Pro Perspectives 11/18/19

November 18, 2019

As we’ve discussed, the Fed has gone from shrinking the balance sheet (quantitative tightening) to expanding the balance sheet again, with any eye toward buying almost half-a-trillion dollars worth of Treasury bills. 

This reversal in global liquidity is probably more important than the flip-flop in interest rates.  And it has been aggressive, as you can see in the chart below.  They’ve already bought $267 billion worth of short-term Treasuries.

With this underpinning, stocks have gone up!  Why?

Let’s take a look back at a quote from the architect of the Fed’s emergency monetary policies.

When the Fed announced QE2 in late 2010, Bernanke penned a column for the Washington Post, titled, Aiding the Economy:  What the Fed Did and Why.

“… low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week … to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 …

This approach eased financial conditions … Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” 

In short, as Bernanke acknowledged here, and more explicitly as he continued doing lengthy interviews to answer critics of QE, QE tends to make stocks go up – which is an intended consequence. 

Join me here to get all of my in-depth analysis on the big picture, and to get access to my carefully curated list of “stocks to buy” now.
Pro Perspectives 11/15/19

November 15, 2019

We’ve talked about the melt-up scenario for stocks heading into the end of the year.  That’s what we continue to get. 

We’ve had nine new record closes over the past fifteen trading days for the S&P 500.

But remember, just six weeks ago, the bears were all excited about the weak manufacturing data — reported at the weakest level in 10 years.

What changed?

I would argue that the sliding manufacturing data increased the urgency for Trump to get something done on trade, given the developments in markets and the timeline on next year’s election.  China was in town for another round of negotiations and, to the surprise of many, the rumors immediately started circulating that a “limited deal” had been struck.  By the end of the week, the President was in the Oval Office shaking hands with the Chinese Vice Premier on a deal (in principle).  

Add to this, the weak manufacturing data also solidified another rate cut to come at the Fed’s October 30th meeting.

With these events in early October, stocks have gone on a 9% run from those October 3rd lows.  Let’s take a look at a chart that I suspect will break-out next week, to play catch-up to the broader market. 
Pro Perspectives 11/14/19

November 14, 2019

As Trump has been battling China over the past nearly two years, in an effort to level the playing field on global trade, he’s also been fighting to level the playing field domestically.

Since last year, we’ve been tracking the progress on this “domestic rebalancing” by watching this “Amazon versus Walmart” chart (from one of my June 2018 notes). 
The divergence in this chart represents the regulatory favor that has been given to the tech giants.  It epitomizes the disruptor/disrupted economy.

That favor has not only disrupted industries, it has nearly destroyed them, and created monopolies in the process. 

But the regulatory tide turned last year, finally.  What started as verbal threats and Twitter attacks by Trump, against the tech giants, slowly materialized into policy.  We’ve had the repeal of “net neutrality,” which may ultimately lead big platforms like Google, Twitter, Facebook and Uber to transparency of their practices and accountability for the actions of its users. We have the Supreme Court ruling that subjects internet sales to state tax.  And the flood gates have scrutiny have since opened even wider. 
This has provided the catalyst for old economy stocks to bounce back. 

With that, we’ve been following this Walmart/Amazon chart looking for the “jaws” to close in the chart.  So, with Walmart’s big earnings report today, let’s take a look at an update …

Not only have the jaws closed on this huge divergence, but there is a new divergence, as Walmart is now outpacing Amazon.  Since the summer of ’18, the performance of Amazon stock is flat, while Walmart is UP 45%.

As we’ve discussed in my past notes, we’ve finally entered the stage where we see the disrupted/survivors, competing, if not beating the disrupters.  After all, if the historical “giants of industry” have moved aggressively to align with the changing economy, they have the distribution, in many cases, to be the ultimate winner.   We shall see. 

 

Pro Perspectives 11/13/19

November 13, 2019

Powell’s testimony to the Congressional economic committee today was a reminder for markets that the Fed has its foot on the gas.

Remember, in just the past 11 months, the Fed has not only stopped raising rates, but they’ve cut rates three times. And it has gone from shrinking the balance sheet (quantitative tightening) to expanding the balance sheet again, with an eye toward buying almost half-a-trillion dollars worth of Treasury bills by the second quarter of next year.

Why does the Fed have its foot on the gas? To hedge against the risks of an indefinite trade war. An indefinite trade war can erode confidence (which it has), which can slow economic activity (which it has). And despite the signals of an impending “limited” deal, the Fed has the luxury, given the low inflation environment, to take the position of assuming the worst-case scenario. It should be there until given a good reason not to be (like a trade deal, followed by booming data).

Remember, it has told us for the entire year that it will do whatever it takes to sustain the economic recovery. It’s an aggressive statement, and they have indeed taken an aggressive stance.

The intent is to promote confidence, promote risk taking, which promotes higher stocks. With that, we get another new record high close today. That puts us up 23% on the S&P 500. And the history of the past decades tells us that, in this highly interconnected global economic recovery, the S&P 500 is not only the barometer of global sentiment, but can also be the driver of global sentiment.

