it has to do with interest rates. We’re right on the cusp of breaking out on interest rates at this level around 3%. (the 10 Year closed the week at 3.06%)…But a lot of people don’t think they’re going to break higher – most people are only saying they’re only going to 3.25%. And I think if they only go to 3.25% for the rest of the year then stocks might be up. But too many people are saying that. And when too many people are saying one thing that’s when I start to get worried. So if we break above that, then stocks might have a problem.- David Tepper Appaloosa Management

Now we must deal with the unintended consequences of zero percent interest rates and the unwinding of QE. Because interest rates are headed higher so is the US Dollar. That is having a chilling effect on emerging markets. The iShares Emerging Market ETF is now trading below its 200 DMA and looks like it may be headed for a fall. I remember 1997 and the Asian Crisis very clearly. It was and still is the only time that US stock markets closed early due to trading curbs and the Dow Jones’ 550 point loss that day. We were on the floor that day and it was particularly eerie. The Asian Financial Crisis began in Thailand with the collapse of the Thai Baht and its effects were felt around the globe. Keep an eye on emerging markets like Argentina, Brazil, Turkey and South Africa. Turkey may merit extra attention as inflation in that country just hit 11% and its dictatorial leader is demanding rate cuts!? The economic textbooks would tell you to do the opposite.

Keep an eye on Bitcoin. The crypto currency market seems to be shaping up as a temperature gauge for risk. Bitcoin just made a lower high and there seems to be pressure in the space. As goes bitcoin so goes the market? It is trading at about $8300 as we write. It is very important that the support at $6700 remain steady otherwise bitcoin could see a $2000 fall quite quickly. The S&P closed the week at 2713 or about 50 points above our fulcrum of 2666. It has been 5 full months since we first hit 2666. Remember, we thought that we could spend 9-18 months here. The S&P keeps swinging back and forth between the 100 day moving average and the 200 day. Those lines are sloping upward and so is the market. The bulls have some work to do.

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

lighthouse

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.

666 Redux

Rollarcoaster markets. Around and around, up and down and we are back where we started. Hopefully, it didn’t cost you money. Another week and month and we are stuck at 2(666). You can read our thesis on the number 666 in our postings Bitcoin and Warning Shot. The short version is that the market has struggled at 2 times, 3 times and now 4 times the low on the S&P 500 of 666. It’s not magic. Its algorithms. The computers are in charge and for now the trading houses love the volatility but it’s all just churning. We have expected this churning to last 9- 18 months but we are getting closer to taking the under on that bet.

While the pundits are obsessed with Elon Musk’s seeming breakdown we will continue to obsess over the recent ranges of gold, stocks and bonds. It could be a long summer as the doldrums kick in but given our track record it will happen when we are furthest from the office. We have a knack for taking vacations at exactly the right time. For an inside tip look at your August calendar.

We continue to be invested because we do not know which way the market will head and time is money. It’s boring and it’s not sexy but look at where you cash, your dry powder, is invested. The differences are staggering and it is well worth your time to pick up 200 basis points. The market continues to struggle and is stuck in the range between 2550-2700 on the S&P 500. The longer it stays in the range the better it is for the bulls and the harder the breakout will be when it comes. We see the market breaking to 2850 and new highs or a trapdoor opening with a swift move to 2400 or lower. The market still struggles with 2666 as we closed the week at 2664 (which is the actual 4 x 666). We are stuck, for now, in a range between the 100 Day Moving Average (DMA) and the 200 DMA and that range is growing tighter each week as the 200 day is trending higher. Something will have to give. Keep an eye on the door. When these ranges break things will change rapidly – but for now we wait.

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.

Full Swing

One of the most positively anticipated earnings seasons in years is in full swing and most of the news has gone according to plan. As earnings seasons go this has been very good Corporate America. Here is the problem. Markets haven’t budged. That in essence shows how the market is a discount mechanism. Great earnings were widely expected and were priced in months ago. Inflation is the new worry and the statistics that we get next week will most likely show inflation rising above the 2% goal of the Federal Reserve. Next week could signal more rate hikes on the way and a higher 10 Yr Treasury. That could prove negative for stocks.

