When Last We Was Trading…

…I’d shared some thoughts on trading volatility and the action of the S&P 500. I was right about the down-move in the S&P 500. I thought a small move was possible of no more than 5% and a 3% percent move down is what we got, then a continuance of the sideways consolidation. However, I was very wrong about volatility. I suspect the reason is because the trade was simply too crowded. Volatility became a trade du jour as the intense bounce that had started in February had obviously grown long in the tooth.

But crowded trades are a trading fool’s errand and my thesis was wrong. And so ended one of the greatest 6-month runs I’ve ever had in reading the tape, but now I’ll just have to start fresh on a new run of prognostications. The crowded trade of long volatility and short the S&P 500 was skewered by the “market making” bot shops. Even Mr. Bonds himself, Gundlach, came out and stated during a Reuters interview that from the 20th of May and on the action in the stock markets felt like a short squeeze. JPM backed that assessment as one of the largest broker dealers out there. Observe a chart they released verifying the quick spike at the end of May in short covering.


As this short-covering burst has squeezed a chunk of the volatility hedging, too, we still very well may get a correction of 5%ish down to just below 2,000 on the S&P 500. Volatility is still worth watching for a quick scalp if enough weak hands have been washed out and the robots let some negative momentum push the S&P 500 down and volatility up.

Let’s return to the soft commodities market as sugar has just been on a silly tear. Observe:


Just look at the last week, specifically. Talk about momentum ignition. The Commercial Hedgers have gone supremely short but this softy keeps ripping higher, moving 16% in the last week. Crazy. But the last two trading days look suspiciously like blow-offs. Have a look at what’s happened during the last two blow-offs in sugar over the past 9 months.


You can see that prior to each of the blow-offs there were frenzied gains in very short time periods, but then astute traders could have made a nice rip quickly shorting sugar for 2 to 4 weeks. Has another opportunity presented itself for one of those rips? It sure looks like it. Go elsewhere for your farm reports, international weather patterns, crop output, regional flood potential, yada, yada, yada. This is straight up tape reading.

Using the futures proxy ETF of SGG, it is clear to see that $36 is an important number for sugar. Magnetic almost.


Using Fibonacci from the August 2015 low to the current June high, $36 also happens to be the 38.2% retracement point on the weekly chart. Tread lightly, if you’re inclined, as the action in sugar has been fast and furious. Just look at that whipsawing action since the start of 2015. Hedge. Trade with discipline. Manage the position.

One final note from a macroeconomic standpoint, have a look at this chart of negative yield curves in Germany and Japan.


If this doesn’t scream insanity to you then nothing can phase you. Maybe all the developed world’s central bankers have been secretly, partially lobotomized. A little frontal lobe here, a little hippocampus there, and you have a compliant banker with the inability to remember what negative rates actually mean and the lack of cognition to act effectively. Germany and Japan combined equal approximately two-thirds of the US economy. Which means their economies matter. A lot. Germany has negative yields out to a decade and Japan out to 14 years, just screaming recession is near if not already present in those two countries. You think the US is in better shape economically because we don’t have negative yields? These are different and unique times, folks. The kind of times that are remembered with head shaking and derisive snorts by future students of the economic past. Trade smart. Build cash. Stay disciplined. New highs are coming, but new lows are closer than you think.

Should the Investing Public Be Worried if Some of the Biggest Banks are Genuinely Scared?

Questions of investing and speculating always require context within time-frame. Players in all asset classes, professional or not, approach the game from their own perspective.

Traders surfing the waves of volatility may be looking only days or weeks out. Investment managers overseeing a growth-oriented portfolio may be looking ahead months or quarters while a value-oriented portfolio manager may be looking years out. The 401k-watching worker bee may be wringing their hands at every market move and every ignorant headline despite the fact that they have 30 more income-earning years left before retirement.

The game is tougher than ever even for the professionals and it’s difficult to decide a course of action with the information overload coming at market players. Determining what’s noise and what is actually valuable information is critical in making the right moves within your portfolio.

I have long been pounding the table on building cash reserves while staying invested in the markets. I’ve also stated that I thought the downturn of late 2015 was the start of the next major bear market. I think that dip and recovery in 2015 was the bear waking up and the poor start in 2016 is investor realization of that bear. However, because everybody now sees it, the markets aren’t going to execute a full-frontal stage-dive. That’s not how these things work, right?

