Pro Perspectives 1/17/20

January 17, 2020

Let's take a closer look at gold today. 

This should be the year, for the first time in a long time, that gold prices become driven by the "inflation hedge" attributes, moreso than the "safe-haven/fear trade" attributes. If that's the case, and if we do indeed finally get a push in inflation, gold could be in for much higher prices.  It will be the manifestation of all of the central bank intervention of the past decade. 

The market poured into gold early on in the financial crisis, and was dead wrong about inflation (it didn't materialize in a world of global indebtedness). 

So, what do the inflation prospects look like now?

Remember, back in December, Jay Powell, at least verbally, committed the Fed to holding off on any future rate hikes until inflation "persistent and significant." In short, they've told us, they are staying put (sitting on their three rate cuts) until inflation bubbles up and proves to be sustaining at or above their 2% inflation target. 

If you consider the scenario of above average economic growth coming down the pike this year, the Fed is clearly in position to get behind on inflation – which I think they are okay with (they think they can beat inflation, and aren't so convinced they can beat deflation).   

This makes the outlook for gold very interesting. 

At the highs last Friday, gold has moved up 10% from the day Powell made those comments in his December press conference.  And often times it takes a catalyst to really things moving.  We may have had that with the escalation with Iran to begin the year. 

So, was this an abnormally large move in gold?  Is it something meaningful? 

It turns out, this type of aggressive move has some rare company.  Take a look at this chart I worked up on the 20-day moves in gold since the beginning of the Financial Crisis.  This $146 move in gold puts it in what I called the "big event zone" (Iran blowing up oil tankers, the surprise Brexit vote, the ECB intervening to avert sovereign debt defaults in Europe, the global financial crisis).    
If this is a real "inflation hedge" trade underway here in gold, we should be in for much higher gold prices. 

Pro Perspectives 1/16/20

January 16, 2020

Yesterday at the U.S./China trade signing event, Trump went around the room and named leaders from about 20 publicly traded companies.

Let’s take a look at the list, and how they’ve performed (today, year-to-date and since the start of 2018)…

You’ll notice half of the group was either a financial or industrial conglomerate.

Clearly they like the prospect of seeing the opening up of China (giving international business access to its 1.3 billion population) and the opportunity to own full control of a business in China. But they are also simply interested in a more stable geopolitical environment, and therefore a better economy (and one with more visability from which to plan and execute).

On the note of “opening up China,” Lui mentioned in his speech that China’s per capita GDP is now exceeding 10,000 U.S. dollars. Aside from the sheer size of the Chinese population, that per capita GDP makes for a very valuable consumer.

Why? Historically, every major developed world economy hit a point of per-capita GDP that triggered an exponential rise in the consumption of commodities. When you hit a certain level of per capita wealth you get the kind of improvements in quality of life that begin to drive demand for things like electricity, air conditioning, cars, etc.

With this in mind, remember this chart of commodities we’ve been looking at here in my Pro Perspectives notes …
And remember, compared to the S&P 500 (the commodities index/S&P 500 ratio) commodities have never been cheaper.

 

Pro Perspectives 1/15/20

January 15, 2020

With stocks sitting on record highs, we had the official signing of the Phase 1 U.S./China trade deal today.

Let’s revisit the important week of October that got us to this point.

It started on October 9th, when Trump, in anticipation of meetings with China in D.C. over the following two days, blacklisted eight Chinese tech firms and restricted the visas on some Chinese officials, all of which they associated with human rights abuses on Muslim minorities in China.

Why do this, just as they were heading into trade negotiations again?

Leverage.  Trump has always had leverage over the Chinese on these negotiations, and had been in complete control (able to make concessions and pull the trigger on a deal at any time).   But that leverage had eroded in recent months.  And China had been signaling that perhaps they would hold out in hopes of seeing a new President in a year’s time.

But Trump found an angle to dissuade the Chinese from turning their backs on a deal.  By taking aim at the human rights abuses of the CCP, he telegraphed how the specter of the fight might change.

Two days later, they were standing in the Oval Office shaking hands on a cut-down trade deal.

