Tag: Doug Kass (page 1 of 2)

Weekend Reading: You Have Been Warned

Authored by Lance Roberts via RealInvestmentAdvice.com,

Investors aren’t paying attention.

There is an important picture that is currently developing which, if it continues, will impact earnings and ultimately the stock market. Let’s take a look at some interesting economic numbers out this past week.

On Tuesday, we saw the release of the Producer Price Index (PPI) which ROSE 0.4% for the month following a similar rise of 0.4% last month. This surge in prices was NOT surprising given the recent devastation from 3-hurricanes and massive wildfires in California which led to a temporary surge in demand for products and services.

Then on Wednesday, the Consumer Price Index (CPI) was released which showed only a small 0.1% increase falling sharply from the 0.5% increase last month.

This deflationary pressure further showed up on Thursday with a -0.3 decline in Export prices. (Exports make up about 40% of corporate profits)

For all of you that continue to insist this is an “earnings-driven market,” you should pay very close attention to those three data points above.

When companies have higher input costs in their production they have two choices: 1) “pass along” those price increase to their customers; or 2) absorb those costs internally. If a company opts to “pass along” those costs then we should have seen CPI rise more strongly. Since that didn’t happen, it suggests companies are unable to “pass along” those costs which means a reduction in earnings.

The other BIG report released on Wednesday tells you WHY companies have been unable to “pass along” those increased costs. The “retail sales” report came in at just a 0.1% increase for the month. After a large jump in retail sales last month, as was expected following the hurricanes, there should have been some subsequent follow through last month. There simply wasn’t.

More importantly, despite annual hopes by the National Retail Federation of surging holiday spending which is consistently over-estimated, the recent surge in consumer debt without a subsequent increase in consumer spending shows the financial distress faced by a vast majority of consumers. The first chart below shows a record gap between the standard cost of living and the debt required to finance that cost of living. Prior to 2000, debt was able to support a rising standard of living, which is no longer the case currently.

With a current shortfall of $18,176 between the standard of living and real disposable incomes, debt is only able to cover about 2/3rds of the difference with a net shortfall of $6,605. This explains the reason why “control purchases” by individuals (those items individuals buy most often) is running at levels more normally consistent with recessions rather than economic expansions.

If companies are unable to pass along rising production costs to consumers, export prices are falling and consumer demand remains weak, be warned of continued weakness in earnings reports in the months ahead. As I stated earlier this year, the recovery in earnings this year was solely a function of the recovering energy sector due to higher oil prices. With that tailwind now firmly behind us, the risk to earnings in the year ahead is dangerous to a market basing its current “overvaluation” on the “strong earnings” story.

Don’t say you weren’t warned.

In the meantime, here is your weekend reading list.


Trump, Economy & Fed


VIDEO – It’s A Turkey Market


Markets


Research / Interesting Reads


“The only function of economic forecasting is to make astrology look respectable.” – Sir John Templeton

http://WarMachines.com

It’s A ‘Turkey’ Market

Authored by Lance Roberts via RealInvestmentAdvice.com,

With Thanksgiving week rapidly approaching, I thought it was an apropos time to discuss what I am now calling a “Turkey” market.

What’s a “Turkey” market?  Nassim Taleb summed it up well in his 2007 book “The Black Swan.”

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,’ as a politician would say.

 

On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”

Such is the market we live in currently.

In a market that is excessively bullish and overly complacent, investors are “willfully blind” to the relevant “risks” of excessive equity exposure. The level of bullishness, by many measures, is extremely optimistic, as this chart from Tiho Krkan (@Tihobrkan) shows.

Not surprisingly, that extreme level of bullishness has led to some of the lowest levels of volatility and cash allocations in market history.

Of course, you can’t have a “Turkey” market unless you are being lulled into it with a supporting story that fits the overall narrative. The story of “it’s an earnings-driven market” is one such narrative. As noted  by my friend Doug Kass:

“Earnings are there to support the market. If we didn’t have earnings to support the market, that would be worrying. But we have earnings.”
Mary Ann Bartels, Merrill Lynch Wealth Management

 

“Earnings are doing remarkably well.”
Ed Yardeni, Yardeni Research

 

“This is very much an earnings-driven market.”
Paul Springmeyer, U.S. Bancorp Private Wealth Management

 

This is very much earnings-driven.”
Michael Shaoul, Marketfield Asset Management

 

“Equities have largely been driven by global liquidity, but they are now being driven by earnings.”
Kevin Boscher, Brooks Macdonald International

 

“Most of the market action in 2017 has been earning-driven.”
Dan Chung, Alger Management

 

“The action is justified because of earnings.
James Liu, Clearnomics

 

In another case of “Group Stink” and contrary to the pablum we hear from many of the business media’s talking heads, the U.S. stock market has not been an earnings-driven story in 2017. (I have included seven “earnings-driven” quotes above from recent interviews on CNBC, but there are literally hundreds of these interviews, all saying the same thing)

 

Rather, it has been a valuation-driven story, just as it was in 2016 when S&P 500 profits were up 5% and the S&P Index rose by about 11%. And going back even further, since 2012 S&P earnings have risen by 30% compared to an 80% rise in the price of the S&P lndex!

He is absolutely right, of course, as I examined in the drivers of the market rally three weeks ago.

“The chart below expands that analysis to include four measures combined: Economic growth, Top-line Sales Growth, Reported Earnings, and Corporate Profits After Tax. While quarterly data is not yet available for the 3rd quarter, officially, what is shown is the market has grown substantially faster than all other measures. Since 2014, the economy has only grown by a little less than 9%, top-line revenues by just 3% along with corporate profits after tax, and reported earnings by just 2%. All of that while asset prices have grown by 29% through Q2.” 

The hallmark of a “Turkey” market really comes down to the detachment of price from valuation and the deviation of price from long-term norms. Both of these detachments are shown in the charts below.

CAPE-5 is a modified version of Dr. Robert Shiller’s smoothed 10-year average. By using a 5-year average of CAPE (Cyclically Adjusted Price Earnings) ratio, it becomes more sensitive to market movements. Historically, deviations above 40% have preceded secular bear markets, while deviations exceeding -40% preceded secular bull markets.

The next chart shows the deviation of the real, inflation-adjusted S&P 500 index from the 6-year (72-month) moving average.

Not surprisingly, when the price of the index has deviated significantly from the underlying long-term moving averages, corrections and bear markets have not been too distant.

Combining the above measures (volatility, valuation, and deviation) together shows this a bit more clearly. The chart shows both 2 and 3-standard deviations above the 6-year moving average. The red circles denote periods where valuations, complacency and 3-standard deviation moves have converged. 

Of course, with cash balances low, you can’t foster that kind of extension without sufficiently increasing leverage in the overall system. The expansion of margin debt is a good proxy for the “fuel” driving the bull market advance.

