It seems like we haven't seen selling like yesterday for months. The market was overbought, and it has chopped since the FOMC meeting to consolidate the gains.
Bonds finally caught a strong bid. That is a good sign if you are a bull not only in bonds, but also in stocks. I see very little upside in yields, perhaps up to 2.80% 10 year, which means this equities rally probably has more to go. The biggest bear case was a bond market continuing to selloff, infecting its weakness onto equities.
Yesterday, it looks like we had those looking to sell stocks ahead of the newly feared January. Market professionals are much simpler than you think. They remember what happened in the past 3 Januarys, when we had chunky pullbacks, and are projecting January 2017 to also present a pullback. The contrarian in me thinks that this market will receive a bunch of inflows in the start of the year, as the trend of big inflows continues, propelling the market to all time highs.
Despite the big inflows, I see no euphoria in the financial media or on Twitter. Sure, there is no more outright bearishness that you saw for much of the year, when people like CNBC's Brian Kelly screamed sell at every opportunity. But there is also a reluctance to fully buy in to the rally because of the uncertainty of what Trump will do when he enters office. And whenever there is uncertainty, there is untapped potential for the market to go higher.
The markets usually top out when there is the most certainty and it seems like there is nothing to fear. A lot of investors are still worried about what policies Trump will enact, especially his trade policies, or even his abrasive tweets. I think the uncertainty is overblown because the Republican playbook is right out in the open. Cut taxes, cut some more taxes, spend on defense, and then cut some regulations. Those are short term bullish for the stock market, and that carrot of those new tax bills being passed will keep this market afloat.
As for Trump's various rants and tweets, they are irrelevant and the market ignores them. You have to consider the source. Trump spews out a lot of abrasive and unpresidential tweets, but at the end of the day, they don't mean anything when it comes to his policies or to the economy.
There is some complacency in this market, but given how strong this market has been, with breadth very strong, it shouldn't lead to more than a couple percent pullback before you test the highs again. Due to the complacency, I am not bullish, but because of the strong uptrend and expectations for strong equity inflows in January, I cannot be bearish. There are no high probability trades here, but if I had to choose, I would rather buy S&P 2250 then sell it.
Thursday, December 29, 2016
Tuesday, December 27, 2016
Anything But Yuan
With Chinese FX reserves getting to levels where they have to slow down their support for the yuan, they have opted to put in stringent capital controls to stem the flood of outflows. There are obvious repercussions to this in the financial markets. The most obvious is a reduction in Chinese capital flowing to foreign markets.
The Chinese have been almost solely focused on buying up real estate, as it is their preferred store of value. In particular, they helped to boost the luxury real estate markets in big cities like New York, Los Angeles, London, Vancouver, Toronto, etc. They added more fuel to the fire to high end real estate, which was already getting a boost from increasing financial asset prices over the past 5 years. I would argue that compared to stocks, there is a bigger wealth effect from increasing home prices because they are viewed as more permanent, and is usually a bigger part of a middle to upper middle class person's net worth. Luxury housing supply is increasing at time when demand will be decreasing. A bad situation for that sector.
The financial media is right to be worried about China. It is in a very difficult situation where their crazy money printing and debt build up over the past 8 years has created an excess of cheap yuan looking for a home. And it doesn't want to stay in China, with real estate already overinflated and equities overvalued considering all the nonperforming loans on the banks' books. The wealthy Chinese realize that the yuan is way overvalued and should be trading more like 10-12 yuan/dollar than 7/dollar. That is why Chinese corporations are finding clever ways to invoice to keep more dollars and not have to exchange back to yuan. Or using their yuan to buy up dollar based assets, like real estate, or do foreign company acquisitions. Anything but yuan.
This weakening yuan is a headache for the PBOC because it can't cut rates and pump as much credit into the system as it needs to in order to pump up the economy. If they do, the pressure on the currency increases and more FX reserves need to be used to keep the yuan stable against the dollar. It is becoming increasingly clear that the best of two bad options to get out of this dilemma is to keep pumping credit into the system, devalue the yuan, and make the big debt pile more palatable via inflation. Of course, that will make imports into China much more expensive, and reduce confidence in the yuan, but it will help to increase Chinese exports, a way to rebuild their FX reserves. This also reduces the pressure to keep building more worthless buildings, roads, and bridges to nowhere, to keep up their GDP numbers. The overcapacity everywhere is a whole another nightmare hanging over China's head.
With China increasing exports through a weaker currency, that will give a deflationary push on manufactured goods, and also crowd out some of their competitors, a net negative for global growth ex China. All in all, this China situation is a time bomb waiting to explode, and it can do some real damage now that equity prices are so high. Something to look for in 2017.
The Chinese have been almost solely focused on buying up real estate, as it is their preferred store of value. In particular, they helped to boost the luxury real estate markets in big cities like New York, Los Angeles, London, Vancouver, Toronto, etc. They added more fuel to the fire to high end real estate, which was already getting a boost from increasing financial asset prices over the past 5 years. I would argue that compared to stocks, there is a bigger wealth effect from increasing home prices because they are viewed as more permanent, and is usually a bigger part of a middle to upper middle class person's net worth. Luxury housing supply is increasing at time when demand will be decreasing. A bad situation for that sector.