I think we get a recovery into new highs followed by another much smaller correction and consolidation potentially followed by another new high. After that, I suspect all the bull energy will be fully used up and the bear will begin in earnest. Remember, these are simply my suspicions based on behavioral observation of the markets; nothing more than forecasts of potential outcomes.

It’s been a long time since I’ve hit readers with some good old chartporn, but I’m in the mood to throw a bunch of squiggly pics out there to possibly help the reader better assess the market situation in 2016. Observe a 20-year, monthly chart of the S&P 500 along with some relevant indicators.


Observe the long-term breakdowns in the indicators matching the actions of 2008 and 2000. Does that mean crisis is imminent? Nope, but I do think it reinforces my call that a new bear has started. Notice also in 2001 and 2008, we saw strong support and a bounce off of the 50-month moving average. Too many technicians are looking for that and thus too many algorithmic shops will be front running ahead of that signal, blowing out orders to drive the market higher.

I suspect this bounce we are currently in the midst of may be a bit stronger than people realize. Market players have been so used to the V-recoveries and yet they’ve already forgotten what they can be like. It appears that players are numb to the potential of a multi-week to multi-month V-bounce from the January 2016 lows. Despite what I surmise about a stronger than expected bounce, nobody can blame investors for either running for the hills or shoving their heads into the sand.

We’ve already seen the peak in net profit margins for this business cycle in the largest US corporates at the same time that markets continue to be overvalued, despite the corrective moves in December and January. Observe the following chart courtesy of ZH via Thomsen Reuters via Barclays. It depicts how the recession fuse has likely been lit.


And with recession generally comes a bear market correction. Or is it the other way around?

Regarding overvaluation, have a look at this comparison chart from AQR depicting market returns based on various starting points of the Shiller P/E. AQR is the shop that Cliff Assnes, billionaire hedge fund manager, founded and runs.


This coincides with GMO valuation models for future returns based on current valuations. There are plenty of Shiller P/E naysayers who believe that the indicator is bunk. The fact of the matter is that evaluating a normalized 10-year look at P/E ratios is a simple and intelligent way of quickly gauging valuation levels compared to prior periods. Of course every period in history possesses its own specific circumstances as the backstory of the valuation levels, but the raw Shiller P/E paints a clear picture for equity performance going forward.

Besides I don’t see or hear anybody calling Bob Shiller a dumb man. Despite what you may think of his ratio, Shiller is a respected academic even within the professional financial community.

Let’s take a look at a chart from one of every perma-bull’s favorite bear-shaped piñata, Dr. John Hussman. Unfortunately, Hussman catches a lot of flak. Less so after admitting to his analytical mistakes coming out of 2011 but I think he catches a bad rap for simply calling it how he sees it. Hussman’s analysis is based on a quantitative and thorough study of the markets. Can the same be said of a vast majority of the financial blogosphere? No it cannot, including myself. Observe the Hussman Hindenburgs. They nailed the current action coming into Q4 of 2015.


The criterion of the Hussman Hindenburg is detailed in the upper left corner of the chart. Dr. Hussman’s Hindenburg indicators proved to be quite prophetic in 1999 while essentially nailing the top in 2007. For your own long-term holdings, ignore these signals at your own risk. Dr. Hussman, like Dr. Shiller, is respected amongst fellow financial professionals. Have a look at Research Affiliates’ (“RA”) own analysis on current valuation levels.


In a research piece they published in July of 2015, RA evaluates the differences in relative valuation metrics (CAPE, Hussman, Tobin) and absolute valuation metrics. They came to the following conclusion.

Our answer to the question “Are stocks overvalued?” in the U.S. market is a resounding “Yes!” Our forecast for core U.S. equities is a 0.8% annualized real return over the next decade. The 10-year expected real return for emerging markets equity, however, is much higher at 5.9% a year. The return potential of the nondeveloped markets is so high, in fact, that the valuation models, warts and all, paint a very clear picture.

May want to rethink that lack of EM exposure going forward, depending on your time-frame.

Shall we move on to a couple of less orthodox indicators of potential trouble in the markets? Observe the two following charts which pertain to income as opposed to valuation or price action. In the first one, created by McClellan, we get an interesting correlation to total tax receipts for the US government as compared to US GDP.