This is what the chart of stocks looks like since that October 11th handshake …

As I’ve said, with a fundamentally strong economy, Trump has been in the driver’s seat to force structural reform.  And he’s getting it.  Don’t underestimate the importance of dealing with the global imbalance issue that ultimately led to the global credit bubble and burst.  And stopping the currency manipulation (and the related trade advantage) is at the core of it.  

As part of the agreement, China has vowed to “achieve and maintain a market-determined exchange rate regime.”  A floating exchange rate in China is very unlikely, but stronger yuan (to pacify the U.S.) is more likely.  That curtails the trade advantage.

As you can see in the chart below, the Chinese have been moving the yuan in that direction (the decline the chart below represents a weaker U.S. dollar/ stronger Chinese yuan) since the handshake agreement in early October in the Oval Office. And there is likely a lot more to come.
Pro Perspectives 1/14/20

January 14, 2020

Fourth quarter earnings kicked off today, with three of the big four banks reporting this morning.   

The banks have been putting up good numbers for a while now, underpinned by strong consumer business.  But now the trading business looks like its coming back.  

The largest bank in the country, JP Morgan, beat earnings estimates, recording another new record profit.  Trading (Markets) revenue was up 56% from the same period a year ago.  

Citigroup beat for the twentieth consecutive quarter.  Trading revenue was up 28%.

 
We'll hear from Bank of America tomorrow.  BAC has had fourteen consecutive quarters of earnings beats.  Wells Fargo isn't enjoying the prosperity, but it's company specific.  Wells is a turnaround story, with a new CEO just three months on the job, trying to resolve the company's self-induced PR debacle.  And as smart new CEO's do, when entering a tough spot, they try to set the expectations bar low. That's being done with Wells.

Tomorrow we also hear from Goldman Sachs.  I suspect we'll also see a pop in trading revenues. 

Trading was the motherlode for banks prior to the financial crisis.  And the jig seemed to be up, following the failure of Lehman Brothers, when the regulators cracked down on proprietary trading, through the Volker Rule (within the Dodd-Frank Act).  

 
The line of managing the risk of market making activities and speculative trading, by the big banks, is a blurry one. And the Volker Rule put the burden on the banks to prove that their trading activity is against their market making activity. That weakened the market making businesses of the banks and increased compliance costs. And the major Wall Street banks were not the same. 
 
But since August of last year, that rule has been revised.  The banks now are "presumed" to be in compliance, rather than having to prove (as part of their everyday trading activities) that they are in compliance.  This was a fairly quiet final revision to a very important regulatory issue facing the big banks — and perhaps one that has begun bearing fruit.
 
With that in mind, if we look back at the sector weightings in the S&P 500, financials were the heaviest weighted sector in the years leading up to the financial crisis — at 22% of the index.  The financials currently make up just 13% of the S&P 500.  

Pro Perspectives 1/13/20

January 13, 2020

I’m looking through hedge fund returns today.  And as you might expect, with a big year for stocks in 2019, hedge funds also had a very good year (though most, and on average, well underperformed the S&P 500).

It was a big bounceback year for many of the high profile investors that have had a tough time in recent years.  At the same time, it was a year where some other high profile investors called it quits — returning investor money, to focus on simply managing their own money, or just closing the doors and walking away from the business.

This reminds me of the departure of one of the best oil traders in the world back in the summer of 2017, after losing 30% on the year on his bullish oil bets.  Andy Hall capitulated – he quit.

And just before oil did this …

Markets always seem to find the pain point for speculators. And the painful position for oil, at that time, had been the long side. And markets tend to squeeze those positions out just before finally moving.

George Soros is a good example in his Thai baht trade back in the 90s. He tried to force the central bank in Thailand to abandon the currency peg and was ultimately forced out of his position (from the cost of carrying the position) just before they de-pegged/devalued the currency.  Hall had a similar fate with oil.

Have the hedge fund closures of the past year similarly capitulated at just the wrong time?  Maybe.

The post-Great Recession decade has proven to be unlike any other trading environment seen by some of these long-tenured hedge fund managers — distorted by government and central bank intervention.  Now we enter a year, finally, where the path has been paved for markets to be less dictated by macro factors (trade disputes, central bank policy changes …) and moreso by the fundamental drivers of the economy and corporate profits.   And it’s a year where things are lined up for a resuscitation of inflation (a missing puzzle piece, over the past decade, for those that have made their living solving the global market puzzle).

