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.

 

Pro Perspectives 11/1/19

November 1, 2019

As we enter November, we continue to track the path of this 1995 comparison we looked at to begin the year. 

Remember, back in ’94, the Fed was overly aggressive in raising rates and choked off the momentum of economic recovery.  That left a world where the best producing major asset class was cash.  By 1995, they were forced to reverse course on the interest rate path (from tightening to easing).  And that unleashed a boom in stocks and the economy over the next four years.

Last year (2018) looked a lot like 1994.  With that, back in December, we laid out this scenario for a repeat of 1995 — and we’re getting it.

Like in 1995, the Fed has reversed course on rates.  And like in 1995, stocks are up big.  But we have the ingredients in place to see an even bigger finish into the end of the year.  Remember, in ’95 stocks did 36%.  Stocks finish today up 22%, with two months remaining in the year.

And we now have the Fed back in defensive mode.  They have reversed a shrinking balance sheet by $200 billion already, and have told us they will pump nearly half a trillion dollars worth of liquidity into the global economy by the second quarter.   And the ECB has started buying assets again, as of today.

As I’ve said, while most have been looking for the next recession around the corner, by early next year, they may find themselves in an economic boom instead. 

Pro Perspectives 10/31/19

October 31, 2019

Tomorrow we get the October jobs number.  This report is expected to come in below 100k, and may create some noise. 

But with a 3.5% unemployment rate and a jobs market adding new jobs at around 175k a month over the past twelve months, jobs data (at this point) won’t reflect a change of course in the hiring/jobs outlook.

On the other hand, we can see the uncertainty of an indefinite trade war adjusted for by businesses in a more agile way in the manufacturing data — as businesses pull back on new orders and investment, to wait and see.  And that has been where we’ve seen the softness.

And we had another soft number today.  The Chicago PMI came in at the lowest reading since December of 2015.  That happens to be the month the Fed started its normalization/rate hiking campaign.

Here’s what that look like on the chart …

This time around, relative to late 2015, the Fed is going in a very different direction (cutting and expanding the balance sheet). 

And, as we’ve discussed, this slump in manufacturing, along with a slide in stocks early this month, is why both parties (the U.S. and China) came to the table to show the markets they were ready to deal – an attempt to reduce if not remove the uncertainty overhang. With the end of October, we’ll see how aggressively a “Phase 1” deal, assuming it gets done, can swing this manufacturing data back in the other direction.

Pro Perspectives 10/30/19

October 30, 2019

The Fed cut rates again today, meeting the market’s expectations.

Remember, just 10 months ago, they made the ninth rate hike in three years, and arrogantly told us that quantitative tightening was on “auto pilot.”

Since then, they’ve stopped QT, cut rates three times, and started expanding the balance sheet with an eye toward buying almost half-a-trillion dollars worth of Treasury bills by the second quarter of next year.

While the media has a fun parsing words and hints about whether or not the Fed could cut rates again, or pause, it’s the global balance sheet where all of the attention should be.

Let me repeat, the Fed has told us (earlier this month, and Powell tried to explain for a second time today) that it plans on buying close to (maybe more than) half-a-trillion dollars of Treasury bills.  That’s aggressively expanding this balance sheet that has already stopped shrinking, and now grown by more than $200 billion since September.
And it is primarily because of this problem — the yield curve inversion of the 3-month tbill to the 10-year note.  This was driven by the mistakes of the Fed’s quantitative tightening program, and proved (the inversion) to be not just a signal, but a real liquidity problem for short-term interbank loan market.

So, the Fed is “replenishing” global liquidity.  And the ECB is scheduled to do the same, starting Friday.  The Bank of Japan meets tonight.  Will they join the party?

The BOJ is already in unlimited QE mode as buyers of unlimited 10-year Japanese government bonds (when necessary), to keep the yield pinned near a zero yield.  However, Kuroda has hinted that they might add a twist to their QE by controlling the yield curve at the shorter end of the government debt market (following the lead of the Fed).

Bottom line, as history has shown us, this should all be very positive for global asset prices (they go UP).

Pro Perspectives 10/29/19

October 29, 2019

The Fed decides on monetary policy tomorrow. 

The interest rate market is pricing in a 97% chance of a 25 bps cut — leaning heavily in favor of a third consecutive rate cut in this flip-flop campaign.

This, despite a very different climate than they entered for their September meeting, where they cut for a second consecutive time.

Then:  In September, the uncertainty of an indefinite trade war was at peak levels.

Now: Three weeks later, Trump and the Chinese Vice Premier shook hands in the Oval Office on a limited deal.   

Then: We were closing in on an October 31 deadline for Brexit that was looking like a “no-deal” was coming.

Now: Four weeks later, we have an agreement on Brexit terms between the UK and EU.

With these developments, what is the Fed thinking?

We did hear from the Fed Chair on October 8th at an economic conference.  He made a few very important statements that should give us clues on what tomorrow’s announcement and press conference will look like — and these clues support the market’s view toward a rate cut. 

Back on October 8th, Powell said:

1) “In the 90s the Fed added support to help the economy gather steam, that’s the spirit in which we are doing this (easing).”  The Fed cut three times over a six month period starting in July of 1995.