The financial media is right to be worried about China. It is in a very difficult situation where their crazy money printing and debt build up over the past 8 years has created an excess of cheap yuan looking for a home. And it doesn't want to stay in China, with real estate already overinflated and equities overvalued considering all the nonperforming loans on the banks' books. The wealthy Chinese realize that the yuan is way overvalued and should be trading more like 10-12 yuan/dollar than 7/dollar. That is why Chinese corporations are finding clever ways to invoice to keep more dollars and not have to exchange back to yuan. Or using their yuan to buy up dollar based assets, like real estate, or do foreign company acquisitions. Anything but yuan.
This weakening yuan is a headache for the PBOC because it can't cut rates and pump as much credit into the system as it needs to in order to pump up the economy. If they do, the pressure on the currency increases and more FX reserves need to be used to keep the yuan stable against the dollar. It is becoming increasingly clear that the best of two bad options to get out of this dilemma is to keep pumping credit into the system, devalue the yuan, and make the big debt pile more palatable via inflation. Of course, that will make imports into China much more expensive, and reduce confidence in the yuan, but it will help to increase Chinese exports, a way to rebuild their FX reserves. This also reduces the pressure to keep building more worthless buildings, roads, and bridges to nowhere, to keep up their GDP numbers. The overcapacity everywhere is a whole another nightmare hanging over China's head.
With China increasing exports through a weaker currency, that will give a deflationary push on manufactured goods, and also crowd out some of their competitors, a net negative for global growth ex China. All in all, this China situation is a time bomb waiting to explode, and it can do some real damage now that equity prices are so high. Something to look for in 2017.
Thursday, December 22, 2016
Save Your Ammo
There will be better setups to play counter trend. With the down Januarys the past 3 years, investors' short term memories create trading biases which are usually not profitable. When you have strong inflows like you did at the end of the year, it is a clear shift in investor sentiment which doesn't change on a dime. Although my forecast is as an S&P blowoff top that will peak in the spring of 2017, there is still a lot of time between now and then.
When I see Stocktwits SPX and SPY sentiment at bearish levels, I know that retail is wary of this rally and thinks it is going to go right back down like we did in July. On some level, retail traders can't believe that the market is going up on anticipation of Trump goodies. They still view that as an uncertainty, when it is a near certainty that Trump will do massive tax cuts. Republicans never met a tax cut they didn't like, and they control both houses of Congress.
Wait for a better opportunity when retail is on board the bull train. They are still too cautious considering the strong rally for me to want to play a counter trend trade short in S&P.
When I see Stocktwits SPX and SPY sentiment at bearish levels, I know that retail is wary of this rally and thinks it is going to go right back down like we did in July. On some level, retail traders can't believe that the market is going up on anticipation of Trump goodies. They still view that as an uncertainty, when it is a near certainty that Trump will do massive tax cuts. Republicans never met a tax cut they didn't like, and they control both houses of Congress.
Wait for a better opportunity when retail is on board the bull train. They are still too cautious considering the strong rally for me to want to play a counter trend trade short in S&P.
Tuesday, December 20, 2016
Bad News for Contrarians
CNBC's Brian Kelly is short-term bearish stocks and short-term bullish bonds. He is one of my best tells on fast money. Neck and neck with Dennis Gartman for the title of Most Valuable Teller. They tell it like how they feel. And what they feel is what a lot of weak handed fast money feels. If this type of fast money has bought, it means that they have to sell, and sell quickly. It is most valuable when they are doing this counter trend, but it also has decent value when they are running with pack.
This year, Brian Kelly has been continuously bearish stocks and bullish gold and TLT (long term Treasury ETF). He has screamed to get long TLT and gold throughout the year. Those that followed his advice has lost chunks. Those who faded him have made a lot.
This gives me pause when it comes to shorting the market, and I covered S&P after I found out that Brian Kelly was bearish stocks. We will be going higher, bullish sentiment or not, because the money is flowing in and will keep flowing in anticipating Trump goodies. The market is always strongest when anticipating good news, not after the good news has come out.
It seems like the market will be dead for the next several days, so mostly staying on the sidelines and reset for what should be an interesting 2017.
This year, Brian Kelly has been continuously bearish stocks and bullish gold and TLT (long term Treasury ETF). He has screamed to get long TLT and gold throughout the year. Those that followed his advice has lost chunks. Those who faded him have made a lot.
This gives me pause when it comes to shorting the market, and I covered S&P after I found out that Brian Kelly was bearish stocks. We will be going higher, bullish sentiment or not, because the money is flowing in and will keep flowing in anticipating Trump goodies. The market is always strongest when anticipating good news, not after the good news has come out.
It seems like the market will be dead for the next several days, so mostly staying on the sidelines and reset for what should be an interesting 2017.