Pro Perspectives 11/12/19

November 12, 2019

Trump touted the strength of the economy in a speech at the Economic Club of New York today.
Market folks were looking for something new. They didn’t get it.
Most were looking for him to implode the status of a China trade deal. I was listening for some hints on turning focus to infrastructure–the yet to be addressed big pillar of Trumponomics. What we did hear, loud and clear, was another hammering of the Fed, which I suspect is related. How?
How do you pay for a massive infrastructure spend (maybe in the neighborhood of $2 trillion)? An infrastructure bond.
By orchestrating an indefinite trade war, Trump has forced global interest rates back toward record lows (if not beyond). If he had his way, the Fed would have slashed rates more aggressively, and market interest rates on our sovereign debt would have plunged into negative territory, as it has for much of the rest of the world (including Europe). Consider this: In August Germany sold 30-year government bonds for zero interest!
Trump may have a chance to sell a 50- or 100-year infrastructure bond, not for 0% interest, but maybe for 2%-3%. That’s still incredibly cheap money, and the global demand (given the state of global rates) should be plentiful.

Pro Perspectives 11/8/19

November 8, 2019

As the prospects of inking a limited trade deal have risen, so has the yuan.

The PBOC has walked UP the value of its currency over the past month.

Remember, on October 11th, Trump said we have a deal, which includes an agreement on “currency issues.”  That means, a stronger yuan, weaker dollar.

That’s what China has manufactured, thus far.  Here’s a look at that chart since …

In the chart above, the falling line represents a strengthening yuan versus the U.S. dollar, and vice versa. 

The next chart gives some bigger picture on what the Chinese have done with their currency, in response to Trump and economic weakness.  Let’s step through it (as we have in the past), and then talk about what it means for the discussion on a rollback of tariffs.
1) They slowly allowed the currency to climb (against the dollar) following threats of a big tariff on China from Graham and Schumer (yes, Schumer) back in 2005.
2) When the global economic crisis hit, they went back to a peg to protect their ability to export. 
3) They went back to a slow crawl higher as tensions rose, and people began to believe the developed market economies might be passing the torch to China for economic leadership. 
4) It became clear that China can’t grow fast enough in a world where developed market economies are struggling. So, they went back to weakening the currency to protect their ability to export. 
5) They strengthened the yuan when Trump was elected to try to ward off a trade war.
6) Trump wasn’t placated and tariffs were launched. They weakened the currency with the idea that a threat of a big one-off devaluation in the currency might create some leverage.
7)  After trying to hold-out, it seemed clear earlier this year that they needed to get a deal done, as the economy continued to sink.  They walked the currency higher again – a signal that they are willing to make aggressive concessions to get a deal done. 

8) But Trump escalated the trade war with bigger tariffs, and the Chinese made one of the largest devaluations in the yuan in years (a warning shot).

9) And now, we have what looks like the Chinese executing on a currency agreement (in principle).

With all of this said, what you’ll notice from the chart, is that a Chinese agreement to a 15% REvaluation of the yuan will only take us back to the levels of 2018, levels at which China had already conceded in efforts to keep Trump’s tariffs at bay.  It didn’t work.  Trump fired off tariffs anyway.  And China simply offset the tariffs by moving the exchange rate.

With the debate over whether or not a deal will come with a rollback of tariffs, it seems clear that an agreement on currency can/will only come if tariffs are rolled back.

 

Pro Perspectives 11/7/19

November 7, 2019

We’ve talked about the ingredients in place for a “melt-up.”  And it’s not just stocks.  It’s an economic “melt-up” scenario. 

Remember, back in ’95 when the Fed did a u-turn on monetary policy, stocks went crazy and so did the economy.  The economy did 4%+ growth for eighteen consecutive quarters.

So, we’re beginning to see broader global financial markets react to a world where indefinite trade war overhang has been cleared from a fundamentally strong economy with tailwinds of fiscal and monetary policy.

We’ve seen stocks on the move.  Now yields are making a move – with big technical breakouts.

Here’s a look at the U.S. 10 year yield …
Here’s a look at the German 10-year yield, moving aggressively from deep negative yield territory …

Remember, as we discussed last week, “the history of the past decade tells us … despite the fact that central banks are buying government bonds, bond prices go down (yields go UP).”  That’s what we’re getting.

And when yields go up, gold goes down.

Why does gold go down?  Because when people fear an indefinite trade war, if not a trade war leading to military war, they buy bonds and they buy gold.  When this fear is removed, they exit the fear trade.  That means yields go higher, gold goes lower. You can see this inverse relationship since Trump launched tariffs early last year. 

But gold will find it’s bid again.  When?  When inflation starts to move.  And within the scenario of economic boom, and very low inflation expectations, the move in inflation, when it finally takes hold, will probably be aggressive.

The first signal will likely come from broad commodity prices.  Keep an eye on this chart, which has broken a huge trendline …
Pro Perspectives 11/6/19

November 6, 2019

If we look at the performance across the stock market since the Fed flipped directions on monetary policy (July 31), value investing is making a big come back.  Morningstar’s US Value index has outperformed the US Growth index by five-to-one — in just a thirteen week period.  

