Catch 22

Much like a cliffhanger episode of your favorite television show the market gave us a cliffhanger at the end of Q1. The rollercoaster, up and down ride of the S&P 500 in Q1 ended the quarter on the down beat and at key support levels. Would markets hold? Tune in next time.  Well, now we know that those levels held and Q2 produced a slow but steady walk higher in markets. The second quarter saw the S&P 500 Index up just shy of 3% which got the S&P 500 back on the positive side for 2018, albeit, just barely. While a decent quarter was had by equity holders it still appears that the market remains stuck in a consolidation range. The same range that we have predicted it would be stuck in for months and that it cannot quite break out. Why are markets stuck? The economy is doing so well. We have seen tax cuts and the repatriation of money from overseas. Shouldn’t that have markets rocketing higher?

Markets discount news in advance. Investors have anticipated peak profits. The tax cut, fiscal stimulus and repatriation of overseas funds were all widely anticipated. All of these maneuvers have helped profits tremendously but they are also all things that cannot be repeated over and over again as part of the business cycle.  These are one time turbo boosts to the economy. Great earnings were widely expected and were priced in months ago.

The second and most important reason that stocks are treading water is that the Federal Reserve has begun pulling back on liquidity and are now draining money from markets. This is done by the reduction of the holdings on the balance sheet of the Federal Reserve and steadily raising interest rates. While the Federal Reserve has only just begun their plan to withdraw liquidity from historical extremes markets have already begun to sputter.

It appears that markets are now waiting for the next catalyst. As you know we are proponents of the central bank thesis. This is the thesis that we, and others, subscribe to, that proffers that central banks are responsible for the rise in assets prices as a direct correlation to loose monetary policy and the existence of historically large balance sheets at central banks around the globe. Those large balance sheets and low interest rates have helped generate a fourfold rise in the S&P from the nadir of the financial crisis.

The Federal Reserve is just getting started removing excess stimulus and yet the ancillary effects of the removal of easy money are already rippling around the globe. Raising rates and draining the balance sheet have the effect of making dollars more scarce and more valuable. The draining of the balance sheet will lead to the draining of asset markets as there are fewer dollars to go around. This could quite possibly engineer a crisis in emerging markets.

Why emerging markets? Emerging countries have borrowed large amounts of money. Part of the broader problem is that they borrowed it in US Dollar denominated terms. Think about that for a second. Say you are Brazil. You borrow US Dollars and turn it into the Brazilian Real. Your currency drops in value by 14% due to rising US interest rates which make the Dollar more expensive. You now need to pay back your debt in US Dollars. That’s a problem. The country’s economy begins to grind to a halt. Then, authorities from around the world beg the US to stop raising interest rates. This is all happening while the Federal Reserve asset removal from their balance sheet has really been just a drop in the proverbial bucket. Almost akin to losing a deck chair off of the RMS Titanic and yet central bankers around the world are begging the Fed to stop raising rates. Central banks from Europe to Japan have indicated that October of 2018 could see further tightening from central banks around the globe. That could be the next catalyst.

The first half of 2018 has seen that there is a new game in town. The high wire act known as the Federal Reserve has made its impact on markets around the globe. The current tightening policies of the FOMC have led to a rise in the US dollar. That rise has had an impact on emerging markets. In just the past 90 days the Argentinean peso has fallen 30%. Other signs of distress have appeared in the Brazilian real, the Turkish Lira and the South African Rand which are all down over 14% this quarter. We have seen Asian emerging markets fall 3-5% while China leads the way to the downside with a double digit fall in its stock market for 2018. The change in policy by the Fed, by raising rates and shrinking its balance sheet has created a new dynamic. This new dynamic brings with it a flattening yield curve. A flattening yield curve makes it harder for banks to make money by lending and is seen as a harbinger of a slower economy.

In October central banks (US, ECB, BOJ) are poised to jointly deliver a net monthly shrinkage for the first time in 10 years and then the pace of that shrinkage is scheduled to increase as the ECB and BOJ both taper. Will markets respond in kind? We suspect they will. Eventually, if markets move low enough and economies slow enough,  it turns into a political issue. Will the Federal Reserve have the political will to continue shrinking policy as central bankers and politicians from around the world balk?

The Catch 22 for the Fed is firmly in place. As inflation begins to take hold in the US and in Germany central bankers will be forced to tighten policy even more. Politicians will cry out in pain as economies slow or markets fall. If central bankers feel threatened by politicians they may end up behind the curve on inflation. They will be faced with a choice. A choice between inflation in developed markets and currency chaos in emerging markets. 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.

Valuations – 1999

We have begun to have that old déjà vu feeling again. When you have been investing long enough you see the same events over and over again. They just come in different forms and names. It’s human nature. We have that feeling that we are seeing the same movie again and perhaps we have seen the ending before. The movie is the late 1990’s.

