As we close the books on 2014 and look to 2015, it is helpful to take a look at the overall market relative to consensus expectations for the year. After a 25% rise in 2013, most market pundits expected a highly volatile equity market for 2014. Most expected (myself included) that interest rates would begin to rise and pressure equity prices. Most predicted (myself excluded) that commodity prices, especially oil would continue to rise.
What we saw in 2014 was actually a low volatility, quiet climb of 8.8% for the Dow Jones Industrial Average. Interest rates, which were expected to rise to 3.25% for the 10-year Treasury, actually closed the year lower at 2.20%. Oil prices fell to 10 year lows and gold remained relatively steady at $1200. All of these unexpected moves have most market pundits now expecting a continued low volatility market with slow but steady growth for stocks.
For 2015, I suggest that we should expect just the opposite. With the unknowns in the Euro zone, a rapidly rising dollar as foreign investors pour into the U.S., and possibly declining oil prices even further, I am expecting extreme market volatility in the coming year. We should be prepared for many 1+% daily moves in the averages as fear and greed play their hands.
Oil prices are taking center stage in the early part of 2015. Oil production in the U.S. contributed .7% of the total 2.4% GDP in 2014. The consensus so far is that the declining prices will stall production in the U.S. and thereby acting to reduce GDP in 2015. I suggest that just the opposite will be the case. Markets should ultimately digest this move and recognize that oil price declines (and therefore lower prices at the pump) actually serve as an immediate and significant “tax cut” for most Americans who commute to work. Lower prices allow for cheaper transport of goods and services, reduced costs for transportation companies, airlines, cruise-liners, etc. All of these allow the consumer to purchase more goods, dine out more often, and hopefully save. Ultimately, I expect the consensus to recognize this, and turn toward an expectation of higher GDP for the year. I agree with the Goldman Sachs projection of 3.1% for 2015, which is contrarian to the consensus (at least for now).
While I expect significant volatility (big daily moves up and down), I do expect to see a very positive market for 2015, especially in the first three quarters. The 4th quarter will really depend on what moves the Fed may make later in the year. If the markets perform well, as I expect, and lower gasoline prices lead to some inflation, we have ideal conditions that might allow the Fed to start retreating from excessive policy accommodation. That process will likely take longer than consensus expectations, which is why I suggest that we may not see any movement until late 2015. The Fed will use extreme caution and care to be sure they are not stalling the recovery as they start raising rates. In sum, with good growth in GDP, lower commodity prices, solid improvement in the jobs market, rising income, and other key areas healing, the table is set for the economy and markets to finally decouple from the Fed…..and that will be a great moment.
Best wishes to all for a healthy and prosperous 2015.
January 6, 2014
2013 in Review
What a year for the equity markets in 2013! The Dow (DJIA) posted its best yearly percentage increase since 1995, up 26.5% for the year. Industrials were the top-performing sector last year with Boeing alone contributing almost 445 points. The SP 500 saw similar upside success, closing the year up 32.4%, its largest increase in 18 years.
Through 2013 the S&P 500 has gained an average of +10.0% per year over the last 50 years, erasing much of the lost decade that was 2000-2010 that saw those long term averages drop. In fact, from the March 2009 low (on 03/09/09) the S&P 500 stock index gained +202.8% through the close of trading on 12/31/2013. Quite a recovery to say the least.
The one mildly negative spot in the markets last year was the bond markets which saw moderate losses in the longer term averages as yields finally started to creep up. The Barclays Capital Aggregate Bond Index lost 2.0% in 2013.
So, what’s ahead for 2014?
It would be very normal for us to see some profit taking here in the beginning of 2014. Many investors and Institutions alike had outsized gains in some stock positions. For obvious tax reasons they held off selling those in 2013 to delay the taxable event. We will likely see selling pressure in the high flying sectors for a few weeks in January (i.e. 3D Printing and Biotech). On the flip side, we may see a nice recovery in the few sectors that were under pressure in 2013 as those were likely sold off in December as investors tried to tax-loss sell anything in the red to offset realized gains (i.e. Gold Miners).
For 2014, the real focus will be on corporate earnings and employment. The unemployment rate declined to 7.4 percent over the summer and continues to improve, albeit slowly. A sustained drop below 7 percent would be a very positive sign for the economy and ultimately stocks. While it might be inflationary to some degree (bad for bonds) it should be a positive driver for stocks. As for earnings, the S&P 500 is trading at 17.3 times trailing earnings, a level that is still below the average post-war ratio when long term rates were under 8%. If corporate profits are up 10 percent this year (general consensus of analysts currently), then we can see this market continue to climb. If we see the economy improve (likely due to better employment numbers) then those corporate earnings could rise by 15 percent which would be a driver for another banner year. I’m expecting closer to consensus as the retail consumer may spend less in 2014 due to increased cost of their health insurance premiums passed on by their employers.
My expectation for 2014 is a mildly positive year with the DOW and S&P returning near the historical average of 10.0%. I anticipate that the chatter of “market peak” that is being touted on CNBC and the like is too early. Market tops occur when “everyone” is bullish. The investing public is still deeply skeptical about the equity markets. More importantly, while we have seen a trickle of flow from bond funds to stock funds, it is nothing compared to what I anticipate. If rates continue to rise we will see the trickle of flows from bonds to stocks turn to a river of flows. This change could fuel stocks to bubble like levels. In sum, I expect the market to continue to “climb a wall of worry” and produce positive returns for 2014 with the real flood of bond-to-stock flow coming in 2015 or 2016.
