January 29, 2016
By Steve Blumenthal, CMG
“Greenspan, Bernanke and Yellen – who are more like teenagers at a prom night. They are spiking the punch bowl and handing out free drinks and hoping to get lucky at the end of the night.”
James Montier, GMO
“Understanding the forces of Supply and Demand in the market is a critical component in evaluating the underlying process of bull markets and the gradual signs of erosion that appear in advance of bear markets. As the major market price indexes continue to move to new highs, most investors are unaware of the actions of Buyers and Sellers as prices become extended and subtle signs of weakness begin to appear.”
“Investors will find good managers and ETFs, but unfortunately they tend not to be able to stay the course. It is the behavioral element where they leave too soon and at the wrong time. A great advisor can help individuals avoid this common mistake.”
Ben Johnson, Director of Research at Morningstar
Speaking of spiking the punch bowl, the Japanese Central Bank surprised this morning announcing they are taking rates into negative territory. The JCB is trying to rescue its struggling economy. And the ECB. And China. In theory, negative rates encourage consumers to save less, borrow more and spend more. It also weakens the home team’s currency with the hope to boost exports and thus domestic growth. Beggar they neighbor – The global currency wars advance forward.
Debt is a drag man. It is a massive drag on growth. And for now, deflation is winning. The global central bankers are in a fight to create inflation. They need to inflate away the debt as best they can. They are “hoping to get lucky.”
The JCB news is helping the equity markets around the world. The U.S. market is up nicely, Europe closed up over 2%, Japan closed up about 3% and China was up over 3%. You’ll see in a chart below that the S&P 500 needs to close today with a gain of 2.6% or more in order to avoid the likely start of recession (79% probability of 2015 recession). I know – hang in there with me on this one and take a look at the data.
Today, I share with you some of my high-level notes from this week’s Inside ETFs Conference in Hollywood, Florida. The forward return theme was consistent, from Vanguard to Wharton Professor Jeremy Siegel: expect low equity and fixed income returns. Jeffrey Gundlach left the audience in a state of depression (well the audience, not Gundlach) and Mark Yusko spoke of likely recession citing poor ISM numbers. This left Prof. Siegel to later say, “It appears I’m the only bull at the conference.”
Stay forward thinking, hedge that equity exposure and overweight liquid non-directionally dependent and tactical strategies. Recession is probable and may just be starting (more below). Equity markets decline more than 40% on average during recessions. It is that we must defend our capital against.
Mauldin was the key-note speaker on Tuesday and shared what he believes to be the top five challenges immediately ahead. There is a lot of content this week. Grab a coffee and jump on in (click on the orange On My Radar link).
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Included in this week’s On My Radar:
- Gundlach – The Outlook for the U.S. Economy
- Siegel – The Last Bull Standing
- S. Recession Watch Charts
- So Yes – The Oil Crash Looks a lot Like Sub-Prime
- GMO’s James Montier – A Quote Too Good Not to Include
- Trade Signals – Sell/Hedge the Rallies
- Mauldin – Top Five Challenges
Gundlach – The Outlook for the U.S. Economy
My notes presented in bullet point format:
- “What the heck is the Fed doing?”
- Aftermath of Fed policies will haunt the markets.
- Kaboom – Game. Pump up the balloon until it pops. Metaphor for the Fed.
- The Fed was supposed to raise rates in September. Since they said they would do in 2015 they backed themselves in corner for December. Further, “idiotically” they said they would raise eight times in the next two years. Fed must scale back its rhetoric!
- Fed may have to reverse course and follow the path other central banks have taken since 2011.
- Most central banks are cutting and we will be raising rates. What is difference between the US & ECB? Why are we cutting? Our growth is almost the same as theirs.
- Average hourly earnings moving higher. The Fed is worried about wage inflation, but what’s wrong with the middle class getting a wage increase?
- HY vs. Treasuries. Spread is bigger than during other rate hikes. Average is 4% now 6% but was 8%.
- The shadow rate was -3.5%. Now we are around 0%. Market has tightened much more than 25 bps.
- “Fed Frozen in Thinking.” US inflation rate is lower than rest of world.
- “The Efficient Market hypothesis is dead wrong.”
- As for GDP – Gundlach said the Fed dead wrong in its forecast.
- “Trying for hope over experience like a second marriage.”
- China 6.9% GDP is a joke. He thinks it’s negative, but will give them zero as benefit of the doubt.
- Currency Wars increasing (SB here: indeed they are).
- Noted the severe downgrade of forecast by Atlanta Fed.
- The “Fed whistles through the graveyard.”
- Nominal GDP does not support Fed raising.
- Fed has never raised with GDP this low.
- Gundlach doesn’t like stats that ignore the bad stuff. People like to take away energy and say that were up. But there are many companies that benefit from lower energy prices.
- Manufacturing still matters.
- Long-term Treasuries are completely appropriate at 2%.
- He will bet dollars to donuts that Junk Bond issuance will collapse.
- Commodity Index. Thinks it is due to lack of demand not just supply. Prices are symptom of growth not being there.
- Emerging markets. More downside to come. Could fall an additional 40%.
- His “recommendation is to short them.”
- Brazil in depression. -4.5% growth.
- When blood in the streets in EM buy India. Massive labor force growth.
- Shanghai looks like Dow in 1929. China might not bounce back.
- Can’t create people… Similar to Japan in 1990. Chinese Yuan must depreciate.
- When Yuan devalues, the markets throw a fit.
- Sees yield curve flattening.
- S&P 500 vs. HY Spreads bigger than 2008. Obvious sell signal.
- More recession signs: S&P 500 profit margins are down. 1985 only period when 60 bp decline did not coincide with recession.
- Thinks dollar has peaked and will fall.
- Investment grade bonds haven’t rallied.
- Downgrade ratio for bonds increasing. When bonds are downgraded they don’t rally. Pensions and Endowments will need to sell if not A or better rating.
- Leveraged loans continue to fall.
- Clock ticking on HY energy.
- Incredible drop in EBITDA.
- Crude Oil inventories are very high. One of biggest gaps between supply and demand ever.
Ok – you get the picture. Not good. Go grab a stiff drink.
His thoughts on the economy:
- Deflation is an issue and oil is our number 1 threat (price declining from $126 to $26).
- There is $2 trillion in infrastructure tied to $56 per barrel oil.
- 30% of capital expenditures spent over the last five years was directly or indirectly tied to oil.
- The threat is the debt tied to those companies.
- He believes this is all part of the Saudi goal for market share (SB here: I think it is that and more).
- He believes that $60 per