Updated 3/14/17 – Extreme US equity valuations don’t matter until they do. Now I believe they will because we are on the cusp of seeing all four major central banks this year pull back in some fashion from their extraordinary policies. Or as I like to refer to these policies as extreme monetary activism or monetary madness. I’ve been calling for a March rate hike for months and this week we will get it. The last Fed dot plot called for three hikes this year and it seems that the Fed might actually pull it off. We also heard from BoJ Governor Kuroda who is acknowledging the risks to bank profitability due to his own policies. We can add a 25% cut in ECB QE in April and the very likely end to QE in the UK in coming months. I’ll combine extreme bullishness as measured by Investors Intelligence (two weeks ago Bulls hit a 30 yr high), Daily Sentiment Index and CNN’s Fear and Greed index and I’m worried about US stocks. Notable this week is that we are now seeing more 52 week NYSE lows than highs. The Russell 2000 and Transportation indices are back to they were 3 months ago.
I’m going to repeat my view that investors should look overseas for better opportunities. Emerging markets such as Brazil (EWZ), India (INDA), and South Korea (EWY) I believe provide better equity valuation opportunities. I also find parts of Europe attractive, such as Spain (EWP) and Italy (EWI). The European bank sector should also benefit from the inevitable end to negative interest rates and QE in Europe at some point in the 2nd half of 2017 and into 2018. Within EWP and EWI includes the largest Spanish and Italian banks that have had a tough go and would benefit from an end to ECB extremism.
My opinion on commodity stocks is now more discriminating. After being bullish on industrial metals for the past year, I’m going to take a step back right now and only buy on sharp pullbacks, particularly in copper (SCCO). I continue to like agriculture and am playing it via POT, MOS and the broader MOO. The gold/silver bear market ended in December 2015 when the Fed finally raised rates for the first time in 10 years. Gold was then $1050. Today gold is at $1200 as the Fed is about to hike rates for a 3rd time. The strong dollar crowd is still way too crowded. This can be played via PHYS, SLV and the miner etf GDX. As for the individual miners, I like GG and NGD in particular. See my comments below on oil and oil stocks which I included under the ‘commodity’ section.
As for individual industry themes, I continue to like the cruise line stocks as a play on an aging population globally and an emerging market (particularly in China) that is getting wealthier and who want to see the world. CCL and RCL are the best way to play this.
Updated 3/14/17 – I’m going to repeat my view on bonds with some updates.
I believe the 35 yr bull market in bonds ended in July when a panic low in yields was reached right after the Brits voted to leave the EU. Levels were reached globally in yields that we may never see again in our lifetimes. I’ll argue that we’ll never see a 7 bps yield in the Japanese 40 yr. Today it’s at 1.05%. I’ll list my reasons for being a bond bear:
- In the epicenter of QE, that being Japan, where the BoJ balance sheet is almost 100% of GDP, they are now allowing a steepening of the yield curve past 10 yrs. QE is reaching its limits in terms of assets to buy. Kuroda this week admitted that he’s damaged bank profitability.
- ECB is about to cut monthly QE purchases by 25%. The ECB is running out of bonds to buy that meet their criteria. They are thus discussing ways of widening their pool of available assets. I call that desperation.
- Negative interest policy in Japan and Europe has reached its limits. Both central banks acknowledge the nasty side effects such as damaging the profitability of their banking system. See #1 on that.
- Inflation is moving higher globally, particularly in the Euro Zone, UK and US. Germany inflation in particular is spiking as it is in the UK due to the profound weakness in the pound. US CPI printed 2.5%, the highest in nearly 5 years. Core CPI is 2%+ for 15 months in a row.
- I expect BoE QE to end this year and just might take away the last rate cut panic after Brexit.
- Foreign investors are large sellers of US Treasuries, particularly China and OPEC countries. Foreigners sold $342b of US notes and bonds in 2016, an unprecedented pace.
- Trump is about to throw fiscal kerosene on an economy that has only a 4.7% unemployment rate and inflation around 2%. Wage growth should accelerate from here.
- Even though I believe that we’ll get a rate hike in March, the Federal Reserve will still go very slow in raising rates which means the long end will do it for them. After all, doves still run the FOMC.
Sovereign bonds, particularly in Europe should be sold. This is where I’m the most bearish as I believe European sovereigns are a train wreck waiting to happen. Corporate bonds are also vulnerable in Euro Zone and in UK as QE eventually ends there. US corporates are very expensive and are exposed on US Treasury weakness and now with the decline in energy prices, high yield pricing has rolled over. Since my last writing, we are now approaching the upper end of the US 10 yr yield range of 2.30-2.60% and European sovereign bond yields are also nearing their recent highs. We are thus at key spots that I expect will be violated to the upside in yields. Be cautious on TLT and BWX and like TBF and TBT.
Updated 3/14/17 – As stated above, I remain a bull on some commodities unlike all in last months’ update. A supply driven bull market resumed last year but I’m taking some chips off the table with industrial metals (SCCO). Oil has had a recent pullback with crude falling back below $50 but I still think $45-$55 will remain the range which I think inevitably will be taken out on the upside as a result of the still large amount of capital expenditures being taken off line over the past few years. I like COP, HP, and XES (the oil service etf). Gold and silver are currencies not commodities but I’ll refer to them in this section. As inflation rises, central banks will be VERY slow to respond, thus real rates will fall and will then boost gold and silver. Mining cap ex has fallen sharply in a variety of industrial metals and that will continue to give a boost to them but they need to now take a breather. Agriculture has lagged badly over the past 5 years on robust harvests but the demand side has been strong. I like DBA.
Updated 3/14/17 – The dollar is stuck in this contradictory vortex between the desire on the part of the Administration for a weak currency as expressed by officials on one hand but the possibility of a border adjustment tax being part of broad tax reform which needs a stronger dollar. As I’m most worried about a rising trend in inflation and a Fed that will very gradually respond with hikes, I’m a seller of the dollar. With the ECB cutting QE in April, I’m a buyer of the euro (FXE). Mario Draghi last week was very dovish but is finally beginning to acknowledge that inflation trends are moving up, the downside risks are basically gone and there is now even a discussion about when negative rates will start going on. With pressure growing on the BoE to take back the easing post Brexit because they have an inflation problem on their hands, I like the pound too as I believe it’s now very undervalued (FXB). I’m going to add a positive stance on Asian currencies, particularly the South Korean Won where the EWY stock etf will benefit from. I also like the Singapore dollar (FXSG) as its cheap relative to the US dollar.