RF's Financial News

Sunday, October 19, 2014

This Week in Barrons - 10-19-2014

This Week in Barrons – 10-19-2014:

Deflation – Inflation – What does it matter?

Dear Ms. Yellen:

I only have a couple questions this week?

#1: Ms. Yellen, why do you hate deflation? Can’t we forget trying to manufacture 2% inflation and simply let the market decide what's best? After all, Wal-Mart is our nation’s largest employer and is also the leader in low prices – and yet they don’t seem to go out of business. And I’ve never heard someone say: “I wish that product would go up in price so that I could buy it.” The theory with ‘deflation’ is that if you know prices are going to fall, you will delay your purchases, and the economy will come to a screeching halt. But that doesn’t seem to make any sense to me. Isn’t it gigantic ‘SALE’ signs that pack stores and showrooms? People don't delay their purchases waiting on lower prices, but rather flock toward lower prices. Also, in emergency situations nobody puts off replacing a water heater, a tire, or a refrigerator until ‘next year’ because it could be cheaper. In fact, electronics are notorious for coming out high and watching prices fall. And despite knowing prices will fall, people still camp out for 3 weeks on sidewalks to get the newest iPhone. Your own FED economists have said: “The only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-34). We find virtually no evidence of such a link in any other period. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.” So if deflation isn’t the ‘kiss of death’ – then why not allow consumers to get more value, buy more products, and spur more investment for expansion, by eliminating your goal of 2% inflation?

#2 Ms. Yellen, a friend of mine MW has prepared the chart below. It tries to simplify a lot of economic factors comparing the West to the BRIC’s (Brazil, Russia, India and China):

I realize that this is a very simplified view, but generally it appears that the U.S. is in trouble on virtually all fronts. When I look at the BRIC economies, I see increasing wages and jobs, and decreasing unemployment and debt. And after the West has pumped trillions of dollars into their economies, I continue to see a weak job market, European double-digit unemployment rates, and a contaction in full-time jobs (as jobs that are being created are part-time in order to avoid Obamacare). Are the BRIC’s just lucky, or is avoiding bail-outs, free money and increased entitlement programs – the way to go? I realize that your QE programs were designed to stop individuals and businesses from failing. Government programs rarely address the cause, and frequently just treat the symptoms of an ailing economy. I have seen the best intended Government programs slowly move from being short-term boosts, to long-term entitlements. I’m scared that we are beginning to breed a generation that believes that they are ‘entitled’ and often ‘reliant’ upon government handouts. This behavior destroys real businesses, keeps the poor – poor, drains public coffers, eliminates competition, and ultimately steals an individual’s pride, self-respect, accountability and responsibility. To that degree I urge you to DISCONTINUE QE – and allow the chips to fall where they may!

The Market:

- The Russell 2000 index of small-cap stocks remains one of the best indicators of general market order-flow. Earlier this week the Russell’s decline slowed, built support and began to rally as the other indices continued to see volatility.

- The Bank of Japan (BOJ) and the European Central Bank (ECB) are ramping up their QE policies and lowering rates even further. This is exactly opposite of what our FED would like – as it will force wider deflation and trade deficits.

- The bond market is pricing in that low rates are here to stay. The 10-year yield has fallen to 2%, and I think we could see 1.6 to 1.8%. If the bond market believed that the FED was actually going to raise rates, end accommodation, and unwind their balance sheet – we should be seeing rates rise to 3%.

- The energy sector (XLE) is down more than 20% and funds that have been invested in the energy sector are imploding right and left. When a fund unravels, a large amount of forced selling hits the market. This is the equivalent of an investor getting a margin call, but on a much larger scale.

- This week the bond market spiked over 5 full points, and the VIX (volatility index) spiked its highest levels in 3 years.

- This week the S&P and NASDAQ touched the 10% correction mark for the first time in 3 years. Typically corrections will last 9 to 20 months, and will fall between 10% and 30%. Fair Warning: this just turned from being an ‘investors’ market to a ‘traders’ market – virtually overnight.

- This week Retail sales reports missed their estimates, and Germany came out and cut its GDP outlook for both 2014 and 2015.

- This week the NFIB small business outlook missed their estimates and lowered forward guidance.

- The Ebola outbreak could cause a crash in the economy, as virtually no one will travel or even go into a mall where coughing and sneezing are prevalent.

- Finally, the dollar rally has had a significant consumer benefit. Oil and gasoline prices are down, and the rise in food prices has slowed. The strong dollar is like giving someone a tax cut. This will certainly help boost confidence among consumers heading into the mid-term elections, and right now the Democrats need all the help they can get.

So the real question is: Can the market hold up and even rise, in the face of failing economic reports, and no new QE? I say no. I think we can see a range forming where we bounce and put in lower highs. We then fall a little more and bounce to a lower high, and on and on. I see a stair step lower without some form of renewed action from the Feds. Frankly I don’t see an easy, safe, and smooth exit from our long-term zero interest rate and accommodative policy.

