Since the election, almost a year ago, we’ve talked about the great passing of the torch, from a monetary policy-driven global economic recovery (which proved dangerously weak and shallow) to a fiscal stimulus-driven recovery (which finally gives us a chance to return to trend growth).
Now, almost a year in, policy execution on the fiscal stimulus front is moving. The Fed has hiked rates three times. In the past week, the ECB has signaled the end of QE in Europe is coming. And this Thursday the Bank of England is expected to raise rates for the first time in a decade.
Again, if you can block out the day-to-day noise, this is all confirming the exit of the post-crisis deleveraging era of the past decade – it’s all playing out fairly close to script.
With that, I want to revisit my note from early January of this year, which argues the case for this “passing of the torch” and emphasizes the value of having some bigger picture perspective…
From my Market Perspectives piece: JANUARY 18, 2017
“Two weeks ago, in my daily Market Perspectives note, I talked about the five reasons, even at Dow 20,000, that stocks look extraordinarily cheap as we head into 2017.
Today I want to talk a bit more about the idea that the timing is right for a pop in economic growth.
For the past ten years, we’ve heard experts pontificate about ‘what inning we’re in,’ during the crisis era. I think there are good reasons to believe the game is over, and it was ended on election night–that was the catalyst.The policy responses and regime shift have more to do with the evolution of the global financial crisis and human psychology, than it does with the character behind it all.
I want to focus on a study from Carmen Reinhart and Kenneth Rogoff – the two economists that laid out the script, back in 2008, for precisely what the world has experienced over the past ten years. Fortunately, Bernanke was a believer in it. That’s why the Fed kept its foot on the gas, even in the face of a lot of scrutiny from people that blamed the Fed on extending the crisis.
Reinhart and Rogoff studied eight centuries of financial crises and they found striking commonalities in the aftermath. They found that financial crises tend to lead to sovereign debt crises. And sovereign debt crises tend to be contagious. Clearly, we’ve seen it.
Reinhart went on to look at the 15 severe financial crises since World War II and found that they were typically driven by credit bubbles. Check.
Importantly, they found that the credit bubble typically took as long to unwind (or de-lever) as it took to build. And the deleveraging period tends to mean ultra-slow economic activity as consumers, businesses and governments are paying down debt, not spending. And because of this, the research suggested that throughout this ten-year deleveraging period we should expect: 1) economic growth will trend at lower levels than pre-crisis growth, 2) housing prices will remain anywhere from 20% to 50% below peak levels and 3) unemployment will hover around 5% higher than pre-crisis levels. Check, check and check.
In the current case, Reinhart and Rogoff said the credit bubble was built over about a decade. That means we all should all have expected a decade long deleveraging period.
Now, with that, you can mark the top in the bubble as the 2006 housing top, or in 2007 when we the first big mortgage company and Bear Stearns hedge fund failed, or 2008, when consumer credit peaked. We’re somewhere in the middle of this window now and major turning points in markets tend to come with significant events. It’s a fair argument to make that the Trump election was a significant event for the world. With that, we may find that the crisis period officially ended with the election, when the history books look back on this current period of time.’
So that was my take back in January. It’s not easy to watch the process play out. It can be slow and ugly. But we’re seeing the reaction in stocks to this thesis – now at 23k in the DJIA. And we’re getting some momentum building on the policy making side that further supports this structural turning point is here (or has been here).
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We talked yesterday about the move in interest rates. We have the collision of two big events nearing for the interest rate markets.
Event number one, as we discussed yesterday, is the President’s decision on the next Fed chair. Event number two will come tomorrowmorning with the European Central Bank meeting. The ECB has been setting expectations for the eventual tapering of its QE program.
At this point, the market view is that Draghi and company will tell us their plans to extend the existing end date of QE, but with a methodical decline in the amount of assets they will be buying. Translation: It’s the beginning of the end of QE in Europe.
Why is that important? When the Fed (Bernanke) first uttered the words taper in May of 2013, U.S. yields went crazy – rising from 1.61% to 2.74% in two months, topping out just above 3% in the months following. Stocks were hit for about 8% in the month following the taper talk.
