Tag Archives: Gallant 500

Small Faces

Posted on by

It’s all too beautiful (the refrain from the band’s most famous song: Itchykoo Park)

There’s a lot to cover here, but we must first dispense with a couple of pieces of business.

In the midst of all of the hubbub around 45’s grandstanding insult of LBJ, y’all might’ve missed a significant milestone that presented itself midweek: The Apple Corporation of Cupertino, CA (or is it Mountain View? I get confused) became the first company every to achieve a market capitalization of $1 Trillion.

And that. Is all. I have to say. About that.

Moving on, I am compelled to address the galactic buzz generated by last week’s note about the Faces. Legions of followers pointed out that the group partially evolved out of an outfit called the Small Faces came first. Some even claimed the Small Faces were the better ensemble. Well, yes, there was a band called the Small Faces that predated the visages presumably of larger size, and yes, a couple of their members were a part of both groups. But any reasonable interpretation of Rock History would suggest that Rod Stewart and Ron Wood’s arrival – fresh from the magnificent and vastly underappreciated Jeff Beck/Truth combo—was the seminal event in the formation of the Faces. And, for the record, while I dig their diminutive predecessors, I’ll stick with my longtime allegiance to the core lineup of the Faces as we knew them.

Finally, and on a related note, I must follow up on last week’s Facebook diatribe. You see, instead of just spitballin’ like I usually do, I checked with a couple of cats that actually follow the stock, and they had some interesting things to convey. It seems that the FB Brain Trust had been warning for the two preceding years of the likelihood of slower user growth – a reporting pattern that ended somewhat abruptly with the Company’s Q1 release in April. Here, in the wake of the whole Cambridge Analytica thing, after Zuck’s Excellent Washingtonian Adventure, they issued their strongest guidance in many quarters. So it came as an enormous shock to the informed that for Q2, they did a 180 on the previous quarter’s 180. In fact, they did a 180+ — demanding that the markets recognize the folly of extrapolating into the future the firm’s extraordinary growth in revenues, sales and user engagement.

Unfortunately, however, this context only adds to the mystery. It would’ve been entirely logical for Team Zuck to take a 2×4 to their valuation back in April; late July, not so much. The most direct inference to draw here is that with respect to a company where > 70% is owned by insiders, where Zuck himself has a majority of the voting rights, the public is informed of its doings on a “need to know” basis. And Zuck doesn’t think we need to know – except what and when he chooses to tell us. A connection of the dots suggests that undisclosed problems continue to lurk beneath a still-shiny surface. And, while we certainly don’t need to know, what lies beneath may be more problematic for the markets in general than is generally assumed. I expect the Menlo Park (or is it Cupertino?) crowd to lay low on all of this, but to me, what happens down the road bears watching and is worrisome, come what may.

However, as the Augustine portion of the Julian Calendar unfolds in earnest, perhaps we can turn our attention to happier tidings. The Gallant 500 recorded its 5th straight week of gains, and is now 113 skinny basis points from its all-time highs. Good Captain Naz recovered his sea legs – albeit modestly, and nasty Viscount VIX retreated back into his shell. He now sports an obsequious 11 handle, and it wouldn’t take too much more complacency and giddiness to push him down to even lower depths.

Because, ladies and gentlemen, much of the news that has hit the tape over the last several sessions can be interpreted constructively. More than 80% of the way through the earnings cycle, reporting companies are exceeding even unambiguously lofty expectations, and projecting out to a plus 24%. Investors are taking notice, and, if that ain’t enough for y’all, feast your eyes on the following two charts:

 

So earnings are strong and investors are reacting favorably. Conversely, and as anticipated in this space, Q3 guidance shades to the negative. 65 intrepid CEOs have shared their associated near-term clairvoyance, and of these 2/3rds are defying both deer and antelope by uttering discouraging words. But hey, it’s early, so let’s not hang our collective heads just yet, OK?

I’d also be remiss if I didn’t share my elation at the positive reversal of fortune in the Grains, particularly Corn, which is showing some A.M. perkiness:

Morning Corn: The Blues Ain’t Gonna Get It

Those sneaky ag traders are attributing some of this to sizzling weather conditions – particularly on The Continent. But I’d be a little careful here. Corn is nothing if not a resilient crop, and if the Good Lord does indeed decide to dial down his heavenly thermostat in realms such as the Grand Republic (France, for the uninitiated), then perhaps it will be yet another sequence of “lookout below”.

But far away from fertile fields from Iowa to Alsace Lorraine, the focus was on very fancy macro events, and the results were, as could have been foretold by the Gods, lacking in clarity.

The Bank of Japan kicked off the festivities early in the week, taking no action and managing to confuse everyone interested in their strategy or associated timelines. Its country’s 10-year rate remains elevated to levels seldom seen outside the Gambino Family’s Jersey City money lending operation, at 0.102% basis points. The Fed did nothing. Finally, the Bank of England maintained its trademark stiff upper lip and raised its overnight rates from 0.5% to 0.75%. This, however, didn’t do much to stem, much less reverse, the gravitational forces currently descending upon the Pound Sterling.

