March 27, 2017

Downside risks outweigh upside rewards

For the last year or more I have been preoccupied and concerned with the answers to three simple questions:

-    In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?

-    In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?

-    With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?

I am still very much concerned with the answers to these basic questions. But there are some more-important questions that concern me today.

Today, I want to add four additional questions to the three above -- the answers to which concern me as an investor:

-    Remember when the big argument in favor of President Trump was that he was a dealmaker who knew how to get things done? That was when he was doing real estate deals. Now he has to deal with 535 other politically partisan legislators in Congress -- on their own real estate turf.

-    Does the administration have the depth of experience, understand the extent of the legwork and organization required for passing legislation or have a coherent idea or shared vision of what it wants to achieve and what problems it means to solve?

-    If President Trump can't easily put through a health-care package -- what does that mean for the more-difficult regulatory reforms, tax- and fiscal-policy agenda?

-    President Trump took credit for the stock market's advance since his election victory. Will he take responsibility for Tuesday's correction -- and possibly a further correction? Is it a slippery slope for an administration to use the S&P 500 as a barometer of success? And is a pro-business and anti-domestic programs (in education, the arts, etc.) agenda going to benefit those -- in the lower and middle class (largely his base) -- who have suffered the most over the last decade?

The Bottom Line
As Tom Brokaw said on Morning Joe Wednesday morning, "There are burning fuses everywhere [in the Trump Administration]. They are not small... I have talked to numerous business people in the last few days and they are appalled."

The markets have risen on the assumption that the new President would be successful in his bold agenda of regulatory and tax reform and aggressive fiscal policy programs.

With housing, retail and autos all peaking, I reject the notion put forward by some that the rate of growth in the domestic economy is re-accelerating -- and that this "trumps" the success of the administration's agenda. Meanwhile, rising gold, contained 10-year U.S. note yield and sinking commodities markets (the price of oil has fallen to October 2016 lows) seem to be negative economic and market "tells," that up to yesterday had been ignored.

The first few months of the Trump administration have already been a test of the president's business acumen. Can his "art of the business deal" be translated into the "art of the political deal" in Washington, D.C.?

Arguably, the body of evidence is that the administration has not been successful -- to some, it is failing spectacularly.

Among other things, it is clear -- at least to me -- that President Trump doesn't have the staff to work the Hill. The job of replacing Obamacare and the introduction of other programs and policies are complicated in Washington -- they require a deep organization, thoughtful planning, full cooperation within the Republican Party and some cooperation across the aisle.

Unfortunately, the Steve Bannon policy of tearing down may work (theoretically) in his own mind, but in practice, it will continue to face "yuge" hurdles and could further jeopardize the president's agenda. This week, in the singular piece of legislation (health care) that is imperative to be passed in order to proceed with the administration's other policy initiatives, the president appears to be coming up short. Moreover, and perhaps equally important, he is alienating portions of his own party (something I discussed might happen in Surprise #4).

As we learned again on Tuesday, risk happens fast. Everyone seems to be dancing to the momentum of price -- hedge hoggers (like David Tepper), quant funds (risk parity and volatility trending), CTAs, ETF investors and most traders -- reminiscent of Citigroup's Chuck Prince, who famously said (three months before a seminal top in 2007), "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

The business media, strategists and other "talking heads" have lulled market participants (who are impacted by their pablum and ever bullish narrative) into a false sense of security. Bears have been dismissed as Cassandras, despite economic sector peaking and a seemingly disorganized and sometimes antagonistic presidency.

To me, the rationalization of rising "animal spirits" have replaced sensibility, financial analysis and common sense. From my perch, the markets are overvalued and risk remains underpriced. The "hockey stick" projections and consensus of rapid profit growth in 2017 and 2018 seems to now be "pie in the sky."

What is dangerous is that consensus sentiment, political, profit and economic expectations are inflated at a time in which many valuation metrics are in at least the 90% decile. By my gauge, the market's downside risk substantially exceeds the upside reward. Perhaps by as much as 3:1.

As I said back in late 2016, Donald Trump will make volatility and uncertainty great again.

March 20, 2017

Why the market rallied last week after Fed Rate Hike

Before starting this morning's opening missive, I want to touch on the importance of skepticism in a marketplace that is more susceptible than ever to exaggerated moves both on the upside and the downside.

Skepticism is an important historical tool. My commentary this morning and my ongoing market narrative is laced with skepticism. 

With that, why did the markets rally after an unsurprising move by the Federal Reserve? 
To begin with, the answer to the question can't be proven by me or anyone else.

We only can make an educated guess.