It seems that we are not the only ones signaling caution as we are seeing that in the positioning of public investors/institutions and sentiment numbers. The key takeaway here is that as investors become more cautious in their positioning it makes it more likely that when we break out of our current range the upside will be exaggerated and the downside could be more limited. Conservative positioning will leave us all with more dry powder and buying power as a group. We are not saying which way it will break but we are trying to decipher which way to lean.

We continue to invest for inflation and anticipate stocks will continue to struggle with their current range. We have low duration with our bond portfolio and continue to add commodities to our asset allocation. The commodity sector is one of the best performing asset classes in 2018. Another focus is our cash and generating for the first time in a decade returns there. Not sexy. Just smart. The market continues to struggle and is stuck in the range between 2550-2700 on the S&P 500. The longer it stays in the range the better it is for the bulls and the harder the breakout will be when it comes. We see the market breaking to 2850 and new highs or a trapdoor opening with a swift move to 2400 or lower. The market still struggles with 2666 as we closed the week at 2669. We are stuck, for now, in a range between the 100 Day Moving Average (DMA) and the 200 DMA and that range is growing tighter each week. Something will have to give. Keep an eye on the door. When these ranges break things will change rapidly – but for now we wait.

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 .

lighthouse

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.

Blackthorn Quarterly Letter April 2018

 Roaring

For some time we have been warning about a melt up in the markets. The stage had been set for asset prices to roar higher. Well, 2018 came roaring in like a lion with, what appears to be, the late stages of a market melt up.  At its zenith the S&P 500 was up almost 7.5% for the month! The incredible start to 2018 was clearly unsustainable and it was obvious that some sort of correction in 2018 was likely. February was clearly much different than January, in that, the S&P 500 that we had come to enjoy over the last 13 months had now turned south.  The volatility quake of February was just what the market needed to wake it from its relentless sleep walk higher. While we have enjoyed the last 9 quarters of positive pricing it was just a matter of time before markets reverted closer to their historical glide path

While we have made note in our letters of historically elevated valuation metrics we see further anecdotal evidence of that elevated pricing in legendary investor Warren Buffett’s latest Annual Letter. Buffett is well known to be constantly on the search for deals in the marketplace. His job is to allocate capital and he does that in buying stocks in companies or preferably entire companies as he adds to his portfolio. One of the main challenges in running Berkshire Hathaway is consistently putting newly acquired capital to work as it is a capital generating machine. In his latest annual address he notes that prices for assets are challenging. He described that finding a deal ata sensible purchase price” has become a challenge”.Berkshire Hathaway Annual Letter 2/26/2018

Why are prices so elevated? As you know from our writings, it is our opinion that elevated prices are directly related to central bank policy around the globe. A policy that, if even spoken of in polite circles a decade ago, would have gotten you laughed out of a room of economists. This past decade has been filled with rising asset prices due to the fire hose of central bank policy. Historically low interest rates, growing balance sheets, and low volatility all combined in excel spreadsheets to justify higher valuations for assets.

This never before attempted policy is now being seen by central bankers as being long in the tooth. Central bankers are now enacting tighter policy if only to have “bullets in the gun”. There is always another crisis and policymakers know they will be expected to respond. Policy maker’s response to the next crisis would be limited in scope if interest rates are along the zero bound and they hold an inordinately large balance sheet. Federal Reserve officials have been more overt in their recent communications that they are concerned about having the capacity to respond to a crisis in the future.

“Long-term risks include reduced capacity of both fiscal and monetary policy to act against downturns. Eric Rosengren Boston Fed President speech 4/13/18

What Changed?

What has changed is the tax cut. The tax plan really started in the middle of September and that’s when you saw the bond market reacting. …At that point, the market had shifted from its disinflationary mindset to a moderate inflation mindset. And that’s the repricing that has been taking place. Jeff  Sherman CIO Doubleline Funds

Central bankers are right to be concerned as the market perceives a change in mindset. Change can create volatility. Volatility can create fear. Fear can manifest itself in a lack of faith in the Fed to maintain stability. Instability creates lower asset prices.  Investors are seeing inflation on the horizon for the first time in a decade and that necessitates a rotation into a different investment game plan. Currently, investors are walking a tightrope between investing for inflation and investing for deflation. A deflationary game plan includes investing in longer term bonds and buying stocks when central bankers inject capital. An inflationary game plan includes commodities, low duration bonds and equities when inflation is controlled. We are walking a tightrope of investing options as the two outcomes are polar opposites.

