For the skeptics on the bull market in stocks and the broader economy, the reasons to worry continue to get scratched off of the list.
Brexit. Russia. Trump’s protectionist threats. Trump’s inability to get policies legislated. The French election.
The bears, those looking for a recession around the corner and big slide in stocks, are losing ammunition for the story.
With the threat of instability from the French election now passed, these are two of the more intriguing catch-up trades.
In the chart above, the green line is Spanish stocks (the IBEX). U.S., German and UK stocks have not only recovered the 2007 pre-crisis highs but blown past them — sitting on or near (in the case of UK stocks) record highs. Not only does the French vote punctuate the break of this nine year downtrend, but it has about 45% left in it to revisit the 2007 highs. And the euro, in purple, could have a dramatic recovery with the cloud of French elections lifted, which was an imminent threat to the future of the single currency.Next … Japanese stocks. While the attention over the past five months has been diverted toward U.S. politics and policies, the Bank of Japan has continued with unlimited QE. As U.S. rates crawl higher, it pulls Japanese government bond yields with it, moving the Japanese market interest rate above and away from the zero line. Remember, that’s where the BOJ has pegged the target for it’s 10 year yield – zero. That means they buy unlimited bonds to push the yield back down. That means they print more and more yen, which buys more and more Japanese stocks.
The Nikkei has been one of the biggest movers over the past couple of weeks (up almost 10%) since it was evident that the high probability outcome in the French election was a Macron win.Again, German, U.S., and UK stocks are at or near record highs. The Nikkei has been trailing behind and looks to make another run now, with 25,000 in sight.If you need more convincing that stocks can go much higher, Warren Buffett reiterated over the weekend that this low interest rate environment and outlook makes stocks “dirt cheap.” Last year he made the point that when interest rates were 15% [in the early 1980s], there was enormous pull on all assets, not just stocks. Investors have a lot of choices at 15% rates. It’s very different when rates are zero (or still near zero). He said, in a world where investors knew interest rates would be zero “forever,” stocks would sell at 100 or 200 times earnings because there would be nowhere else to earn a return.
Buffett essentially said at zero interest rates into perpetuity, the upside on the stock market (and any alternative asset class with return) is essentially infinite, as people are forced to find return by taking risk. Why you would buy a treasury bond that has no growth, and little-to-no yield and the same or worse balance sheet than high quality dividend stock.
This “forcing of the hand” (pushing investors into return producing assets) is an explicit objective by the interest rate policies of the Fed and the other major central banks of the world. They need us to buy stocks. They need us to spend money. They need economic growth.
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We closed last Friday with another new weekly record high on the Dow. But we closed with an all-time record low in the German 2-year bund. That development in Europe, weighed on U.S. yields, pulling yields down here from 2.5 to 2.31%.
So we had this divergence between what was happening in stocks and what the bond market was communicating. The bond market was telling us there was growing concern about danger to European economic stability, and therefore global economic stability, in the upcoming French elections. Stocks were telling us, growth is king – the ultimate problem solver, and growth is coming.
With that, Trump’s address to Congress on Tuesday night became a major sentiment gauge/the arbiter on which would win out, based on the perception of whether or not the Trump administration could execute on its economic plans.
The vote was “affirmative” for the growth story. Stocks gapped higher to new record highs (closing this week at another weekly record high). And the bond market turned on a dime, following Trump on Tuesday night, and have been climbing since. German yields have bounced. And U.S. yields have bounced. That leads us up to today’s speech from Janet Yellen.
There has been a tremendous shift in the past week in the expectations for a March rate hike. It’s gone from a 27% chance of a March 15 rate hike being priced in last Friday. By Wednesday morning, after Trump’s speech, it was 70%! And we close out the week with an 80% chance of a hike this month.