 

Pro Perspectives 1/10/20

January 10, 2020

We kick off fourth quarter earnings next week.  We’ll hear from the big four banks on Tuesday and Wednesday.

As I’ve said coming into the year, the table has been set for positive surprises on earnings. The expectations were dialed down as confidence (particularly business confidence) eroded over the past half year from the uncertainty on trade.

That said, on Wednesday, China’s top trade official to travel to Washington to formally sign the “Phase 1” agreement.

And with the improved outlook on trade heading into the end 2019 (“improved” relative to what had formerly been an outlook of an indefinite trade war), even the Atlanta Fed’s GDP estimate (incorporating Q4 data) has risen to 2.3%.  For context, in mid November, the projection was for sub 1/2% growth for the fourth quarter.

So what about earnings?

The market is looking for 2% contraction in Q4 earnings (year-over-year).

According to FactSet, in September, the market was looking for 2.5% earnings growth for Q4.  So, again, we head into earnings season with expectations that have been dialed down.  They’ve been dialed down because business confidence waned.  Business confidence waned because of the perception of a never-ending trade war. 
That script has since changed.  So the table is set for positive surprises. 
Now, let’s incorporate this view into the valuation on stocks, as we end the week after printing new record highs. 
The market goes out at 18.5 times forward earnings (earnings expectations for the next 12-months).  That is still cheap, considering we have a 10-year yield, still, at 1.8% (ultra-low levels).  As we’ve discussed, historically when rates are at low, valuations on stocks tend to run north of 20.  We’ve discussed this analog for the four years I’ve been writing this note.  And for the four years I’ve been writing this note, rates have remained low, and the P/E on stocks has indeed expanded to 20 or above to end the year.  If the market is, again, underestimating earnings, then the market is cheaper than it appears, at even 18.5 times forward earnings.   
Pro Perspectives 1/9/20

January 9, 2020

Just six days into the new year, and stocks are up 1.4% already, printing higher record highs. 

Since we’ve been looking for a repeat of the late 90s for the economy and for stocks, let’s take a look at the way stocks performed to open the latter half of the 90s (hint: it was good).

Remember, we’re talking about the period that followed the 1995 flip-flop by the Fed, where the Fed was forced to reverse course on monetary policy after aggressively tightening into a low inflation, tepidly recovering economy.

They cut rates.  Stocks went crazy. And within four quarters the economy was printing growth above 4% (annualized).

And as we’ve observed, that was just the beginning.  Stocks went on to do this over the next four years …

And economic growth went on to do this …

With this in mind, as we open 2020, following the 2019 Fed flip-flop, stocks are already off to a hot start.  But it doesn’t mean we should expect things to cool down.  Here’s a look at the “January effect” on the late 90s …
Pro Perspectives 1/8/20

January 8, 2020

We talked about the early 2000s analog for oil yesterday, and the prospects for another run-up to $100 for oil prices. 

As of about 7:00 last night, it looked like it may be on its way, sooner rather than later.  As the day ends, oil made violent move up and a more violent move down, same with gold.  And stocks did the opposite, rallying from a deep sell-off overnight, and back to record highs.

By the day’s end, markets appear to have priced OUT the risk of war with Iran.

Will Iran truly “stand down” from this point?  As long as they are being economically suffocated with sanctions, probably not.  But who knows.

The bottom line, the potential for continued conflict remains a catalyst for oil and gold – an often it takes a catalyst (some sort of event or trigger) to reprice undervalued assets.  More importantly, the underlying tailwinds for oil, gold and commodities are blowing north.

Remember, we talked earlier in the week about the catalysts lined up to unleash above trend growth for the year (and perhaps several years of above trend growth).  In addition to ultra-easy global monetary policy, the economic-boom cocktail includes the introduction of 5G, a reduction of tariffs, and global fiscal stimulus (including progress toward a $2 trillion U.S. infrastructure spend).

This should finally lift broad commodities out of the decade-long depression. And that will resuscitate the inflation heartbeat, which has been pronounced by many as dead.

 
As you can see in the chart below, the trend change in commodities prices appears to be underway, and in the very early stages.  In addition, compared to the S&P 500 (the commodities index/S&P 500 ratio) commodities have never been cheaper. 
Pro Perspectives 1/7/20

January 7, 2020

We opened the year with an escalation of U.S./Iran tensions.   With that, oil prices have become a front burner focus for markets.

