For much of the summer, while the world has been obsessed with Trump tweets, we’ve talked about the sharp but under-acknowledged move in copper and the message it was sending about the global economy and China (the biggest consumer of commodities), specifically. As I’ve said, people should Stop Watching Trump And Start Watching Copper.
Why copper? It is often an early indicator of economic cycles. People love to say copper ‘has a Ph.D. in economics’ because it tends to top early at economic peaks and bottom early at economic troughs. And it tends to lead a bull market in broader commodities.
Well, copper bottomed on January 15. Fast forward to today; the most important industrial metal in the world is up 24% on the year and sniffing back toward three-year highs. While the world continues to focus on Washington drama, this continues to be the proverbial “bell” ringing to signal a pop in economic growth is coming, and a big run for commodities investors is ripe for the taking.
With that in mind, we’ve talked in recent days again about the research from the top minds in commodities investing, Leigh Goehring and Adam Rozencwajg (managers of the commodities funds, ticker GRHIX and GRHAX). We know they like oil. In fact they think we see triple-digit oil prices by early next year.
They love the commodities trade in general. They have one of the most compelling charts I’ve seen in my 20-year career, to support the view that there is a generational bull breaking lose in commodities.
Stocks minted billionaires in the 1980s. Currencies minted billionaires in the 1990s. Tech and housing (bust) minted billionaires in the early 2000s. Then it was equity activism (stocks). The next opportunity looks like commodities.
In this chart below you can see, as Goehring and Rozencwajg say, commodities are as cheap today as they have ever been. “Only in the depths of the Great Depression and at the end of the dying Bretton Woods Gold Exchange Standard did commodities reach this level of undervaluation relative to equities.”
With this, they say, for those that can block out the noise, “there is a proverbial fortune to be made if they invest today.”
Here’s an excerpt from their most recent investor letter on their work on the stocks to commodities valuation:
“When commodities are this cheap relative to stocks, the returns accruing to commodity investors have been spectacular. For example, had an investor bought the Goldman Sachs Commodity Index (or something equivalent) in 1970, by 1974 he would have compounded his money at 50% per year. From 1970 to 1980 commodities compounded anually in price by 20%. If the same investor had bought commodities in 2000, he would have also compounded his money at 20% for the next ten years–especially attractive considering the broad stock market indicies returned nothing over the same period.”
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Crude oil was the biggest mover of the day across global markets, up almost 3%, and back above the $50 level.
Though oil has been stuck, oscillating around this $50 mark for some time, we’ve talked about the prospects for much higher oil prices. So, when?
Remember, back in May I spoke with one of the best research-driven commodities funds on the planet, led by the star commodities investor Leigh Goehring and his long-time research head Adam Rozencwajg. They do some of the most thorough supply/demand work on oil and broader commodities.
Earlier this year, they were pounding the table on the fundamental case for $100 oil again. Since then, as oil prices haven’t complied. With that, we’ve seen Andy Hall’s departure from the market, of one of the biggest oil bulls, and one of the best and most successful tactical traders of oil in the world.
Meanwhile, the fundamentals have continued to build in favor of much
higher oil prices. We’ve seen supply drawdown for the better part of the past seven months – to the tune of more than $60 million barrels of oil taken out of the market.
I checked back in with Goehring and Rozencwajg and they are now more bullish than before. They say demand is raging, supply is faltering, and the world has overestimated what the shale industry is capable of producing – and the market is leaning, heavily, the wrong way (i.e. “maximum bearishness”). They think we’ve now hit the tipping point for prices – where we will see the price of oil accelerate.
They’re calling for $75-$110 oil by early next year, based on their historical analysis of price and inventory levels.
We’ll talk more about their work on the oil market in the coming days, and their very interesting work on the broader commodities markets – both of which support the themes we’ve been discussing in recent months.
As we know, one of the pillars of the Trump administration’s growth policies has been deregulation. With that, today the head of the EPA signaled the withdrawal from the Clean Power Plan – an Obama regulation to fight climate change.
What does this mean for coal stocks?
