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.

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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.

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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.

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

 

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.

The Greatest Game

 

“Golf is deceptively simple and endlessly complicated; it satisfies the soul and frustrates the intellect. It is at the same time rewarding and maddening – and it is without a doubt the greatest game mankind has ever invented.” – Arnold Palmer

 

My great passions, besides my family, are golf and investing. They are very similar in their nature. As Mr. Palmer so eloquently stated both games are maddening but perhaps that is why they are so rewarding and satisfying. We enjoy that both games seem simple but are frustratingly complex and it is in conquering their complexity that we find such satisfaction.

The 3rd Quarter of 2016 was maddening as the entire quarter was spent watching and waiting for some sort of resolution to market direction. While investors and hedge fund managers went off to the beach, the market, with the exception of the first two weeks in July, looked like it went off to the beach as well. The S&P 500 was up 3.5% in the first two weeks of July and that is where it closed for the quarter.  Much like a duck it was about what was going on under the surface that counted.

The pressure in the market continues to build as the market stays range bound between 18,000 and 18,500 on the Dow Jones Industrials. The pressure, if you listen to the media, is increasingly blamed on the election but it is the course of central banker policy that should hold your attention. The election is merely a sideshow. Central bankers, while publicly stating that negative interest rates are working, are finding that negative interest rates in Japan and Europe are having serious consequences. The pressure is mounting on central bankers to claw back higher interest rates without disturbing the animal spirits of the market place which would knock down asset prices while hindering confidence in the recovery.

Deutsche Bank and Interest Rates

Of late, central bankers in Europe have also come face to face with another dilemma and that is the market is attacking the stock price of Germany’s largest bank, Deutsche Bank (DB). The market has begun speculating that Germany’s largest bank and perhaps the world’s most systemically important bank could be in trouble. While we don’ think Deutsche Bank is on the brink of failure attention must be paid. When Wall Street senses weakness they feed upon it. The market has a way of cleaving the weak antelope from the herd. Financial firms’ biggest asset is confidence in the institution itself. A bank is only as good as its promise that it will deliver on its obligations. If there is no confidence in the institution then it is no longer viable and money will flow away from it. A bank run is not always logical.

Markets are going to push Deutsche Bank, possibly to their limit. Markets have a way of fleshing out the weak players. Traders will get into to a position where they will profit from a fall in Deutsche Bank’s stock. It has been this way since the dawn of Wall Street. You could call them parasites but as speculators they perform a function. They keep the system honest and flesh out the weak hands. That is what capitalism is. We have seen it over and over again. This can be seen in the failure of Lehman Brothers, Bear Stearns and probably most clearly in the failure of Long Term Capital Management.

(In 1998, Long Term Capital Management was THE hot hedge fund full of famous Wall Street traders and Nobel Prize winners. They made increasingly larger bets that put them in hot water.  Traders around the Street got wind of their problems and garnered insights into Long Term’s worsening positions and bet against them until Long Term had to capitulate and be bailed out by the big banks.)

One of the biggest issues surrounding Deutsche Bank and the European banking system is the unintended consequences of negative interest rate policy. The current negative interest rate environment is curtailing bank profitability. By trying to save the European economy European Central Bank (ECB) officials are putting the solvency of their banking/insurance sectors and pension funds at risk.

From a macro perspective we see that not only can central banks no longer lower interest rates they must raise them to enable banks to make profits and heal their balance sheets. Danielle DiMartino Booth is a former advisor to Federal Reserve of Dallas President Richard Fisher and is now President of Money Strong and serves as a consultant on worldwide central banking. Here is what Danielle had to say on the current interest rate environment.

In a reversal of economic fortunes, today’s economy is in desperate need of higher rather than lower interest rates, of a normalization of policy to put a floor under the bloodletting in pensions, insurance companies and among retirees worldwide. – Danielle Martino Booth Fed http://dimartinobooth.com/the-overlords-of-finance/

Central banks are currently trying to keep zombie companies and banks from failing. They are not allowing capitalism and its creative destruction component to function. The capitalist system is designed and needs to allow weaker hands to fail and the system to heal and become stronger. That has been what is missing since the dawn of this crisis – The allowance of failure. The politics of it are not palatable. The system is weakened because of it. At some point authorities must allow creative destruction or we will end up in an endless series of crises and become like Japan with low growth and stagnation for decades. The piper must be paid. Pain must be felt. Could we be at the beginning of that realization? Rates must be allowed to rise so banks can make money and repair their balance sheets. Central banks may be forced to raise rates.

