Macro, Markets, and Malarkey

Stocks and Bonds
It feels like forever ago, but back in February, the S&P 500 hit its lowest level since 2014 as global growth fears spooked investors, leading to liquidations and deleveraging—most notably for sovereign wealth funds.

Fast forward to now…as of the end of July 2016, the S&P 500 closed at 2,173.60—up 7.5% from the beginning of the year. And, 10-year treasury yields started the year at 2.24%; as of the end of July 2016, rates were at 1.46%—a 35% decline in yield from the beginning of the year. These are big movements in both domestic stock and bond markets which investors shouldn’t take lightly.

Fig1_S&P+10yrTreasury

Also, more than $11 trillion in negative yielding bonds are outstanding, largely in Europe and Japan. The Financial Times wrote a great piece recently highlighting the post-Brexit surge in investor bond purchases.[1]

Fig2_GlobalNegYieldSovDebt

This means that if an investor holds one of these bonds until maturity, they actually lose money. They are also paying the issuer for the right to own these bonds, versus receiving some sort of payment in return—as Finance 101 teaches us should be the case. Governments with massive stimulus policies (ECB, Bank of Japan, and now the Bank of England) are buying up bonds, bidding up the price of these bonds and thus sending yields negative. Accelerating the decline in yields is the fact that the supply of such bonds is not ample enough to meet this demand. Negative yields are supposed to entice investors to invest in other assets, since they clearly lose money by investing in such bonds. This hasn’t happened. And yes, this is completely backwards and deflationary.

Currencies and Commodities
Currency markets have not been immune to this storyline; as Europe and Japan use monetary policy to help grow their economies, foreign investments flow to the US for its higher yields. Since May, foreign buying coupled with more hawkish Fed speak has strengthened the US dollar versus other currencies.

Fig3_USDollarIndex

If the US dollar continues to strengthen or simply stays strong on a relative basis, this has the potential effect of placing a lid on US inflation. The stronger the US economy gets versus its global counterparts, the stronger the dollar looks versus other currencies.

A strong dollar is usually a negative for commodities. And in fact, the strong dollar has kept commodity markets mostly in check since early May, as we wrote about in Commodities at a Crossroads. Of note, crude oil fell to under $30 a barrel earlier this year, sliding alongside the S&P 500, touching its lowest levels since May of 2002. It then spiked to above $50, and now hovers just north of $40 due to dollar related price pressure—nearly 20% below its peak in June of $50.11.

The US Economy and Election
That’s not all. We’ve barely discussed the domestic economy. Here at home, despite anemic GDP growth of 1.2% for Q2, economic growth is indeed expanding as evidenced by the latest payroll and hiring figures. Non-farm payrolls increased by 255,000 in July on a seasonally-adjusted basis, with the unemployment rate at a very healthy 4.9%. Wage growth and labor market improvements here in the US makes a strong case for the Fed to raise rates. Our view is they should raise rates in September, ahead of the election. Whether they will or not remains another question.

Lastly, and as an homage to Vice President Biden’s favorite saying, “malarkey,” rhetoric around the US election has truly captured the American public, including ourselves. We are seeing raw democracy at work here and elsewhere. People are voting against the establishment; it’s a small segment of the human race, but it affects us all. In the meantime, it may become clearer that at extremes, when enough of the populace is truly feeling disadvantaged, capitalism has to make some changes. Otherwise capitalism and democracy are not going to work when the rule of law favors a few as opposed to the many. While this line of thinking may be too philosophical for a financial markets blog, it merits consideration because it does affect one’s view on investing.

Thus far financial markets have not reacted to the election news melee, but investors should pay attention. Should the Republicans lose their majority in the House and Senate, and Hillary Clinton is elected, this could have a dramatic impact on GDP as government spending will very likely increase…then again, it will also increase if Trump builds his wall.

What Should Investors Do?
Stocks can be at record highs throughout the year. The reality is that it doesn’t take much of a move to set a new record high when you have just made one. Odds are we will see low growth for the rest of the year, maybe the rest of the decade. One should expect dispersion by country and company with thoughtful, well analyzed decisions to make on what to own. This is going to take real professionals who are either doing real fundamental analysis or machine learning or can take advantage of the volatility and the anomalies. It’s going to be a different market. We all know that global and country growth comes from demographics and technology (of which productivity is a subset if you can measure it). But, there is a payback when the easy money goes away, causing slower growth than the demographics and technology would suggest.

