Pro Perspectives 11/12/19

November 12, 2019

Trump touted the strength of the economy in a speech at the Economic Club of New York today.
Market folks were looking for something new. They didn’t get it.
Most were looking for him to implode the status of a China trade deal. I was listening for some hints on turning focus to infrastructure–the yet to be addressed big pillar of Trumponomics. What we did hear, loud and clear, was another hammering of the Fed, which I suspect is related. How?
How do you pay for a massive infrastructure spend (maybe in the neighborhood of $2 trillion)? An infrastructure bond.
By orchestrating an indefinite trade war, Trump has forced global interest rates back toward record lows (if not beyond). If he had his way, the Fed would have slashed rates more aggressively, and market interest rates on our sovereign debt would have plunged into negative territory, as it has for much of the rest of the world (including Europe). Consider this: In August Germany sold 30-year government bonds for zero interest!
Trump may have a chance to sell a 50- or 100-year infrastructure bond, not for 0% interest, but maybe for 2%-3%. That’s still incredibly cheap money, and the global demand (given the state of global rates) should be plentiful.

Pro Perspectives 11/8/19

November 8, 2019

As the prospects of inking a limited trade deal have risen, so has the yuan.

The PBOC has walked UP the value of its currency over the past month.

Remember, on October 11th, Trump said we have a deal, which includes an agreement on “currency issues.”  That means, a stronger yuan, weaker dollar.

That’s what China has manufactured, thus far.  Here’s a look at that chart since …

In the chart above, the falling line represents a strengthening yuan versus the U.S. dollar, and vice versa. 

The next chart gives some bigger picture on what the Chinese have done with their currency, in response to Trump and economic weakness.  Let’s step through it (as we have in the past), and then talk about what it means for the discussion on a rollback of tariffs.
1) They slowly allowed the currency to climb (against the dollar) following threats of a big tariff on China from Graham and Schumer (yes, Schumer) back in 2005.
2) When the global economic crisis hit, they went back to a peg to protect their ability to export. 
3) They went back to a slow crawl higher as tensions rose, and people began to believe the developed market economies might be passing the torch to China for economic leadership. 
4) It became clear that China can’t grow fast enough in a world where developed market economies are struggling. So, they went back to weakening the currency to protect their ability to export. 
5) They strengthened the yuan when Trump was elected to try to ward off a trade war.
6) Trump wasn’t placated and tariffs were launched. They weakened the currency with the idea that a threat of a big one-off devaluation in the currency might create some leverage.
7)  After trying to hold-out, it seemed clear earlier this year that they needed to get a deal done, as the economy continued to sink.  They walked the currency higher again – a signal that they are willing to make aggressive concessions to get a deal done. 

8) But Trump escalated the trade war with bigger tariffs, and the Chinese made one of the largest devaluations in the yuan in years (a warning shot).

9) And now, we have what looks like the Chinese executing on a currency agreement (in principle).

With all of this said, what you’ll notice from the chart, is that a Chinese agreement to a 15% REvaluation of the yuan will only take us back to the levels of 2018, levels at which China had already conceded in efforts to keep Trump’s tariffs at bay.  It didn’t work.  Trump fired off tariffs anyway.  And China simply offset the tariffs by moving the exchange rate.

With the debate over whether or not a deal will come with a rollback of tariffs, it seems clear that an agreement on currency can/will only come if tariffs are rolled back.

 

Pro Perspectives 11/7/19

November 7, 2019

We’ve talked about the ingredients in place for a “melt-up.”  And it’s not just stocks.  It’s an economic “melt-up” scenario. 

Remember, back in ’95 when the Fed did a u-turn on monetary policy, stocks went crazy and so did the economy.  The economy did 4%+ growth for eighteen consecutive quarters.

So, we’re beginning to see broader global financial markets react to a world where indefinite trade war overhang has been cleared from a fundamentally strong economy with tailwinds of fiscal and monetary policy.

We’ve seen stocks on the move.  Now yields are making a move – with big technical breakouts.

