Risk/Reward Vol. 391
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
Corporate America is well on its way to a record earnings season. Profits are up on average 25% over Q1 2017, and more than 80% of reporting companies have beaten forecasts. Some market leaders such as Boeing and Amazon have dazzled. Moreover, the economy grew at a respectable 2.3% in the first quarter, and peace on the Korean peninsula seems possible for the first time in nearly 70 years. Nonetheless, all three averages finished the week lower than last. How can this be? Perhaps what John Authers saw a few weeks ago is coming to pass: to wit, the favorable impact of tax reform has already been baked into stock prices. Whatever the reason, one is at a loss as to what if anything can spur this market.
Meanwhile, Mr. Market seems to be warming to a 3% yield on the US Ten Year Bond and a nearly 2.5% yield on the 2Year. Although I never thought Barb and I would find such paltry returns attractive, we have decided to park some cash in one year CD's yielding 2.2%. We are not alone. I have it on good authority that some other subscribers are making similar moves. Rumor has it one has started a short bond ladder. Frankly the older I get the more attractive these meager returns look. Moreover for a host of reasons including the differential between domestic and ECB rates and the futures market now pricing a 50% probability of four Fed hikes this year, I don't see yields increasing much more in the near term.
One factoid in Friday's Financial Times I found troubling. According to Gillian Tett (whose reporting I find credible), the quality of commercial loans in the United States is deteriorating. She noted that in 2007 Single B (risky) loans represented 25% of US lending portfolios. Now more than 65% of loans are rated Single B. Moreover, over 75% of loans have "lite" covenants which means that lenders have limited tools with which to collect. This is a natural byproduct of a decade of easy money and subsidized rates. Fortunately the percentage of these risky loans held by non traditional lenders (not banks) has also increased which should lessen the effect should defaults increase. Nevertheless, this is something to watch.
Sunday, April 29, 2018
Sunday, April 22, 2018
April 22, 2018 Authers Continued
Risk/Reward Vol. 390
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Rumors that Cohen will cop a plea, another mistress ready to publish, a series of Comey interviews, the release of FBI memos, McCabe referred for possible criminal prosecution and the DNC suing Russia and The Donald's campaign---actually a pretty tame week in Trumpland. That said, not even continued strong earnings from money center banks and from recent market laggard GE inspired Mr. Market as the major indices closed essentially flat for the week. The biggest drag on stocks appeared to be the continuing rise in short term rates and the spike in the 10 Year U S Treasury yield. Indeed, rates/yields loom so important they warrant a deeper look.
Exactly one year ago the 2Year US Bond yielded 1.176%. It closed Friday yielding 2.45%. In fact it is trading where it did in August, 2008: a time before the collapse of Lehman Brothers, a time before the Great Recession and a time when the 10Year was yielding nearly 4%. On Tuesday, before its spike later in the week, the 10Year yield was a mere 41 basis points above that of the 2 Year, considerably below the long term average of 1% and the lowest spread to the 2Year in a decade. Historically, when the yield on the 2 year is less than the yield on the 10 Year (termed an "inverted yield curve") a recession is signaled. Thus, the sudden jump in the 10Year yield later in the week to 2.95% was viewed with relief by some economists even if not by Mr. Market. His enthusiasm was tempered by words from noted market bull Jeremy Siegel who is convinced that a 10Year rate of 3.25% this year will be bad for stocks.
So why is the 2Year rate escalating, John Boy ? (One of my nicknames in law school; despite never being a fan of The Waltons) Because unlike the 10Year, the 2Year is closely correlated to the Fed Funds (overnight) rate. And even though wags were convinced after March's Fed meeting that only 3 Fed Funds rate increases were in the ,cards for 2018, I pointed out that that opinion was based upon the vote of 8 of 15 members and that a switch by any one member could result in 4 increases this year. (See Vol. 386 http://www.riskrewardblog.blogspot.com/ ). Given the presence of inflation-creep (note the report from the Philly Fed this past week), the futures market is now pricing in a 44% probability that 2018 will indeed see four rate increases in 2018. The 2Year is merely reflecting that sentiment.
