Besides wanting to wish all of our clients, friends and families a Happy Holiday season, I thought I would write a quick blog on Seasonality in the markets.
Looking back at the last 4 Decembers and Januaries, it is quite interesting that January has been rather unkind to the S&P 500 (SPX) while it has been very kind to the 10yr US Treasury Bond.
Here is a simple table showing the Total Returns for both asset classes. Remember that the normal correlation is that when stocks do well, bonds typically do poorly, and vice versa.
Now, I am obviously making an assumption that December 2016 Total Returns will be largely unchanged from today.
So on average, December has been a fairly benign month for both stocks and bonds but January is a different story...stocks have been pounded into submission the last 3yrs and bonds have done extremely well. Why?
A big part of the reason is called "window dressing". This is where fund managers, mutual fund managers etc all want to report or show their portfolio as following the prevailing trend. And as we all know the prevailing trend, post US election, has been stocks up and bonds down. Taking the contrarian bet may not be what investors want and most fund managers are more worried about collecting and keeping assets than true performance. So they all fall in line with the prevailing trend. Come January, they worry less about window dressing because they may only report their portfolio every quarter or six months.
Another reason why there is not a lot of selling in December is because taxes are going to drop in January so why sell today? Best to sell in January when you would have a lower marginal tax rate.
Let's see how January ends up. I need to run out for a Christmas lunch with a very good friend so I leave this with you and wish you a safe and happy holiday and hope that 2017 is as good as 2016 (at least from an investing point of view). Cheers.
Part of our approach throughout 2016 has been to utilize our expertise and skill in investing more in our Tactical Model, rather than just going and buying a stock index(es). It is true, we are slightly underweight stocks/equities outside of Canada but if we can manage, as we have since inception, to outperform our global benchmark without assuming so much market risk, then that is a good thing. As we say at High Rock, "stronger risk-adjusted returns".
And today we harvested (an old partner of mine at Merrill Lynch used to love referring to taking profits on investments as "harvesting" as in harvesting gains) some gains or sold a position we had on for only one month.
Given I was on BNN about 6 weeks ago and Catherine asked me what our Tactical Model was all about (she said they have become a popluar term), I should probably first define what our Tactical Model is and how it operates.
First thing is security selection. This Model currently includes some select stocks/equities, a preferred share (not a typical one your Advisor would buy), a convertible bond and several high yield bonds (also rather specific). Pretty much across the entire capital structure of a corporation...IE...from the most volatile at the bottom (stocks) to the most senior/less volatile at the top (high yield bonds) and everything inbetween.
Second thing is trading. As I have written in the past, one of the biggest benefits to our clients (and oursleves, given we are managing our own money too) is that we manage money on a discretionary basis thru our license with the Ontario Securities Commission as a Portfolio Manager. What this means is that every trade we do (stocks, bonds) are all done on a bulk trade...we buy or sell one block of stock or bonds with a dealer on the "street" at one price. So every client buys/sells that stock/bond at the exact same time and the exact same price. Then at the end of the day, we allocate to each account on a pro-rata basis. We can move pretty quickly.
Ok so a late season harvest came through today. On Nov 11th I bought this US stock, CVR Energy (CVI). CVR is a Texas-based holding company with interests in a Refiner and a Fertilizer manufacturer. I bought this stock at $15.80. I sold it today at $23.45 (Dec 9th). That represents a +48% return over almost a one month period. With a return like that, you don't need to own a ton. A 1% weight added almost .5% to an overall portfolio (in this market, I will take that).
Your first question should be "why did you buy it"? Here goes:
One of my office mates came across the idea and we researched it for a day or two after the election (wish it was a few days before that because it had already started moving higher by Nov 11th). US Refiners have been hammered on a cost basis with Obama's EPA policies. Refiners need to either blend fuel with ethanol or buy Renewable Identification Numbers (RINs). These RINs have gone thru the roof the past two years, so much so, that the industry is calling it "RINsanity". By way of numbers, CVR currently has about $300mm in Ebitda (Earnings before Taxes, Depreciation and Amortization) but spends about $200mm in RINs per year. So removing the RINs would add a huge lift to the cash flow of CVR. Now the fact that legendary investor, and Trump supporter, Carl Icahn, owns 82% of CVR certainly didn't hurt our view at all.