Naturally, as long as that “fuel” isn’t ignited, leverage can remain supportive of the market’s advance. However, when the reversion begins, the “fuel” that drove stocks higher will “explode” when selling forces liquidation through margin calls.

While the media continues to suggest the markets are free from risk, and investors should go ahead and “stick-their-necks-out,” history shows that periods of low volatility, high valuations and deviations from long-term means has resulted in very poor outcomes.

Lastly, there has been a lot of talk about how markets have entered into a new “secular bull market” period. As I have addressed previously, I am not sure such is the case. Given the debt, demographic and deflationary backdrop, combined with the massive monetary interventions of global Central Banks, it is entirely conceivable the current advance remains part of the secular bear market that began at the turn of the century.

Only time will tell.

Regardless, whether this is a bull market rally in an ongoing bear market, OR a bull rally in a new bull market, whenever the RSI (relative strength index) on a 3-year basis has risen above 70 it has usually marked the end of the current advance. Currently, at 84, there is little doubt the market has gotten ahead of itself.

No matter how you look at it, the risk to forward returns greatly outweighs the reward presently available.

Importantly, this doesn’t mean that you should “sell everything” and go hide in cash, but it does mean that being aggressively exposed to the financial markets is no longer opportune.

What is clear is that this is no longer a “bull market.”

It has clearly become a “Turkey” market. Unfortunately, like Turkeys, we really have no clue where we are on the current calendar. We only know that today is much like yesterday, and the “bliss” of calm and stable markets have lulled us into extreme complacency.

You can try and fool yourself that weak earnings growth, low interest rates and high-valuations are somehow are justified. The reality is, like Turkeys, we will ultimately be sadly mistaken and learn a costly lesson.

“Price is what you pay, Value is what you get.” – Warren Buffett

http://WarMachines.com

Weekend Reading: It’s The Debt, Stupid

Authored by Lance Roberts via RealInvestmentAdvice.com,

As I noted last Friday, the recently approved budget was an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

 

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.”

I then followed this up this past Monday with “3 Myths Of Tax Cuts” stating:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.

 

As the chart below shows there is ZERO evidence that tax cuts lead to stronger sustained rates of economic growth. The chart compares the highest tax rate levels to 5-year average GDP growth. Since Reagan passed tax reform, average economic growth rates have only gone in one direction.”

On Thursday, Fitch confirmed the same in their dismal report on the reality of what the effect of the “tax cut”

“Such reform would deliver a modest and temporary spur to growth, already reflected in growth forecasts of 2.5% for 2018. However, it will lead to wider fiscal deficits and add significantly to US government debt. As such, Fitch has revised up its medium-term debt forecast. US federal debt was 77% of GDP for this fiscal year. Fitch believes the tax package will be revenue negative, even under generous assumptions about its growth impact. Under a realistic scenario of tax cuts and macro conditions, the federal deficit will reach 4% of GDP by next year, and the US debt/GDP ratio would rise to 120% of GDP by 2027.

 

Tax cuts may lead to a short-lived boost to output, but Fitch believes that they will not pay for themselves or lead to a permanently higher growth rate. The cost of capital is already low and corporate profits are elevated. In addition, the effective tax rate paid by large corporations is well below the existing statutory rate.

 

Fitch expects US economic growth to peak at 2.5% in 2018 before falling back to 2.2% in 2019. The US will enter the next downturn with a general government “structural deficit” (subtracting the impact of the economic cycle) larger than any other ‘AAA’ sovereign, leaving the US more exposed to a downturn than other similarly rated sovereigns. The US is the most indebted ‘AAA’ country and it is running the loosest fiscal stance. Long-term debt dynamics are also more negative than those of peers, with health and social security spending commitments set to rise over the next decade. “

There is nothing “good” in any of the statements above,  and drive to the same conclusions I discussed last Monday.

You can’t solve a debt problem, by issuing more debt. 

While Congressional members continue campaigning that the “tax plan” would give an $1182 tax cut to most Americans, and boost wages by $4000, such has never been the case. A recent study by the Economic Policy Institute suggested the same in a recent study:

“Cutting corporate tax rate cuts would do very little to boost employment generation. In fact, cutting corporate tax rates ranks as the least effective form of fiscal support for employment generation, since corporate tax cuts primarily benefit rich households—who are less likely to increase their consumption than low- or middle-income households when they receive tax cuts.”

This is a point I have made previously. Corporate tax rate cuts will unambiguously redistribute post-tax income regressively. The corporate income tax is a progressive tax, with the top 1% of households accounting for 47% of the corporate income tax.

Don’t be bamboozled by the idea that tax cuts and reforms will lead to sustained economic growth. There is simply NO evidence that such is the case over the long-term.

However, there is plenty of evidence to suggest that further costly reforms and run-away budgets will lead to an increase of the current national debt and the ongoing low-growth economy that has plagued the U.S. since the turn of the century.

In other words….“it’s the debt, stupid.”

In the meantime, here is your weekend reading list.


Trump, Economy & Fed

 


VIDEO – Tax Cut/Reform Discussion (Real Investment News)


Markets


Research / Interesting Reads


“In investing, what is comfortable is rarely profitable.” – Rob Arnott

http://WarMachines.com

Bond Bears & Why Rates Won’t Rise

Authored by Lance Roberts via RealInvestmentAdvice.com,

Here we go again…

Since June of 2013, I have been writing about the reasons why rates can’t rise much and why calls for the end of the “bond bull market” remain wrong.

Regardless, about every 3-months or so, there is a tick up in rates and you can almost bet that soon thereafter will be a litany of articles explaining why THIS time the “bond bull market” is really dead. For example, just from this past week:

What is the argument from low rates will rise?

It basically boils down to simply this – rates are so low they MUST go up.

The problem, however, is that interest rates are vastly different than equities. When people go to make a purchase on credit, borrow money for a house, or get a loan for a new car, they don’t ask what the level of the stock market is but rather “how much will this cost me?” The differentiator between making a purchase, or not, is based on the simple outcome of the interest rate effect on the loan payment. If interest rates rise too much, consumption stalls, and along with it economic growth, causing rates to go lower. If economic demand is robust, rates rise to meet the demand for credit.

The trend and level of interests are the singular best indicator of economic activity. As Doug Kass recently noted:

“The spread between the two- and ten-year U.S. notes has fallen to 68 basis points — that’s the lowest print in ten years and if history is a guide it is signaling a potential domestic economic slowdown.”

“The flattening in the yield curve is happening despite a likely continued Federal Reserve tightening and a rise back to December levels for overnight index swaps (OIS). It was back in 2004 — as the Fed started its tightening cycle (that concluded in Summer, 2006) — that both the curve flattened and the five year OIS rose. At the conclusion of the tightening in the middle of 2006, a deep recession followed by about fifteen to eighteen months later.”