Notice that in 2000, the US crossed the 18% threshold and stayed there awhile before rising even higher at the beginning of the market selloff. For the GFC of 2007, America almost got to 18% but not quite and we still literally almost vaporized the entire financial system. Currently, we’ve reached 18% but that may or may not mean anything. In each previous occurrence, tax receipts stayed at the level for months or even years so this is an indicator worth watching but only in conjunction with many others.

Interestingly, federal tax receipts as a percentage of GDP currently reached 18% right before the markets began selling off last year. Repeat after me. Correlation is not causation, but the timing is still interesting.

The other chart that doesn’t get a lot of coverage but is very well known is net worth of US households and non-profit organizations as a percentage of disposable personal income. You can find it courtesy of our friendly Federal Reserve Bank of St. Louis and their FRED tool. The grey vertical bars in the FRED charts denote recessions.


It’s been a clear indicator in 5 of the last 6 recessions and we also had that annoying fakeout in 1987. Much like the prior graph, this particular chart should be coincident with additional economic indicators if one is attempting to forecast potential economic as well as investment outcomes.

I want to move on to a particular area that everyone should be concerned about and that is nonperforming loans (“NPL”) at major banks. Not just at US banks but around the world. China’s commercial banks have raised fear levels in even the most seasoned professional investors due to their NPL levels increasing so drastically in 2015. I’ve long stated how debt levels in Italy have the potential to dismantle a good portion of the financial system because the Mediterranean Boot is such a key economic cog in the European Union. Some of the biggest commercial banks in Italy are on the verge of toppling during a period where now the ECB is less amenable to the previously used “bad bank” options. The pressure is beginning to mount for Italy’s leadership to formulate a strategy around potential bank failures.

You might be inclined to observe the following chart and think all is at least well for the US.


But take a look at the following chart in commercial-only loan performance and begin to understand why the total situation looks toppy from the economy to the markets.


For the record, commercial loans comprise approximately $2 trillion of the outstanding debt within the banking system. It is clear to see that a bottoming and an upturn occurred before the last 3 recessions and market dislocations. Now we are currently in the early innings of an upturn in NPL. If commercial loan performance behaviorally adheres to what we saw in the prior two recessions, we will see at least an additional 2% of total commercial loans become impaired assets. That’s potentially between an additional $40 billion to $50 billion at minimum that banks will have to provision for. No easy task in light of current leverage levels and collateral utilization across the repo and derivative space.

This is especially concerning because of the systemic importance of each bank to the entire financial system. Just look at the consolidation that has occurred since 1990.


Couple this concentration with a lack of regulation allowed by Gramm-Leach-Bliley and you can see that debt impairment at the banks is not going to have a happy ending. And if you think Dodd-Frank was the answer to all of our problems, I might stop laughing sometime in March.

What would work to alleviate a lot of the financial pressures around the world in the short term is a weaker dollar. I don’t say that as a proponent of a weaker dollar. Rather, I am stating that currency exchange due to a weaker USD could help sugarcoat revenue reporting across international corporates. It would relieve pressure in the management of reserves for countries with an excess of US treasuries. The oil price could stabilize temporarily but it is well-documented that abundant supply and less-than-expected demand is still the story. Commodities could lift and thus commodity producing countries who are already fighting with their reserves issue could see a double-positive impact. All these effects would be temporary as world debt levels are at unsustainable levels and a bear market for all assets has potentially already arrived. It just has yet to completely sink its claws and fangs entirely into the world’s financial system.

Coming back to the initial question behind this post. Should the investing public be scared? Maybe not scared. Let’s call it aware. They should be aware of all the happenings that are occurring right now. Cash levels should be raised. Certain assets should be paired down depending on losses, gains, and risk exposure. More importantly it’s time to take stock in your own investing psyche. If you are building cash levels, will you have the courage to act at the appropriate time? That’s what raising cash boils down to. Do you have an understanding of the intrinsic valuation levels of specific asset classes that will motivate you to put cash to work?

Aside from brushing up on your ability to properly assess valuations, take a look inside yourself and evaluate your ability to deploy cash when fear is running rampant and the nadir of multiple markets appears to be nowhere in sight.


Believe Your Eyes and Ears, Not the Data

The evidence continues to mount that the US is entering into a recessionary environment. Really, it’s old news however it’s also unsupported by official data. It’s a slow descent into a recession, because we know that the “data” will not be displayed to show the recession in real time. It will be ex post facto revisions from the BEA that finally let the cat out of the bag, so to speak, sometime next year by my estimation.

