May 22, 2017 Get On Up

Risk/Reward Vol. 308

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

“So get on up
On the floor
Get on up, now
And dance some more”---lyrics from “Get On Up” sung by The Esquires

“Sky high
Hey, let's fly
Sky high”---lyrics from “Sky High” sung by The Atlantic Rhythm Section

“Spark and it's like gasoline
I start pumping like a machine,
My heart only runs on supreme”---lyrics from “Gasoline” sung by Britney Spears

Two weeks ago (Vol. 306 www.riskrewardblog.blogspot.com ), I discussed a core tenet of modern investing: markets are driven more by monetary policies set by central bankers than by traditional metrics such as earnings and profits. This week put to rest any dissenting view. On Tuesday, two members of the Federal Reserve indicated that the Mr. Market had underestimated the likelihood of a rate increase this summer. On Wednesday, the Fed released the minutes from its April meeting which read much more hawkish on interest rates than the press release following that meeting. In the wake of these events, the futures market “got on up/Off the floor” as the likelihood of a June increase shot up from 4% at of the beginning of the week to 34% on Thursday. Over the past eight years, the threat of higher rates has caused Mr. Market to sell off and this time was no different as both the Dow Jones Industrial Average and the S&P 500 gave back gains achieved earlier in the week.

So why are Fed members so concerned about Mr. Market’s misreading of their intentions? The answer is succinctly addressed in an opinion piece that appeared in Wednesday’s Wall Street Journal written by Martin Feldstein, President Reagan’s chief economic advisor. Therein, Feldstein described the disruptions that have resulted from eight years of zero bound interest rates. Among those are a stock market that trades at a historically high price/earnings ratio and a commercial real estate bubble that will undoubtedly burst in the near future. If you doubt this latter point, drive around your city or any city and take stock of the building boom---apartments and office buildings are springing up everywhere. Cranes are “sky high/let’s fly/sky high.” Why are they being constructed? I doubt that it is to serve tenant demand. Rather, investors are in a desperate search for a decent return and are willing to take outsized risks, and banks need to deploy capital. Thus a perfect storm is brewing. Several members of the Federal Reserve see what’s ahead and are trying to soften the blow by moderating Mr. Market's expectation of endless low rates.

Although the stock markets cooled, the price of oil rose again this week. News of increasing inventories and the adverse impact of a rising dollar were offset by continuing supply disruptions in Canada and Nigeria and a report that Americans are consuming a record amount of gasoline. This bodes well for oil prices as the ever important summer driving season begins. Early in the week Goldman Sachs raised its near term crude oil price target, and Daniel Yergin, considered by many as the most knowledgeable student of oil pricing, 1, 2017raised his September, 2016 estimate to $50/bbl. My oil stocks (listed in previous editions) continued to appreciate. “Spark and it’s gasoline/pumping like a machine/My heart (and portfolio) run on supreme.” Leading the surge once again is OKE which is up 16% since I repurchased it on April 28th and up an incredible 80% since I first purchased it on February 26th!

So what do I make of this week’s action? If I believed that the Fed would raise rates in June, I would sell on the next big up day. I don’t believe that they will act in June. The data upon which they rely is not sufficiently firm, and everyone is sweating the world wide impact should Britain vote to exit the European Union. That referendum is scheduled for June 28th, after the next Fed meeting. However, if the data continues to improve and Britain stays in the EU, July could see a rate increase. I will be out of the market in advance of that event. We all saw what happened after the last rate increase in December. Both major indices dropped by more than 10%. Who needs that? I will sell and reenter once the market experiences a confirmed rebound---like it did in late February of this year. I take heed from Britney’s first big hit. Once Janet gives “me the sign, Baby”, I won’t wait for her “to hit me one more time.”