As we head into the election, there’s one sector in the stock market that looks especially interesting.
Healthcare stocks have been beaten up over the past two years. It’s the worst performing sector on the year. Biotech is down around 20% over the past two years. And it’s driven by fear of price regulations and threats from the Democratic presidential race and nominee. Clinton cracked biotech stocks about a year ago when she tweeted that she would take on price gouging in the industry. But that was after Bernie Sanders presented a bill to curb prices. The perception for the industry is that Clinton would try to curb “excessive” profits at the pharma and biotech companies.
With that, you can see in the chart above, the damage that has been done to pharma and biotech stocks – and healthcare in general.
That said, it’s probably time to buy. It looks like a classic “sell the rumor, buy the fact.” As we know, regardless of who wins the White House, the promises and threats on the campaign trail rarely become policy. And Clinton is known to be friendly to the industry (collecting money for industry speeches in the past). A Trump win would almost certainly send this sector on a tear higher.
Warren Buffett wrote a famous op-ed piece in the New York Times in October 2008 in which he that said the following:
“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.”
This is the mindset of a great investor and how great investors react when there are opportunities like we’re seeing in this beaten down sector. They buy when others are selling.
The point of Buffet’s piece is that you don’t get rich buying into a high market or selling into a falling market. You can get rich though, buying into market corrections and beaten-down markets. When everyone was running from bank stocks in 2008-2009, Buffett was buying. When everyone was running out of energy stocks earlier this year, Buffett was buying. I suspect the same is happening with healthcare stocks as we head into the election, and will continue in the aftermath.
As we discussed on Friday, the dominant theme last week was the big run-up in global yields. This week, we have four central banks queued up to decide on rates/monetary policy.
With that, let’s take a look at the key economic measures that have been dictating the rate path or, rather, the emergency policy initiatives of the past seven years. Do the data still justify the policies?
First up tonight is Australia. The RBA was among the last to slash rates when the global economic crisis was unraveling. They cut from 7.25% down to a floor of just 3% (while other key central banks were slashing down to zero). And because China was quick to jump on the depressed commodities market in 2009, gobbling up cheap commodities, commodities bounced back aggressively. And the outlook on the commodity-centric Australian economy bounced back too. Australia actually avoided official recession even at the depths of the global economic crisis. With that, the RBA was quick to reverse the rate cuts, heading back up to 4.75%. But the world soon realized that emerging market economies could survive in a vacuum. They (including China) relied on consumers from the developed world, which were sucking wind for the foreseeable future.
The RBA had to, again, slash rates to respond to another downward spiral in commodities market, and a plummet in their economy. Rates are now at just 1.5% – well below their initial cuts in the early stages of the crisis.
But the Australian economy is now growing at 3.3% annualized. The best growth in four years. But inflation remains very low at 1.7%. Doesn’t sound bad, right? The August data was running fairly close to these numbers, and the RBA CUT rates in August – maybe another misstep.
The Bank of Japan is tonight. Remember, last month the BOJ, in a surprising move, announced they would peg the 10 year yield at zero percent. That has been the driving force behind the swing in global market interest rates. At one point this summer $12 trillion worth of negative yielding government bonds. The negative yield pool has been shrinking since. Japan has possibly become the catalyst to finally turn the global bond market. But pegging the rate at zero should also serve as an anchor for global bond yields (restricting the extent of the rise in yields). That should, importantly, keep U.S. consumer rates in check (mortgages, auto loans, credit card rates, etc.). Also, importantly, the BOJ’s policy move is beginning to put downward pressure on the yen again, which the BOJ needs much lower — and upward pressure on Japanese stocks, which the BOJ needs much higher.
With that, the Fed is next on the agenda for the week. The Fed has been laying the groundwork for a December rate hike (number two in their hiking campaign). As we know, the unemployment rate is well into the Fed’s approval zone (around 5%). Plus, we’ve just gotten a GDP number of 2.9% annualized (long run average is just above 3%). But the Fed’s favorite inflation gauge is still running below 2% (its target) — but not much (it’s 1.7%). Janet Yellen has all but told us that they will make another small move in December. But she’s told us that she wants to let the economy run hot — so we shouldn’t expect a brisk pace of hikes next year, even if data continues to improve.
