Bonds Are High Risk-Low Reward

Since stocks dipped last week, I’ve heard the chatter (again) about how a 3% 10-year note has suddenly created a high appetite for Treasurys over stocks (i.e. people are selling stocks in favor of capturing that whopping 3% yield).

But in this post-crisis environment, a rise toward 3% promotes the exact opposite behavior. If you are willing to lend for 10-years locked in at a paltry rate, you are forgoing what is almost certainly going to be a higher rate decade than the past decade. If you need to exit, you’re going to find the price of your bonds (very likely) dramatically lower down the road.

Coming out of a zero-interest rate world, bond prices are going lower/not higher. Here’s the chart of the 10-year Treasury note (price). You can see we’ve now broken the three and a half decade bull market in bonds (yields go up, as bond prices go down) …

stocks

Bottom line: The bond market is the high risk-low reward investment in this environment. And there continues to be plenty of fuel for stock prices as money exits bonds.

Stocks This Cheap Only Two Times In 26 Years

 

October 16, 5:00 pm EST

Stocks are racing back, just as everyone is turning gloomy. 

This squeezes the shorts that have been looking for reasons to believe a big trend change is coming for stocks, depite the fundamentals that suggest the opposite.

We now have this chart on the S&P 500 ….

 
Which is beginning to look like this (below) V-shaped move in stocks back in late 2014. And it was right around the same time of year.

This 2014 correction was 17 days, and -9.8%.  It was all recovered in 13 days.  Now we have a 7.8% decline over 14 days, and bouncing aggressively.

The more important chart for the benchmark S&P 500 index, is the longer term one below – which shows the big “Trump-trend” continues to hold.  The yellow trendline represents the ascent of stocks following the Trump election, which has been driven by pro-growth economic policies.

And with this above chart in mind, remember as we discussed yesterday, from a valuation perspective, Wall Street is estimating stocks on next year’s estimated earnings to be as cheap as we’ve seen only two times in the past 26 years.

Again, if we take the 2019 estimate earnings on the S&P 500 of $176 and multiply it by 23, we get 4,048.  That’s 47% higher than Friday’s close.  Today we closed at just 2,810.

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The Case For S&P 4,000

October 15, 5:00 pm EST

On Friday we talked about the opportunity presented by this recent dip in the broad stock market.

We’re beginning to see more clearly today the rotation out of tech and into value.  That is translating into a continued slide in the Nasdaq, while the Dow is rising.

Now, even though this looks like a re-pricing of the high-flying tech stocks, as we often see the “baby gets thrown out with the bathwater.”  In this case, because the big tech giants have been so widely held, when they crack, everything has cracked.  That’s an opportunity to buy broader stocks on sale. And stocks are indeed cheap.

Take a look at historic valuations (P/E on the S&P 500) …

 

From a valuation perspective, Wall Street is estimating stocks on next year’s estimated earnings to be as cheap as we’ve seen only two times in the past 26 years.

You can see where stocks were valued on the S&P going into 2012.  Stocks finished up 16% that year.  The other year was 1995 (a P/E of 14.89). Stocks finished that year up 37.6%.

Still, many have continued to harp on valuation, always pointing to the long run average P/E on stocks, which is around 16.  That’s a long history.  If we look back at the past twenty years, the average valuation is MUCH, MUCH higher. It’s 23 times earnings!

If we take Wall Street’s estimate on S&P 500 earnings of $176 and multiply it by 23, we get and S&P at 4,048.  That’s 47% higher than Friday’s close.

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How Billionaires Respond To Stock Market Declines

October 12, 5:00 pm EST

The S&P 500 has declined more than 5% (from peak to trough) on four different occasions this year.  That’s despite an economy that is heating up, finally escaping the slow growth rut of the past decade.

So, should you be fearful when these declines occur, or should you be greedy?

During market declines – with the constant barrage of market analysis and opinion on financial television, in newspapers, or through the Internet – it’s easy to get sucked into drama played out in the media.

And that tends to make many investors fearful.

But while the fearful start running out of the store when stocks go on sale, the best billionaire investors in the world, start running IN.

The fact is, the best investors in the world see declines in the U.S. stock market as an exciting opportunity.  And so should you.

Most average investors in stocks are NOT leveraged. And with that, they should have no concern about U.S. stock market declines, other than saying to themselves, “what a gift,” and asking themselves these questions: “Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?”

Billionaire Ray Dalio, the founder of the biggest hedge fund in the world, has said what we think is the most simple yet important fact ever said about investing.

“There are few sure things in investing … that betas rise over time relative to cash is one of them.”  

In plain English, he’s saying that major asset classes, over time, will rise (stocks, bonds, real estate). The value of these core assets will grow faster than the value of cash.

That comes with one simple assumption. The world, over time, will improve, will grow and will be a better and more efficient place to live than it was before. If that assumption turned out to be wrong, we have a lot more to worry about than the value of our stock portfolio.

With that said, as an average investor that is not leveraged, dips in stocks (particularly U.S. stocks – the largest economy in the world, with the deepest financial markets) should be bought, because in the simplest terms, over time, the broad stock market has an upward sloping trajectory.

This is the very simple philosophy Dalio follows, and is the core of how he makes money and how he has become one of the best, and richest, investors alive.

Billionaires Bill Ackman and Carl Icahn, two of the great activist investors, lick their chops when broad markets sell off on fear and uncertainty.

Ackman says he gets to buy stakes in high quality businesses at a discount when broad markets decline for non-fundamental reasons.  Icahn says he hopes a stock he owns goes lower so he can buy more.

What about the great Warren Buffett?  What does he think about market declines?  He has famously attributed his long-term investing success to “being greedy when others are fearful.”

Bottom line:  Declines in the broad market are times to take out your shopping list.

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Gold Is The New Bonds

October 11, 5:00 pm EST

Yesterday we talked about the repricing of the tech giants as the catalyst for the slide in global stocks.  That slide continued today. 

But the brunt of the punishment is back on the Dow, which was down another 2%.  At the lows today, that takes us back to flat on the year for the DJIA … up 1% for the S&P 500.  And the Nasdaq, at the lows today, was up just 4.8% on the year.

As they say, stocks go up in an escalator and down in an elevator.

Interestingly, in this slippery slide for stocks, money has NOT been piling into bonds.  This is the flight to safety trade we’ve seen throughout the post-financial crisis era.  It doesn’t seem to be happening this time.  The 10-year yield remains in sniffing distance of 3.25% (closing today at 3.14%).

So, where is the money going?  Gold.

Gold is on the move — the top performer in global markets today.  And it looks like it’s just getting started.  As I said last week, “the set up for a bounce in gold here looks ripe. The level to watch will be 1,214.”

You can see in the chart, the 1214 level gave way today, and we had a break of the downtrend of the past six months.

Now, when we discussed gold last week, we were talking about the potential for China to perhaps try a few shenanigans over the next month, in order to influence the outcome of the November elections.

Here’s an excerpt from that October 3rd note:  “China remains the holdout on making a deal with Trump on trade. And it looks likely that they are holding out to see what the November elections look like.

Will Trump retain a Republican led Congress? I suspect we may see China do what it can to influence that outcome. As we know, the Republicans will be promoting the economy as we get closer to voting day.

What can China do to rock that boat?

They can sell Treasuries, in an attempt to ignite a sharper climb in rates. And a fast move in rates (at these levels) has a way of shaking confidence in equity markets–which has a way of shaking confidence in the economy.“

I suspect we may be seeing precisely this above scenario play out.

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Slide In Stocks Is All About Deflating The Bubbly Tech Giants

October 10, 5:00 pm EST

Yesterday we talked about the risks surrounding markets (Italy, Interest Rates, China), and said these risks are likely serving as a catalyst to start the correction in tech stocks. 
And we looked at this chart on Amazon as the key one to watch.

Here’s what the chart looks like today …

billionairesportfolio.com

This big trendline broke today, a line that represents the more than doubling of Amazon in a little more than one year’s time.  This is a company that went from a valuation of $500 billion to $1 trillion in a year.

So we get this big technical break, and Amazon is now down 14% from the highs.

Again, as we’ve discussed here in my daily note many times, at a trillion dollar valuation, the market was pricing Amazon like a monopoly that would go unchecked, and allowed to destroy any and all industries in its path.

But Trump has made it clear that he’s not going to let it happen.  Amazon, Facebook and Google have all been subject to Trump threats to rein them in through regulation — to level the playing field for their competition.  And if there’s one thing we know about Trump, as the President: he will follow through on threats, and he likes a good fight.

With that, the FANG (Facebook, Amazon, Netflix, Google) trade, after being UP as much as 50% this year (as an equal weighted group), isfinally breaking down.  And that is creating some shock waves in broader markets.

So, is this the beginning of a bigger global meltdown or will it ultimately be a repricing of the tech giants.  I think the latter.

Remember, the tech heavy Nasdaq, for much of the year, performed with near impunity from any geopolitical turmoil.  As trade rhetoric heightened, the Dow would suffer, while the Nasdaq continued to climb.  At one point this summer, the Nasdaq was up double-digits on the year, while the Dow was down.

So this is more likely a rebalancing (the rotation from tech giants to value stocks).

As we go into third quarter earnings, we continue to run at 20% earnings growth on the year.  The P/E for stocks remains low, in a low/accommodative interest rate environment (yes, 3.2% 10-year yield remains low relative to history).  And the economy is hot, with low and stable inflation.

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Cracks In Big Tech Stocks Finally Showing

October 9, 5:00 pm EST

There are always plenty of risks surrounding markets.  Still, stocks tend to be pretty good at “climbing the wall of worry.”

But we’ve now had some swings since the beginning of the month.  Have stocks hit the wall at the recent record highs?  Have the growing geopolitical risks begun to finally outweigh the fundamental strength in the economy and the stock market?

Not likely.  More likely, these risks have served as a catalyst for a correction.  In this case, a correction in tech stocks.

And it has been driven by one of the highest flyers:  Amazon.

At the highs of last month, Amazon had jumped 112% in a little less than 12 months.  That’s over $500 billion in market cap gains for Amazon since September of last year.  Just that increase in valuation alone is bigger than all but four stocks in the world.

So, as we’ve been discussing in this daily note for quite some time, the regulatory screws have been tightening on big tech.  And Amazon is in the crosshairs.  Meanwhile, it has been priced as if the developing monopoly would go unchecked.  As I’ve said, “not a good bet.”

Now that “monopoly premium” seems to finally be deflating.

After crossing the trillion-dollar valuation threshold (which was the dead top in the stock), Amazon has now had an official 10% correction.  
This big trendline in Amazon will be key to watch.

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Time To Watch China’s Currency Closely

October 8, 5:00 pm EST

China was on holiday last week (Golden Week).  So today, with China back to work, we saw the response in Chinese markets, for the first time, to the spike in global bond yields (and the slide in global stocks).

Chinese stocks fell by 3.7%.  The yuan slid back to the 21-month lows.  And the PBOC stepped in with the fourth cut of the year to its reserve ratio.

Now, China has been running sub-7% growth since late 2015.  And in China, that’s recession like economic activity.  The Chinese government’s sensitivity to this level of growth is clear through the behavior of the central bank’s use of RRR cuts and the currency (the yuan).   Cutting the required reserves for banks is a way to stimulate the economy – to promote lending.  Weakening the currency is a way to stimulate exports.

You can see in the chart below, that has been the path for both (the currency and the RRR) since late 2015.
You can also see in the chart, a period where the yuan strengthened sharply.  What gives?

That was China’s response to the Trump election.  The Chinese ran the currency back UP, in hopes of pacifying Trump and staying above the trade dispute fray.  It didn’t work.  As we know, they have found themselves at the center of Trump’s trade offensive.  As such, they have dug in, and returned to weakening the yuan — the best way they know, to defend/drive growth in their economy (i.e. undercut the world on price).  The USD/CNY rate here will probably become the most important market to watch in the coming days and weeks.  A return to 7 yuan per dollar would be the weakest level of the Chinese currency since 2008, pre-Lehman.  That will cause some geopolitical fireworks.

