Stocks fell sharply this morning, but recovered nearly all the losses from the lows of the day.
Today we got a reminder of the impact that algorithmic trading can have on markets. When the headline hit today about Flynn, here’s what stocks did…
Big institutions have been trading stocks through computer programs for a long time, but the speed at which these algorithms can access markets and information have changed dramatically over the past decade – so has the massive amount of assets deployed through high frequency trading programs. They can remove liquidity very quickly. Combine that with the reduced liquidity in markets that has resulted from the global financial crisis (i.e. the shrinkage of the marketing making community and of hedge fund speculators, and the banning of bank prop trading) and you get markets that can go down very fast. And you get markets that can go up very fast too.
The proliferation of ETFs exacerbates this dynamic. ETFs give average investors access to immediate execution, which turns investors into reactive traders. Selling begets selling. And buying begets buying.
Now, with the Flynn news, Wall Street and the financial media spend a lot of time trying to predict when the market will correct and what will cause it. But as the great billionaire investor, Howard Marks, has said: “It’s the surprises no one can anticipate that move markets. But most people can’t imagine them, and most of the time they don’t happen. That’s why they’re called surprises.”
Still, if you’re not a leveraged hedge fund, this tail-chasing game of trying to pick tops and reduce exposure at the perfect time shouldn’t apply.
More important is the observation that stocks remain cheap at current levels, when we consider valuations in historically low interest rate periods. And we continue to have very low interest rates. So the question is: Is it more likely that corporate earnings will get worse from here, or better from here?
There’s plenty of evidence to suggest the momentum and the fundamental backdrop supports “getting better” from here. And we add to that, the fuel of tax cuts, and earnings should continue to make stocks very attractive relative to a 2.3% ten-year yield.
The Dow is now up 23% on the year. The index that measures the broader market, the S&P 500, is up 18%. This is more than double the performance of the long run compounded average growth rate for the stock market.
People continue to be surprised that policy execution is improving, and that tax cuts are actually coming. And they speculate on whether or not the stock market already has it all priced in. I think the steady rise in stocks is telling them it’s not.
As I’ve said, we remain in an ultra-low interest rate world, where incentives continue to push money into stocks (as the best alternative). And in ultra-low rate environments, historically, the multiple on stocks (the P/E) runs north of 20. It’s 18 right now, on the consensus estimate on next year’s earnings. So on a valuation basis, there’s room. This doesn’t take into account a corporate tax cut that will take the rate from 35% to 20%. That goes right to the bottom line for companies (earnings go UP). When earnings go up, the multiple stocks trade for goes down (stocks get cheaper).
Citibank thinks each 1% cut in corporate taxes will add roughly $2 in S&P 500 earnings. And Citibank says the effective tax rate across the S&P 500 is more like 27%. So a cut to 20% would mean a seven percentage point reduction. This would put next year’s S&P 500 earnings in the mid-$150s, which would put the multiple at 16 to 17 times next year’s earnings.
And don’t forget, we’re getting fiscal stimulus for a reason: to pop economic growth, which has been in a rut (post-crisis), running well south of the 3% long run average growth rate for the economy. The prospects for better growth, means prospects for better earnings. The outlook for better earnings, on a better economy, should also put downward pressure on valuations, making stocks more attractively valued.
In my January 2 note, I said: “there will be profound differences in the world this year, with the inauguration of a new, pro-growth U.S. president, at a time where the world desperately needs growth.” I think it’s safe to say that is playing out—albeit maybe slower and messier than expected.
I also said: “The element that economists and analysts can’t predict, and can’t quantify, is the return of ‘animal spirits.’ This is what has been destroyed over the past decade, driven primarily by the fear of indebtedness (which is typical of a debt crisis) and mistrust of the system. All along the way, throughout the recovery period, and throughout a tripling of the stock market off of the bottom, people have continually been waiting for another shoe to drop. The breaking of this emotional mindset appears to finally be underway. And that gives way to a return of animal spirits, which haven’t been calibrated in all of the forecasts for 2017 and beyond.”
The adoration for Bitcoin has been growing by the day, though no one understands how to value it.
CNBC went on “watch” the other day for Bitcoin $10,000. Today it traded above $11,000 and then fell as much as 21% from the highs.
Here’s a look at the chart.
I heard someone today say, everyone should have a small portion of their net worth in Bitcoin. That sounds an awful lot like the mantra for gold. Gold has been sold all along as an inflation hedge. But unless you have Weimar Republic-like hyperinflation, you’re unlikely to get the inflation-hedge value out owning it.
Remember, gold went on a tear from sub-$700 to above $1,900 following the onset of global QE (led by the Fed). Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply. Still, nine years after the Fed’s first round of QE and massive global responses, we’ve been able to muster just a little better than 1% annualized inflation. So gold is a speculative trade. It’s a fear trade. And it’s volatile.