When it comes to markets and macro-data, people often assume that a forecast of possible events means the event is absolutely imminent. We are moving into a recessionary environment in total and even if this is yet to be supported by official government data sources, the real-world business data is painting a fairly clear picture. Caterpillar has been tanking for how many quarters now? Fastenal, a leading industrial supplier with close to $4B in revenues, recently had the pleasure of having its newly promoted CEO, Daniel Florness, exclaim to the investing world just exactly what kind of economic environment the company is currently operating in.

In a recent Q3 conference call with analysts, Florness unleashed the following gems, “…I would argue that anybody selling into the industrial market is not selling into a non-recessionary environment…The industrial environment is in a recession – I don’t care what anybody says, because nobody knows that market better than we do.”

Want a larger business as proof? Take Grainger’s guidance then. Grainger is in a similar business however they do almost 3 times as much revenue and own a larger share of the MRO (maintenance, repair, operations) supplier market. Additionally, a full third of Grainger’s business is earned via government, retail, and commercial businesses versus just manufacturing and other industrial segments.

Grainger has lowered earnings guidance after each quarter in 2015. Their margins are being squeezed and they’ve comped down again in Q3 top line sales. The CEO, Jim Ryan, continues to communicate that Grainger’s results “reflect the challenging industrial economy in North America.”

Opposing opinions will point to the 2 very obvious elephants weighing down US economic results, which are the continued rout in petroleum energy and the strength in the US dollar. The fact of the matter is that petroleum-based energy sources are not the only commodities sold and moved through the US. Self-evident? Sure energy companies have taken a major hit, but look what cheap oil and gas has done for everybody that uses the product. Wasn’t the savings from cheap gasoline supposed to drive retail sales? Are airlines not actually producing record profits on the back of cheap jet fuel?

Let’s take a look at the AAR monthly rail traffic report through most of the 3rd quarter.


Observe how carload and intermodal traffic are beginning to tip over. For the sake of unfamiliar readers, carloads are what commodities such as coal, grain, etc. are transported in. Intermodal is utilized for consumer goods like appliances, TV, clothes, and all the other goodies that credit cards get maxed out for. If you visit the AAR site and just drill down on carloads, the data is significantly more alarming. The funny thing about commodities is that they’re the input that the manufacturers consume in order to create an output the end-users consume. Reduced end-user consumption, reduced commodity consumption. Basic economics, right?

The drop-off in traffic for carloads only is vast. Intermodal continues to grow but how much of that traffic can be attributed to excess inventory buildup for a holiday sales party that may never materialize? Come on Black Friday don’t fail us now!

I know how important energy is to total market earnings and how petroleum has skewed the data downward. That data is readily available for all to see the impact.


However, the rail traffic, commodity prices, wholesaler and retail sales are supposed to simply take a backseat to oil and the dollar when it comes to analysis of the US economy?

Wal-Mart rocked the entire stock market single-handedly when it guided that 2016 profits would drop by as much as 12% next year as the behemoth spends heavily to increase wages, improve the store experience, and build out and expand its online presence, all while dropping a cool $20B over the next couple years in share buybacks…which is not to support earnings of course. Managing earnings would be unethical. Putting salt on the wound, management also shared that they expected sales to be flat as opposed to previous estimates of 1% to 2% sales growth.

Let’s find a bright spot somewhere. Do a dance around your sombrero for Mickey D’s reporting positive comps in sales, finally, of less than 1% but I’d still be a whole lot more worried about what Wal-Mart’s performance in Q4 could mean from a macro standpoint.

All the information examined so far is widely reported, but let’s take a closer look at a less orthodox indicator. The hospitality industry, specifically hotels, reports all sorts of proprietary business information. One of the leading aggregators of this data is STR Global. They produce reports that can be drilled down to specific markets and segments.

As these reports are proprietary, STR of course sells this information to whomever would find it useful and are known in the industry as Star reports. Some of the specific knowledge shared is figures on Average Daily Room Rate (“ADR”), Revenue Per Available Room (“RevPAR”), and Rooms Available (“Supply”). ADR is a simple calculation of the average rate paid for rooms which is calculated by dividing room revenue by rooms sold. RevPAR is similar in that it is the total guest room revenue divided by the total number of available rooms, but the sticking point is “available rooms.”