Attention loyal readers:  The Billionaire’s Portfolio is my premium advisory service.  And I’d like to invite you to join today, as we are beginning what I think will be a tremendous run for value stocks into the end of the year.  It’s a great deal for the money. Just click here to subscribe, and get immediate access to my full portfolio of billionaire-owned stocks. When you join, you’ll get immediate access to every recommendation–past, present and future–in the portfolio. And I’ll deliver my in-depth notes on our portfolio and the bigger picture every week, directly to your inbox.
Bond Market Is Still Short Of Pricing In Fed’s 200 BPS Of Hikes

October 5, 5:00 pm EST

We ended the week with the jobs report today.  The headline payroll number itself is less important. It’s been plenty good for the past seven years, and has averaged over 200,000 new jobs over the past twelve months.

Remember, the missing piece in this report, that has NOT confirmed a hot job market, has been wage growth.  Throughout much of the post-Great Recession environment, despite the low headline unemployment number that central banks were able to manufacture, workers had little leverage in the job market to maximize potential, much less command higher wages.  That means mid-level managers were happy to have a job and keep it, and college graduates were (have been) relegated to a career as a barista.  That’s not a sign of a hot economy.

That said, wage growth has been on the move, but slowly.  Today’s report of the September average weekly hourly wages was up 2.8% (compared to last year this time).  Here’s what the history of that number looks like:

So wages are on the rise, but not fast.  And that explains why inflation is on the rise, but not fast.

That should comfort those who think the interest rate market is about to run away.  Remember, the Fed hiked by another 25 basis points last month, and contrary to what we’ve seen throughout the Fed’s three-year tightening cycle, the bond markets are finally beginning to price some of it in.
For perspective, the Fed went by another 25 basis points in September, and the 10-year yield has since risen by 20 basis points.

As you can see in the chart, we’ve had 200 basis points of Fed tightening since December of 2015.  But the 10-year yield, since the Fed began “normalizing” policy three years ago, has risen less than half of that (<100 basis).  It’s far from a runaway train in the market-determined interest rate market.

As I said yesterday, the move in rates is a growth story, not a crisis (or end of growth) story.  With the optimism of economic momentum supported by fiscal stimulus and structural reform, the interest rate market is finally pricing OUT the risks of slow growth forever and post-Great Recession crises.
Market Rates Are Finally Adjusting To Fed Tightening

October 4, 5:00 pm EST

 The move in rates continued to spook markets today.  The 10-year yield traded as high as 3.23%.
Now, despite the dramatic tone you’ll find on CNBC when stocks go down, a 10-year yield at 3.23% isn’t a crisis.  And a stock market that is down 1% from all-time highs isn’t a crisis or even a “sell-off.”

For perspective, the Fed has now moved 8 times off of zero.  The leaves the benchmark (short term) rate set by the Fed at 2-2.25%, still well below long-term average rates.  And that leaves the market determined (longer term) interest rate, just below 3.25%, still well below the long-term average.  With that, rates are still low.  In fact, if we took the record low in the 10-year yield, set in July of 2016, and applied the Fed’s 200 basis points of hikes, we would have a 10-year of 3.34%.  We are still south of that.  I would argue at current levels, the interest rate market is finally pricing in sustainable economic recovery (pricing out risks of another post-economic crisis shock/slump).

Now, when rates are on the move, people immediately start talking about debt service.  On that note, consumers and companies are in as good a financial position as they’ve been in a very long time (record high household net worth, record profits) .  Household debt service ratios are at record lows.

Bottom line, the move in rates is a growth story, not a crisis story.  We have 3%+ economic growth, with low inflation and solid employment.  We may have finally returned to the level of trust and confidence in the economy that fuels “animal spirits.”

Attention loyal readers:  The Billionaire’s Portfolio is my premium advisory service.  And I’d like to invite you to join today, as we are beginning what I think will be a tremendous run for value stocks into the end of the year.  It’s a great deal for the money. Just click here to subscribe, and get immediate access to my full portfolio of billionaire-owned stocks. When you join, you’ll get immediate access to every recommendation–past, present and future–in the portfolio. And I’ll deliver my in-depth notes on our portfolio and the bigger picture every week, directly to your inbox.