“We have to deal with the possibility that at one point the Fed and other central banks may have to take more drastic action than they currently anticipate” and rates “may go higher and faster than people expect.” – JP Morgan CEO Jamie Dimon Annual Letter 2018

Ironically, the next crisis will probably be caused by the central banker’s actions (or inactions) as they try to pare down their balance sheets and normalize interest rates.

Until Something Breaks

And if you respect financial history, what the Fed has always done is hike until something breaks. We definitely had the debt build up. Looking at debt to GDP, people talk a lot about a bond bubble. But it’s not in the treasury market and it’s not in the housing market. It’s in Corporate America – Jeff Sherman CIO Doubleline Funds

What could break? We surmise that it may be the corporate debt market. Currently the 2 year US Treasury is the highest it has been since 2008 and if interest rates continue to rise there is concern that corporations may not be able to refinance debt that is coming due in the next two years. The artificially low interest rate regime that has prevailed since the GFC has given rise to zombie companies. Zombie companies are corporations that would have otherwise, with normalized interest rates, not been able to refinance their debt and stay alive. Those companies may not be able to stay afloat with rising interest rates and with less access to capital. That could create a significant drag on the economy as they close their doors. An additional concern is the rising share of the US budget that is being outlaid to interest payments. If rates were to normalize then the US budget is in danger of becoming a slave to its interest payments. That is the cross for the Federal Reserve to bear. How much is tightening is too much? How much can they tighten before something breaks?

Asset prices, which have risen on the back of loose central bank policy, should now, theoretically, reverse given central bankers current goal of tightening monetary policy. Central bankers are walking a fine line when trying to reverse their experimental policy. The trick here is for central bankers strike a balance where they are able to rein in policy without collapsing asset prices.

One of the biggest keys to success in this environment will be how the Fed responds to the markets’ response to any change in policy. If the market falls into a bear market a key driver will be how the Federal Reserve responds to any market correction. That response is likely to determine how long and how deep any correction might be. Our first clues may not come from the equity market as to markets overall response but from the bond market. Bond yields may be the risk temperature gauge for markets. Rising/falling bond yields or a continued flattening of the yield curve may portend equity market action.

“Spreads between corporate bonds and 10-yr Treasuries has fallen to relatively low levels, notes studies have showing investor confidence that generates low credit spreads often precedes subsequent economic reversals.” – Eric Rosengren Boston Fed President

The rising specter of inflation may have been the initial culprit of the recent sell off in February but that is normal for this late in the cycle. Pundits are saying “but the economy is doing so well”. The reason markets sell off when the economy is doing well is due to the central bank and its efforts to maintain a balance between prices and a strong economy. If the economy is doing well central banks will raise rates to slow the economy as inflation begins to rise. The reverse is true as well. If deflation arises and the economy is performing poorly central banks will lower rates to stir the economy and its concerns about inflation go on the back burner.

Then the acceleration of demand into capacity constraints and rise in prices and profits causes interest rates to rise and central banks to tighten monetary policy, which causes stock and other asset prices to fall because all assets are priced as the present value of their future cash flows and interest rates are the discount rate used to calculate present values. That is why it is not unusual to see strong economies accompanied by falling stock and other asset prices, which is curious to people who wonder why stocks go down when the economy is strong and don’t understand how this dynamic works. -Ray Dalio Bridgewater Associates

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. Buy the dip may have turned into sell the rip. The 3% level on the 10 year is the key. Equity markets continue to tumble whenever bond yields rise and bond yields fall whenever equity markets stumble. We are stuck in a loop. Markets may be stuck in neutral until central bankers either stop tightening or tighten too much.