In other words, “It’s the economy, stupid.”

Economic Growth Drives Rates

The chart below is a history of long-term interest rates going back to 1857. The dashed black line is the median interest rate during the entire period. I have compared it to the 5-year nominal GDP growth rate during the same period.

(Note: As shown, interest rates can remain low for a VERY long time.)

Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing” as France, England, Russia, Germany, Poland, Japan and others were left devastated. It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed. But that was just the start of it.

Beginning in the late 50’s, America embarked upon its greatest quest in history as man took his first steps into space. The space race that lasted nearly twenty years led to leaps in innovation and technology that paved the wave for the future of America. Combined with the industrial and manufacturing backdrop, America experienced high levels of economic growth and increased savings rates which fostered the required backdrop for higher interest rates.

Currently, the U.S. is no longer the manufacturing powerhouse it once was and globalization has sent jobs to the cheapest sources of labor. Technological advances continue to reduce the need for human labor and suppress wages as productivity increases. Today, the number of workers between the ages of 16 and 54 is at the lowest level relative to that age group since the late 70’s. This is a structural and demographic problem that continues to drag on economic growth as nearly 1/4th of the American population is now dependent on some form of governmental assistance.

This structural employment problem remains the primary driver as to why “everybody” is still wrong in expecting rates to rise.

As you can see there is a very high correlation, not surprisingly, between the three major components (inflation, economic and wage growth) and the level of interest rates. Interest rates are not just a function of the investment market, but rather the level of “demand” for capital in the economy. When the economy is expanding organically, the demand for capital rises as businesses expand production to meet rising demand. Increased production leads to higher wages which in turn fosters more aggregate demand. As consumption increases, so does the ability for producers to charge higher prices (inflation) and for lenders to increase borrowing costs. (Currently, we do not have the type of inflation that leads to stronger economic growth, just inflation in the costs of living that saps consumer spending – Rent, Insurance, Health Care)

The chart above is a bit busy, but I wanted you to see the trends in the individual subcomponents of the composite index. The chart below shows only the composite index and the 10-year Treasury rate. Not surprisingly, the recent decline in the composite index also coincides with a decline in interest rates.

In the current economic environment, the need for capital remains low, outside of what is needed to absorb incremental demand increases caused by population growth, as demand remains weak. While employment has increased since the recessionary lows, much of that increase has been the absorption of increased population levels.

Many of those jobs remain centered in lower wage paying and temporary jobs which do not foster higher levels of consumption. To offset weaker organic consumption, artificially suppressed interest rates, though monetary policy, gives the appearance of economic growth by dragging forward future consumption which leaves a future “void” that has to be continually refilled.

Currently, there are few economic tailwinds prevalent that could sustain a move higher in interest rates. The reason is that higher interest reduces the flow of capital within the economy. For an economy that remains dependent on the generosity of Central Bankers, rising rates are not the outcome that “stock market bulls” should NOT be rooting for.

The Implications Of A Bond Bust

If there is indeed a bond bubble, a burst would mean bonds decline rapidly in price pushing interest rates markedly higher. This is the worst thing that could possibly happen. 

1) The Federal Reserve has been buying bonds for the last 9- years in an attempt to push interest rates lower to support the economy. The recovery in economic growth is still dependent on massive levels of domestic and global interventions. Sharply rising rates will immediately curtail that growth as rising borrowing costs slows consumption.

2) The Federal Reserve currently runs the world’s largest hedge fund with over $4 Trillion in assets. Long Term Capital Mgmt. which managed only $100 billion at the time nearly brought the economy to its knees when rising interest rates caused it to collapse. The Fed is 45x that size.

3) Rising interest rates will immediately kill the housing market, not to mention the loss of the mortgage interest deduction if the GOP tax bill passes, taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in interest rates means higher borrowing costs which lead to lower profit margins for corporations. This will negatively impact the stock market given that a bulk of the “share buybacks” have been completed through the issuance of debt.

5) One of the main arguments of stock bulls over the last 9-years has been the stocks are cheap based on low interest rates. When rates rise the market becomes overvalued very quickly.

6) The massive derivatives market will be negatively impacted leading to another potential credit crisis as interest rate spread derivatives go bust.

7) As rates increase so does the variable rate interest payments on credit cards.  With the consumer are being impacted by stagnant wages, higher credit card payments will lead to a rapid contraction in income and rising defaults. (Which are already happening as we speak)

8) Rising defaults on debt service will negatively impact banks which are still not adequately capitalized and still burdened by large levels of bad debts.

9) Commodities, which are very sensitive to the direction and strength of the global economy, will plunge in price as recession sets in.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on but you get the idea.

The problem with most of the forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds. However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates, however, are an entirely different matter.

I won’t argue there is much room left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases. Since interest rates affect “payments,” increases in rates quickly have negative impacts on consumption, housing, and investment. This idea suggests is that there is one other possibility that the majority of analysts and economists ignore which I call the “Japan Syndrome.”

Japan is has been fighting many of the same issues for the past two decades. The “Japan Syndrome” suggests that while interest rates are near lows it is more likely a reflection of the real levels of economic growth, inflation, and wages.

If that is true, then rates are most likely “fairly valued” which implies that the U.S. could remain trapped within the current trading range for years as the economy continues to “muddle” along.

The irrationality of market participants, combined with globally accommodative central bankers, continues to push asset values higher and concentrate investors into the ongoing “chase for yield.” There isn’t much guessing on how this will end, history tells us that such things rarely end well.

http://WarMachines.com

Weekend Reading: Will Tax Reform Deliver As Expected?

Authored by Lance Roberts via RealInvestmentAdvice.com,

As I noted last Friday, the recently approved budget was an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

 

While the original House budget balanced on paper and offered some real savings, the Senate’s version accepted today by the House fails to reach balance, enacts a pathetic $1 billion in spending cuts out of a possible $47 trillion, and allows for $1.5 trillion to be added to the national debt.

 

Make no mistake – this is a defining moment for the Republican party. After years of passing balanced budgets and calling for fiscal responsibility, the GOP is now on-the-record as supporting trillions in new debt for the sake of tax cuts over tax reform and failing to act on the pressing need to reform our largest entitlement programs.”

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.

As the CFRB concludes:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.”

That is absolutely correct.

As the chart below shows there is ZERO evidence that tax cuts lead to stronger sustained rates of economic growth. The chart compares the highest tax rate levels to 5-year average GDP growth. Since Reagan passed tax reform, average economic growth rates have only gone in one direction.

However, the most likely unintended consequence of the proposed tax “cut” bill is that it will likely translate into a “hike” on middle class Americans. Take a look at the proposed tax bracket chart below.

Now, compare that with the actual breakdown of “who pays taxes.”

