Liquidity is not solvency

Apparently this is not a very well understood concept among the financial elite. Or perhaps they understand it all too well and are milking every incentive and easing measure for all of the salary, stock options and bonuses they can provide.

Not much has truly changed

Other than transferring an enormous amount of risk from the financial system in to the hands of central banks and governments, the underlying fragility of the financial system remains. Further, because the lenders of last resort are now burdened and their arsenal of financial ammunition near empty, there are not many options for the next economic hiccup.

With both US equities and bonds expensive by most measures, the logical alternative for most value conscious investors is to search for value in other asset classes: emerging markets, commodities, foreign exchange and real estate in distressed markets. But these options don’t come without risks of their own as their fates are tied to that of the US dollar (read more below).

With a great rally comes a greater upset

The last 7.5 years have been very generous to equity and bond investors. Perhaps too generous if current valuations are of any indication. What many are not prepared for based on current sentiment readings is a sustained downturn. Yet at the same time expectations of interest rate hikes by the Federal Reserve continue to rise (as they have in fits and bursts since jaw boning about such tightening began in 2013).

When rates rise, lending conditions tighten. And as that happens margin levels shrink, leverage is reduced as the cost of holding positions rises. This means that most of the time a series of rate hikes, as is being priced in to Fed Funds Futures, is the beginning of the end for modern bull markets in equities.

Yet stocks don’t seem to have received the memo. And they usually are last. 10 year Treasury Bonds, however, have seen yields rise from a paltry 1.3% to nearly 1.75% over the last few months. This may be more than just smoke signals as there are many foreign sovereign investors lightening up on Treasury Bond positions over the course of 2016, including China.

King Dollar’s mighty move

The US dollar has been rallying as of late on interest rate expectations as well. This has knocked down many commodities, outside of the energy sector, and caused renewed pressure on foreign currencies. Dollar strength should be watched carefully. If the dollar continues to rally (the dollar index is now testing 97) then we may see a renewal of equity selling as rate hike fears begin to permeate the US stock market.

Fears of the Fed are foolish

They say don’t fight the Fed. But what if the Fed is all talk? Over the last three years, there’s been a lot of talk of higher rates, even normalization. But what we have after all that talk is one lonely rate hike that is almost a year old now. The market seems to key in on every word every Fed official says, almost as if their words were seen as valuable insights.

But if each speaker’s rate forecast, economic forecasting track record and previous speeches are carefully examined the inconsistencies and inaccuracies accumulate. My opinion is that many of these officials, while they probably mean well, don’t have the requisite tools to forecast something as complex and intricate as the US economy. Why? Because no one does. Such tools do not exist.

But one thing is certain…

With a track record as dismal as Fed officials seem to have, their forecasts and banter about tightening should be taken with nothing more than a grain of salt. They don’t have a magic ball  and they can’t see in to the future much more than any other market participant, economist or statistician.

These are the same minds that brought us such failed monetary experiments as quantitative easing, which had the effect of redistributing middle class wealth to the already very wealthy, and bank bailouts which enabled more systemically reckless gambling.

As if flooding the system with credit would resolve the underlying structural solvency problems that our financial system and our government suffer from (hint: it made these issues worse by failing to address them in any meaningful way).

In conclusion, and I’m talking to you Mr. Market, let’s try not to take the hot air too seriously. After all, the people making it don’t seem to recognize the difference between liquidity and solvency.

Dollar downtrend confirmed; business cycle ending?

The end of the dollar rally is a topic that I’ve discussed previously. Now that the period of congestion (or sideways trading within a range) is over, the short and intermediate term trends seem to be re-aligning with the longer term downtrend in the exchange traded value of the US currency.

While this downward move is likely only in its early stages, it’s important to remember why the dollar rally happened in the first place: A Fed rate fake out.

dollar_chart

Time and time again from 2014 and on the Fed said it would raise rates. Talk of tightening even prompted taper tantrums and rate hike jitters leading to large, volatile market moves.

Now that the Fed has walked back on its promise of 4 rate hikes in 2016, and may not even hike again this year, reflation is beginning to show itself in various commodity prices. And this is a good thing.