That additional bump came today on a speech and Q&A session from Janet Yellen today. Here’s the expectations bar she chose to set: She said the Fed would likely be moving faster than it had in 2015 and 2016. It should be said that they only hiked once in 2015 and 2016 because their forecasts proved grossly overly optimistic and they had to adjust on the fly. So they’ve already told us, back in December, that they think it will be three times this year. That’s faster than one. And today she reiterated that today.
And today she also said that if the data continued to improve as they forecast, they can hike this month.
Now, they have a post-FOMC meeting press conference scheduled FOUR more times this year (March, June, September and December). Despite what they suggest, that they could hike at any meeting and just call an impromptu press conference, they would be crazy to introduce such a surprise in markets. Stability and confidence work in their favor. Surprises threaten stability and confidence.
So if they indeed hike three times, they have a narrow window. And if they think they need to hike faster, because perhaps fiscal policy accelerates growth and inflation, they may need to keep the December meeting open for a fourth hike.
But, Yellen and company have recently gone out of their way to tell us that they are not even factoring in fiscal stimulus and deregulation (growth policies) into their view on the economy. They’ll believe when they see it and take that information as it comes, which puts them in an even more vulnerable position to needing more tightening this year, if you take them at their word and trust their forecasting abilities.
So with that in mind, why has the Fed become so bulled up on interest rate picture since December? Is it because the inflation and jobs data has gotten that much better? The unemployment rate has been below 6% (the Fed’s original target) since September of 2014 and below 5% for the past year. And the core inflation rate has been above 2% since November of 2015, which includes all year last year, when the Fed was reversing course on its promises for a big tightening year. That’s near normal employment in the Fed’s eyes and above its target for inflation – a clear signal to normalize interest rates. But they’ve barely budged.
Why? Because last year the global economy looked vulnerable. With that, they threw every other guiding data point out the window and went back to playing defense. And as recent as August of last year, the Fed messaging was quite dovish. What’s the biggest difference between now and then? The prospects of major fiscal stimulus – precisely what they say they are leaving out of their forecasts for now.
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Yesterday we talked about the warning signal flashing from the German bond market. That continues today.
While global stocks and commodities are reflecting broad optimism about the new pro-growth government in the U.S., the yield on 2-year German government bonds is sending a negative message — it hit record lows yesterday, and again today — trading to negative 90 basis points. You pay almost 1% to loan the German government money for two years.
Here’s a longer term look at German yields, for perspective…
And here’s the divergence since the election between German and U.S. 2 year yields…
This divergence is partially driven by rising U.S. yields on optimism about the outlook, about inflationary policies, and about the Fed’s response. On the other hand, German yields have gone the other way because 1) the ECB is still outright buying government bonds through its QE program (bond prices go up, yields go down), and 2) capital flows into bonds, in search of safety, because a Trump win makes another populist vote in Europe more likely when the French elections role around in May.
So that bleed to new lows in the German 2-year yield sends a warning signal to global markets. Today we have a few more reasons to think this could be a signal that the optimism being priced into U.S. markets at the moment could take a breather here.
Trump’s Secretary of Treasury, Mnuchin, was doing his first rounds on financial TV this morning and gave us some guidance on a timeline for policies and impact. Most importantly, he says we’ll see limited impact from Trump policies in 2017, and that the growth impact won’t come until 2018.
Let’s consider how that can impact where the Fed stands on their forecasts for monetary policy.
Remember, they spent the better part of 2016 walking back on the promises they had made for 4 rate hikes last year. And then, when they finally moved for thefirst time this past December, following the election and a rallying stock market, they reversed course on all of the dovish talk of the past months, and re-upped on another big rate hiking plan for 2017.
Though they don’t like to admit it, we can only assume that when they considered a massive fiscal stimulus package coming, like any human would, they became more bullish on the economy and more hawkish on the inflation outlook.
So now as Mnuchin tells us not to expect a growth impact from Trump policies until next year, maybe the Fed lays off the tightening rhetoric for a while.