PS. I drafted this edition Friday afternoon after the close of the market. I should have waited and not wasted my time. Saturday morning's edition of The Financial Times has a column entitled "The Long View" written by my favorite financial reporter, John Authers. It is a much better explanation than mine of what is happening in the all-important US government bond market. In a word, the article is elegant. It can be found here: https://www.blogpvan.org/main/investors-cannot-ignore-the-message-of-the-us-bond-market/ I recommend it to your attention.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Rumors that Cohen will cop a plea, another mistress ready to publish, a series of Comey interviews, the release of FBI memos, McCabe referred for possible criminal prosecution and the DNC suing Russia and The Donald's campaign---actually a pretty tame week in Trumpland. That said, not even continued strong earnings from money center banks and from recent market laggard GE inspired Mr. Market as the major indices closed essentially flat for the week. The biggest drag on stocks appeared to be the continuing rise in short term rates and the spike in the 10 Year U S Treasury yield. Indeed, rates/yields loom so important they warrant a deeper look.
Exactly one year ago the 2Year US Bond yielded 1.176%. It closed Friday yielding 2.45%. In fact it is trading where it did in August, 2008: a time before the collapse of Lehman Brothers, a time before the Great Recession and a time when the 10Year was yielding nearly 4%. On Tuesday, before its spike later in the week, the 10Year yield was a mere 41 basis points above that of the 2 Year, considerably below the long term average of 1% and the lowest spread to the 2Year in a decade. Historically, when the yield on the 2 year is less than the yield on the 10 Year (termed an "inverted yield curve") a recession is signaled. Thus, the sudden jump in the 10Year yield later in the week to 2.95% was viewed with relief by some economists even if not by Mr. Market. His enthusiasm was tempered by words from noted market bull Jeremy Siegel who is convinced that a 10Year rate of 3.25% this year will be bad for stocks.
So why is the 2Year rate escalating, John Boy ? (One of my nicknames in law school; despite never being a fan of The Waltons) Because unlike the 10Year, the 2Year is closely correlated to the Fed Funds (overnight) rate. And even though wags were convinced after March's Fed meeting that only 3 Fed Funds rate increases were in the ,cards for 2018, I pointed out that that opinion was based upon the vote of 8 of 15 members and that a switch by any one member could result in 4 increases this year. (See Vol. 386 http://www.riskrewardblog.blogspot.com/ ). Given the presence of inflation-creep (note the report from the Philly Fed this past week), the futures market is now pricing in a 44% probability that 2018 will indeed see four rate increases in 2018. The 2Year is merely reflecting that sentiment.
PS. I drafted this edition Friday afternoon after the close of the market. I should have waited and not wasted my time. Saturday morning's edition of The Financial Times has a column entitled "The Long View" written by my favorite financial reporter, John Authers. It is a much better explanation than mine of what is happening in the all-important US government bond market. In a word, the article is elegant. It can be found here: https://www.blogpvan.org/main/investors-cannot-ignore-the-message-of-the-us-bond-market/ I recommend it to your attention.
Sunday, April 15, 2018
April 15, 2018 Syria
Risk/Reward Vol. 389
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Economic and investing fundamentals be damned. I remain of the opinion that this market is about Donald Trump. Except for Friday (discussed below) Trump dominated every day this week. On Monday a bullish market plummeted in the last hour of trading on news that the FBI had raided The Donald's lawyer's office. Tuesday stocks rose as The Donald's tough language seemed to soften China's position on auto imports and patent protection. Stocks fell on Wednesday as our President taunted Syria and Russia to "get ready" for air strikes, and a Trump-frustrated Paul Ryan announced his retirement. Thursday's market rose on a Presidential tweet that the air strikes were not imminent. Mr. Market has become Mr. Trump---unpredictable and mercurial. In fact, although the Dow and the S&P remain within 2% of where each began the year, the Dow has made triple digit moves (some up, some down) in 21 of its last 25 trading days. Exhausting, isn't it.
Given the move against Syria on Friday night, it is likely that market fundamentals will be overshadowed once again by The Donald. But if that is not the case, Friday may be a harbinger. Despite record earnings reported by JP Morgan Chase and others, banks took a big hit with JPM down 2.7% and Wells Fargo down 3%. Officially beating The Street's estimates, they nevertheless disappointed Mr. Market who was looking for considerably more loan growth. This reaction caused John Authers to write in Saturday's Financial Times that any favorable impact that tax reform has had on earnings may already be baked into stock prices. Thus even blockbuster profits may not be enough to spark a rally. Time will tell as earnings season is in full swing next week.