All of this set up for a nominally dramatic July Jobs Report release Friday morning, but this, in retrospect, was something of a non-event. Private Payrolls were a little light at 157K, but the base rate dropped a titch to 3.9%. The much-anticipated Average Hourly Earnings component came in exactly as expected, and precisely in line with the GDP report at 2.7%.

All of the above merits, even by the harshest reasonable assessment, a Gentlemen’s B. But the macro situation is arguably more complicated than meets the eye – mostly due to the ubiquitous but unknowable overhangs of trade wars, and (increasingly as the calendar moves forward) a potential calculus changing election, now a skinny three months away. Of these matters I have little insightful to convey.

By contrast, the related trade action has been worth a gander, as evidenced, first, by a continuing build-up of short interest in U.S. long-term treasury instruments:

Certainly, we’ve seen this movie before. Lots of smart guys and gals have been, for years, anticipating both a rise in longer-term interest rates, and even, for the fully fanciful, a steepening of the yield curve. Maybe someday they’ll be right. Maybe even soon. But the perpetual bid on long-term Treasuries has been perhaps the toughest nut to crack across my market career, which (I remind you) began during the administration of Millard Fillmore. So I reckon we’ll have to see.

On a partially related note, I observe with interest that the self-same smart crowd has thrown in the towel on their long Crude Oil positions.

There are a lot of moving parts here, as Crude Oil is at least theoretically impacted not only by trade wars with the Chinese, but also various cajoling in the Middle East, where a dizzying matrix of production quotas and import/export protocols with utopias like Iran are creating mind-numbing crosswinds. I suspect that in many cases, rather than reversing their investment hypotheses here, crude speculators may be simply capitulating.

It’s all too beautiful, now, isn’t it? But one way or another, it won’t last. The Almighty did not intend us to spend all our days resting our eyes in fields of green, so, perhaps soon, we’ll be forced to bid farewell to Itchykoo Park. The Small Faces had its innings there, as did the (not so small) Faces afterward. Facebook has been the object of our desire for several years, but now we may be forsaking her in favor of our old flame: Apple.

And wouldn’t you know, after Friday’s $1T close, the Cupertino (or is it Menlo Park?) crowd was forced to contend with a shutdown of a major components supplier’s – Taiwan Semi – production plant, so it’s entirely possible that the lofty-but-menacing 13-figure valuation may disappear as early as the Sunday night session.

But here, having violated Paragraph 3’s solemn pledge, I will rest my keyboard, wishing everyone who receives this note a sincere (if redundant) Ooh La La.

TIMSHEL

Pearl of the Quarter

Posted on by

On the water down in New Orleans, my baby is the pearl of the quarter,

She’s a charmer like you never seen, singing voulez voulez voulez vous,

Where the sailor spends his hard-earned pay, red beans and rice for a quarter,

You can see her almost any day, singing voulez voulez voulez vous,

I walked alone down the Miracle Mile, I met my baby by the Shrine of the Martyr,

She stole my heart with her Cajun smile, singing voulez voulez voulez vous,

She loved the million dollar words I say, she loved the candy and the flowers that I bought her

She said she loved me and was on her way, singing voulez voulez voulez vous

— Donald Fagen/Walter Becker

A little Steely Dan on this hot, pre-holiday weekend? How ‘bout it kids? Well, anyway, it’s my call, and I say yes.

“Pearl of the Quarter” is merely one of the gem’s on the Dan boys’ 1973 “Countdown to Ecstasy” LP, the second in a string of remarkable albums, recorded over a 5-year period in the early ‘70s. The sequence begins with “Can’t Buy a Thrill”, continues on to “Ecstasy”, then soars through “Pretzel Logic”, “Katy Lied” and “The Royal Scam”. My own view is that the quality of the songwriting dropped from that point on. However, many disagree, feeling that the group’s subsequent release: “Aja”, was their finest work. But you can take that record, along with your Big Black Cow and Crimson Tide, and get out of here. There are a few sublime moments on “Aja’s” follow up: “Gaucho” (1980), but that’s about it. They didn’t hit the studio for the next 20 years, and the produced two forgettable albums around the turn of the century. Then, as I believe was a wise move on their part, they cashed in by touring for about a decade and a half (the only way even the Stones or McCartney make money these days). And now Walter Becker is dead. So it goes.

But oh those first five albums! We could’ve chosen to honor SD by featuring virtually any track contained therein. “Pearl” however, is among my faves, telling the age-old story of a loney guy falling head over ears for a Cajun prostitute in the French Quarter of the Crescent City. Her allure is irresistible, and yes, she loves him (or at least tells him so). But in her inscrutable way, she knows she must spread her love around. He knows it too.

Voulez, voulez voulez vous?

But of course, we have other reasons to home in on “POTC”. Friday, after all, marked the end of an interesting, but on the whole, frustrating, second quarter of 2018.

Across the three-month cycle, there weren’t many pearls about which to report, at least from an investment perspective. And I certainly have a personal beef with its swansong, which made hash out of a prediction of mine that the equity markets were poised for a rally.