Let’s take a look at the two largest American coal producers, both of which filed bankruptcy last year: Peabody Energy and Arch coal.
These are now two post-bankruptcy stocks!Peabody emerged from bankruptcy earlier this year after shedding about $5 billion in debt. Similar story for Arch coal. They filed early last year and emerged from bankruptcy late last year, eliminating $5 billion in debt in the process. So shareholders were wiped out and debt holders became stock holders in new low debt, cash flow positive companies with deregulation coming down the pike. With that, you would think the stocks would be screaming higher. That hasn’t been the case.
Here’s a look at the charts…
So we now have Peabody Energy, the leading coal producer in America with a $3 billion market cap. And Arch Coal, number two, has just a $1.7 billion market cap.
Are these cheap stocks?
Let’s take a look at who owns them…
The biggest shareholder in Peabody is billionaire Paul Singer’s hedge fund, Elliott Management. They own half a billion dollar’s worth of the stock and it’s a top ten position. As for ARCH – the top shareholder is the $5 billion hedge fund Monarch Alternative Capital. ARCH makes up 20% of their highly concentrated long equity portfolio (their biggest single stock position). If you’re going to dip your toe in the water on a post-bankruptcy stock, there are few better places to look for guidance than Paul Singer – a former attorney, turned one of the most influential and successful investors in the world.
As we head into the weekend, today I want to talk a bit about the 401k.
I’m looking today at a relatives 401k offering. Nothing has made Wall Street richer than the advent of the 401k. They get a constant monthly stream of fresh capital to skim fees and commissions from, and you get all of the market risk.
For the average person, selecting from the “options” in their 401k plan is a practice of picking the highest number. No surprise, the fund providers know that, and play plenty of games to show you the best numbers possible.
Here’s an example: As I’m looking through the limited choices in this particular 401k plan provider, there is a common theme in the “inception date” of most of the company’s mutual fund offerings. They tend to have track records that start in 2002 at or near the bottom of the internet bubble-induced stock market crash, OR they start in 2009 AFTER the 50% collapse in stocks, OR they start in late 1987 AFTER the crash.
Clearly the long-term returns will look quite a bit better when you’re starting from a bottom, after a crash. And clearly returns will look better without hanging a negative 30%-50% in 2008 and then another negative 30%-40% in the early 2000s.
Maybe they are newer, better strategies and had the good fortune of launching at the right time?
More often, they close them down and reopen them under a new, tweaked name. Add to that, they are constantly launching and running hundreds, if not thousands of funds, so that at any given time they can cherry pick the best performers over a certain period, to put them in front of a captive audience.
Bottom line: Big mutual fund giants are mass asset gatherers feeding on the passive 401k flow of capital, rather than astute investment managers. And the long term returns, after fees, prove it. People are locking their money up for a very long time, and getting a fraction of the market return.
When Congress invented the 401k in the 70s to transfer risk and obligations from the employer (traditional defined benefit pensions) to the employee (defined contributions), they didn’t do you any favors.
We looked at small caps last week when the the Russell 2000 broke to new highs.
Remember, at that point, small–caps had done only 9% on the year at this point. That’s against 13% for the S&P and Dow.
Here’s the chart now…
The Russell 2000 is now up 12% since the lows of August (up 11% ytd) and if you bought the small cap index on the Monday before the elections last year, you’re up 26%. But small caps continue to lag the bigger cap market. And that makes the last quarter a very intriguing opportunity to own small caps.
Bull markets tend to lift all boats. And with that, equal-dollar weighted small caps tend to outperform equal-dollar weighted large caps in bull markets (in some cases by a lot). This one (bull market) looks like plenty of room to go in that regard. And small cap companies should have more to gain from a corporate tax cut as the tend to have fewer ways to shelter income (relative to big multinationals).
Now, with that bull market assertion, let’s talk about the general uneasiness that seems to exist (and has for a while) from watching the continued climb in stocks.