Monday, December 19, 2016
Not a Long Lasting Trend
The market is now in a trending phase, with stocks and dollar uptrends, and a bond downtrend. Based on what I have mentioned about the Trump tax cuts, and overvaluation and aging population, the fundamentals do not support this trend to continue for much longer. Sure, the market can remain irrational for a long time, but you need the investing public to have something more concrete than Trump magic and hope to keep this rally going. All the measures that Trump will take to boost the economy are short term, and are long term unsustainable because the budget deficit would balloon to a point where the stimulus becomes a net negative, keeping interest rates artificially high.
Soros has stated that the participants in the market are fallible, and oversimplify complex systems. He also mentions that in his theory of reflexivity, two functions determine prices: 1) the perception of reality, and 2) the behavior based on that perception by market participants. I agree with his definition of what moves markets, but his writings make his theories more complex than they really are. He could have explained his theory concisely in a couple of pages, rather than over a half a book.
The current perception of a stronger US economy and higher inflation in the next few years due to Trumponomics is gaining popularity and the prices reinforce the perception, in a feedback loop that keeps the S&P and dollar going higher, and Treasuries lower. But the perception will be tested in 2017 and 2018, because that is when the actual results have to start coming in.
The perception will be invalidated sooner than many people think, as it is based on oversimplistic and overoptimistic logic. It overestimates the ability of fiscal spending and tax cuts to boost the economy when it is already running near full capacity. Fiscal stimulus has always been less effective in boosting the stock market than monetary stimulus. After all, the markets are based on supply and demand, and fiscal stimulus that is tax cut heavy is a mere reallocation of assets from the bond market to a mix of cash, stocks, bonds, and real estate. By making bonds cheaper, they have taken money away from the bond holders' hands and given it to those who get the tax cuts. Theoretically, there is no net addition to the supply of dollars like you would get with monetary stimulus. Monetary stimulus is always the easiest way to boost the stock market, as we have seen since 2008.
If this strong US economy perception gets proven false, it will lead to a spectacular reversal in the stock, dollar, and bond trades. Watch for that sometime in 2017.
I have always traded better around market turns than when the market is strongly trending. It has not been easy to trade as a fader for the last few weeks. But 2017 should provide much better opportunities for those trading based on fundamentals and not short term momentum. Timing is the tricky part, but the tax cut bill being introduced and passed in Congress will probably be close to the climax of this up move. That is likely to happen in the spring of 2017. In the meantime, I will not be taking any long term positions either short stocks or long Treasuries. But after the bill gets passed, it will be time to look to take a long term short (12-18 months) in S&P and long in Treasuries.
Soros has stated that the participants in the market are fallible, and oversimplify complex systems. He also mentions that in his theory of reflexivity, two functions determine prices: 1) the perception of reality, and 2) the behavior based on that perception by market participants. I agree with his definition of what moves markets, but his writings make his theories more complex than they really are. He could have explained his theory concisely in a couple of pages, rather than over a half a book.
The current perception of a stronger US economy and higher inflation in the next few years due to Trumponomics is gaining popularity and the prices reinforce the perception, in a feedback loop that keeps the S&P and dollar going higher, and Treasuries lower. But the perception will be tested in 2017 and 2018, because that is when the actual results have to start coming in.
The perception will be invalidated sooner than many people think, as it is based on oversimplistic and overoptimistic logic. It overestimates the ability of fiscal spending and tax cuts to boost the economy when it is already running near full capacity. Fiscal stimulus has always been less effective in boosting the stock market than monetary stimulus. After all, the markets are based on supply and demand, and fiscal stimulus that is tax cut heavy is a mere reallocation of assets from the bond market to a mix of cash, stocks, bonds, and real estate. By making bonds cheaper, they have taken money away from the bond holders' hands and given it to those who get the tax cuts. Theoretically, there is no net addition to the supply of dollars like you would get with monetary stimulus. Monetary stimulus is always the easiest way to boost the stock market, as we have seen since 2008.
If this strong US economy perception gets proven false, it will lead to a spectacular reversal in the stock, dollar, and bond trades. Watch for that sometime in 2017.
I have always traded better around market turns than when the market is strongly trending. It has not been easy to trade as a fader for the last few weeks. But 2017 should provide much better opportunities for those trading based on fundamentals and not short term momentum. Timing is the tricky part, but the tax cut bill being introduced and passed in Congress will probably be close to the climax of this up move. That is likely to happen in the spring of 2017. In the meantime, I will not be taking any long term positions either short stocks or long Treasuries. But after the bill gets passed, it will be time to look to take a long term short (12-18 months) in S&P and long in Treasuries.
Friday, December 16, 2016
Due for a Pullback
With the Fed turning more hawkish, we have laid the foundation for the market to consolidate its gains and have a pullback. Yellen has decided that the stock market is a little overheated. Trust me, the Fed knew how the market would perceive 3 rate hikes forward guidance. It wanted to cool this freight train down, and I think she will get what she wants, at least for the next several days.
It also coincides with the high optimism and heavy inflows into equity ETFs since the election. It has been over 5 weeks since the election, and that has given most institutional investors plenty of time to add positions and after this Fed announcement, I don't see them adding to positions with just 2 weeks left in the year and with the newly feared January ahead. It used to be that Januarys was a bullish month where investors put risk money to work in the new year. That hasn't been the case since 2014.