In light of this, our view is that investors should have two areas of their portfolio well covered. First, there are downside risks to the market right now. Ignoring this fact would potentially leave one’s portfolio without a buffer, and we believe every portfolio needs uncorrelated assets. While it is self-serving to advocate for managed futures, Altegris has a focus on managed futures because time and time again they have performed during some of the worst periods for traditional equity markets.
Fig4_PR_ManagedFuturesPerfDuringEquityMarketStress_1288-NLD-882016

Equity markets could continue to push for new highs, but we believe they are also susceptible to periods of steep losses. Managed futures performance has historically been uncorrelated to the performance of the broad stock market, and we strongly believe all investors with risk capital should consider this diversifying return stream, given the current macro picture.

The second bookend to investors’ portfolios, given the market environment, is private equity. Private equity was one of the few areas that didn’t sell off when investors panicked earlier this year, and whose returns can be orthogonal to the returns of traditional markets. Now, private equity is not a liquid investment option, so investors must be thoughtful in terms of just how much they allocate. But it is the forgoing of frequent liquidity that makes private equity attractive in our opinion. This is what is commonly referred to as the illiquidity premium, which is essentially the potential reward of enhanced returns—over time. This potential for enhanced returns may be particularly attractive for investors given the uncertainty in traditional equities at present.

The bottom line is that investors should aim to diversify portfolios. Look for ways to grow and preserve capital in your portfolio and seek returns in areas where investment managers have a real edge and understanding of the underlying investments. Pay attention, and invest for the future of your portfolios.

 

Data sourced from Bloomberg unless otherwise specified.

[1] Financial Times, June 29, 2016: http://www.ft.com/fastft/2016/06/29/negative-yielding-sovereign-debt-rises-to-11-7tn-globally/

Preparing for the Unemployment Numbers in December and January.

Don’t expect much help reading the economy or the markets or the Fed

The initial weekly claims data for the week ending December 26th showed a seasonally-adjusted increase of 20,000 from the previous week and raised the 4-week moving average by 4,500 to 277,000. The Department of Labor did note the instability of seasonal factors around the holidays. These numbers still suggest a tight labor market as we find ourselves with one of the lowest 4-week moving averages in history, certainly relative to the total labor population.

Fig1_Unemployment-IC-to-CLF

Reproduced with permission from Doug Short, PhD. Copyright 2015. Advisor Perspectives, Inc.

This coming Friday we will see what happens to the employment numbers for the month of December. More importantly, we will see what happens to hourly earnings and other measures of wages. I have already made the point that one has to take any forecast estimates for 2016 with a grain of salt. One will actually have to take the reported labor numbers for December and January with several grains of salt. “Grain of salt” is an appropriate expression for the labor statistics. The use of Pliny’s phrase regarding a seasoning to reduce the effect of poison or, in modern terms, to imply a bit of skepticism, has to do, for these months, with the seasonal adjustment factors. As the table below shows, the not-seasonally-adjusted numbers in December and January, have historically been negative. January, in particular, has been a big month for layoffs following the holiday season and general corporate timing on staffing decisions. The employment rolls go down by two-and-a-half to three million real people. The sizable negative numbers have typically produced a positive seasonally-adjusted number when the economy is not in free fall. We tend to focus on the seasonally-adjusted number making profound statements about the direction and degree of change. If someone can show me the consistency in the formulae to produce these seasonally-adjusted numbers, particularly given the impact of holidays and weather, I will be happy to remove a few of the grains of salt when discussing the data. As I have said before I have never met a seasonally-adjusted person.

Fig2_TBL_Blog_EmploymentNos_Nov-Jan_2008-2016_010416v2

Our focus will be on the wage data as we move through the year. The numbers for December may produce a reinforcement that wages are rising. The year-over-year numbers may have more value than the monthly changes. We believe this will be a focus for the Fed. However, given the issues around first quarter data, among other variables, it will likely lead to no further action on their part until well into the year. This should also be a focus for investors relative to expectations for corporate earnings and, possibly, inflation away from the impact of lower energy prices.

As I said, one has to take all of these numbers with a grain of salt, certainly until we get through what has so far been a mild but disruptively wet winter. We won’t get much help in figuring out what securities to buy from the macro data such as employment. This will be a year when focus on the micro becomes critical. Pay attention.

STA Money Hour—The Economy, The Markets, Oil, and Investing

A week ago I was in Houston for a presentation and was able to spend an hour with Mike Smith and Luke Patterson on their radio program, which provides some very good financial insights to the local listening audience. I had just come out of a presentation so was loaded with information, which they proceeded to extract from me in a useful fashion for their audience.  We discussed some history of the markets, Harry Markowitz, the current outlook, and of course, being in Texas, the energy situation.  It was an interesting session with some great questions. You will have to listen to check out the quality of the answers. It is worth visiting their archives. They have had some interesting guests who have covered a wide variety of topics. I would recommend visiting their website and view some of the archives.

Part 1:

 

Part 2: