Risk/Reward Vol 372
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
For the reasons discussed last week (TINA, improved economy and cheap money), I, for one, was not surprised by the record setting week that Mr. Market just experienced. As has been the case often this year, Amazon led the charge. Up nearly 5%% for the week and over 58% year to date, Mr. Bezos' company not only has made him the richest man in the world ($100billion net worth), but also the most feared. Indeed, the specter of Amazon domination in such varied fields as entertainment and drug delivery has spurred a bevy of big time merger talks including ATT/Time Warner, CVS/Aetna and Disney/Fox. The boxes bearing the distinctive Amazon tape that accumulate in our building's mail room and the hours I spend watching Trial and Retribution, Red Oak and Catastrophe are testaments to the power of that juggernaut.
Although I remain generally bullish on the market, I am neither a Pollyanna nor a Jeremiah. One would be foolish not to peer over the horizon in search of that which may disrupt this unprecedented string of upward moves. As I have written in previous editions, today reminds me of sitting in board meetings in 2006 of a company that was heavily reliant upon construction and land development. We sensed that the real estate boom could not last forever. We just did not know when it would end. We created a "canary in the mine shaft" report that we thought would give us visibility on a collapse. It worked, but no report could have predicted the severity of the crash of 2008. As suggested last week, I believe there are some canaries worth watching today. Inflation and monetary policy always merit monitoring, but frankly with central banks so attuned to these I don't see them as the cause of any sudden reversal. But credit risk, that is a different matter.
What do I mean? Remember Lehman Brothers? Back in 2008 it was a major player in the financial world serving as a prime broker and counterparty for several large institutions. In order to boost its own profits, Lehman Brothers bet heavily on the highly illiquid subprime mortgage market. When that market suffered a host of reversals, Lehman found itself in a cash crunch and filed for bankruptcy. This caused a run on various types of credit insurance (swaps, etc.) held by AIG and others. The ensuing game of financial musical chairs froze the credit markets world wide. Central banks were forced to cheapen the cost of and to backstop virtually all credit. Thus began the current era of low interest rates and quantitative easing. We have yet return to anything close to "normal" prompting some to call this era of easy money the "new normal."
But, the new normal has its own risks. With rates at record lows for nearly a decade and with so much money available, investors seeking a return, even conservative ones like insurance companies and pension funds, have been forced into much riskier assets. Equities, junk bonds, emerging country sovereign debt and senior loans have replaced triple A rated government bonds in their portfolios. Indeed, a recent report by the Chicago branch of the Federal Reserve noted that credit conditions are as loose as they have been since 1993---looser than they were in 2006. Small wonder the yield on European junk bonds fell below 2% this week for the first time ever. As the stretch for yield causes money to flow into even riskier investments, the threat of default increases. And it is credit defaults, not disappointing earnings, rate increases or inflation that in my humble opinion will take the oxygen out this market.
It is only prudent that you find your own canary.
Sunday, November 26, 2017
Sunday, November 19, 2017
November 19, 2017 Limited Supply
Risk/Reward Vol. 371
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
On Wednesday, all three major indices dropped. The S&P 500 lost more than 0.5% for the first time in 50 trading days, the longest such streak since 1965. Reading the financial press the next morning, one would have thought a bear market was afoot. That is until the trading day began. Bang. Bear talk disappeared as the bulls ran again. By the close Thursday, both the Dow Jones Industrial Average and the S&P 500 were up 0.8% and the NADAQ jumped 1.3%. Apparently, every reporter is looking to break the news that a correction is impending, even if one is no where in sight. Lost in the reports was the fact that Wednesday's slip notwithstanding, the S&P has fallen by 1% in a single day only four times this year, its fewest since 1964 and that it has not had 3% intraday drop in over 250 days--an all time record.
Why do stocks continue to rise, Fridays' negative close notwithstanding? As I have preached ad nauseam herein, one reason is that with interest rates so low, there simply is no alternative to stocks right now (TINA). Another reason is that the economy seems to be improving. A third reason is that there are fewer stock issues to buy. Allow me to explain. A limited supply means a higher price---Econ 101. In 1996 there were 7522 publicly traded companies in the US, the stock of which was yours to buy. Today, there are only 3671 public companies. How come? Thanks to central bank policies (quantitative easing, low rates, etc.) the financial world is awash in money. With so much money available, fast growing companies need not look to the public markets for capital. They can access private equity and other such entities which are hungry to put their capital to work. In 1996, 845 companies went public. In 2016, only 127 did. Concomitantly, undervalued public companies can access that same ready source of capital to go private. Read Jason Thomas' piece in Friday's Wall Street Journal on the implications of this development. One takeaway is that the reduction in the number of stock issues available to purchase has contributed to stock prices being less correlated to an individual company's fundamentals and more correlated to fund flows into the market in general.
