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A sampling of some of the analysis I've made that has come to pass is or happening now...
Welcome. The content below is free to the public. It might be worth what you are paying for it. Having studied economics and being in finance for over two decades, I have learned that only one thing is certain - that almost nothing is certain. As we endeavor to come up with our best analysis of the world around us, the opportunities and risks, we have to try to overcome a myriad of issues including our own ignorance, biases and emotions. What follows are my attempts to overcome those obstacles. Welcome to my view - publishing Monday and Friday afternoons.
The markets reached an 8 month high today and breadth is wide. Normally that signals a bull trend. And to be honest, we could see one for a few more months. But that doesn't negate everything else we've been talking about recently.
Chasing markets higher is a trap that the big market players set for the little guys. Take a look at volume, it is very low. What that means is little guys are chasing higher and big guys are letting them do it by standing aside.
This is a just a quick mid-week interjection. As you know, I recently issued a crash alert. There are literally dozens of reasons I did that. However, here are three more charts that should hit home and make the point that being a very, very patient buyer right now is the play.
The lead chart is the Shiller CAPE ratio. What is that? It is the cyclically adjusted price-to-earnings ratio. Basically, it adjusts for normalized earnings over a ten-year period. It does this to represent the cycles that earnings go through from peak to trough to peak again.
The normal CAPE is around 15 or 16, but it can go a few points higher or lower with no real consequence. Right now, earnings are just coming off of peak that was the fourth highest in history. Certainly, with enough central bank money or government stimulus, the ratio could climb to challenge all-time highs. However, given global debt and general mood, the odds of central banks and governments printing and borrowing without a crisis to rally around seems remote.
The more plausible scenario is that the earnings cycle plays out, meaning that earnings, which are already heading down, fall more. So, if earnings do indeed fall, then we would expect prices of stocks to follow suit. I think this is especially true for a few reasons I mention below.
Janet Yellen spoke today and took the opposite view of several of her peers on the Federal Reserve Open Market committee and struck a very dovish tone by stating a need to "proceed cautiously" on interest rate hikes. While this was not unexpected, the tone of her remarks signals that an April rate hike is almost impossible unless there is some unexpected huge uptick in employment or inflation. She pointed out unfavorable market conditions, international concerns and uncertain inflation expectations.
Interestingly, she also said that the Fed had little room to reverse course. This is another signal to me that unless markets and the economy normalize in the direction desired - which is almost impossible due to demographics and accumulated debt - we are simply waiting for the next deflationary event so that the Fed can take "extraordinary" actions during a crisis event. As I have discussed in the forum and am discussing in an upcoming MarketWatch article, we are on the verge of inflation one way or the other. The central banks are going to create inflation, with or without growth - we know mostly without - so they can devalue debt. That devaluation will in turn diminish the standard of living of hundreds of millions of people.
There is a vocal group that likes to talk about the Fed in very negative terms. I have withheld any permanent sort of judgement because I believe there is good and bad in any institution. For example, during the 2008-09 financial crisis it is clear that the Fed did the right thing lowering interest rates to zero and embarking on the first round of quantitative easing. Without that action and the bailouts, the banks would not have survived. Sure, other banks would have taken their place in time, however, the social cost to that multi-year transition would have been monumental and likely violent.
The "good" financial crisis response actions by the Fed of course followed a period where their oversight of the banking industry was woefully deficient and monetary policy the prior eight years was questionable at best. Since the financial crisis ended, which I think can reasonably be put at 2011-12 when real estate bottomed, the Fed has probably been deficient in normalizing monetary policy on the misguided assumption that more easy money is better for stimulating growth. I firmly believe that is not true for two reasons. First, as I have discussed in three articles the past year, "slow growth forever" is due to global aging demographics and an overwhelming debt load, those things cannot be cured with easy money. Second, continued extra easy money clearly leads to the idea that something is wrong, which lowers consumer and business confidence and results in a drag on further economic development.
Wednesday while listening to listened to Janet Yellen give her post-Fed meeting press conference I came away with the distinct impression that the Fed is scared. They are afraid of both the fragile nature of the minor economic growth occurring in the United States and they are now on notice that inflation is starting to rear its head. If that's so, this scenario is a upon us much faster than I thought it would be.
A period where the economy grows slowly or not at all, but still has inflation is called "stagflation" - as coined in late 1960's England. While I believe we are in a "slow growth forever" economic world, I didn't believe inflation would be a problem until after the next major deflationary event and another massive round of devaluations. However, with the world is already so awash in devalued cash and now facing rising energy and food costs, it is possible that we are much closer than I expected. "Stagflation" for those who weren't around in the 1970s is bad news.
Asset allocation is what the pie chart represents to most people with investments today. Over the past few decades, financial planners have trotted out pie charts that show the benefits of having assets in different asset categories. They espouse that being spread around limits risk. They also know that approach helps sell product.
The charts these financial salespeople show are usually loosely based upon an idea called Modern Portfolio Theory (MPT). The concept around MPT is that investors can use historical data to build safer portfolios. Certainly, when employed very well, there is some benefit to MPT as a way to use mean reversion as an investment tool. Unfortunately, in most cases, financial advisers do not use MPT properly to begin with due to a lack of training and relevant up-to-date data.
In addition, because MPT is focused on backwards looking data, it in no way takes into account changing secular conditions, such as, an aging population and aggregated global debt. Over the next 30 years, aging demographics and accumulated global debt will be two of the most important global trends that will have significant impacts on every aspect of the global economy and finance - and MPT has no way to incorporate that information.
Most financial people's idea of asset allocation therefore sticks with the notion that broad diversification equals safety. Nothing could be further from the truth. Consider 2008. With the exception of being short the markets or in U.S. Treasuries, everything dropped in price - a lot. Being diversified carried almost no benefit for investors. For many people, MPT was even worse as they hadn't properly accounted for mean reversion, thus, they not only lost on the crash, but they lost because much of their portfolios were "invested high" in various assets in the first place.
On several occasions, including in the winter Oil & Gas Report, I have pointed out that the financing of new oil projects must be economic based on conservative assumptions and not based on hopeful future projections. This past week in Houston, Saudi Arabia oil minister Ali al-Naimi made the point very clear:
"Cutting low cost production to subsidize higher cost supplies only delays an inevitable reckoning.”
“The producers of these high-cost barrels must find a way to lower their costs, borrow cash or liquidate,”
“Inefficient, uneconomic producers will have to get out... This is tough to say, but it’s a fact.”
“It sounds hard, and unfortunately it is, but it is a more efficient way to rebalance markets,”
“If we can get all the major producers not to add additional barrels, then this high inventory that we have now will probably decline in due time... It’s going to take time. It’s not like cutting production. That is not going to happen.”
“There is no sense in wasting our time seeking production cuts; they will not happen... What will happen is we will all as major producers find it easy to freeze production, let demand rise and let some inefficient supplies decline, and eventually the market will balance.”
If there is any doubt that Saudi Arabia and their Gulf Cooperation Council allies aren't going to keep producing at their current paces, then those doubters simply aren't paying attention. The idea that the lowest cost producers would cut production now that oil demand is flattening and high cost producers were taking market share simply makes no sense. It is the highest cost producers that need to move out. That is not manipulation, that is a normal market. For those who want a free market, here it is.
Immediately after that meeting, Whiting Petroleum cut capital spending 80%, Continental Resources 66% and Chesapeake Energy 69%. Those come shortly after other announced capex cuts of 20% to 60% for 2016 at Anadarko, Conoco, Apache, Devon, Marathon, Exxon, Chevron and a raft of others. This all of course after the massive cuts in 2015.
Who are the "high cost" producers?
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