Do we think that Deutsche Bank is going to fail? No. The legal settlements will not be as high as the headline grabbing amounts suggested so far. The bank does have sufficient liquidity at the moment but bank runs are bank runs and if one begins for Deutsche Bank there is never enough capital. Bank runs are panics and cannot be reasoned with.  We look at the macro risks and opportunities. We believe that there has to be a Plan B in effect and the German government will step in if Deutsche Bank begins to fail. A lack of confidence in Deutsche Bank and a lower stock price will deny them the ability to raise more capital. Either the governments will have to back off and allow them to operate under less stringent capital measures or Germany may have to step in and take a large stake in the world’s largest derivative dealer. The contagion risks are too high worldwide. What we see from a macro perspective is that the ECB will have to back off its pledge of negative interest rates as the unintended negative consequences are too high. Banks need positive rates and a steeper yield curve to make money. You cannot have your banks fail. They are the plumbing of the economic system. If Deutsche Bank fails then Credit Suisse is next and so on. The dominoes fall. Central bank leaders need to make it easier for banks to generate profits and negative rates are killing banks.

http://www.zerohedge.com/news/2016-09-29/run-begins-deutsche-bank-hedge-fund-clients-cut-collateral-exposure

 Saudi Issues – Oil

 

The other issue that has had our attention all summer is the lingering dissension among OPEC members and talks to tighten oil supply. Saudi Arabia is the 800 lb gorilla in the oil markets and without a definitive commitment on Saudi Arabia’s part no supply cut will have any effect.  A younger generation has taken control in Saudi Arabia and has been attempting a different tack in managing its foreign policy and economy. This has led them to attempt a change in their oil policy. The Saudi’s have been trying to drive prices lower in order to maintain market share and perhaps drive Russian and United States policy in their favor. The continued oversupply of oil markets has had the effect of dragging down oil prices but the outcome may have been too painful for the Saudi’s to handle. Things in the Kingdom have gotten much worse for the rulers as social issues mount. The Saudi Arabian government was forced to tap the international bond market for the first time in decades in order to fund a large budget deficit approaching 16% of GDP.  Currently their stock market is tumbling and the default risk of Saudi Arabia is rising in world markets.

Efforts to manage the fallout from cheap oil gathered steam over the past two weeks. Policy makers have suspended bonuses and trimmed allowances for government employees. Ministers’ salaries were cut by 20 percent. The central bank also said it’s injecting about 20 billion riyals ($5.3 billion) into the banking system to ease a cash crunch.

Austerity will help Saudis reduce a budget deficit that reached 16 percent of gross domestic product last year

 

The benchmark Tadawul All Share Index is down 18.5 percent this year, the third-worst performer among more than 90 global indexes tracked by Bloomberg. The MSCI Emerging Markets Index has climbed 15.4 percent.

http://www.bloomberg.com/news/articles/2016-10-05/saudi-arabia-s-post-oil-plan-off-to-a-rough-start-in-year-one

Current Saudi policy of over production is not working and the latest negotiations among OPEC nations may be the royal family admitting defeat and enabling a fundamental change in policy. The Saudi’s’ must constrict production in order to raise prices which will entail them taking the brunt of production cuts.  By agreeing to those terms perhaps they can elevate the price of oil. Higher oil prices will bring greater supply especially above $55 a barrel here in the United States but the capitulation of the Saudi’s could indicate a broader policy reform that over time will help support oil prices.

Bubble in Central Bank Policy

High interest rates are going to encourage savings, and I think we desperately need savings. Take a widow: they don’t know what to do with the money. There is no way they can do anything with it unless they go into stocks. I think forced equity investing creates the bubble.”

