April 3, 2016 Bunny Market

Risk/Reward Vol. 302

THIS IS NOT INVESTMENT OR TAX ADVISE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

Due to travel and family commitments, this edition will not follow the usual pattern. However, important developments occurred this week which require recording and reporting.

. Both the Dow Jones Industrial Average and the S&P 500 gained each day and now reside in the green: the DJIA up over 2% and the S&P up over 1.5% year to date.

. No one can doubt the sway that the Fed holds over Mr. Market. Much of the gains experienced this week came after Janet Yellens’ speech on Tuesday. Before she spoke the DJIA was down nearly 100 points. After she spoke it spiked 200 points (1.2%), and never looked back.

. In her speech, she noted that despite several indicators pointing to a strengthening economy, inflation as measured by the Fed’s favorite yardstick (the PCE Index) remained at 1.7% year over year; stubbornly below the Fed’s desired 2%. She emphasized the “asymmetry” that now exists in the Fed’s tool box. That is, the Fed’s tools to spur inflation are nearly exhausted (zero bound interest rates and prolonged quantitative easing) while those that exist to curb inflation remain unused (higher rates and increased reserve requirements). This observation was interpreted by some to suggest that the Fed may wait until the PCE Index attains or exceeds 2% before raising rates.

. Yellen’s speech lessened the likelihood of a rate increase in April to nearly zero. The spotlight now is squarely on the June meeting. If the Fed is to maintain any credibility in regard its prognostications , one should expect the minutes following the April meeting to signal a move in June.

. Oil prices hovered just below $40 until Friday when the Saudi oil minister reversed position and said that Saudi Arabia would not support limits at this month’s OPEC meeting in Doha unless Iran and other large producers likewise agreed. This statement caused a significant drop in oil prices. Adding to the woes in the energy sector was news on Friday that natural gas reserves were at an all time high (52% higher than the five year average) just as the heating season ends. This was not good news to nat gas iproducers or to pipeline companies.

. Friday’s energy sector news notwithstanding the DJIA rose 100 points on Friday following an encouraging, but not too rosy employment report. Perhaps the correlation between oil and the indices about which I have written over the past several weeks may be coming to an end.

. Does this week's action portend that the indices will continue to rise as they have since hitting the year’s low in February? I suspect not. And I am not alone. Take a look at the most recent newsletter from James Paulsen, Chief Investment Strategist at Wells Fargo Capital Management and a frequent contributor to CNBC’s Squawk Box. http://www.wellscap.com/docs/emp/20160321.pdf . Paulsen terms the current situation a “bunny market”; one that hops up and down but does not go anywhere. Unlike most of his peers, Paulsen recommends that investors attempt to time the market, a strategy that is heresy to most money managers.

. So what does this all mean to me? As loyal readers know, I study correlations; primarily those tied to the yield on the 10 Year US treasury. That yield impacts domestic interest rate sensitive stocks (my favorite sectors) and the value of the dollar/oil internationally. As the rate on the 10 Year rises, the value of the dollar increases and the price of oil falls. Since my portfolio is premised upon 1) the rate of the 10 Year not spiking above 2% and 2) the price of oil remaining near $40/bbl. , I have done quite well so far this year as the 10 Year rate has fallen consistently and the price of oil has appreciated nearly 50% since my mid February re-entry. That said, I see little upside in remaining as fully invested as I am as mid-April approaches--- when both the Doha (OPEC) and the Fed meetings are scheduled. I see great risks to my two investment premises coming from these two events. Accordingly, I will harvest some profits soon. Hopefully, I will catch a bunny hop that will vault me to year to date highs (as experienced Thursday past), but even if I don’t I will raise cash. I intend to watch the Fed and Doha mostly from the sidelines.