Here’s a look at the U.S. 10 year yield …
Here’s a look at the German 10-year yield, moving aggressively from deep negative yield territory …

Remember, as we discussed last week, “the history of the past decade tells us … despite the fact that central banks are buying government bonds, bond prices go down (yields go UP).”  That’s what we’re getting.

And when yields go up, gold goes down.

Why does gold go down?  Because when people fear an indefinite trade war, if not a trade war leading to military war, they buy bonds and they buy gold.  When this fear is removed, they exit the fear trade.  That means yields go higher, gold goes lower. You can see this inverse relationship since Trump launched tariffs early last year. 

But gold will find it’s bid again.  When?  When inflation starts to move.  And within the scenario of economic boom, and very low inflation expectations, the move in inflation, when it finally takes hold, will probably be aggressive.

The first signal will likely come from broad commodity prices.  Keep an eye on this chart, which has broken a huge trendline …
Pro Perspectives 11/6/19

November 6, 2019

If we look at the performance across the stock market since the Fed flipped directions on monetary policy (July 31), value investing is making a big come back.  Morningstar’s US Value index has outperformed the US Growth index by five-to-one — in just a thirteen week period.  

The tide has turned  on the “great disrupters” (FAANG) and Silicon Valley.

With the prospects of a trade-war-absent global economy going forward (at least over the next year), there is a growing likelihood (in my view) of an economic boom.  That would coincide with continued regulatory screw tightening on the disrupters.  And with that, those companies and industries that have been disruptED, are in the position to regain market share.  That’s where there is tremendous pent-up value in the stock market, even as it sits at record highs.

With this in mind, I want to revisit one of my Forbes pieces from April where I discussed the prospects for the end of the exuberant tech cycle in Silicon Valley …
Lyft was valued at close to $25 billion when shares started trading on Friday.  Today, it’s down as much as 20% from the Friday highs.
In the buildup to the IPO, the last private investment in the company came in June of last year, and valued Lyft at $15.1 billion.  Those investors had a paper gain of over 60% on Friday, for just a 9-month holding period.

For everyone else, remember, you’re looking at a company that did a little over $2 billion in revenue, while losing almost a billion dollars. Most importantly, over the three years of data that Lyft shared in its S-1 filing, revenue growth has been slowing and losses have been widening. 

So, you’re buying a company that hopes to be profitable in seven years, to justify the valuation today. Keep in mind, this is a company that has only existed for seven years. To think that we can predict what the next seven will look like, in the ever changing technology and political/regulatory environment (much less economic environment), is a stretch.

For some perspective on these valuations, below is what it looks like if we compare the three largest/dominant car rental car companies (Enterprise, Hertz and Avis) to the two largest/dominant ride sharing companies (Uber and Lyft).

With Uber now expected to be valued at around $120 billion when it goes public (possibly this month), the ride sharing industry is valued at about 14 times the car rental industry.

The rental car industry has been priced as if the ride-sharing industry has all but killed it.

Ironically, if the ride sharing movement is to succeed in the long-run, and is to fully reach the potential that is being priced into the valuations today, then they will need these car rental companies to supply and manage the fleet of vehicles required for Uber and Lyft to scale. If this industry does indeed prove to be the future and ‘high growth’, these car rental companies will be right in the middle of it (indispensable).

With the above in mind, this valuation gap clearly shows a disconnect from that reality.

It also reflects the regulatory and policy advantage Silicon Valley has enjoyed for the past decade (which is ending).  It shows the displacement of capital from Wall Street to Silicon Valley (as a result of those advantages).  And it likely shows the exuberance stage of the cycle.

I suspect the Lyft (and Uber) IPO might mark the end of the boom cycle for Silicon Valley.

Here is the chart on Lyft since it went public …

 

Pro Perspectives 11/5/19

November 5, 2019

As we discussed in my October 11th Pro Perspectives note, when Trump stood in the Oval Office and ceremonially shook hands with the Vice Premier of China, “the intent was clearly to signal the end of the trade war, to clear the overhang of uncertainty on markets, and move any further phases of negotiations to back burner issues for the global economy.”