When asked who do you blame for this mess, the legendary hedge fund investor had one name: Janet Yellen, who Robertson says “is unwilling to see the American public taking pain at all and because of that I think she is creating a serious bubble where serious pain is going to come.”- Julian Robertson Bloomberg 9/28/2016

 

We could be on the cusp of real change in how investors are maneuvering especially in reaction to higher interest rates. Because of low interest rates investors, and in particular retirees, have been forced into buying ever higher priced income producers. Those income producers, such as real estate and utilities, have become overpriced in historical terms. We are looking to pull back from those areas of the market. In addition, low volatility strategies are seeing increased downside risk due to leverage, risk parity strategies and the current correlation of stocks and bonds.

The Saudi’s are indicating a change of heart on production numbers as things in the kingdom are getting rough. Whether or not they will be able to get production numbers down is another story. We think that the major gains for the 30 year bond market are behind us but we do not see interest rates heading much higher in the near future. The Fed is too afraid to rattle markets and they will raise rates even slower than most think.

 

While we can make the case for markets to fall the fact remains that we are in a binary environment and stocks could sharply rise as well. Although we think that risks continue to be tilted to the downside. In making the case for higher stock prices we note that professional investors are under invested and under performing. According to Goldman Sachs only 16% of Large Cap money managers are beating their benchmarks. There are some very high levels of cash at mutual funds and under performing managers will be looking to protect their jobs. Also, central bank policy may be forced into buying riskier assets to continue to forestall another crisis. That means they may be forced to buy equities as the Swiss and Japanese have already begun to do. If under invested under performing mutual funds begin to chase the market and inflation begins to move higher central banks will be reluctant to take away the punch bowl.

The election could roil markets but we think that a rate rise from the Federal Reserve in December is the more likely suspect to press markets. If that is the case we could be in for a replay of late 2015 and early 2016.

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

 

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Terry@BlackthornAsset.com

The Federal Reserve is Becoming the Problem

 

We have contemplated writing a blog titled “How I learned to Stop Worrying and Love the Fed”. We just cannot get ourselves over that line. The Federal Reserve has created and continues to promulgate a very dangerous position as capital is mal-invested. It also continues to punish a generation of savers, fixed income retirees, insurance companies and pension funds. The zero and even, in the case of Europe and Japan, Negative interest rate environment is hampering all of these groups ability to operate.

In light of this low income environment, we are seeing larger amounts of Ponzi schemes and investment fraud out there. Salesmen are pitching hard on annuities and income oriented schemes. These schemes are being proffered as a way to get 7-8% income on your investments. There is no Golden Ticket. There is no Holy Grail. If you are being promised those levels of income off of your investments it comes with outsized risk. Please do your due diligence. Everyone from insurance companies to pension funds to individual investors are begging for income as central banks have suppressed rates. If someone promises you this run, don’t walk, in the other direction. If it sounds too good to be true, it is.

Annuities are increasingly being offered as a solution but they come with their own set of problems. You may think that you are offloading risk on the annuity provider but it may blow back at you. These insurance companies are having the same trouble you are generating income and returns. If central banks continue to suppress rates then these companies may find it hard to keep their promises or even stay in business. You will be taking the haircut along with paying their generous fees. There is no silver bullet out there folks. Just good old fashioned hard work, diligence and patience in your investing.

We have been a big proponent and holder of smart beta ETF’s. We have been overweight dividend focused ETF’s and low volatility. They have been generous providers of return so far this year as low volatility, dividend focused ETF’s and utilities have done quite well. When everyone wants in the room – we want out. We are contemplating exchanging those funds as they are now all the rage. They have over the years provided downside protection if markets falter. That may not be the case this time around. We will continue our due diligence. No decision yet. Just an early warning. Chasing yield is a very dangerous proposition. Do your homework and don’t fall for the latest fad.

According to Standard & Poor’s the S&P 500 is now down month and quarter to date while it has maintained a slight gain of 0.13% for 2016. The fourth year of US Presidents second term tends to have below average returns as the market is unsure of who will be the next leader of the free world. Once it becomes evident who the next President is the market will steady. While that outcome is decided it could be a rocky Summer but an opportunity filled Fall.