Hotel properties can report to STR that they have decreased their supply of rooms. This will of course positively affect a property’s STR revenue-based metrics. How is this done? Simply. Let’s say a hotel has 500 rooms on the property. Business may be exceptionally slow and cannot support current labor levels. So the GM simply puts 250 rooms out of service indefinitely. Now when data is uploaded to STR, room supply is halved but ADR and RevPAR at the very least maintain but more probably improve due to a lower bar being set for occupancy based room supply.

Where does this begin to affect the greater economy? In the suppliers to the hospitality industry. Less rooms in use means less cleaning supplies needed, less turnover in linens & terry, FF&E investment diminishes and so on. But what’s worse is that suppliers, whether they are manufacturers or wholesale suppliers may create or modify business operations based on STR market data. Revenue goals at suppliers may be maintained at artificial levels despite decreasing occupancy levels in various hospitality markets. There are continued knock-on effects to be rationalized. I leave those effects to readers’ imaginations.

Do you think this is not happening, that rooms are simply identified as “out of service” so that results can be manipulated? I assure you this is happening. Room supply is one of those very important pieces of information that gets completely overlooked as long as ADR and RevPAR are steady or increasing. It’s absurd. You’d think sharp, experienced minds would see through this kind of thing but it is regularly glossed over, much like budget timing cycles in evaluating an underperforming sales person who may simply be having a tough time attaining goals due to the timing cycle after coming off of a monster year, as opposed to an actual lack of effort or skill.

I have multiple, highly reliable sources that have assured me of this practice but it’s not like it’s a secret or some sort of industry cover-up. It will be openly talked about if addressed by the appropriate parties. None the less, this behavior of massaging hospitality data can be misleading in one of the US’s leading service-based industries.

For an idea of how important hospitality is to the US economy, have a read of the following blurb right on the front page of the Select USA travel, tourism, and hospitality site administered by the Department of Commerce,

The travel and tourism industry in the United States generated nearly $1.5 trillion in economic output in 2013. This activity supported 7.8 million U.S. jobs, and accounted for more than 9 percent of all U.S. exports. One out of every 18 Americans is employed, either directly or indirectly, in a travel or tourism-related industry. In 2014, U.S. travel and tourism output represented 2.6 percent of gross domestic product.

Hospitality matters and data integrity across all industries and entities is critical in making accurate business and economic assessments. But let’s come back to the larger markets.

I would venture that there are only a handful of quarters left at best where debt issuance will be seen as “cheap and easy” in order for companies to fund share buybacks. Once that jig is up, then actual sales, profits, and responsible allocation of free cash flow will have to continue to push that game forward. You willing to continue betting your hard earned cash on the responsibility of corporate CEOs in a world already overflowing with debt?

The question, as always, is how is all this actionable? And the answer is that inaction is the action. Continue raising cash. I’ve been sharing that same tired message for a little over 18 months and I’ll continue to reiterate it. I’m still highly allocated to the equity markets. I continue to actively trade albeit much, much more selectively now. The strategy is not go to all-cash, it’s raise cash. There is little doubt in my mind that cash-poise will be rewarded with asset-prosperity.

Coming back to what all this data talk is focused on, the BEA releases the advance estimate for GDP tomorrow morning at 8:30am EDT. Let’s see if a convergence begins with the real world compared to official-statistics world. The 3.9% revision in Q2 from the negative Q1 was eye-opening. I’d say get ready for some volatility tomorrow either way the estimate reads.

American Assets Discounting European Politics

Last summer, I shared some thoughts on the stock markets’ abilities as a discounting mechanism for future events. The gist was that stocks may provide a murky read some times when it comes to prophesying.

Reading the current macro signals is a tough endeavor for any speculator, and with today’s volatility, all the more dangerous when making bets based on those signals.

That being said, I get the feeling that last week’s action in some of the rate-sensitive sectors in combination with general stock market consolidation is portending a positive outcome in the Greece/Europe situation. Bear in mind these thoughts are pure suppositions based on nothing more than a hunch. I’ve been wrong before. I’ll be wrong again. As the old Soros saw goes, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

Kimble recently provided a long-term view of two key sectors.


We’ll revisit the impact of the breakdowns in those sectors, but the whole world of finance is focused on the potential resolution of Greece’s debt-financing problems. We have Goliath, the Troika(ECB, IMF, and European Commission “EC”), attempting to dictate the how, what, and when to David aka Greece. Right now a political game of poker is being played with the potential for worldwide ramifications. Greece’s new management is playing the hand it’s been dealt in what appears to be a very transparent fashion. Basically, they’re happy to stay in the euro as long as fair terms are met in a reworking of current debts to the Troika.

