Remember when major currencies used to be stable?

The British pound keeps reminding me that once a reserve currency loses the confidence of its participants, volatility becomes a big problem.

GBP crash

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.

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.

Inflation data causes stock market to vomit

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.

 

Buffet buys Apple after losing $2 billion on IBM

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?

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.