With the evidence building that we’ll get a signed “Phase 1” deal, and with the fog of negative global economic sentiment slowly beginning to lift, it does indeed look like the handshake moved “trade war” off of the front burner.

You can see what stocks have done since that took place: virtually straight up, with 10 higher highs over 17 days!

For those wondering how far this can go?  Keep in mind, with the removal of trade war from the global economy, we get to see what the unfettered power of fiscal stimulus, structural reform and ultra-easy global monetary policy can do for a U.S. economy that already has very solid fundamentals (record low unemployment, record household net worth, record consumer credit-worthiness, a record low household debt-service ratio, well-capitalized banks, low inflation, affordable gas).

For stocks, the question is, how much growth did a 21-month trade war “stunt”? We still have a forward P/E on the S&P 500 of less than 18, in an interest rate environment that should warrant north of 20 (if not well north of 20). And that doesn’t factor in the potential for rising earnings prospects in an environment over the next twelve months that won’t (we assume) have the overhang of an indefinite trade war. Just a 20 P/E on forward earnings gives us an S&P 500 north of 3,500.
Pro Perspectives 11/4/19

November 4, 2019

We have what looks like a melt-up brewing into the year end. 

And given that this is a bull market with plenty of non-believers, expect institutional investors to start pouring into higher beta stocks, as they scramble to get find some extra return.

If we look across the broad index returns, the S&P 500 is now up about 23%.  That’s almost three-times the long run annualized return on the broad market.  It’s no surprise this index is leading the way globally, given the S&P 500 is the proxy for global stability and risk appetite.

Meanwhile, the Russell 2000 (small caps) is trailing, up 18%.  Let’s take a look at the chart …

While we’re running to new record highs in the blue-chip stocks, small cap stocks are still 8% off of the highs of August of last year.  But as you can see in the chart above, we have this series of highs in the index that are being tested. It looks like a breakout is coming.     

If look back at the July Fed meeting, where they officially flipped directions on the policy path (from tightening to easing), value stocks have been the clear leaders — far superior to growth stocks.  And small cap value has trailed large cap value.  With the technical setup above, and the need for managers to “catch-up” that performance gap might close quickly.

 

Pro Perspectives 11/1/19

November 1, 2019

As we enter November, we continue to track the path of this 1995 comparison we looked at to begin the year. 

Remember, back in ’94, the Fed was overly aggressive in raising rates and choked off the momentum of economic recovery.  That left a world where the best producing major asset class was cash.  By 1995, they were forced to reverse course on the interest rate path (from tightening to easing).  And that unleashed a boom in stocks and the economy over the next four years.

Last year (2018) looked a lot like 1994.  With that, back in December, we laid out this scenario for a repeat of 1995 — and we’re getting it.

Like in 1995, the Fed has reversed course on rates.  And like in 1995, stocks are up big.  But we have the ingredients in place to see an even bigger finish into the end of the year.  Remember, in ’95 stocks did 36%.  Stocks finish today up 22%, with two months remaining in the year.

And we now have the Fed back in defensive mode.  They have reversed a shrinking balance sheet by $200 billion already, and have told us they will pump nearly half a trillion dollars worth of liquidity into the global economy by the second quarter.   And the ECB has started buying assets again, as of today.

As I’ve said, while most have been looking for the next recession around the corner, by early next year, they may find themselves in an economic boom instead. 

Pro Perspectives 10/31/19

October 31, 2019

Tomorrow we get the October jobs number.  This report is expected to come in below 100k, and may create some noise. 

But with a 3.5% unemployment rate and a jobs market adding new jobs at around 175k a month over the past twelve months, jobs data (at this point) won’t reflect a change of course in the hiring/jobs outlook.

On the other hand, we can see the uncertainty of an indefinite trade war adjusted for by businesses in a more agile way in the manufacturing data — as businesses pull back on new orders and investment, to wait and see.  And that has been where we’ve seen the softness.