The Troika, god I hate saying that word but it does beat out typing the three entities, is really trying to play hardball with Greece but they have no leverage. None. Ok, maybe the smallest amount; just to play chicken. In my estimation, 98% of the leveraging power belongs to Greece. Dijsselbloem, EC head finmin, and Schauble, German Minister of Finance, have both been bellowing the fiery rhetoric from the tops of their lungs, “Greece better pay or else!” Or else what? They’re going to let Greece depart the euro? Ok. Yeah, sure.

Greece isn’t going back to the drachma in an exit from the euro, at least not this year, because the markets would be roiled. There are simply too many things that could go wrong to upend the European status quo for a Grexit to happen. Let’s just logically play out a generic sequence of events. Europe can’t let Greece totally default. For the owners of Greek debt and of course credit default swaps on the debt, credit events would be triggered across a multitude of financial institutions which could in turn then trigger counterparty liquidity risks which would instantly panic the financial universe. This instant panic would hit all the developed stock markets but with a focus on the European stock markets, which would negate the positive effects of the trillion-euro QE plan before it even had a chance. Too me, that’s enough to know that even if the deadline for a Greek debt resolution is pushed out, it’s still going to end with Europe caving but in a manner which saves as much face as possible.

Germany’s account surplus is so ridiculously large that I don’t really think they are going to tell Greece to go souvlaki itself. German total employment is high and exports continue to be robust. Pushing Greece to exit the euro would create an environment of fear where recession could rear its ugly head at a time when German companies are rolling. While Greece has all the appearances of being the linchpin holding the euro together, they’re really just a very, very important lugnut. Italy is the real linchpin. Their debt has the potential to topple the world. Which is why Europe doesn’t want to easily concede to Greece and open the door for Italy to dictate revised terms of its sovereign debts. Aside from Italy, there is obviously still Spain, Portugal, and Ireland; but Italy is the megaton nuke that can change everything.

Aside from the financial obstacles for Europe, there are the more important political complexities that must be addressed in pushing Greece too far, too hard. Russia has already extended an olive branch for Greek funding and Greece officials are reporting that China has now offered a helping hand. The world knows that China possesses the funds to help provide a financial backstop for Greece. I suspect the world may doubt how much funding Russia can lend in light of its own domestic problems concerning the ruble’s decline alongside oil’s rout. I contend that doubt would be misplaced. Does anyone really believe that Europe would simply push Greece into Russia’s waiting and open arms, where after, Greece will be free to negotiate any number of fear-inducing considerations like the usage of Greek ports for the Russian navy. Or how about land or sea allowances for petroleum energy pipelines. Maybe missile battery emplacements “for protection” on the northern Greek borders.

These are extreme examples as Greece is still a NATO participant, but it is unknowable with which the speed of certain actions could be taken should political alliances be shifted over this money. Consider how fast Russia appropriated the Crimean peninsula. All the angles have to be considered and with Merkel’s established relationship with Putin, I don’t see the Troika being allowed to precipitate negative financial and geopolitical outcomes.

What is difficult to reason, for me at least, is how the US will come to bear its influence in this whole game of thrones. America will have its say on bailing out Greece, but how and where and with what level of impact is a challenging thought experiment.

Coming back to American assets and their ability to discount the European outcomes, I think the speed with which the rate-sensitive sectors dropped last week are the tell-tell signs. Examine the two following weekly charts of TLT and XLU.


After a stellar run in 2014, that was a precipitous drop last week. The overall trend remains up, but the situation is very fluid as we have to consider the interrelationships between markets, especially the dollar and implied volatility across Treasury yields.


A familiar market adage is that Utilities tends to be a precursor for the greater stock markets. Any correlation is possible at any given time in the markets, however, we live in an age with remarkable volatility across asset classes. Thus, old interrelationships that once used to prove semi-reliable, may just not be so consistent. I think the Utilities, Treasuries, and yields are telling us that the general market environment is about to go risk-on with another leg-up in the greater stock markets.

There has been no shortage of writing on the significant perils in the market. I have read many a sound analysis that a major dislocation is “near.” But that’s the problem with using a word like “near” or any of its synonyms. Near is a relative term. It’s a word that gets used in a sentence and can mean anything from 1 day to 3 months to 2 years or whatever. Most analysts, bloggers, and general market commentators aren’t willing to stick their necks out and provide a more precise timeframe based on their opinions. They just point to a lot of evidence that says it’s “near.”