I will be shorting the S&P for a trade today and will ride probably hold it into next week. This will be one of my first S&P trades since the election, as the market isn't that good for trading at the moment. I am playing for a post opex pullback as Yellen tries to be the party pooper. Not looking for much, perhaps 20 points down.
It also coincides with the high optimism and heavy inflows into equity ETFs since the election. It has been over 5 weeks since the election, and that has given most institutional investors plenty of time to add positions and after this Fed announcement, I don't see them adding to positions with just 2 weeks left in the year and with the newly feared January ahead. It used to be that Januarys was a bullish month where investors put risk money to work in the new year. That hasn't been the case since 2014.
I will be shorting the S&P for a trade today and will ride probably hold it into next week. This will be one of my first S&P trades since the election, as the market isn't that good for trading at the moment. I am playing for a post opex pullback as Yellen tries to be the party pooper. Not looking for much, perhaps 20 points down.
Thursday, December 15, 2016
Fed are Stock Jockeys
Let's not pretend like the Fed really looks that closely at jobs numbers or inflation, which is their dual mandate. I think they have a single mandate now. It is to control the S&P 500 in a slow and steady ascent. They must have felt like the S&P 500 was getting short term overheated so they threw out another one of their empty forward guidances in the form of 3 rate hikes in 2017. This time, they surprised the market which was expecting the status quo of 2 rate hikes for 2017 and neutral to dovish language. Yellen didn't oblige. Even though these forward guidances are mostly empty promises, this time the bond market is paying attention, so it means these promises aren't as empty as they've been over the past 8 years. The difference between bond market expectations and Fed expectations is as small as I've seen since 2008.
Yellen is without a doubt a lot more hawkish than Bernanke. She will occasionally say things which she knows the market will not like, and she doesn't really seem to care. Bernanke was explicitly trying to pump up the S&P to as high a level as he could get it without losing all credibility. Thankfully he decided to excuse himself from the position so he could cash out from his notoriety.
So with a newly hawkish Fed, what are we to make of the stock market? I think little if anything at all, for now. The equity fund inflows are through the roof, and will help perpetuate this market higher for the next couple of months. The magical thing about this equity rally is that it is based on perception of tax cuts and infrastructure/defense spending, and it can't be disproven until Trump actually has the plan actually enacted, which will be in 2018. So you can live in this fantasy world of how good things will be after Trump's fiscal stimulus gets put to work, and it won't be tested until 2018. That is a long time to anticipate goodies, but it also keeps the hope alive even if the economic data comes in weak in 2017.
That fiscal stimulus hope is the tailwind for the stock market, and a headwind for the bond market. So even though Yellen slowly tries to take away the alcohol from the party, the market is ignoring it because Trump is the one who is providing the punch from the other side.
I continue to stay away from the S&P 500 and will stay away until I see more volatility and/or signs of topping in the market. The odds still favor trading from the long side in SPX but I don't feel comfortable doing that at these lofty levels. The Treasuries look panicky today, and I wouldn't be surprised if we made short term bottom in bonds today or tomorrow. Short-term, we should be locked in a 2.45-2.65% 10 year range. In the intermediate term, there is more bond weakness in early 2017 as the Trump plan becomes clearer and more concrete.
Yellen is without a doubt a lot more hawkish than Bernanke. She will occasionally say things which she knows the market will not like, and she doesn't really seem to care. Bernanke was explicitly trying to pump up the S&P to as high a level as he could get it without losing all credibility. Thankfully he decided to excuse himself from the position so he could cash out from his notoriety.
So with a newly hawkish Fed, what are we to make of the stock market? I think little if anything at all, for now. The equity fund inflows are through the roof, and will help perpetuate this market higher for the next couple of months. The magical thing about this equity rally is that it is based on perception of tax cuts and infrastructure/defense spending, and it can't be disproven until Trump actually has the plan actually enacted, which will be in 2018. So you can live in this fantasy world of how good things will be after Trump's fiscal stimulus gets put to work, and it won't be tested until 2018. That is a long time to anticipate goodies, but it also keeps the hope alive even if the economic data comes in weak in 2017.
That fiscal stimulus hope is the tailwind for the stock market, and a headwind for the bond market. So even though Yellen slowly tries to take away the alcohol from the party, the market is ignoring it because Trump is the one who is providing the punch from the other side.
I continue to stay away from the S&P 500 and will stay away until I see more volatility and/or signs of topping in the market. The odds still favor trading from the long side in SPX but I don't feel comfortable doing that at these lofty levels. The Treasuries look panicky today, and I wouldn't be surprised if we made short term bottom in bonds today or tomorrow. Short-term, we should be locked in a 2.45-2.65% 10 year range. In the intermediate term, there is more bond weakness in early 2017 as the Trump plan becomes clearer and more concrete.
Tuesday, December 13, 2016
Hawkish Fed
If there ever was a time for one to bet on the Fed coming out more hawkish than market expectations, it is this one. I don't remember seeing the investment community this complacent going into an expected rate hike last year at this time. Of course, the market was weaker back then.