And look who got elected as POTUS...one Donald Trump. Like him or hate him, he is all about removing regulations, like RINs, to free up businesses to grow. CVR was trading at a low $12.03 on Nov 3rd. It obviously popped up on the 9th to $15.87 and hovered there for a few days. I bought it in there on the 11th at $15.80. It started to move higher but at a fairly moderate pace. Then this week it went ballistic when Trump announced Oklahoma AG and Obama Clean Power Plan critic, Scott Pruitt, as Head of the Environmental Protection Agency (EPA). This guy's nomination alone moved the stock up to almost $25.00 on Dec 9th (darn close to where I had a sell order at $25.75...too bad it didn't make it).
Now my valuation thought process on this was the following. CVR pays about $200mm per year in RINs. If the entire RIN program was cancelled (not 100% sure 100% of it would be but let's assume for a minute it was), then all $200mm would accrue to Ebitda. And Ebitda trades on a multiple basis and, for CVR, that multiple is about 7x so $200mm in RIN savings X a 7 multiple = $1.4bln in additional stock value. Given CVR was trading with a stock value in early Nov at about $1bln, I figured it would move close to this $25 level which would represent about $2bln in stock value or close to the full $1.4bln in RIN savings. (Sorry if it is confusing but there was some method to the madness).
Today, it got very close to my sell order but didn't quite get there. I ended up calling a dealer and selling at $23.44. Almost at my target but not quite as it just wasn't responding well today...could be that after one month, all kids of stories started popping up about what a great trade this is.
If there is one thing I have learned from a career of trading and investing it is that if it hits the front pages of the newspapers...it is time to sell (as the old saying goes, "buy the rumour, sell the fact"). Part of being Tactical is to be ahead of the market. It's not easy and we can't always do it but we keep on searchng for good ideas with what we feel represent strong risk-adjusted returns for us.
Past performance is no guarantee of future performance.
The US Federal Reserve Board (the US central bank) has an all-ecompassing and interesting way to look at the state of the labor market. They use something called the Labor Market Conditions Index (LMCI).
There are 19 labor market variables that go into the LMCI such as the unemployment rate, the labor force participation rate, part-time workers, private payrolls, average weekly hours, average hourly earnings, etc etc. Effectively, this takes just about every data series into account.
What is interesting is that the LMCI has been ticking up a little bit since June (it comes out monthly like the employment report). Note the most recent uptrend in the chart below:
But over a longer term, since 2010, it has been in a downtrend. What this means is that the overall employment situation has been weakening, not strengthening. Some of the reasons for this persistent weakness in the labor market might be due to: wage stagnation, weak economic recovery, demographics (baby boomers aging), productivity in technology decreasing need for labor, etc. Will Trump's policies change all that? Maybe a little bit but it is highly unlikely as I think the most important aspect to the weak labor market is the demographic story (and I wrote about our views on Trump's policies and their effect on the economy last week). Anyway, here is the graph on the LMCI for the longer term with the downtrend shown by the arrow:
Make America Great Again.
Certainly the market has little doubt about Trump's ability to follow through on his campaign slogan with a Dow rally for Nov of 6.7% and S&P 500 of 4.4%. Government bonds were anihilated in Nov with long US Treasuries, as measured by the BAML G802 Index of 15+ year treasury bonds, being -7.5% after being -4.1% in Oct. These are big moves all the way around but especially so in the long end (10-30yr) bond markets. What happened?
We went from Deflation on Nov 7th to Inflation on Nov 8th/9th...overnight, jsut like that. Deflation is good for long bonds, cash and otherwise slow gorwth, conservative investment vehicles. Inflation is bad for long bonds and good (at least in the short term for stocks). But wow, did it move fast and hard.
It moved so fast and hard, one has to wonder if it is overdone and what is priced into the market.
What I notice first and foremost, is the amount of monetary tightening accomplished in the US system in a matter of weeks (as I said to Scott earlier this month, "we just got a year's worth of monetary tightening in one week"). We call this "monetary conditions" and what really tightened up those conditions were two things:
Where does this leave us?
You have all probably done a bit of reading on Trumpflation, Trumpenomics, etc which have one basic goal...create inflation through fiscal stimulus. Monetary stimulus has run it's course as I wrote in early Sept here: highrockcapital.ca/pauls-blog/what-the-ecb-said-or-didnt-say-yesterday-and-peak-central-bank-liquidity and Trump was smart enough to seize on it and come with a campaign with a promise of massive fiscal stimulus. The reason why this was somewhat surpirsing to most was that the level of government debt (and government debt to GDP) is so high that governments the world over are in no position to be gambling on increasing debt levels in the hopes that their infrastructure spend, and other debt-increasing policies, will increase growth and therfore tax receipts which, ultimately, will help decrease the debt burden. Well Trump was a little bit more, "damn the debt", and "lets get at it". He does own a casino or two, doesn't he?