The weakening of the dollar is the natural response to a situation where the international interest rate differential is being neutralized by a nervous central back here at home. What had caused the rally is now being discounted. And the rally started at a much lower exchange traded rate — so chances are that this downturn in the dollar has much farther down to go.

Translation? Higher commodity prices, resource stocks will continue their rally and the international players that benefit from a weaker dollar (like exporters) will benefit. Prices for food and energy will rise. Services will follow.

This is the natural final inning of a business cycle approaching. There’s nothing wrong with it provided that an exit plan is mapped out.

Correction brings opportunities in resource sector

The resource sector is getting slammed today on account of a marginally higher dollar, and one dissenting Fed member (Bullard) jawboning an April rate hike (conceivably to test the market’s reaction).

In all likelihood, given that the Fed has all but lost its credibility and certainly doesn’t want to be credited with causing deflation, a rate hike will not happen in April.  In fact, if anything I expect more dovish language on account of a deteriorating domestic housing market, more global economic uncertainty and the fact that we are right in the midst of election season (and the Fed seems to have more of a democratic bias — perhaps because many republicans are openly hostile toward the Fed).

My thought is that Bullard’s bluff will be called. That means the lower prices I am seeing now across the resource sector could be a wonderful opportunity to allocate capital at a discount.

Stay nimble.

Negative interest rates, positive investment returns?

I wrote in January that it was time to look at the resource sector. Since then energy, materials and precious metals producers have provided double digit returns. And this is likely only the beginning.

Negative rates are the new normal.

Major changes are occurring in the global picture. Changes that may appear to be disorienting.  Such as today’s ECB rate cut and QE extension causing a massive near 2% rally in the Euro, defying all expectations.

Or the Bank of Japan’s negative interest rate program boosting the Yen.

This may be a sign of something much more critical to resource sector stocks: a beginning of the end for the US dollar rally.

I wrote last year that the US dollar rally was stalling. Since then the dollar has stalled, moving up and down, but having a very hard time making a decisive continuation of its short term uptrend — or its long term downtrend.  Instead it has been consolidating with a more downward bias as of late.

This to me is suggestive that the US dollar rally is in a phase where the next trend is being decided by the conviction of buyers and sellers and the global economic picture as it changes.  And it is changing — rapidly.

There is no doubt that the US economy has made some progress since the depths of the crisis in 2008-2009, but it is not the level of progress that the stock market would suggest or that the unemployment rate seems to portend.

Instead we’ve enjoyed a very slow, very weak recovery that has mostly created part time, low paying jobs. And this is not as much of a political issue as it is a monetary policy issue.

QE, low interest rates and bail outs have transferred wealth from the working class, and shrinking middle class to the wealthy.

This actually hurts the economy. Slowing consumption, reducing confidence and shrinking the job market. Reality is setting in. Federal Reserve policy makers seem to be realizing that their hawkish hopes of hiking interest rates may be just that. We may even see negative interest rates before we see a 1% Federal Reserve interest rate again.

Such a development is very positive for those traditional inflation hedges.  Which is why I will continue to circle various components of the resource sector in pursuit of misunderstood or undervalued companies which could be valuable investments for the long term.

Now is the time to look at the resource sector

The streets are red with the blood of disemboweled investors. Just the sort of situation that is ripe with opportunity. When emotions run high logic is a distant second.

What’s wrong with this picture?

Enormous allocations of capital have gone in to a variety of companies, including social media, discretionary technology and biotechnology that are speculative at best. Yet they have achieved lofty valuations as money rushes anywhere it may find a return.

Meanwhile, companies in the real world that have viable businesses  are languishing in the current commodity bear market.  Many trading at attractive valuations. What’s the deal?

Now is the time to look at the resource sector.

Seesaw market creates opportunities in volatility

There is a lot of emotion charging the market, creating exaggerated moves both up and down.  One day everything is fixed, the next everything is broken.  Manic depression wouldn’t even begin to describe the back and fourth being witnessed.

But with chaos comes opportunity.  And the opportunity here is finding beaten up, misunderstood and frankly cheap assets.  Right now the areas that seem to be most attractive are commodities, commodities companies, energy and energy companies.

