Spinning fantasies is catching on globally. Here’s how Bank of Japan Governor Haruhiko Kuroda addressed the audience at a recent conference discussing the state of affairs in that country:

“The issues I have raised so far are all complex, and there are no quick, definitive solutions for them. Nevertheless, I strongly believe that, at this one-and-a-half day conference, we will address the issues we currently face and find our way forward through lively discussions. I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.’ Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions.”

Mr. Kuroda is having about as much luck with money printing there as the Fed did here. It is not working to drive the real economy towards sustainable growth and it has also fouled up the functioning of the local bond market.  With the pressure building, apparently the BOJ thinks that all the long-suffering Japanese need to do is think “happy thoughts.”  It’s not the policy; it’s the mental state of the people who just don’t get the wonders of QE according to Kuroda’s reasoning.  His comments suggest exasperation and fatigue to us.  

We had mentioned in our prior letter that political winds were blowing against Fed policy and in May it became crystal clear that it too is feeling intense pressure.  GDP growth for the first half of this year is looking pretty close to 0-1%.  In addition, inflation, according to the Fed’s favorite measure, Core PCE (Personal Consumption Expenditures) is running at a historically low 1.2%.  Remember, for whatever reason, the Fed wants us all to pay more for things, so that inflation number does not make it happy.  

To combat uneasiness, the powers-that-be have decided to delve further into the absurd to make their angst over QE’s ineffectiveness go away.  Last month, the San Francisco Fed, the former home of Ms. Yellen, released research that declared that seasonal adjustment factors were to blame for weak first quarter GDP data.  Apparently, that data, which is already heavily massaged to account for the typically lower economic activity during winter months, needs to be seasonally adjusted some more in the researchers’ estimation.    Quite soon after that release, the BEA (Bureau of Economic Analysis) said it was re-working the numbers. 

GDP data had already been doctored in recent years to include intangibles.  Anything for the perception of growth! Over in Europe the deciders have taken to estimating illegal drug and prostitution spending and adding those to GDP. We are not joking.  After all, given the wonders of extreme central bank policy, it simply could not be possible that growth was negative in the winter quarter in the U.S now could it?    Fed Chair Yellen has not employed a fairy tale analogy yet like Mr. Kuroda, but she does not mind if what many consider to be the most important indicator, the quarterly GDP estimate, turns into one.    

Most of the other economic reports across the globe have come in decidedly weak for much of this year. We have looked at a lot of earnings releases the last few weeks and read company comments in many industries.  In general, those views are closer to the GDP numbers before the BEA has another “whack” at them.  Most retailers not only reported poor sales for the first quarter, they sounded less than optimistic for the second.  In addition, capital goods orders are slow and the industrial economy seems softer than the surveys or employment numbers suggest. W.W. Grainger, a leading industrial supplier, just reported that last month’s daily sales were flat versus May 2014. That does not happen very often. It makes sense though because industrial production has grown at only 1.4% over the last year.  Elsewhere, wholesale inventories are entirely too large relative to sales.  

The Atlanta Fed second quarter GDP estimate is now running at only 1.9%.  Rail traffic was down 0.6% for the first five months of this year.  True, auto sales were quite strong for May, but that period included an extra weekend and unusual employee discounts for the masses to “move some metal.”  Subprime lending and extended loan terms are other big supporting factors, but dealer inventories are now high.  You do have to read the fine print or you might think it was real organic sales growth.  The May employment report had the typical strong headline number, but only 7,000 manufacturing jobs were added in a continuation of a weak trend.  That is not getting it done, yet the Fed wants to “Peter Pan” its way to into its tiresome sustainable growth propaganda mode in spite of the preponderance of evidence that suggests otherwise.    

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

It is simply a perfect confluence of events when yesterday the Federal Reserve told us in the afternoon that things were getting better just after the package delivery giant Federal Express had told us in the morning that the economy was worse than thought.  Suffice it to say we trust the Federal that has to deal with the real world.  Broadly speaking, with the exception of the euphoric Chinese stock market, equities have lost a lot of momentum and breadth is deteriorating as the year progresses.  In particular, transportation stocks and some higher quality equities are off meaningfully from their highs in the U.S.  Bond markets, especially in Europe, have suffered big hits in spite of the ECB QE efforts and global currencies are suffering renewed bouts of volatility as investors try to come to grips with the difference between what common sense tells them and what the central bankers doth mandate.

