U.S. stock markets are up on nothing but bad news

Kicking the can down the road

kicking

Mario Draghi made comments last week that the ECB is preparing a fresh blast of stimulus to halt the slide in global equities. The Bank of Japan blindsided global financial markets today by adopting negative interest rates for the first time ever, buckling under pressure to revive growth in the world’s third-largest economy.

The BOJ is charging banks for the privilege of parking some of their excess funds which was an unexpected move, although not something new. The European Central Bank has slashed interest rates below zero before to push down borrowing costs and prod banks to lend more.

In a move that was signaled by the Nikkei business daily minutes ahead of the decision, the BOJ said it will apply a rate of negative 0.1 percent to excess reserves that financial institutional place at the bank, effective February 16.

Now U.S. economic growth slowed sharply in the fourth quarter as businesses stepped up efforts to reduce an inventory glut because of a strong dollar and tepid global demand for exports. Gross domestic product increased at a 0.7 percent annual rate, the report showed a further cutback in investment by energy firms grappling with lower oil prices.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased at a 2.2 percent rate. That was a step-down from the 3.0 percent pace notched in the third quarter.

The Commerce Department said Thursday that durable goods orders declined 5.1 percent last month, likely also weighed down by a strong dollar, after slipping 0.5 percent in November.

Why is this bad news for the United States?

The fact that both the ECB and BOJ are adding stimulus signals slower world economic growth. More stimulus will lower the value of the Euro and the Yen against the U.S. dollar. This will make U.S. exports more expensive and less competitive in global markets.

Forward sales guidance from companies like Apple, Boeing and Caterpillar are weak primarily due to a strong U.S. dollar and slower global growth. It also gives European and Japanese companies an advantage in selling their products into the U.S. domestic market.

I am not surprised that Wall Street traders are disconnected from economic reality. I believe that this rally is based on the hope that the Fed will not be removing the punch bowl from the party. Most Fed watchers have reduced their expectations of a rate hike in March from 50 percent down to 10 percent. Some are calling for no rate hikes in 2016 and even a possibility of a rate cut.

The chart below illustrates that over the last 6  months money has been moving into the utility sector (XLU) and away from financials (XLF). In a nut shell, raising interest rates are good for financials and bad for utilities.

29-jan

The utility sector, in the past, has also been known as a good place to hide during volatile times in the stock market. You get paid to wait for the markets to settle down.

 

 

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Should you buy the dips or sell into the rallies?

buy sell

The strategy of buying the dips has worked very well during bull markets. However, every business circle has an upward trend which is followed by a move downward. Technically speaking, a bull market will end when there is a 20% or greater drop from the high point of the major indexes.

On Wednesday, the MSCI All-Country World Index has fallen more than 20 percent from the market peak. So that means that roughly one-fifth of all stock market wealth in the entire world has been wiped out. The selloff in the U.S. markets may seem bad right now but the truth is that they still have a long way to go to catch up with the rest of the world.

Now the S&P 500 had a two-day rally at the end of this week based on a bounce back in the price of crude oil and comments from Mario Draghi that the ECB is preparing a fresh blast of stimulus to halt the slide in global equities. Plus Wall Street believes that the Fed will hold off any interest rate increases until much later in the year.

My trader’s instinct tells me that this is a dead cat bounce in the price of crude oil. I have seen a couple of sucker rallies in oil during 2015 and this looks like a classic short covering rally. Fundamentally, nothing has changed in the oversupply situation and slow world economic growth will not boost demand anytime soon.

So, why is the price of crude oil effecting stock prices?

Wall Street is secretly afraid of another 2008 financial crisis caused by debt that is tied to the price of oil. U.S. hedge funds have been shorting Canadian banks because of their loan exposure to Canadian oil producers. They expect big loan losses will reduce bank profits.

Now, the big U.S. banks are building up their reserves to deal with potential energy-sector losses. In the fourth quarter, Bank of America increased loan loss provisions by $264 million, Citigroup set aside another $250 million while J.P. Morgan Chase added $124 million to brace for potential trouble with energy loans.

Bank of America leads the list with $21.3 billion in energy loans. Citigroup is next at $20.5 billion. Wells Fargo is third at $17 billion. JP Morgan Chase is at $13.8 billion. Morgan Stanley is at $4.8 billion, PNC Bank has $2.6 billion and U.S. Bancorp is at $3.1 billion.

That is only the tip of the iceberg, European & Asian financial institutions also have loan exposure to oil-producing companies in other parts of the world. There are also added risks of debt default from oil-producing countries like Russia, Venezuela, Norway, Brazil and Mexico.

domino

The S&P 500 has begun 2016 with its worst performance ever. This has prompted Wall Street supporters to come out in full force and try to explain why the chaos in global currencies and equities will not be a repeat of 2008. However, these individuals that dominate financial institutions and their economists seldom predict a down-tick on Wall Street, so I don’t expect them to warn of a possible global recession or market mayhem until after the fact.