The tide has turned  on the “great disrupters” (FAANG) and Silicon Valley.

With the prospects of a trade-war-absent global economy going forward (at least over the next year), there is a growing likelihood (in my view) of an economic boom.  That would coincide with continued regulatory screw tightening on the disrupters.  And with that, those companies and industries that have been disruptED, are in the position to regain market share.  That’s where there is tremendous pent-up value in the stock market, even as it sits at record highs.

With this in mind, I want to revisit one of my Forbes pieces from April where I discussed the prospects for the end of the exuberant tech cycle in Silicon Valley …
Lyft was valued at close to $25 billion when shares started trading on Friday.  Today, it’s down as much as 20% from the Friday highs.
In the buildup to the IPO, the last private investment in the company came in June of last year, and valued Lyft at $15.1 billion.  Those investors had a paper gain of over 60% on Friday, for just a 9-month holding period.

For everyone else, remember, you’re looking at a company that did a little over $2 billion in revenue, while losing almost a billion dollars. Most importantly, over the three years of data that Lyft shared in its S-1 filing, revenue growth has been slowing and losses have been widening. 

So, you’re buying a company that hopes to be profitable in seven years, to justify the valuation today. Keep in mind, this is a company that has only existed for seven years. To think that we can predict what the next seven will look like, in the ever changing technology and political/regulatory environment (much less economic environment), is a stretch.

For some perspective on these valuations, below is what it looks like if we compare the three largest/dominant car rental car companies (Enterprise, Hertz and Avis) to the two largest/dominant ride sharing companies (Uber and Lyft).

With Uber now expected to be valued at around $120 billion when it goes public (possibly this month), the ride sharing industry is valued at about 14 times the car rental industry.

The rental car industry has been priced as if the ride-sharing industry has all but killed it.

Ironically, if the ride sharing movement is to succeed in the long-run, and is to fully reach the potential that is being priced into the valuations today, then they will need these car rental companies to supply and manage the fleet of vehicles required for Uber and Lyft to scale. If this industry does indeed prove to be the future and ‘high growth’, these car rental companies will be right in the middle of it (indispensable).

With the above in mind, this valuation gap clearly shows a disconnect from that reality.

It also reflects the regulatory and policy advantage Silicon Valley has enjoyed for the past decade (which is ending).  It shows the displacement of capital from Wall Street to Silicon Valley (as a result of those advantages).  And it likely shows the exuberance stage of the cycle.

I suspect the Lyft (and Uber) IPO might mark the end of the boom cycle for Silicon Valley.

Here is the chart on Lyft since it went public …

 

Pro Perspectives 11/5/19

November 5, 2019

As we discussed in my October 11th Pro Perspectives note, when Trump stood in the Oval Office and ceremonially shook hands with the Vice Premier of China, “the intent was clearly to signal the end of the trade war, to clear the overhang of uncertainty on markets, and move any further phases of negotiations to back burner issues for the global economy.”

With the evidence building that we’ll get a signed “Phase 1” deal, and with the fog of negative global economic sentiment slowly beginning to lift, it does indeed look like the handshake moved “trade war” off of the front burner.

You can see what stocks have done since that took place: virtually straight up, with 10 higher highs over 17 days!

For those wondering how far this can go?  Keep in mind, with the removal of trade war from the global economy, we get to see what the unfettered power of fiscal stimulus, structural reform and ultra-easy global monetary policy can do for a U.S. economy that already has very solid fundamentals (record low unemployment, record household net worth, record consumer credit-worthiness, a record low household debt-service ratio, well-capitalized banks, low inflation, affordable gas).

For stocks, the question is, how much growth did a 21-month trade war “stunt”? We still have a forward P/E on the S&P 500 of less than 18, in an interest rate environment that should warrant north of 20 (if not well north of 20). And that doesn’t factor in the potential for rising earnings prospects in an environment over the next twelve months that won’t (we assume) have the overhang of an indefinite trade war. Just a 20 P/E on forward earnings gives us an S&P 500 north of 3,500.
Pro Perspectives 11/4/19

November 4, 2019

We have what looks like a melt-up brewing into the year end. 

And given that this is a bull market with plenty of non-believers, expect institutional investors to start pouring into higher beta stocks, as they scramble to get find some extra return.

If we look across the broad index returns, the S&P 500 is now up about 23%.  That’s almost three-times the long run annualized return on the broad market.  It’s no surprise this index is leading the way globally, given the S&P 500 is the proxy for global stability and risk appetite.

Meanwhile, the Russell 2000 (small caps) is trailing, up 18%.  Let’s take a look at the chart …

While we’re running to new record highs in the blue-chip stocks, small cap stocks are still 8% off of the highs of August of last year.  But as you can see in the chart above, we have this series of highs in the index that are being tested. It looks like a breakout is coming.     

If look back at the July Fed meeting, where they officially flipped directions on the policy path (from tightening to easing), value stocks have been the clear leaders — far superior to growth stocks.  And small cap value has trailed large cap value.  With the technical setup above, and the need for managers to “catch-up” that performance gap might close quickly.