I believe it was a confluence of three factors:

No Fed Surprise: As Jim Cramer expressed, there was no surprise in the Fed's comments and investors are no longer hostage to our monetary authorities. So, with the economy improving, Jim and bullish investors may feel that the Fed did nothing to derail the capital markets yesterday -- that the skies are now all blue and the transition from easing to tightening will be seamless.
As you all know I have a less optimistic outlook for the domestic economy, which the Atlanta Fed, the Federal Reserve (forecast of roughly 2% GDP growth in 2017-2018) and the bond market apparently agree with. Check out the pop-up chart below to see why.

I think Jim is partially correct that the Fed has removed a market hurdle. But, when we look at the amount of debt that has been created, the market valuations that have been built and the economic growth that has been pulled forward during the last eight years, Jim and others might be giving too much credit that the withdrawal from zero interest rates will be benign. I would arbitrarily attach a 20% causality of the afternoon ramp to "No Fed Surprise."

Players Offsides: Traders and some investors remain "offsides" -- either short or under-invested. To me, this is a significant reason for the market's post-Fed rip. I would arbitrarily attach a 30% causality of Wednesday's rally to "Players Offsides."

The Role of ETFs and Quants: Systematic investors and funds -- in passive ETFs, CTAs, risk-parity and volatility-trending quant strategies -- are influencing the markets more than any time in history. They are agnostic to price and beholden to price momentum. They believe the concepts of private and/or replacement market value of equities are inconsequential and they lack knowledge and ignore the importance of balance sheets and income statements. Those systematic vehicles and strategies all likely conspired to buy and fed on each other yesterday afternoon, because they base their decisions on price momentum.

To me, this is the primary reason for the market's rally on Wednesday afternoon. But, arguably, the robotic effect of rebalancing and strategies that worship at the altar of price and momentum are producing the impact of increasing risk and creating assymetric reward versus risk. When the trends change, it will likely be abrupt and brutal. I would arbitrarily attach a 50% causality of yesterday's rally to "The Role of ETFs and Quants."


Bottom Line

...Fed Chairwoman Janet Yellen reminded market participants just how dovish the governors truly are, where the most we will get out of this rate hike cycle is three hikes out of eight meetings this year and in the two years to follow after just one and one in the two prior years. In my view, Yellen mistakenly believes that she somehow can avoid the pain of tightening the slower she goes. Unfortunately, former Fed Chairman Alan Greenspan thought the same thing when he went slowly, relative to his previous hike cycles, in the mid 2000's.

Greenspan's policy ended badly, with the deepest economic contraction since The Great Depression. By contrast with the bullish consensus, I see the withdrawal from eight years of monetary largesse as not likely being smooth or seamless.

There will be casualties. There are always casualties.

From my perch, we are in a high danger level in which animal spirits are elevating, valuations are expanding, complacency reigns and the yield curve is flattening. The latter is usually a sign of slowing economic growth, not accelerating growth, which embodies the consensus view.

A flattening yield curve might be based on the notion that the Trump administration's regulatory and tax reform policy implementation -- and, as I suspect, that the "E" (earnings) in "P/E" (price/earnings) may not be forthcoming. I feel my skepticism may be justified based on the already-rocky road thus far in the president's failed attempt at a "travel ban," and in the problems currently encountered by Trump's attempted repeal and replacement for Obamacare. As well, the president's recent attempt to muddy the waters through the accusation that the former president (Obama) had committed a crime of wiretapping runs a further risk that his other major fiscal policy initiatives could be jeopardized, delayed or diluted.

The tension created by rising financial asset prices, ever higher P/E ratios and a flattening yield curve is growing ever more conspicuous.

This confluence of factors/results is occurring at a time when machines (ETFs, risk-parity and volatility-trending strategies) dominate the investment landscape. Among other things, when the dominant investors are all on the same side, operating with similar algorithms as they "buy higher (and sell lower)" -- while playing against each other and against the markets -- the outcome almost always results in a tripped-up, unexpected aftermath, a "flash crash" or something worse.

This ends badly and abruptly. If only I knew the timing.


via thestreet

March 15, 2017

US Housing may have peaked

While few might be interested in concerns Wednesday, real estate maven Mark Hanson shares some of his concerns:

My bearish demand and price ideas for 2017 were supported over the past two weeks in the "January" high-frequency housing data (yet multiples continue to expand).

Weak "new home sales" and "pending sales"--both coincident, or leading indicators--indicated that this housing cycle is not only tired, but injured due to the rate surge.

An outlier, "existing sales," an extreme lagging indicator that beat expectations last week, was due to nothing more than a "pig in the python" effect that pumped up the headline print because of the heavy annual, January-specific seasonal adjustments.