Having spent the past week nursing my mother and her broken wrist instead of vacationing in Sicily, my attitude may be a little darker than usual. But concern is justified. Short term, Paul Ryan's resignation cannot be viewed as good for the equity markets. Clearly, Ryan sees the Democrats taking control of the House (and maybe the Senate) come November. If that occurs, impeachment proceedings likely will ensue plummeting the country and the world into a period of grave uncertainty. And as we all know, Mr. Market abhors uncertainty. Longer term doesn't look so great either. The Pew Research Center just reported that 33% of all 25-29 year olds in the US live with their parents or grandparents---three times as many as in 1970. I leave to you to debate the reasons. But the fact that so many have failed to launch does not portend well for a population that is already demographically challenged.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Economic and investing fundamentals be damned. I remain of the opinion that this market is about Donald Trump. Except for Friday (discussed below) Trump dominated every day this week. On Monday a bullish market plummeted in the last hour of trading on news that the FBI had raided The Donald's lawyer's office. Tuesday stocks rose as The Donald's tough language seemed to soften China's position on auto imports and patent protection. Stocks fell on Wednesday as our President taunted Syria and Russia to "get ready" for air strikes, and a Trump-frustrated Paul Ryan announced his retirement. Thursday's market rose on a Presidential tweet that the air strikes were not imminent. Mr. Market has become Mr. Trump---unpredictable and mercurial. In fact, although the Dow and the S&P remain within 2% of where each began the year, the Dow has made triple digit moves (some up, some down) in 21 of its last 25 trading days. Exhausting, isn't it.
Given the move against Syria on Friday night, it is likely that market fundamentals will be overshadowed once again by The Donald. But if that is not the case, Friday may be a harbinger. Despite record earnings reported by JP Morgan Chase and others, banks took a big hit with JPM down 2.7% and Wells Fargo down 3%. Officially beating The Street's estimates, they nevertheless disappointed Mr. Market who was looking for considerably more loan growth. This reaction caused John Authers to write in Saturday's Financial Times that any favorable impact that tax reform has had on earnings may already be baked into stock prices. Thus even blockbuster profits may not be enough to spark a rally. Time will tell as earnings season is in full swing next week.
Having spent the past week nursing my mother and her broken wrist instead of vacationing in Sicily, my attitude may be a little darker than usual. But concern is justified. Short term, Paul Ryan's resignation cannot be viewed as good for the equity markets. Clearly, Ryan sees the Democrats taking control of the House (and maybe the Senate) come November. If that occurs, impeachment proceedings likely will ensue plummeting the country and the world into a period of grave uncertainty. And as we all know, Mr. Market abhors uncertainty. Longer term doesn't look so great either. The Pew Research Center just reported that 33% of all 25-29 year olds in the US live with their parents or grandparents---three times as many as in 1970. I leave to you to debate the reasons. But the fact that so many have failed to launch does not portend well for a population that is already demographically challenged.
Sunday, April 8, 2018
April 8, 2018 Liquidity
Risk/Reward Vol. 388
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Another week, another roller coaster ride. This time it was talk of a trade war. Monday's downdraft was stemmed and reversed by the calming voice of Larry Kudlow. But saber rattling later in the week reinvigorated the bears. Tariffs may have been the topic this week, but at its core, the insanity in the market lays at the feet of (or more accurately at the mouth of ) The Donald. Not even a very interesting jobs report on Friday (discussed below) moved the needle. Next week it will be a government shake up or another mistress or a Mueller revelation or an improvident Tweet. Let's face it folks, he loves controversy. If none exists, even for a moment, either he or his detractors will create some. What a way to live.
Although lost in the tariff kerfuffle, the jobs report on Friday was a curious one. The number of new jobs fell short of expectation, but the unemployment rate remained at historic lows. Of more importance was the higher than expected growth in wages. Although still short of signaling the arrival of inflation, the trend is such that the Fed may have to act more aggressively should the Holy Grail of 2% inflation be exceeded any time soon. Remember, although the commentators proclaimed that only three rate increases are to be expected in 2018, they did so based upon the fact that 8 of 15 voting members of the FOMC so indicated on their March "dot plots." Seven indicated that four raises would be appropriate. Should inflation spike, that narrow majority could dissolve. Should the Fed be more aggressive in rate hikes it would have an adverse effect on equities. So heads up.