Best of luck to all in 2014 for a happy and prosperous year.
December 27, 2011
Predictions for 2011 (Graded) and 2012
As 2011 draws to a close, it’s again time to grade my predictions for the previous year, highlighted below that were published last December. In all, my macro-economic view of the equity markets was nearly spot-on, a feat nearly impossible to achieve. Specifically, number 1 below called for a mostly flat market. On that date the S&P 500 index was at 1257 and sits this morning at 1260. That said, my political “predictions” continue to be dead wrong! (I hope I’m right this year!)
Predictions for 2011- GRADED
Equity Markets will again provide a very nice environment for expert stock pickers. The overall indexes will trade in a narrow range (to the upside) while the stock pickers will again produce outsized returns if allocated appropriately. A focus on financials will rule the day early in 2011. GRADE: A+
Interest Rates, especially on the long end will continue to rise. Being short the 30 year Treasury bond will be very favorable and gains momentum as my previously stated “trade of the decade.” GRADE: D (European meltdown led to a flight to safety in Treasury bonds keeping yields low)
Merger and Acquisition activity will be rampant in 2011 as companies use their cash hordes to buy competitors/complimentaries. This should be especially evident in financials and technology. GRADE B- (Cash is at unprecedented levels)
Unemployment numbers remain high as companies are slow to add new permanent employees, rather favoring temporary workers. This provides the ceiling on the equity markets that keeps them in the aforementioned trading range. The corporate cash in reserve is used for M&A activity rather than hiring. GRADE: A
The unemployment numbers serve to further damage the current administration’s approval rating forcing President Obama and the Democrats to move more to the center prior to the 2012 elections. Nancy Pelosi steps down under pressure from her party as a move toward center. GRADE: C (Obama’s numbers are slipping but no such luck on Pelosi)
Rising commodities prices become the greatest concern for our economy as inflation rears its ugly head. This adds fuel to the fire with interest rates rising (#2 above.). GRADE: C
Oil will continue to trade higher in 2011, especially in the summer months, with retail gasoline prices hitting $4/gallon. GRADE B+
Gold will finally cool and actually drop in price 10%-20% as the dollar strengthens. GRADE: A-
Natural Gas will begin getting some traction in Washington DC as it is embraced as the natural bridge fuel to cleaner energy. It becomes political fodder leading into the election year as “clean, plentiful, cheap, and DOMESTIC!” GRADE: F
The Arizona Wildcats will make a surprise run in the 2011 NCAA tournament, making the Final Four, losing in the semi-finals to Duke. The Football team wins 5 football games and misses a bowl bid. GRADE: A- (Surprisingly the Cats did make a run, beating Duke to get into the Elite 8 but lost to eventual winner UConn….the football team was even worse than 5 wins, with no bowl appearance)
And now…….Predictions for 2012
U.S. Equity Markets are highly volatile throughout the year but close in 2012 near the all time market highs set in 2000. Massive cash flows out of bonds and into stocks fuels the second half rally. A possible 1st quarter retreat brings bulls in the market is full force.
Bond investors experience the worst bear market for bonds in two decades as interest rates begin to rise.
30 Year Treasury rates (currently 2.99%) trade up near 4% during 2012, fueling the bear market in #2 above. The “short Treasury trade” is finally a winner and still remains my trade of the decade.
Unemployment rates finally begin to decline as corporations begin putting the massive cash hordes to work. Unemployment numbers finally fall below 8% in 2012.
Financial stocks rebound dramatically and lead the overall market as the largest performer of the year.
Merger activity is extremely high as corporations see value in buying competitors to grow and to put their cash hordes to work. Yahoo gets caught up in a bidding war with Microsoft the eventual winner.
China has a massive upside move in their equity markets as a result of superior fiscal and monetary policy moves.
Oil prices fall below $80 per barrel and acts as a form of “tax cut” for the working American. This leads to superior sales results for retail.
Mitt Romney wins in a very narrow election with the Republicans advancing in the House and Senate, controlling all three.
The Arizona Wildcats basketball team wins the Pac-12 with a squad of freshman and wins their first two NCAA tournament games, losing in the Sweet 16 round. The football team pieces together 6 wins and makes a marginal bowl appearance.
Tiger Woods completes his comeback run, winning two major championships including the Masters.
August 8, 2011
Hysteria, the Dow, and the Debt Debate
Major stock market indices worldwide are under tremendous pressure, the Dow alone down 11.50% in the last three weeks. There is no single piece of news driving the sell-off; rather a culmination of many pieces of data and news related mostly to Europe.
Like 1987, the selling appears to be gathering its own downward momentum fueling on itself without fundamental justification. Nonetheless, the selling persists and the markets gain momentum. A look, however, at the macroeconomic fundamentals tells a different story. The Fed continues to be accommodative, money supply data shows no contraction, corporate earnings are rising considerably, jobs numbers are finally improving as of last week, retail sales including autos were up 6.9% in July, and the list goes on……
This leaves us perhaps the best explanation for the decline: European debt problems, specifically Italy, and the looming question of whether Germany will continue to prop up the weak Euro zone. The Euro is falling, European bond yields are rising, US Treasury yields are plummeting (even in the face of the SP downgrade to AA), and gold is up. Surely European countries have painted themselves in a corner, but correcting this mistake will be good for the long term.
In the US, we have also created our own “painted corner” situation with regard to debt, as evidenced by the messy debt ceiling debate in Washington. As a result, S&P over the weekend downgraded the US debt rating from AAA to AA. The market’s initial reaction has been clearly to disregard S&P as the flight to safety continues and bond yields are actually declining. Perhaps the market recalls the agency reiteration of Lehman’s AA rating only weeks before it defaulted and closed their doors in 2008!
In the end, I will argue that the debt debate is indeed a positive, albeit messy, situation. The debate has forced a political debate about the size of government and debt and the need to curb our spending. This should, over time, lead to a leaner government and a smaller government with a watchful eye of spending. At least that is the prudent takeaway for Washington.
This is just hysteria and politics. Let the politicians be hysterical. As investors, we must remain committed to capital strength- companies with strong balance sheets, solid earnings and solid management teams. The debt debate will end, the downgrade will pass, the Euro crisis will settle (as so many others have- remember the Asian contagion). The US will remain the bastion of safety and risk assets will attract dollars. If the debt ceiling debate does indeed serve to reduce government relative to GDP, jobs and growth will pick up and the stock market will rise too.
December 30, 2010
Making The Grade
Last year at this time I posted my “Ten for 2010” predictions. So, it’s that time……where I grade my performance and post new predictions for 2011.
“Never make predictions, especially about the future.”- Casey Stengel
Here is last year’s post with the appropriate “grade:”
Gold will settle into a comfortable trading range around current levels as the dollar once again re-emerges as the stable currency of choice. Foreign governments continue to see their creditworthiness questioned fueling the dollar even more. Grade: D. Gold broke out of the range early in 2010 and hasn’t looked back as the dollar remains weak.
The equity markets will provide a very boring landscape, moving mostly sideways through 2010 forcing money managers to trade on small profits to provide a positive return for their clients/shareholders. Grade B-. The equity markets were positive overall modestly. The good stockpickers, however, were able to produce nice returns as we moved in and out of technology and materials during the year for outsized gains.
The housing market will finally bottom, stabilize, and begin to move positively. Grade A+ We bottomed in the 3rd quarter and we are starting to see positive housing numbers.
Natural gas will continue to gain momentum as it is embraced as the alternative energy source of choice given its abundant supply and clean features. The Obama administration will move away from its clean coal initiative further “fueling” the move in nat gas. Grade D-. Nat gas still is being overlooked by the current administration. The change in the balance of power in D.C. however should allow the clean gas to finally have its day in the limelight in 2011 and 2012.
Retail sales will begin to recover and merchants will find themselves significantly lacking inventories due to the conservative sales outlooks finding that their “shelves are bare.” This will be a strong positive for the global shippers and rails. Grade B+. Retail sales have indeed begun a very nice spike, with online sales for Christmas blowing away previous records. Ships are again full but the markets are valuing the shippers accordingly…..yet.
Interest rates will begin to rise in the second half of 2010 causing some concern for the mass of retail investors that poured into bond mutual funds seeking “safety.” That security will be met with the realization that their principal erodes as rates move up. The Fed will move in tandem and begin to raise rates. Grade B. Rates have indeed begun their ascent to higher levels. The Fed has not yet raised.
Health care reform in some form will be passed causing a number of ripple effects. The most significant will be a stall in the employment recovery as unemployment rates will remain around 10%. This will cause the current administration to further slip in popularity resulting in the GOP gaining seats in the mid-term elections. Grade A+.
The SEC will reign in on short sellers with new restrictions and will bring the “uptick rule” back as a preventative measure. Grade A-. No uptick rule yet but there are/were significant restrictions placed on short sellers throughout the year with the inclusion of some shorting bans for periods of time.
More hedge fund turmoil emerges as they can’t justify their high fees in a sideways market with limited short side ability. Many more hedge funds close their doors. Grade A.
The Arizona Wildcats men’s basketball team misses the NCAA tournament for the first time in 26 years. Ironically, the football team, which has never played in the Rose Bowl, wins the Pac-10 in 2010 and finally earns a trip to the Rose Bowl. Grade D. The first half was correct warranting a C grade…..however the 2nd part of the prediction was abysmal and the exclamation point was added last night as the Cats got drummed by a mediocre Oklahoma State team.
Now: Predictions for 2011
Equity Markets will again provide a very nice environment for expert stock pickers. The overall indexes will trade in a narrow range (to the upside) while the stock pickers will again produce outsized returns if allocated appropriately. A focus on financials will rule the day early in 2011.
Interest Rates, especially on the long end will continue to rise. Being short the 30 year Treasury bond will be very favorable and gains momentum as my previously stated “trade of the decade."
Merger and Acquisition activity will be rampant in 2011 as companies use their cash hordes to buy competitors/complimentaries. This should be especially evident in financials and technology.
Unemployment numbers remain high as companies are slow to add new permanent employees, rather favoring temporary workers. This provides the ceiling on the equity markets that keeps them in the aforementioned trading range. The corporate cash in reserve is used for M&A activity rather than hiring.
The unemployment numbers serve to further damage the current administration’s approval rating forcing President Obama and the Democrats to move more to the center prior to the 2012 elections. Nancy Pelosi steps down under pressure from her party as a move toward center.
Rising commodities prices become the greatest concern for our economy as inflation rears its ugly head. This adds fuel to the fire with interest rates rising (#2 above.)
Oil will continue to trade higher in 2011, especially in the summer months, with retail gasoline prices hitting $4/gallon.
Gold will finally cool and actually drop in price 10%-20% as the dollar strengthens.
Natural Gas will begin getting some traction in Washington DC as it is embraced as the natural bridge fuel to cleaner energy. It becomes political fodder leading into the election year as “clean, plentiful, cheap, and DOMESTIC!”
The Arizona Wildcats will make a surprise run in the 2011 NCAA tournament, making the Final Four, losing in the semi-finals to Duke. The Football team wins 5 football games and misses a bowl bid.
October 19, 2010
Quantitative Easing 2 (QE2)
The media is giving plenty of press to QE2, as they are calling it. In a nutshell, QE2 is a potential FED policy of one “final” round of stimulus to spark the American consumer by providing additional money supply. Only time will tell if more stimulus will work or be shrugged off by investors. At the onset, it appears though that investors are optimistic about the FED strategy as buyers of equities in all classes have emerged, pushing the market indexes to the top end of the range I wrote about in July.
I find myself again taking the road less traveled with regard to the markets and believe that a strategy of caution be employed. While I am cautiously optimistic about large-cap domestic value stocks, the overall market still seems range bound. In what has been a low growth corporate and market environment, dividends are still a critical factor in overall performance….never has that been more true. In a market with near zero short term interest rates and flat equity performance, the dividend yields of even Dow components is outsized and should be considered.
I have previously noted my short position in long Treasuries (betting on higher long term rates in the future) and point to a recent Fortune Magazine interview with Warren Buffett. The Berkshire Hathaway’s Buffet said that he “can’t imagine anybody having bonds in their portfolio.” As you have read, I have been positioning this trade as I believe the short 20+ treasury trade may be the most compelling opportunity in front of us as rates climb back to “normal” levels……and likely higher to a new normal for quite some time.
Repeated for emphasis from last post: Re-risk. Prudently.
September 15, 2010
Distress and Prosperity
Bull markets are born out of distress. Bear markets are born out of prosperity.
In my last post I indicated that I expect the major U.S. stock indices to remain range bound for the foreseeable future. That said it appears that the top end of that range is, as expected, being tested once again. Some selective selling of our trading “rentals” here is advisable. All the while, adding quality long term positions is increasingly compelling.
From a macro perspective, the de-risking out of equities that has taken place (money still pouring into bond funds) has set up a nice backdrop for equities over the longer term. Specifically, since early 2008, retail investors have sold over $200 billion of domestic equity funds, while purchasing nearly $600 billion in fixed-income funds (see previous posts on bond bubble forming). The gap is unprecedented and history tells us that the S&P 500 performs famously in a contrarian way to a peak in flows.
I will re-state that now is an opportune time to take a variant view and become constructive on stocks. Make no mistake, the variant position will continue to have bumps, and some of the potholes will be with us for some time such as regulation and increasing tax burdens. Additionally, a policy of populism aimed at the wealthy and large corporations will have negative implications, mostly for job growth. Fiscal imbalances at local, state and federal levels will also be a factor. But, in the end, equities still represent the best long term value for investors, relative to outsized bond prices. Notably, most of the aforementioned headwinds that are now recognized by most investors and quite naturally are largely priced in.
In summary, the long Treasury, yielding just 3.8% seems puny and should be shorted and the contrarian view of re-risking with equities offers the better road to travel.
“Two roads diverged in a wood, and I-
I took the road less traveled by,
And that has made all the difference.”-Robert Frost
August 25, 2010
The airwaves are more cluttered than ever with permabears and the overly bullish, both projecting massive moves in opposite directions for the broad US equity markets. I maintain that the economic “truth” lies somewhere in between. For some time I have suggested that the economic recovery would be uneven and inconsistent and the markets range bound. I see no reason to alter that view currently.
As I have previously written, we are facing certain headwinds of tax and regulatory issues. The uncertainty of policy in Washington has led to corporate indecision and almost paralysis. Until we get some clarity on policy decisions, I believe that we will remain in our current range. When we do get the needed clarity (perhaps the November elections) it appears quite obvious to me that stocks are ultimately cheap on a relative basis.
The low level of interest rates remains the most compelling bullish argument for stocks. For the first time since 1962, the yield on the DJIA exceeds that of bond yields. In fact, nearly 80% of the companies in the S&P 500 have earnings yields that are greater than bond yields. Second, at under 12x 2010 earnings estimates, equities seem inexpensive to a multi-decade average P/E of 15x.
There is little argument that this environment has been unsettling and caution and diversification remain our priority. The talking heads continue to banter about a double dip and that has had a significant effect on confidence. I will suggest, however, that the U.S. stock market has already discounted a douple dip (if it even happens) and it is time to begin to fade the growing negative consensus and adopt a variant view by becoming more constructive on stocks.