I agree that the next major leg down in the markets that began with the Great Recession in 2008 is near. I’ve long-stated that I thought 2015 – 2016 were going to be the years that major catalysts presented themselves for an epic sell-off, but I don’t think that time is upon us. I’m convinced that the markets will draw in a lot more participants first. I want to get that 1999 and 2007 feeling first. You know the feeling I’m talking about; that feeling that the markets will never go down and speculating in the stock market is a can’t lose venture.

The danger of deflationary forces is reasonably priced into the markets. Japan is still easing while the Fed is continuing to roll assets and now we have the ECB embarking on a trillion dollar extravaganza. I have read analysis that the efficacy of the ECB’s easing is highly questionable due to negative rates around the continent. I say nonsense. Animal spirits only care about a liquidity buffer to fill voids. Besides in a risk-on environment, yields will rise as higher levels of capital will flow into equities in a sector-rotational chase for alpha.

Risk-on is not mutually exclusive of risk management, no matter what. Countless interviews with billionaires around the world back up the fact that risk management is the number one key to successful speculation and investing. That being said, look for the general stock markets to pick up a little speed in advance of a potential workout between Europe and Greece. In just the last few days we’ve had two US hedge fund billionaires share their opinions on a Grexit. Dan Loeb, of Third Point, thinks there’s a lot of risk associated with these markets and has lowered net exposures across his funds so far this year. David Tepper, of Appaloosa, thinks there is nothing to worry about if Greece exits the euro. He basically stated that there’s a handful of percentage points of loss to worry about, but that the markets are strong enough to overcome a negative outcome. Loeb is prudent. Tepper believes in his analysis. I think the GermansEuropeans will reach an accord with Greece sometime soon(another relative term) and the stock markets will eat it up.

There is still that little matter of the dollar, euro, and their extreme levels in sentiment. Carry trades continue to be wonky in light of the dollar strength. Maintain a close eye on these currencies as they will enhance a risk-on move. Whether you believe the markets are discounting future events or not, there is a persistence of extreme movements. A European resolution with Greece and a shift in dollar sentiment may just provide a profitable environment for stock market participants.

Oil & Economics – All Q, No A

Almost nobody saw the crash in oil coming. A handful of savvy investors and analysts shared this thesis but were largely ignored. For all intents and purposes, “nobody” foresaw the action in oil which is the essence of the dumb crowd missing it again. Not inferring that I am not an occasional member of that dumb crowd, just commenting on the oil industry.

When oil prices dropped, the instant message that was and continues to be bellowed across the financial landscape is that the drop would provide a pseudo-tax cut for the great unwashed in the form of lower gasoline prices. Along this line of thought is that the commoners will spread this saved gas money throughout the economy in various outlets. This should in turn support GDP levels, which is of course fallacious. Through Q3 of 2014, the US is annualizing 5% GDP growth. WHOOOOO! Gonna get some cold cuts based on that level of growth!

The problem with the thesis that lower gasoline prices should support or maybe even boost GDP levels discounts two very important factors to the economy. Number one, nobody can predict the level of the money saved from lower gasoline prices that will go into personal savings. Number two and more importantly, the importance of the oil industry to national employment and economic growth has been totally discounted by far too many educated parties. Just look at how important the oil industry has been to America’s employment recovery.

(chart courtesy of Prof. Mark Perry)

Now add in North Dakota and it’s growth in employment thanks to the Bakken. Last month the Joint Economic Committee provided an update courtesy of the BLS. Since February of 2010, the national low point in private sector employment, North Dakota added 102,500 private sector jobs. A vast majority of those went to petroleum related companies, making the “US Employment Minus Texas” numbers look even worse. Maybe you’re one of those thinking in your head with a Patrick the starfish voice, “Yeah, but a percentage of that job growth for Texas and N. Dakota is dedicated to non-oil like teaching, retailing, food services, etc.” Sure there’s growth in those areas too but an overwhelming majority of the growth has come in industries like mining, logging, transportation, utilities, and construction; where the pay has been significantly higher on average than in the non-oil industries. An argument could even be made that a high percentage of the growth in non-petroleum based jobs was simply derivative growth from the petroleum industry.