“The bottom 80% currently pay only about 18% of individual taxes with top 20% paying the rest. Furthermore, the bottom 40% currently have a NEGATIVE tax liability, and with the new tax plan cutting many of the deductions currently available for those in the bottom 40%, it could be the difference between a tax refund and actually paying taxes. “

“Of course, those in the top 20% of income earners are likely already consuming at a level with which they are satisfied. Therefore, a tax cut which delivers a few extra dollars to their bottom line, will likely have a negligible impact on their current levels of consumption.”

Given the newly designed tax brackets compresses individuals into fewer groups, it is quite likely a large chunk of the bottom 80% will likely experience either a hike or an inconsequential change. With the bottom 80% already consuming at max capacity, as discussed yesterday, a tax increase will hit the economy right where it hurts the most – in consumption expenditures. 

 “As the chart below shows, while savings spiked during the financial crisis, the rising cost of living for the bottom 80% has outpaced the median level of ‘disposable income’ for that same group. As a consequence, the inability to ‘save’ has continued.”

But while Congressional members were campaigning yesterday that the “tax plan” would give an $1182 tax cut to most Americans, it should not be forgotten that since they failed to “repeal and replace” the Affordable Care Act, any tax cut will only be diverted to offset a substantial rise in health care premiums in 2018.

Regardless, the proposed tax bill is just the first step.

Let the “horse trading” begin.

In the meantime, while we await the actual tax reform bill, here is your weekend reading list.


Trump, Economy & Fed


Markets


Research / Interesting Reads


“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations which do not meet these requirements are speculative.” – Benjamin Graham

http://WarMachines.com

Weekend Reading: Markets Love Central Banks – No Matter What They Do

Authored by Lance Roberts via RealInvestmentAdvice.com,

I discussed yesterday, the apparent “myth” of the Fed’s proposed “balance sheet reduction” program as the most recent analysis shows a $13.5 billion “reinvestment” into their balance sheet which has helped fuel the recent market advance.

But therein lies the potential “fatal flaw” of the “bullish logic.” 

At the September FOMC meeting, the Federal Reserve announced their latest decision which contained two primary components:

  1. No rate hike currently, although, further rate hikes are likely in the future, and;
  2. The beginning of the process to cease reinvestment of the Fed’s balance sheet. 

That announcement was notable for two reasons:

  1. The Fed did NOT hike rates because the underlying economic data, and, in particular, the inflation data, suggests the economy is too weak to absorb a further increase currently, and;
  2. The unwinding of the balance sheet is generally believed to be bullish for stocks. 

So, despite the clear evidence of the support for the markets provided by near zero-interest rate policy and trillions in monetary injection, it is believed that “unwinding” those supports will have “no effect” on the market. In other words, it doesn’t matter what the Fed does, it’s “bullish.”

The same is also believed to be the case for the European Central Bank and Mario Draghi who just announced yesterday that the ECB’s QE program will begin to be reduced by €30 Billion per month (down from €60 Billion). While this will continue the expansion of their balance sheet currently, the end of “QE,” as the markets have come to know it, is coming to an end.

Don’t misunderstand me, Central Banks are still very actively engaged in the support of the financial markets for the time being which keeps asset prices positively buoyed. However, with Central Banks now “tightening” monetary policy, the risk of a policy error has risen markedly. This is particularly the case when the financial markets insist on ignoring the knock-off effects of less liquidity.

Tax Reform With Complete Disregard

Yesterday, the House of Representatives passed the Senate-approved budget. This budget is an anathema to any fiscally conservative policy. As the Committee for a Responsible Federal Budget stated:

“Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance.

 

While the original House budget balanced on paper and offered some real savings, the Senate’s version accepted today by the House fails to reach balance, enacts a pathetic $1 billion in spending cuts out of a possible $47 trillion, and allows for $1.5 trillion to be added to the national debt.

 

Make no mistake – this is a defining moment for the Republican party. After years of passing balanced budgets and calling for fiscal responsibility, the GOP is now on-the-record as supporting trillions in new debt for the sake of tax cuts over tax reform and failing to act on the pressing need to reform our largest entitlement programs.”

Passing fiscally irresponsible budgets just for the sake of passing “tax cuts,” is, well, irresponsible. Once again, elected leaders have not listened to, or learned, what their constituents are asking for which is simply adherence to the Constitution and fiscal restraint.

As the CFRB concludes:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.”

That is absolutely correct.

Here is your weekend reading list.


Trump, Economy & Fed


Markets


Research / Interesting Reads


“There have been three great inventions since the beginning of time: fire, the wheel, and Central Banking.Will Rogers

http://WarMachines.com

Mauldin: “Investors Ignore What May Be The Biggest Policy Error In History”

Submitted by John Mauldin

My good friend Peter Boockvar recently shared a chart with me. The University of Michigan’s Surveys of Consumers have been tracking consumers and their expectations about the direction of the stock market over the next year. We are now at an all-time high in the expectation that the stock market will go up.

The Market Ignores Monetary Uncertainty

It is simply mind-boggling to couple that chart with the chart of the VIX shorts (I wrote about the VIX craze in this this issue of Thoughts from the Frontline).

Peter writes:

Bullish stock market sentiment has gotten extreme again, according to Investors Intelligence. Bulls rose 2.9 pts to 60.4 after being below 50 one month ago. Bears sunk to just 15.1 from 17 last week. That’s the least amount since May 2015. The spread between the two is the most since March, and II said, “The bull count reenters the ‘danger zone’ at 60% and higher. That calls for defensive measures.” What we’ve seen this year the last few times bulls got to 60+ was a period of stall and consolidation. When the bull/bear spread last peaked in March, stocks chopped around for 2 months. Stocks then resumed its rally when bulls got back around 50. Expect another repeat.

Only a few weeks ago the CNN Fear & Greed Index topped out at 98. It has since retreated from such extreme greed levels to merely high measures of greed. Understand, the CNN index is not a sentiment index; it uses seven market indicators that show how investors are actually investing. I actually find it quite useful to look at every now and then.

The chart below, which Doug Kass found on Zero Hedge, pretty much says it all. Economic policy uncertainty is at an all-time high, yet uncertainty about the future of the markets is at an all-time low.

Why This Is Happening Now

At the end of his email blitz, which had loaded me up on data, Dougie sent me this summary:

  • At the root of my concern is that the Bull Market in Complacency has been stimulated by:
  • the excess liquidity provided by the world’s central bankers,
  • serving up a virtuous cycle of fund inflows into ever more popular ETFs (passive investors) that buy not when stocks are cheap but when inflows are readily flowing,
  • the dominance of risk parity and volatility trending, who worship at the altar of price momentum brought on by those ETFs (and are also agnostic to “value,” balance sheets,” income statements),
  • the reduced role of active investors like hedge funds – the slack is picked up by ETFs and Quant strategies,
  • creating an almost systemic "buy the dip" mentality and conditioning.
  • when coupled with precarious positioning by speculators and market participants:
  • who have profited from shorting volatility and have gotten so one-sided (by shorting VIX and VXX futures) that any quick market sell off will likely be exacerbated, much like portfolio insurance’s role in a previous large drawdown,
  • which in turn will force leveraged risk parity portfolios to de-risk (and reducing the chance of fast turn back up in the markets),
  • and could lead to an end of the virtuous cycle – if ETFs start to sell, who is left to buy?