Over the past 3 months, the economic data has been beating expectations. The S&P is at an all-time high, which is probably the most important factor. And there is the Trump factor, which will not be mentioned, but is in the back of the mind of Fed officials when they try to forecast growth and inflation.
It is interesting to see that the financial pundits believed the Fed and was expecting 4 rate hikes in 2016 after that December 2015 hike, but they were completely wrong, and the Fed surprised on the dovish side at the March, June, and September meetings this year. I will not mention the other meetings because they seem to be like mini-meetings, where nothing big is decided on. Now with rates higher than in December 2015, the financial pundits are saying 1 or 2 rate hikes for 2017. They have finally figured out the Fed's game, which is to overpromise on rate hikes, and underdeliver. But with those more dovish expectations of the Fed, they are setting themselves up for a disappointment when Yellen starts talking up the economy and inflation expectations.
While I don't think stocks will selloff that much on this news, Treasuries, especially the short end of the yield curve, will probably not like it. If I had to take a position ahead of the FOMC meeting, I would be shorting T-notes.
Over the past 3 months, the economic data has been beating expectations. The S&P is at an all-time high, which is probably the most important factor. And there is the Trump factor, which will not be mentioned, but is in the back of the mind of Fed officials when they try to forecast growth and inflation.
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| CESI/USD Index is Over 60 |
While I don't think stocks will selloff that much on this news, Treasuries, especially the short end of the yield curve, will probably not like it. If I had to take a position ahead of the FOMC meeting, I would be shorting T-notes.
Monday, December 12, 2016
Watch VIX as S&P Rises
I am not getting any imminent signs that the market is topping out. One of my favorite indicators of a market top is when volatility rises with the S&P 500. It is not that common, but it was deadly accurate in forecasting the top in the summer of 2007 and the market weakness in January 2015. I vividly remember when the VIX was stubbornly high in the December 2014 holiday period even though the market had just made a short term bottom and was rallying strongly. If you look at the VIX chart from 2014-2015 below, you will see the VIX stayed above 14, making a higher high as the S&P was making higher highs.
The connection is much more obvious in 2007 when the VIX bottomed out below 10 in February 2007 and preceded to rally with the S&P into the summer, as the S&P was making new highs week after week. Right now, the VIX is making lower lows as the S&P is hitting new highs. So there is no inverse VIX divergence signal with the S&P. You need to be patient here with shorts, as it looks like we will be making higher highs in early 2017. It is too early to try to call a top. Give the rally time till at least February 2017, or whenever the Trump tax cuts get passed, probably sometime in spring 2017.
The connection is much more obvious in 2007 when the VIX bottomed out below 10 in February 2007 and preceded to rally with the S&P into the summer, as the S&P was making new highs week after week. Right now, the VIX is making lower lows as the S&P is hitting new highs. So there is no inverse VIX divergence signal with the S&P. You need to be patient here with shorts, as it looks like we will be making higher highs in early 2017. It is too early to try to call a top. Give the rally time till at least February 2017, or whenever the Trump tax cuts get passed, probably sometime in spring 2017.
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| SPX 2007 |
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| VIX 2007 |
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| SPX 2014-2015 |
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| VIX 2014-2015 |
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| SPX 2016 |
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| VIX 2016 |
Friday, December 9, 2016
Harry Dent on CNBC
Yesterday, Harry Dent showed up on CNBC Futures Now program and unbelievably, I agreed with his views. He sees this up move in stocks as a blowoff move that will form a top in 2017 and believes that Treasuries are the place to put your money when it tops.
He has been bearish for quite some time, and I don't think he's a good market forecaster, but he's got the facts right. Trump's economic plan will be a bust, Europe is a mess, with Italy in trouble, China's real estate bubble is about to blow up, and aging demographics will keep growth low. I also believe his timing is finally right this time, he was bearish way too early, and CNBC called him out on that, and his views were met with a lot of skepticism. And they didn't refute his facts, but just stated that he's been wrong by being bearish, so he can't be believed. But at least he hasn't gone from bearish to bullish near the top, which would be MUCH worse.
In any case, the upside in the S&P is limited, unless we enter a bubble. I put the odds of a bubble forming at around 10%. I would consider a move above S&P 2400 in 2017 as a bubble. I don't believe the market is a bubble now, but it is very overvalued. A bubble has to have two essential things: 1) very overvalued 2) going up quickly. We have the overvalued part, but not the going up quickly part.
I am thinking more and more that the good news top will happen when Trump gets all his tax cut and infrastructure spending plans passed through Congress. Hard to guess what level the S&P will be at that point, but the higher it goes, the harder it will fall in the second half of 2017.
Dow to rally another 10-20%, then plunge to 6,000: Economist Harry Dent
He has been bearish for quite some time, and I don't think he's a good market forecaster, but he's got the facts right. Trump's economic plan will be a bust, Europe is a mess, with Italy in trouble, China's real estate bubble is about to blow up, and aging demographics will keep growth low. I also believe his timing is finally right this time, he was bearish way too early, and CNBC called him out on that, and his views were met with a lot of skepticism. And they didn't refute his facts, but just stated that he's been wrong by being bearish, so he can't be believed. But at least he hasn't gone from bearish to bullish near the top, which would be MUCH worse.