2) “There are concerns surrounding business investment, manufacturing and trade.”  On October 1, the ISM report showed that manufacturing contracted for a second consecutive month in September.

3) The “time is now upon us” to expand the balance sheet.  The Fed is back to expanding the balance sheet in response to a disruption in short-term lending markets stemming from the Fed’s quantitative tightening program (i.e. the Fed is in the mode of reversing its over bad policy/overly-aggressive tightening mistakes).

So, despite the clearing trade war overhang, the above three comments from the Fed three weeks ago should keep the Fed on track tomorrow for another cut.

Pro Perspectives 10/28/19

October 28, 2019

Before I get to today’s note, so you don’t miss any of my future notes, please take a moment and add my sender address to your email address book:  bryan@newsletter.billionairesportfolio.com.  This will prevent filters from inadvertently blocking my emails, ensuring that you (and others) get these notes in the inbox.  

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Thanks in advance!  Now, onto today’s note …

Stocks have lifted off to new record highs as we start the week.

We have a Fed meeting mid-week, and that will be followed by a Bank of Japan meeting.

While the market is pricing in a third rate cut in the Fed’s flip-flop campaign, let’s take a look at the most important Fed-related chart…

This is a look at the Fed’s balance sheet.

Remember, it was not only the Fed’s rate path of the past three years that ultimately shook market late last year, it was the withdrawal of global liquidity, and the signals given by the Fed and the ECB that it would continue, if not accelerate.  This was thanks to the one-two punch of the Fed’s mechanical process of shrinking its balance sheet and the end of the ECB’s QE program. 

This sent global interest rates haywire, plunging, in many cases, into negative yield territory.  What has turned the tide?  Balance sheet expansion is back!

The Fed quit shrinking the balance sheet in July, and as you can see in the chart above, they have been back to expanding the balance sheet again.

Add to that, as of next week, the ECB will be back in the business of QE.

So, what happens when the balance sheets of the two most powerful central banks in the world are expanding?  The history of the past decade tells us, stocks go up.  And despite the fact that central banks are buying government bonds, bond prices go down (yields go up). 

That’s what we’re getting.

Below is the chart of U.S. stocks, breaking out to new record highs …
And here’s a look at U.S. 10 year yields, bottoming as the Fed starts expanding the balance sheet again (in September) and a break of the downtrend looks like it’s coming … 

 

Pro Perspectives 10/25/19

October 25, 2019

With the big Microsoft earnings beat yesterday, and the miss from Amazon, I want to revisit my notes from earlier this summer on the "disruptors" and the "disrupted."

As I've said, with the regulatory screws tightening on the disruptors, we may finally be entering the stage where we see the disrupted/survivors, competing, if not beating the disruptors.  If the "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're seeing it with Microsoft and Amazon (maybe signs of it).   

Remember, thanks to the strategy reset that took place five years ago, Microsoft is part of the duopoly in cloud computing (and taking share).  MSFT grew cloud revenue by 59% last quarter.  Amazon grew AWS (cloud) revenue at 35%, the slowest rate in the five years.  How have the stocks done?  

Microsoft has transformed and become one of two trillion-dollar companies (along with Apple). 

Let’s revisit the Walmart/Amazon battle too — another great example.  The market has priced Amazon like a runaway monopoly — killer of all industries, especially retail.  And the perception has been that Walmart was destined to become another rise and fall story of a dominant American retailer.  Sears, Toys R Us and about 70 other retailers have gone under in the last four years. 

But Walmart has been transforming.  
 

Walmart has been aggressively investing in online. They bought Jet.com in 2016, an American online retailer.  That same year they took a large stake in the number two online retailer in China, JD.com.  
 
JD.com already has a big share of ecommerce in China.  They are number two to Alibaba, but gaining ground due to some clear competitive advantages.  JD owns and controls its logistics infrastructure, and does quality control from the supplier to delivery.  And unlike Alibaba, JD sources product to its warehouses to fight the counterfeit goods risk – a big problem in China. JD has 500+ warehouses around the country, and they now source product and service customers from one of the more than 400 Walmart stores in China. 

So Walmart is positioned well to take advantage of the growth in the middle class in China.  Amazon has yet to find its way in China.  It has about 1% market share.   Add to this, Google came in last year with a $550 million investment to help position JD to challenge Alibaba and Amazon on a global scale.  Walmart is still about a third of the value of Amazon, but the gap has been closing (slowly). 

Lastly, let's look at Netflix and the response underway at Disney.  In recent years, Netflix has been thought to be taking over the entertainment industry with its disruptive direct-to-consumer model. 

Fox responded early and aggressively (thanks the activist investor, Jeff Ubben).  They made an aggressive move to build the direct-to-consumer model (taking stakes in Hulu, Star India and Sky).  That set the company up as an acquisition target.  And now with the Disney acquisition of Fox, Disney is positioned with a dominant duel threat — among the world's deepest and most valuable library of content and the distribution to take it to the consumer.  This makes the world's preeminent entertainment company.