I believe that no one can time the market so selling everything and holding cash is a very bad strategy. A good strategy would be not putting any new money into this market, raising some cash by selling some poor performing stocks and getting more defensive. I am not a big fan of CNBC’s Mad Money host Jim Cramer but sometimes he goes come out with some outstanding comments.

“Every once in a while, the market does something so stupid it takes your breath away.” – Jim Cramer

The chart below illustrates the daily stock price of the S&P 500 from Jan 4, 2007 until Mar 31, 2009. The market seems fairly flat until Oct 2007 before it started a roller coaster ride downward.

2007-2009

This next chart of the S&P 500 is from Jan 4, 2015 until Jan 23, 2016. Again the market seems flat for a while before the start of a new, more volatile roller coaster ride.

2015-2016

My trader’s instinct tells me that the U.S. markets may bounce up but that the rally will be short-lived because the price of crude oil hasn’t made a bottom yet. I am not a big fan of technical price indicators but the S&P 500 has to break through the 2000 level for this correction to be over and a breakdown below the 1820 level will see more selling. A double bottom pattern that formed during the August 2015 correction is very bullish.

Unfortunately, the average investor closed their eyes, put their portfolio statements in a drawer unopened during the 2008 financial crisis and waited almost 4.5  years to break even. They missed one of the best stock buying opportunities of some really stupid bargains.

“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” – Warren Buffett

What do think? Is it safe to buy now or are you going to sell into the rallies?

 

Investment Club Meeting: a tad bearish on Canada but bullish on foreign equities

club

We had a very lively discussion during our annual shareholders’ meeting. As promised in my last post, I asked the advisors in the group for their investment outlook. These advisors were very skeptical about the bullish sentiment that the Canadian market would out perform the U.S. in 2016. Over the past five weeks, they have been getting more bearish commentary regarding Canada. One advisor commented that it was getting more difficult to separate the 80% that is bull shit and the 20% that is real.

He gave out a Dec. handout with Bankers’ predictions for oil in the $50 to $58 range, the Canadian dollar around $0.73 and the TSX closing near the 14,500 to 15,000 level. “How can RBC predict the price of oil to double by the end of the year and our dollar rebound to only $0.73?”

Key bearish comments on Canada

  • Saudi Arabia is not likely to cut production in 2016 because they have introduced economic reforms to ride out lower for longer oil prices.
  • Tensions between Iran and Saudi Arabia have increased. The U.S. (Saudi’s biggest ally) has been negotiating with their biggest enemy (Iran). Low oil prices has become a weapon to hurt Iran’s ability to finance their aggressive military expansion plans in the region.
  • The lower Canadian dollar is not helping our economy recover from low oil prices. Our manufacturing industry has lost production to Mexican whose currency has been lower for longer than Canada.
  • Canadian consumers have less disposable income, the savings from lower gasoline prices isn’t enough to offset the cost of higher food prices.
  • The selloff in Canadian Reits points to an increase possibility of a recession in Canada. Despite the fact that interest rates were cut twice in 2015, investors fear lower rental revenue in the office and industrial space.

Since our meeting I am even more bearish

  • The end of Iran’s oil export ban is expected to occur this weekend and could add another million barrels a day of surplus supply. IPA has projected a reduction in U.S. shale production of only 750,000 barrels by the end of 2016.
  • The U.S. oil export ban has been lifted, two weeks ago U.S. oil companies have started to export cruel oil. I believe that this could delay U.S. production cuts.
  • Back in November, three U.S.  tankers carrying diesel fuel heading to Europe had to turn around because the storage tanks in Europe were full.
  • Liquid natural gas (LNG) prices in Asia and Europe have fallen more than 50% making the whole process for North America suppliers less lucrative. Canada’s LNG window of opportunity is closing as we are still in the planning stages and years away from construction.

Blackrock Chairman and CEO Larry Fink said Friday the stock market could fall another 10 percent and oil prices could test $25 per barrel. But by the second half of the year, Fink said, the stock market should be higher. “Over the course of the next six months, we think it’s going to feel a lot better.”

club1

Club member’s views

Members believe that the Bank of Canada will cut interest rates again in 2016 and falling crude oil prices will weaken the Canadian dollar to the $0.60 to $0.62 range. We decided to move 50% of our cash into U.S. dollars.

They agreed with my short-term bearish views and with my suggested to protect our long positions selling covered call options and buying some short ETFs. (SH & DOG)

They are bullish on Europe based on the positive effect that Q.E. had on U.S. stock prices and that it should have same effect on European stocks.

Keep some cash on hand to pick up some bargains!

Disclaimer: These just opinions and you should consult with a financial advisor!