Market participants seem to be quite tired of hanging on every utterance from a central banker and the central bankers are tired of being in charge because that requires them to accept responsibility for efforts that are just not working.  Policy failure is causing all of the deciders and their cheerleaders to describe the current soft economic environment as much stronger than the numbers are suggesting so they can deflect criticism and keep the fantasy alive.  That is leading to higher rates, hurting rate sensitive sectors like housing.

The strong dollar was already a big enough problem for earnings.  The Fed would like to tighten policy just so that it has room to reverse course if the economic situation worsens.  Otherwise, it will have completed a cycle without ever really refraining from the emergency measures of zero rate policy.  That alone speaks volumes.

We think policy exhaustion has taken over markets and economies globally.  Problems ignored are not problems solved.  The leadership is turning to familiar as well as stranger antics to try to return a sense of normalcy to a highly abnormal landscape. After being given billions more in debt assistance over the last few years, Greece has failed to make a scheduled payment to the IMF.  Deposits at local banks are cratering and the economy remains a basket case.  Greek bond prices now suggest a restructuring is nigh, though another extend and pretend is always possible.  Even if yet another lifeline is thrown to avert near term drama, the reality is that Greece needs to leave the Euro and lenders must accept more losses on a few hundred billion dollars of debt. Anything else is just gamesmanship and delay.

We are all tired of the “Greece is saved headlines” because we know a painful restructuring will have to occur at some point, but the deciders won’t let it happen because they would have to take more losses.  Instead, many of the parties involved would still like to act as if a default and Euro exit would not be a big deal while the ECB quietly slips a few billion more euros to Greece as if doing that might one day magically solve things.

It is a fantasy. 

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

The deciders at the central banks have told us things were getting better when deep down most of us have known otherwise. Reality is a relentless master and it intervenes at inconvenient moments.  Sustainable growth cannot be created out of thin air from a printing press in the Eccles Building, the home of the Fed.  It looks like the final GDP numbers will show that the economy shrank in the first quarter as we suspected it might.  The inventory build in that report is a cause for concern going forward.   Retail sales for April were flat, so the second quarter is starting soft as well.

The average consumer is sitting out of the Fed’s fictional recovery.  Their incomes are simply not growing.  Most of the pundits wonder why “Joe six-pack” cannot be goaded into taking on just one more dollar of debt.  That added debt might keep the party going for the markets, but that is the last thing already strapped borrowers need.  Total consumer borrowing is going nowhere in spite of a subprime lending bubble in autos and another bubble in student lending.    

When all the cheerleaders can point to in recent years is one small part of the monthly employment report and ignore everything else we have a problem.  They disregard the seasonal adjustments and other statistical gyrations that go into the employment numbers and the overall message of that report by just looking at the total number of jobs created in the establishment survey. However, even that number is beginning to show that job growth has moved into a slower gear this year. In addition, people not in the labor force hit a record at over 93 million people in April. In a continuation of the trend, the jobs that were created last month were heavily biased toward the part-time variety and went disproportionally to those 55 and over who cannot even think about retiring.  We also strongly suspect that the numbers still do not reflect that the fact that net new business formations are not as robust as assumed in the employment models, so jobs from small businesses are being overstated.  To top it off, we have added a grand total of 1,000 manufacturing jobs across the U.S. in the last two months.  Wow! That is a stunner you will not hear from many talking heads. Finally, the Fed’s own Labor Market Conditions Index has fallen by the most since 2012. 

Even at these very low levels of economic activity, though, equity markets are cheering the weakness because participants believe it keeps the Fed at bay and may lead to more QE.  That is their only hope.  One day it will dawn on investors that they need growth to justify stock prices because markets already reflect low discount rates and peak margins as far as the eye can see.  Without real growth, the number of companies whose cash flows shrink enough to alarm their stockholders will continue to build.  We speak from firsthand experience.  When one of our positions disappoints, it is the “same as it ever was.”  QE does not insure against 10-20% hits on the day of a bad earnings report.