Could it happen in Europe? Likely. As we discussed yesterday, the 10 year yield there remains under 50 basis points, and 2 year government debt has a negative 70 basis points yield.
Will it hit stocks?
The world is in a different place now. And the ECB isn’t the Fed. But it’s safe to expect that there will be speculators with a finger on the trigger trying to sell stocks on an ECB taper theme, assuming that is discussed tomorrow.
With this in mind, ahead of tomorrow’s ECB meeting, we get this in stocks today…
You can see the trend break on this acceleration higher in stocks of the past two months. It wouldn’t be surprising to see stocks pull back a bit on these interest rate events. But any weakness on this type of speculation will be a nice opportunity to buy at cheaper prices in front of coming fiscal stimulus.
We’ve a lot about the positive outlook for stocks on a valuation basis, relative to historical ultra-low interest rate environments. And we’ve talked about the influence on valuation on a corporate tax cut – which will make stocks cheap.
Here’s a look at how stocks would look if we applied the long run average return of 8% to the pre-crisis peak (back in 2007). You can see the orange line, with the S&P growing at 8% annualized from the peak in 2007. And you can see the actual path for stocks in the blue line.
source: Billionaire’s Portfolio
Despite the nice run we’ve had in stocks, off of the bottom in 2009, we still have a big gap to make up (the difference between the blue line and the orange line)!
If you believe that the country will continue to innovate, become more efficient, productive and better, over time, as we have through history, and if you believe that we will ultimately return to long-term trend economic growth, then you believe that we’ll have hotter than average economic growth going forward. We have a catalyst for that: It’s fiscal stimulus.
And that hotter growth would argue for bigger than average stock market returns going forward, to put us back on the path of the long term growth rate in the S&P 500 – closing that gap in the chart above.
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Forbes has just ranked the top 400 richest people in America for 2017.
Among the top 50, a fifth have created their wealth from some sort of Wall Street activity (mostly hedge funds, but also brokerage and asset management). There’s not much new there–the rich have gotten richer on Wall Street despite the challenges of the past decade. But as we’ve discussed, the torch was, in many respects, passed to Silicon Valley over the past decade, as the best spot to create–that’s where the biggest proportion of the wealthiest 50 have built their wealth.
But much of that technology wealth can be refined down to the very industries that are being displaced on the wealth list, such as publishing, energy and retail.
That makes you wonder how long some of these companies can command a software-like valuation when the core of their business models are rather traditional things like selling ads, distributing content, making cars or selling retail products.
To this point, as long as they started in Silicon Valley, they tend to get a very long leash. They can lose money with immunity.
Consider this: GM is valued at $66 billion. Telsa is valued at $57 billion. GM has made (net profit) $43 billion over the past six years. Tesla has lost$2.5 billion over the past six years. Meanwhile, Elon Musk, Tesla’s founder, has amassed a $20 billion net worth.
The question is how defensible are these businesses (Facebook, Netflix, Tesla, Twitter)? How wide is their moat? A couple of years ago, the answer was probably very wide–very defensible given the adoption, the scale, and the deep pocket investors that were willing to continue plowing money into them. But, as we’ve discussed, if the regulatory environment becomes less favorable and the money dries up (in the case of private companies, like Uber), the operating advantages can begin to evaporate. This bubble-up of regulatory scrutiny on tech is something to keep a close eye on. It may become one of the big themes in the coming year.
Interest rates and stocks are on the move today (higher), following the vote last night in the Senate to pass the budget. This opens the way for an approval on the tax plan.
As stocks continue to print new record highs, so does policy execution for the Trump administration (the latter the cause, the former the effect).
So we’re seeing more and more of the pro-growth plan fall into place. Markets have been telling us this (betting on this) for a while.
Remember, we talked about the prospects that hurricane aid could kickstart the Trump infrastructure plan (proposed at $1 trillion over 10 years). There’smore progress on that front in the past week.
Among the pillars of Trump’s growth plan, this one (infrastructure/government spending) looked to be among the long shots given the politicians can always play the debt card to fight it. But then the hurricanes hit.