But rally they did not. Yeah, after a horrific start, they threw me a small bone as the week wound down, picking up a skinny half a percent in the last two sessions. But their hearts weren’t in it. Friday morning, and on the back of a slight ratcheting down of the China thing, they gathered themselves for an energetic climb, but, as I suspected at the time, they lost their vitality in the afternoon. The Gallant 500 did manage to gin up a 0.3% gain for the April-June interval, and at least this is better than Q1, which socialized a loss of slightly smaller magnitude. Thus, despite an historic tax cut, an earnings cycle that has shattered records, and various other hope-inspiring catalysts, Mr. Spoo now tips the scales at +1.67%.

Of course, it could’ve been worse, and, in fact is — across most of the planet. To wit, of the ~20 indices tracked on Bloomberg’s ubiquitous World Equity Index (WEI) page, the SPX is the only one that has earned the right to paint its performance in green:

Sure, we could turn our attentions to happier environs, including those haunted by the indomitable Captain Naz (+8.79%) or Ensign Russell (+7.00% but falling fast). And certainly the news has, on balance, been positive for the holders of 10-year notes (and, lately) the USD, but I’m gonna go the whole route here and suggest to the Market Gods that, with half of the year now in the books, I’m just a tad bit disappointed.

But the Market Gods most certainly operate in mysterious ways, and who are us mere mortals to question these?

We’re entering what is likely to be a sloppy week, and I think I can speak for the market-obsessed masses when I suggest that Wednesday is the least productive day to celebrate American Independence. Most of us would prefer to either get it over with earlier, or postpone it to the end of the week so we can chop some wood before giving our shout-outs to the Stars and Stripes.

But the Julian Calendar was established well before most of you were even twinkles in the collective eyes of your forebears, so I reckon we’ll just have to live with that. Those of us who plan to return to our posts after the last Roman Candle has burned out will no doubt turn collective attention to next Friday’s Jobs Report, where the base rate is expected to hold steady at 3.8% and195K new private gigs are anticipated. The real action, though, is likely to revolve around Average Hourly Earnings, and the testing of the hypothesis of whether or not wage gain acceleration is, or ever can be, part of the picture.

This may be even more important than usual, because, as has been the case so often in recent years (and proven wrong each time), a big concern for us pointy-headed types is whether the indefatigable American Consumer might, at long last, be running out of steam. About the only interesting macro number that dropped last week was a surprising downward shift in Personal Consumption Expenditures, expected to clock in at +3.7%, but only managing to reach a tepid +2.7%. So alarming (to some at any rate) was this miss that it caused the recently high flying GDPNow Index to undertake an unsettling nosedive:

But what the Atlanta Fed taketh away, the Atlanta Fed can surely giveth back. And one thing that would almost surely invigorate both our domestic shoppers and give a boost to the broader measures of economic performance would be some evidence that pay raises, long promised, are actually manifesting.

There are indications, however, that the market doesn’t believe this to be the case – none more visible than the continued rally in global bonds, which also went against my recent call, and which now have tethered 10 year yields to a rather pedestrian 2.86%.

For those tracking such matters, yes, Generalissimo Francisco Franco is still dead, and 10 Year Swiss Notes are still offered at negative yields.

Once we get through the holiday and the Jobs Report, we can, the following week, turn our attention to highly anticipated Q2 earnings. The early returns have been good, but of course investors have not been overly impressed; otherwise the indices would have done what I ordered and rallied.

But c’mon, people.! Estimates for the quarter are the 2nd best (i.e. after Q1) since the crash, and have actually, been rising across the last three months. This, as indicated in the following chart, is something of an anomaly:

Current P/E’s, at 16.1, are below the 5-year average but above the 10-year mean. But please; the latter takes us back to the period covering the crash and the recovery, and are hardly reflective of what might be expected across today’s strong economic environment, with very favorable financing conditions, and an awful lot of companies putting up astonishing – and still expanding – bottom line performance.

So, though chastened by my misdeeds over the last couple of weeks, I continue to project the near-term balance of the risks in the equity markets to be shaded to the upside.

And, in closing, here’s hoping that Q3 generates more pearls than what was served up to us in Q2. However, this is most certainly out of our hands. After all, sometimes you walk alone down that Miracle Mile; sometimes you do so in the most pleasant of company. And sometimes the pearls we find are artifacts of God’s perfection, while other times they are Cajun women of easy virtue, singing “voulez voulez voulez vous”.

Either way, we take what we can get, because there’s really nothing else for us to do. So we carry our lovingly purchased flowers and candy, and utter our million dollar words, often to no avail. But we return, each day, to the Shrine of the Martyr, hoping for the best.

I reckon I’ll see you there, next week. In the meantime, I bid you a happy holiday, and, as always, a heartfelt…

TIMSHEL

Mondo Fugazi

Posted on by

Welcome to Mondo Fugazi, my friends, where Fugazis abound – so much so that some of the Fugazis are actually Fugazi Fugazis, and are thus actually the real thing. Look around. Stay as long as you like. Stay forever if you will. But stay on your toes, because in Mondo Fugazi, the bona fide and the implausible blend into a dizzying vortex, which, if you’re not careful, could suck you dry.