The result?  Disney's valuation has leapfrogged Netflix.  Disney now has a market cap of $236 billion. That's twice the value of Netflix now. 

 

Pro Perspectives 10/24/19

October 24, 2019

The ECB met this morning and made no adjustment to the plans to restart QE.  Why does the ECB matter?

Remember, by the ECB ending it's three-year QE program last December, a stabilizer of global liquidity was removed – an offset to the Fed's QT was removed.  With that, a shrinking global balance sheet of the top three central banks in the world proved disruptive for global markets and the global economy.  We now have the ECB back in the QE business.  And the Fed has not only stopped QT, but is now expanding its balance sheet again.  

This was Mario Draghi's last meeting and press conference as head of the ECB.   This is the man that led the strategy to avert disaster for Europe and the global economy back in 2012. A contagion of global sovereign debt defaults were lining up in Europe.  And the second most widely held currency in the world, the euro, was vulnerable to a break-up.  To stop the meltdown, Draghi publicly threatened/vowed to become the backstop in the European government bond market.   

Here's what he said in a July 2012 speech: "the ECB is ready to do whatever it takes to preserve the euro.  And believe me, it will be enough."

The imminent risk was sharply rising yields in the big, dangerous weak spots in Europe:  Spain and Italy.  Speculators were hitting the bond market, yields were rising to unsustainable levels.  Spain and Italy were on the path of default and once one went, the others would fall.  The next step would mean these countries leaving the euro, returning to national currencies and inflating away the debt through currency devaluations. 

It didn't happen because Draghi stepped in.  With the statement above, he threatened to be the unlimited buyer of these troubled government bonds, which was enough to purge the speculators from the market.  Quickly the yields on those bonds plunged, without Draghi having to buy a single bond. 

Here's what the chart of those bond yields looks like …
 
Trouble in Europe means trouble for the global economy.  So, when the rules aren't working, don't underestimate the appetite of policymakers to change the rules.  That's what Draghi did.  He backstopped the bond crisis, and later launched QE.  The global economic recovery was back on path.
 

Now, in this post-financial crisis world, as long as everyone's fate is interconnected, there are few, if any, market penalties for what may seem to be desperate, dangerous and profligate actions.

With that, we've talked about the prospects of the ECB turning to the stock markets — to become buyers of stocks, to help boost wealth, confidence, hiring, spending and investment.  When Draghi was asked today about the options the ECB has to enlarge the composition of the asset purchase program, he ignored the question and went into a long-winded answer about something else.   That's the elephant in the room.  The WSJ ran a piece today saying the ECB would run out of bonds to buy by the end of next year — proposing equities as an option. 

 

Pro Perspectives 10/22/19

October 23, 2019

The European Central Bank will meet tomorrow.  Remember, in September, they announced they would restart QE. 

We've since had softer euro area inflation, manufacturing and confidence data — and softer manufacturing data, globally.

Now, the ECB's decision to get back in the QE business was clearly driven by the downside risks associated with an indefinite global trade tensions and the prospects of no-deal on Brexit.  And we now have what looks like a deal on U.S./China trade and Brexit. 

 
Problems solved? 
 
No. While potentially dialing down tariffs on China, Trump slapped tariffs on Europe.  And while Europe now has more certainty the terms of Brexit, they have to manage the downside risks of the outcome.  

So, will they have to up-the-ante?  Yesterday we revisited the "bazooka" option for the ECB:  buying stocks. 

 
Why would they buy stocks?

As we discussed last month, negative rates haven't worked in Europe, because the policies aren't forcing savers into higher risk assets. It's not in their culture to buy stocks. 

 

The ECB's explicit presence in European stock markets would reduce the risk premium in stocks, which incentivizes capital flows out of negative yielding bonds and into higher returning stocks.  And a higher stock market would go a long way toward driving, confidence, investment and ultimate economic demand. 

With this in mind, European stocks continue to be the spot to watch.  European blue chips have a long way to go to catch up with the peformance of U.S. blue chips over the past decade, and the past five years …

Pro Perspectives 10/22/19

October 22, 2019

We've talked about the Brexit deal over the past few days. 
 
The deal that was struck between the UK Prime Minister and EU officials last week, was indeed approved by Parliament today! 

However, what wasn't approved today, was the timeline on how long it will take Parliament to agree on how to legislate it.  With that, the formal exit of the UK from the EU may happen at the end of month, or may not.  The ugly process of law making will likely take longer than nine days, but importantly, this continues to signal that both sides are ready to move on — as we've seen in the case of U.S./China trade dispute.  The removal of uncertainty is good for the global economic outlook.

But EU officials now have more certainty on what the deal looks like for Europe. 

With the above in mind, we have a big European Central Bank meeting on Thursday.  Remember, last month, the ECB announced that it was going back in the QE business, to start buying assets again in November.

Their stated plan, at the moment, is not to change the asset mix from their past asset purchases, which consists of corporate and sovereign bonds.  The question is, will the ECB step up the firepower, to manage any increased downside risks associated with the terms of the Brexit deal? 

As we've discussed here, adding European equities would be the "bazooka" of monetary stimulus for the European economy. 

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