Wednesday, May 6, 2015

The Morning Call & Subscriber Alert---Is the bond market pushing the Fed for a rate hike?

The Morning Call


The Market

The indices (DJIA 17928, S&P 2089) got banged yesterday.  The S&P remained above its 100 day moving average; but fell back below its prior high---this is the second failed attempt to break the trend of lower highs.  The Dow closed above its 100 day moving average and (remains) below its prior high.  The trend of lower highs remains intact.

Longer term, the indices continue to trade well within their uptrends across all timeframes: short term (17110-19907, 2003-2984), intermediate term (17232-22347, 1809-2582 and long term (5369-18873, 797-2129).  

Volume rose; breadth was terrible.  The VIX was up 11%, but still finished below its 100 day moving average and within a short trading range. Its pin action remains supportive of rising stock prices; though given its proximity to the lower boundary of its long term trading range, I still believe that it cheap portfolio insurance.

The long Treasury was down again, though only slightly.  It ended below its 100 day moving average, the lower boundary of its short term trading range, thereby negating it and the lower boundary of its intermediate term uptrend.  If TLT closes below this boundary at the end of the day, that trend will also be negated.  

As you know, I am very concerned about the fundamental implications of rising interest rates because (1) it suggests our economic forecast (weak economy, potential deflation) is incorrect and (2) hence, our muni bond bet in the ETF Portfolio is at risk.  I listed a number of different explanations for higher interest rates in yesterday’s Morning Call. 

Two of those were cited as reasons for yesterday’s sell off: higher oil prices (inflation) and fear of a Fed rate hike. I still have a problem with the inflation explanation.  But the more I think about it, the more the reason (3) listed in yesterday’s Morning Call (i.e. investors are sick and tired of getting paid little to nothing and are fearful that others may feel the same) is making sense to me in this context: the Fed has always missed the timing of a transition to tighter money; indeed, what has prompted the eventual tightening move most frequently was not economic conditions but rather the bond market forcing the move by pushing interest rates up on its own leaving the Fed no choice but to follow.  I am not saying that this is what is now occurring; I am saying that it is becoming my number one choice if this latest move in yields is something more than noise.  I am on the edge of my seat.

The Fed balance sheet is shrinking. i.e. it is tightening.  Could this help explain the poor price action in Treasuries? (short):

Here is a discussion on the time lag between rising rates and recession (medium):

GLD was up but closed below its 100 day moving average and continued to build a head and shoulders formation.

Finally, oil appears to be breaking out to the upside of its recent trading range (see above).

Bottom line: try as they might, the indices have not been able to successfully challenge (under our time and distance discipline) the trend of lower highs dating back to late February.  That suggests that the ranks of the bulls are diminishing.  That said, there has been no sign of a pickup in number of bears.  So on a short term basis, the Averages seem stuck between their 100 day moving averages (or the lower boundary of their short term uptrends) on the downside and the trend to lower highs on the upside.   I have no clue which way they break. 

Longer term, the Averages are solidly within uptrends across all timeframes.

The pin action in the long Treasury makes me more nervous each day---I just don’t know about exactly what.  There are several possible fundamental explanations and one strictly technical one---random price movement.  The last notwithstanding, I am looking for a potential change in the economic landscape which could alter our economic and investment outlooks.

            Sell in May and go away. Myth or reality? (medium):


            Lots of US economic data yesterday; and they were evenly divided.  Negatives: the March US trade deficit and the April PMI services index.  Positives: month to date retail chain store sales and the April ISM nonmanufacturing index---the ISM and trade data being the most significant.  Week to date, the stats have been mixed.

            Overseas, Australia’s central bank lowered its key interest rate, keeping the global QE merry-go-round spinning; and the EU raised in 2015 economic growth forecast---another indication that Europe may be pulling out of its slump.  On the other hand, forecasts of improvement, especially from eurocrats, for the last seven years have largely proven to be well short of reality. 

Plus, I doubt that there is any provision for a Greek exit/default in that outlook; and yesterday’s news on that front was anything but optimistic:

(1)   EU Commission slashes Greek economic forecasts (medium):

(2)   the Troika can’t agree among themselves on the proper conditions for a bail out (medium):

(3)   and the ECB tightens the screws on Greek banks (short):

            ***overnight, Greece made a E200 million payment to the IMF but faces a more daunting one of E750 million on May 12; the UK services PMI came in at 59.5 versus expectations of 58.5.

