Updated 5/2/17 – The 1st round of the French elections, the DJT tax blueprint and some better than expected earnings lit a match under a market that was becoming listless. Even so, the S&P 500 and DJIA are still below their March 1st peak and its becoming clear that the NASDAQ has been the only main winner driven by the tech stocks everyone loves. 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 printed just a .7% Q1 growth rate after just a 1.6% performance in 2016. The Fed of course is also raising rates too under these circumstances. I’ll repeat again what this year is all about for stocks and it’s not earnings and not the economy. It’s the hoped for tailwind of tax reform facing off against the headwind that is now monetary policy. If history is a guide, it is the latter that becomes the dominant factor.
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 taper in June after CPI last week printed higher than expected, especially on the core side. Draghi talked out of all sides of his mouth last week but he’s running out of excuses. The BoJ is in a subtle tapering as the quantity of purchases is now less important than ‘yield curve control’ but it’s become clear that the BoJ will be the last central bank to really back off in their monetary road to nowhere. 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. I’m now calling the latter Quantitative Tightening. I expect groundwork to be laid in this week’s statement for a June hike.
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 this earnings season but that’s not good. That is just normal. Revenue growth has been running about in line. If we take out the influence of energy companies Q1 rebound y/o/y in their earnings, earnings ex that are expected up by about 6%. Thus, the stock market gains have already priced this in.
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. There is now a love affair with European stocks so I now have one foot out the door and will recommend selling these ETF’s on any further strength.
There is this persistent belief that gold is a safety play and I need to reiterate that it is not. It is just a currency that happens to be yellow, weighs more than paper and is really tough to get out of the ground. So, after the French election and the easing of worries that resulted, gold sold off. Please ignore this reaction. 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 US dollar doesn’t trade well and I keep finding holes in the bull case. 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. Earnings from AEM were excellent and the stock had a nice move higher last week. GG and NGD were fine but investors sold them off as they didn’t beat the estimates. Only algo’s would trade gold mining stocks on whether a company beats or misses earnings expectations as this is one tough business.
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. POT reported much better than expected earnings last week and these two fertilizer stocks are really washed out. Demand is good and supply is getting under control. 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 and RCL reported great earnings last week and the stocks were up sharply. 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. Both reported good earnings last week and responded positively. I never like to chase stocks and all four of these names have had good runs. Thus, I’d wait for a pullback to buy or add but my long term view point remains intact.
I’m going to add an investment idea this week. Cameco (CCJ) is the world’s largest private miner of uranium. The uranium market has been in a tailspin since Japan shut down every single one of their reactors after the Fukushima disaster a few years ago. Why like this stock now? The entire industry is underway in that it costs more to dig it out of the ground than it can be sold for. Production is being cut and very slowly Japan is beginning to bring on more reactors online. At the same time, China and India are voracious builders of nuclear power because it’s safe, clean and a great source of stable power in big size. In total worldwide there are 57 plants under construction. The CEO said this last week in the midst of the tough conditions, “Six years is a long time to be in a down market. But that’s where it’s at. We can’t control the market; all we can control is how the company operates in it … We’re going to work our way through this.” Successful investing long term is buying things when the news is bad and there is light at the end of the tunnel. Chasing what everyone else loves is not investing, it is just momentum driven speculation.
Updated 5/2/17 – WTF is going on in US Treasuries? Here we have this ebullient stock market that thinks the economic world is great and DJT is going to wave a magic wand and taxes will get slashed for all which in turn will drive an economic revival. The US 10 yr yield now trading below the multi month range of 2.30%-2.60% has a different opinion of things. Or maybe they see the economic hopes and believe the Fed rate hikes and QT will stomp it out. Maybe that is why we are seeing this continued flattening of the yield curve. I mean last week the optimism over the French election and the tax reform blueprint were both not enough to steepen that curve.
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. One interesting dynamic in Treasuries has reversed. Just a few weeks ago there were record net shorts in 10 yr Treasuries by non commercial speculators. They’ve now completely reversed themselves and are now sharply net long by the most since January 2008.
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 the Euro Zone and in UK as QE eventually ends there and these bonds trade at egregiously tight spreads. 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 on pullbacks. 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 5/2/17 – 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 in oil 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. Gold backed off last week in the ‘flight from safety’ trade but again, gold should not be viewed as a safety play. IT IS A CURRENCY.
Mining cap ex has fallen sharply in a variety of industrial metals and that will continue to give a boost to them but they are trading now more squishy as iron prices in particular have fallen sharply on excess supply worries out of China. On the other hand, aluminum prices have rallied sharply on supply cuts in China. Bottom line in this group, it is the supply side that is mostly driving things. 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 too 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 5/2/17 – I’m sorry but the dollar just does not trade well. We have Trump slamming it only to have his Treasury Secretary give it a boost. We have Fed rate hikes this year but real rates are still falling. The BoJ, BoE and ECB are still dovish, albeit a bit less so, and the dollar still can’t rally. I’m a seller of the dollar. 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 up. 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 which continues to be a nuisance. I also like the Singapore dollar (FXSG) as its cheap relative to the US dollar.