April is consistently one of the strongest months of the year and that helped returns. However, we are now entering the weakest part of the year from May until November and the election season is not going to help. I think that volatility may be even more pronounced and returns suppressed with Donald Trump in the mix. Not because of his polices or beliefs but because he is bringing a much broader audience to the game and the media is all a buzz. That talk show fodder may convince investors to keep their wallet attached to their hip until things settle down. We have faded the recent rally and continue to cull underperformers and reduce risk. It could be a volatile summer.

Not recommendations just information. Investing is not a game of perfect.  It is a game of probabilities.

 

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.

Fickle Stock Markets and Daughter’s Driving

‘There are decades where nothing happens; and there are weeks where decades happen.’  – Vladimir Ilyich Lenin

It has been some time since our last quarterly letter but then again not much of anything of consequence has happened since the summer began. As you can see from our above quote, stolen from Vladimir Lenin, this week has seen some market moving news. China’s devaluation this week felt earth moving. A little background perhaps? Currencies are a tool which governments can use to speed up or slow down their economies. China has seen a serious deterioration in its export driven economy in recent weeks. A weaker currency is a lever to pull to get exports going again. Look at the relationship between the US and China. If I wanted to buy Chinese manufactured goods I would use US Dollars to do it. If the Chinese currency goes lower versus the US Dollar than my Dollars go farther. Instead of it costing $600 dollars for a piece of furniture maybe it only costs $540 now. If I am a dealer here in the US maybe I increase my purchases by 10%. A nice little jumpstart to the Chinese economy and cheaper goods here in the US. Cheaper goods is a good thing right? Well, maybe not so much. You now have the idea that China is not only exporting goods but cheaper goods and prices begin to fall. The Federal Reserve here in the US has been trying to ignite INFLATION and not having much success. Now we may be seeing waves of deflation hitting our shores further pushing the Federal Reserve into a bind. China is now exporting deflation around the world.

This puts the Federal Reserve in a bigger bind than they were previously. The IMF and World Bank have asked them not to raise interest rates. Higher interest rates in the US will only make the Dollar rise faster and higher. Why is that a problem? I can go travel internationally for less money. The problem is that many countries tie their currencies to the US Dollar. Their currencies are rising and that is harming their economies. These countries may have to devalue their currencies and around and around we go in a race to the bottom. Eventually something will have to give. For now my money is on a currency like the Malaysian Ringgit. A currency in a far off land none of us are concerned about until we are all very concerned. This sounds much like the beginnings of the 1997 Asia Financial Crisis. That crisis started with the collapse of the Thai Baht. The crisis migrated its way to Russia where they defaulted on their debt and soon to the US where the collapse of a large hedge fund forced the Federal Reserve to intervene. We are all interconnected. Watch out for currency crises.

From Jason Goepfert of SentimenTrader comes an interesting statistic. Friday’s have historically been up days in the market. No one likes to have risk on a weekend so shorts like to cover. Shorts have infinite risk. If you are short over a weekend and the company that you are short is purchased you have infinite risk. Not much fun at the beach worrying about that so you cover your position driving prices higher. Goepfert points out that over the last 3 months out of 12 Fridays the S&P 500 has been down 10 times. Investors seem to be seeing the glass as half empty and not half full with the unexpected weekend surprise being skewed to the downside.

Clients are asking about my feelings on commodities and crude oil in particular. Anecdotally, I am hearing advisors ask about eliminating commodities from model portfolios. As clear as a bell being rung we may be closer to the bottom in commodities than the top.

“Corporate insiders in the energy sector have dried up their selling activity while making some buys. At the same time, sentiment on crude oil has soured to one of its worst levels in over a decade. When we’ve seen this kind of difference in opinion between insiders and public, energy stocks have consistently rallied.”  –  Jason Goepfert – Cashin’s Comments – 7/28/2015

When there is no one left to sell…

Keep an eye on gold, silver and oil but especially copper. Copper may tell us whether China – the global growth engine- is getting back on its feet.