And speaking of heads up, I recommend that you Google and read Jamie Dimon's letter to the JPMorgan Chase stockholders. It is a comprehensive overview from an extremely knowledgeable man. He addresses a wide range of topics, but highlighting lack of liquidity (set forth below) about which I have written in the past is particularly noteworthy. Lack of liquidity creates a bottleneck which in turn promotes volatility which can lead to panics. Remember the Taper Tantrum of 2013.
Far more money than before (about $9 trillion of assets, which represents about 30% of total mutual fund long-term assets) is managed passively in index funds or ETFs (both of which are very easy to get out of). Some of these funds provide far more liquidity to the customer than the underlying assets in the fund, and it is reasonable to worry about what would happen if these funds went into large liquidation.
Market making is dramatically smaller than in the past (e.g., aggregate primary dealer positions of bonds — including Treasury and agency securities, mortgage-backed securities and corporates — averaged $530 billion in 2007 vs. an average of $179 billion today). While in the past that total may have been too high, virtually every asset manager says today it is much harder to buy and sell securities, particularly the less liquid securities.
Liquidity requirements, while much higher, now have an element of rigidity built in that did not exist before. Banks will be unable to use that liquidity when they most need to do so — to make loans or intermediate markets. They have a “red line” they cannot cross (they are required to maintain hard and fast liquidity requirements). As clients demand more liquidity from their banks, the banks essentially will be unable to provide it.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Another week, another roller coaster ride. This time it was talk of a trade war. Monday's downdraft was stemmed and reversed by the calming voice of Larry Kudlow. But saber rattling later in the week reinvigorated the bears. Tariffs may have been the topic this week, but at its core, the insanity in the market lays at the feet of (or more accurately at the mouth of ) The Donald. Not even a very interesting jobs report on Friday (discussed below) moved the needle. Next week it will be a government shake up or another mistress or a Mueller revelation or an improvident Tweet. Let's face it folks, he loves controversy. If none exists, even for a moment, either he or his detractors will create some. What a way to live.
Although lost in the tariff kerfuffle, the jobs report on Friday was a curious one. The number of new jobs fell short of expectation, but the unemployment rate remained at historic lows. Of more importance was the higher than expected growth in wages. Although still short of signaling the arrival of inflation, the trend is such that the Fed may have to act more aggressively should the Holy Grail of 2% inflation be exceeded any time soon. Remember, although the commentators proclaimed that only three rate increases are to be expected in 2018, they did so based upon the fact that 8 of 15 voting members of the FOMC so indicated on their March "dot plots." Seven indicated that four raises would be appropriate. Should inflation spike, that narrow majority could dissolve. Should the Fed be more aggressive in rate hikes it would have an adverse effect on equities. So heads up.
And speaking of heads up, I recommend that you Google and read Jamie Dimon's letter to the JPMorgan Chase stockholders. It is a comprehensive overview from an extremely knowledgeable man. He addresses a wide range of topics, but highlighting lack of liquidity (set forth below) about which I have written in the past is particularly noteworthy. Lack of liquidity creates a bottleneck which in turn promotes volatility which can lead to panics. Remember the Taper Tantrum of 2013.
Far more money than before (about $9 trillion of assets, which represents about 30% of total mutual fund long-term assets) is managed passively in index funds or ETFs (both of which are very easy to get out of). Some of these funds provide far more liquidity to the customer than the underlying assets in the fund, and it is reasonable to worry about what would happen if these funds went into large liquidation.
Market making is dramatically smaller than in the past (e.g., aggregate primary dealer positions of bonds — including Treasury and agency securities, mortgage-backed securities and corporates — averaged $530 billion in 2007 vs. an average of $179 billion today). While in the past that total may have been too high, virtually every asset manager says today it is much harder to buy and sell securities, particularly the less liquid securities.
