November 21, 2016, 6:30pm EST
Stocks hit new record highs again in the U.S. today. This continues the tear from the lows of election night. But if we ignore the wild swing of that night, in an illiquid market, stocks are only up a whopping 1.2% from the highs of last month — and just 8% for the year. That’s in line with the long term average annual return for the S&P 500.
And while yields have ripped higher since November 8th, we still have a 10 year yield of just 2.32%. Mortgages are under 4%. Car loans are still practically free money. That’s off of “world ending” type of levels, but very far from levels of an economy and markets that are running away (i.e. you haven’t missed the boat – far from it).
Despite this, we’re starting to see experts come out of the wood works telling us that the economy has been in great shape for a while. That’s what this is about – what’s with all the fuss? Not true.
Remember, it was just eight months ago that the world was edging toward the cliff again, as the oil price bust was threatening to unleash another global financial crisis. And that risk wasn’t emerging because the economy was in great shape. It was because the economy was incredibly fragile — fueled by the central banks ability to produce stability, which produced confidence, which produced some spending, hiring and investment, which produced meager growth. But given that global economic stability was completely predicated on central banks defending against shocks to the system, not on demand, that environment of stability was highly vulnerable.
Now, of course, we finally have policies and initiatives coming down the pike that will promote demand (not just stability). If have perspective on where markets stand, instead of how far they’ve come from the trough of election night, we’re sitting at levels that scream of opportunity as we head into a new pro-growth government.
When the economic crisis was in the early stages of unraveling, the most thorough study on past debt crises (by Reinhart and Rogoff) found that delevering periods (the time after the bust) took about as long as the leveraging period (the bubble building period before the bust). With that, it was thought that the deleveraging period would take about 10 years. History gave us the playbook, in hand, from very early on in the crisis.
With that in mind, the peak in the housing market was June of 2006. That would put 10 years at this past June. The first real event, in the unraveling of it all, was the bust of two hedge funds at Bear Stearns in mid 2007. That would put the 10 year mark at seven months out or so.
That argues that we’re not in the late stages of an economic growth cycle that was just unfortunately weak (as some say), but that we should just be entering a new growth phase and turning the final page on the debt crisis. And that would argue that asset prices are not just very cheap now, but will be for quite some time as a decade long (or two) prosperity gap closes.
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We’ve talked a lot about oil, the rebound of which has probably led to the trade of the year. If you recall back on February 8th, we said policymakers finally got the wake up call on the systemic threat of the oil price bust when Chesapeake Energy, the second largest oil and gas producer, was rumored to be pursuing bankruptcy.
This is what we said:
“The early signal for the 2007-2008 financial crisis was the bankruptcy of New Century Financial, the second largest subprime mortgage originator. Just a few months prior the company was valued at around $2 billion.
On an eerily similar note, a news report hit this morning that Chesapeake Energy, the second largest producer of natural gas and the 12th largest producer of oil and natural gas liquids in the U.S., had hired counsel to advise the company on restructuring its debt (i.e. bankruptcy). The company denied that they had any plans to pursue bankruptcy and said they continue to aggressively seek to maximize the value for all shareholders. However, the market is now pricing bankruptcy risk over the next five years at 50% (the CDS market).
Still, while the systemic threat looks similar, the environment is very different than it was in 2008. Central banks are already all-in. We know, and they know, where they stand (all-in and willing to do whatever it takes). With QE well underway in Japan and Europe, they have the tools in place to put a floor under oil prices.
In recent weeks, both the heads of the BOJ and the ECB have said, unprompted, that there is “no limit” to what they can buy as part of their asset purchase program. Let’s hope they find buying up dirt-cheap oil and commodities, to neutralize OPEC, an easier solution than trying to respond to a “part two” of the global financial crisis.”
Chesapeake bounced aggressively, nearly 50% in 10 business days.
And on February 22nd, we said, “persistently cheap oil (at these prices) has become the new “too big to fail.” It’s hard to imagine central banks will sit back and watch an OPEC rigged price war put the global economy back into an ugly downward spiral. And time is the worst enemy to those vulnerable first dominos (the energy industry and weak oil producing countries).”
As we’ve discussed, central banks did indeed respond. The BOJ intervened in the currency markets on February 11, and that (not so) coincidently put the bottom in oil and global stocks. China followed on February 29, with a cut on bank reserve requirements, then ECB cut rates and ramped up their QE and the Fed joined the effort by taking two projected rate cuts off of the table (we would argue maybe the most aggressive response in the concerted central bank effort).
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From the bottom on February 8th, Chesapeake shares have gone up five-fold, from $1.50 to over $7. Oil bottomed February 11 and is up 77%. This is the trade of the year that everyone should have loved. If you’re wrong, the world gets very ugly and you and everyone have much bigger things to worry about that a bet on oil and/or Chesapeake. If you’re right, and central banks step in to divert another big disaster (a disaster that could kill the patient) you make many multiples of your risk.
We think it was the trade of the year. The trade of the decade, we think is buying Japanese stocks.
Overnight the BOJ made no changes to policy. And the dollar-denominated Nikkei fell over 1,200 points (more than 7%).
As we said yesterday, two explicit tools in the Bank of Japan’s tool box are: 1) a weaker yen, and 2) higher stocks. I say “explicit” because they routinely have said in their minutes that they expect both to contribute heavily to their efforts. So now Japanese stocks and the yen have returned near the levels we saw before the Bank of Japan surprised the world with a second dose of QE back in October of 2014. So their efforts have been undone. And they’ve barely moved the needle on their objective of 2% inflation during the period. In fact, the head of the BOJ, Kuroda, has recently said they are still only “halfway there” on reaching their goals.
So they have a lot of work left. And if we take them at their word, a weak yen and higher stocks will play a big role in that work. That makes today’s knee-jerk retreat in yen-hedged Japanese stocks a gift to buy.
U.S. stocks have well surpassed pre-crisis, record highs. German stocks have well surpassed pre-crisis, record highs. Japanese stocks have a long way to go. In fact, they are less than “halfway there.”
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