Finally, the Bank of England comes Thursday. They cut rates and launched another round of QE in August, in response to economic softness/threat following the Brexit vote. There were rumors over the weekend that Mark Carney, the head of the BOE, was being pushed out of office. But that was quelled today with news that he has re-upped to stay on through 2019. The UK economy showed better than expected growth in the third quarter, at 2.3%. And inflation data earlier in the month came in hotter than expected, though still low. But inflation expectations have jumped to 2.5%. With rates at ¼ point and QE in process, and data going the right direction, the bottom in monetary policy is probably in.
So the world was clearly facing deflationary threats early in the year, which wasn’t helped by the crashing price of oil. But the central banks this week, given the data picture, should be telling us that the ship is turning. And with that, we should see more hawkish leaning views on the outlook for global central bank policies and the global rate environment.
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Remember, up to mid 2015, there were reasons to be optimistic about the outlook for the global economic recovery. The U.S. economy was improving. With the job market hitting targets, the Fed was preparing the world for the first rate hike, to begin moving away from emergency policies. The BOJ was keeping its promises of going full bore into an aggressive easing program which had driven the yen much lower, and stocks much higher, which was beginning to reflect in the economic data. And the European Central Bank had finally started an aggressive easing program to deal with deflationary malaise in the European economy. Better data plus continued aggressive global stimulus was reason to believe better times ahead.
But then came a jolt to markets by the Chinese making an about face on their currency (from strengthening to weakening). That created question marks about the health of China. Were things there worse than people think? And is China beginning to respond with a mass currency devaluation? That shook markets and confidence. And then we had the oil price bust early this year. That threatened mass industry defaults, and a spread to the global financial system. That shook markets and confidence. And, of course, we’ve had the surprising vote from the UK to leave the European Union (Brexit). That shook markets and confidence.
In this environment, stocks (especially U.S. stocks) are a key barometer of confidence. And it becomes self-reinforcing. When confidence shakes, stocks go lower. When stocks go lower, confidence wanes more. Weak confidence starts reflecting in weaker economic data. Weaker economic data pushes stocks lower. And the circle continues.
With this said, for much of the year, there has been speculation of another recession coming. The interest rate market had been pricing in a deflation forever story, with $12 trillion worth of global government bonds in negative yield territory at one point this past summer.
And despite the fact that the intensity of the macro concerns has abated, the fall back in the interest rate market was still sending a very cautionary signal to markets. That caution signal looks like it’s lifting. U.S. 10 year yields look like a run back above 2% is coming soon. And most importantly, the yield on German 10 year bunds (another key global benchmark interest rate) has been on a tear, exiting negative yield territory this week and running up to levels not seen since the day of the Brexit vote.
This move higher in rates, from record low levels, should be good for confidence, good for the economic outlook, and therefore good for stocks (as it removes the another cautionary cloud over sentiment).
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Last week we talked about the set up for a move in global bond yields. And we discussed the case for why the bond market may have had it very wrong (i.e. rates have been too low, pricing in way too pessimistic a view on the current environment).
Well, today rates have finally started to remind people of how quickly things can change. The U.S. 10 year yield finally broke above the tough 1.80% level and is now trading 1.85%. German yields have now swung from negative territory just three days ago, to POSITIVE 19 basis points at the highs today. Importantly, German yields are now ABOVE pre-Brexit levels.
Still, we’re approaching a second Fed rate hike and U.S. yields are almost 1/2 point lower than where they traded just following the Fed’s first hike in December of last year. As for German rates (another key benchmark for world markets), we found with the Fed in its three iterations of QE, that QE made market rates go UP not down, as people began pricing in a better outlook. That’s yet to happen in Germany. The 10 year yield was closer to 40 basis points when they formally kicked off QE – still above current levels.
But remember this chart we looked at last week.
In the white box, you can see the screaming run-up in yields last year. The rates markets had a massive position squeeze which sent ten–year German bond yields from 5 basis points (near zero) to 106 basis points in less than two months — a 20x move. U.S. ten–year yields (the purple line in the chart below) moved from 1.72% to 2.49% almost in lock–step.
