Updated 8/21/17 – President Trump’s personality finally caught up with him in the eyes of the populace in addition to the viewpoint of the markets. Up until this past week, his tweets, verbal fights, and other bizarre commentary was met with a ‘I don’t care’ by the markets as long as it didn’t impact our $18T economy and the prospects for tax reform/cuts. Well, that is now in question as DJT picks fights with members of his own party that are so vitally needed in order to help with getting a fiscal agenda passed. These Congressman do have their own self interest in mind however which could be good and bad. The latter if they don’t care to work with the President anymore and wanting no association. The former could be good in that their own ass is on the line if they don’t get broad tax reform done.
Or maybe the market selloff was a long time coming in that quantitative tightening is beginning next month? The prospect of the reverse of QE that got markets so excited on 3 different occasions might be growing as a potential headwind to a market that has been relentless in its persistence higher (for the big cap indices at least) which has brought valuations to extremely lofty levels.
Or was it jawboning with North Korea that caused investors to say ‘no mas’ to this rally? Maybe it was a factor temporarily but assuming no nuclear weapons are launched, geopolitics rarely matter for more than a few days.
I think the tip off to the recent market pullback really began early on in this past earnings season. It started with the banks when after some reported better than expected earnings, the reaction in their respective stocks was met with selling. That was then followed by a slew of selloffs in companies that either met or beat estimates. If you were unfortunately not able to meet expectations, your stock got hammered. This of course means that a lot of perceived good news had already been priced in.
I’ve said this before but will again. The earnings recovery seen in Q1 and Q2 (which about half resulted from a rebound in energy earnings) was priced in last year when the S&P 500 rallied 10% in a year that saw ZERO earnings growth. We can even extent this back 5 years where the stock market has extended higher at a far faster pace than earnings growth. This is otherwise known as multiple expansion and gets into the potential growing concerns with QT in that QE expanded multiples and QT now might compress them.
As for the loved FAANG stocks, it turns out that the June 9th selloff was the beginning of a splintering of that group. This is hugely important because they were the leadership and now that leadership is in question. Bottom line with earnings, I believe it is clear that investors/traders are becoming more discriminating and more selective with divergences beginning to occur as we approach the typically unknown time of August thru October with respect to historical market hissy fits. Thus, the correction over the past few weeks could be the beginning of something deeper.
I do want to point out not just the action this week in the big headline indices that everyone watches but for the broad market too. I like to look at the Value Line equal weighted geometric index as it consists of 1700 stocks that are all treated the same. As of Friday’s close, that index is down on the year. In fact, since the Fed started tapering QE3 at the end of 2013, that index has essentially done nothing outside of a one month rally right after the Presidential election. Therefore, when one talks about what the ‘market’ has done, it is in the eye of the beholder and depends on how it is defined.
With very high valuations (has been the case for the past few years but hasn’t mattered), the question is whether investors are starting to become choosier because central banks are just not the same type of friend anymore. September is becoming a really big month with the Fed and ECB meetings. I was hoping to get some clues from Mario Draghi on August 25th but Reuters tapped into ECB sources who said Mr. Draghi may wait until the September meeting to tell us his intentions with a program that is currently expected to expire at the December and which we all know won’t and will be extended.
Bottom line, we have the possibility that central banks are not your BFF anymore at the same time markets lose confidence in the ability of Congress and DJT in getting substantive tax reform done. Keep in mind, there is no tolerance whatsoever on the part of Republicans to have another legislative loss of significance. Therefore, instead of something big and bold, we might get something modest and safe.
With respect to your US equity exposure, it’s time to be taking chips off the table or at least putting in stops depending on one’s time horizon. A longer-term time horizon is an investors best friend but a short one is now fraught with risk. Is this the end of the bull market? I’ve been burned before trying to predict and I know it’s a fool’s game but I will say again, the key pillars of this bull market, central bank largesse and most recently fiscal optimism which extended the bull run, are now very much in question.
While I completely understand that emerging markets will not be immune to any selloff in developed markets driven by central bank tightening, I remain a bull on many of these markets such as Brazil (EWZ) and India (INDA). I recommended selling EWY, the South Korean stock etf, two weeks ago. Emerging markets have had a great run this year, better than US markets but I expect outperformance for years to come both from a growth and valuation perspective. US stock markets have just pulled forward so much in terms of future returns.