 What’s Next

For one thing, I’m convinced the easy money has been made.  … the one thing we can say for sure is that the current prospects for making money in U.S. equities aren’t what they were half a dozen years ago.  And if that’s the case, isn’t it appropriate to take less risk in equities than one took six years ago? – Howard Marks Co-Chairman Oaktree Capital 1/23/2018

The lack of volatility in recent years has led to a one way market – up. So far in 2018 we have seen the return of volatility that has been missing from market advances in recent years. As we see a rise in the fear gauge we expect a repricing of assets and, with that, markets are going to be increasingly volatile and move in two ways- both up and down- rather than what we have seen over the last 9 quarters. While it may become more difficult to make money in this environment we feel that opportunities will present themselves to readjust asset allocations to our benefit. In the past 25 sessions, as we write, we have seen the Dow move triple digits in 21 of those sessions. While that may offer opportunities it also may indicate that something is not quite right under the surface. How do we position ourselves at the current time when it comes to equities? Here is some advice from Benjamin Graham, Warren Buffett’s mentor.

We can urge that in general the investor should not have more than one half in equities unless he has strong confidence in the soundness of his stock position and is sure that he could view a market decline of the 1969-70 type with equanimity. It is hard for us to see how strong confidence can be justified at the levels existing in early 1972. Thus, we would counsel against a greater than 50% apportionment to common stocks at this time. -Benjamin Graham The Intelligent Investor

 From Graham’s perspective he saw a massive run higher in the Dow Jones from 1942 -66 and, subsequently, saw markets struggle in 1969-70 period. The move lower from 1969-70 totaled a 35% loss in equities. That is the kind of loss Graham is talking about. Graham’s lack of confidence in 1972 was well founded as a massive bear market would take place from 1972-74.

We wholeheartedly agree with Graham as to strategy. We also think that Graham would agree with us on the market’s current position and the highly elevated valuations that we see today. We are not saying that a massive bear market is around the corner. What we are saying is that equities are at historical valuations. Is it not prudent to take less risk in equities than one took 6 years ago? The current markets may consolidate and then move higher still but we are not willing to bet the farm on that. We expect a long period of consolidation and a move higher or a shorter period of consolidation and a move lower. We must position accordingly.

Emotional Capital

We have spent a good deal of time lately talking to clients about emotional capital. When cycles reach a more mature stage it is prudent to sell some winners and build a cash (and emotional) cushion with which to buy future bargains. That way when market losses come you are keenly aware that you prepared for this moment and this money was set aside to buy assets at bargain prices. If you are holding too much in the way of assets when they begin to fall you will be tempted to start selling. It is then that you will be managing your money from an emotional point of view.

 lighthouse

First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. – Warren Buffett

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

 

5845 Ettington Drive

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678-696-1087

Terry@BlackthornAsset.com

 

 

 

 

Disclosure: According to SEC Custody Rule 206(4)-(a)(2), Blackthorn urges you to compare statements/reports initiated by your Blackthorn with the Account Statement from the custodian of your account for data consistency. To that end, if you find any discrepancy between these reports and the statement(s) that you received from your account’s custodian, please contact your Advisor or custodian. Also, please notify your Advisor promptly if you do not receive a statement(s) from your custodian on at least a quarterly basis.

Blackthorn is an investment adviser registered in the state of Georgia. Blackthorn is primarily engaged in providing discretionary investment advisory services for high net worth individuals.

All information provided herein is for informational purposes only and should not be deemed as a recommendation to buy or sell securities. All investments involve risk including the loss of principal. This transmission is confidential and may not be redistributed without the express written consent of Blackthorn Asset Management LLC and does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential offering memorandum.

FANG’s Lay an Egg

The attack on the FANG’s is the second attack of 2018. The first was the short volatility trade that blew up in February. Each attack has a lasting effect on the market. The short vol trade suppressed the price of volatility which helped elevate stock prices. The dismantling of this trade is still reverberating through markets. The next break down is what we call the shooting of the Generals. The leaders of the market have been producing an outsized portion of the gains and those leaders are now being questioned by the market. The move lower in the FANG’s has the market on its heels and investors are nervous. Where will the new market leadership come from? When will it arrive? This is a tough blow for stocks. New leadership cannot come quickly enough and large enough to steady the market. Tech is 25% of the S&P 500 with Apple, Amazon , Google, Microsoft and Facebook making up 14% of the S&P 500. You can see how weakness in just those five stocks will have an outsized negative effect on the S&P 500. The Generals of the market are the leaders. Those leaders, when shot, need to be replaced before the market loses confidence. The market is growing increasingly rudderless. There will be a third shoe to drop.

