December 29, 2015

Economic conditions appear to be weakening around the world

The main indices might look good, but so many groups have gotten schmeissed and the average stock is far off of its 2015 high.

Global economic growth is also wobbly. Here in America, third-quarter GDP reading of +2% followed a disappointing first half where growth failed to meet consensus expectations for the fourth year in a row. Fourth-quarter real GDP growth won't be much better, with housing activity and retail sales foundering in our supposed "oasis of prosperity."

Non-U.S. economic activity is worsening as well, led by the BRICs (Brazil, Russia, India and China), those former engines of worldwide growth. They're all "exporting" lower commodities prices, weakening economic growth and reduced corporate profits to America these days.

Despite this reality of slowing growth, optimism about our economic future are upbeat. The Federal Reserve forecasts four rate hikes, while the futures market is pricing in two or three.

But corporations don't share this optimism and instead continue to shave capital-spending plans even as they keep buying back their own shares (which is often only a simple offset to options issuance).

We're in an earnings recession, and I don't see a thing that brings us out of it.

If you're an optimist, I suggest you read the transcript of Tuesday's earnings call from Steelcase (SCS) , whose shares dropped some 20% that day. Compare CEO Dave Sylvester's remarks to that of the upbeat "dots" provided by our Federal Reserve.

"We've seen a reduction in large projects, both in terms of what we booked, but also as we look into the pipeline of future opportunities," Sylvester said. "We also see less of our overall business coming from our larger customers than in the past, and orders from our larger customers were down in the quarter. As we've discussed before, we probably have more of our business from large customers than the overall industry, so we are probably feeling the effect of the slowing economy a little earlier than others might."

"Second, orders in the second half of the quarter softened compared to the prior year, reflecting an apparent pullback in business from our corporate customers, as we did not receive the same level of year-end business we have experienced in the past couple of years," he continued. "We don't know the motive of each customer-purchasing decision at the end of the year, but we suspect that some of the recent economic uncertainty may have contributed to the pullback."

Meanwhile, technology stocks are holding up despite a drop-off in smart phones, personal computers, tablets, TVs and chips. But even Apple (AAPL) -- my largest short -- is beginning to feel the fallout of analysts lowering their earnings expectations and cutting price targets.

Elsewhere, there's new evidence of peaking conditions in autos and housing. We're also seeing peaks in venture funding and lower valuation, while IPO activity has been moribund.

All of the above conditions are a potentially toxic combination for stocks in 2016, as they're occurring at a time of above-average valuations.

Be forewarned: Mr. Market might be living on borrowed time.


December 22, 2015

Doug Kass vs Carl Icahn on High Yield bond ETFs

I have nothing but the utmost respect for Carl Icahn. In fact, I believe he and Warren Buffett might be the modern era’s two greatest investors. But that doesn’t prevent me from criticizing the things that either say or the investments that they make when I disagree with them. (I’ve been openly critical of some of Buffett’s moves since 2010).

I believe Icahn is wrong and hyperbolic as a leading voice in warning that high-yield-bond exchange-traded funds represent a systemic risk to our financial system.

Icahn appears wrong regarding the systemic risk associated with high yield ETFs, partly because the ETF universe simply doesn’t represent much in the way of total assets. Still, he’s probably is right about the “knock-on” impact that widening junk-bond spreads might have on the U.S. stock market.

As for Icahn, some of his largest investments say to me that he doesn’t practice what he preaches, or else he never would have made them. He’s also gotten the equity class of some of his targets wrong. For instance, Icahn would have ironically been better off buying debt instead of equity with energy/resource companies.

December 21, 2015

Market may have made an important top in May 2015

Now, I'm nowhere close to being bullish over the intermediate term. I still hold the view that the market likely made an important top in May, and that 2016 will be a challenging year. But I expect some market stability and a bit of a reprieve over the balance of the year. 

December 16, 2015

Change your investing strategy

There's little question that the market's complexion and character are changing. My baseline expectation is that Wall Street has been undergoing a topping process since May and has morphed from a "one-way" market (i.e., mostly rising) to a two-way one (rising and falling).

This "market without memory from day to day" might continue for some time, and if I'm correct, we'll need for a new playbook. We'll have to deal with the renewed volatility, randomness in stock prices and -- at the very least -- lack of a primary trend. (And at the worst, a nascent bear market.)

So, just like A Chorus Line's fictional character Val Clark -- a foul-mouthed but excellent dancer who came to New York to become a Rockette but couldn't get hired -- we have to adjust.

The debate as to whether global economic growth is slowing and profit expectations are too optimistic will remain core narratives in discussing market direction over the coming winter months (at least). We'll likely see volatility as markets react to economic releases and changes in policy. 

But to me, the accumulating body of evidence is that disappointment lies ahead. My view remains that the global economy faces a false economic dawn, while the corporate-profit landscape is challenging and long in tooth and stocks are overpriced.

As I've counseled over the last year, opportunistically trading on both the long and short side will probably deliver better returns than longer-term investing will. At the very least, you might consider more-active trading as an adjunct to longer-term investing -- although neither shorting stocks nor a trading-oriented approach are for everyone.

.........we can profit by investing and trading longs and shorts opportunistically.

But changing our modus operandi is easier said than done. My advice -- start slowly and ease into both the shorting game and increased trading activity. Expand your involvement only when you're comfortable with shorting and a more action-oriented strategy amid what I suspect will be heightened volatility in a market without memory from day to day.