On the Brink of the Largest Policy Error

The chart above, which shows the growing uncertainty over the future direction of monetary policy, is both terrifying and enlightening. The Federal Reserve, and indeed the ECB and the Bank of Japan, went to great lengths to assure us that the massive amounts of QE that they pushed into the market would help turn the markets and the economy around.

Now they are telling us that as they take that money back off the table, they will have no effect on the markets. And all the data that I just presented above tells us that investors are simply shrugging their shoulders at what is roughly called “quantitative tightening,” or QT.

I simply don't buy the notion that QE could have had such an effect on the markets and housing prices while QT will have no impact at all.

In the 1930s, the Federal Reserve grew its balance sheet significantly. Then they simply left it alone, the economy grew, and the balance sheet became a nonfactor in the following decades. I don’t know why today’s Fed couldn’t do the same thing.

There really is no inflation to speak of, except asset price inflation, and nobody really worries about that. We all want our stocks and home prices to go up, so there’s no real reason for the central bank to lean against inflationary fears; and raising rates and doing QT at the same time seems to me to be taking a little more risk than necessary.

And they’re doing it in the midst of the greatest bull market in complacency to emerge in my lifetime.

Do they think that taking literally trillions of dollars off their balance sheet over the next few years is not going to have a reverse effect on asset prices? Or at least some effect? Is it really worth the risk? Remember the TV show Hill Street Blues? Sergeant Phil Esterhaus would end his daily briefing, as he sent the policemen out on their patrols, with the words, “Let’s be careful out there.”

* * *

Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

http://WarMachines.com

Weekend Reading: Dow 24,000 By Christmas

Authored by Lance Roberts via RealInvestmentAdvice.com,

This past week, the Dow crested 23000 sending the networks into a “tizzy.” It took about 5-minutes of crossing that magical “round number,” before questions raised of how long before the markets cross 24,000, and 25,000.

The chart below shows the 1000-point milestones of the Dow going back to 2009. After a long break between 18,000 and 19,000 in 2015 through the election in 2016, the Dow has surged higher ticking off 4-more milestones in less than a year.

As I have shown previously, these late stage “melt-ups” are not uncommon. In fact, as shown below, it is something witnessed prior to every market peak previously. 

As I stated just recently:

“This past weekend, I discussed what appears to be the markets ongoing melt-up toward its inevitable conclusion. Of course, that move is supported by the last of the ‘holdouts’ that finally capitulate and take the plunge back into a market that ‘can seemingly never go down.’ But therein lies the danger.

 

‘However, it should be noted that despite the ‘hope’ of fiscal support for the markets, longer-term conditions are currently present that have led to rather sharp market reversions in the past. Regardless, the market is currently ignoring such realities as the belief ‘this time is different’ has become overwhelming pervasive.’”

With volatility crushed, and record short positions on the VIX, there will likely be an event at some point that leads to a massive reversal in the assessment of “risk” and an unwinding of the market.

However, such is not the case currently as even “small dips” are met with eager buyers which continues to reinforce the very dangerous lack of fear.

With more ETF’s currently available to investors than there are stocks to fill them, it is quite likely the demand ramp for ETF’s will continue to push the Dow higher into the end of the year.

Dow 24,000 by Christmas?

Don’t be surprised if it happens.

Just remember, all market melt-ups end just when things look their brightest.

Here’s your reading list to for the weekend.


Trump, Economy & Fed


Markets


Research / Interesting Reads


“A bear market returns capital to those who it rightly belongs to.Ian McAvity

http://WarMachines.com

Weekend Reading: $7 Trillion To Manipulate Prices

Authoreed by Lance Roberts via RealInvestmentAdvice.com,

As the stock market continues to press new highs, the level of optimism climbs with it. I discussed yesterday Richard Thaler’s, a recent recipient of the Nobel Price in Economics, comments about not understanding the current “irrationality of investors relating to their investing behavior.”

What is interesting is that Thaler’s received his Nobel Prize for his pioneering work in establishing that people are predictably irrational — that they consistently behave in ways that defy economic theory. For example, people will refuse to pay more for an umbrella during a rainstorm; they will use the savings from lower gas prices to buy premium gasoline; they will offer to buy a coffee mug for $3 and refuse to sell it for $6.

The fact that a man who studies the “irrationality of individuals” is stumped by current investor behavior should be alarming at the least.

But as earnings season gets underway we once again return to quarterly Wall Street “beat the estimate game,” in which companies are rewarded by beating continually lowered estimates. Of course, the primary catalyst used to beat those estimates was not a rise in actual revenue, or even reported earnings, but rather ongoing accounting gimmickry and stock buybacks. As shown below, through the second quarter of this year, reported EPS, which includes “all the bad stuff,” actually declined in the latest quarter and has remained virtually unchanged since 2014. (But, even that is an illusion as shares have been aggressively bought back in order to sustain that same level of EPS.)

The difference between reported earnings with and without the benefit of share repurchases is substantial. The chart below shows the net difference between gross reported earnings with and without the buyback impact. Importantly, the net effect of buybacks is having less impact which, as was the case in 2007, was a precursor to the crash. 

Ralph Nader just recently did an in-depth expose on the problems with share repurchases. To wit:

The monster of economic waste—over $7 trillion of dictated stock buybacks since 2003 by the self-enriching CEOs of large corporations—started with a little-noticed change in 1982 by the Securities and Exchange Commission (SEC) under President Ronald Reagan. That was when SEC Chairman John Shad, a former Wall Street CEO, redefined unlawful ‘stock manipulation’ to exclude stock buybacks.”

Yep, stock buybacks used to be considered stock manipulation, yet today, it is widely accepted by investors as “just the right measure to boost earnings in the ongoing “beat the estimate” game.

As Ralph Nader points out – there is a problem.

“The stock buyback mania was unleashed. Its core was not to benefit shareholders (other than perhaps hedge fund speculators) by improving the earnings per share ratio. Its real motivation was to increase CEO pay no matter how badly such burning out of shareholder dollars hurt the company, its workers and the overall pace of economic growth.

The bottom line is that while companies take trillions of dollars and buyback shares, it only benefits the executives of the company at the expense of both workers and, ultimately, shareholders as companies with excessive stock buybacks experience a declining market value.