The FED is very concerned about the dollar rising and the impact it will have on GDP, corporate growth, and earnings. The other interest rate issues involve the massive amount of borrowers (not just the Federal government) that will have difficulty paying higher interest rates. Higher U.S. interest rates could trickle over to stall emerging markets and BRIC growth, as the U.S. has been a massive lender to the booming emerging markets.

I think the FED will try and talk us higher, and yet resist doing anything; therefore, expect a lot more chop and slop over the next several weeks. I’m hearing with more and more frequency that more FED money will solve all of our problems. For example, I’m hearing that “our schools need MORE money.” I am not sure at what point J.Q. Public realizes that MONEY is not the magic answer that solves ALL problems, but rather just ‘papers over them’ until tomorrow.

Tips:

I think it is pre-mature to think that the Fed is going to change course. I think we are experiencing a similar market reaction to the ending of QE1 and QE2. The FED may ride to the rescue in support of the mid-term elections; however, (due to their lack of credibility) it will need to be under the guise of a national disaster – such as Ebola. If that were to be the case, then I would NOT fight the FED. This stock market still has enough faith in the Fed that more QE and zero interest rates will keep this market moving higher a little longer – before the REAL bubble bursts.

At this point all of the indexes have broken through their 200-Day moving averages - which is a big red flag. The Eurozone is continuing to weaken, but sentiment may be changing soon as the ECB meets on NOV 6^th. I expect that some form of European QE will be discussed, and this should really help firm up both European and U.S. markets.

I still think that the only way to make money in this market is to put and call credit spreads in order to collect premium. This coming week we have another 25% of the S&P companies reporting earnings – including AAPL, LMT, and PII. I do not want to call the bottom here as we will likely see more volatility, but I do want to start looking for some bargains in the carnage. My current list of potential candidates is as follows: CME, CBOE, ICE, WYNN, TEX, HOG, SLW, IYT, TRV, FDX, UTX. In the energy sector I’m watching HERO, XLE, UPL and am watching PAA, KMI, EEP in the MLP space. I still like the biotech sector as well with names such as VRTX, AMGN, REGN, and IBB.

My current short-term ‘Larger-Cap’ holds are:

- KO (Beverage) – in @ $41.17 – (currently $42.68),

My short-tem ‘Small-Caps’ holds are:

- IG – in @ $7.27 – (currently $8.87),

To follow me on Twitter and on StockTwits to get my daily thoughts and trades – my handle is: taylorpamm.

Please be safe out there!

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Sunday, October 12, 2014

This Week in Barrons - 10-12-2014

This Week in Barrons – 10-12-2014:

“What line were you in when they were giving out testicles?” … The Judge (the movie)

Dear Ms. Yellen:

Do you remember in 1973 when FASB (the Financial Accounting and Standards Board) began regulating a company’s financial reporting according to GAAP (Generally Accepted Accounting Principles)? GAAP is an excellent, ‘real’ representation of a company’s health. It seems, because GAAP is so clear and hard-hitting, that we have allowed our companies to fall back and report on a ‘Pro-forma’ basis. ‘Pro-forma’ accounting allows a company to EXCLUDE any transactions (mostly expenses) that it believes can obscure the accuracy of its financial outlook. These excluded transactions (called ‘ex-items’) are reported separately. For example, between 2007 and 2010, companies reported $1.87T in real earnings, and correspondingly over $550B in Pro-forma ex-Items. It was this $550B, which allowed over 78% of our corporations to ‘make’ (rather than ‘miss’) their earnings estimates. I was thinking (as we enter yet another earnings season), what if we forced companies to return to GAAP accounting? If you forced companies to ‘Man-Up’ to their real earnings, wouldn’t that be a good thing in terms of transparency and understanding?

Ms. Yellen, when QE was first introduced – did you realize that it would have such a ‘slowing’ effect on the ‘velocity’ of money. I have to think that when Ben Bernanke can’t refinance his mortgage – banks aren’t lending enough. And you can’t blame them because banks earn larger returns by investing all of your interest free money back into the stock market. But, by investing in the stock market, it means that banks are NOT investing in mortgages, and that does fairly dramatically slow down the ‘re-circulation’ of money. It also slows down inflation. Honestly, inflation should be between 3% and 4% by now; however, the CPI (Consumer Price Index) is only up 1.7% and your inflation measure (the PCE deflator) is only up 1.5%. On one hand you have 5.9% unemployment, you’re stopping QE, and increasing rates – while on the other hand you have deflationary pressures and the dollar is rallying. I think you’ll agree that the strong dollar (although good in the short-term for the voters - lowering gasoline prices) is bad for the markets, government debt and deficits. Aren’t we all going to have to ‘Grow a Pair’ and just realize that our stock market should be around 10,000 and not 16,400 – and accept the crash that is coming?

Ms. Yellen – globally we going to have to grow a ‘Major League pair of Cajones’ in order to continue to ignore:

- Germany’s industrial production crashing to lows not seen since 2009 – due mainly to U.S. sanctions on Russia.