Growth stocks again have taken a tremendous lead over value stocks and rumblings in emerging markets are growing steadily. Lately, what has piqued our interest is the tremendous disparity between large cap tech (i.e. Netflix) and consumer staples (i.e. Kraft Heinz). 1999 was when tech overtook all reasonable valuations and left good quality companies in the dust. We currently see Netflix valued at 275x earnings with no dividend versus Kraft Heinz at 7 x earnings and a 4.0% dividend. The change in sentiment may not be immediate but it is important as investors that we are not blinded by the bright lights of the pundits and the headline du jour. At some point value will become valuable again and growth will pay the dear price of not having any margin of safety in its valuation.

“Haven’t we seen this movie before? Technology takes over the stock market late in a recovery cycle, seemingly making the bull ageless, pushing portfolios toward a more concentrated new-era exposure, stimulating investor greed bolstered daily by watching a chosen few (FANGs) rise to new heights, and convincing many that tech is really a defensive investment against late-cycle pressures which trouble other investments.”- Leuthold Group’s Jim Paulsen

While the hoards are chasing growth at any price (Amazon, Netflix, Microsoft) we look to note what the smart money is doing. In our April 22 2018 blog we noted that Goldman Sachs made an announcement that went widely missed. Goldman decided to halt the corporate buyback of Goldman stock. That gave us the sneaking suspicion that Goldman’s leadership felt that their stock was not worth the price that it was currently trading. As we write financial stocks have just finished a losing streak of 13 consecutive trading days – a new record. In April, when the announcement was made, Goldman Sachs was priced north of $260 a share. The stock is now down over 15% from those levels. Smart money indeed.

What’s Next

If you are a regular reader you know that we follow certain investors as guides along this journey to try to parse out clues to the macro environment.  Recently, Bridgewater Associates, the largest hedge fund in the world, offered this very direct warning about what comes next.

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. ­

Markets are already vulnerable, as the Fed is pulling back liquidity and raising rates, making cash scarcer and more attractive – reversing the easy liquidity and 0% cash rate that helped push money out of the risk curve over the course of the expansion. The danger to assets from the shift in liquidity and the building late-cycle dynamics is compounded by the fact that financial assets are pricing in a Goldilocks scenario of sustained strength, with little chance of either a slump or an overheating as the Fed continues its tightening cycle over the next year and a half. – Bridgewater’s latest Daily Observations authored by co-CIO Greg Jensen

The Fed is pulling back on liquidity as it is the right thing to do for the United States. However, there are many outside the US that don’t share that view. In particular those include emerging markets that are beginning to submerge from Argentina to Turkey to Brazil. Those ripples across the pond from a rising US Dollar will form into waves that eventually hit our shores. This will put pressure on the Fed to slow its tightening cycle. As we always like to say, “There are no problems only opportunities”. We are loath to enter emerging markets as we see the Fed continuing to raise rates but there are places to hide. Currently, small caps and mid caps have been the out performers here in the US. The theory being that small and mid cap stocks will not suffer as much as their large caps brethren due to their lack of international sales.

Elsewhere, we see commodities as a place to generate return. We envision a scenario where the Fed will be handcuffed by political pressure.  The Fed will be forced to slow rate hikes by Congress and by external international pressure. That should allow inflation to run unchecked for some time until the pain delivered by inflation becomes worth the cure and the cure is painful – much higher interest rates. We are already starting to see inflationary wage pressures in trucking and the oil patch. Commodities should continue to flourish under this scenario.

We are 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. Europe is not raising rates and therefore there is no impetus or motivation for people to spend. Jobs are getting more plentiful in the US. People can get raises, get better jobs, move, and spend money. 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 believed that 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.

Markets are pricing in a goldilocks scenario that is ever elusive and fleeting. Change is the only constant. 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. 

We have been expecting and investing for a 9-18 month period of consolidation after which we should see a rise in volatility as the market breaks out of its consolidation range. Our thesis about the market consolidating its gains around the 2666 level on the S&P 500 for 9- 18 months continues to hold. At the end of June we will have seen month 7. Midterm election years in the United States have a poor record performance wise over history. We would expect more of the same in 2018. In fact, more specifically, July in midterm years has a particularly poor track record. That will have our focus as liquidity remains very light in the summer months and markets could be prone to shocks.

We continue to invest for low and rising inflation and anticipate stocks will continue to struggle within their current range. We have low duration with our bond portfolio and continue to add commodities to our asset allocation. Another focus is our cash and, for the first time in a decade, generating returns there. We continue to be the contingency planner. We are not predicting the direction of the market but developing scenarios and having a plan no matter the outcome. It’s not sexy. It’s Investing 101. Do the basics right and the rest will take care of itself.

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

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

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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.

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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.

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.

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.

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.

S&P To Triple in 2018

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

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

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

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

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

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

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

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

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

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

Dr. Ben Hunt Epsilon Theory

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

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

NY Federal Reserve President William Dudley

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

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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.

One More Thing to Consider in Retirement

One of the next big crisis’ in the United States is pension funding. If you think that this will not affect you think again. It will hit you right in your wallet when you can least afford it – in your retirement. As a good portion of my readers and clients are approaching retirement this probable pension crisis should factor into where you retire.

