Another Bounce or Not

Hmmmm.  What to do in a market like this?

For your long portfolios, my advice would be to sit tight.  The odds are strong that we’re in a multi-week bounce before another little shakeout.

SPX Thru 2018 Holidays (Nov. 2018)

I’d suggest getting long after the next move downward.  Market behavior suggests a rally into 2019.  It could be the start of the final leg of the melt-up as “late-cycle” keeps getting bandied about out there.  Over the past few years, the drill seems to be a quick move down followed by the exhaustion-bounce followed by another move downward before regaining the up-trend (weekly charts).

For the contrarians, it’s hard not to look at China and energy as two obvious areas for medium-term plays.  If you play in the markets at all, I don’t need to throw up charts to illustrate the performance of both sectors of late.  Tencent and JD could be easy moneymakers.  And the energy toll roads can provide a nice yield along with cap. gains on an oil bounce over the ensuing months.

EPD has the infrastructure footprint and financial efficiencies that begs for yield-starved investors who’ve been waiting for a better opportunity for entry.  However, the company’s price remains quite steady in the $20 to $30 range.

Oil’s price action looks exhaustive.  Fundamentals appear to bear out an inexplicable magnitude of this sell-off.  If institutional traders on the wrong side are able to quickly offload positions, then there may be enough support by energy bulls to resume an up-trend without extreme volatility.  I remind energy traders of what we saw in H2 of 2016.

I liked the Starbucks story, but it quickly got white-hot before I could position with my long portfolios.

SBUX Retrace (Nov. 2018)

Based on the trajectory over the last several weeks, it wouldn’t surprise me to see a retrace down to the $56 – $58 range.  That’s a good spot to get positioned if you’ve been eyeballing this world-class caffeinator.

In the quasi-cash-equivalent area, muni-CEFs have presented recent value with their widened NAV discounts.  The discounts have come off a few points as investors have taken advantage of the historically free money and positioned accordingly.  The big question mark is interest rates.

Does the Fed raise rates next month?  If so, that could renew selling action in muni-CEFs and widen discounts again.

Interest rate tape reading has rates looking a little toppy.  Not like they’re going to topple over as we know the Fed will raise rates which will force support.  But still, I like interest rate-sensitive funds here to drive a little yield for a bit in place of sitting on excess cash.

          IIM Current NAV Discount (Nov. 2018)

          JPS Current NAV Discount (Nov. 2018)

Remember, these aren’t long-term investments.  We’re talking about using them as cash-equivalents, but their volatility makes them decidedly un-cash-equivalent.  We’re speculating on additional points on your money earned relatively conservatively.  Mind your stops.  Protection first.

Evaluating Markets Not Called Stocks

In my last financial post, I stated that I thought the market would move sideways for approximately 7 weeks before a catalyst would present itself to drive the market higher going into the beginning of the summer. So far, so good. Yes, the market is up about 1.5% but it appears to be the start of a sideways consolidation as the market exhales some energy.

I suspect we see a little downside move over the next week or two, as part of the sideways action, followed by a move back up to current levels about 3 maybe 4 weeks from now. By then, that catalyst should present itself for the resumption of the trend back up to new highs. Will my hot streak continue? If past is prologue…

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Right now, I want to talk about the US dollar and its potential effects on various commodities. Specifically, we want to watch oil, precious metals, and the grains.

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It’s easy to observe the stiff support at $94 and I think this time is no different. I suspect we get a slight bounce of about $4 up to about $98. This is in line with previous bounces off of $94 during this 15-month consolidation. There are plenty of analysts out there who think the USD bull will renew to move a lot higher. The thesis of the trade being a fear-based allocation in light of a pessimistic international outlook to various economies and the worthless, respective monetary policies currently employed by central banks.

I disagree. When the big one hits, the real correction across all markets, the USD will at first be a bastion of relative strength but that sentiment will be temporary. The problem with the thesis that we are in the early phases of a USD bull is that it runs counter to the other widely held thesis that the next financial crisis will be co-focused around an international collapse in confidence in the USD. That’s a discussion for a future post.

I believe the momentum has shifted for commodities. I suspect the worm has turned in the precious metals complex. Corn, wheat, and soybeans are potentially at the beginning of a spike. Oil has been unstoppable, but that DOHA meeting of the controlling powers will have a heavy influence on trading behaviors. It’s not inconceivable that the USD and commodities could run in the same direction but that belies decade’s worth of a consistently negatively correlated relationship.

Specifically, I’m referring to short-term action. Months not years. But let’s look at multi-year charts for gold and the grains, of which I’ll use my typical go-to trading medium of JJG.