With all of this in mind, another interesting dynamic in markets today, the Dow shrugged off some weakness early on to trade higher most of the day, posting another new record high. Meanwhile small caps diverged, trading weaker all day. And gold traded to the highest level since November 11. Remember this chart we’ve looked at, which looks like higher gold to come (a lower purple line), and lower yields.
This would all project a calming for the inflation outlook, which would be good for the health of markets. Among the biggest risk to Trumponomics is hot inflation, too fast, and a race higher in interest rates to chase it.
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There’s little in the way of economic data next week to move the needle on markets and the economic outlook. With that said, the catalyst will continue to be Trumponomics, and the President said yesterday that we should expect to hear “big things” coming in the next week or two.
As we head into the weekend, let’s take a look at some charts of interest.
The S&P 500 is now up 10% since election day (November 8). For some perspective, since the 2009 bottom, when the global central banks stepped in to pull the world back from the edge of collapse, you can see the trend has been a 45 degree angle UP. And despite all of the fear and pessimism along the way, the sharp corrections along the way were quickly reversed, most of which were completely recovered inside of ONE MONTH.
With central bank policy around the world still promoting higher global asset prices, and with pro-growth policies underway in the U.S., any dip in stocks will be a gift to buy.
We looked at this next chart last week. It’s the inverse price of gold versus the U.S. 10 year yield. You can see they have tracked nicely since the election.
With Yellen’s session on Capitol Hill this week, the yield has whipped around from 2.40 back to 2.50 and back to 2.41 today.
Meanwhile, with the continued hostility surrounding the Trump administration, and accusations about Russian conflicts, gold has been stepping higher. This all looks like higher gold and lower yields coming. As questions arise about the execution of (or speed of execution) growth policies, some of the inflation optimism that has been priced in may begin to soften. That would also lead to a breather for the stock market. In both cases, it would create opportunities — to buy any dip in stocks, and sell any rally in bonds.
Stocks were down a bit today, for the first day in the past six days. Yields were lower, following two days of Janet Yellen on Capitol Hill. Gold was higher on the day. And the dollar was lower.
Of the market action of the day, the dollar and yields are the most interesting. The freshly confirmed Treasury Secretary, Steven Mnuchin, held a call with Japan’s Finance Minister last night, early morning Japan time.
What did USD/JPY do? It went down (lower dollar, stronger yen). Just as it did the week leading up to the visit between President Trump and Japan’s Prime Minister Abe.
Remember, the yen has been pulled into the fray on Trump’s tough talk on trade fairness and currency manipulation. The subject has cooled a bit, but with the new Treasury Secretary now at his post, the world will be looking for the official view on the dollar.
As I said before, I think the remarks about currency manipulation are (or should be) squarely directed toward China. And I suspect Abe may have conveyed to the president, in their round of golf, that Japan’s QE is quite helpful to the U.S. economy and policy efforts, even if it comes with a weaker yen (stronger dollar). Among many things, Japan’s policy on keeping its ten-year yield pegged at zero (which is stealth unlimited QE) helps put a lid on U.S. market interest rates. And that keeps the U.S. housing market recovery going, consumer credit going and U.S. stocks climbing, and that all fuels consumer confidence.
Yesterday we talked about the fourth quarter portfolio disclosures from the world’s biggest investors. With that in mind, let’s talk about the porfolio of the man that’s best position to benefit from the Trump administration: the legendary billionaire investor, Carl Icahn.
Icahn was an early supporter for Trump. He was an advisor throughout the campaign and helped shape policy plans for the president.
What has been the sore spot for Icahn’s underperforming portfolio in recent years? Energy. It has been heavily weighted in his portfolio the past two years and no surprise, it’s contributed to steep declines in the value of his portfolio over the past three years. Icahn’s portfolio is volatile, but over time it has produced the best long run return (spanning five decades) of anyone alive, including Buffett. And he’s worth $17 billion as a result.