August 9, 2010
We remain in a period of inconsistent and uneven economic growth, as previously indicated, that will continue to be difficult for corporate managers to navigate. This will likely lead to a continued expansion in usage of temporary workers over full time employees, creating a headwind for the all-important employment number.
Lumpy growth and the existence of non-traditional headwinds (fiscal imbalances at the federal and state levels, higher marginal taxes, burdensome regulatory backdrop, etc) could serve to cap the market’s upside. That said, we are in an environment where the risk premium (S&P earnings yield less the risk-free rate of return in fixed income) is at the highest level since 1980, when the great bull market started. This means that stocks are currently cheap relative to bonds……or that bonds are significantly overpriced and in bubble territory.
I am most comfortable with the latter, given the aforementioned nontraditional headwinds, and tip in favor of shorting bonds. Even with a surprise equity market run that could come from economic clarity, the result could be an even larger drop in fixed income prices. Just how expensive are bonds? Consider that a 2.89% yield on the U.S. 10 year Treasury note is priced at a P/E multiple of 34.5x (the inverse of 2.89%) against the S&P’s P/E multiple of only 12x.
Position: Long TBT and Rydex Inverse Govt Bond Fund
January 14, 2017
Our equity markets appear to be stuck in a very definite, and tight, trading range much as I predicted in my opening piece at the beginning of the year. I did not, however, expect the wild volatility or rapidity between the highs and lows. The quant funds and program trading are affecting the market wildly and probably warrants a strong look from the SEC (more on that in a later piece).
There are a number of headwinds that many talking heads are pontificating will keep this market from breaking out of the range to the upside as they certainly have deflated P/E multiples.
• Rising taxes
• Fiscal imbalances at the federal and state levels
• Quiet residential and nonresidential construction
• European debt crises (Spain, Greece, Portugal, etc)
• Anti-business Obama Administration
While these are truly headwinds, they are at least now mostly “known” and most would argue have been priced into the equity markets. That said, improvements in those key headwinds, and more significantly, improvements in two or more of those noted above could be the catalyst we need to break out to the upside.
A look at the 2011 earnings projections (which have been muted) tells me a different story when you aggregate them. The S&P 500 now trades at only 11.5x those projected earnings numbers, a very low number historically. More significantly, the S&P now provides an 8.7% earnings yield (the inverse of P/E ratio). Compare that to a 2.95% return on the 10 year Treasury note and the market starts to look pretty attractive.
All that said, this market was and is still driven by fear. When the headwinds start to diminish that fear will be replaced by greed. It will be too late at that point to make the real gains……Be greedy when others are fearful!
June 8, 2010
Having spent the last two weeks traveling through Europe, I wanted to post my reflections on the European Union. As anticipated, the rich history and culture of the areas of Spain, Italy, France, Monaco, and Malta are an amazing experience to say the least. My simple goal in traveling the region(in addition to experiencing the histories and beaches!) was to get an “on the ground” understanding of what is taking place from the perspective of the citizens, not the media’s perception.
My first takeaway was quite simply, Confusion. The European superpowers (especially Spain) are in total disarray. The average worker has an overwhelming sense of entitlement; Entitlement to an afternoon siesta, entitlement to a government wage, entitlement to a comfortable retirement. Repeatedly our group heard, “I work for the state.” Keep in mind that many of these comments came from sales people in stores, waiters, bartenders, cab drivers…This populist mindset is a dangerous road. Just ask Greece!
The weak currency has been labeled in the media as the opportunity for Americans and Asians to travel to Europe on a bargain. I was a believer-until I actually went. When you speak with the locals, you learn that prices on everyday items for them have dramatically increased in price. Simple things like food are considerably more expensive than just six months ago. While impossible to quantify exactly, the math suggests that prices have increased almost in lock-step with the decline in the Euro vs. the Dollar and Yen. That’s a wash for the international traveler, but really unfortunate for the resident. And they are feeling it.
Put simply, until the Eurozone returns to more capitalist persuasion with regard to savings, work ethic, retirement, and business building, the confusion will continue. It appears that the Euro will continue to slide vs. the Dollar. I would also wager that they are headed for an environment similar to our economy of the late 1970’s with high interest rates and run-away inflation. I’ll avoid the region for quite some time with regard to our investment line-up. I hope they find their Ronald Reagan to climb out of the mess.
On a positive note, the international consumer is alive and well. Visitors from all over the world (non-EU) were gathered at the various historical attractions in mass. Trains were full of visitors as were the restaurants. So, the global consumer and therefore likely their economies are healing and confidence has returned amongst those. I am returning to a more bullish (still cautious) perspective on the U.S. Equity markets and the Asian markets. To quote the great Doug Kass, “I am seeing rays of sunshine, but I still wear my raincoat to work each day.”
On a final positive note, the emerging market zones I visited are bustling and active. Specifically, Tunis in Africa is hungry…..hungry for capitalism, hungry for tourism, hungry for the rewards that come from hard work. The same can be said for Valletta, Malta. To that end, there is likely handsome potential for selectively investing in the emerging markets again…..more to come on that front.