The interview is worth watching, and read the article, and think about it.

Here’s your reading list to for the weekend.


Trump, Economy & Fed


Markets


Research / Interesting Reads


“Making it, and keeping it, are two different things.Anonymous

 

http://WarMachines.com

Kass Warns: “The Probability Of A Flash Crash Grows Exponentially”

Submitted via Doug Kass,

"We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. I admit to not understanding it.'

–Dr. Richard Thaler, Nobel Prize winner

In an interview with Bloomberg Tuesday, University of Chicago economics professor Richard Thaler went on to say in response to the market's low volatility and continued investor optimism, "It's certainly puzzling… and it's puzzles that attract my attention." He added that he is nervous, and when investors get nervous "they are prone to being spooked."

A World Without Risk?

These observations and, specifically, the quote I started with this morning are much like what I have been saying in my Diary — namely, that never in history have there been so many potentially adverse political, geopolitical, economic and market outcomes.

I am not alone in this view, as Macquarie's Viktor Shvetz recently wrote:

"Investors are probably suffering extreme mental exhaustion. Historically low volatilities and risks, coinciding with high valuations, would make anyone nervous."

According to the brokerage, the reason for this underlying dysphoria is that "investors understand that there is nothing normal in the current environment of unprecedented financialization and economic disruption. The deadweight of US$400 trillion 'cloud' of financial instruments (backing into assets that are either worthless or are declining in value) must be supported by ongoing financialization."

In a world seemingly without risk and with spreads at all-time tights, Bank of America's David Woo writes in a similar vein that the market is more complacent than it was in the summer of 2007:

"This implies that liquidity must continue to grow, volatilities must be controlled and neither demand nor supply can yield higher cost of capital. Thus, risks facing investors are that either CBs and/or China misjudge extent to which reflation is dependent on inflating asset values and China's fixed investment.

 

If the market is underpricing the uncertainty with respect to the outlook of US monetary policy, we are even more concerned that it seems totally impervious to the risk of two potentially disruptive, if not dangerous, Games of Chicken likely to unfold in the summer and the beginning of the fall….

 

"We find it difficult to reconcile the record low volatility in financial markets at the moment with growing political risk in Washington and geopolitical risk in Asia. There are many reasons why we are living in a different world than the one we used to know and we would caution against relying too much on history for forecasting the likely outcome of these risks."

Yesterday I observed the volatility records being made recently:

"Month to date, the annualized realized volatility of the S&P Index is 5.2% — that's the lowest vol in an October in over 90 years.

 

By means of perspective, the average October volatility since it has been recorded is 17.0%.

 

It is interesting that the four other low volatility Octobers all occurred in the 1960s — a period that preceded a sharp acceleration in inflation and rise in interest rates over the next decade."

So, with volatility at record lows, the S&P 500 climbing to new heights and the Nasdaq higher in 10 of the 11 trading sessions, why do I think the risks associated with a "flash crash" are multiplying?

It is market positioning — something I and others rarely consider in our market analysis.

Today, speculators have breathtakingly large short positions in volatility futures, so that a relatively small spike lower in the averages, for any reason, of 3% or so could drive volatility much higher and demand (covering) of VIX futures. (The largest S&P selloff when the VIX was under 12 was 3.5% in February 2007).

Let me explain how a short volatility unwind might develop and what its implications are.

If Markets Spike Lower and the VIX Goes Bananas

It is tautological that as volatility moves lower and stock prices move higher, risks rise.

Several buy- and sell-side analysts have done a great deal of work as to what current positioning in the market may have if an exogenous event (from any Black or "Orange" Swan) produces a quick woosh lower in the averages and a spike in volatility.

From Morgan Stanley's Chris Metli:

"It's easy to become numb to the low volatility environment and the risks it presents. While trying to pick a trough in vol has been a fool's errand, focusing on the risks resulting from vol being so low is not. Low volatility has produced a regime where the risks are asymmetric and negatively convex, so being prepared for an unwind is critical. This is not a call that vol is almost to spike, but you need a plan if it does."

The pain of an unwind in VIX futures could be exacerbated in the days following a woosh lower by the dominance of passive investors (quant strategies and ETFs). The deleveraging of highly leveraged risk-parity funds, in particular, represents a risk that may not be easily repaired or reversed after the initial market drop.

Here is a further explanation from Morgan Stanley by way of Zero Hedge of the positioning risks that were in place in July.

Since then, as volatility has declined and the S&P index continued to climb, the risks have grown greater with an even larger base of short volatility futures.

Francesco Filia of Fasanara Capital writes about the potential damage delivered by the possible covering of short volatility futures:

"Market fragility must surely be a concern in the current investing environment. Yet, the psychological damage on investors and their behavioral reaction function to a sudden risk-off environment can never be as certain and direct as a wipe-out risk to a whole cluster of them. That is the nature of the risk that short-vol vehicles are facing today."

And consider this important update on positioning from Morgan Stanley's Metli — specifically, that more than 400,000 VIX futures would likely needed to be bought if the S&P Index falls by 5% in one day, nearly double what it was in July!

Bottom Line

Though large daily drops in the markets are rare, the factors that could contribute to a quick drop have increased.

Investors have been concerned about the VIX for years, but the positioning has now moved to an extreme. Such positioning could accelerate a market drop as the chances of a flash crash have escalated.

But, Dr. Minsky has warned about the risks of becoming numb to the risks associated with a period of stability amid rising asset prices; it is not only inevitably followed by instability, it inevitably creates it.

In a world in which the chances of an external market shock are rising and at a time when volatility is cratering and stock prices never decline, the risks of a flash crash caused by the one-sided market positioning in VIX futures is increasing and are at a higher probability of occurring than at any time in history.

http://WarMachines.com

Weekend Reading: Bull Market In Complacency

Authored by Lance Roberts via RealInvestmentAdvice.com,

With the market recently breaking above 2500, there seems to be nothing to dampen the bullish exuberance. The recent run, which has largely been focused on areas in the market with the most sensitivity to tax cuts, has exploded over the last two weeks to record highs.

That explosion has also lead to a surge in the Market Greed/Fear Gauge which comprises different measures of market complacency and bullishness.

But the rush to chase performance can be clearly seen in the chart below of the S&P 600 index (small cap) which is now 4-standard deviations above the 6-month moving average.

Then there is the widely viewed CNN Fear/Greed Index.

Of course, not surprisingly, with investors as optimistic and bullish as they can be equity to money market ratios are at extremes.

And “Dumb Money” is continuing to pile into markets as “Smart Money” is willing to sell positions to them.

After 9-years of a bull market, and pushing a 270% gain from the lows, investors have now decided it is now time to get back into the market. But that is the nature of a bull market, and particularly one that has entered into the final stages of long-term cyclical advance, where the last of the “holdouts” are sucked back into the game.