Corporate earnings numbers have joined commodities prices in implying the cycle has turned lower.  Given soft economic growth, it is no wonder that expected “operating” or “fudged” non-GAAP earnings estimates for the S&P 500 for 2015 have dropped from a number around $137 a year ago to closer to $117 now.  That is a 15% hit to expectations, yet that index remains close to all-time highs.  Holy Fed bubble, Batman!  In essence, the equity market rallied powerfully for two years into a meaningful decline in expectations.    

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

We see our central bank and the financial markets beholden to it as in a gargantuan bind brought on by years of monetary experimentation that is not producing optimal results for most of the population to say the least.  The Fed’s desire to shift to a tighter stance is about two years too late, making it woefully out of step with the underlying or true economy as opposed to the speculative economy.  This speculation was given a new birth in recent years by a stubborn refusal to see that QE might be causing horrific distortions that made things worse in the long run.  Nonetheless, given our positioning, we are almost ambivalent about the Fed rate hike false drama.

Comments from Fed head Yellen in recent days seem to indicate she is now worried about high stock valuations and euphoric credit market issuance levels.  Other influential members of the FOMC are “jawboning” about raising short rates in a weak attempt to return some rationality and normalcy to markets.  They seem to have finally recognized the “monster” they have created.  Encouraging corporations to issue massive amounts of debt in order to fund stock buybacks has not been pro-growth, but it has been one of the most significant direct results of current policy.  Recently, treasuries and sovereign bonds of all types are selling off hard in preparation for a tighter Fed in response to the “jawboning.” Equities are suffering less turmoil than bonds for now, but are feeling some pressure.    

Global economies are collectively at their slowest points in years. Greece teeters on the edge of another restructuring.  That decades long growth engine known as China seems to be struggling with bad debt troubles as its economy shows clear strains.  It seems an astounding $20 trillion debt binge over the last decade or so might be catching up there.  GDP growth in Europe is near just 1%.  We cannot emphasize enough that such an environment is the polar opposite of what would normally move the Fed to tighten. 

While we applaud the Fed’s belated acknowledgement of ebullient equity and fixed income markets, it does not change the reality that we are in a predicament where speculative market activity from free money has taken on a manic life of its own that is virtually divorced from the real economy.  If that speculation is not stopped now, cleaning up the mess from the excesses will just become harder and harder, though we harbor serious doubts the Fed can muster the courage to do too much in the way of tightening other than talking about it. 

Six years of central planning with academics running the world’s largest economies will go down in history as the height of PhD hubris and our generation will be viewed as one that allowed monetary policy to drive the economy to a ridiculous degree.  We were effectively told the system was too weak to stomach dealing with writing down bad loans like we did with the Resolution Trust in the early 1990’s and that everyone but the banks must pay a high price for the banks’ mistakes of the last cycle.  In 2009 FASB (the Financial Accounting Standards Board) told banks they did not need to mark-to-market anymore and the fantasy began.

Having pushed stocks to the highest median valuation ever by virtually holding a knife to the necks of savers, our dear Fed has transformed the equity market into a call option on investor irrationality.  We do not trouble ourselves with determining how long levitation can continue because, as always, we are determined to align ourselves in concert with about one hundred years of market valuation data.  We wonder how long investors will be willing to pay twice the normal price for half the normal growth.  We also wonder how long central banks can remain relevant after their miracle cure has been exposed as “snake oil.”

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

Some pundits are pointing to a pickup in C&I  (Commercial and Industrial) loans as a sign of the malaise ending here, but we suspect that bump is likely tied to deal making and stock buybacks.  We just do not see any convincing evidence of a major pickup in bank lending when we look at the balance sheets of the big banks and now a recently released forward looking survey of credit managers has us thinking the spigots are closing.  No wonder small business optimism and hiring plans rolled over. 

We suspect that some business owners and consumers who may not be versed in analyzing the big picture financial data are making decisions that they might not if more informed.    Like us, Japan, China, and Europe have also seen each marginal unit of debt spurring less growth.  What’s more, if debt is just future spending brought forward, then real final demand in coming years is a major question mark.  Importantly, much of the debt created has been low power because it was not used to buy productive assets that lead to future growth.  

Suffice it to say that we suspect that a good portion of the business activity that has occurred since 2009 was predicated on the assumption that extremely easy Fed policy could continue with no negative effect to us from a QE counter-attack by our trading partners.  They were forced into the same shenanigans by our QE zeal.  The assumption has been that QE just must lead to growth!  Debt growth was confused with real income growth.  The notion that the music will never stop is still a common refrain, so any move to even a slightly less easy stance has and will produce an inordinately negative response.  

