Updated 4/17/17 Stocks have gotten wobbly as the S&P 500 is now trading below its 50 day moving average and the Russell 2000 small cap index down on the year. Patience is wearing a bit thin on when and to what extent tax reform will come our way. At the same time economic growth remains in a mediocre state notwithstanding all the ebullient confidence figures seen over the past few months from businesses and consumers. In fact, GDP may print below 1% in Q1 after just a 1.6% growth performance in 2016. The Fed of course is also raising rates too under these circumstances. There are times to play offense and times to play defense. This is one of the latter moments.
I’ve been saying for a while that valuations don’t matter until they do which is not a revelation to market watchers and investors but important to acknowledge. The question is always searching for the catalysts that make them matter. I repeat my belief that now they matter because all four major central banks are taking away some of their respective bunch bowls this year. The BoE has filled their QE program to the brim and are now no longer increasing its size. The ECB we know has trimmed its monthly purchases by 25% and I expect another cut right after the summer. The BoJ is in a subtle tapering as the quantity of purchases is now less important than ‘yield curve control.’ And finally, the Fed right now seems intent on raising rates two more times possibly by September which will then maybe be followed by shrinkage, a shrinking of their balance sheet.
The bull case is that earnings are beginning to grow again and are expected to be up about 10% y/o/y in Q1. But, any analysis of earnings compared to stocks must look at what’s already happened. Let’s take earnings at the end of 2012 right as QE infinity was just about taking hold. As of Q4 2016, earnings grew by 10% for both GAAP and Non GAAP view points while the S&P 500 is up by 65%. Can you say multiple expansion? Like the market P/E going from 14x to 22x. Thus, because of higher rates and less QE, expect multiple compression that will overwhelm any earnings improvement from here. We will see about 70% of companies beat estimates in the coming three weeks but that’s not good. That is just normal. I still expect punk revenue growth.
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 and of course assuming no bomb drops on North Korea or elsewhere which I don’t expect) 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. I added HSBC (HSBC) a few weeks ago. It’s the ADR of the London based global bank and as I’m bullish on the washed out British pound, any appreciation in Sterling will add to the gains in the ADR. About half of their business is in Asia and anyone with a 10 yr+ time frame should understand that is where the global economic center is shifting to. One also collects a healthy 6% dividend yield. There is now a downturn in US lending so it’s why I prefer banks outside of the US.
Thank you President Donald J Trump for giving a nice kick in the pants to the price of gold and silver with your belief that “the dollar was too strong.” That and worries about North Korea (typically fleeting) has gold approaching $1,300 even after the 3rd rate hike. 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. The strong dollar crowd is still way too crowded and investors should also be watching REAL yields, not nominal. The 5 yr REAL yield is at -.16 bps vs +.43% when the Fed first hiked rates back in December 2015. The gold idea can be played via PHYS, SLV and the miner etf GDX. As for the individual miners, I like GG, AEM and NGD in particular. If I am correct that a bull market in precious metals is now getting into gear, I expect them to take out the 2011 highs in the few years to come. That’s what bull markets do.
My opinion on other 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. 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. I’ll add Las Vegas Sands (LVS) and Wynn Resorts (WYNN) as a great way to play the rebound in Macau and the rise of the Las Vegas of Asia.
Updated 4/17/17 – The 10 yr US Treasury yield broke below the multi month range of 2.3-2.6% on geopolitical worries and US economic mediocrity in light of the recent data that has the expected Q1 growth gain possibly as low as .5% at the same time the Fed is hiking interest rates and the flattening of the curve as a result. We are now witnessing a battle between the pull upward on yields as central banks take away accommodation at the same time worries over the ability of the US economy to handle it and the drop in longer term rates as a result. We’re already seeing the very credit sensitive auto sector begin to roll over.
I still 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%. But, the path to higher rates will still be a lumpy one as the global deflationary trends of too much debt face off against the inflationary desires of central banks. My main worry with global bonds is the upward pull in yields due to central bank activity (or a reduction thereof) but acknowledge that a slow economy will be a natural suppressant to yields. Thus, stay in short term maturities.
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 with corporate debt levels relative to cash flow at historic highs. Spreads are very tight with little room for error. Be cautious on TLT and BWX and like TBF and TBT. While we’ve seen a break below the lower end of the recent 10 yr yield range, I expect it back in that range soon enough. It was central bank activity that broke rates to historic lows and that trend as stated is now reversing.
Updated 4/17/17 – As stated above, I remain a bull on some commodities. A supply driven bull market resumed last year but I’m taking some chips off the table with industrial metals (SCCO). 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). COP had some great news last month after selling their Canadian assets for more than $10b and the stock was up sharply.
Gold and silver are currencies not commodities but I’ll refer to them in this section again (see equities). As inflation rises, central banks will be VERY slow to respond, thus real rates will fall and will then boost gold and silver. I touched upon real rates above. In a recent note, I upgraded gold/silver from buy to pound the table buy after DJT’s dollar comments.
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. With respect to China’s voracious appetite for commodities but with worries about their debt bubble, I worry to on the demand side but belief the supply side has responded enough over the past year that any declines in prices will be muted.
Updated 4/17/17 – Well, I guess it’s now official Administration policy. A weaker dollar is what is wanted it seems after President Trump endorsed one in an interview with the WSJ. It’s not a surprise considering his desire to revitalize manufacturing and exports but now there is confirmation. I’m a seller of the dollar. Again, REAL rates are still firmly negative in the US even with 3 interest rate hikes from the Fed and gives a good reason why the US dollar has stopped rallying over the past year. I’m still a buyer of the euro (FXE) as the ECB takes its first step toward the exit door. Mario Draghi is still 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. The BoE is done with expanding their balance sheet and will now only be maintaining its size. I believe the pound is very undervalued (FXB). I also like Asian currencies, particularly the South Korean Won where the EWY stock etf will benefit from. I of course assume no war with North Korea. I also like the Singapore dollar (FXSG) as its cheap relative