In any case, the upside in the S&P is limited, unless we enter a bubble. I put the odds of a bubble forming at around 10%. I would consider a move above S&P 2400 in 2017 as a bubble. I don't believe the market is a bubble now, but it is very overvalued. A bubble has to have two essential things: 1) very overvalued 2) going up quickly. We have the overvalued part, but not the going up quickly part.
I am thinking more and more that the good news top will happen when Trump gets all his tax cut and infrastructure spending plans passed through Congress. Hard to guess what level the S&P will be at that point, but the higher it goes, the harder it will fall in the second half of 2017.
Dow to rally another 10-20%, then plunge to 6,000: Economist Harry Dent
Wednesday, December 7, 2016
Short Term Thinking
One of the reasons opportunities arise on Wall Street is because of the prevalence of short term thinking. Short term results are emphasized, even though these asset managers talk about the long term while trading in and out of positions on a daily and weekly basis.
You don't see investors stick around with a fund manager if they have a couple of bad years. A few bad months is tolerated, a couple of bad years is not. That kind of investor behavior keeps the fund managers on their toes, always worried about short term performance. This leads to herd like behavior, because one is forgiven for going down with a crowded ship, but going down in a ship as the only passenger leads to pink slips and redemptions.
Right now, the Trump trade of buying the dollar, buying US equities, and selling bonds is pervasive on Wall Street. Even though we are in the late stages of a bull market in both the dollar and stocks. To enter now and buy the dollar and S&P, you are taking a big risk for a small reward. On a PPP basis, the dollar is already overvalued, and speculative positioning is already loaded up on long dollars. For the S&P, at over 2200, you are trading at over 20 times earnings which are growing in the low single digits with rates rising. It is one of the worst times in stock market history to enter a long term investment in the S&P.
These are not big secrets. And although valuations/earnings were mentioned as being a concern in 2015, and earlier this year, almost no mention of it now. It is known, but not mentioned. Because it goes counter to the prevailing theme of having to play the Trump trade, of buying stocks on hopes of big tax cuts, some infrastructure spending, and deregulation. Those are hits of crack, as I mentioned before, which the market will eventually see for what it is: a short term earnings boost that doesn't affect the long term value of US corporations.
Yet the short term thinking of Wall Street buys stocks at what are bad prices for long term investment because that is the safest way to keep their jobs. If they lag the averages and the market keeps going higher without them, they will be fired.
For individual investors, this presents an opportunity to play the other side. Fade the extremes of short term investment flows and build positions for the ride down. The tricky part is the timing, because tops are always harder to time than bottoms. But with the amount of exuberance we are getting off this Trump victory, my gut tells me the top is not far away. I give this bull market 6 months at most.
I have been doing a lot less short term trading and more long term fundamental research. The long term picture looks bad. Overvalued, lots of debt, with no growth, and now with a lot of optimism. But I have refrained from shorting because we are not that far removed from the tumult of earlier this year when the S&P went down to 1812. It usually takes the stock market at least a year to top out after forming such a powerful bottom. But as that scary period gets further and further away from the rear view mirror, the risk of a big move lower gets higher and higher. Hopefully in 2017, the short term behavior of the funds and institutions will provide the exquisite selling opportunity that I am waiting for.
Monday, December 5, 2016
Another Hyped Up Nonevent
The Italian referendum has come and gone, and another midget hurdle has been cleared, although this was supposed to be bad news, with a No vote winning. But it was expected, and honestly, no one outside of Italy really cares. With Brexit, the US election, and now the Italian referendum, the knee jerk selling is lasting less and less. With Brexit, the knee jerk dumb money selling lasted 2 trading days. With the election, it lasted 6 hours. This one, the selling was hardly noticeable, and we went straight back up and above the Friday close with ease.
The crowd is catching on. Or maybe the dumb money is running out of ammo, after selling in the hole after Brexit and the US election. Most of these events are meaningless, at least when they are considered scary events. They are meaningful only in that market participants act surprised that the market did what it did. Like go up on Brexit. Or on Trump winning. Or now this.
The Italians are not leaving the EU unless they are forced out. They are free riding off the credit market benefits of Mario's QE and the frictionless access to other EU markets. There is no way they give that up so they can ignore Brussels, spend like mad, and devalue their currency.
After overnight sessions like today, you can see why volatility is so low. Even these supposedly scary talked up vol events end up being more hype than reality. Eventually the crowd catches on and ignores these events and moves on to the next "scary" thing. You do that for long enough and a lot of complacency builds up for actual meaningful events in the future, things that will actually affect markets for more than a few hours or days.
This S&P market has been quite the bore, and it has lived up to what I expected. A no-touch market. It is only worth touching when volatility is elevated. Now is definitely not one of those times.
The crowd is catching on. Or maybe the dumb money is running out of ammo, after selling in the hole after Brexit and the US election. Most of these events are meaningless, at least when they are considered scary events. They are meaningful only in that market participants act surprised that the market did what it did. Like go up on Brexit. Or on Trump winning. Or now this.