As we enter into earnings season, we once again enter into the “beat the estimates game,” where analysts act surprised that companies “beat” lowered estimates. In the short-term, these “beat rates” will provide support for the bullish case, but in the long-term, it is valuations and actual revenue growth that matters.

I agree with Doug’s sentiment yesterday:

  •  Massive injections of liquidity from the world’s central bankers
  • Passive investing (quants and ETFs) are now dominating markets (at nearly 40%) at the margin
  • Machines and algorithms, as well as many individual investors, are behaving differently as they are now programmed and conditioned to buy the dips.
  • 17% of the listed shares outstanding have been retired in corporate stock repurchases since the Generational Low in March, 2009.
  • More than half of the listed companies on the exchanges have disappeared over the last eight years

“We have a Bull Market in Complacency.” – Doug Kass

Clearly.

Here’s your reading list to for the weekend.


Trump Tax Cuts…


Markets


Research / Interesting Reads


“In a bear market all stocks go down and in a bull market they go up.Jesse Livermore

http://WarMachines.com

Weekend Reading: Tax Cut Wish List

Authored by Lance Roberts via RealInvestmentAdvice.com,

On Wednesday, the President announced his plan to cut taxes for Americans, return jobs to America and return the country to economic prosperity.

It’s a tall order to fill, and the proposed tax reform is a “Christmas Wish List” that will have to checked twice to determine which parts are “naughty” and “nice.”

As I pointed out yesterday,

“The belief that tax cuts will eventually become revenue neutral due to expanded economic growth is a fallacy. As the CRFB noted:

 

‘Given today’s record-high levels of national debt, the country cannot afford a deficit-financed tax cut. Tax reform that adds to the debt is likely to slow, rather than improve, long-term economic growth.’

 

The problem with the claims that tax cuts reduce the deficit is that there is NO evidence to support the claim. The increases in deficit spending to supplant weaker economic growth has been apparent with larger deficits leading to further weakness in economic growth. In fact, ever since Reagan first lowered taxes in the ’80’s both GDP growth and the deficit have only headed in one direction – lower.’

That little green bump in the deficit was when President Clinton “borrowed” $2 trillion from Social Security to balance the budget, and since there were no cuts to spending, led a surplus that lasted about 20-minutes.

The problem is that the tax plan may not provide the benefits as hoped. While President Trump suggests the plan will return “trillions” of dollars locked up overseas to create jobs, the reality, according to Goldman Sachs, is likely closer to $250 billion that will primarily go to share buybacks, dividends, and executive compensation.  

Of course, such actions do not boost economic growth but are a boon to Wall Street and the 10% of the economy that invest in the market. 

But here is the key point with respect to tax cuts. History is replete with evidence that shows tax cuts DO NOT lead to a rapid growth in the economy. As shown below, the slope of economic growth has been trending lower since the “Reagan tax cuts” were implemented.

Lastly, tax cuts have relatively low economic multipliers particularly when they primarily only benefit those at the top of the income spectrum. With the average household heavily indebted, credit is being used to sustain the standard of living, there is likely to be little transfer of “tax savings” back into the economy.

It is a simple function of math. But the following chart shows why this has likely come to the inevitable conclusion, and why tax cuts and reforms are unlikely to spur higher rates of economic growth.”

As is always the case…“it’s the debt, stupid.” 

However, here are plenty of discussions both for and against the tax plan so you can decide for yourself.


Trump Tax Cut Plan


Markets


Research / Interesting Reads


A bull market is like sex. It feels best just before it ends.” – Warren Buffett

http://WarMachines.com

Kass: “Investors Seemingly Learned Nothing From History”

Authored by Doug Kass via RealInvestmentAdvice.com,

“‘A bull market is like sex. It feels best just before it ends.'” – Warren Buffett

Excuse me for being redundant, but the following Jim Rogers quote that I posted yesterday underscores Mark Twain’s famous quote that “history doesn’t repeat itself, but it often rhymes”:

“When things are going right, we all need a 26-year-old. There’s nothing better than a 26-year-old in a great bull market especially in a bubble. They’re fearless. They don’t know. It will never end. They will tell you why it will never end. They know that it cannot end and will never end. So in the bull market, you’ve got to have a 26-year-old. But when they end you don’t want the 26-year-old around… they make a lot of money. They don’t know why they made money. So they don’t know why they lose money. They don’t know what happened. -Jim Rogers on Realvision

Back in 1997 I wrote this editorial in the Other Voices section of Barron’s that echoed Rogers’ recent quote.

In the difficult business of piling up a fortune everyone has an infallible strategy and a set of assumptions, technical and./or fundamental, that leads them to investment nirvana.

But it is never easy. The rules change and so do the players.

From my perch I steadily have listened to the irrational being rationalized as the bulls declare, with straight-faced confidence, that valuations in the 95% decile should be ignored because a synchronized global expansion will “earn out” from these extended metrics.

This confidence is expressed despite a plethora of possible adverse outcomes, particularly in the interconnected world in which we live.

The positive outcome of steadily expanding global growth coupled with low inflation and equally low interest rates may yet prove to become reality. Geopolitical friction may subside. Political partisanship in Washington, D.C, may succumb to cooperation, leading to the initiation of tax and regulatory reform and the repatriation of overseas corporate cash. The Orange Swan may wake up and reject the extreme influences of the Republican right. Trump may stop threatening a war with North Korea in a ping-pong of outrageous and provocative tweets. The rate of growth in real GDP may expand to 3% and we may be in another new paradigm of uninterrupted growth. S&P profits will grow at a rate of 8% annually, ad infinitum. Natural disasters will be a thing of the past and global warming concerns are nonsensical. The North Korean Rocket Man may be all hat and no cattle. The proliferation of ETFs, which in number now exceed the number of listed equity securities, and the ever-present quant strategies that are ignorant of fundamentals may not yield a “flash crash,” easily accommodating any selling waves. Every dip will continue to be bought. And interest rates and inflation may be in a permanent stage of adolescence.

But, I am blinded by a sense of history, and the belief that few of the conditions in the last paragraph are likely to be met.

In our flat, interconnected and network world, the odds favor less stability over more stability.

To this observer the markets’ dominos are exhibiting signs of falling around all over — in consumer packaged goods, in (T)FANG, in retail and elsewhere. Yet the selective memory of the talking heads in the business media emphasize the narrowing field of outperforming stocks (e.g., Nvidia Corp. (NVDA) and Deere & Co. (DE) ) that have been working, failing to see those falling dominoes around them.

Fear and Doubt Have Left Wall Street

The ever-present risk to the contrarian is that, over the short term, the past literally is repetitive and the crowd typically outsmarts the remnant. Tuesdays always follow Mondays and Wednesdays follow Tuesdays. But as we extend time cycles, history seems to move from repeating itself to rhyming with the past.