 

Investing Outlook for 2016: Cloudy with high volatility & increasing risks for negative returns

2016

Over the past three weeks I have been trying to separate what is noise from the business media and what is reality. I am preparing for my investment club’s annual shareholders’ meeting. Facing a room full of financial advisors can be nerve racking. They expect my experience in option trading to produce positive returns regardless of market direction. My 2015 results will not disappoint them.

However, I found investment trends in 2015 to be very obvious but 2016 is going to be much more difficult. Last week I posted that world economic growth in 2016 is going to suck. World growth estimates came down on Thursday from 3.5% to 2.9%. Fourth quarter GDP growth estimates for the United States have been reduced to a range of 0% to 1.2%. Trying to find companies that can grow their revenue and profits in a slow growth environment will be challenging.

Why my 2016 crystal ball is cloudy

  1. Most experts were wrong with their predictions on the price of oil in 2015. Their current prediction is for low oil prices for the first half of 2016 and a rebound to the $50.00 range later in the year. If they are wrong again, many oil producers will default on their high yield debt, leading to bankruptcies that could cause panic in the stock markets.
  2. The Federal Reserve has been communicating 4 interest rate hikes but Wall Street experts believe that only 1 or 2 hikes will actually happen. If they are wrong, the U.S. dollar will increase in value causing lower profits for U.S. multi-national corporations. Plus higher interest rates will reduce share buybacks which isn’t very positive for stocks prices.
  3. China is struggling to manage their economy. Economic growth in China, the second largest economy, is questionable at best. China buys Brent crude oil which usually trades higher than WTI. The price spread has been narrowing confirming weak oil demand and slower economic growth. (Brent $33.34, WTI $32.92)
  4. A stock is considered to be in a bear market when it trades 20% or more below its 52 week high. More than half the stocks within the S&P 500 are in a bear market. Current price to earnings ratios are high in comparison to lower profit growth.
  5. No Santa Claus rally and January started with five straight down days in spite of a positive jobs report. (Scary)
  6. The Canadian stock market is down 20% from its Sept 2014 high which is already in bear market territory. Many fund managers believe that a rebound in oil could cause the Canadian market to outperform the U.S. One young fund manager recently stated that his energy fund is 100% invested in the oil patch. (Foolish?)

bear

Here is a small portion of what I am going to say at our shareholders meeting

I took some profits leading up to the Dec 16, Fed meeting and also did some tax lost selling. Our current portfolio contains 55% cash, 5% in Canadian stocks and 40% in U.S. stocks. I expect market volatility to increase during 2016 making option trading more profitable. It will also make buying put options for downward protection more expensive.

The three biggest unknowns are the future price of oil, the number of interest rate hikes by the Fed and GDP growth in the U.S. and China. I believe that the Canadian stock market is pricing in a recession in Canada. If crude oil doesn’t rebound in the second half of 2016, the Canadian dollar could fall further and we should consider moving more of our Canada cash to U.S. dollars. I will also ask them for their views on the current market turmoil and for some of their recommendations to clients.

Stay tuned for my next post which will hopefully have some investment ideas.

roller

I am very sure that the roller coaster ride that started in 2015 will continue in 2016.

 

 

 

Here is why you may own mutual funds that are losers

mutual2

You would think that active mutual fund managers would have an easier time beating their benchmarks when most indexes were down for the year. These so-called expert stock pickers are supposed to underweight stocks in the poor performing sectors and overweight stocks in the top performing sectors.

The root of the problem is pretty simple! Most managers were underweight many of the stocks that saw the biggest gains. It’s hard to beat the market when you’re not on board with the best-performing companies. That was the fate of most mutual fund managers, who again fell short of their benchmarks over the past 12 months.

In a year that many had touted as ripe for the return of stock pickers, just 27 percent of large-cap core funds topped the S&P 500, according to a recent Goldman Sachs analysis. That number falls well below the 10-year average of 36 percent.

The business media referred to the best performing stocks in the S&P 500 as the “FANGS.” Most fund managers missed owning; Facebook (up 35.8%), Amazon (up 117.6%), Netflix (up 140%) Google (up 45.2% and is now Alphabet) and Starbucks (up 46.7%).

When I was a financial advisor, I didn’t expected the mutual fund managers to outperform the markets during a raging bull market. Bull markets tend to get overvalued. I did expect a fund manager to lose less in down markets and outperform during years of modest returns. In my humble opinion, a 27% success rate for mutual fund managers in 2015 is just sad. The odds are really stacked against you if only 36% of active managers beat the index on average.