Fugazi, of course, is the Italian vernacular word for Fake. However, in general, I prefer the former, mostly because of the way it trips off the tongue. Try it yourself: say Fugazi out loud a few times. My guess is that you will never use the word Fake again.

We’re all tired of the English word anyway, right? Let’s begin, for instance, with the wearisome, dubious and oxymoronic concept of Fake News. I’m just sick of hearing about it, and, if pushed I’d go so far as to state my belief that Fake News is itself a Fugazi. Using the full-on Italian phrase: Notiza Fugazi – helps, but only a little. Besides, we’ve got Fugazi issues that extend well beyond Notazi. So let’s start to unpack them, shall we?

I wish to begin with Fake IDs, or, if you will, Identificaziones Fugazi. A long time ago, I was something of an expert on this topic. Wishing, around age 16, to prematurely join the adult world in those most meaningful of ways – purchasing alcohol and patronizing bars — my friends and I all thought it would be a swell idea to obtain identification suggesting we were older than we were. Our first sojourns in this realm took us to the iconic Maxwell Street, the open air marketplace on Chicago’s Near South Side (For the uninitiated, please refer to the Aretha Franklin sequence in “The Blues Brothers”). There, after making discreet inquiries, we were ushered to a beat up trailer, owned by a middle aged African American gentleman who had suffered severe burn damage across his face. He snapped our pictures and typed some information (including changing our birthdates) on to orange cards, ran them through a laminating machine, and charged each of us 10 big ones for the service.

We were ecstatic, but, predictably, the ruse didn’t work very well. A lot of bouncers laughed at us, and one actually confiscated our cards. So we were forced to move to Plan B. This took the form of surgically altering our driver’s licenses, by flipping the 9 (we were all born in 1959) into a 6. The strategy worked for a while, but eventually the bouncers got wise. They’d shine a flashlight on our official IL DLs, see the holes, and send us away to raid our fathers’ liquor cabinets.

At that point, there seemed to to do but wait out the unforgiving calendar. But then the unthinkable happened. Just as my 18th birthday was approaching, Illinois raised its drinking age to 21, adding 3 years to my hiatus. I took this very personally, and it was time for all-out war. I’m not particularly proud of this, but I was forced to resort to bona fide identity theft. Somehow, I was able, in addition to my restored driver’s license, to obtain an Official State ID (with my mug in the upper right hand corner) in the name of one Kenneth Costigan, a real guy whose birthday was sometime in September of 1956. Here, not only had I solved my most vexing longstanding problem, but I gained the added benefit of being able to walk into bars in my college turf of Madison, WI, and demand a free drink on my Fake ID birthdays. One Mad Town bartender was a bit stingy, and didn’t want to come across, but I insisted. So he poured me a shot of what I thought was standard (if bottom shelf) Vodka, which turned out to be 190-proof Pure Grain Alcohol.

I fell immediately ill and stayed in bed for the following week. And this, my friends, cured me of such proclivities. I have NOT turned back since, and had not even thought of the concept for many years. But recently, I have found myself the victim of a new form of Fake ID chicanery. Specifically, through the marvelous conveyance of CALLER ID (for which Verizon hits me for an extra couple of bucks), I can see, at the point of first ring, who’s trying to reach me. Unfortunately, a depressingly large number of my incoming calls are unwanted solicitations for such products as extended warranties on cars I don’t own, refinancing plans on outstanding student loan debt that I managed somehow to retire in 1992, and instant access lines of credit. OK; fine. I get it. I’m a capitalist through and through, and believe (albeit with some caveats) in the principles of caveat emptor. However, many recent calls show IDs clearly intended to deceive. Just in the last couple of weeks, my phone has been lit up with caller identifications that have included Fox News, New York Presbyterian Hospital, Music Mogul Clive Davis (who still owes me a major label recording contract) and even actor Lloyd Bridges (who died in 1998).

With respect to the last of these, when the phone rang, instead of Lloyd’s golden pipes, my ears were assaulted by the recording of a female voice speaking rapidly in what I am assuming was Spanish, but can’t be sure. I tested my theory by shouting Fugazi, but her only response was to hang up on me.

So Identificazione Fugazi has clearly entered the information age, and it strikes me that there’s too much of this type of thing going on lately.

***********

I returned from dinner on Friday night to a phone notification that the North Koreans had suspended large portions of their nuclear testing programs. Was this Notazi Fugazi? Only time will tell, I suppose. All the news outlets confirmed the report, so perhaps there’s something there. But I recognize that the next time a welcoming proclamation issues forth from L’il Kim or his forebears is followed up with constructive action will be the first, so I’m a l’il skeptical on that score.

I am wondering how the markets will react to these tidings, but it’s the weekend so I really don’t know. Certainly it shades towards the accretive, but in Mondo Fugazi, one never knows.

As we retired on Friday, the Equity Complex had bounced around over the preceding week with little to show for its efforts:

But one element, of the action, the technicals, has a strong ring of non-Fugazi authenticity. Over the past several weeks, the Gallant 500 has dropped twice to the menacing breach of the 200 Day Moving Average, only to bounce jauntily in the aftermath. Conversely, the index has clawed back towards the 50 and 100 Day thresholds, it has been beaten back like a little you know what.