May 6, 2010
Natural gas has continued to weaken in price to 40 year lows. I am surprised by the continued slide as it is domestic, it is plentiful and it is cheap. We’ve seen oil prices spike up as far as $150 a barrel since 2008, while the new technologies and sources of natural gas, in contrast, continue to expand and make the fuel superior to crude in every way. But, so far, environmental hurdles and a reticent Washington have slowed the embrace of natural gas as the transition fuel to renewable sources of energy.
The inability of the Obama administration, so far, to embrace this clean alternative has not slowed the energy players from seeing it rather clearly. We have seen a tremendous amount of merger and acquisition activity in this space. Most notably was the massive takeover of XTO Energy by Exxon for $41 billion. And there have been a number of other smaller yet significant takeovers. This is a “tell” that Big Oil sees the future clearly and they are competing for position in the natural gas space. This should, at some point, lead to higher natural gas prices (UNG) and escalating stock prices for the group.
March 23, 2010
Encouragement in the Market
Further evidence of an improving economy, along with continued easy monetary policy from the Fed, have continued to lead markets higher. The DJIA has been up 9 of the last 10 trading days. The Healthcare Reform vote even had no immediate negative effects on the markets as it appears that just “having it behind us” is enough for the markets.
Encouraging data points in housing start revisions, cap utilization rates and CPI reports are also welcome signs that the macro environment is recovering. Credit card delinquencies are dropping signaling that the consumer is stabilizing.
All of these data points seem to be pushing the markets north and subsequently “squeezing” the short sellers to cover. Combine this with China paying up for everything, especially iron and copper, and we have had a nice run up.
I remain cautious in this market, especially given $80+ oil as that has proved to be a real consumer deterrent above this level. A continued focus on capital strength and companies with strong balance sheets is advisable. Notably, we are seeing real momentum in the mobile internet space, as projected. This sector should continue to thrive as more and more users switch to smart phones and notebooks like the iPad. Lastly, natural gas bottoming? Seems to be the case. If the current administration will acknowledge and embrace nat gas as the logical bridge to cleaner energy, we could see explosive growth here.
February 19, 2010
The Federal Reserve surprised the markets late yesterday with a 25 basis point increase in the Discount Rate to 0.75%. This sent futures down sharply initially but by market open, futures had stabilized based on the Fed’s comments about future increases. This falls right in line with one of my “10 for 2010” projections that rates would indeed begin to rise in 2010. I think this is a bit sooner than anyone expected, however.
The biggest risk to the retail investor in this next cycle will be the massive inflows into bond funds of late under the auspices of “safety.” Bond prices move inversely to interest rates creating a dangerous set-up for those retail investors if rates continue to rise…..and the Fed has shown its hand. Interest rates have been forced down to artificially low levels and should rise just based on the enormous stimulus infused into the monetary system. As bonds have just come off of their best performance decade in more than 100 years, we should expect a reversion to the mean of sorts, creating a dangerous situation for bond investors.
The likely challenge for the remainder of 2010 and 2011 will be making money in what could very well be a sideways equity market and negative bond performance. Positive returns will require tactical capital allocation. Specifically, stock selection will be paramount and companies with strong balance sheets and solid, predictable earnings should be the focus. In short, individual stock selection will “rule the day” for the foreseeable future.
February 1, 2010
1. ANOTHER SLOW START – The S&P 500 was down 3.6% (total return) in January 2010. The loss is the 3rd consecutive year in which the stock index has started with a decline in January. The S&P 500 was down 6.0% in 1/08 and then lost 8.4% in 1/09. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market (source: BTN Research).
2. HISTORICAL DATA – The S&P 500 has produced a negative total return for each of the last 3 Februarys. The stock index was down 2.0% in 2/07, down 3.2% in 2/08 and then lost 10.6% in 2/09. February’s average performance over the last 20 years (1990-2009) is a loss of ½ of 1% (i.e., -0.5%), ranking February as the 10th best month over the 2-decade period (source: BTN Research).
3. IN THE NEXT YEAR – The S&P 500 has gained at least +25% (total return) 8 times in the last 25 calendar years (i.e., 1985-2009), including last year (the stock index gained +26.5% in 2009). In the calendar year following the 7 previous “25% and up” years, the S&P 500 was up 6 out of 7 years, gaining an average of +14.8% annually (source: BTN Research).
4. SOME DISAGREEMENT – Ben Bernanke was approved for a 2nd 4-year term as Fed Chairman by a 70-30 vote in the Senate last Thursday (1/28/10). The 30 votes against Bernanke’s confirmation were the greatest number of votes opposing a Fed Chairman nominee since 16 senators voted against Paul Volcker’s nomination in 1983. Bernanke’s new term will run to 1/31/14 (source: Federal Reserve).
5. RATES GOING UP? – There are now just 2 months remaining (i.e., February and March) in the Fed’s program to purchase $1.25 trillion of mortgage backed securities. The program, which originally began with Fed purchases in March 2009, will stop by the end of next month. Eric Rosengren, the President of the Federal Reserve Bank of Boston, predicted last month that mortgage interest rates will rise by as much as 0.75% when the purchase program ends (source: Federal Reserve).
January 25, 2010
Politics and Markets
On the heels of Goldman Sachs powerful earnings report, President Obama announced a plan to tax and further regulate the banks, sending stocks down considerably. The proposal says that banks cannot own, invest, or sponsor hedge funds or private-equity funds for their own accounts. The plan also proposes a limit on the size of a bank’s activities. Unfortunately for the markets, there is little clarity as to the specifics of that plan and we all know the markets dislike uncertainty.