Bottom line:  yesterday’s US economic news was mixed and that is a plus.  But it is not to say that economy isn’t weakening.  The eurocrats are predicting that the EU economy is improving, though I believe it should be taken with a grain of salt.  The Greek bail out remains iffy.  The Australian central bank is cutting rates, suggesting that all may not be well out in the Pacific.  And finally, bonds are acting like something is amiss (at least in our weak economy/deflation forecast).  In short, the news flow is confusing; so it is no wonder stocks are acting the same way. 

I have no big picture conclusions about this mixed bag of news or about the message of the bond market.  I do believe that stocks are extremely overvalued; so unless the ultimate economic/interest rate environment is quite positive, stock prices are at risk.

 I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.

Bear in mind, this is not a recommendation to run for the hills.  Our Portfolios are still 55-60% invested and their cash position is a function of individual stocks either hitting their Sell Half Prices or their underlying company failing to meet the requisite minimum financial criteria needed for inclusion in our Universe.

            The latest from John Hussman (medium):

            QE and stock prices (short):

       Subscriber Alert

            A number of the stocks on our Buy Lists have fallen below the lower boundaries of their respective Buy Value Ranges, so they are being Removed from their respective Buy Lists.  None of them have traded down to their Stop Loss Price.  They include:

In the Dividend Growth Portfolio:

ITC Corp (ITC-$36)
South Jersey Industries (SJI-$51)
Chevron (CVX-$108)

The Dividend Growth Portfolio doesn’t own ITC and will continue to Hold SJI and CVX.

In the Aggressive Growth Portfolio:

Cummins (CMI-$139)
Donaldson (DCI-$35)

The Aggressive Growth Portfolio will continue to Hold CMI and DCI.

      Investing for Survival

How to learn more about investing?

There are three main answers here:
1.      Study the classics
2.      Study areas where there are current problems
3.      Read widely

When I talk about the classics, I am talking about the writings of Ben Graham, Buffett, Munger, Phil Fisher, and notable investors who have spilled their theories to the world.  Also men like Seth Klarman, Howard Marks, Ray Dalio, George Soros, Bill Gross, Jeffrey Gundlach and other clever investors who understand the markets well.
Second, if there are current problems in the market, do your research, and try to understand them well.  This may take more effort, because current problems are not well-understood, or they would have been solved already.
The correct answer is not immediately obvious.  Prior to the crisis, it is a minority view.  After the crisis, everyone knew it would happen ;) .
Try to view the markets in a comprehensive way.  Think of the buyer and the seller, and their motives.    Look for minority opinions, and analyze them — maybe that have it right.  Most of the time, you will throw their opinions away, but in rare cases you might find something valuable.
Finally, read widely.  Try to understand the changing economy. and where value is being added where current valuations don’t reflect it.  Understand the economic world, and dedicate time to it.  I dedicated an hour par day while I was an actuary to understanding all manner of investments for ten years before I had my first job in investing at age 38.
And read economic history.  It is very valuable to understand how things worked in the past, because it offers clues to those of us in the present who don’t think “It’s Different This Time.”

      News on Stocks in Our Portfolios
·         Occidental Petroleum (NYSE:OXY): Q1 EPS of $0.04 in-line.
·         Revenue of $3.09B (-37.7% Y/Y) misses by $210M.
·         Western Gas Partners (NYSE:WES): Q1 EPS of $0.26 may not be comparable to consensus of $0.44.
·         Revenue of $375.1M (+27.7% Y/Y) beats by $32.03M.


   This Week’s Data

            Month to date retail chain store sales improved slightly year over year.

            The April PMI services index was reported at 57.4 versus estimates of 57.7.

            The April ISM nonmanufacturing index came in at 57.8 versus forecasts of 56.5.

                Weekly mortgage applications fell 4.6% but purchase applications rose 1.0%.

            The April ADP private payroll report showed a 3.4% decline in employment versus expectations of an 8.4% increase.

            First Quarter nonfarm productivity declined 1.9%, in line; unit labor costs rose 5.0% versus consensus of up 4.6%.


            The source of the EU’s economic problems (medium):

            QE and inflation (short):

            SEC commissioner bashes Deutschebank (medium):



  International War Against Radical Islam

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