Yesterday, we revisited the impact the Iraq war had on oil prices.  Ultimately, the Iraq invasion led to a near double in the price of oil over 18-months.

Will Iran be the catalyst for run at $100 oil? Maybe.

Remember, oil was trading north of $100 in the summer of 2014.  By November, prices were sub-$80, and the table was set for OPEC to cut production and stabilize oil prices.  They refused, triggering a crash in oil prices that ultimately sent oil down to as low as $26.  OPEC’s strategy: Kill off the emerging threat of the U.S. shale industry by forcing prices well below where they could produce profitably. To an extent it worked. More than 100 small oil-related companies in the U.S. filed for bankruptcy from 2014-2016.

While they nearly succeeded in killing the shale industry, these oil producing countries nearly killed their own economies in the process.  So, in effort to drive oil prices higher, to salvage oil revenues, they had to flip the switch in late 2016, cutting production for the first time since 2008.

And they did so, in a market that was already undersupplied.  And in a world where demand has been underestimated, and growing.  With that, oil bounced aggressively — from $26 in early 2016, to as high as $77 by late 2018.

Over the past few years we’ve discussed the work Leigh Goehring, one of the best research-driven commodities investors in the world.  He has been wildly bullish on oil and commodities.  And he has been looking for a return to $100 oil.

Here is an analog Leigh has been watching on oil:  he says “the last great bull market in oil started in 1999; by 2004, everyone was still bearish. You had four years of a bull market before anyone really began to accept it. Once they did, commodity prices really took off and the investments took off … I think the psychology is going to change. It’s going to realize that US oil shale is not enough to balance the market.”

The parallels continue on this early 2000s analog, including the role of Middle East conflict.  Meanwhile, as you can see, while oil prices may still prove well undervalued (and poised for a revaluation), oil and gas stocks are (and have been) dirt cheap.
Pro Perspectives 1/6/20

January 6, 2020

Happy New Year!  This time last year, we were talking about the prospects for a huge year for stocks, on the thesis that the Fed would be forced to reverse course on monetary policy, unleashing another 1995-like melt-UP in asset prices.  We had it.

What should we expect for 2020?  More of the same.

Remember, that mid 90s flip-flop from the Fed, laid the ground work for a boom in the economy and in the stock market into the late 90s.

We enter 2020 with an economy that has run at sub-par pace for the past decade, and now we have the fundamentals in place, and catalysts in line to unleash above trend growth (perhaps several years of above trend growth).  That scenario has not been priced into markets.  That means positive surprises in growth and earnings can be among the biggest themes this year.

Among the other major themes at work that give us the chance to see above trend growth this year: 1) the introduction of 5G (this will make wireless internet ubiquitous, connecting nearly everything we do and own to the internet – the impact of which has been compared to the widespread adoption of electricity), 2) a reduction of tariffs and the visibility of an end to the trade war, and 3) global fiscal stimulus (likely to include progress toward a big U.S. infrastructure spend).

This looks like an economic-boom cocktail.  In fact, it looks a lot like the periods that bookended the Great Depression: the Roaring twenties (fueled by fiscal stimulus and innovation – like the automobile and the pervasive access to electricity) and the late 30s (fueled by reduction in tariffs, a big government spending/pulic works programs, and later, war spending).

On the latter, remember back in September, when Iran attacked Saudi oil supply, we talked about the prospects of war – and the way oil prices, gold and stocks behaved in the early 2000’s when the U.S. invaded Iraq. Let’s take a look at an excerpt from that September 16th note:

“We have a shock to global oil supply, and that has some predicting much higher oil prices… 

But I suspect we’ll see oil prices, first, go the other way. 

This all looks like the timeline is setting up for a rate cut, a cut-down China deal, and then the U.S. greenlighting an attack on Iran. 

What happened to oil prices when we invaded Iraq in 2003.  Prices first went down, big. 

Here’s a look at the 2003-2004 crude oil chart  …

What went up on the Iraq war catalyst?  

Gold went up 25% over the next year …

And stocks went up 45% over the next year …
I suspect we’ve already seen the first down-leg for oil, following the September provocation.  The path from here is probably up, big.