After Irma rolled through Florida the estimated damages for both Harvey and Irma were estimated at $200 billion. Then Hurricane Maria decimated Puerto Rico. Estimated damages there are now $95 billion. I’ve thought we’ll ultimately see a 12-figure package out of Congress in response to the hurricanes. The ultimate federal aid on Katrina was $120 billion.
In September Congress approved $15 billion in aid for hurricane victims. They just approved another $35 billion! This quiet government spending piece, that will substantially grow from here, may turn out to be the most powerful in terms of driving wage growth and economic growth.
So tax reform and infrastructure, two big pillars of Trumponomics continue to progress. And on the deregulation front, Trump has already been aggressively peeling back regulations that have crushed some industries, while ramping UP regulatory scrutiny on Silicon Valley, as we discussed yesterday.
Some of the top venture capitalists in Silicon Valley said this week that they expect to see some failures this year of startups once valued north of a billion-dollar. That’s a result of less money flowing that direction, less government favor, and more money flowing back into publicly traded stocks.
With that in mind, let’s take a look at the chart on Amazon to finish the week …
We talked about Amazon’s miss on earnings back on July 27th as the catalyst to take profit on the FAANG trade (the loved tech giants). The top continues to hold in Amazon.
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On Friday we talked about the biggest market movers: oil, copper and iron ore.
Oil was up 5.3% on the week. Copper was up 4%. And iron ore reversed sharply on Friday to jump 6%.
All were stronger again today.
Remember, China is the world’s largest consumer of commodities. And the import data late last week out of China showed hotter imports in copper and copper products (26.5% growth, year over year), iron ore (record high imports, up 10% from a year earlier), and crude oil imports hit the second highest level on record (up 12% year over year).
This leaves us wondering: Is China’s economy doing better than most think? And/or is this China hoarding commodities again?
At the depths of the financial crisis, China opportunistically stepped in and started gobbling up global commodities on the cheap (at the time).
Remember, China has $3 trillion in currency reserves, about $2 trillion of which are in U.S. dollars. Commodities are a good way to put those dollars to work.
And there always seems to be currency play at work in China, to gain some sort of advantage. You can see in the chart below, as the PBOC has weakened the yuan, commodities prices have fallen. And as they’ve been strengthening the currency this year, we may be seeing commodities coming back as a result.
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Yesterday we talked about the case for commodities and the opportunity for a rotation into commodities stocks.
The valuation of commodities relative to stocks has only been this disconnected (stocks strong, commodities weak) twice, historically over the past 100 years: at the depths of the Great Depression in the early 30s and toward the end of the Bretton Woods currency system.
That supports the case that we’re in the early days of a bull market in commodities, especially considering where we stand in the global economic recovery, underpinned by the “reflation” focus at both the monetary and fiscal policy levels. It’s a recipe for hotter demand for commodities.
With that, let’s take a look at a few charts as we close the week.
Copper
We talked about copper yesterday. This continues to ring the bell, alerting us that better economic growth is coming – maybe a boom.
Copper is up 6.5% in the past two weeks, back of $3 and closing in on the highs of the year – which is a three year high. And remember, we looked at the potential break of this big six-year downtrend back in August. That has broken, retested and confirms the trend change.
Crude Oil
We talked about the fundamental case for oil this week. And we looked at the technical case, as it made a brief test of the 200 day moving average and quickly bounced back. It’s up about 4% on the week.
We have this inverse head and shoulder (in the chart below) that projects a move back to the low $80s. And as part of that technical picture, we’re setting up for a break of a big two-year trendline that should open the doors to a move back into the $70+ oil area.
Iron Ore
Iron ore was the biggest mover of the day – up 6% today. This has been a deeply depressed market through the post-financial crisis era. In addition to the broad commodities weakness, iron ore prices have suffered from the dumping of poor quailty iron ore by Chinese producers. Those times seem to be changing.
This week there was a fraud claim on a big Japanese steel maker for fudging it’s quality data. Keep an eye on this one as it could lead to more, and could lead to a supply disruption in industrial metals.