This here looks like a tough channel to break. Equity Markets appear to like the 2650 – 2700 range, and despite the somewhat Fugazi-like concerns about excessive volatility, it’s unclear to me that it is likely to break out in either direction any time soon. On the other hand, we’re in the middle of a content-rich information cycle, so stay tuned.

After a long hiatus, however, there appears to finally be some action in other Asset Classes. Over the last several sessions, yields on the U.S 30 Year Note careened past the 3% threshold, and even those precious Swiss Bonds sold off back into positive rate territory. The USD enjoyed its strongest week of the year, and commodities remain in play – mostly on upside.

Seemingly out of nowhere, All God’s Children are now concerned about the slope of the Yield Curve, which indeed have flattened to Olive Oyl thresholds, at both the short and long end of the maturity spectrum:

The Long Short and Flat of It: 2s/10s: 

10s/30s:

Textbook economic analysis suggests that such trends are indicators of weaker economic conditions on the near-term horizon. However, here in Mondo Fugazi, I believe we may need to throw out the textbooks, and look to a new roadmap. Specifically, I feel that the relationship between short and long-term Treasury debt has decoupled, and that as such, we must look to each component separately.

It strikes me that with respect to the faster-approaching maturities, a number of factors should work to suppress prices and place upward pressure on yields. We begin of course with stated Fed policy to lift rates, and even they would tell you that all of their juice is on the short end. In addition, as the Fed goes about the righteous path of reducing its gargantuan Balance Sheet, its main tool is allowing shorter term notes to mature without repurchase, in the process removing perhaps the most important buyer from the near-term equation. Heroic efforts have been made in this respect over the last year, with the value of the Fed’s Holdings plunging from $4.48T to the current $4.38T. That may not look like much in percentage terms, and in fact it’s not; it’s just a little over 2%. But it is a divestiture to the tune of $100B, and to yet again paraphrase the late, great Everett McKinley Dirksen (R, IL): $100 Billion here, $100 Billion there and it all starts to add up to real money.

Almost all of this reduction has transpired at the short end, and, of course, we still have a long way to go, because, even those 30 year bonds whose maturities look like dots in the distance will someday become short-dated notes.

Finally, with respect to near term Treasury obligations, you should be made aware that Mnuchin and Company are planning to auction off $275B of freshly minted obligations this week – almost all of them with maturities of two years or less. By my count this will bring total 2018 issuance to the threshold of $1 Trillion, and we’re not even 1/3rd of the way through this infernal year yet.

If this bothers you, I suggest you write your Congressman or President who green-lighted our monstrosity of a budget, and, in doing so, if you invoke the memory of the fiscally conservative Senator Dirksen, you’ll get no complaint from me.

Moving on to the longer-dated end of the curve, we face something of a stickier wicket. Most believe that on balance, the economy would benefit from higher extended rates, but it has been nearly impossible to effect this in the markets. Reasonable minds can disagree over root causes, but clearly the opacity of inflation trends are a contributing factor. In addition, it is my belief that all of that global QE has created a financial dynamic where there’s more money sloshing around than low-risk places to put it. Thus, for what seems like eons, no matter how much long-term debt a given developed country wishes to issue, it gets hoovered up in ravenous fashion.

So I think there are divergent dynamics at play across the yield maturity spectrum, with multiple factors causing upward yield pressure on shorter term securities, while improbable supply shortages bring gravitational pull to bear at the longer end.

For what it’s worth, I also continue believe that, at 50,000 feet, there’s a shortage of stocks as well, but I’ve backed off on mentioning this in light of the heightened volatility manifested over the last rolling quarter. Stocks can be risky (or so I’m told), and therefore subject to more capricious pricing patterns. For now, the risk premium remains sufficiently elevated to counter the supply/demand imbalance. But imagine a world where our two political parties were not intent on blowing each other up, where our two historical adversaries (Russia and China) were not causing us untold aggravation and perhaps worse, where everybody minded their business and tried to do the best they could. Now take a look at the following charts:

Yes, Profit Margins are accelerating while P/E ratios are reverting to normalized levels. I dream of opportunity in these images, and I’m not the only one.

But unfortunately we must operate in the real world, which at least at present is a Mondo Fugazi. So take care. And now, if you’ll excuse me, I must take my leave. The phone is ringing and my screen says it’s Kenneth Costigan. I suspect that he wants his identity back, and, having no more use for it personally, I’d be happy to comply.

If only I could be sure that it was really him on the line.

TIMSHEL

I’m In

Posted on by

I know it’s been a long week for everyone, but did you ever stop to consider, in light of the professional path I have chosen, the toll it’s taken on me?

Didn’t think so.

So, with a frazzled hope that you will temper justice with mercy, I need to inform you that I’m in. I actually bought some stock. I have long resisted the temptation to do so, chiefly due to my lack of confidence in my ability to make anything other than a mess of it. In addition, however, please feel free to consider my deference a nod to what I believe to be the preference of the clients who have given me the honor of sharing their proprietary information with me: that I eschew any direct participation in the markets in which they traffic.