India remains an exciting long term story as the benefits of Modinomics takes hold. The new goods and services tax, however difficult it will be to implement, is a potential game changer in making the marketplace much more efficient as it replaces a multitude of taxes at every stage of the supply chain. It was July 1st that the GST officially began but will definitely take time for most businesses to adjust to. This won’t go smoothly but the benefits I believe are tremendous. An early read is that the implementation has gone without any major disruptions. Technology has also taken over the country’s record keeping system where the history of every individual in the country is essentially being digitized which opens up the banking system to millions left out. Stocks here are not cheap but the long term story is compelling. A clean up of the banking system is also potentially a huge positive where bankruptcy laws are changing which would speed up the process and more quickly extinguish bad debt.
I remain bullish on Brazil. Michel Temer has successfully passed two of the important three key legislative goals when he took office. The first one was limiting government spending to the rate of inflation in order to slow the excessive rises in debts and deficits. Just two weeks ago labor market reform passed and this is a major step in liberalizing the Brazilian labor market. Within the bill, companies would be able to more freely negotiate with employees directly instead of thru collective bargaining. Also, union members would not be forced to pay union dues which instead would be voluntary. Having the ability to more freely fire an employee for cause without major repercussions makes companies more inclined to hire which results in a net improvement in job creation. The third key piece of needed change is reform to the pension system by extending out retirement ages. It remains to be seen if Temer has enough political capital to get this done but he did gather enough support a few weeks ago to not get impeached. The country is coming out of its two worst recession years since the Great Depression in the early 1930’s and many are still down on the Brazilian market.
For the broad European markets, I’ve recommended selling your positions over the past month in response to the great run the bourses there have had but now that QE tapering is most likely about to continue, I’m much more circumspect with markets there.
Gold and silver stocks are trading better as the US dollar continues to trade terribly and last week’s DJT comments helped to temporarily lift gold above $1300. I’m hoping we are on the cusp of the next leg higher in the precious metals because it seems that the fundamentals are coming together with a weak dollar, low real rates, central banks that will remove accommodation at a snail’s pace and importantly, the hits to their reputation will only intensify.
Central bankers will tighten us right into the next recession and bear market and will quickly halt and then reverse the process. That is when gold and silver really explode higher. In the last 13 rate hike cycles by the Fed since WWII, 10 put us into a recession. 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.
I continue to like agriculture and am playing it via POT, MOS and the broader MOO. What I thought was a possible trend change last month in agriculture prices, particularly wheat, corn and soybeans turned out for now to be a head fake as prices have since come back down again on better weather and more overseas supply. After closing at a one year high, the CRB food price index has pulled back. Also, the USDA data two weeks ago reflected more yield and supply than estimated. I still believe we are potentially seeing the beginning of the next bull market after 6 years of a bear as pieces are falling into place. The global demand for food is on a perpetual rise so it’s always the supply side that helps to drive prices. Also, ending stocks have fallen recently as demand is beginning to ‘eat’ into the supply of robust harvests seen over the past 5 years. The 2017/2018 harvest may result in the first fall in ending stocks for corn since 2010 and 2011. Chinese imports of soybeans have been incredible.
Oil remains in large part smack in the middle of its multi month range of $45-55 but oil stocks are depressed with XLE sitting just off the lowest level since April 2016. As I don’t see much more downside as I truly believe that progress is being made on the supply side, I am holding on to COP and HP as two individual companies. HP has been a terrible stock but I wouldn’t sell it just yet. COP has hung in pretty well. Both pay good dividends. I added a new recommendation in early July, Williams (WMB), the large natural gas pipeline, gathering, processing and storage company last month. They own a large stake in the MLP Williams Partners which generates almost all of its revenues from fee based, toll booth type activity. Natural gas continues to take market share from coal and exports of LNG are becoming a large business. A few insiders, including the CEO, recently bought stock and I love that as an endorsement of current levels. Williams also pays a dividend of almost 4.5%. If there is a down and out sector outside of ag, it is energy.