The President seems to be positioning, whether for financial stability or political posturing, the banks in a light of “villains vs. victims,” with the banks clearly being the villains. While this may be sensational, it will be damaging to the profitability of the financial institutions and Wall Street will take its toll on those. So far, the administration is focusing on the biggies, the Goldmans, the Wells, the BofAs, the JP Morgans….the big financials who got it right to at least a degree better than the smaller players. Sure they made a lot of money from the TARP program that saved them, but wasn’t that the point? Why isn’t the administration focusing on what went wrong with Fannie, Freddie, Lehman, AIG? Why aren’t those CEO’s being deposed?
The Massachusetts Senate race gave us a glimmer of hope for the markets, as evidenced by the run-up Tuesday on the rumor that Brown would win. The voters and the markets gave us a clear message Tuesday-Americans (and therefore the markets) love gridlock. Perhaps the President is just trying to change the news headlines?
January 11, 2010
How the Build America Bond Program Will Impact Municipal Bonds
The Build America Bonds (BABs) program, a new piece of legislation from the Obama Administration, focuses on aiding struggling state and local municipalities across the U.S. The program, part of the American Recovery and Reinvestment Act of 2009, creates taxable municipal bonds, a radical departure from the long-standing tax exempt status quo for munis.
While bonds issued under the BABs program are fully taxable, the issuer receives a direct subsidy equal to 35% of the bonds coupon, or stated interest rate. The intent is to make some of the benefits of traditional muni bonds available to investors outside the highest tax brackets.
For many years there has been talk within the Treasury Department and the IRS that the tax exemption for municipal bonds is an inefficient subsidy since it allows only the highest taxpayers to benefit from the tax exempt income. At current tax rates, top bracket earners avoid paying 35% on that income. That benefit obviously will increase if/when taxes go up.
The BABs program will have significant benefits if it is embraced by lower bracket earners who need taxable income from their investments. The program will make it easier for municipalities to raise needed funds by bringing in a large new group of investors that have not previously participated in the municipal bond arena.
There is some question about what effect this program might have on existing tax exempt municipal bonds. The BABs program only allows bonds to be sold for new projects, not to refinance debt incurred in the past. An issuer can’t issue BABs to call old debt. Therefore, if the BABs program gains significant momentum, the municipal bonds currently in the marketplace are less likely to be redeemed early. As a result many of the bonds already issued are, in-effect, non-callable. More importantly, if new issues of tax exempt bonds are virtually non-existent, the demand for existing issues by the highest tax payers could increase significantly.
Some critics of the program argue that while BABs might have some benefits for those outside the highest tax brackets, the wealthiest individuals will still reap the most rewards. While this might be the case, I applaud the program’s goal of trying to bring the median income individual into the muni bond market. This could very well be a nice addition for those living on their income from investments (like CD’s, etc.) and a huge win for municipalities in those parts of the country that are struggling right now.
That said, the biggest winners just might be those that already own the old-style, tax exempt version of municipal bonds. We are telling our clients to hold on to their high quality Arizona tax free bonds.
December 29, 2009
10 for 2010
(10 Predictions for the coming year….A lot can happen over the course of a year to change any/all of these. And it’s always dangerous to make predictions as they rarely are entirely accurate. But, you have to have a road map in the markets and be willing to put yourself out there.) HAPPY NEW YEAR!
1. Gold will settle into a comfortable trading range around current levels as the dollar once again re-emerges as the stable currency of choice. Foreign governments continue to see their creditworthiness questioned fueling the dollar even more.
2. The equity markets will provide a very boring landscape, moving mostly sideways through 2010 forcing money managers to trade on small profits to provide a positive return for their clients/shareholders.
3. The housing market will finally bottom, stabilize, and begin to move positively.
4. Natural gas will continue to gain momentum as it is embraced as the alternative energy source of choice given its abundant supply and clean features. The Obama administration will move away from its clean coal initiative further “fueling” the move in nat gas.
5. Retail sales will begin to recover and merchants will find themselves significantly lacking inventories due to the conservative sales outlooks finding that their “shelves are bare.” This will be a strong positive for the global-shippers and rails.
6. Interest rates will begin to rise in the second half of 2010 causing some concern for the mass of retail investors that poured into bond mutual funds seeking “safety.” That security will be met with the realization that their principal erodes as rates move up. The Fed will move in tandem and begin to raise rates.
7. Health care reform in some form will be passed causing a number of ripple effects. The most significant will be a stall in the employment recovery as unemployment rates will remain around 10%. This will cause the current administration to further slip in popularity resulting in the GOP gaining seats in the mid-term elections.
8. The SEC will reign in on short sellers with new restrictions and will bring the “uptick rule” back as a preventative measure.
9. More hedge fund turmoil emerges as they can’t justify their high fees in a sideways market with limited short side ability. Many more hedge funds close their doors.
10. The Arizona Wildcats men’s basketball team misses the NCAA tournament for the first time in 26 years. Ironically, the football team, which has never played in the Rose Bowl, wins the Pac-10 in 2010 and finally earns a trip to the Rose Bowl.