Here’s a look at what I mean: In 2009 he returned +33%, +15% in 2010, +35% in 2011, +20% in 2012 and +31% in 2013. That’s quite a run, but he’s given a lot back–down 7% in 2014, down 20% in 2015 and down 20% last year.
Even with this drawdown, Icahn doesn’t see his energy stakes as bad investments. Rather, he thinks his stocks have been unfairly harmed by reckless regulation. And he’s been fighting it.
He penned a letter to the EPA last year saying its policies on renewable energy credits are bankrupting the oil refinery business and destroying small and midsized oil refiners.
And now that activism is positioned to pay off handsomely.
The new Trump appointee to run the EPA was first vetted by Icahn–it’s an incoming EPA chief that was suing the EPA in his role as Oklahoma attorney general. Safe to assume he’ll be friendly to energy, which will be friendly to Icahn’s portfolio.
And as we know, Icahn has since been appointed as an advisor to the president on REGULATION.
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Today we heard from Janet Yellen in the first part of her semi-annual testimony to Congress. She gave prepared remarks to the Senate today and took questions. Tomorrow it will be the House. The prepared statement will be the same, with maybe a few different questions.
Remember, just four months ago, the most important actor in the global economy was the Fed. Central banks were in control (as they have been for the better part of 10 years), with the Fed leading the way.
The Fed was the ultimate puppet master. By keeping rates ultra-low and standing ready to act against anything that might destabilize the global economy and threaten to kill the dangerously slow recovery, they (along with the help other major central banks) restored confidence, and created the stability and incentives to drive hiring, investing and spending — which created economic recovery.
When Greece bubbled up again, when oil threatened to shake the financial system, when China’s slowdown created uncertainty, central banks were quick to step in with more easing, bigger QE, promises of low rates for a very long time, etc.. And in some cases, they outright intervened, like when the ECB averted disaster in Italy and Spain by promising to buy unlimited amounts of Italian and Spanish government bonds to stop speculators from inciting a bond market collapse and a collapse of the euro and European Union.
This dynamic of central bank activism has changed. The Fed, and central bank intervention in general, is no longer the only game in town. We have fiscal stimulus coming and structural change underway that has the chance to finally mend the decade long slump of the global economy. That’s why today’s speech by the Fed Chair was no longer the biggest event of the week — not even the day.
The scripts has flipped. Where the Fed had been driver of recovery, they now have become the threat to recovery. So the interest in Fedwatching today is only to the extent that they may screw things up.
Moving too fast on interest rate hikes has the potential weaken or even undo the gains that stand to come from the pro-growth policies efforts from the new administration.
Remember, the Fed told us in December that they projected THREE hikes this year. But keep in mind, they projected FOUR in December of 2015, for 2016, and we only got one. And that was only AFTER the election, and the swing in sentiment regarding the prospects of pro-growth policies.
Remember, Bernanke himself has criticized the Fed for stalling momentum in the recovery by showing too much tightening (i.e. over optimism) in their forecasts. And he argued that the Fed should give the economy some room to run and sustain momentum, fighting inflation from behind.
On that note, the Fed has now witnessed the bumpy path that the new administration is dealing with, and will be traveling, in implementing policy. I would think they would be less aggressive now in their view on rate hikes UNTIL they see evidence of policy execution, and a lot more evidence in the data. Let’s hope that’s the case.
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We’ve talked about the drift (now slide) lower in interest rates over the past couple of days. This is a big deal and something to keep a close eye on. Remember, this move lower comes in the face of a strong jobs number on Friday. Following that number, the yield on the 10-year traded up to 2.50%. Today we’re looking at 2.35% (low of 2.32%).
In contrast to this move in rates, stocks are sitting on record highs, if not making new record highs. Oil has been stable in a $50-$55 range. The dollar isn’t doing much. Implied volatility on the stock market is dead. And commodities are relatively quiet, except for gold.
On that note, yesterday we looked at the tight correlation of the inverse price of gold and yields since the election (i.e. gold goes up, yields go down). And in recent weeks, yields have been lagging the strength in gold, making the case for even lower yields to come.