The global markets are pricing in worldwide depressed demand.  Oil producers are pumping at frantic rates, more concerned about the flow of cash than the margin on each sale.  This has created a glut of energy supply — and with little demand oil prices have crashed below $30.00 to about $28.00 a barrel for West Texas Intermediate Crude (WTIC).

Consider the following opportunity: The US dollar has had a rally which induced a de facto tightening even before the US Federal Reserve raised interest rates.  As such, one can reasonably expect that the actual pace of interest rate tightening, with the backdrop of a softening US economy, will likely be subdued.

Markets have priced in a more aggressive interest rate hiking cycle, which is putting pressure on everything that’s priced in dollars.  Even stocks.

I think that we’re getting ahead of ourselves here.  The Federal Reserve is unlikely to let this situation turn in to a full blown 2008 panic again, unless there is a desire to bring back all the calls to audit the Fed and the political upheaval that protests and social unrest would bring.  Instead, especially given that it’s a critical election year, I believe the Fed will tap the breaks and ease off the gas, leaving interest rates at 0.25% and possibly cutting them to negative levels if the global slowdown increases in momentum.

Energy falls, stocks mauled

There’s a deflationary wind that’s been blowing this way since late 2014. It’s been strengthening since the August 24th intraday market crash in the US. And now I think it is really picking up.

What comes of this brewing storm has yet to be realized in equity markets, but energy prices (and the companies vulnerable to lower profits) have tumbled. As have the prices of mining companies and the materials they extract.

The weakness in China coupled with a slowing US and EU consumer portends to a long-term deflationary headwind.

And don’t look now, but the Japanese Nikkei market seems to be crashing…

This time it’s different

The last time the market crashed, commodities were booming until they weren’t — and then equities tanked even more.

This time commodities are ahead of the business cycle as represented by equities.  At least in the US.

It seems as though we are confronting a new era. One where many other asset classes, including commodities, credit (bonds) and foreign currencies may be first in line to suffer from headwinds in global economic growth.

But that doesn’t mean that stocks will lag too far behind.  It just means that investors have been given every single warning indicator possible that something is amiss.  The question is, will anyone pay attention?

Stocks, dollar topping. Commodities closer to bottom.

It’s my opinion that the stock market rally, which lasted from early 2009 until late 2014 by many accounts, is largely over. Charts show a consolidation churning over the last year that gives reason to believe that the bull market is long in the tooth. The momentum in stock market buying has significantly stalled on a technical basis.

Fundamentals don’t look much better as earnings haven’t been particularly stellar in retail, materials, energy, construction and industrial equipment.

The dollar rally, which brought the dollar from about 78 in 2011 to just over 100 in 2015 seems to be topping out as well.  There’s not much conviction over the 100 level and the long dollar trade is quite lop sided with bulls outnumbering bears by the highest levels in years.

Meanwhile, commodities have been sold off to lows we haven’t seen in years if not decades in some cases.  The very stuff that drive economies, trade and the basic fundamentals are selling off as if the abundance of supply and lack of demand now is a permanent situation.

Markets always look ahead, until they don’t.  And sometimes they get a bit emotional both on the way up and the way down.  That emotion can drive exaggerated reactions.

The biggest emotional reactions tend to happen during periods of excessive greed during a top or excessive pessimism during a bottom. These emotional extremes can drive prices in to areas where opportunities may be realized by taking the opposite position.

That is to say, sometimes being a contrarian, while risky, can also pay off big.

I’m of the belief that this is one of those times.  The emotions are running high with stock and dollar bulls as well as commodity bears.  In fact I think it’s reasonable to speculate that many of these trades are tied together: long the dollar and stocks and then short commodities (and their equities) to maximize alpha.

It’s been a great trade for several years — there’s no doubt about that.  Most funds participating in such a trade have delivered outsized returns.  But now that positioning has matured, the gains have been largely realized and taking the opposite position may be more lucrative and less risky.

It may be time to consider going long commodities and taking a short position against equities. But don’t do anything risky without talking with a qualified investment professional. Good luck investing!