December 21, 2009
Choppy Trading Range
There was a lot of positive news last week, but the decline in commodities, driven by a rise in the dollar, overshadowed sentiment, and the markets drifted lower. Volatility picked up as expected with options expiration (quadruple witching) on Friday. We could have a very interesting week if investors decide to focus on decidedly improving fundamentals.
Importantly, Ben Bernanke and Fed team maintained their stance on interest rates, stating that rates will remain low for an “extended period.” This will allow corporate America to continue to fund operations and maintain the modest growth momentum currently emerging. The trick will be to time the tightening before inflation begins to kick in. For now, though, Bernanke seems to have his eye on the ball with priority number one being job recovery. Following the end of our last 8 month recession in November 2001, the Fed first raised interest rates on 06/30/04 or more than 2 ½ years later.
In a market like this, which is in a very choppy trading range, the best thing to do is focus more on individual stock-picking than overall market direction. Such stock-picking has been difficult, though, because there are no real clear pockets of momentum. We have had the oil and commodity trade for a while as the dollar trended down, but that reversed in the last week and now the chances look good that the dollar may bounce a bit more.
December 7, 2009
There was a flurry of economic data last week, highlighted by the financial crunch in Dubai. The only report, however, that the markets seemed to care about was the employment report on Friday. By the end of the week, Dubai seemed a fading memory for investors. Even the improvement in housing data had little impact on the markets. It was all employment.
The bigger picture in employment shows the job situation getting better. At 10% unemployment, we have a long way to go, but the government’s fiscal and monetary policies are finally having an effect, and that is critical. The topic not yet being discussed by the media is “under-employment,” the employed worker that isn’t getting the number of hours he/she is accustomed to working. This will clearly have an effect on retail sales this month.
The markets may see some profit taking this month as hedge fund managers and mutual fund managers lock in their gains for the year. The long gold/short dollar trade is still long in the tooth and may see some unwinding here the last few weeks of the year. This should be positive for the dollar but may create some pressure on the equity markets, specifically in the materials sector. In the end, however, an overall increase in global infrastructure and stability will ultimately be good for the broad indexes over time.
November 23, 2009
The markets were down only slightly for the week, even with the three day losing streak from Wednesday to Friday. The lackluster economic data in housing, industrial production and retail sales started the week on a down note. Then disappointing earnings from Dell along with some corporate downgrades; and the bears had exactly what the wanted and were able to push the averages down.
Unemployment remains high, but we are losing fewer jobs than we were and many retailers are finally posting better profits on disciplined inventory control and a tick up in demand. Retailer inventories are showing that the “shelves are empty” as they have worked off existing inventory. This should lead, at some point, to a nice pick up in shipping loads and rates providing a nice opportunity in that sector.
Right now, there are two very different market theories grabbing media attention. The first is that we are overbought and bears are looking for a “double dip.” The other camp believes that there will be a mad scramble to improve performance by managers who have under-performed year to date. These managers, say the prognosticators, will be forced to buy up strong performers well into the end of December. I will stay with the middle ground here and continue our focus on “Capital Strength”- the companies and issuers that maintain strong balance sheets, adequate cash, and experienced management teams.
November 17, 20019
Short The Dollar, Long Gold
The DJIA and S&P 500 both hit new highs briefly this week on the heels of good data points from Applied Materials, Disney, Wal-Mart and JC Penny’s, to name a few. We also got a good set up with the announcement last week that Hewlett Packard is acquiring 3Com. The big surprise of the week came from Toll Brothers, the home builder, announcing a 42% new order rate and 2010 profit projections, possibly signaling a bottom in the housing market.
The most over-crowded trade amongst the institutional community continues to be: Short the dollar, long gold. This trade appears to be very “long in the tooth” and may be quite volatile if there is an unwind in those spaces. As such we continue to be cautious in the overall markets, looking for value opportunities.
The latest buzz building in the media is around the shipping sector. If the economy continues to show modest signs of improvement and the return of the retail buyer, inventories will have to be re-stocked. Over time, the shippers will consequently find themselves busy again. Companies and retailers have done a tremendous job in working off existing inventories and “leaning up.” If that inventory has been sufficiently depleted, we may see a real resurgence in the shipping data as the shelves are re-stocked.
November 9, 2009
Markets Prefer Gridlock
The combination of a heavy economic calendar and more positive corporate earnings made for a very active week. Add in Buffet’s purchase of Burlington Northern, Johnson & Johnson’s larger restructuring, and Ford’s better than expected third quarter, and it was especially interesting.
The real test came on Friday with the 10.2% unemployment number, which initially rattled the markets, but after digging through the details, investors found some encouraging signals, like an increase in temporary work and the positive revisions from prior months. Some of the forward-looking reports this week were good, and they point to a recovery in home sales, manufacturing, and factory orders.
What’s really impressive is how lean corporations have gotten over the last year. They are slashing fixed costs and operating much more efficiently. Output per worker is up 9.5% on an annualized basis and productivity is up 4.5%. This is why we are seeing earnings reports coming in much better than anticipated.
The other big story of the week was the Republican sweep in the Virginia and New Jersey elections. The American people seem to be showing that they prefer a balance of power in Washington. With the old adage that “Markets prefer gridlock,” we could see some continued upward bias into the mid-term elections.