We looked at the below trendline on the 10-year yesterday that was testing… that gave way today.
This move lower in yields puts both the Trump administration and the Fed in a much more comfortable spot.
A continued rise in market interest rates would force the Fed to be more aggressive, both of which would work against fiscal stimulus, dulling the contribution to growth, if not neutralizing it all together. Higher rates would slow the housing market and slow spending, especially in a fragile economy. Among the things to be worried about, higher rates, too soon, could be the biggest (bigger than protectionism, European elections…)
President Trump was said to be asking for advice on the administration’s view on the dollar overnight. I suspect the upcoming meeting with Japan’s Prime Minister (and co.) had something (a lot) to do with it. This is precisely what we’ve been talking about. The dollar and the yen are squarely in the crosshairs for this face-to-face meeting. But Trump may learn from the meeting that he would far prefer a stronger dollar and weaker yen, than a 4-4.5% ten year yield by the end of the year.
As I’ve said, Japan’s QE policies, which weaken the yen, also offer an anchor to U.S. interest rates, keeping them in check. I suspect the softening of U.S. yields, as all other markets are quiet, may have something to do with Chinese money leaving China (as we discussed yesterday). But it also may be influenced by Japan, finding the best, safest parking place for freshly printed money (i.e. buying U.S. Treasuries, which pushed down U.S. rates) – and showing that benefits of that influence to the new President.
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Remember, it wasn’t too long ago that the world was sitting on every word uttered by a central banker. Those days are likely over — at least to the extreme extent of the past decade. For now, Trump has supplanted central bankers as the most powerful policy maker in the world.
Still, the Fed will meet following their rate hike last month, the second in their very slow hiking cycle – 1/4 point hike twelve months apart. They’ll do nothing this week, but the data tends to be going as desired by the Fed, and other major central banks for that matter (aside from Japan) — meaning, inflation has recovered and is nearing the target zone.
Remember, this time last year, the world was staring down the barrel of DE-flation again. Inflation, central bankers have tools to combat. Deflation is far more difficult, and far less predictable. It can spiral and grind economies to a halt. When consumers are convinced prices will be cheaper in the future, they wait. When they wait, economic activity stalls. With that, deflation tends to create more deflation. The fear of that scenario, and the potential of an irreversible spiral, is why central bankers were cutting rates to negative territory last year.
Where was the imminent deflationary threat coming from? Slow economic activity, but mostly a crash in oil prices.
Central bankers have the tendency to change the rules of the game when it suits them. When inflation is running hot, they may hold off on tightening money by pointing to hot “food and energy” prices. These are temporary influences, as they say. Interestingly, they are much more aggressive, though, when oil prices are creating a deflationary threat – as they did last year.
With that, oil prices have doubled from the lows of last February. So it shouldn’t be too surprising that inflation numbers are rising, and getting close to the desired targets (around 2%) of the central bankers of the U.S., Europe and England.
So will we see a turning point for global central banks (not just the Fed) in the months ahead? The world has already been pricing in the likelihood that the pro-growth policies coming from the Trump administration will take the burden of manufacturing economic recovery off of the central banks.
But we may find that “transitory oil prices” will be the excuse for more inaction by the Fed, and continued QE from the ECB and BOE in the months ahead, which may result in a slower pace of rate hikes than both the Fed projected in December and the market has been anticipating.
Higher rates at this stage: 1) creates problems for the housing recovery, 2) promotes more capital flight from emerging markets like China (which means more dollar strength),and 3) threatens to neutralize the fiscal stimulus and reform coming down the pike for the U.S.
In December, the Fed dialed back their talk about letting the economy run hot (i.e. staying well behind the curve on inflation to make sure recovery is robust). We’ll see if they switch gears again and start explaining away the inflation numbers to oil prices.
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The Trump agenda continues to dominate the market focus as we entered the second week of Trumponomics.