Now before you get all in my grill about this breach of long-standing protocol, know that the particulars of this ad-lib are such that I gave my mother-in-law, one Elizabeth J. (Beppie) Oechsle full power of attorney on my account. Those of you who know Beppie may be aware that in addition to dishing up a mean pot roast, she is one of the savviest, and more importantly, most successful, portfolio managers in my wide acquaintance. She’s been trading actively for more than 3 decades, and has never had a down year. In fact, she has the most pristine track record of any I have encountered – setting aside, of course, the golden era of Bernard L. Madoff. Ironically, Bernie was born one month to the day after Beppie, and both will be celebrating their 80th birthdays over the next few weeks, but the similarities end there. Until I begged her to do so, Beppie had never even thought of managing anyone else’s money, so, unless she is somehow in the business of defrauding herself, we can take it as a given that her returns are legit. Let’s just hope her 30+ year hot streak continues.

But more importantly for our purposes, you need to know that this is Beppie’s show. I have no control over this account, and will use neither my experience nor my knowledge of existing market positions and flows to influence her in any way.

On a related note, it may interest you to know why I believe that now is a good time to make my move. By way of context, I had been planning on taking this step for quite some time. But I had been hesitating on pulling the trigger, and was a bit annoyed with myself, because, it seemed that the more I delayed, the higher the prices I’d be forced to pay. But I was planning on taking the plunge nonetheless.

I thought I’d caught a considerable break a week ago Friday, when – horror of horrors – the January Jobs Report showed some signs of life in terms of upward wage pressure, and investors turned tail at the first whiff of this inflationary grapeshot. Then came Monday, and oh what a ride that was. By mid-afternoon, the Gallant 500 had yielded some 140 hard-won index points before regaining some equanimity and closing down a more gentlemanly 113. Still and all, it was the biggest single day point drop in Mr. Spoo’s storied existence. While the key drivers of the plunge remain a mystery – even to Beppie – it was clear that Monday’s panic session set the tone for the rest of the week. Wild rallies and equally unhinged selloffs ensued and lasted throughout the week – all the way through the late Friday upward reversal, which added an impressive 85 handles (~3%) from the mid-afternoon lows – all in the space of a couple of getaway hours.

And that, my friends, is where we left off.

So what gives? Well, first, as has long been apparent, the suppressed volatility that has partially paralyzed (at least below the waist) equities since the 2016 election: a) could not last; and b) was likely when it ended to evince a major Newtonian reaction. Most of the market rabbis with whom I have reasoned this week are relieved that volatility has returned, and here’s hoping that they are correct – albeit in tones more subdued than last week’s. However, I’m not sure. I think there’s a fair chance that within a reasonable time frame, the equity markets simply recover lost ground and find themselves back inside the volatility vortex.

In the meantime, while I didn’t see last week’s train wreck coming, in retrospect, when it did arrive, it came as no surprise. But there were some technical factors that contributed to the mess – most notably the unwind of those beastly, levered short volatility products that never should have been sold to the public in the first place. Here, the head of the dragon was an odd little fellow called the XIV – a ticker that cleverly reverses that of the VIX index that it its mission against which to facilitate speculation. As part of its overly crafty design, the XIV combines a short position in the VIX with a long one in the SPX. Thus, when the volatility powder keg (inevitably) exploded, and XIV sell orders flooded in, the custodians of this instrument were forced, as part of liquidation, to contemporaneously buy the VIX and sell the SPX Index. This was a double whammy to the markets, that quite naturally manifested itself at the worst possible point from an investment perspective. By early evening, XIV lost > 95% of its peak market capitalization (~$6B), and had blown a hole through the equity index and volatility markets deep enough to sink a battleship. And XIV was not alone; there are dozens of these formerly high-flying products –each, best case, now flat-lining in the critical care unit.

Confused yet? You ought to be. But I think the main takeaway is that the heretofore somnolent markets were not prepared for these liquidation flows. While the unwind was taking place, it was all a big ball of confusion, and it looked for a time like all of the big dogs across the forlorn planet were getting out while the getting was good. The levered short vol liquidations, and the attendant confusion, lasted all week, and this, in my humble opinion, deeply exacerbated the carnage.

But matters would’ve been much worse had not the two houses of Congress gotten together in the wee hours of Friday morning to pass a budget resolution. It was nip and tuck there for a while, and it bears mention that an equity tape that by mid-day the following day had yielded an incremental >3% before its aggressive upward reversal, was well-poised to experience the bottom falling out. To those that may argue against this assertion, I ask what Friday’s close might’ve looked like if investors were facing the prospect of heading into the weekend with a full-fledged market meltdown/government shutdown staring them in the face.

