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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.
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?
After multiple attempts to put in a bottom, the oil and gas markets finally seem to be working their way to definite bottoms. Don't jump in with both feet just yet though, bottoming is a process and as we've seen, it can be a very painful one. Friday's jump in crude of 12% wasn't even enough to make it a profitable week for oil. Our short oil trade earlier last week did very well. I expect more bets against oil to do well as it works its way to a bottom with a price per barrel in the teens for a day or two this spring.
I know most of you know about the Super Bowl market predictor. Basically, if an old AFL team wins the Super Bowl, the stock market falls. If an old NFL team wins, that's good for the stock market. I don't really want to get into that even if it's been like 80% accurate. What I know is that there are multiple reasons that the stock market should continue to correct despite the potentially soothing sounds of Janet Yellen this Wednesday and Thursday.
While Cam Newton might have a hard time understanding what happens when everybody on his team doesn't play well - including himself - the markets sure are starting to understand what happens when the world economy grows at a slower pace. Back in January I wrote an article for MarketWatch titled Markets Are Adjusting to "Slow Growth Forever" that described exactly what is going on in global markets. Here's the short of it:
Almost a year ago I started warning to carry more cash in your portfolio. In September I declared that "The Bear Market Has Begun." Finally, a few weeks ago, I explained that Markets Are Adjusting to "Slow Growth Forever."
In the past few months we have now seen a downturn that is officially a correction and threatening to become an outright bear market. I believe that the bear market is virtually guaranteed at this point. As I covered in my annual letter, excluding the largest companies, most of the various parts of the economy reached bear market territory in 2015. Given declining earnings estimates for the third consecutive quarter, it would be a surprise if mega-caps didn't join in the pain.
Some of the market darlings sport huge price to earnings ratios and with growth peaking even at those companies, it is unlikely they don't fall in sympathy. After a brief relief rally, we are once again seeing the downward trends in markets. What investors need to keep in mind, is that the bear market really has begun. Short of central bank intervention - which we'll get - there is very little hope of not completing the process. I expect the S&P 500 to reach about 1600 before reversing course upwards. It could of course get worse, but it would take a crisis event for that to happen.
The below chart takes advantage of something I learned in economics, that is, when approximating, use thick lines.
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