Liquidity requirements, while much higher, now have an element of rigidity built in that did not exist before. Banks will be unable to use that liquidity when they most need to do so — to make loans or intermediate markets. They have a “red line” they cannot cross (they are required to maintain hard and fast liquidity requirements). As clients demand more liquidity from their banks, the banks essentially will be unable to provide it.
Sunday, April 1, 2018
April 1, 2018 Easter
Risk/Reward Vol. 387
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
The holiday shortened week ended better than the one before, but it sure wasn't a smooth or pleasant ride. I am certain that high frequency traders are enjoying this volatility, but it is wreaking havoc on the rest of us. The two major indices are down for the quarter experiencing their worst three month stretch since 2015. As far as what to expect next quarter---honestly I haven't a clue. Who knows what The Donald will visit upon us in the coming days---heck in the coming hours.
Frankly, I spent this past week more attuned to the bond market which has been at once predictible and confounding. On the short end, rates have escalated with the US One Year Bond now yielding nearly 2.1%. Less than a year ago that same instrument was yielding below 1%. This rise was to be expected given the Fed's past and anticipated future hikes in the overnight interest rate (Fed funds). Activity on the longer end, particularly in the bellwether US Ten Year Bond, has been another matter. Because the Fed is no longer as active a bond bidder as it was during the height of quantitative easing and because more bonds are being issued and sold to compensate for the anticipated revenue shortfall attendant to the tax cut, one would think that the demand for bonds would lessen and thus yields would go up. (Remember, rates/yields are inverse to price/demand. That is as the price/demand of a bond goes down the yield/rate goes up). Just the opposite has occurred however. Indeed, the rate on the 10Year ended the week below 2.75% as low as it has been since January. As such, the 10Year is signaling that Mr. Market does not anticipate much inflation or economic growth. And he may be right. Despite record low unemployment and jobless claims, wage increases have been modest and inflation as measured by the Federal Reserve's favorite yardstick, the PCE Index, remains well below the Holy Grail of 2% (1.8% headline inflation, 1.6% core inflation---minus food and energy prices). This past week, Mohamed El Erian wrote a thought provoking piece on why the rate on the 10Year is so stubbornly low, and I recommend it to you. https://www.bloomberg.com/view/articles/2018-03-29/why-10-year-treasury-yields-continue-to-defy-conventional-wisdom
And so I close. Gut Yomtov and Happy Easter.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
The holiday shortened week ended better than the one before, but it sure wasn't a smooth or pleasant ride. I am certain that high frequency traders are enjoying this volatility, but it is wreaking havoc on the rest of us. The two major indices are down for the quarter experiencing their worst three month stretch since 2015. As far as what to expect next quarter---honestly I haven't a clue. Who knows what The Donald will visit upon us in the coming days---heck in the coming hours.
Frankly, I spent this past week more attuned to the bond market which has been at once predictible and confounding. On the short end, rates have escalated with the US One Year Bond now yielding nearly 2.1%. Less than a year ago that same instrument was yielding below 1%. This rise was to be expected given the Fed's past and anticipated future hikes in the overnight interest rate (Fed funds). Activity on the longer end, particularly in the bellwether US Ten Year Bond, has been another matter. Because the Fed is no longer as active a bond bidder as it was during the height of quantitative easing and because more bonds are being issued and sold to compensate for the anticipated revenue shortfall attendant to the tax cut, one would think that the demand for bonds would lessen and thus yields would go up. (Remember, rates/yields are inverse to price/demand. That is as the price/demand of a bond goes down the yield/rate goes up). Just the opposite has occurred however. Indeed, the rate on the 10Year ended the week below 2.75% as low as it has been since January. As such, the 10Year is signaling that Mr. Market does not anticipate much inflation or economic growth. And he may be right. Despite record low unemployment and jobless claims, wage increases have been modest and inflation as measured by the Federal Reserve's favorite yardstick, the PCE Index, remains well below the Holy Grail of 2% (1.8% headline inflation, 1.6% core inflation---minus food and energy prices). This past week, Mohamed El Erian wrote a thought provoking piece on why the rate on the 10Year is so stubbornly low, and I recommend it to you. https://www.bloomberg.com/view/articles/2018-03-29/why-10-year-treasury-yields-continue-to-defy-conventional-wisdom
And so I close. Gut Yomtov and Happy Easter.
Subscribe to:
Posts (Atom)