The Italians are not leaving the EU unless they are forced out. They are free riding off the credit market benefits of Mario's QE and the frictionless access to other EU markets. There is no way they give that up so they can ignore Brussels, spend like mad, and devalue their currency.
After overnight sessions like today, you can see why volatility is so low. Even these supposedly scary talked up vol events end up being more hype than reality. Eventually the crowd catches on and ignores these events and moves on to the next "scary" thing. You do that for long enough and a lot of complacency builds up for actual meaningful events in the future, things that will actually affect markets for more than a few hours or days.
This S&P market has been quite the bore, and it has lived up to what I expected. A no-touch market. It is only worth touching when volatility is elevated. Now is definitely not one of those times.
Friday, December 2, 2016
The Five Year
This Treasury maturity is often ignored in favor of either the 10 year or the 30 year, but it is the portion of the curve that has been an enigma. The 5 year is most closely tied to the intermediate term expectations for the Fed funds rate. But the problem is that those intermediate expectations have been wrong. For 8 years. They have been too optimistic about the path and timing of interest rate hikes. And yet the 5 year note still hasn't performed well despite that reality.
Usually you don't get a five year yield that is too far from the current Fed funds rate, unless the current rate is viewed as long term unsustainable. Thus, with the 5 year at 1.8%, the market is viewing rates below 1% as long term unsustainable. But to me, interest rates below 1% seem much more long term sustainable than interest rates at 2% or higher. The growth in government debt supply over the past 10 years makes it unlikely that you can have a big rate rise without hurting a lot of investors. Add in higher duration on that debt compared to 10 years ago and it amplifies the leverage. And when you hurt a lot of investors, what does the Fed do? They start easing. Which is what happened in Japan. They tried to get off the zero bound and they failed miserably.
Japan is an extreme case in being stuck at zero when there is little growth and so much government debt. That is the only way that economy can survive.
There is a lot of Treasury supply. It is not like the German Bund, or other European government bonds. The US government debt to GDP ratio is over 100%, and likely going to rise even faster with Trump and his massive tax cuts. While you would think a lot of supply would cause bond prices to go down, and stay down, but bonds aren't completely priced off of natural supply and demand. There is a little institution called the Fed that intervenes when it thinks there is too much supply.
Along the yield curve, probably the best risk/reward would be the 5 year. It is closely tied to intermediate term Fed rate expectations so with the Fed unlikely to raise too many times before the economy goes sour, there isn't as much downside as the 10 or 30 year, but with enough duration to benefit from a move back into risk free assets when equities get weak.
I believe this bond market selloff cannot continue for the long term. The US is just not growing fast enough, and with worsening demographics, no new revolutionary tech innovation, and a lot of debt, you cannot compared this time period with anything like the last 100 years. As I mentioned yesterday about tax cuts, they act like a hit of crack. Fast acting, but short lived with lots of side effects. Yet, you hear random financial "experts" talk about a possible 6% Fed funds rate like we are back in 1999.
What you are seeing is a slow liquidation and repricing of fiscal policy uncertainty risks associated with big tax cuts and a concurrent big increase in Treasury issuance. Once all the blood is shed in the bond market, there will be an opportunity waiting on the other side. The question is how much more blood needs to be shed.
I am guessing we reach a top in yields sometime in early 2017, when the optimism about Trump's economic plan reaches its peak. Until then, I would be careful buying bonds. I initially thought 2.35% would hold and the market would consolidate between 2.15% and 2.35%. I was wrong. I underestimated the amount of money and long speculative positioning built up this year. The liquidation is still ongoing, although it looks like we hit a climax of selling yesterday. I expect another wave of selling as we get closer to the FOMC meeting in two weeks. I think we go higher in yields into January. Under a worst case scenario, we could have 10 yr yields go up to 2.80-2.90%. But under my base case scenario, I expect yields to top out at 2.60-2.70%.
Usually you don't get a five year yield that is too far from the current Fed funds rate, unless the current rate is viewed as long term unsustainable. Thus, with the 5 year at 1.8%, the market is viewing rates below 1% as long term unsustainable. But to me, interest rates below 1% seem much more long term sustainable than interest rates at 2% or higher. The growth in government debt supply over the past 10 years makes it unlikely that you can have a big rate rise without hurting a lot of investors. Add in higher duration on that debt compared to 10 years ago and it amplifies the leverage. And when you hurt a lot of investors, what does the Fed do? They start easing. Which is what happened in Japan. They tried to get off the zero bound and they failed miserably.
Japan is an extreme case in being stuck at zero when there is little growth and so much government debt. That is the only way that economy can survive.
There is a lot of Treasury supply. It is not like the German Bund, or other European government bonds. The US government debt to GDP ratio is over 100%, and likely going to rise even faster with Trump and his massive tax cuts. While you would think a lot of supply would cause bond prices to go down, and stay down, but bonds aren't completely priced off of natural supply and demand. There is a little institution called the Fed that intervenes when it thinks there is too much supply.
Along the yield curve, probably the best risk/reward would be the 5 year. It is closely tied to intermediate term Fed rate expectations so with the Fed unlikely to raise too many times before the economy goes sour, there isn't as much downside as the 10 or 30 year, but with enough duration to benefit from a move back into risk free assets when equities get weak.