But a budget resolution did pass, and, at least for now, the markets have recovered a bit. The Debbie Downers on both sides of the aisle are currently lamenting the all-out spending binge embedded in the bill, projected, as it is, to add hundreds of billions to our burgeoning deficit, and one can hardly blame them. There is already, as mentioned above, enough pressure on government paper to cause anyone paying attention to take notice. And, in the midst of all of these shenanigans, the Treasury held an auction of 10-year notes and 30-year bonds that went about as badly enough to gladden the hearts of the many bond bears of my acquaintance:

I reckon that the main inference we can draw from all of this is that on paper, a perfect storm of upward yield pressure appears to be forming on the horizon. There are as yet unclear but growing signs of inflation everywhere one cares to look. In addition, just as the Treasury is planning to issue paper to beat the band (as it must to fund the ever-widening deficit), its pals at the Fed are raising rates and selling down their balance sheet – to the tune of between $300B and $400B per year. It now resides at a beggarly $4.42T. This trend is expected to continue, as well, perhaps, it should. Us old geezers remember when the Fed holdings barely rose to the dignity of One Trillion, and of course, what comes up must come down:

Fed Balance Sheet: Look Out Below!

There’s also the odd chance that we annoy the Chinese and even the Japanese sufficiently to cause them to sell down the 20% of our debt obligations that they own. And, of course, it is at least theoretically possible that someday – maybe even soon – the ECB and BOJ will discontinue their QE programs, at which point it may well behoove them to start thinking about some balance sheet reduction of their own.

The confluence of these factors means that there should be galaxies of govies available for purchase over the coming months and quarters, and it might be reasonable to assume that this flood of paper will only move at lower prices and higher yields.

So, at magnitudes not witnessed for eons, the probability of a bursting of the bond bubble of thirty years running looks to be rising towards materiality. No doubt that this prospect is part of what’s all of a sudden scaring all those snowflakes out of the equity markets.

So why did I choose this moment to take the plunge? Well, for a number of reasons. As I’ve pounded into these pages for many months, I don’t think there is enough equity supply to meet demand, and I am fairly convinced that the imbalance will continue to grow. In addition, there’s earnings, now, with 2/3rds of the precincts in the books are projecting out at +14%. Sales extrapolate to a handy +8%. Also, guidance is sufficiently optimistic that CEO prognostications, combined with the (widely reported) selloff in equities, have brought forward looking EPS (16.3) down to just about the long-term average (16.0). Visually, the convergence looks like this:

Now, let’s understand that a significant portion of the happy 2018 income sooth-sayings are due and owing to the impact of tax reform. Some in my circle view these kind of adjustments as a form of cheating. Well, maybe so at 2875 on the SPX, but at 2620? Perhaps not so much.

I further believe that the political winds are blowing in such a way as to strongly incentivize a “kitchen sink” policy of economic expansion. Wherever else our honorable legislators disagree, they almost certainly share a dread of returning to their districts this summer with the economy on the down.

Bear in mind, they’ll be asking you for your money – to be invested in the worthy effort to ensure their return to office, and with this return, a continuation of the good works they undertake on our behalf. If the economy turns sour, ALL of them (well, almost all) are vulnerable, and this, among other factors, is the reason why what I truly believe was a budgetary cycle setting up as a nasty game of chicken turned into a combined love fest/spending spree.

But the big question remains: can this here 9-year rally, unquestionably fueled by cheap and sometimes free financing, survive/thrive in a normalized interest rate environment? Loyal readers of this publication are aware that while I believe the answer is yes, I have been much more concerned about the process of rising interest rates than I am about higher interest rates themselves. Pattern recognition suggests that while we probably can survive elevated yields and diminished bond prices, the Fixed Income selloff that is needed could be unpleasant or worse.

I retain this fear, but have forged ahead nonetheless. For what it’s worth, I kind of doubt that the hyper volatility period is over just yet. Investors entered the weekend in an advanced state of confusion, and, while a couple of days off should’ve done a world of good for them, I expect them to enter Monday’s proceedings as befuddled as they were when we left off on Friday.

But the lower the market goes, the more Beppie is ready to step in and do some buying. The SPX closed this week down 2% for the year, and I’m willing to put some money behind the proposition that a level such as this is a constructive one.

But again, it’s not up to me. Beppie is calling the shots, and my final bit of risk management advice is to avoid overtly pushing her buttons. To the outside world, she’s as well-bred and dignified a woman as you’re every likely to meet, but cross her one time and…

…forget it; you don’t want to know.

TIMSHEL

Sometimes a Great Notion

Posted on by

“The story is told that when Joe was a child his cousins emptied his Christmas stocking and replaced the gifts with horse manure. Joe took one look and bolted for the door, eyes glittering with excitement. “Wait, Joe, where you going? What did ol’ Santa bring you?” According to the story Joe paused at the door for a piece of rope. “Brought me a bran’-new pony but he got away. I’ll catch ’em if I hurry.” And ever since then it seemed that Joe had been accepting more than his share of hardship as good fortune, and more than his share of sh*t as a sign of Shetland ponies just around the corner, Thoroughbred stallions just up the road. Were one to show him that the horses didn’t exist, never had existed, only the joke, only the sh*t, he would have thanked the giver for the fertilizer and started a vegetable garden”. 

— Ken Kesey –“Sometimes a Great Notion” 

Really sorry to do this to you, what, with it being Christmas Eve and all. But old habits die hard. I’ve seldom missed a week of sending out this Thoroughbred Stallion of a note, and, even though today’s offering may be nothing more than a Shetland Pony, I reckon this week is no exception.