Well what’s the point? There are a couple of points, actually. Talking to one’s self consistently is a strong precursor to madness, so at least I’ve got that going for me…which is nice. Seriously though, one of my points is where does the job growth come from in America now that the oil patch growth and development has fallen off of a cliff? Amazon DC part-timers? Wal-Mart part-timers? McDonald’s part-timers? Maybe I’m failing to notice a forest through some trees here but I’m having a hard time seeing the downward trend in unemployment continue its happy descent into “full employment.” And for the 1 plus 1 crowd, if there’s less people employed then there’s less people to buy things. Maybe there will be enough growth across all the other non-oil and gas industries, but that chart up above sure says a lot about placing too much faith in that thesis.

The second point, which may be even more relevant, is where will the growth in US corporate capital expenditures now occur? It’s very late in this business cycle coming out of the Great Recession and capex output is still relatively weak compared to previous cycle recoveries at the same stage. Capex has been essentially carried by energy. Let’s look at some facts regarding US capex and the oil industry. Energy(primarily oil and gas) accounts for approximately a third of all capex in the S&P 500. That means it’s virtually irreplaceable. Need a visual? No problem.

(chart courtesy of Zero Hedge via Deutsche Bank and the Bureau of Economic Analysis)

So if I’m understanding the basic tenets of the TV economists’ argument, US GDP will be just fine despite the oil industry tightening their belts because American consumers will use all that money they saved at the gas pumps at their favorite retailer, service provider, or online. BOOM! Problem solved.

I just can’t reconcile that thesis with the facts as they are presented via the press releases of major oil companies. ConocoPhillips has already announced it’s slashing its capex budget by 20% for 2015, which means $3 billion less than 2014. Suncor, Canada’s largest company by revenue, is slashing it’s capex budget by $1 billion dollars for 2015 while also cutting operating expenses by up to $800 million in addition to a 1,000 person reduction in the workforce. Conoco did not announce layoffs in their presser regarding capex but you can be sure there will be layoffs there and across the board. We have yet to hear from the two giant US elephants of petroleum energy, Exxon and Chevron. Analysts are essentially expecting an average decrease of 25% in investment spending by energy companies.

This subject has been covered extensively at Zero Hedge. You can obtain additional details and their always-optimistic opinion right here and here. There are some blog and finance news snobs out there who look down their nose at Zero Hedge, but the fact of the matter is they do a good job credibly covering a wide swath of financial, economic, and geopolitical news; and literally everybody reads it. None the less, for you financy snobs that need a Wall St. bank’s take on capex, here’s a September 26th, 2014 report courtesy of UBS with impeccably timed commentary on capex. Here’s a couple of gems from their Equity Strategy team: 1. “Capex rising thesis still intact”, and 2. “…business fixed investment is forecasted by UBS economists to rise by 6.2% in 2014 and 7.8% in 2015.”

Let’s just see how the timing of that report’s issue coincides with the fall in the price of West Texas Intermediate Crude.


Does 7.8% growth in 2015 capex sound credible now? Well done UBS Wealth Management. Positive guidance on capex right before capex is about to be gutted via a 50% slide in the oil price. Let’s do some basic, rough arithmetic based on the Deutsche Bank chart up above. Thirty-two percent of $685 billion is $220 billion. Twenty-five percent of $220 billion is $55 billion. So approximately $55 billion of what was to be potentially spent in 2015 is going to be eliminated and yet employment or GDP should be unaffected as the economy is recovering in the US. That’ll be what gets sold by the main stream media.

Oil and gas notwithstanding, the capital expenditure reports coming out of the Federal Reserve branches were laughable. It’s all IT spending. Go read the December 3rd, 2014 Beige Book to see for yourself. Here’s an exercise for those who refuse to read the sleep-inducing report. Click that Beige Book link and search(hit ctrl-F) the document for “capital expenditure” and simply read the surrounding text. It’s mostly IT. I’m pretty sure that network upgrades and addressing cyber security concerns aren’t going to carry the US economy in conjunction with consumer spending, but we’ll have to wait for 2015 to play out.

The bottom line is that 2015 is going to be a most interesting year for the US economy and the rest of the world for that matter, too. Just look at the volatility we’ve already seen across currencies, central banking behaviors, geopolitics, etc. I’m still seeing plenty of rosy projections for the US economy, coming off that 5% read, and maybe I just need somebody to crack me in the head to help me see the data in a better light.