Then today we had Chinese data that showed record imports of iron ore. This is a signal that there’s both an envirionmental movement and an anti-dumping movement against low grade iron ore that has been influencing supply and prices (and crushing producers). This big Chinese data point is also in line with the message copper is sending: perhaps the Chinese economy is doing better than most think.
With that, let’s take a look at a few charts as we close the week. The valuation of commodities relative to stocks has only been this disconnected (stocks strong, commodities weak) twice, historically over the past 100 years: at the depths of the Great Depression in the early 30s and toward the end of the Bretton Woods currency system.
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For much of the summer, while the world has been obsessed with Trump tweets, we’ve talked about the sharp but under-acknowledged move in copper and the message it was sending about the global economy and China (the biggest consumer of commodities), specifically. As I’ve said, people should Stop Watching Trump And Start Watching Copper.
Why copper? It is often an early indicator of economic cycles. People love to say copper ‘has a Ph.D. in economics’ because it tends to top early at economic peaks and bottom early at economic troughs. And it tends to lead a bull market in broader commodities.
Well, copper bottomed on January 15. Fast forward to today; the most important industrial metal in the world is up 24% on the year and sniffing back toward three-year highs. While the world continues to focus on Washington drama, this continues to be the proverbial “bell” ringing to signal a pop in economic growth is coming, and a big run for commodities investors is ripe for the taking.
With that in mind, we’ve talked in recent days again about the research from the top minds in commodities investing, Leigh Goehring and Adam Rozencwajg (managers of the commodities funds, ticker GRHIX and GRHAX). We know they like oil. In fact they think we see triple-digit oil prices by early next year.
They love the commodities trade in general. They have one of the most compelling charts I’ve seen in my 20-year career, to support the view that there is a generational bull breaking lose in commodities.
Stocks minted billionaires in the 1980s. Currencies minted billionaires in the 1990s. Tech and housing (bust) minted billionaires in the early 2000s. Then it was equity activism (stocks). The next opportunity looks like commodities.
In this chart below you can see, as Goehring and Rozencwajg say, commodities are as cheap today as they have ever been. “Only in the depths of the Great Depression and at the end of the dying Bretton Woods Gold Exchange Standard did commodities reach this level of undervaluation relative to equities.”
With this, they say, for those that can block out the noise, “there is a proverbial fortune to be made if they invest today.”
Here’s an excerpt from their most recent investor letter on their work on the stocks to commodities valuation:
“When commodities are this cheap relative to stocks, the returns accruing to commodity investors have been spectacular. For example, had an investor bought the Goldman Sachs Commodity Index (or something equivalent) in 1970, by 1974 he would have compounded his money at 50% per year. From 1970 to 1980 commodities compounded anually in price by 20%. If the same investor had bought commodities in 2000, he would have also compounded his money at 20% for the next ten years–especially attractive considering the broad stock market indicies returned nothing over the same period.”
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Crude oil was the biggest mover of the day across global markets, up almost 3%, and back above the $50 level.
Though oil has been stuck, oscillating around this $50 mark for some time, we’ve talked about the prospects for much higher oil prices. So, when?
Remember, back in May I spoke with one of the best research-driven commodities funds on the planet, led by the star commodities investor Leigh Goehring and his long-time research head Adam Rozencwajg. They do some of the most thorough supply/demand work on oil and broader commodities.
Earlier this year, they were pounding the table on the fundamental case for $100 oil again. Since then, as oil prices haven’t complied. With that, we’ve seen Andy Hall’s departure from the market, of one of the biggest oil bulls, and one of the best and most successful tactical traders of oil in the world.
Meanwhile, the fundamentals have continued to build in favor of much
higher oil prices. We’ve seen supply drawdown for the better part of the past seven months – to the tune of more than $60 million barrels of oil taken out of the market.
I checked back in with Goehring and Rozencwajg and they are now more bullish than before. They say demand is raging, supply is faltering, and the world has overestimated what the shale industry is capable of producing – and the market is leaning, heavily, the wrong way (i.e. “maximum bearishness”). They think we’ve now hit the tipping point for prices – where we will see the price of oil accelerate.