History undoubtedly teaches lessons about investment, but it does not say which lesson to apply when. “Find value, always” is as good a precept as any, but value is subjective and its definition is liable to change. In highly speculative markets, value means, to most, “it is going up.”

Stay abreast because in bull markets there is rarely a clear demarcation between progress and fantasy. I remain of the strong belief that we are in a Bull Market in Complacency that likely ends poorly and that has reduced the upside and has expanded the potential market downside.

To the bullish cabal the market “feels” great now (for, as Warren Buffett says, it is because, like sex, if feels best at or near the end), but after an eight-year bull market it may be time to consider the investment contrary. As James Surowiecki wrote in “The Wisdom of Crowds”:

“Diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise.”

Investment returns likely have been pulled forward by central bank liquidity, low interest rates and passive investing. However, over the next five years returns may be substandard at best, but more likely, negative. At worse, we face an incipient bear market.

As expressed in yesterday’s opener, the nature of and players in the investment business have changed. This helps to explain the Teflon nature of the S&P 500 Index.

But as Grandma Koufax used to say, “my matzah brei doesn’t grow to the sky,” and every day we move closer to a Minsky Moment.

The salutary environment perceived by many today may be transitory and weak in foundation.

The potential political, geopolitical, economic and market outcomes are many, and a clear and market-friendly path is not certain.

Bottom Line

The name of the game is money. It was Lord Keynes who first saw that the handling of it is a game. Most discussions of money and investing speak only of economics and statistics, but that’s only a part of the game. The other part is people, individually and together, the emotional investor and the irrational crowd.

And it again might be the market scene that is often (as it was in 2000 and 2007) seen only in kids’ eyes or in the eyes of older investors who behave like 26-year-olds at or near the end of every significant bull market cycle:

“‘See, see,’ said the Great Winfield. ‘The flow of the seasons ! Life begins again! It’s marvelous! It’s like having a son! My boys! My kids!'” -Adam Smith, “The Money Game”

Do some reading over the weekend as it appears that the only thing many investors have learned from history is that they haven’t learned from history.

http://WarMachines.com

Weekend Reading: Yellen Takes Away The Punchbowl

Authored by Lance Roberts via RealInvestmentAdvice.com,

September 20th, 2017 will likely be a day that goes down in market history.

It will either be remembered as one of the greatest achievements in the history of monetary policy experiments, or the beginning of the next bear market or worse.

Given the Fed’s inability to spark either inflation or economic growth, as witnessed by their dismal forecasting record shown below, I would lean towards the latter.

The media is very interesting. Despite the fact there is clear evidence that unbridled Central Bank interventions supported the market on the way up, there is now a consensus that believes the “unwinding” will have “no effect” on the market.

This would seem to be naive given that, as shown below, the biggest injections of liquidity from the Fed have come near market bottoms. Without the proverbial “punch bowl,” where does the “support” come from to stem declines?

I tend to agree with BofA who recently warned” the paint may be drying but the wall is about to crumble.”

This point can be summarized simply as follows: there is $1 trillion in excess TSY supply coming down the line, and either yields will have to jump for the net issuance to be absorbed, or equities will have to plunge 30% for the incremental demand to appear.”

“An unwind of the Fed’s balance sheet also increases UST supply to the public. Ultimately, the Treasury needs to borrow from the public to pay back principal to the Fed resulting in an increase in marketable issuance. We estimate the Treasury’s borrowing needs will increase roughly by $1tn over the next five years due to the Fed roll offs. However, not all increases in UST supply are made equal. This will be the first time UST supply is projected to increase when EM reserve growth likely remains benign.

 

Our analysis suggests this would necessitate a significant rise in yields or a notable correction in equity markets to trigger the two largest remaining sources (pensions or mutual funds) to step up to meet the demand shortfall. Again, this is a slower moving trigger that tightens financial conditions either by necessitating higher yields or lower equities.”

Of course, as I have discussed previously, a surge in interest rates would lead to a massive recession in the economy. Therefore, while it is possible you could experience a short-term pop in rates, the end result will be a substantial decline in equities as money flees to the safety of bonds driving rates toward zero.

“From many perspectives, the real risk of the heavy equity exposure in portfolios is outweighed by the potential for further reward. The realization of ‘risk,’ when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. This is why I continue to acquire bonds on rallies in the markets, which suppresses bond prices, to increase portfolio income and hedge against a future market dislocation.”

My best guess is the Fed has made a critical error. But just as a “turnover” early in the first-quarter of the game may not seem to be an issue, it can very well wind up being the single defining moment when the game was already lost. 

In the meantime, here is what I am reading this weekend.


Politics/Fed/Economy


Markets


Research / Interesting Reads


“If you are playing the rigged game of investing, the house always wins.” ? Robert Rolih

http://WarMachines.com

Weekend Reading: They’re Baaaccckkk!

Authored by Lance Roberts via RealInvestmentAdvice.com,

I remember the first time I saw the movie “Poltergeist.” It scared the $*#@ out of me, and I slept with the lights on for a month.

Recently, I got a chance to catch a rerun. It certainly wasn’t the same experience. It was kind of like eating a “twinkie” as an adult, the sponge cake and creamy filling aren’t nearly as delicious as I remembered them. “Poltergeist” is now more of a “campy” flick with bad special effects.

But the run up in the markets over the last few days, on really no news at all, reminded me of the scene where “Carol Anne” is pointing to the static filled television screen proclaiming “they’re back.”

After a brief decline, market sentiment got bearish enough to provide the catalyst for a short-term rally. With Trump now caving in to “Chuck and Nancy,” the North Korean threat deflated, and hopes for tax cuts on the horizon, “the bulls are back.”

Since the election, there has been a concerted effort to push stocks higher on the hopes of tax reform, ACA repeal, and infrastructure building which would lead to strongly improving earnings for U.S. companies. Now, eleven months later, stocks have been breaching the psychologically important levels of 2200 in December, 2300 in February and finally 2400 in May. 2500 is the next target.

The problem is that NONE of the legislative agenda has been passed. Zero, Nada, Zip.

But such small details have not, as noted yesterday, deterred investors who have once again fully abandoned reason and have gone “all in.”

With cash levels at the lowest level since 1997, and equity allocations near the highest levels since 1999 and 2007, it also suggests investors are now functionally ‘all in.'”

“Here is the point, despite ongoing commentary about mountains of “cash on the sidelines,” this is far from the case. This leaves the current advance in the markets almost solely in the realm of Central Bank activity.”

Yes, the bulls are indeed back for now.

The ending of this version of “Poltergeist Market” will surely be just as scary as the last.

In the meantime, here is what I am reading this weekend.


Politics/Fed/Economy


Markets


Research / Interesting Reads


“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” – Alan Greenspan

http://WarMachines.com