- Yields on French Bonds are seeing their lowest rates in 250 years.

- Greece is defaulting – yet again.

- China is creaking and groaning due to over-building – not to mention clashing with Hong Kong.

- Russia is still invading the Ukraine,

- ISIL is still attacking IRAQ and Syria,

- The International Monetary Fund (IMF) lowered its estimate for global growth for the 3^rd time this YEAR.

- And Ebola is beginning to have a real impact on travel and decision-making.

Lastly, Ms. Yellen your FOMC meeting (on October 29th) directly precedes the November 4th midterm election. If you stick to your path of ending QE and continue talking about increased interest rates – you could really sound the ‘death knell’ for the Democrats in the midterm elections. Wouldn’t it be easier and more ‘democratically’ accommodative to announce QE4 – on October 29^th – just 6 days before the elections? And let us not forget, the last time the FED announced a QE (QE3) it was September of 2012 – directly before the Presidential elections. So I truly think on October 29^th, every member of the FED is going to have to figure out: “Which line they were all in – when they were giving out Testicles.”

The Market:

A couple weeks ago I devoted a large portion of this newsletter to a potential pullback in the market. I explained all the reasons, the warning signs that were flashing, and how we could be looking for our first, true 10% correction in over 3 years. We did get the pullback, and (as usual) it magically stopped when the market was down 4.5%. That is exactly what happened on Wednesday when we got that ‘insane’ 280 point bounce, which looked (once again) like they were going to just let it rip back to the upside, and take us right back to the highs. But on Thursday – someone didn’t get the memo – because instead of following through with a nice green close – we fell for 300 more points. And then (as if to add insult to injury) we lost another 115 points on Friday – falling over 445 DOW points in 2 days.

Therefore, we are at a very interesting place indeed.

- The Russell 2000 has completely broken down,

- The VIX (fear index) jumped over 30% on Friday,

- The TLT (bond index) increased substantially on Friday,

- The DOW is under it’s 200-day moving average, and

- The NASDAQ and S&P are sitting at their 200-day moving averages (that have not been broken since 2012.)

This week starts earnings season. On Tuesday and Wednesday we're going to receive earnings from most of the major banking institutions. Will they show enough ‘Pro-forma’ earnings to make everyone believe that all is well and jam us higher, or are we really going to finally see our first real correction? I want to say that this time it is different, and they're NOT going to reverse this any time soon and jam us higher. But just saying that brings ‘shivers’ to my spine.

I think that the FED will try for a bounce on Monday, because the bond market is closed for the Columbus Day Holiday. I think that ‘bounce’ will carry into Tuesday and Wednesday and then it’s all up to the earnings in the financial sector. I think if the financial sector cannot ‘kick it in gear’ in a major way, then ‘yes’ we are headed considerably lower.

For Monday, watch the 200-day moving average on the S&P. If that fails (with or without the banks), we are going considerably lower. FYI: If we get a real 10% correction, the DOW will be dropping an additional 1,000 points. So hold on to your hats.

Tips:

Factually:

1. Bloomberg reported that companies in the S&P are poised to spend $974B on buy backs this year, which is 95% of ALL their earnings.

2. Wal-Mart (the single largest employers in the U.S.) announced that it is ending healthcare for its part time workers because it's too expensive.

3. The difficulty with the markets gaining any footing quickly is the huge headwind coming from the energy sector, where the combination of horizontal drilling and fracking is transforming the industry. Supply is simply booming and prices are falling. Back in 2005, the US was importing ten-times (10X) as much oil as it was exporting; now that ratio is down to two-times (2X) and headed lower. In the next few years, the US could easily become a net exporter of petroleum. These forces are creating disarray in OPEC. Saudi Arabia is willing to accept lower prices for oil, undercutting other oil exporters in the Middle East as well as Russia. West Texas Intermediate, which was $104/barrel in late June is now approximately $86/barrel, and probably has further to fall.

I predict that the next FOMC meeting (at end of October) will sound far more dovish, and will halt or reverse course from their current mentality. For optics sake, they may wind-down and end the QE3 program, but that will be coupled with a new accommodative policy and certainly long-term zero interest rates. If they maintain their hawkish tone, this market will come under a huge amount of pressure and it would be damning for the Democrats in the upcoming midterms. Remember, the market saw corrections of 15% to 18% following the ending of QE1 and QE2. And, other than the midterm elections – why should this time be any different?

In terms of my own portfolio, I’m fairly ‘ruthless’ in cutting stocks that are declining in a downturn. My mantra is: “Re-Entry is just a Commission away.” I either use the a) 2-closes below the 21-day moving average rule, or b) trailing stops to sell during a downturn.

My current list of potential candidates is as follows: I still like the indexes RUT, SPX, and NDX. As far as individual names: CME, CBOE, MON, UA, PRU, STJ, ABT, WYNN, IYT, TRV, FDX, UTX, MYL HERO and TEX. I like the biotech sector as well with names such as VRTX, AMGN, REGN and IBB beginning to look interesting.