Economists from the Austrian school of thought, who for decades have routinely received nothing but derision from the Keynesians that dominate positions of power, predicted this debt exhaustion outcome decades ago.  The idea of solving over indebtedness with ever more debt, of course, has mostly been celebrated as brilliance by governments and central banks because it is what they like to do to stay in power and Keynes is still their hero.  Oh, for just one Austrian economist at the Fed…or, even better, just one of us from the “unwashed masses” that helps meet payroll at a real company somewhere other than a Wall Street bank!  We know, that’s pure and utter heresy.  

It now appears that with such a high percentage of the newly issued government debt being monetized through QE in places like Japan and now the EU, it is getting tougher for the central banks to find additional sources of debt to monetize. We still think the national central banks in Europe will struggle to buy enough sovereign bonds to meet targets because many sellers have so few choices for reinvestment and new capital requirements make alternatives much more costly to hold.  These factors are enormously important in a world addicted to money printing and it may mean that we have reached an upper bound to these foolish policies. 

Although we have learned that one can never be cynical enough in analyzing the realm of the deciders, we think the deflationary signal being sent by precious metals and other commodities may well be a sign that the central bankers are running out of room to manipulate markets and the news cycle at least for now.  However, because it is foolish for us to underestimate their “creativity,” we do own precious metals positions as insurance against more of the only trick the central bankers know and that is printing or otherwise debasing fiat currencies by holding short rates below the level of inflation.    

We suspect the Fed must be concerned over the fact that it dominates stock market activity to a degree that would have seemed laughable not that long ago.   We do wonder how long confidence can be maintained when it takes “sweet nothings” from the Fed to prevent panic every time the S&P 500 sells off even 1-2%.  After all, stocks cannot continue to go one way while the economy and earnings go another. 

We think investors are about as exposed to equities as they ever have been just as more doubts begin to surface about what QE has really accomplished.  The Fed is in the astounding and untenable position of needing to tighten to restore some semblance of discipline to euphoric markets just as the economy hits the softest patch in years.  Investors have been taught to fear nothing and leave risk management to the central banks.  The gap between the real economy and equities has never been wider in our view.

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

We are left with the façade of an equity market held aloft by the hundreds of billions of dollars of borrowed money companies are using to buy back stock instead of growing their business thanks to a Fed policy that encourages that deflationary tactic. The computers still bid at what appear to be pre-established points throughout the day, making our market appear as rigged as the emerging markets we used to ridicule.  However, as mentioned last month, earnings in corporate America are clearly turning meaningfully south and when the news is bad enough, the affected stocks are going that way too.  With equities broadly the most expensive ever, we do wonder who will buy stocks from current holders when they need to sell.  We call this “running out of greater fools” just as some important warning signs begin to flash.  For instance, it appears that margin debt at the broker-dealers may be rolling over and we have found that is often a key early sign of the party ending.

We continue to hunt for investment ideas, of course, but in the equity market most of the value is still on the short side if you rely on normalized free cash flow valuation.  That is no surprise when the median stock trades for more than two times historic averages on a price to sales basis.  What we see now are some stocks getting interesting on the long side as they have corrected meaningfully on earnings worries, but when we dig through the numbers they are just not cheap enough for us to want to hold a meaningful position.   

For purchase candidates, we look for high single-digit free cash flow yields and reasonable comfort with the future revenue picture.  That is tough to find mostly because market participants are too willing to assume that a return to peak revenues and margins for the many cyclicals that we have researched is right around the corner.  A common thought process in the market is that revenue weakness, if due to the massive rally in the dollar, will reverse itself soon, seemingly forgetting that it was the earlier weakness in the greenback that cast a positive bias to many companies’ performance for many years. Energy producers are mostly way out of line with the current price of crude.  We have added a few longs, but these are just small starter positions with one theme being that some are suppliers of equipment or services to the much maligned energy sector

We have also shorted a few more names in recent weeks in a number of sectors.  We can see these stocks trading for less than half of current prices in coming years.  For instance, we are now short a manufacturer of residential construction materials at over 60 times estimates for this year.  In addition, free cash flow for this company has been quite paltry in recent quarters.