The "December Case Shiller," so lagging it's virtually worthless, as it measured house shopping, purchase and pricing decisions from as far back as the summer busy season in August, was buoyed due to certain markets with a high percentage of fully rehabbed repeat sales comps, which artificially pushed regional index values through the roof, lifting the national numbers.

Virtually all the tailwinds that drove housing for years--especially those "unorthodox" in nature that I believe blew Bubble 2.0 in near the same manner as Bubble 1.0--have turned into headwinds.

With...
-    end-user, shelter-buyer affordability at post-crisis lows;
-    effective house prices to end-user shelter-buyers up nearly 15% from a year ago due to price increases and the rate surge;
-    institutional demand for single-family rentals off sharply and some beginning to liquidate;
-    foreign capital for rentals and lock boxes drying up;
-    middle-high to high-end, core markets experiencing a sharp decline in demand and double-digit list price haircuts;
-    multifamily rental demand and prices dropping, vacancies rising, and a flood of supply to hit over the next two years;
-    a Fed in reverse;
-    an unknown outcome for U.S. immigration, especially H1B and EB5 visas, which drove housing in core, STEM-centric markets;
-    and first-timers saddled with so much student, auto and card debt, a large percentage are indefinitely sidelined.

I struggle to come up with bullish catalysts going into the pivotal spring and summer "busy season," when most of each year's house price mark-ups and demand increases traditionally occur.

Bottom line: The evidence continues to mount that this housing cycle is already past its peak, both in demand and prices. This year will bring about the stiffest year-over-year comps since 2006 and several months of weaker year-over-year demand and prices. Yet, housing and related stocks are rising on the widely accepted belief that "rising rates are great for housing" and multiple expansion.

There is a huge air pocket under core, leading-indicating housing markets right now just looking for a catalyst, which will come when it does.

March 13, 2017

We may be approaching a Market correction

In the main, it remains my strong view that financial asset prices have decoupled from fundamentals in 2017. 

First-quarter GDP estimates predictably have moved lower relative to previous consensus forecasts.

Meanwhile, despite obvious legislative, executive branch organizational and other headwinds, second-half consensus profit and economic forecasts remain unrealistic. (The same may apply to 2018).

Malls in crisis
"About one-third of malls in the U.S. will shut their doors in the coming years, retail analyst Jan Kniffen told CNBC Thursday. His prediction comes in the wake of Macy's reporting its worst consecutive same-store sales decline since the financial crisis.

Macy's and its fellow retailers in American malls are challenged by an oversupply of retail space as customers migrate toward online shopping, as well as fast fashion retailers like H&M and off-price stores such as T.J. Maxx. As a result, about 400 of the country's 1,100 enclosed malls will fail in the upcoming years. Of those that remain, he predicts that about 250 will thrive and the rest will continue to struggle." --Time Magazine

Housing is peaking and so are automobile sales.

And in retail land we are seeing the bust of all busts; I have seen estimates that as many as one-third of the country's malls will be closed in the next several years (see quote above).

The number of distressed retailers is at an all-time high. HHGregg (HGGG) is about to file bankruptcy, BCBG Max Azria filed for bankruptcy last week, a financially and operationally crippled Sears Holdings (SHLD) limps along and there are major store closures at Macy's (M) , JC Penney (JCP) and others. The demise of the U.S. mall lays ahead, and with it more economic dislocations.

But, that's opinion (mine) and here are the facts that lead me to the conclusion that the character of the market is changing:

-    The VIX has decoupled from the averages.
-    The Russell Index is lower four days in a row, its longest streak in three months.
-    The S&P Index has declined over the last four trading days for the first time since November.
-    Strength in transports, heralded by the bulls as recently as last week, is also rolling over.
-    The S&P Index has had its first back-to-back loss in five trading weeks.
-    The Nasdaq is lower over the last trading week.
-    The Russell Index is underperforming the senior averages and testing key technical support.

Emerging markets began to roll over a week ago. The Stoxx 600 is on pace for its fifth consecutive decline and the ninth drop in the last 11 days.

Dr. Copper is falling under the weight of slowing growth and rising inventories.

The high-yield bond market is beginning to show topping signposts, with iShares iBoxx High Yield Corporate Bond ETF (HYG) down $0.57 and SPDR Barclays High Yield Bond ETF (JNK) down $0.22 yesterday.

Taxable bonds are making new lows. The 10-year U.S. note yield has risen for eight days in a row -- the longest streak in five years. Sovereign bond yields in Europe are following suit. With both stocks and bonds moving in the same direction (lower), risk-parity quant funds are getting hit. Remember my thesis -- buyers live higher and sellers live lower; this could exaggerate a decline.

Bottom Line

I believe we rapidly are approaching a market correction of some consequence.


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