If you bought gold at the top in 2011, the value of your “investment” was cut in half just four years later. That’s a lot of risk to take for the prospect of “hedging” against the loss of purchasing power in the paper money in your wallet.
Now, Bitcoin is becoming a pretty polarizing “asset class.” The gold bugs get very emotional if you argue against the value of owning gold. Those that own Bitcoin seem to have a similar reaction. But Bitcoin, like gold, is a tough one to value. You buy it because you hope someone is going to buy it from you at a higher price.
So is Bitcoin (cryptocurrencies) an investment? Sophisticated investors that are involved, likely see it as similar investment to a startup. It has traction. It has a lot of risks. It could go to zero. Or it could pay them multiples of what they pay for it. But they thrive on diversification. When they have a large portfolio of these types of bets, when a few payoff, they put up nice returns. Bitcoin may be one of the few, or it may not.
Stocks continue to rise today, up another 1% on the Dow. So year-to-date, the Dow is up 20% now, the S&P 500 is up 17% and the Russell 2000 is up 13%. Remember, most of Wall Street was expecting 3%-4% returns for stocks this year.
What did they miss? Mostly the rise in optimism surrounding the incoming pro-growth government.
With consumer and corporate balance sheets as good as we’ve seen in a long time, unemployment at 4.1% and corporate earnings growing at a 10% clip through the first three quarters, and tax cuts coming, we should expect almost everything to go up.
As for tax cuts, that got a step closer today, as it was approved by the Senate budget committee. Now it goes to a vote on the floor of the Senate.
All of this, and market interest rates are going nowhere. The 10-year yield, at 2.33%, is just about where we started the year. That’s, in part, being weighed down by some comments by incoming Fed Chair Jerome Powell.
Today, Powell gave prepared remarks and took questions for his confirmation hearing with the Senate today. The general view has been that Powell is a like-thinker to Yellen, but with partisan alignment for the president.
But under Yellen’s leadership at the Fed, the overly optimistic forecasts about inflation and the rate path affected consumer behaviors and nearly stalled the recovery last year. They had to reverse course on their projections and game plan early in 2016. And then we had the election, and the prospects of fiscal stimulus, and the Fed (under Yellen) went back to the script of telegraphing a more restrictive rate environment.
Now, with that in mind, I thought early on that Trump would show Yellen the door. And I expected him to appoint a new Fed Chair that was a clear dove–someone that would leave rates alone (given the weak inflation) and let fiscal stimulus feed into the recovering economy, to finally fuel some animal spirits. Do no harm to the economy. Even Bernanke suggested the Fed should let the economy run hot, warning not to kill the recovery by setting expectations for tighter credit coming down the pike.
From Powell’s comments today, it sounds like we may be getting less Yellen than people have believed. In his short prepared remarks, he made an effort to say he strives to support the economy’s progress toward full recovery. He implied the job market needs more improvement, and that he favors easing the regulatory burden on banks. This doesn’t sound like a guy that thinks the economy can withstand mechanically stepping rates higher in the face of weak inflation and sub-trend growth.
U.S. stocks printed new record highs again today, as numbers come in for the Black Friday period, which carries through Cyber Monday.
The National Retail Federation has projected about 4% growth in the number from last year, which is better than the past two years, but a bit softer than 2014, 2011 and 2010.
But it’s a safe bet we’ll see better than expected numbers before the shopping season is over. If we take the Atlanta Fed’s GDP forecast for the fourth quarter (which admittedly changes like the wind), we’re on pace to have the second hottest growth for the year, since the Great Recession. And, of course, consumers are in as healthy a position as they’ve been in a long time—housing prices are nearing pre–crisis levels, household net worth is on record highs, consumer credit is on record highs, but so is consumer credit worthiness.
Add to that: The stock market is at record highs. The unemployment rate is 4.1%. Inflation is low. Gas is cheap ($2.38), and stable. Mortgage rates are under 4%, and stable. And you can borrow money for five years at 2% to buy a car.
And then there’s the confidence the economy is improving and that a raise is coming (through tax cuts and a corporate tax cut which should ultimately drive wages higher). Here’s a look at the Conference Board’s Consumer Confidence Index—at 17–year highs…
Later in the week we’ll hear from OPEC on their plans to extend their production cuts to keep the upward pressure on oil prices. We’ve talked about the case for an explosive move higher in oil prices, given the impact the oil price crash of last year has had on supply. Meanwhile demand has picked up, and OPEC has been cutting production into this scenario. As we sit about 20% higher in oil prices since OPEC announced its first production cut in eight years (last November), there are now some building voices for much higher oil prices as we head into this week’s meeting.
We talked last week about what may be the bottom in the “decline of the retail store” story.
Walmart may be leading the way back for traditional retail. And it’s doing so, in part, by pouring money into e-commerce to fight back against Amazon.
Just as the energy industry has been beaten down by the rise of electric vehicles and clean energy, the bricks and mortar retail industry has been beaten down by the rise of Amazon. But those energy and retail companies that have survived the storm may have magnificent comebacks. They’re getting fiscal stimulus, which will lower their tax rates and should pop consumer demand. And they may be getting help with the competition. The regulatory game may be changing for the Internet giants that have nearly put them out of business.
Over the past decade, the Internet giants of today have had a confluence of advantages. They’ve played by a different rule book (one with practically no rules in it). And many of the giants that have emerged as dominant powers today, did so through direct government funding or through favor with the Obama administration.
One of the cofounders of Facebook became the manager of Obama’s online campaign in early 2007. In 2008, the DNC convention in Denver gave birth to Airbnb. By 2009, the nearly $800 billion stimulus package included $100 billion worth of funding and grants for the “the discovery, development and implementation of various technologies.” In June 2009, the government loaned Tesla $465 million to build the model S. In 2014, Uber hired David Plouffe, a senior advisor to President Obama and his former campaign manager to fight regulation.
The U.K.’s Guardian has a very good piece (here) on what this has turned into, and the power that has come with it, calling it “winner takes all capitalism.”
This all makes today’s decision to repeal “net neutrality” very interesting. Is this the event that will ultimately lead to the reigning in the powerful tech giants? For the big platforms like Google, Twitter, Facebook and Uber, will it lead to transparency of their practices and accountability for the actions of its users? If so, the business models change and the Wild West days of the Internet may be coming to an end.
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As we head into the Thanksgiving day weekend, let’s talk about oil and Saudi Arabia.
On Thanksgiving night three years ago oil was trading around $73, when the Saudis blocked a vote on an OPEC production cut. Oil dropped 10% that night, and that set off a massive oil price bust that ultimately bottomed out early last year at $26.
The goal of the Saudis was to put the emerging, competitive U.S. shale industry out of business–to force oil prices lower so that these shale companies couldn’t product profitably. The plan: They go away, and Saudi Arabia retains its power on global oil. It nearly worked. Shale companies started dropping like flies, with more than 100 bankruptcies between 2015 and 2016.
But cheap oil had broader implications for the global economy, following the Great Recession. It exposed the global banks that had lent the shale industry hundreds of billions of dollars.
Additionally, collapsing oil prices directly weighed on inflation measures and the inflation expectations. That was bad news for the central banks that had committed trillions of dollars to avert a deflationary spiral and promote a normalization of inflation. High inflation is bad. Deflation is worse. Once a deflationary mindset takes hold, it feeds into more deflation. Central banks can raise rates to kill inflation. They have few tools to fight deflation (especially after the financial crisis).
So cheap oil became bad news for the fragile global economic recovery. With that, central banks stepped in early last year and responded with coordinated easing (which included direct asset purchases, which likely included outright oil and oil-related ETFs). Oil bottomed the day the Bank of Japan intervened in the currency market, and prices jumped 50% in a month as other major central banks followed with intervention.
Now, the other piece of this story: cheap oil damaged the shale industry and the global economy, but it also damaged the same folks that set the collapse into motion–Saudi Arabia and other oil producing countries. These countries, which are heavily reliant on oil revenues, have seen their budget deficits balloon. So, with all of the above in mind, in November of last year, the oil producing countries (led by Saudi Arabia) reversed course on their plan, by promising the first production cuts since 2008.
Oil prices have now recovered to the mid-$50s. And since OPEC announced production cuts last year at this time, U.S. petroleum supply has drawn down 5%. Meanwhile, global demand is running far hotter than forecasts of last year. Yet, OPEC is extending their production cuts into this market and may get even bolder next week at their November meeting. Why? Because now it suits them. Remember, Saudi Arabia’s next king has been cleaning house over the past two weeks, in the process of seizing hundreds of billions of dollars from his political foes. Higher oil prices help his efforts to reshape the Saudi economy.
As liquidity dries up into the end of year and holidays, we may see oil find its way back up toward those November 2014 levels (low $70s)–where the whole price-bust debacle started.
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Yesterday we talked about the comeback underway in Wal-Mart and the steps it has made to challenge Amazon, and to challenge the idea that Amazon will crush everyone.
It’s beginning to look like the “decline of the retail store” may have bottomed too.
And it so happens that it may have bottomed precisely when a new ETF launched to capitalize on that story. ProShares launched it yesterday, and that is the name of it –ProShares Decline Of The Retail Store ETF. It gives you short exposure to bricks and mortar retailers.
It’s off to a bad start–down 3% in the first day of trading.
For retail, the week started with a big earnings beat for Advance Auto Parts (the stock was up as much as 20% on Tuesday). Then it was Wal-Mart. And today we had earnings beats in Foot Locker and Abercrombie and Fitch.
With this, while the Dow and S&P 500 were down on the day, the small-cap (Russell 2000) was up nicely. Here’s why …
As bad as retail has been, the energy sector remains the worst performing for the year–down 11% year-to-date as a sector and the only sector in the red. This, as oil has reversed from down 22% on the year, to up around 5%, with a very bullish outlook.
This sets up for a big year ahead for energy stocks. And if you believe the worst of the economic challenges are behind us, the survivors in retail could have quite a revival–especially if Amazon begins to see more regulatory scrutiny.
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After some broad selling across markets yesterday, stocks bounced back today. With that, you might expect interest rates to push up and commodities to be rising too. That was not the case, which continues the trend of the past week (or so) of odd market behavior.
About a tenth of the strength in the S&P 500 can be attributed to Wal-Mart. Wal-Mart had a big earnings beat today with the best sales growth since before the financial crisis.
With that, let’s take a look at how Amazon’s war on traditional retail has affected Wal-Mart.
It wasn’t long ago that Wal-Mart was the biggest company in the world. It topped the Fortune 500 list from 2002 through 2005, and then again in 2007 (with a more than $300 billion market cap). At that time, Amazon was a $25 billion company. And then the financial crisis hit. Wal Mart was almost put out of business because of the global credit freeze. And then we had massive intervention to get credit moving again and to save the economy. With that intervention came a massive fiscal stimulus package. A huge chunk of it flooded into Silicon Valley (pension money followed it).
And, since then, although Amazon was a decade old company at the time, Amazon has had a trajectory similar to the other big tech giants of today. It’s more than 20 times as big today.
For perspective, in 2006, Wal-Mart was a $315 billion company. Today, the U.S. economy is 34% bigger than it was in 2006 (about $5 trillion bigger). And Wal-Mart is 15% smaller than it was in 2006 (at a market cap of $268 billion).
But Wal-Mart has finally started fighting for its life.
They bought a controlling stake in JD.com in the middle of last year to access the growing middle class in China. JD.com is the number two e-commerce site in China, but is rapidly closing the gap between itself and Alibaba (number 1). And JD has competitive advantages over Alibaba, in that, like Amazon, it owns its distribution centers and has control over quality (unlike an ebay and Alibaba). They’ve since upped the stake to 20% and may ultimately buy all of it. And Wal-Mart bought the startup Jet.com in the U.S. in August of last year. If they continue to win share in China through JD.com, this gap between Amazon and Wal-Mart may begin to start closing.
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Stocks were broadly lower today. Bond yields were lower. Commodities were mostly lower. And the VIX, the index that measures investor demand for protection from a decline in stocks (also known as the “fear index”), was the biggest mover of the day. But it’s rising from a low base.
As you can see in the chart above, the VIX was under 10 (very near record lows) at the close on Friday, November 3. That weekend, we got the news that the future Saudi king had directed the arrests of corrupt Saudi royals, ministers and investors (including billionaire Alwaleed bin Talal).
So you can see the rising VIX as we’ve seen the growing signs that there may be some forced selling across markets related to those arrests, and the Kingdom’s pursuit of hundreds of billions of related assets.
Still, for perspective, you can see how low the VIX remains, relative to history.
This shows you how the market has been lulled to sleep–underpricing the prospects of volatility. If you look back over time, you can see how quickly that can change.
Still, a market event doesn’t mean an economic event is occurring. The economy is good. And with stimulative fiscal policy coming down the pike, it should be better over the next 12 months (and coming years). So there is a difference between volatility and recession risk.
On that note, in the next chart from the NY Fed, the Treasury market is telling us recession risk is very low–9% chance in the next 12 months).
And the difference between high grade corporate bonds and the U.S. Treasury yield tells the same story–very low recession risk/probability of economic hiccup.
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We talked last week about what may be the bottom in the “decline of the retail store” story.
As we head into the Thanksgiving day weekend, let’s talk about oil and Saudi Arabia.
Yesterday we talked about the comeback underway in Wal-Mart and the steps it has made to challenge Amazon, and to challenge the idea that Amazon will crush everyone.
After some broad selling across markets yesterday, stocks bounced back today. With that, you might expect interest rates to push up and commodities to be rising too. That was not the case, which continues the trend of the past week (or so) of odd market behavior.
Stocks were broadly lower today. Bond yields were lower. Commodities were mostly lower. And the VIX, the index that measures investor demand for protection from a decline in stocks (also known as the “fear index”), was the biggest mover of the day. But it’s rising from a low base.