This time around, as we discussed last week, let’s hope a rise in rates is orderly and not messy. Another sharp rise in market rates like we had last year would destabilize global markets (including the very important U.S. housing market).
But the buffer this time around should be the Bank of Japan. Remember, the Bank of Japan, just last month announced they would peg the Japanese 10 year yield at zero. Even with the divergent monetary policies in Europe and Japan relative to the U.S. (central bank rate paths going in opposite directions), the spread between U.S. rates and European and Japanese rates should stay tame. That means that Japan’s new policy of keeping their 10 year yield at zero will/should prevent a run away U.S. interest rate market – at least until there is a big upgrade in the expectation in U.S. growth. On that note, we get a U.S. GDP reading tomorrow.
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As of the end of last week, 78% of the companies that have reported earnings for the most recent quarter have beaten estimates.
That’s on about a third of S&P 500 companies that have reported thus far. Remember, FactSet says on average (the five-year average), 67% of companies in the S&P 500 beat their analyst expectations. And they beat by an average of 4%. So the numbers in this earnings season are running a little hotter, albeit on a lowered bar.
We’ve talked quite a bit in the past week about the run up to Apple earnings, which came in yesterday after the market close. The earnings number beat expectations. But it was by a slim margin.
The stock was lower on the day. Still, on the second quarter report, this past July, Apple was a sub $100 stock (trading at just above $96). Today it will close above $115. That’s 20% higher in the span of one quarter, and it was on a report that was very much in line with the report we heard yesterday. And the report included only a few weeks of the new iPhone7 release. And it doesn’t reflect implosion of Apple’s competitor, Samsung.
As the media and analyst tend to do, especially when the macro news front is quiet and market volatility is quiet, they picked apart and speculated on the future of Apple today as a company that may have peaked.
Let’s just take a look at the stock, and not pretend to have better visibility on the future of the company than the people do inside — the same one’s that put a transformational supercomputer in our pockets.
The stock still trades at 13x earnings. The S&P 500 trades at 16x. Apple trades at 13x next year’s projected earnings. The S&P 500 trades at 16.5x. Clearly it’s undervalued compared to the broader market. What about Apple’s monster cash position? Apple has even more cash now — a record $237 billion. If we excluded the cash from the valuation, Apple trades at 8.6x earnings. Though not an apples to apples (pun), and just as a reference point, that valuation would group Apple with the likes of these S&P 500 components that trade 8 times earnings: Dow Chemical, Prudential Financial, Bed Bath & Beyond, a Norwegian chemical company (LBY), and Hewlett Packard Enterprise. It’s safe to say no one is debating whether or not Hewlett Packard is at the pinnacle of its business. Yet, if we strip out the cash in Apple, AAPL shares are trading at an HPE valuation.
Apple still looks like a cheap stock.
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The markets are sitting on Apple earnings, which will come after the close today (by the time you read this).
We’ve been talking about the quiet move in currencies, some commodities and some foreign stock markets.
Given that the dollar is looking like another (maybe big) run is in store, which means much lower euro and much lower yen (and higher German and Japanese stock markets, as we’ve discussed), what does a higher dollar mean for commodities?
Commodities have, of course, been crushed throughout this post financial crisis period. And earlier this year, oil was the most recent mass declining commodity. That was after an initial collapse in 2008, and a sharp recovery from 2009 through much of 2014. But then of course, it came crashing back to earth to revisit the deeply depressed levels of most other commodities, following OPEC refusal to cut production back in late 2014.
So, we’ve talked about the importance of oil. Cheap oil had all of the ingredients to be even more destructive to the global economy than the credit bubble burst (and housing bust). But it’s out of the danger zone now, at around $50, and the outlook is bullish, given the supply dynamics and given that OPEC is prepared to cut for the first time in eight years.
So this begs the question: If the dollar is strengthening, and may continue to strengthen, isn’t that bad for commodities? And therefore, isn’t that bad news for the oil price recovery?
The mainstream financial media usually is very quick to attribute moves in commodities to an inverse move in the dollar (and vice versa). On the surface, it’s a logical enough argument. After all, commodities like gold, oil, and grains are all priced in dollars.
Therefore, if the dollar weakens the value of the commodity shouldn’t be penalized. With that logic, it should strengthen to maintain its value on the global stage.
So all things remaining equal, the commodity should move in the directly proportional opposite direction of the dollar.
The only problem with this argument is that all things never remain equal …
So is there a legitimate price relationship between the dollar and commodities? Or is it just market fodder to attempt to explain and justify the market activity?
That depends on the time period you look at …
For example, from December 1998 to September 2000 the relationship of oil and the dollar was positive, as shown in the chart below. When one went up, the other went up.
On the other hand, from 2006 to 2009, the relationship was been negative. Take a look at the following chart: When oil was crashing, the dollar was rising sharply. And toward the far right of the chart, oil recovered and the dollar fell.
Of course, these are just two isolated periods of time that I’ve used here to demonstrate exact opposite relationships.
However, over longer periods the influence of the dollar on oil, or oil on the dollar, is found to have NO statistical significance. There’s not a significant positive or negative correlation. Consequently, statisticians would conclude that the dollar and oil have nothing to do with one another.
So there is no reason to believe oil can’t continue its strong recovery, and do so in an environment when the Fed is moving in the opposite directions of other major central banks, providing fuel for a much higher dollar.
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By November 15th, the biggest investors in the world will be required to disclose a snapshot of what their portfolios looked like at the end of the third quarter.
I suspect we’ll find that Apple was heavily bought during the period.
You might recall, the media was stirring about the second quarter filings (which were reported back in August). Some big names had sold or trimmed stakes in Apple.
But, as I discussed at that time, the Q2 portfolio snapshots came just days following the big surprising Brexit decision in the UK. Global markets swung violently on the news back in June. Remember, between June 23rd and June 27th, the S&P 500 fell as much as 5.7%. It made it all back the subsequent four days.
With that event in mind, billionaire investors David Einhorn, George Soros and Chase Coleman – all had sold Apple shares by the end of the second quarter.
But remember, unlike most stocks they own, they can all trade Apple with virtual anonymity between quarters. The stock is too large for anyone one investor to take a 5% controlling stake, which would trigger the requirement of a 13D or 13G filing with the SEC, which would require updated filings (or amendments) within 10 days of any change in the position size (sell one share, you have to report it).
Einhorn even bragged in one of his investor letter’s this year that they have done a good job of “trading” Apple.
Make no mistake, even with the trimmed stakes of Q2, Apple was (and is) still the “who’s who” of billionaire investor-owned stocks. It was still Einhorn’s largest position into the end of Q2. Buffett swooped in and bought shares near the 52-week low.
When we see the Q3 filings next month, I would expect those that were cutting stakes at the end of Q2, were adding it all back in early Q3. And with the run-up in Apple shares since, up 22% from the June lows, I predict it will be the most bought stock of the third quarter. If that’s true, I predict the media and Wall Street will be talking about how great Apple is again (i.e. analyst upgrades will follow).
In the past month, there’s been a solid take up on the new iPhone 7 for Apple. Importantly, with the iPhone 7 launch, all four major carriers have returned to the model of offering free new iPhones for long term contracts. That’s a huge positive on the stock as a product-cycle driven company. Add to that, there’s no other stock that, if not owned and owned enough, can get a professional money manager fired than Apple. That creates a “fear of missing out” trade in the institutional investor community — pushing them off of the sidelines and back into Apple.
But perhaps the most important event for Apple has been the very public implosion of their biggest competitor Samsung. Samsung has been forced to recall their competitive smartphone the Galaxy Note 7 because it’s been bursting into flames. It’s projected to cost the company over $5 billion. Most importantly, it’s positioning Apple, right in the sweetspot of their new product (latest phone) rollout, to take more market share.
If we do indeed find next month that the biggest and smartest investors in the world spent Q3 loading up on Apple, it should give a stamp of approval that sentiment has turned for the stock. Apple remains one of the most undervalued stocks in the S&P 500, with the most powerful fundamentals: it’s cheap at 13x trailing and forward earnings, has an incredible balance sheet with $231 billion in cash, and a high analyst price target of $185 a share.
As I noted last week, the company reported a second consecutive quarter of year-over-year earnings decline in July. But it crushed estimates. The stock took off from $96 and trades today at $117. They report on the most recent quarter on October 25. The consensus earnings estimate is $1.64–which would be a third consecutive year-over-year decline. The recent revisions to that estimate have been down (not surprisingly), which sets up for a beat. The last time Apple reported two consecutive quarters of year-over-year declines was mid-2013. The stock bottomed in that period.
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I talked last week about the move in oil, and the lag in natural gas.
But natural gas was knocking on the door of a technical breakout. As you can see, that breakout looks to be underway now.
Nat gas is now at $3.25. If history is any indication, it could be in the low $4s soon.
That’s helped by chatter today from OPEC members out vocally supporting the production cut that was agreed to two weeks ago. And the Secretary General of OPEC piled on today by saying the sharp contraction in investments (due to low prices) poses a threat to global oil supply. As we’ve discussed, for those that had the “oil price to zero” arguments earlier in the year, supply changes, so does demand.
With all of this, oil continues to climb higher, testing the June highs today. Here’s another look at the chart.
A break above the June highs of $51.67 would project a move to near $65 (technically speaking, it’s a C-wave). Another big technical level above is $68.60, which is the 61.8% retracement of the move down from almost $95 in late 2014, to the lows of earlier this year. That’s the breakdown in oil prices driven by OPEC’s 2014 refusal to cut production. And now were on the verge of getting the first cut in eight years. So oil is looking like higher levels are coming — it was up another 3% today.
What’s does it mean for stocks? As we’ve discussed, for much of the year, lower oil has meant lower stocks, and higher oil has meant higher stocks.
This emerging bullish technical and fundamental backdrop for energy should be very good for stocks. Remember, higher energy prices, in this environment, removes the risk of another oil price shock-to-sentiment (good for stocks, good for the economy). And it means producers can start producing again, downstream businesses can fill capacity, and we can start seeing some of the hundreds of thousands of U.S. jobs replenished that have been lost over the past two years.
Since OPEC rigged lower oil prices back in late 2014, we’ve had over 100 North American energy company bankruptcies. Some of those have/are reorganizing and emerging with lean balance sheets into what could be a hot recovery in energy prices. I’ll talk about some tomorrow.
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As you might recall, since I’ve written this daily note starting in January, I’ve focused on a few core themes.
First, central banks are in control. They’ve committed trillions of dollars to manufacture a recovery. They’ve fired arguably every bullet possible (“whatever it takes”). And for everyone’s sake, they can’t afford to see the recovery derail – nor will they. With that, they need stocks higher. They need the housing recovery to continue. They need to maintain the consumer and growing business confidence that they have manufactured through their policies.
A huge contributor to their effort is higher stocks. And higher stocks only come, in this environment, when people aren’t fearing another big shock/ big shoe to drop. The central banks have promised they won’t let it happen. To this point, they’ve made good on their promise through a number of unilateral and coordinated defensive maneuvers along the way (i.e. intervening to quell shock risks).
The second theme: As the central banks have been carefully manufacturing this recovery, the Fed has emerged with the bet that moving away from “emergency policies” could help promote and sustain the recovery. It’s been a tough road on that front. But it has introduced a clear and significant divergence between the Fed’s policy actions and that of Japan, Europe and much of the rest of the world. That creates a major influence on global capital flows. The dollar already benefits as a relative safe parking place for global capital, especially in an uncertain world. Add to that, the expectation of a growing gap between U.S. yields and the rest of the world, and more and more money flows into the dollar… into U.S. assets.
With that in mind, this all fuels a higher dollar and higher U.S. asset prices. And when a dollar-denominated asset begins to move, it’s more likely to attract global speculative capital (because of the dollar benefits).
With that in mind, let’s ignore all of the day to day news, which is mostly dominated by what could be the next big threat, and take an objective look at these charts.