Gold:

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What goes up generally comes down. Gold has held strong with a sideways move off the hard spike higher to start the year, but with the pending move in the USD, I think we’ll finally see the correction that many have been calling for. You can see that around $1,140 represents a stiff area of support. I suspect that could be gold’s next destination over the next several weeks or months, however that still represents a higher-low leaving a new uptrend intact. If one were inclined to trade, that’s $100 of movement to design a short-term, multi-month play as it moves lower and then begins a recovery. One pattern to watch, if you believe in such hokum, is the little head & shoulders that has formed since February. Will the break of the right shoulder-base be a catalyst?

Grains:

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I have had a lot of luck trading this grains ETF. Some of my biggest returns in the shortest amount of time have come from scalping the market for a nice rip on these multi-month grain rallies. Sentiment, professional hedging, and seasonality point towards the potential of another run. More importantly though, price action agrees. It looks like a based-low was established to start the year and last week represented a possible higher low. The price action was especially promising to end the week. Position accordingly.

But if the USD is about to bounce, won’t that hurt commodities? Even agriculturals? Not necessarily. Oil will very likely be affected but again the speculator positioning by huge players could potentially cause another squeeze as much as the DOHA meeting could negatively affect prices. Gold sentiment was stretched anyways. But the grains don’t always run counter to the dollar. In fact correlations between the USD and grains do not share an easily deciphered message. Grains can and do run in lockstep with the dollar at times. Have a look below.

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In two of the last 3 rallies, the grains (blue-dotted) ran concurrent with the USD. Even though the USD is potentially beginning a bounce, so could be the grains.

As stocks continue their consolidation, the USD should be the dominant theme in the markets as it moves upward over the next several weeks. Watch associated commodities. If you’re feeling really brave, try trading the other currencies with a rising USD as your foundation for analyses. Good luck out there.

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.

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(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.

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(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.

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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.

Some Musings About Q3

Musing 1. Why do new home sales data releases by HUD possess any significance?

Maybe so that the HFT houses have a headline for an algorithm to pump millions of unfilled bids into a market. It’s baffling. For me, the most important part of a release by HUD regarding new residential sales is the Explanatory Notes. In this section they tell you how wrong their data could be and they lay out all the statistical errors that could be occurring due to things such as “bias, variance from response, nonreporting, and undercoverage.” Reported numbers are consistently displayed with standard deviations of plus or minus percentages in the teens or twenties. For example, September’s results show a 0.2% (+/- 15.7%) above revised August new home sales.

That means the actual number may have been as low as -15.5% or as high at 15.9%. The dispersion is so wide as to render the results effectively meaningless, which is why there are always revisions. But why would revisions possess any more statistical relevance when weighed against the potential of HUD’s self-reported surveying errors? Observe the median sales price from August to September. It went from $275,600 at the end of the summer to $259,000 in the beginning of the fall. While the average price of a new home sale dropped from $348K to $313K. Drops of that magnitude have to make you question the credibility of the August new home sales pricing data. Did prices for a new residence actually drop that much in a single month or was it that the data was massaged to begin with? Not even the Census Bureau will provide a quality answer. I know the confidence level of the statistics is at least 90% but c’mon. Honestly.

Can you imagine if other industries were allowed to utilize such wide standard deviations in their statistical reporting. Take biotech. “Each participant that takes the pill in the study has approximately a 50% chance of increasing their lifespan by 12 more years…plus or minus 40%.” Or how about plane engine manufacturers. “We believe this critical engine component will operate in extreme conditions with a failure rate of 0.03% (+/-72.7%)” These are extreme, outlandish examples to be sure, but you hopefully get the point. Admittedly, my statistical skillset is decidedly above the average dolt off the street, but assuredly below regular practitioners such as finance & economics professionals or academics. The book is still open on whether or not to reject the null hypothesis that MarginRich is actually just one of the said dolts off the street.

Musing 2. What’s the big deal about oil reserves vs. oil resources?

This musing stems from an article I read at Bloomberg that was titled, We’re Sitting on 10 Billion Barrel of Oil! Ok, Two. The theme was expanded on at Zero Hedge that potentially the whole petroleum renaissance is nothing more than smoke and mirrors. Now I enjoy Zero Hedge as much as the next bloke, but I wouldn’t expect them to so quickly jump on the extremist bandwagon when it comes to E&P’s sharing their opinions on resources.