I have been reading John Mauldin’s Thoughts From the Frontline for over twenty years on the recommendation of Arthur Cashin. If you haven’t read John’s work here is a link to his website. It is sent to over 1 million readers a week. It is well worth your time. Here are the highlights from John’s latest letter in regards to the looming pension crisis.

Total unfunded liabilities in state and local pensions have roughly quintupled in the last decade.

According to a 2014 Pew study, only 15 states follow policies that have funded at least 100% of their pension needs.

The only way to bring it out of the spiral is with huge cuts to other needed services or with massive tax cuts to pension benefits.

But wait, it gets worse. The graph we showed earlier stated that unfunded pension liabilities for state and local governments was $2 trillion. But that assumes an average 7% compound return. What if we assume 4% compound returns? Now the admitted unfunded pension liability is $4 trillion. But what if we have a recession and the stock market goes down by the past average of more than 40%? Now you have an unfunded liability in the range of $7–8 trillion.

We throw the words a trillion dollars around, not realizing how much that actually is. Combined state and local revenues for the US total around $2.6 trillion.

This issue is going to set neighbor against neighbor and retirees against taxpayers. It will become one of the most heated battles of my lifetime. It will make the Trump-Clinton campaigns look like a school kids’ tiddlywinks smackdown.

http://www.mauldineconomics.com/frontlinethoughts/pension-storm-warning

The ten year Treasury hit 2.28% mid week and looks to be headed back to resistance at 2.5%. A decisive break through the 2.7-2.8% level could mean that rates are headed higher longer term breaking the 30 year down move.  The punch through 2480 on the S&P 500 still has the bulls in control. The next target on the S&P 500 is 2540. The market is still firmly in an uptrend but there are signs that bulls may not be all that strong. Gallup poll has 68% of investors optimistic about the stock market over the next year. That matches the record high for that poll set in January of 2000.  Investor sentiment is very high which is a contra indicator while valuations are in the 90th percentile historically. The animal spirits are unpredictable. Gotta be in it to win it but maybe just a little less in. Keep an eye on the 10 year and commodities.

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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.

 

 

 

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

Crackdown, Smackdown and Fever

Two areas of asset pricing that we always keep an eye on in an attempt to decipher the market’s next move are US Treasuries and the oil patch. Let’s take a look at the current oil market and the commodity sector. Falling oil prices indicate lessening demand and therefore a lagging economy. In a nasty selloff oil is now down 11% in the last 3 weeks. There are rumors of major oil focused hedge funds liquidating or taking all risk off of their books as the price of oil swiftly moves lower. All of this while copper takes a tumble too. A falling oil price (and copper for that matter) does not bode well for the economy, high yield stocks or the stock market. When we talk weak commodities our thoughts immediately turn to China. The recent selloff in the commodity sector is being linked to a tightening of monetary conditions in China. A crackdown by the Chinese government is leading to higher interest rates and a tightening of the money supply in an effort to deleverage the economy. That, in turn, leads to lower commodity prices as China is one of the world’s largest consumers of commodities. A slowdown in China needs to be on our radar.

We have also been seeing a drift lower in hard data on the US economy. This data has been dragging since the failure of Trump & Co. to repeal Obama Care the first time in March. It seems that the market is waiting on some good to come out of Washington DC. We should never count on anything to come out of Washington DC.

The market is stuck in consolidation mode. In spite of recent data on a slowing economy we still expect the market to break out of its recent range to the upside and in favor of the bulls. More often than not when a market consolidates a major move it breaks out of that pattern the same way that it came into it. It’s all about momentum and the animal spirits of the market. That would mean we break out to the upside. There are lots of negatives about like weak US data, a Chinese slowdown and massive insider selling by US Corporate executives but the market refuses to break down. Many astute investors are warning about valuations in the market and are taking down risk.  They could be forced to chase the market higher adding fuel to the fire of animal spirits.

There is currently a massive speculative fervor in the crypto currencies like Bit Coin and Ethereum. A speculative fever has broken out and it is suspected that a lot of that money is coming out of China as capital controls are implemented and from Japan where a tax on investing in crypto currencies is going to be waived soon. Please approach with caution! This market is moving fast.

This may be a bit too inside baseball but the lack of volatility is important to watch. One of the most popular trades on the street over the last few years has been to sell volatility. Massive selling of volatility compresses the price of volatility, the numbers of players executing this strategy increases with the trade’s success and it brings in more and more investors to the trade. The word is that 95% of the float in VXX (Volatility ETN) is being used to short volatility. Ladies and gentlemen 30% would be large, but 95%!! The boat is listing to port as too many investors are in on this trade. This will explode violently in their faces. We don’t know when but it will. It always does. The risk parity trade and the selling of volatility combined with the reliance on passive investing ETF’s with High Frequency Trading market makers create a structural weakness in the market and will at some point create an opportunity for those with cash when the time comes. Forewarned is forearmed.

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.