Here is why their results are disappointing

  1. They tend to reduce their exposure to their winning stock picks when the percentage of anyone stock exceeds 5% of the portfolio. Basically trimming back their winners instead of letting them run higher.
  2. They still own stocks in poor performing sectors instead of avoiding them all together. For example: the S&P 500 contains 10 sectors, if energy makes up 9% of the index then fund managers will underweight this sector by having 5% of their portfolio in energy names.
  3. They trim their winners and average down on their losers, hoping for a rebound.
  4. Their management fees are high and paid monthly which reduces their returns over the course of the year. (Fee based advisors get paid by mutual fund companies)
  5. Some financial advisors will recommend mutual funds based on how much they will get paid and not based on long-term performance of the fund manager. (Be careful, a lot of bad apples out there)

Some investors in 2015 have flocked to exchange-traded funds, these passively managed vehicles track market indexes like the S&P 500 and offer lower fees, more liquidity and tax advantages.

For the year, the scorecard is stark: $198.8 billion in inflows for global equity ETFs and $177.2 billion in outflows for mutual funds, according to Bank of America Merrill Lynch.

Mutual funds remain the leader by a large margin, with $13.2 trillion in assets excluding money market funds, according to the latest data from the Investment Company Institute. However, ETFs are catching up, with the $2.1 trillion currently under management, an increase of 11.3 percent from the previous year.

This year’s results will only add fuel to the active versus passive investing debate. To me it is a simple decision, anybody can make money in a raging bull market! If you don’t feel comfortable investing in ETFs, stick with managers that lose less in down markets and have a history of making positive returns.

I have to warn you that I am somewhat bias against active managed mutual funds because I used to pick them for a living. I can tell you from personal experience that the majority of the advisors in my former office, including myself, found it very difficult to pick winners. Even if I was lucky to find a few good funds, there is no guarantee that the successful manager running the fund won’t be lured away by another mutual fund company. The end result is a rush to the exits triggering massive redemptions as everyone follows the successful manager and turns a winning mutual fund into a loser.

 

scam-financial-advisor

This is a good year to grade your advisor if you have one. Remember, advisors get paid even when they recommend buying mutual funds that are losers.

Happy New Year, btw, World Economic Growth for 2016 is going to SUCK!

new year 4

Let me start by saying that I am usually very optimistic at the start of a new year. However, 2015 was a difficult year to make money.  Santa Claus wasn’t very generous to Wall Street and downright mean to Canada.  Plus, I  just can’t resist being an armchair economist. A lot has changed during the past 40 years since I graduated from university with a degree in economics. Some factors that affect economic growth remain the same. I call them the 3 “Ds”, debt, demographics and deflation.

Too much debt dampens growth

Economic growth depends upon government, business and consumer spending on goods & services. It is hard for these three engines of economic growth to spend if more dollars are being diverted to paying down debt plus paying interest charges. Monetary policy of keeping interest rates low hasn’t spurred very much growth so far.

Now, prior to the “Great Recession”, governments were able to stimulate spending by reducing tax rates for both business and consumers. Slower than normal economic growth is compounding the problem for governments because tax revenues are being reduced. Canada is one of the few countries whose government has plans to spend money on infrastructure and lower taxes for middle-income families to avoid a recession.

Demographics – the graying population are saving instead of spending

There are 10,000 U.S. baby boomers turning 65 each day and most are inadequately prepared for retirement. Nearly half of elderly Americans would be living in poverty without Social Security. These retiring baby boomers will be a burden on government health care programs and social services. Even, China has made a surprise move to end its one child policy.

China’s government has said the country could become home to the most elderly population on the planet in just 15 years, with more than 400 million people over the age of 60. Researchers say, and the world’s second-largest economy will struggle to maintain its growth

The children of the baby boom generation have different spending patterns than their parents. They are less materialistic and focus their spending on experiences. They are also delaying moving out of their parent’s basement, getting married and having children. This is  partly due to high levels of student debt.

Deflation – has some negative effects on growth

Falling prices encourages consumers to delay spending, waiting for items to get cheaper. Deflation makes it difficult for business to increase prices which leads to cutting costs. Corporations end up reducing staff and freezing employee wages. They also reduce or delay corporate spending which adds to a slowdown in economic growth.

Many resource based countries are facing recessionary pressures from the collapse in commodity prices. Australia, Brazil, Canada and Russia are just a few countries smuggling to generate some economic growth.

Slow economic growth equals lower stock market returns

The NASDAQ was the only U.S. index to have positive returns in 2015. The other three indexes, S&P 500 (SPY), Dow Jones (DIA) and the Russell 2000 (IWM), were all negative. See chart below:

2015

Canada is a good example of the correlation between economic growth and stock market returns. Economic growth was negative for the first six months of 2015, slightly positive for the next three months and the results for the last three months are not available yet. The deflationary factor of the collapsing price of commodities was the main cause for the negative returns in the Canadian stock market (XIC). See the chart below:

2015a

The outlook for stock market returns in 2016 isn’t very bright from an economic point of view. This could be the year of the bears and not the bulls to make money.