For the few of us who remain fixated on interest rates and are less fascinated by stock prices (our numbers seem to be dwindling), comments by Robert Kaplan on Tuesday, a noted Federal Reserve dove, caused a minor panic in the fixed income community. He stated that he now is considering voting to raise short term interest rates in December and three times in 2018. I took the opportunity to buy one of my favorites (HPS) on the cheap. It recovered nicely the next day as Mrs. Bond came to see that the rise in short term rates resulting from Kaplan's comments had not adversely impacted longer term rates (read the rate on the10Year US Treasury Bond) and thus should not impact the securities correlated thereto such as HPS. Indeed, the spread between the interest rate on the 2Year versus the 10Year US Treasury Bond has contracted to less than 65 basis points, the flattest since November, 2007. This indicates that Mrs. Bond is pricing in the raises discussed by Kaplan yet still believes the prospects for inflation remain subdued. The persistence of lower longer term rates means that the era of easy money likely will continue even if the Fed increases rates on the short end of the curve. Indeed, with rates so low, corporations and governments are borrowing like mad. Corporate bond issuances are on a record pace and junk bond issuances are 17% higher than in 2016. The issuance of bonds by emerging market countries is through the roof. I read this to mean that the continuation of easy money is less threatened by rate risk than by default risk. (Venezuela anyone? Venezuela? Or 2006? 2006?). But that discussion is for another day.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
On Wednesday, all three major indices dropped. The S&P 500 lost more than 0.5% for the first time in 50 trading days, the longest such streak since 1965. Reading the financial press the next morning, one would have thought a bear market was afoot. That is until the trading day began. Bang. Bear talk disappeared as the bulls ran again. By the close Thursday, both the Dow Jones Industrial Average and the S&P 500 were up 0.8% and the NADAQ jumped 1.3%. Apparently, every reporter is looking to break the news that a correction is impending, even if one is no where in sight. Lost in the reports was the fact that Wednesday's slip notwithstanding, the S&P has fallen by 1% in a single day only four times this year, its fewest since 1964 and that it has not had 3% intraday drop in over 250 days--an all time record.
Why do stocks continue to rise, Fridays' negative close notwithstanding? As I have preached ad nauseam herein, one reason is that with interest rates so low, there simply is no alternative to stocks right now (TINA). Another reason is that the economy seems to be improving. A third reason is that there are fewer stock issues to buy. Allow me to explain. A limited supply means a higher price---Econ 101. In 1996 there were 7522 publicly traded companies in the US, the stock of which was yours to buy. Today, there are only 3671 public companies. How come? Thanks to central bank policies (quantitative easing, low rates, etc.) the financial world is awash in money. With so much money available, fast growing companies need not look to the public markets for capital. They can access private equity and other such entities which are hungry to put their capital to work. In 1996, 845 companies went public. In 2016, only 127 did. Concomitantly, undervalued public companies can access that same ready source of capital to go private. Read Jason Thomas' piece in Friday's Wall Street Journal on the implications of this development. One takeaway is that the reduction in the number of stock issues available to purchase has contributed to stock prices being less correlated to an individual company's fundamentals and more correlated to fund flows into the market in general.
For the few of us who remain fixated on interest rates and are less fascinated by stock prices (our numbers seem to be dwindling), comments by Robert Kaplan on Tuesday, a noted Federal Reserve dove, caused a minor panic in the fixed income community. He stated that he now is considering voting to raise short term interest rates in December and three times in 2018. I took the opportunity to buy one of my favorites (HPS) on the cheap. It recovered nicely the next day as Mrs. Bond came to see that the rise in short term rates resulting from Kaplan's comments had not adversely impacted longer term rates (read the rate on the10Year US Treasury Bond) and thus should not impact the securities correlated thereto such as HPS. Indeed, the spread between the interest rate on the 2Year versus the 10Year US Treasury Bond has contracted to less than 65 basis points, the flattest since November, 2007. This indicates that Mrs. Bond is pricing in the raises discussed by Kaplan yet still believes the prospects for inflation remain subdued. The persistence of lower longer term rates means that the era of easy money likely will continue even if the Fed increases rates on the short end of the curve. Indeed, with rates so low, corporations and governments are borrowing like mad. Corporate bond issuances are on a record pace and junk bond issuances are 17% higher than in 2016. The issuance of bonds by emerging market countries is through the roof. I read this to mean that the continuation of easy money is less threatened by rate risk than by default risk. (Venezuela anyone? Venezuela? Or 2006? 2006?). But that discussion is for another day.