Trudeau campaigned with the same promise and he is 14 months into his infrasturcture spend and massive deficit-increase. Anyone feeling like it is getting through to the rank and file voter in those 14 months? Not me. Not seeing it in the economic numbers either, that is for sure.
So why doesn't this Keynesian spend seem to be working as expected, at least in Canada? Because there is too much structural debt to be repaid and serviced, that's why? Every penny earned by a newly hired infrastructure worker goes to servicing debt, paying down debt and basic needs...not an F150 or a trip to Disney World.
As for Trump's plan, I have some doubts and observations:
To conclude, we are a little cautious that the rally in US stocks and the bloodbath in bonds might have just too much built in to them. Without doubt, Trump is a man of action and I do believe he will roll out his plan as quickly as he can so he can Make America Great Again. The problem might be Congress. Any and all delays will leave the market wondering. And they can look north of their border to see the effect on our economy of a $20bln deficit-spend (I lost count, is it -$30bln now?) over a 1 year period. Damn the debt.
I think Keynes is dead, isn't he?
With a two-day hiatus on writing about our Macro Views (due to writing about the more important-at-the-moment topic of OPEC and oil) I am back on schedule today.
Moving from the East (India) we will continue East to West and talk about Europe today.
The major theme in Europe for the next six months or so, will be, elections. The importance of the election outcomes will determine the fate of Europe, the European Union and the Euro currency.
The United Kingdom leaving the EU (Brexit) was the first sign of voter dissatisfaction with the status quo of European (and global) trade, borderless migration of EU citizens and just a general distrust of the mainstream politicians that have been in power for generations. I suppose it is fair to say, "folks have just had enough" and were looking for change. Well, change they got. Now the hard part...the logistics of exiting the EU. Now for the UK, it is a much easier goal to accomplish than for a Euro nation because the UK didn't use the Euro currency and still retained it's own Central Bank and monetary policy. Not so for Italy, Holland, France, etc.
Well guess what time it is in Europe? (please don't give me the time on the clock right now in GMT). It is election time. I will run through some of the major elections (and a referendum) in Europe over the next few months as we think these are very important for global markets.
Italy - Sunday Dec 4, 2016 - Referendum
Home of fine wine, food, bicycles (I finally recieved my crashed carbon fiber (that was blessed by Pope Benedict himself) race bike back after 3months of repairs) and my maternal grandparents. Also home to a disenchanted voter base. On Sunday Dec 4th, Italy will vote on a Referndum to make dramatic changes to ammend their Constitution and the powers of parliament as they affect state, regions and administrative entities. I am most certainly not an Italian Constitutional expert but it sounds to me like the changes being proposed by PM Renzi and his left-leaning Democratic Party will actually give more powers to the PM. Anyone who has followed Brexit and Trump think this to be a good idea? I doubt it. Should a "No" vote carry the referendum, PM Renzi said he would resign. Where does that leave Italy? In a huge hole is my best guess. They already have had issues with at least one bank teetering on insolvency...just imagine what would happen if a hole opened up for the other, right-leaning political parties to step in and make the next move for Italy - a Italexit? Even if the right (the Five Star Movement) didn't get organized for months, the most immediate effect would be a "run on the banks", that being, depositors would be yanking Euros from Italian banks like crazy. So although a No vote on Sunday will not lead to Italy immediately leaving the EU, it would be a precursor and one that would provide immediate uncertainty. How the Bank of Italy and the ECB deal with it will be discussed at the end.
Germany - February 12, 2017 - Presidential Election
This is far less important an event as it is really the electors (current politicians) who will elect/nominate their candidate. Given Merkel's CDU/CSU party and the Social Democrats hold 75% of the house (the Bundestag), it is highly likely a mainstream candidate will be chosen. I don't think this is a major event but worth putting on the calendar.
Holland - March 15, 2017 - General Elections
Ok, this is a big and important one. The Dutch voters will elect 150 Members of the House of Representatives. Holland, like Germany, has had the typical, mainstream parties (Labour and People's Party for Freedom and Democracy) in power for a long time but there is a new underdog in the race. I don't need to mention this but we have seen this movie twice in the past six months and the underdog wins...Brexit and Trump. There is clearly a socio-economic movement afoot in western developed nations. Just two days ago, underdog Geert Wilders and his Party for Freedom (PVV) took the lead in the polls. If you have never heard of Wilders, go ahead and Google him but I can tell you he makes Trump look like Mother Theresa. Whatever you may think of him, his social views, his comments and anything else he stands for, I put aside because the only thing that matters to me, sitting here on Toronto St in front of my bank of monitors is, how to avoid losing money for the accounts we manage. So what if Geert picks up further steam and is actually elected to PM of Holland? He may not get a majority but who knows? Like Italy, his win would provide a massive uncertainty. And like Italy, there would likely be a run on the Dutch banks as depositors withdraw Euros. I will discuss shortly what the ECB might do to hold it all together.