The Fed wants to raise rates this year just to be able to say that it did so, as if somehow that would be proof positive of its success.  The weak jobs report for March was likely painful for the FOMC because it forced a deviation from its rosy script. After all, the Fed has trained the market monkeys and their computers to base any and all economic views on the high number of jobs that had been showing up in the lagging economic series known as the monthly employment report while ignoring the big picture.  It has painted itself into a corner and will be loath to admit growth is softening yet again.  Regardless of whether any rate hike occurs, a few hundred billion dollars of bonds is set to roll off of the Fed’s balance sheet early next year, so further dollar scarcity is “baked in the cake” to some degree and that will be a tightening of policy. 

If we were to sum up the biggest fact that many analysts seem to be missing or choosing to ignore it is that the central bank mechanism of keeping rates low and printing currencies is running into the reality that the enormous debt growth that resulted from those policies is having less and less positive impact on growth.  The econ geeks would describe this as money velocity shrinkage overcoming the money printing. All that cash just sits in free reserves unless a banker lends it.  The banks don’t really want the cash based on the low rates they pay and high fees they charge for deposits.  In Europe, borrowers are actually paid to borrow by some banks.

Talk about distortion!

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

We find it very amusing that former Fed czar Bernanke has now taken to blogging his views in an effort to explain (defend) the current state of affairs.  CD’s and short Treasuries in the U.S. offer nothing but a “stick in the eye” to savers and many blame him.  That reality and the frustration it breeds, of course, pushes many investors to jump into stock land where the idea seems to be that returns there must be better than the virtually nothing in notes or bank savings vehicles.

Our guess is that the vast majority of investors would be shocked if told that a 10-year Treasury yielding near 2% will likely outperform the S&P 500 over that note’s life based on historic valuation measures.  Just because most investors do not know how valuation math works for stocks over time does not mean that those returns can be anything one hopes or needs them to be.  Just like with bonds or any investment, the initial earnings yield (not dividend yield) one receives upon purchase explains most of the returns one can expect over a reasonable investment horizon.  Right now, based on numerous metrics, the yield on the median stock has never been lower.

Looking back over the last hundred years, someone owning a portfolio of equities would be hard pressed to find investors willing to pay the multiples of the median stock today and low interest rates or easy policy do not guarantee high stock prices.  History proves that.  Some of the worst market performance occurs when the Fed is in easing mode.  Besides, 30-40% corrections are the norm for a typical economic cycle let alone the bubble we are in now.  Mr. Bernanke might just want to mention that on his blog.

We find it stunning that the Fed and other central banks now target a need for higher inflation as their excuse for zero-bound policies, but we come from the school of thought that likes lower prices.  It will be fun to watch the former chairman try to explain on his blog why it is better that the average consumer spends more at the grocery store.  We suspect he might quietly cheer for higher oil prices because it would boost gas prices and inflation measures, but we know very few consumers who would be excited about that.

The reality is that the Fed needs to inflate assets to 2007 bubble highs or the banks that “butter its bread” will have to start provisioning for bad debt again as opposed to releasing loan loss reserves to goose earnings.  That will be a tough pill to swallow and call into question the wisdom of all of those Greek lettered equations the FOMC members studied in their economics classes.  Right now, all those Greek letters are spelling t-r-o-u-b-l-e not only in Athens, but also in the capitals of far too many countries.

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

Greek debt trades at the highest yields since the dark days of 2012 as that story of false hope faces the reality of a likely default.  Nothing was fixed there, really, just like nothing was done to truly rectify balance sheets anywhere else after the crash of 2008.  Speculative activity is the only thing the deciders can elicit and without it growth would be more apparently challenged.

The entire “house of cards” of the stock market rests on the hope that 100 years of valuation data is of no meaning in the heavily manipulated construct of recent years even as earnings fall.  Global GDP is near the weakest it has been since the last recession, yet we are supposed to trust that the sustained growth the Fed promised countless times will arrive at any second now, though their forecasting errors have been stunning in their consistency.  By jawboning pleasantries when any worries surface either about low economic growth or higher rates, the Fed is doing its best to hold the 2,050 S&P 500 peg it seems to have established as the level which assures its acolytes will blindly assume all is right with the world.  Eerily, equity investors have turned to celebrating the idea that rates are stuck at low levels for longer and selling on any stronger economic data.  