I’ll dedicate it to old Joe: Joe Ben Stamper, one of the greatest characters in what may be my favorite book of all time: Ken Kesey’s “Sometimes a Great Notion”.

I highly recommend this novel to anyone who wants to place his her squarely on a piece of true terra firma. But you’ll have to be patient. Let the book come to you. It is written in a stream of conscious motif, with multiple characters, along with a narrator, telling the story from different points of view, at different times. Once you crack the code, if you’re like me, you won’t be able to put it down.

I read it first in college, and, while I have since consumed hundreds of works of literary fiction, this is the only one for which I can say, once I finished it, I went back to the beginning and began again.

One cannot help but admiring Joe Ben and his inexorable optimism, particularly given that the book’s title (and some of its content) assumes darker hues. The title itself is purloined from Hudie (Leadbelly) Ledbetter’s classic song “Goodnight Irene”, and more specifically from the verse:

“Sometimes I live in the country, sometimes I live in the town, 

Sometimes I take a great notion, 

To jump in the river and drown” 

Well (SPOILER ALERT), Joe Ben did end up drowning in the river, but it was no great notion of his; in fact, it was no notion at all. The very thought would’ve horrified him.

With ’17 winding down, I feel we could all use a little dash of Joe Ben’s eternal hopefulness, but this righteous quality appears to be in drastically short supply this holiday season. Everyone, instead, appears to be angry, and one wonders why.

Case and point: completing my cycle of obligatory holiday conspicuous consumption (as perhaps reaching its crescendo with last week’s viral news of my purchase of an I-Phone 8), on Friday, my wife and I copped a full drum kit, begging the question as to how we endured without one for so long.

The model I chose looks like this:

Pretty sweet set, no? But at the checkout line, I got into argument with the cashier when she positively insisted on trying to sell me one of those rip-off Extended Warranties.

An Extended Warranty? For a drum set? The sound that you hear is John (Bonzo) Bonham and Keith Moon executing a synchronized roll in their final resting places. I still plan on enjoying the purchase, and I don’t even play drums. But some of the seasonal tidings were lost in Warranty Episode, and I can’t help but feeling that this sort of buzz kill vibe is needlessly pervading our sensibilities, to no good purpose, in inappropriate forms, and certainly at an unfortunate point in the calendar.

Closer to our core interests, for instance, the Ruling Party managed, against considerable odds, to push through a pretty material piece of tax reform legislation this past week, and, in what can only be characterized as a double dip, even gathered itself to waive in a Continuing Budget Resolution which enabled the President to sign the Big Bill. But did the equity markets rally on this achievement? They did not. The Gallant 500 actually closed down a few basis points on the heels of the announcement.

Perhaps this is due to (presumably backed by the type of extensive voter analytics that catapulted Hillary Clinton to – well, back to Chappaqua) the Democratic Leadership’s desperate struggle to outflank one another in terms of hysteria-driven criticism of the initiative. Here, there was a clear winner, the Favorite: one Nancy Pelosi (D-Cali), who characterized the legislation as “the worst bill in the history of the United States Congress”.

Even Bernie couldn’t top that one.

But really Nancy? Worse than the Fugitive Slave Act of 1850, which forced indentured souls captured on free soil to be delivered back into servitude? Worse than the Alien and Sedition Act of 1798, that allowed for the wholesale imprisonment of non-naturalized immigrants, and made it a crime for anyone to speak out against the Adams Administration?

But apparently, for whatever we’ve lost during these troubled times, we have gained back in the form of unhinged political hyperbole.

Last week also featured a rude awakening for Bitcoin investors and other virtual currency enthusiasts. Everyone’s favorite (at least for now) non-asset asset dropped 25% on Friday, in part due to some mean things that former Hedge Fund Honcho/current crypto maven Mike Novogratz tweeted about the concept. Those that read the tweet all the way through (admittedly a challenge in the expanded 240-character Twitterverse) are aware that at the end of the “tome”, he characterized his selloff projection as “just pausing”. But no matter, the damage had been done.

Be that as it may, I have nothing useful to convey about Bitcoin, so I will leave it at that.

Soy Beans continued their rout, as did Natural Gas.

Soy Beans:

Natural Gas: 

Other markets were quiet, and presumably will remain so through the ball drop at midnight on 12/31.

So I think I’ll take my leave on a more Joe Ben-like note. I have a Great Notion that investors may be served up a pretty strong market in ’18. My repeated theory about the scarcity of quality investment securities is now so ubiquitous that I heard Cramer crowing about it on TV last week. All the macro figures are pointing upward, and not just in the United States. The good folks with whom I reason are telling me that Q4 earnings look like a blowout. And whatever else happens with this new tax regime, it is a windfall for most corporations, and Ms. Pelosi is right when she predicts that many will apply large portions of their newfound bounty to the continuance of their stock repurchase programs.

So the time may indeed be upon us to look past the sh*t served up in our stockings and towards the Shetland Ponies from which it issued forth. Joe Ben showed us how, keeping (SPOILER alert) his joyful spirit to the very end, when, though drowning, he actually died laughing. This holiday season, we could do worse than follow his example.

Happy Holidays to everyone, and of course, as always….

TIMSHEL