Industrial metals prices continue to trade well. Just this past week zinc prices rose to a 10 yr high and copper and aluminum are at or near 3 year highs. Again, I don’t believe it is the demand side but the supply side that continues to be reined in, especially in China. I’m not making any moves yet but copper stocks are on my radar screen. Copper is on the cusp of being referred to as a new economy metal as its used in electric cars and the transmission of solar.
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. CCL reported earnings last week that exceeded expectations. 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. I do want to emphasize though that all 4 stocks have had great moves and as I never like to chase things, I’d wait for pullbacks to add but that pullback may only come with a broader market selloff.
I still like Cameco. 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 but some Japanese plants are coming back online with about 9 expected to be operating by year end with 5 currently open. Why like this stock now? The entire industry is underwater 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 on top of about 450 on line.
Two weeks ago I added a buy recommendation in this new Ideas page update and that was General Electric. GE is down almost 20% year to date and has been dragged down by its exposure to the oil and gas industry. The lumpiness of their renewable business has also been a big factor and free cash flow has disappointed some. The company does though have a new CEO John Flannery who I have confidence in to reset expectations and further simplify the company’s businesses. I don’t believe there are any sacred cows. With more realistic earnings expectations, the stock trades around 15x forward earnings and with a near 4% dividend yield. Talk about a hated stock with almost no upside expectation built into its stock price. If you sense a pattern here it is that I like things that most others dislike.
Updated 8/21/17 – Lowered expectations as to when and maybe what Mario Draghi decides to do with his QE program has led to a backing off in European yields after the mini tantrum that his Sintra, Portugal speech created. As stated above, August 25th will likely end up being a non event and we’ll have to wait until the ECB September meeting for QE news.
As I’ve said many times, the European bond market, both sovereign and corporates, are in an epic bubble and as goes European yields, as might go US yields. Throw in of course Japanese JGB’s and we’re all in this bubble together.
The current ECB QE program is scheduled to end on December 31st but we all know that will never happen but they at least need to give us a blueprint of what comes next. I’m not sure if something new starts in September or they’ll wait until January. With this very dovish committee, I’d say January looks more likely. Either way, tapering is coming.
The recent fall in European yields has helped to keep a lid on US yields in addition to the safety trade in Treasuries that was so evident last week with the selloff in US stocks. As for US growth and its influence on interest rates, the data remains mixed. The Atlanta Fed currently has a 3.8% GDP growth rate estimate for Q3 while the NY Fed is closer to 2%. I’m cautious on US growth as the auto sector is now in a recession and consumer spending is showing strain. On the latter, all one has to do is looking at the action in retail stocks for confirmation. I don’t believe it’s all about the internet.
With respect to the Fed, they seem intent on tightening again in September via QT. The Fed seems to believe that QT will be a smooth, boring, ‘watching paint dry’ type process. I think they are delusional but it’s that belief that will cause them to move forward. I want to be clear, this process must take place. The Fed must remove themselves from bullying and manipulating our markets but this will be highly disruptive to asset prices and the economy. A recession will most likely follow. As for when the next rate hike might come, tell me where the S&P 500 will be in December in response to QT and I’ll answer the question.
I still believe the 35 yr bull market in bonds ended in July 2016 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 around 1.10% and near the highest level since early January 2016. But, the path to higher rates will still be a lumpy one as the global deflationary trends of too much debt and the progress of technology face off against the inflationary desires of central banks. I repeat that my main worry with global bonds is the upward pull in yields due to the removal of ECB largesse but acknowledge that a slow economy will be a natural suppressant to yields. Thus, stay in short term maturities. I don’t believe the reward of slightly higher longer term yields is worth the large potential downside as central banks are less influential in the market. The global bond bubble was the biggest bubble in the history of bubbles in terms of dollar size. That air is now coming out has major implications that cannot be ignored.
Sovereign bonds, particularly in Europe should be sold. This is where I’m the most bearish as stated and have been as I believe European sovereigns are a train wreck waiting to happen. Corporate bonds are also vulnerable in the Euro Zone. The yields on European junk bonds are about the same as the US 10 yr Treasury note. Let that sink in for a moment. 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. Stay short HYG. Further monetary tightening on top of a slowing US economy is not a good combination for high yield.