To this point the market focus has been on the pro-growth agenda. With that, stocks have been higher, yields have been higher, the dollar has been higher, and global commodities have been broadly rising. Meanwhile, gold (the fear trade) has been falling and the VIX has been falling, toward ultra-low levels. The VIX, like gold, is a good market indicator of uncertainty and/or fear.
Let’s talk about the VIX…
The VIX measures the implied volatility of options on the S&P 500. This is a key component in the price investors pay for downside protection on their portfolios.
So what is implied volatility? Implied volatility measures both actual volatility and the options market maker community’s expectations (or perception of certainty) about future volatility. When market makers feel confident about the stability in markets, implied vol is lower, which makes the price of options cheaper. When they aren’t confident in stability, implied vol goes up, which makes the price of an option go up. To compensate those that are taking the other side of your trade, for the lack of predictability, you pay a premium.
With that in mind, on Friday, the VIX traded to the lowest levels since the days before the failure of Lehman Brothers. That indicates that the market had (or has) become a believer that pro-growth policies, combined with ultra-easy central bank policies have created a buffer against the downside in stocks. But that perception of downside risk is changing today, with the more vocal uprising against Trump social policies. You can see the spike (in the far right of the chart) today…
So as big money managers were closing the week last Friday, looking at Dow 20,000+ and a VIX sliding toward levels not too far from pre-crisis levels, buying downside protection was dirt cheap. This morning, they’re paying quite a bit more for that protection.
With that said, this pop in the VIX and the Dow trading off by more than 100 points today gets a lot of attention. But is there justification to think that market turbulence will begin to reflect the turbulence and division in public opinion toward Trump policies? Just gauging the extent of the market reaction from the VIX today, it’s unlikely. The chart below is the longer term view of the VIX.
My observations: The VIX has had a small bounce from very, very low levels. On an absolute basis, vol is still very cheap. When there is real fear in the air, real uncertainty about the future, you can see from the spikes in the longer term chart above, the premium for the unknown gets priced in quickly and aggressively. Given that there has been virtually no risk premium priced into the market for any falter in the Trump Presidency, or the execution of Trump policies, the moves today have been very modest. And gold (as I write) is barely changed on the day.
We are likely entering an incredible era for investing, which will be an opportunity for average investors to make up ground on the meager wealth creation and retirement savings opportunities of the past decade. For help building a high potential portfolio for 2017, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
The S&P 500 traded up to new record highs today. This morning the new President had three more big American business leaders (the car makers) in the White House for a face-to-face.
The three big American car makers all had big stock performance on the day, and their leaders walked away with very positive remarks (not dismay). It turns out that logical business operators like the prospects of doing business with the tailwinds of pro-growth economic policies.
Now, with Obamacare on the chopping block for the new administration, today let’s take a look what healthcare stocks might do.
Healthcare stocks in general have been beaten up since July of 2015, when a Republican Congress brought a vote to repeal Obamacare. The S&P 500 is up 7% from that date. The XLF (the ETF that tracks healthcare stocks) is down 9% in the same period.
Before that, Obamacare had been a money printing machine for much of the healthcare industry.
In this chart below, of the health insurance provider, Aetna, you can see the impact of Obamacare on the stock.
And here’s a look at the hospital company, HCA, also a big winner under Obamacare.
So what happens under Trump care? Trump has said he wants to keep people insured. It sounds like a rework to a more competitive system, rather than a tear down and rebuild. The first sign of visibility on a new plan is probably the greenlight to buy the healthcare ETF, and maybe the under performers in the Obamacare era.
For help building a high potential portfolio, follow me in our Billionaire’s Portfolio, where you look over my shoulder as I follow the world’s best investors into their best stocks. Our portfolio more than doubled the return of the S&P 500 in 2016. You can join me here and get positioned for a big 2017.
For the skeptics on the bull market in stocks and the broader economy, the reasons to worry continue to get scratched off of the list.