It sure looks to us like QE in its practical application is deflationary at this point and a crushing blow to the real economy’s long-term prospects.    This is the exact opposite of what the PhD’s tell us about monetary policy and the very notion is heresy among the ranks of the Keynesians who have the controls.  However, free money, not surprisingly, has led many in business to decide that they simply must build something. Capital decisions are being based on the cost of money, not the underlying dynamics of business and industry. When hurdle rates are zero many think anything is possible. That adds to overcapacity and destroys pricing power when the demand side, already severely burdened by over indebtedness, fails to meet the added supply. For instance, we are literally running out of storage for crude oil in the U.S. because too much is being produced as drillers borrowed vast sums of money that they thought was too cheap to pass up.  

It is not just that oil prices have cratered as inventories hit 80-year highs in the U.S.  We can also point to skyscraper mania in Asia and elsewhere, commercial jet production across the planet, student lending, and subprime auto debt as other clear examples of extremely reckless behavior.  We wonder how many casual restaurant chains like Shake Shack (now trading near 1,200 times the average estimate for 2015) can IPO before that door closes.  As if we did not have enough corporate restaurants that are struggling to fill seats.  

Investor protection in junk bonds has hit the lowest level ever according to Moody’s and a huge percentage of the massive amounts of corporate bonds being issued are low quality.  Markets have learned nothing from 2008.  We do wonder who will buy those very bonds when sellers multiply.  Liquidity is already poor on the bid side.  

A new endeavor, “crowd” financing has taken on a speculative frenzy in this cycle as retail investors are throwing hard-earned cash at private sector start-ups at a frenzied pace in the hopes of picking the next Twitter, Facebook or Uber (we could do without any of them).  We do not think that phenomenon can end well.  

Of course, savers are effectively being punished for their thrift and have less money to spend on goods and services. That is not pro-growth! Perhaps nothing sums up the current landscape better than the fact that Switzerland became the first country ever to issue a ten-year bond at a negative yield just as former Fed chairman Bernanke released the title of his upcoming memoir, The Courage to Act.  He and his cronies acted alright and stagnation for much of the economy is the result.    

We don’t buy the idea that things would be worse now if emergency measures had been stopped years ago.  Until the deciders admit that the trillions of legacy bad debt must be restructured and related assets are allowed to fall to clearing prices we cannot achieve sustainable growth.  Greece is not the only problem that will not go away, incapable of being papered over with additional debt.  Many years of bad lending cannot be made to vanish no matter how hard the Fed and other central banks try.  For instance, the data indicates that in the bottom third of the housing market in the U.S. a high percentage of homeowners are still underwater on their mortgages despite all of the stimulus attempts.  These are the same homeowners whose wages are not growing like those of the corporate titans and the bankers whose high end homes are doing just fine (for now) thank you very much!

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

Pressure is building to return some sanity to markets as the problem becomes “more impossibler” to ignore.  We have read that the former SEC Director of Trading and Markets, John Ramsay, is out discussing market dysfunction in recent days.  He told Bloomberg:

“I’ve been able to find my voice on these issues in a way I couldn’t have done when I was in the government, because you’re always limited by internal politics and not wanting to get too far out in front of the agency,” he said. “I feel like I’ve been a little bit uncorked.” 

We guess we like the sound of that. We hope it bears some fruit, but we would have to be naïve to wonder for even the nanosecond it takes for a computer to fake a bid as to why he stood silent for so long.  Now he is employed by IEX Group, the firm discussed in the book, Flash Boys, which exposed the nuttiness of Wall Street trading last year.  IEX hopes to profit by creating a venue that is more fair.  We wish them well!

Importantly, the very issue that many point to as the reason one must own stocks is the very reason that owning them is made even more risky.  Rates near zero or even negative in many instances is the result of a global economy struggling to grow.  That makes revenue and earnings projections subject to major negative surprises as companies attempt to deliver returns in such a difficult environment.  Throw in currency volatility and the crystal ball gets cloudier.  As we mentioned last month, the collapse in earnings expectations has become quite pronounced as the year begins, though amazingly analysts still have 20% earnings growth in fourth quarter S&P 500 estimates after a few slightly negative quarterly projections for the first part of the year.  Good luck. 