The FANG’s (Facebook, Amazon, Apple, NetFlix, Google)moved even lower this week as the bears took full control. They are oversold and due for a bounce as is the market. Unfortunately, the bounces that are coming are of the bear market variety. They are very large bounces on light volume. Bear market rallies rise sharply and die in low volume.

The longer the gaps stay unfilled at 2850 and 2700 the more they are validated. The 200 DMA is the key as the market has used it as support but the bulls just can’t get lift off especially as the FANG’s are taking such a pounding. April is, historically, the best month for the Dow. Unfortunately, that number dips in midterm election years. New money for the new month could help but if it doesn’t – watch out. We still anticipate a move to at least touch and test 2550. We do not think the street has studied for the test and may fail. But first, we should see some bounce to test 2700-2750 at the very least. If we don’t retest then that is another win for the bears.

A short one today as it is Easter Sunday. We will also have an abbreviated note next week as we tee up our quarterly letter.

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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 .

 

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 Ides of March

“Beware the Ides of March.” As we know from Plutarch, a Greek biographer, a seer had prophesied to Julius Caesar that harm would come to him by the Ides of March. He would, in fact, be assassinated on that day. Wall Street is a superstitious lot but it’s the bears that may feel they got assassinated last week. Some of the feedback that we received on our blog last week was that we were a touch bleak. We don’t feel that it is our job to talk about sunshine and roses. Our job is to be the cynic. Our job is to find the risk and avoid it or profit from it. We are not bleak on the market. We are just looking to manage risk and get the best risk return ratio for our clients. We are still heavily invested in stocks for clients but just underweight them as we feel that the risk reward here is turning against investors. In what is probably the best investing book ever written Benjamin Graham, of whom Warren Buffett is a disciple, outlines how to allocate your investment portfolio.

We can urge that in general the investor should not have more than one half in equities unless he has strong confidence in the soundness of his stock position and is sure that he could view a market decline of the 1969-70 type with equanimity. It is hard for us to see how strong confidence can be justified at the levels existing in early 1972. Thus, we would counsel against a greater than 50% apportionment to common stocks at this time. -Benjamin Graham The Intelligent Investor 

We wholeheartedly agree with Graham as to strategy but we also think that Graham would agree with us on the market’s current position and how to allocate in 2018. After seeing a massive run in the Dow Jones from 1942 -66 markets were struggling in 1969-70 period. The move lower from 1968-70 totaled a 35% loss in equities. That is the kind of loss Graham is talking about. Graham’s lack of confidence in 1972 was well founded as a massive bear market would take place from 1972-74. 

Markets tend to go higher over time and the majority of annual returns in stocks are positive. We don’t need to tell you that stocks are a very good investment over the long haul. Our job is to look at risk/return ratios and know when to back off. You wouldn’t bet on Secretariat to win if a $5 bet would return $1. The metrics on stock valuations are historically elevated right now and history tells us that equity returns from here could be subpar. There is nothing wrong with rebalancing, taking profits and taking down risk. We are not out of the market just underweight stocks. 50% in and 50% out. We can find a reason to be happy whatever Monday brings. The key to what Graham is saying is can you weather the storm? If you are overweight and you get a discount in prices you either cannot buy because you are already all in or will not buy because you lack the psychological and emotional will. You should never be all out and never all in. That way, when Mr. Market offers you a ridiculous price on a stock that you have always wanted to buy you are financially and emotionally ready to take advantage. Not gloom and doom. Just proper risk management.

The Ides of March were known in ancient Rome as a time to settle debts. It looks like the bulls settled one with the bears a week early. Last week we said that the line on the bull/bear game was a push. We thought that with the market a touch oversold the bulls had a slight advantage but that neither the bulls nor the bears really had the upper hand. Well, the bulls made it clear they are not ready to go away yet and shrugged off potential trade wars and another high profile resignation from the White House. The bulls had an outstanding week and let the bears know who is really in charge. The bulls now have the gap at 2850 on the S&P 500 clearly in their sights.

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 .

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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.

Trump Stepping on The Gas

As Warren Buffett famously said, “When the tide goes out you find out who has been swimming naked”. That tide may be rising interest rates. The tide has only begun to recede and yet it appears we may have found some to be swimming naked. In recent weeks we have seen unexpected announcements from the likes of Met Life and GE in regards to accounting irregularities and large conglomerates in China and the Netherlands with liquidity issues. HNA Group which owns Hilton Hotels is desperately searching for liquidity. The tide hasn’t even gone out yet. This could be the tip of the iceberg as zombie companies which have been left alive due to central bank zero interest rates may now fight to stay afloat. The rising tide of interest rates should bring us more instances of who has been swimming naked.

Coming off one of the worst weeks in years for equities we now have one of the best weeks in years. Don’t be lulled into complacency. This was to be expected as investors have now reversed half of the sell off after retesting the lows at the key 200 day moving average. We do not think that the all clear can be given yet. The selloff was violent from extremely elevated levels and that should give us caution. The true test, as we have been warning, is the retest of the old highs. The old highs were hit with such fervor that we do not think that the amplitude will be the same when we get there again. The swift and violent move off of the extreme highs has brought doubt into the equation for the first time in awhile. Let’s see if equities can pass this exam.

It appears that the expected outcomes by market participants may have changed the moment the tax bill was passed. Fiscal stimulus this late in the business cycle with a performing economy could force the central bank to tighten quicker than it had planned. That only increases the level of difficulty of the high wire act that the central bank is already attempting. The odds of a central bank policy mistake are rising and that contributed to the selloff along with rising inflation and the prospect of higher interest rates. Another contributing factor of the sell off was that Wall Street can smell weakness. Much had been made about the overzealousness of the volatility selling crowd. Those sellers were ripe for a lesson and Wall Street gave it to them. Wall Street, when sensing weakness, will press the case against the weak. Much like culling the slow and weak from a herd Wall Street feeds on the same. We have no doubt that the case was pressed against vol sellers until they capitulated. That gave rise to further de leveraging which spurred the computers into an all out rout. The key question here is, has the tide turned? We will see soon enough when the highs on the S&P 500 are tested once again.

Point here being that the uber-ambiguous “something has changed in the market” meme that’s been going-around is based-upon the underlying change in perception with regard to a bond market that is waking from its slumber due to a new-found Central Bank willingness to normalize policy on account of actual signs of “growth” and “inflation”—ESPECIALLY after being “put over the top” by US fiscal stimulus.  The above observations are simply the manifestations of this mentality-shift in the market….qualitative observation into quantitative phenomenon.- From Charlie Mcelligott, head of Nomura’s Cross-Asset Strategy

We have been writing that the Trump policies would give the FOMC cover to raise interest rates but those same policies may be too much of a good thing. Fiscal stimulus, tax reform, deregulation and infrastructure spending may force the Fed to raise rates faster than they would like. As the Fed is hitting the brakes Trump is stepping on the gas.

We continue to hold short duration bonds coupled with a slight underweight in equities. However, we did cautiously add to equities during the selloff. We continue to add to new positions that prepare for a further rise in inflation. We believe that we are in the late stage of the business cycle where commodities tend to prosper. Current central bank positioning combined with fiscal stimulus could lead to a quicker than expected rise in inflation. We are positioning for a surprise to the upside.

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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 .

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.

It’s Just Math

So much to say and so little space. Let’s jump right in.

What Happened?

Investors are convinced that Interest rates have begun to move higher and may have broken their 30 year + downtrend. The US 10 year has gone from 2% to 2.85% in just 5 months. The 10 year is in every risk calculation. The risk free rate is a base from which just about every valuation springs from. Has the 30 year bond bull market ended? It seems more and more are in that camp.

It can’t be just Bonds. Can it?

No. The severity of the move was exacerbated by the short volatility trade (see our warnings Very Superstitious, Less In and Fall is In the Air) and market structure which we warned about My Name is Mario, Paradox and Caution Flags.

Short Volatility Trade

In the next sharp market move volatility will be the driver as investors scramble to cover their shorts wiping out many involved in that trade. Blog Post 10/21/2017 “Very Superstitious

Bonds, the Vol Trade and Risk Parity

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 we will see it start. Blog PostLess In” 11/18/2017

Market Structure – Or Why the Market Fell So Fast

The market is flawed in its design as its automated structure puts the momentum players, the market makers and algorithms in control. While it is pleasurable to see it go up every day it will be much quicker and painful when the market goes down in a one way fashion. For every action there is an equal and opposite reaction. Blog Post “My Name is Mario” 10/28/2017

You may have pundits who say that it cannot be bond yields. They will say, “Four years ago the 10 year was at 3%. 3% 10-year yields didn’t stop the bull market then”.  Yes, but 3 years ago the S&P 500 was at 2000. It is now closer to 3000 with a high of 2872 put in a month ago. The S&P 500 at 2000 with a 3% ten year yield is a lot more palatable than when the S&P 500 is at 3000. Stocks are more expensive and have a lower dividend yield in 2018. Remember, stocks are valued in light of the risk free rate – the 10 year yield.

We are now in the late part of the short-term debt/business cycle when demand is increasing faster than the capacity to produce, so interest rates rise to put the breaks on and that hurts investment asset prices before it hurts the economy. -Ray Dalio Bridgewater Associates LinkedIn 2/8/18

The three legged stool of a higher stock market since the GFC has been stronger economic growth, low inflation and central bank stimulus. Those components of a stronger stock market may become a headwind in 2018. Currently, the Atlanta Fed is predicting 4% GDP in Q1 of 2018. That tells us that if growth gets much stronger central banks will have to take away stimulus at a more rapid pace. Inflation is rising with higher wages and central banks are already scheduled to take away stimulus in 2018. Don’t fall for the stronger economy = stronger stock market argument. A stronger economy and higher inflation will only lead to the Fed tightening faster. Trump’s policies may force the Fed to take away stimulus.

The combination of experimental central bank monetary policy and the Trump administration’s stated goals, if not enacted in concert, raise the risks that something is going to break. Those stated policy goals, while giving the Federal Reserve cover to raise rates, also make the Federal Reserve’s exit from their easy money polices of the last 8 years particularly tricky. To be frank their exit was never going to be easy. Blog Post Witches’ Brew 4/8/2017

Governments want inflation – just not too much inflation. Great investing minds such as Jeff Gundlach and Paul Tudor Jones are telling us that inflation is coming and commodities should play out well this late in the cycle. Central banks still have negative rates in parts of the world and in the US we have a President trying to stimulate the economy and having success. Right policies, wrong timing. Central banks are now behind the curve and markets may not like faster tightening. Another issue is the Fed Put. The Fed Put has given investors enormous confidence to buy ever rising stocks. Where will the Fed step in if markets get in trouble? We think that as inflation rises the Fed Put moves lower. The Fed cannot repeat the mistakes of the Weimar Republic and let inflation rage out of control. They will need to stop inflation and the acceptance of more volatility and a lower stock market may be the price.

The fundamentals have changed. Good news has become bad news. Any positive developments on the economy may be translated to a need for more tightening from the Fed. As Main Street benefits in higher wages Wall Street may suffer. Inflation will create the regime change from global economic recovery to global stimulus withdrawal. Governments want some inflation. Some inflation is good. From a government’s perspective deflation is always bad. That is why the Fed will support the market in a deflationary environment but not support it as quickly when it comes to too much inflation. Their support of the market is much, much slower to arrive in an inflationary environment especially when it sees a White House that is already stimulating the economy fiscally.

We have grown weary of hearing one pundit after another tell us that “The fundamentals have not changed; that the economy is strong and that stocks will go higher once this correction has run its course.” It is precisely because the fundamentals have not changed that stocks are weak, for the history of equities is to discount the future and the equity markets are looking beyond today’s economic fundamentals… which are, again, very strong… and are looking to the future when those fundamentals will eventually change for the worse. That is the job of the capital markets: to discount the future by looking into the future and not looking at the present. Dennis Gartman – The Gartman Letter

Bull market tops are a process and are usually not an event. We believe that we are at the beginning of that process. Fixed income is becoming more attractive as rates rise and central bankers will now attempt to step away from their support of assets. We do not think that they will have any luck but we think that the next 12-18 months in markets will be difficult with a strong increase in volatility.

This is what we had to say last month.

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. Paradox 1/8/18

 

We were prepared for this selloff and continue to position our clients for success in this environment. We have been underweight equities and have shortened bond duration as far we can stand. We continue to expect volatility and market shocks while being prepared for the return of inflation and to profit from both.

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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/ .

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.