U.S. Stocks
Clearly the trend in stocks since 2009 is higher (like a 45 degree angle). Since that 2009 bottom in stocks, we’ve had about 4 higher closes for every 1 lower close on a quarterly basis. That’s a very strong trend and we’ve just broken out to new highs last quarter (above the white line).
U.S. Dollar
This dollar chart shows the distinct effect of divergent global monetary policy and flows to the dollar. You can see the events annotated in the chart, and the parabolic move in the dollar. Any positive surprises in U.S. economic data as we head into the year end will only drive expectations of a wider policy gap — good for a higher dollar.
Oil
We looked at this breakout in oil last week after the OPEC news. Oil traded just shy of $50 today. That’s 17% higher since September 20th.
Oil trades primarily in dollars. And we have a catalyst for higher oil now that OPEC has said it will make the first production cut in eight years. That makes oil a prime spot for speculative capital (more “fuel” for oil). And as we’ve discussed in recent days, weeks and months… higher oil, given the oil price bust that culminated earlier this year, is good for stocks, and good for the economy.
What’s the anti-dollar trade? Gold. As we discussed yesterday, gold has broken down.
If we keep it simple and think about this major policy divergence, we have plenty of reasons to believe a higher dollar and higher stocks will continue to lead the way.
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Stocks continue to chop around as we head into the big jobs report this week. But the dollar has been a mover today, so has gold.
Let’s take a look at the chart of gold. It has broken down technically.
You can see the longer term downtrend in gold since it topped out in 2011. And we’ve had a corrective bounce this year, which was contained by this descending trendline. And today we broke the trend that describes this bullish technical correction (i.e. the trend continues lower).
A lot of people own gold. And it’s a very emotional trade. Whenever I talk about negative scenarios for gold, the hate mail is sure to follow.
We’ve talked quite a bit about the drivers of the gold trade. I want to revisit that today.
Gold has been a core trade for a lot of people throughout the crisis period. When Lehman failed in 2008, it shook the world, global credit froze, banks were on the verge of collapse, the global economy was on the brink of implosion—people ran into gold. Gold was a fear–of–the–unknown–outcome trade.
Then the global central banks responded with massive backstops, guarantees, and unprecedented QE programs. The world stabilized, but people ran faster into gold. Gold became a hyperinflation–fear trade.
Gold went on a tear from sub–$700 bucks to over $1,900 following the onset of global QE (led by the Fed).
Gold ran up as high as 182%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply.
Still eight years after the Fed’s first round of QE (and massive global responses), we have just 13% cumulative inflation over the period.
So the gold bugs overshot in a big way. We’ve looked at this next chart a few times over the past several months. This tells the story on why inflation hasn’t met the expectations of the “run-away inflation” theorists.
This chart above is the velocity of money. This is the rate at which money circulates through the economy. And you can see to the far right of the chart, it hasn’t been fast. In fact, it’s at historic lows. Banks used cheap/free money from the Fed to recapitalize, not to lend. Borrowers had no appetite to borrow, because they were scarred by unemployment and overindebtedness. Bottom line: we get inflation when people are confident about their financial future, jobs, earning potential…and competing for things, buying today, thinking prices might be higher, or the widget might be gone tomorrow. It’s been the opposite for the past eight years.
When this reality of low-to-no inflation and global economic malaise became clear, even after rounds of Fed QE, there were a LOT of irresponsible people continuing to tout gold as an important place in everyone’s portfolio, even at stratospheric levels. People bought gold at $1900 and have since lost as much as 40% on the value of their investment – an investment that was supposed to “hedge” against inflation.
On that note, today the IMF downgraded U.S. growth estimates for the year from 2.2% to just 1.6% — in a year that many were initially expecting to be a good year, nearing trend growth levels (3%-3.5%). So eight years from the inception of the Fed’s extraordinary policies, the case for gold remains weak and an investment with more risk than reward.
The Billionaire’s Portfolio is up 23% year-to-date — that’s nearly four times the return of the S&P 500 during the same period. We recently exited a big FDA approval stock for a quadruple, and we’ve just added a new pick to the portfolio — following Warren Buffett into one of his favorite stocks. If you haven’t joined yet, please do. Click here to get started and get your portfolio in line with our Billionaire’s Portfolio.