The February employment report was more of the same.  It showed the creation of many low paying jobs, limited wage growth, and a poor labor force participation rate.  Roughly 60,000 or 20% of the new jobs that were added came in the restaurant sector.  We are guessing a lot of waiters and bartenders are being hired to staff the eateries involved in the restaurant IPO frenzy.  Strangely, layoffs that we know to be hitting the energy sector have yet to show up in the data, though the oil rig count has crashed by over one-third.  We are reasonably confident that GDP growth this quarter has fallen to closer to 1% based on other data.  For instance, retail sales have been negative for three straight months and the business inventory-to-sales ratio is at the highest since 2009.  Manufacturing production has now been negative for three months in a row. To check our overall view, we looked at the Atlanta Fed GDP estimate, which is a decent real-time indicator of activity, and it seems to corroborate our expectations.  As a result, because employment is a lagging indicator, we would expect hiring to cool as the year progresses in response to this slowing.

Sometimes you can be in a majority and not even know it.  It all depends upon your frame of reference and the sample group.  Contrarian investors, like us, are often simply aligning themselves with the views of the larger crowd that includes past investors with their experiences as well as current ones. We obviously think most equities are a foolish game right now and current sentiment indicators would suggest we are almost a “lone wolf” with a serious failure to understand the wonders of throwing cash at stocks.  We beg to differ.  We are in a large and rather overwhelming majority if one considers the large crowd of “historic” investors over the last hundred years who, with the benefit of their hindsight, would likely advise the current fevered masses of today that this time is not different.  It never is.

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.

We have begged for monetary policy normalization for years, and still do, but the Fed, fearful of undoing the unsustainable climate it has created, will find tightening enormously difficult.  Tightening now appears way out of step with reality. It would be like orchestrating a global margin call whether it knows it or not.  The long Treasury bond and commodities have been screaming this for months.  While it is moving to a less easy policy, major trading partners like those in the EU and Japan, responding to the currency war we started, are as loose as they have ever been.  That is an historic juxtaposition of policies that cannot be underestimated.  The resulting 23% rally in the dollar since last summer is putting huge strains on the levered financial system.  At the same time, the economy has slowed to a slower crawl and earnings estimates are being cut dramatically.

The Fed can talk about raising rates all that it wants and equity markets can follow that “bouncing ball” all that they desire, but dollars are already becoming more scarce.  In the world of currency wars in which we reside, all that matters is that if a non-U.S. entity borrowed dollars during the money printing (and trillions were lent), then it now owes over 20% more and its interest payments are over 20% higher than a year ago.  Ouch!  Given the enormous leverage in the system, for many borrowers the pain is likely much higher than those percentages imply.   

Still, somehow, stocks are viewed as a warm and pleasant island where these bitter currency winds do not blow with the same ferocity of our east coast winter.  This is in spite of the fact that earnings for the S&P 500 sank 5% last quarter. With negative interest rates becoming quite common and finding high quality paper north of even 0.5% a tough task, frustrating is not a strong enough word to describe the environment that the deciders have concocted to save the financial system that keeps them in control.  For instance, roughly one quarter of sovereign debt in the EU trades at a negative rate and German bunds yield 0.20% or so.  Meanwhile, we remain concerned by all of the sovereign credit risk on the balance sheets of the European banks just as it seems to be a 50-50 proposition as to whether Greece defaults and leaves the EU to its own devices.

If the going gets tough, don’t look for heroics from bank trading desks that are reducing capital once devoted to providing customer liquidity. Regulatory changes and lower profitability are to blame for that.  Also, the high frequency trading crowd might just be long gone or their fancy computers simply turned off when bids are really needed.  We talked about “winks and nods” last month and maybe the most significant common perception is that the frantic quoting on small lots with little transaction volume that we witness every trading day will somehow, some way enable price levitation to continue indefinitely.  We are skeptical.  That the regulators have not policed this chicanery known as “spoofing” more fervently is no surprise because it helps paint a nice tape.  Anything goes if it makes us “feel” better.  After all, with the stroke of a pen, the accounting regulators decided in 2009 that assets no longer had to be marked to market on bank balance sheets, so why not extend that thought to market making.

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.