And we had another soft number today.  The Chicago PMI came in at the lowest reading since December of 2015.  That happens to be the month the Fed started its normalization/rate hiking campaign.

Here’s what that look like on the chart …

This time around, relative to late 2015, the Fed is going in a very different direction (cutting and expanding the balance sheet). 

And, as we’ve discussed, this slump in manufacturing, along with a slide in stocks early this month, is why both parties (the U.S. and China) came to the table to show the markets they were ready to deal – an attempt to reduce if not remove the uncertainty overhang. With the end of October, we’ll see how aggressively a “Phase 1” deal, assuming it gets done, can swing this manufacturing data back in the other direction.

Pro Perspectives 10/30/19

October 30, 2019

The Fed cut rates again today, meeting the market’s expectations.

Remember, just 10 months ago, they made the ninth rate hike in three years, and arrogantly told us that quantitative tightening was on “auto pilot.”

Since then, they’ve stopped QT, cut rates three times, and started expanding the balance sheet with an eye toward buying almost half-a-trillion dollars worth of Treasury bills by the second quarter of next year.

While the media has a fun parsing words and hints about whether or not the Fed could cut rates again, or pause, it’s the global balance sheet where all of the attention should be.

Let me repeat, the Fed has told us (earlier this month, and Powell tried to explain for a second time today) that it plans on buying close to (maybe more than) half-a-trillion dollars of Treasury bills.  That’s aggressively expanding this balance sheet that has already stopped shrinking, and now grown by more than $200 billion since September.
And it is primarily because of this problem — the yield curve inversion of the 3-month tbill to the 10-year note.  This was driven by the mistakes of the Fed’s quantitative tightening program, and proved (the inversion) to be not just a signal, but a real liquidity problem for short-term interbank loan market.

So, the Fed is “replenishing” global liquidity.  And the ECB is scheduled to do the same, starting Friday.  The Bank of Japan meets tonight.  Will they join the party?

The BOJ is already in unlimited QE mode as buyers of unlimited 10-year Japanese government bonds (when necessary), to keep the yield pinned near a zero yield.  However, Kuroda has hinted that they might add a twist to their QE by controlling the yield curve at the shorter end of the government debt market (following the lead of the Fed).

Bottom line, as history has shown us, this should all be very positive for global asset prices (they go UP).

Pro Perspectives 10/29/19

October 29, 2019

The Fed decides on monetary policy tomorrow. 

The interest rate market is pricing in a 97% chance of a 25 bps cut — leaning heavily in favor of a third consecutive rate cut in this flip-flop campaign.

This, despite a very different climate than they entered for their September meeting, where they cut for a second consecutive time.

Then:  In September, the uncertainty of an indefinite trade war was at peak levels.

Now: Three weeks later, Trump and the Chinese Vice Premier shook hands in the Oval Office on a limited deal.   

Then: We were closing in on an October 31 deadline for Brexit that was looking like a “no-deal” was coming.

Now: Four weeks later, we have an agreement on Brexit terms between the UK and EU.

With these developments, what is the Fed thinking?

We did hear from the Fed Chair on October 8th at an economic conference.  He made a few very important statements that should give us clues on what tomorrow’s announcement and press conference will look like — and these clues support the market’s view toward a rate cut. 

Back on October 8th, Powell said:

1) “In the 90s the Fed added support to help the economy gather steam, that’s the spirit in which we are doing this (easing).”  The Fed cut three times over a six month period starting in July of 1995.

2) “There are concerns surrounding business investment, manufacturing and trade.”  On October 1, the ISM report showed that manufacturing contracted for a second consecutive month in September.

3) The “time is now upon us” to expand the balance sheet.  The Fed is back to expanding the balance sheet in response to a disruption in short-term lending markets stemming from the Fed’s quantitative tightening program (i.e. the Fed is in the mode of reversing its over bad policy/overly-aggressive tightening mistakes).

So, despite the clearing trade war overhang, the above three comments from the Fed three weeks ago should keep the Fed on track tomorrow for another cut.