As we’ve discussed, you often here the argument that the fundamentals don’t support the level of stocks. It’s just not true. The fundamental backdrop continues to justify and favor higher stocks. We have the prospects of fiscal stimulus building, which will be poured onto an already fertile economic backdrop — with low rates, cheap commodities, record consumer high credit worthiness and low unemployment.
As the old market adage goes, “bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” I don’t think anyone could argue we are currently in the state of euphoria for stocks. And as the great macro trader Paul Tudor Jones has said, “the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic” (i.e. euphoria can last for a while).
Finally, let’s revisit this analysis from billionaire Larry Robbins on the influence of low interest rates, Fed policy and oilon markets. He says every time ONE of these (following) conditions has existed, the market has produced positive returns. Here they are:
When the 30 year bond yield begins the year below 4%, stocks go up 22.1%.
When investment grade bonds yield below 4%, stocks go up 16%.
When high yield bonds yield below 8%, stocks go up 11.6%.
When cash as a % of asset for non-financials is above 10%, stocks go up 17.6%.
When the Fed tightens 0-75 basis points in the year, stocks go up 22%.
When oil falls more than 20%, stocks go up 27.5%.
Again, his study showed that there has NEVER been a down year stocks, when any ONE of the above conditions is met.
It worked in 2015. It worked in 2016. And now, not only does ONE of these conditions exist, but ALL of these conditions are (or have been) met for 2017.
The media is giving more attention today to the potential change in power at the Fed. We talked about this on Monday. Remember, the President said last week that he expected an announcement to be made in the next two or three weeks on the future Fed Chair.
Along with any advancement on the fiscal stimulus front, the appointment of the next Fed Chair will be the most important news for markets and economy this year (though Yellen isn’t officially done until January of 2018).
Back in March I made the case for Trump ousting Yellen and hiring the Fed newbie, Neel Kashkari. Admittedly, I didn’t think Yellen would last this long. While Bernanke (the former Fed Chair) can be credited for averting a global apocalypse and keeping the patient alive, for as long as it took to bridge the gap to a real recovery. Under Yellen’s leadership, the Fed has been doing it’s best to kill the patient, at precisely the time the real recovery could be taking shape, with the assistance of fiscal stimulus finally in the works.
If the Fed continues on its path, borrowing costs (or, as importantly, the perception of where they may go) may strangle the economy before fiscal stimulus gets out of the gate. This is why I’ve said Kashkari should be the President’s best friend at the Fed. He’s the lone dissenter on the rate hiking path, and he’s been vocal about leaving monetary policy alone until the inflation data warrants a move.
Kashkari released an essay on Monday where he blames the Fed for creating its own low inflation surprise by tightening money and forecasting a tighter path for monetary policy, therefore creating a contractionary effect on the economy as consumers/businesses anticipated the negative effects of higher rates on the economy.
Guess who made this same case? Bernanke. He did so in a blog post last year, around this time. It was just as the world was spiraling into negative rates. He said the Fed shot itself in the foot by publishing an overly optimistic trajectory and timeline for normalizing rates. And that the communication alone resulted in an effective tightening.
This is why the ten year yield (still at just 2.34% after four rate hikes) is pricing in something that looks a lot more like recession than a hot economy.
With the above in mind, there has been a roster of candidates for Fed Chair floated today, which did not include Neel Kashkari. That was until word began to circulate that Jeff Gundlach, manager of the world’s biggest bond fund, said yesterday that he thinks Kashkari will get the nod, because he’s the most easy money guy. Still, it was refuted in the media that he was even a candidate.
Stocks open the week with another record high. The dollar continues to do better. And as we open the new month, yields are now up 32 basis points from the lows of early last month.
That’s a dramatic shift in the interest rate environment. And in recent days, underpinning that strength, is the idea that a hawk could be taking over for Janet Yellen when her term ends at the end of January.
Over the past few days the President has met with candidates for the Fed Chair job, and has said he will be announcing his decision in the next two to three weeks. That’s a big deal for markets and the economy — something to keep a close eye on.
His interview last Thursday was with a known hawk, former Fed governor Kevin Warsh – who has publicly criticized the Fed for keeping rates too low. He was also a hawk through some of the darkest days of the recovery – he’s been proven wrong for that view. As for Yellen: She has been among the most dovish Fed members throughout the crisis but has been leading the rate normalization phase (i.e. higher rates), which has proven to be questionable judgment, with missteps along the way resulting from the Fed’s overly optimistic and hawkish outlook.
Interestingly, though Trump criticized the Fed for keeping rates too low throughout the recovery, it’s higher rates, now, that are a significant threat to his growth policies. So he needs the Fed to step out of the way, and do no harm to the hand-off from a monetary policy-driven recovery, to a fiscal policy driven-recovery. Higher rates can choke off the positive effects of tax cuts and government spending.
On that note, his friend on monetary policy should be (and I think will be) Neel Kashkari (a new Fed member). Kashkari has been the lone dissenter on the Fed’s tightening path, arguing along the way to let the economy run hot, to ensure a robust recovery, before moving on rates.
Over the past two years, Yellen has blamed their pauses in their tightening program to the lack of evidence that the economy is overheating. It’s safe to say that the economy is not overheating (nor has it been), with both growth and inflation still undershooting long run averages.
With a Fed decision queued up for tomorrow, let’s take a look at how the rates picture has evolved this year.
The Fed has continued to act like speculators, placing bets on the prospects of fiscal stimulus and hotter growth. And they’ve proven not to be very good.
Remember, they finally kicked off their rate “normalization” plan in December of 2015. With things relatively stable globally, the slow U.S. recovery still on path, and with U.S. stocks near the record highs, they pulled the trigger on a 25 basis point hike in late 2015. And they projected at that time to hike another four times over the coming year (2016).
Stocks proceeded to slide by 13% over the next month. Market interest rates (the 10 year yield) went down, not up, following the hike — and not by a little, but by a lot. The 10 year yield fell from 2.33% to 1.53% over the next two months. And by April, the Fed walked back on their big promises for a tightening campaign. And the messaging began turning dark. The Fed went from talking about four hikes in a year, to talking about the prospects of going to negative interest rates.
That was until the U.S. elections. Suddenly, the outlook for the global economy changed, with the idea that big fiscal stimulus could be coming. So without any data justification for changing gears (for an institution that constantly beats the drum of “data dependence”), the Fed went right back to its hawkish mantra/ tightening game plan.
With that, they hit the reset button in December, and went back to the old game plan. They hiked in December. They told us more were coming this year. And, so far, they’ve hiked in March and June.
Below is how the interest rate market has responded. Rates have gone lower after each hike. Just in the past couple of days have, however, we returned to levels (and slightly above) where we stood going into the June hike.
But if you believe in the growing prospects of policy execution, which we’ve been discussing, you have to think this behavior in market rates (going lower) are coming to an end (i.e. higher rates).
As I said, the Hurricanes represented a crisis that May Be The Turning Point For Trump. This was an opportunity for the President to show leadership in a time people were looking for leadership. And it was a chance for the public perception to begin to shift. And it did. The bottom was marked in Trump pessimism. And much needed policy execution has been kickstarted by the need for Congress to come together to get the debt ceiling raised and hurricane aid approved. And I suspect that Trump’s address to the U.N. today will add further support to this building momentum of sentiment turnaround for the administration. With this, I would expect to hear a hawkish Fed tomorrow.
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Yesterday we looked at some key markets, some that have recovered nicely following the Brexit news, and others that are still down on either safe-haven demand or speculation of economic drags due to the Brexit. One particular spot that hasn’t fared well in the past week is Japan.
Japan is three years into a bold plan to beat two decades of deflation and restore its economy to prominence. The data shows that their efforts haven’t translated so well just yet. Inflation is still dead, and economic growth — about the same.
Two key tools in the Bank of Japan’s QE program, which is designed to drive inflation and economic activity, is a weaker yen and a higher stock market. Since they telegraphed their intentions of big, bold QE in late 2012, Japanese stocks have risen by as much as 140%. And the yen has declined by as much as 38% against the dollar. But over the past 12 months, about half of those “policy gains” have been given back. And post-Brexit the attrition has only worsened.
Still, after three years and big moves in the yen and stocks, the inflation objective remains a distant target. What does it mean? The Bank of Japan has to do more. A lot more.
We think they can, and will, ultimately destroy the value of the yen — mass devaluation.
Unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, Japan has the ingredients to make QE work, to promote demand, and to promote growth. Japan has the largest government debt problem in the world. They have an undervalued currency. They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.
They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.
In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity. But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth. We wouldn’t be surprised to see USDJPY return to the levels of the mid-80s (versus the dollar)in the not too distant future. That would be 250+. Currently, 103 yen buys a dollar.
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Yesterday we talked about the ECB’s projection on how the Brexit will impact on euro area GDP. And we looked at charts of Spanish and Italian sovereign debt. Both suggested that the market reaction, to the downside risk from Brexit, might be over-exaggerated.
Some markets have already fully recovered the Brexit-induced declines. But some key safe-haven assets continue to show healthy capital flows.
Let’s look at some charts.
Source: Reuters, Billionaire’s Portfolio
The chart above is a look at UK stocks. These are blue chip companies listed on the London Stock Exchange. You can see the 9% has been completely erased in just three trading days.
What about commodities? This is Goldman’s commodity index. It’s completed recovered declines, in large part to the reversal in oil and the continued surge in natural gas. Remember we talked about natural gas earlier in the month as it looks like it’s on a path to $4. It nearly hit $3 today.
Source: Reuters, Billionaire’s Portfolio
So we have some traditional “risk-on” assets sharply recovering losses.
But, the “risk-off” trade continues to hold in the traditional safe-haven assets. Bonds are being bought aggressively. You can see the U.S. 10-year yield is nearing levels of the peak of the European Debt Crisis, when Spain and Italy were on the precipice of blow-up.
Source: Reuters, Billionaire’s Portfolio
Interestingly, the 30-year yield is sliding too. This flattens the yield curve, which suggests bets on recession. But this extreme level is historically has been a bottom throughout the crisis period (2008-present).
Source: Reuters, Billionaire’s Portfolio
The dollar continues to hold post-Brexit gains — another sign of safe-haven flows.
Source: Reuters, Billionaire’s Portfolio
And next, the safe-haven flows continue to hold up in gold. But it’s not the runaway market gold bugs would hope for in a time of global stress.
Source: Reuters, Billionaire’s Portfolio
One could argue that the safe haven flows could be coming from core Europe, as Germany is most at risk in the Brexit for the ultimate bad outcome scenario (as we discussed yesterday, where the Brexit could create a spill over into European Monetary Union countries looking for the exit door). But as we reviewed yesterday, the sovereign debt markets in the vulnerable spots in Europe (Italy and Spain) aren’t giving that “bad outcome” signal.
Source: Reuters, Billionaire’s Portfolio
What about Japan? Japanese stocks have bounced sharply, but were among the worst hit given the sharp rise in the yen (a traditional safe-haven).
Source: Reuters, Billionaire’s Portfolio
And finally, U.S. stocks have come back aggressively, but haven’t fully recovered the decline.
Source: Reuters, Billionaire’s Portfolio
What do we make of it? If we consider that the biggest risk associated with Brexit is a destruction of global confidence, rising/recovering stocks go a long way toward defending against that risk. Since the central banks are in the business of defending stability and confidence in this environment, and they are clearly on patrol, they may have a little something to do with stock market recoveries (if not directly, than indirectly).
To follow our big picture views and our hand selected portfolio of the best stocks owned by the best billionaire investors in the world, join us in our Billionaire’s Portfolio.
For much of the summer, while the world has been obsessed with Trump tweets, we’ve talked about the sharp but under-acknowledged move in copper and the message it was sending about the global economy and China (the biggest consumer of commodities), specifically. As I’ve said, people should Stop Watching Trump And Start Watching Copper.