Here are some parameters to consider:

-    If you normally have a 3-1 mix of investing capital to trading capital, move it into balance by reducing your investment exposure to 50% and increasing your trading exposure to 50%. Personally, given my negative market view, I've for months moved dramatically in the direction of trading over investing.

-    Slowly begin to accumulate shorts of less-volatile (lower-beta) securities, essentially learning shorting as you go. Avoid high-beta shorts and shorts with high short interest.

-    Given the bifurcation and less-certain market ahead, stay more diversified and less concentrated than usual. Keep any industry's concentration to less than 15% of your portfolio and any individual stock (long or short) to under 4% or so. Also keep your shorts to under 2% on average.

-    As I've emphasized repeatedly, err on the side of conservatism. Maintain above-average cash reserves and reduce your portfolio's value at risk (or "VAR"). After all, rising volatility produces a wider profit or loss on the same capital investment.

-    In terms of trading style, I tend to be news- or catalyst-driven and thematic in my portfolio construction. In a volatile market, I also often like to buy the dips and sell the rips. I predominately do this with ETFs.

-    In today's relatively range-bound market, I also have a tendency to buy sector laggards and to sell or short sector leaders.

-    You should also consider pair trades and selling option-premium puts and calls, especially when volatility picks up.

via thestreet

December 14, 2015

Rate hike expectations for this week

There's an overwhelming consensus as we approach [this] week's Federal Open Market Committee meeting that the Federal Reserve will hike the federal funds rate for the first time since June 2006. The only thing that remains unclear is the trajectory of any additional rate increases.

The consensus appears to call for two to three additional rate hikes next year, but I disagree. I expect a "one-and-slow" approach (as opposed to my previous expectations of a "one-and-done" hike).

From my perch, the Fed's statement accompanying next week's rate hike should sound fairly dovish, based in part on these factors:

-    The domestic and global economic picture and its foundation are more wobbly than consensus expectations.

-    Deflationary conditions still dominate the landscape.

-    Peak housing and autos likely lie ahead.

-    The U.S. manufacturing base remains frail, and policymakers are fully aware of this.

-    Fragile economic growth exposes the rate-hike trajectory to vulnerability from unexpected events. Policymakers are fully cognizant of this as well.

-    A near bottom in commodities likely lies ahead.

-    Wages have bottomed, too.

-    Growing geopolitical risks can quickly seep into (and reduce) growth expectations.

-    Credit markets have tightened, and delinquencies and defaults are rising. The widening spreads between investment-grade and high-yield bonds have already tightened markets. The widening of CCC/BB credit spread is also really conspicuous and should be worrisome, as it weakens the most-vulnerable companies.

-    We're entering a presidential-election year, so the Fed will probably err on the side of conservatism in its policy.

Of course the $64,000 question is how markets will respond to dovish rhetoric next week.

My answer: I don't know.

On one hand, recognition of a fragile global-growth slope could frighten fundamentally based investors. On the other, a "one-and-slow" approach and a range-bound 10-year Treasury yield could elevate valuations.

But again, unlike many so-called "experts," I'm willing to admit that I just don't know. Unfortunately, much will depend on how the machines and their algorithms interpret the headlines and news.

December 7, 2015

World wide QE will end badly

The Federal Reserve and the world's other central bankers have long been encouraging asset bubbles and higher stock prices through easy monetary policy. 

This always ends with a very bad hangover. Pushing stock prices ever higher should never substitute for prudent monetary policy and/or responsible fiscal policy.

In the early stages of the central banks' easy-money policies (2008-2011), we needed more and more "cowbell" to avoid a "double-dip" recession. But now, it's inevitably leading to "malinvestment," sustaining companies that shouldn't be sustained and causing asset-price overvaluation. Using too much cowbell for too long can be hazardous to our investment health, as we've lost all sense of price discovery and "normalcy of policy."

Columnist Richard Breslow vividly observed this state of investment affairs in a rant (as quoted by ZeroHedge):

    "In the history of tightening cycles, we've never had a Fed so intent on hammering home the message that if anything goes wrong they will be quick to respond, backtrack and ensure financial stability (a term that has become a sorry euphemism for propping up stocks).

    What is meant to soothe should be having the opposite effect. In a 'normal' world, a rate hike is meant to cool off the economy. In this case, it is equally motivated by the imperative to make monetary policy functional again. Does anyone seriously think they are worried about inflation getting out of control?

    Of greater concern is that the focus on asset prices at the expense of the real economy has desensitized markets from rationally (or even at all) responding to geopolitical events. When bad or dangerous events occur, the weight of the consequences is borne solely by the non-financial community. Here we go again.

    All global events have been reduced to monetary-policy events, i.e., buy-the-dip opportunities. France's CAC-40 sold off the two trading days before the recent horror. It was a solid buy the following Monday.

    By always protecting risk-takers, the authorities are complicit in trivializing issues that need an all-hands-on-deck response. 'Bad news is good news' has metastasized into an even baser concept.

    Raising rates will, hopefully, be a step in the right direction, but there is little that is normal as yet."

Valuations are elevated, with the ratio of market capitalization to GDP (Warren Buffett's favorite indicator) at a dangerous level. The market's fundamental and technical foundation are weak, but the S&P 500 is within 2% of all-time highs. Global economic growth is also wobbly, but few seem concerned.

Stated simply, the investment waters have grown unnatural, hostile and more difficult to navigate -- and it appears that what we've learned from history is that we haven't learned from history.

Baruch Spinoza put it well when he wrote: "If you want the present to be different from the past, study the past."