The basic gist of the Bloomberg piece was that oil and gas companies are grossly irresponsible in reporting resource potential in their corporate presentations versus the actual reserves they are filing with the SEC. However, before they get into the meat and potatoes of the article they share a giant caveat about investors and the differences between reserves versus resources. The authors quote Scott Sheffield, CEO of Pioneer Resources, one of the largest players in Texas with significant rig counts in the Permian and Eagle Ford. Sheffield states that experienced investors know the difference between the two numbers. Specifically, “Shareholders understand. We’re owned 95 percent by institutions. Now the American public is going into the mutual funds (or ETFs), so they’re trusting what those institutions are doing in their homework.”

Precisely. Experienced and sophisticated investors know that resource potential is not the same as current, existing barrels of oil in ground. That doesn’t mean that through innovative techniques that a high percentage of those resources cannot be converted into reserves. Patience and demand are the keys to the development of refined exploration techniques that can continue to expand the US energy base. The article implies that the shale boom is potentially a large scandal waiting to blow-up with Enron-like repercussions. That is an epically gross exaggeration. E&P companies have time and again improved or grew reserves at rates consistent with estimates. Additionally, we’ve seen the oil and gas players consistently beat reserve estimates established by the EIA for various geographic areas.

Bloomberg provided a snapshot of companies to graphically show the disparity between the two numbers:

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Any speculator in hard assets, knows what the steak and the sizzle are in natural resources. The reserves are the steak. The resources are the sizzle. It would help if more of the E&P players would utilize the P’s more in their presentations for the retail players who want to get in on the action. The P’s stand for proven, probable, and possible. Proven or 1P reserves have a high probability of being produced and you can count on the number. Then there is proven and probable, which is 2P; and then proven, probable, and possible is 3P. The higher the number of P, the less likely the company can produce the reserve. However, that doesn’t eliminate the current or future viability and economic potential of the resource. These P-designations, standard nomenclature in the industry, are easy to understand and not nearly utilized enough in company presentations. Oil and gas are no different than gold, silver, platinum, copper, or any other natural resource. All natural resource companies report reserves and resources and it’s up to the speculators to conduct their own due diligence.

Musing 3. There’s some serious Kool-Aid drinking at First Trust

First Trust is an investment advisory firm founded back in 1991. They’re fairly sizeable in that through their assortment of ETFs, mutual funds, and other various products; they’ve been able to garner $32 billion in assets under management. A hefty sum by any measure, but very small compared to the biggest players in the game.

The Monday Morning Outlook is a weekly little opinion piece that First Trust puts out that also includes a schedule of important economic releases for the week. Content is hit or miss with this shop, however, there was one piece from last month that struck me as an egregiously, cowardly article. You can have a read for yourself to see if I’m out of bounds in my assessment. I admit that based on my own opinions shared at this site, that I could be labeled a doom & gloomer, but I simply refuse to un-acknowledge the current and future distortions that have and will occur in asset markets around the world thanks to central bank interference.

The piece titled Why Do Stocks Keep Rising?, from September 8th, pumps First Trust’s fist in the air behind a sis-boom-bah of how the markets have continued their upward ascent despite the steady flow of negative-impact events over the last 5 years. They don’t understand how pessimism can remain so ingrained for certain pockets of investors under such conditions. I know it’s a quick 1-page offering that they throw up every Monday, but you can’t just break out the pom-poms and then stick your head in the sand without truly acknowledging the reasoning of the very parties you are criticizing. Amateur hour!

They don’t touch on how central banks have kept the cost of capital at virtually zero for longer than any period in history despite an “improving” economy and “improving” employment. They extol the virtues of the rising profits across industries but share nothing on top-lines and how that will affect profits going forward. Or how slashing SG&A and CapEx in combination with share repurchases has significantly affected stated earnings to the positive. Nor do they expound on how these behaviors are unsustainable. They fail to acknowledge that the current situation of central bank involvement in the developed nations has absolutely no precedent, and thus, no back-testable strategy for when the house of cards begins to wobble.

As an investment adviser it behooves them to cheerlead so as to grow assets under management higher and higher. That’s fine and they have a right to share a one-sided puff piece. They should just try not to be so damn cowardly the next time they want to cheerlead investing in a rising market right before a 7%(which I stated will not be the low) haircut commences.

Before signing off, I wanted to touch on the current action in the S&P 500. In my last article, I had stated that if the price action is simply a bounce within a larger correction that I thought the 1,950 area to be a solid resistance point before turning down again. Today’s close at 1,964 is still around 1,950, so we’re not quite out of the woods just yet. If we move onto sustained new highs then I will offer a mea-culpa, but I continue to think that caution is warranted. I’ll leave you with a chart shared by Lance Roberts at STA Wealth that displays the price action in the S&P 500 during the last two corrections that reached a depth of 10% or more.

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