They’re calling for $75-$110 oil by early next year, based on their historical analysis of price and inventory levels.
We’ll talk more about their work on the oil market in the coming days, and their very interesting work on the broader commodities markets – both of which support the themes we’ve been discussing in recent months.
As we know, one of the pillars of the Trump administration’s growth policies has been deregulation. With that, today the head of the EPA signaled the withdrawal from the Clean Power Plan – an Obama regulation to fight climate change.
What does this mean for coal stocks?
Let’s take a look at the two largest American coal producers, both of which filed bankruptcy last year: Peabody Energy and Arch coal.
These are now two post-bankruptcy stocks!Peabody emerged from bankruptcy earlier this year after shedding about $5 billion in debt. Similar story for Arch coal. They filed early last year and emerged from bankruptcy late last year, eliminating $5 billion in debt in the process. So shareholders were wiped out and debt holders became stock holders in new low debt, cash flow positive companies with deregulation coming down the pike. With that, you would think the stocks would be screaming higher. That hasn’t been the case.
Here’s a look at the charts…
So we now have Peabody Energy, the leading coal producer in America with a $3 billion market cap. And Arch Coal, number two, has just a $1.7 billion market cap.
Are these cheap stocks?
Let’s take a look at who owns them…
The biggest shareholder in Peabody is billionaire Paul Singer’s hedge fund, Elliott Management. They own half a billion dollar’s worth of the stock and it’s a top ten position. As for ARCH – the top shareholder is the $5 billion hedge fund Monarch Alternative Capital. ARCH makes up 20% of their highly concentrated long equity portfolio (their biggest single stock position). If you’re going to dip your toe in the water on a post-bankruptcy stock, there are few better places to look for guidance than Paul Singer – a former attorney, turned one of the most influential and successful investors in the world.
As we head into the weekend, today I want to talk a bit about the 401k.
I’m looking today at a relatives 401k offering. Nothing has made Wall Street richer than the advent of the 401k. They get a constant monthly stream of fresh capital to skim fees and commissions from, and you get all of the market risk.
For the average person, selecting from the “options” in their 401k plan is a practice of picking the highest number. No surprise, the fund providers know that, and play plenty of games to show you the best numbers possible.
Here’s an example: As I’m looking through the limited choices in this particular 401k plan provider, there is a common theme in the “inception date” of most of the company’s mutual fund offerings. They tend to have track records that start in 2002 at or near the bottom of the internet bubble-induced stock market crash, OR they start in 2009 AFTER the 50% collapse in stocks, OR they start in late 1987 AFTER the crash.
Clearly the long-term returns will look quite a bit better when you’re starting from a bottom, after a crash. And clearly returns will look better without hanging a negative 30%-50% in 2008 and then another negative 30%-40% in the early 2000s.
Maybe they are newer, better strategies and had the good fortune of launching at the right time?
More often, they close them down and reopen them under a new, tweaked name. Add to that, they are constantly launching and running hundreds, if not thousands of funds, so that at any given time they can cherry pick the best performers over a certain period, to put them in front of a captive audience.
Bottom line: Big mutual fund giants are mass asset gatherers feeding on the passive 401k flow of capital, rather than astute investment managers. And the long term returns, after fees, prove it. People are locking their money up for a very long time, and getting a fraction of the market return.
When Congress invented the 401k in the 70s to transfer risk and obligations from the employer (traditional defined benefit pensions) to the employee (defined contributions), they didn’t do you any favors.
Since the election, almost a year ago, we’ve talked about the great passing of the torch, from a monetary policy-driven global economic recovery (which proved dangerously weak and shallow) to a fiscal stimulus-driven recovery (which finally gives us a chance to return to trend growth).
We talked yesterday about the move in interest rates. We have the collision of two big events nearing for the interest rate markets.
Forbes has just ranked the top 400 richest people in America for 2017.
Interest rates and stocks are on the move today (higher), following the vote last night in the Senate to pass the budget. This opens the way for an approval on the tax plan.
On Friday we talked about the biggest market movers: oil, copper and iron ore.