France - April 23, 2017 - Presidential Elections and June 11 2017 - Legislative Elections
This may just be the biggest and most important of all of the European elections in 2017. First up is the Presidential elections on April 23rd, 2017. The three front runners are the newly elected Republican candidate, Francois Fillon, who just won his party's primary in an upset against a more moderate Alain Juppe, the winner of incumbent Francois Hollande's Socialist Party primary and...Marine Le Pen, the leader of the National Front. Like Geert Wilders, Marine Le Pen is a nationalist and a protectionist. Her message is beginning to ring through to the people of France as she is doing better than expected in the polls. I don't want to get into what is behind her recent popularity but she is clearly gettting through to the French voters. Again, like Italy and Holland, what the heck happens if Le Pen wins the day in France and they leave the EU? Remeber, we are talking about France, not Greece.
Before I conclude on what I think might happen over the next six months, I wanted to give you my views on part of the reason why this "populist" vote is rising up in the developed western world. Obviously, some of it is social. We all read the press about social unrest in Europe and the USA (so far in Canada, we have been somewhat immune to such domestic terrorism like we saw just a few days ago on the campus of Ohio State). Away from the social and immigration aspect, but not totally unrelated, is the more economic aspect to this movement and is best represented by modern day free trade. Modern day free trade was a socio-economic experiment that came into vogue about 30yrs ago. On paper, this seemed like a great idea and was well-supported by economic theories like that of Comparative Advantage which sates that one nation who produces something cheaply and in abundance (say wheat in Canada) should do so full-throttle while another nation that produces another good cheaply and in abundance (say autos in South Korea) should also do so full-throttle. So we would sell wheat to South Korea and they would sell us cars and the wheat and cars would cross borders without being taxed so consumers in both countries win...sort of. Where free trade and comparative advantage theory breaks down, as we are now seeing in this political movement, is that no one ever really thought about the socio-economic consequences when an entire town or city that used to produce cars (say St Thomas near London) abandons it car plant. The town and its people suffer enormously while wheat farmers in the mid-west are laughing all the way to the bank. I think the free trade experiment is starting to come home to roost and that is part of what is driving this populist political movement.
I am obviously not 100% sure that Le Pen or Wilders or whoever takes up the right in Italy will actually win the day and execute on leaving the EU and go back to their own home currency and central bank. What I do know, is the movement is gaining steam and if it does happen, look out below.
I have been talking to a friend of mine about the logistics of how the ECB or the central bank of France, Holland or Italy would support their banking system and save the day. I have no answers, unfortunately. You may say, "hey, it wasn't that bad in the UK, what is the worry?" The worry is, the UK used the Great British Pound as its currency and had its own central bank before, during and after Brexit. Not so for France, Holland and Italy. So if France votes to constitutionally leave the EU and there is a run on French banks, which central bank steps in to prop them up and what currency do they use to do so, Francs or Euros? Imagine the systemic risk amongst European and global banks if this were to happen. The Franc would get pounded into oblivion and a nation already on the fiscal brink, would become that much more so. This would likely mean the end of the EU and the Euro currency. I would envision that most every currency in the Euro Zone would get hammered hard, save for Germany where the Deutschemark would skyrocket. What I do know if this political movement does play out is...it would be a complete and utter mess for capital markets. Just the systemic risk in the banking system alone would be unreal.
How this would affect us here is an interesting question. It certainly doesn't look it today, but I think there would be a significant flight to the safety and quality of US (and Canadian) treasury bonds. European bourses would take a beating led by banks/financials on counter-party systemic risk. Gold would likely find some legs on the European currency weakness. Commodities would probably decline a fair bit on European economic weakness.
The sheer logistics of how the EU would be held together if this type of event were to unfold is mind-boggling. Dealing with a financial crisis when you have a functioning central bank and a currency is difficult as it is (USA 2008, UK 2016) but when you don't have a functioning central bank or currency, the solution is just a little bit clouded.
(Exhausted. I think that was the longest blog I have ever written. Apologies for the length).