I believe this bond market selloff cannot continue for the long term. The US is just not growing fast enough, and with worsening demographics, no new revolutionary tech innovation, and a lot of debt, you cannot compared this time period with anything like the last 100 years. As I mentioned yesterday about tax cuts, they act like a hit of crack. Fast acting, but short lived with lots of side effects. Yet, you hear random financial "experts" talk about a possible 6% Fed funds rate like we are back in 1999.
What you are seeing is a slow liquidation and repricing of fiscal policy uncertainty risks associated with big tax cuts and a concurrent big increase in Treasury issuance. Once all the blood is shed in the bond market, there will be an opportunity waiting on the other side. The question is how much more blood needs to be shed.
I am guessing we reach a top in yields sometime in early 2017, when the optimism about Trump's economic plan reaches its peak. Until then, I would be careful buying bonds. I initially thought 2.35% would hold and the market would consolidate between 2.15% and 2.35%. I was wrong. I underestimated the amount of money and long speculative positioning built up this year. The liquidation is still ongoing, although it looks like we hit a climax of selling yesterday. I expect another wave of selling as we get closer to the FOMC meeting in two weeks. I think we go higher in yields into January. Under a worst case scenario, we could have 10 yr yields go up to 2.80-2.90%. But under my base case scenario, I expect yields to top out at 2.60-2.70%.
Thursday, December 1, 2016
Tax Cuts Have a Price
Bonds are the main show. Despite what you hear about all the Trump theme plays, like financials and industrials, the big move is happening in bonds. The carnage is extreme and will have lasting implications for the sustainability of this bull market. The stock market is not strong enough or cheap enough to sustain an uptrend with this kind of relentless rise in yields. At a certain point, the high dividend plays become roach motels and bonds become more attractive on a relative value basis.
The Trump experiment of having big tax cuts and big deficits is taking from one hand and giving it to another. They are taking money away from bond holders and giving them to the high income earners, corporations, and to equity holders. Lighting a flaming torch to all those bonds outstanding is a bold experiment in testing how deeply dependent financial markets are on low interest rates. The global economy will collapse under a huge weight of debt if Trump gets 100% of what he wants.
QE is free money. Tax cuts are not free money. There is no price to pay in the financial markets with QE. But there is one to pay with tax cuts. When there is no QE, the price to be paid for running up huge budget deficits is higher interest rates. An economy growing like it did in the 1980s and 1990s can handle a 10 yr yield above 5%. An economy this weak would go into a deep recession if the yields got even a sniff of that level.
I am not saying we will keep selling off in bonds and enter a bond bear market. But too many equity investors are sanguine about rising interest rates. They are what cash flows are discounted off of. I have serious doubts that these tax cuts will boost growth as many think. The Bush tax cuts did very little for the economy from 2001 to 2012. Most tax cuts are saved, not spent as many people think. And since most of the Trump tax cuts will go to the rich, most of the extra money will be saved. You are mostly shifting savings from the bond market to a mix of stocks, bonds, real estate, and cash.
While Trump has succeeded in killing the bond market, I don't think he will succeed in keeping the equity bull market going. The best way to support the financial markets as we have seen over the past 7 years is through monetary policy, not fiscal policy. As I figured, the end game for this bull market would come on hopes for a stronger economy, which would take away the monetary policy stimulus this bull market has thrived off of. If I am long stocks, a Fed feeling confident about the economy and higher inflation is the last thing I would want to see.
The Trump experiment of having big tax cuts and big deficits is taking from one hand and giving it to another. They are taking money away from bond holders and giving them to the high income earners, corporations, and to equity holders. Lighting a flaming torch to all those bonds outstanding is a bold experiment in testing how deeply dependent financial markets are on low interest rates. The global economy will collapse under a huge weight of debt if Trump gets 100% of what he wants.
QE is free money. Tax cuts are not free money. There is no price to pay in the financial markets with QE. But there is one to pay with tax cuts. When there is no QE, the price to be paid for running up huge budget deficits is higher interest rates. An economy growing like it did in the 1980s and 1990s can handle a 10 yr yield above 5%. An economy this weak would go into a deep recession if the yields got even a sniff of that level.
I am not saying we will keep selling off in bonds and enter a bond bear market. But too many equity investors are sanguine about rising interest rates. They are what cash flows are discounted off of. I have serious doubts that these tax cuts will boost growth as many think. The Bush tax cuts did very little for the economy from 2001 to 2012. Most tax cuts are saved, not spent as many people think. And since most of the Trump tax cuts will go to the rich, most of the extra money will be saved. You are mostly shifting savings from the bond market to a mix of stocks, bonds, real estate, and cash.
While Trump has succeeded in killing the bond market, I don't think he will succeed in keeping the equity bull market going. The best way to support the financial markets as we have seen over the past 7 years is through monetary policy, not fiscal policy. As I figured, the end game for this bull market would come on hopes for a stronger economy, which would take away the monetary policy stimulus this bull market has thrived off of. If I am long stocks, a Fed feeling confident about the economy and higher inflation is the last thing I would want to see.
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