Sunday, November 12, 2017
November 12, 2017 Tax Flop
Risk/Reward Vol. 370
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
OK. So as a result of the collapse of the President's tax plan the Dow Jones Industrial Average suffered its first negative close in eight weeks. But c'mon guys, down a measly 0.5%? That is hardly a blip. I stand by my previous statement that tax reform or not, the stock market will continue at current or higher levels until a reasonable alternative arises. And that alternative does not appear to be bonds any time soon. The rate on the all important U S Treasury 10 Year Bond continues to hover around 2.4%, hardly an attractive return. I highly recommend a read of Martin Wolf's column in Saturday's Financial Times. He addresses the entire low-interest-rate=stock-bubble debate in a succinct yet comprehensive manner. His take is that even though stocks are in historic Shiller PE territory (above 30x) we are also experiencing historically and persistently low interest rates. For a host of reasons, he does not see this predicament ending soon.
And speaking of historically low rates, I do mean HISTORICALLY LOW rates. Recently the Bank of England (the British central bank) did an analysis of world wide interest rates back to the 13th Century. That was at the dawning of a banking renaissance in Siena and Florence; banking that had not been so robust since Roman times. The BOE found that the rates prevailing in the spring and summer of 2016 were lower than at any time since at least 1273. Given the depth of this interest rate trough and how little rates have risen in the past year, I do not see bonds providing a reasonable return for conservative investors any time soon. Those that play the bond market for capital gains (think shorting) may do well if rates start to climb, but I suspect it will be a long time before traditional fixed income securities provide a livable return.
Lost in the news surrounding tax reform (or more appropriately the lack thereof) is the amazing story in oil. Do you appreciate the level of turmoil afoot in Saudi Arabia right now? Between sabre rattling with Iran and arrests in the royal family, the world outside the US is getting very nervous about a secure supply of petroleum from its largest producer. Indeed, the price of oil on the international market (Brent) is now above $64/barrel. In contrast, WTI (US price oil) is $56/bbl. Indeed, had the problems in Arabia arisen before our post 2008 oil boom they would have dominated our headlines. Now they are a page 3 item at best. Between our record high domestic production (thanks to fracking) and the improved supply from Canada, North America is getting close to energy independence. And frankly were supplies to be totally cut off, between our reserves and our ability to ramp up production we could get by. Not so the rest of the world. This gives us a 'uu-uge advantage. One that is rarely discussed these days outside this publication.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
OK. So as a result of the collapse of the President's tax plan the Dow Jones Industrial Average suffered its first negative close in eight weeks. But c'mon guys, down a measly 0.5%? That is hardly a blip. I stand by my previous statement that tax reform or not, the stock market will continue at current or higher levels until a reasonable alternative arises. And that alternative does not appear to be bonds any time soon. The rate on the all important U S Treasury 10 Year Bond continues to hover around 2.4%, hardly an attractive return. I highly recommend a read of Martin Wolf's column in Saturday's Financial Times. He addresses the entire low-interest-rate=stock-bubble debate in a succinct yet comprehensive manner. His take is that even though stocks are in historic Shiller PE territory (above 30x) we are also experiencing historically and persistently low interest rates. For a host of reasons, he does not see this predicament ending soon.
And speaking of historically low rates, I do mean HISTORICALLY LOW rates. Recently the Bank of England (the British central bank) did an analysis of world wide interest rates back to the 13th Century. That was at the dawning of a banking renaissance in Siena and Florence; banking that had not been so robust since Roman times. The BOE found that the rates prevailing in the spring and summer of 2016 were lower than at any time since at least 1273. Given the depth of this interest rate trough and how little rates have risen in the past year, I do not see bonds providing a reasonable return for conservative investors any time soon. Those that play the bond market for capital gains (think shorting) may do well if rates start to climb, but I suspect it will be a long time before traditional fixed income securities provide a livable return.