As for US Treasuries, they will be caught in the push and pull of lower yields due to weak growth and modest inflation stats on one hand and at risk of getting dragged by a selloff in European bonds as we get closer to more tapering from the ECB.
Stay short BNDX. It’s the Vanguard Total International Bond ETF.
Updated 8/21/17 – As stated above, I remain a bull on some commodities. I remain on the sidelines with industrial metals until we get better clarity on the economic situation in China BUT I’m considering getting back in as supply side discipline has helped to lift prices. China’s economy seems to have stabilized for now and I’m particularly intrigued by copper again as demand is now coming from new emerging sources. Oil continues to mostly be stuck in its multi month range of $45-55 as OPEC’s production cut deal was not enough to stem the inventory glut, or the perception of one as Libya, Nigeria and US shale have offset this. Oil at current levels then is really tricky from a trading standpoint as the market now questions OPEC’s resolve. Longer term, I’m no fan of oil as the rate of growth in its global usage should continue to slow as alternatives gain greater share. In the median term (1-3 years) however, there is a lot of long term supply that is being taken out of the market and I believe oil has one last bull run left in it in coming years. Bottom line, below $40 I’m a buyer of oil, above $60 I’m a seller.
Gold and silver are currencies not commodities but I’ll refer to them in this section again (see equities). I continue to remain a huge bull and you can see my arguments above. Gold and silver prices were awoken from their stupor because of a continued weak dollar and President Trump’s constant drama. A close above $1305 in gold would put it at the highest level since November 7th, the day before the election.
Agriculture has lagged badly over the past 5 years on robust harvests but the demand side has been strong. As stated above, wheat, corn and soybean prices spiked last month and have since consolidated lower. I still believe though that a trend change might be upon us. I like DBA and added CORN, the etf to my buy list six weeks ago. A month ago I added SOYB, the soybean etf. China has recently ramped up their imports of soybeans. The global demand for food is on a one way trip higher. The CRB food stuff index has corrected and the space remains frustrating but I believe this is part of a major bottoming process.
Updated 8/21/17 – The US dollar still can’t get out of its own way and now DJT is a main catalyst for that weakness. We’ve had 4 rate hikes from the Fed and they are getting closer to embarking on quantitative tightening and even this can’t boost the US dollar. I believe the market is getting worried about the US economic slowdown that is underway at the same time we are seeing this tightening along with the uncertain political situation. Also, the BoJ and ECB are still dovish, but a bit less so with a subtle tapering going on with the former and more to come for the latter this year or for certain in 2018. Mario Draghi changed the bond/FX world with his laying groundwork for policy change in September a few months ago. While the ECB has since backed off a bit, some tapering will take place. We also have a growing mutiny within the BoE that wants to hike rates and at least take back the emergency rate cut implemented after Brexit last year. I’m still a seller of the dollar BUT with one caveat, the sentiment has gotten very anti dollar so we may be on the cusp of a contra trend rally. On any pullbacks though, I’m still a buyer of the euro (FXE) as the ECB takes its first step toward the exit door and the European economy right now is growing faster than the US. I expect the US dollar to trade much lower from here against a broad basket.
I still like Asian currencies, and have been a particular bull on the South Korean Won which has traded well this year. With my recommendation to sell EWY, I’ll also say to sell the Won and take profits. I still like the Singapore dollar (FXSG) as its cheap relative to the US dollar and is at the highest level since last September. The Chinese seem to be backtracking on its move to liberalize the trading of the yuan and the yuan has rallied sharply in response as they added ‘counter cyclical measures’ as a factor in determining its daily reference rate. At least for now, the yuan is quietly at a 10 month high vs the US dollar. The recent Chinese economic data has been stable, however manipulated and artificially driven by credit stimulus.
Last month I added the Canadian dollar (FXC) to my buy list but it’s pulled back a bit from its big move higher over the past few months which put FXC at a two year high. We got the anticipated rate hike from the Bank of Canada who seem willing to look past the current modest pace of inflation. They hiked rates by 25 bps to .75% and thus took back one of the two emergency cuts they implemented in response to the oil price collapse. I expect them to hike again in coming months.