It is getting harder and harder to generate a return in these markets. The S&P 500 has moved in a 5% range since last November when the Federal Reserve stopped increasing its balance sheet. Bonds have continued to do well as interest rates are back to recent lows. The 200 day Moving Average (DMA) is critical support on the S&P 500. China’s actions may be the key. If they continue to let their currency depreciate then markets may suffer. Keep an eye on the US Dollar. If the Federal Reserve raises rates while China continues to depreciate then the probability of downside risks accelerate. We could be in for a bumpy ride here. September and October can be the cruelest times of the year for investors.

The Dow Jones Industrial Average has swung to either side of breakeven in 2015 over 20 times. No other year has been so fickle, the closest being the 20 times the blue chip index swung in both 1934 and 1994, according to research compiled by Bespoke Investment Group. This shows the lack of conviction by market participants going back to last November. As a reminder, 1934 finished up 4.1% for the year while in 1994 the Dow Jones closed higher by just 2.1%. The years after the most fickle years look like this. 1935 was up 38.6% and 1995 was up 33.5%. Not enough data to go on but we will keep digging.

My oldest got her Driver’s License on Friday. Time is flying by. After her test, the first thing that I did was call my insurance agent. For all of you, this is a good time of the year to check out your insurance and make sure that you are getting the most bang for your buck whether it be home, auto, life or liability. If you need help I have some excellent resources for you. As a disclosure I am a fee only Registered Investment Advisor. I do not make money on your insurance needs. My only goal is to help you protect your assets and save money.

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.

Broken Clocks and Sandcastles

Many of you have been anxious to hear how we feel things are unfolding. While we are busy this week writing our quarterly letter we thought that given the volatility and pain of this week we would write you a small note. Like a broken clock that is right twice a day we have been in tune with the market of late. We felt that the wind down of QE in October would bring volatility to the markets that the Fed, while not welcoming it, would ALLOW volatility to proceed. This bull market has been built on the back of dullness. Most of the returns garnered since the lows in 2009 have been when volatility was low. High volatility has been seen only during pullbacks in the market. A lack of volatility breeds complacency and risk taking. Stability can breed instability. Like a child’s pile of sand at the beach that grows ever higher it only takes one additional grain of sand to knock down an entire side and you don’t know which grain of sand that will be. The Federal Reserve knows this and, I feel, senses the need to bring back volatility and a respect for risk. Not to mention the fact that they may be out of bullets.

As a reminder we had this to say in our blog post back titled Riding the Waves back in July.

The central theme here is that investors should be expecting an increase in volatility as the Federal Reserve tries to exit its loose monetary policy. We expect trading bands to widen over the coming months as Fed officials warn of approaching volatility. The bankers are asking for it and the Fed is ready to let it happen. We intend to be prepared. https://terencereilly.wordpress.com/2014/07/07/riding-the-waves/

The bearish thesis that we laid out certainly showed itself this week as the S&P 500 had its worst week in two years. Our key level on the Russell 2000 ETF (IWM) had been a break of 108 which would lead the bears to make a push down to 96. We closed Friday at 104.74. (Remember these are not predictions just food for thought. Broken clocks you know.) The market is oversold at this point and due for a bounce. October’s Ghosts are out and about as fear is rising. Tough Thursday’s in October which are followed by dull Fridays have led to historic Monday’s. Tuesday could be a chance for the bulls to push back as Turnaround Tuesday comes back into vogue.  We will move our stop loss a little higher as a move above 114 on IWM would mean that the bulls are back in charge.

We are still very concerned about the Fed’s exit from QE while seemingly the rest of the world’s central banks are ramping up their money printing efforts. Currency wars are all the rage as it is a race to the bottom. If your currency is lower than your neighbors you will sell more stuff. Japan, China and Europe are seemingly in economic decline while Russia may be in the midst of a currency crisis. Not a great feeling when profit margins in the US are at all time highs with overpriced markets and highly margined accounts.

Keep an eye on the Russian Ruble. Small caps are the road map. Monday morning may be very interesting if history is our guide.

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.