SPX is up about +271% since its low in March 2009, so that’s pretty good correlation with the growth in earnings. But the trouble with earnings is that the growth has been mainly accomplished through the use of smoke and mirrors. Sales for these same companies have increased only +32%. Either companies have been extremely efficient in cutting costs (since prices haven’t increased much) or else they’ve done some financial engineering to accomplish earnings growth that is nearly 9 times sales growth.
The smoke and mirrors is of course stock buybacks, which reduces the number of shares outstanding and that in turn drives EPS higher, even if in fact earnings did not improve. With the use of nearly zero- cost borrowing companies have been the primary driver behind the buying of their own stock and hence higher prices. One could argue whether or not it’s smart for companies to be paying top dollar for their stock right now.
The hiatus of MooTrades.com is over. I’m going to be posting regularly again to express my views on the markets — and hopefully provide valuable insights! The content is meant for institutional and accredited investors, but everyone is welcome to indulge themselves. Just be aware that I am not providing any investment advice. This is all for educational and information purposes.
As the dollar surges past 97, toward 100, the rest of the market seems to be catching on that this is a risk off signal. Just about every asset class is selling off today as a result. There’s no single catalyst for the stronger dollar. More a myriad of micro-catalysts:
- The assumption that the EU, UK, Japan and others will continue QE and ZIRP/NIRP as the US Fed raises rates.
- The notion that the US Fed will raise rates at a faster pace (than they have in the last 3 years of jawboning about it).
- The structural economic problems in other economies (making ours seem like the least bad of the bunch).
- Weakness in demand for assets in Japan and Europe.
- Brexit and the follow-on economic impact on UK.
With all of that in mind, I believe that the current leg of the US dollar rally is becoming problematic for the goals of the US Federal Reserve. Indeed, a strengthening dollar on top of rising US Treasury yields is in a way a de facto tightening. Liquidity tightens and lending/margin speculation decreases.
Should the rally strengthen I believe it will create a significant downside catalyst for a multitude of other asset classes. And there is some small chance that it could spiral in to a deflationary headwind should the situation grow out of the control. My opinion is that the dollar strength could be utilized as an entry point in to beaten up asset classes, especially commodities and emerging markets.
Let’s watch carefully and see where the market takes us from here.
The British pound keeps reminding me that once a reserve currency loses the confidence of its participants, volatility becomes a big problem.
Crashing, as it had post-Brexit and most recently during an HFT-triggered 2 minute flash implosion, shows that even the most liquid markets can become bidless.
This is, in a nutshell, why diversification of investments, including across different asset classes and base currencies, is critical.
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.
Rising gas prices are driving what is perceived as a ‘surge’ in inflationary data. Which isn’t all that surprising seeing as how crude oil has about doubled from its low.
Instead, the reaction to this data shows that there’s a lot of nervous market participants who apparently are convinced that this data set will increase the odds of an interest rate hike. And they’re taking their profits (or at least scaling out of positions).
Whether or not there is a hike depends largely on a seemingly reluctant, if not apprehensive Federal Reserve, whose promises to raise rates in 2016 have yet to be fulfilled.
But the data set we got today isn’t telling us anything new or interesting. It’s just a realization of higher energy prices working their way through consumables like gasoline.
I learned today that famed investor Warren Buffet bought about a billion dollars worth of Apple shares only 6 months after famously losing two billion on former PC maker IBM. Is this a sign of the oracle of Omaha thinking differently about technology investments?
A cursory glance shows Apple as a value stock. A P/E of 10 with a dividend of 2.5% seems attractive. But then an enormous market capitalization and a product pipeline that is heavily reliant on sagging mobile sales calls in to question how discounted Apple’s price truly is at this point.
After all, if the company cannot create another iPhone-like product — and the unfortunately humble Apple Watch does not fit that criteria — then all bets are off and Apple’s days as the world’s most valuable company will surely be behind it.
I remember Mr. Buffet once wisely proclaimed he would not buy what he didn’t understand.
I don’t even think IBM’s own upper echelon of executives completely understand the company they work for. That’s probably more than half the problem with the execution — a lack of vision. But more to the point, if they don’t, how can Mr. Buffet have hoped to understand the IBM that delivered him a massive loss after their share buyback plan imploded their earnings?
Will Apple be any different?
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.
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.
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.
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.
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.