Lost in the news surrounding tax reform (or more appropriately the lack thereof) is the amazing story in oil. Do you appreciate the level of turmoil afoot in Saudi Arabia right now? Between sabre rattling with Iran and arrests in the royal family, the world outside the US is getting very nervous about a secure supply of petroleum from its largest producer. Indeed, the price of oil on the international market (Brent) is now above $64/barrel. In contrast, WTI (US price oil) is $56/bbl. Indeed, had the problems in Arabia arisen before our post 2008 oil boom they would have dominated our headlines. Now they are a page 3 item at best. Between our record high domestic production (thanks to fracking) and the improved supply from Canada, North America is getting close to energy independence. And frankly were supplies to be totally cut off, between our reserves and our ability to ramp up production we could get by. Not so the rest of the world. This gives us a 'uu-uge advantage. One that is rarely discussed these days outside this publication.
Sunday, November 5, 2017
November 5, 2017 Powell
Risk/Reward Vol. 369
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
When will it ever end? Several months ago I quoted Jim Paulsen, the well respected former chief investment strategist for Wells Fargo, who said that the current stock market rally could last forever. He may be right. Whether he is or not, the events of this week set the table for the bulls to keep running.
First, the President nominated Jerome Powell as the next Federal Reserve Chair. As has been discussed at length in this publication, Mr. Market has been worried that The Donald would name Congressional Republican favorites John Taylor or Kevin Warsh. Their nomination would have caused a negative reaction in the markets as the prospect of higher interest rates sooner would have heightened. Mr. Powell has been aligned with both Bernanke and Yellen in rate setting policy and with Yellen in the gradual reduction of the Fed's balance sheet. In other words, the clear path set by Yellen which Mohammed El Erian has termed "a beautiful normalization" and which Mr. Market has loved will continue.
Second, the Republican tax reform bill went public this week. Can anyone say "hot mess". I mean really guys and gals could you publish a more distasteful POS? In its current form, it contains something to piss off everyone and stands as much chance of passage as camel through the eye of a needle. And yet...And yet...And yet. This mishigas notwithstanding all three of the major indices closed the week at record highs. As I reported last week, I don't see the market's performance being adversely affected by the success or failure of any tax proposal. Think TINA (There Is No Alternative)!
Third, the economy is humming. More than 75% of the S&P 500 beat earnings estimates last quarter which is well above average. As of Friday's report, unemployment is at a 17 year low. Add to this the fact that growth in 3rd quarter gross domestic product came in above 3% on an annualized basis. The insanity in DC aside, what could be better? To this last point, one is left to marvel as to how out of touch our government and those who report the news really are. As sick as all of the Harvey Weinstein inspired stories have been at least they have taken politics off the front page. Unfortunately, Mr. Market has not been able to change headlines despite experiencing an incredible year so far.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
When will it ever end? Several months ago I quoted Jim Paulsen, the well respected former chief investment strategist for Wells Fargo, who said that the current stock market rally could last forever. He may be right. Whether he is or not, the events of this week set the table for the bulls to keep running.
First, the President nominated Jerome Powell as the next Federal Reserve Chair. As has been discussed at length in this publication, Mr. Market has been worried that The Donald would name Congressional Republican favorites John Taylor or Kevin Warsh. Their nomination would have caused a negative reaction in the markets as the prospect of higher interest rates sooner would have heightened. Mr. Powell has been aligned with both Bernanke and Yellen in rate setting policy and with Yellen in the gradual reduction of the Fed's balance sheet. In other words, the clear path set by Yellen which Mohammed El Erian has termed "a beautiful normalization" and which Mr. Market has loved will continue.
Second, the Republican tax reform bill went public this week. Can anyone say "hot mess". I mean really guys and gals could you publish a more distasteful POS? In its current form, it contains something to piss off everyone and stands as much chance of passage as camel through the eye of a needle. And yet...And yet...And yet. This mishigas notwithstanding all three of the major indices closed the week at record highs. As I reported last week, I don't see the market's performance being adversely affected by the success or failure of any tax proposal. Think TINA (There Is No Alternative)!
Third, the economy is humming. More than 75% of the S&P 500 beat earnings estimates last quarter which is well above average. As of Friday's report, unemployment is at a 17 year low. Add to this the fact that growth in 3rd quarter gross domestic product came in above 3% on an annualized basis. The insanity in DC aside, what could be better? To this last point, one is left to marvel as to how out of touch our government and those who report the news really are. As sick as all of the Harvey Weinstein inspired stories have been at least they have taken politics off the front page. Unfortunately, Mr. Market has not been able to change headlines despite experiencing an incredible year so far.
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