|
|
Musings Report #28 7-9-16 Risk-On, Risk-Off Schizophrenia: Investment Outlook for the 2nd Half of 2016
You are receiving this email because you are one of the 500+ subscribers/major contributors to www.oftwominds.com.
For those who are new to the Musings reports: they are basically a glimpse into my notebook, the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books. As always, I hope the Musings spark new appraisals and insights. Thank you for supporting the site and for inviting me into your circle of correspondents.
Risk-On, Risk-Off Schizophrenia: Investment Outlook for the 2nd Half of 2016
It's become a tradition here to issue at least two investment outlooks, one around the start of each year and another in summer.
This year has been particularly interesting, which is another way of saying "unpredictable" as global markets have gyrated wildly from risk-on (stocks rising sharply, U.S. dollar falling) to risk-off (USD rising along with bonds and gold and silver, and stocks falling) literally from week to week. The word "schizophrenic" comes to mind.
Today. the strong jobs report has powered stocks (risk-off) and the U.S. dollar, 30-year Treasury bond and the Japanese yen (risk-off) higher.
Despite today's advance in stocks, declining bond yields and the rise of precious metals tells us risk-off sentiment has strengthened while risk-on sentiment has lost momentum. The S&P 500 hasn't made new highs in over a year, and stocks have suffered three sharp declines that were reversed by central bank jawboning ("whatever it takes") or concerted action.
It certainly feels as if the Powers That Be are trying very hard to keep risk-on assets such as stocks aloft.
The flood-tide of cash into bonds has helped push yields into negative territory, an unprecedented development: owners of capital are so concerned about getting their money back that they are accepting negative returns, i.e. guaranteed losses, to park their cash.
Capital is focusing less on earning a return on cash and more on making sure the cash is returned.
The conventional view seems to be that a sharp decline in stocks is likely in August-October, but stocks will rebound after the presidential election (the usual relief rally plus seasonal strength from November through May).
Suppose we were central bankers; what would we do in this precarious state, when risk-on assets like stocks are vulnerable to sharp sell-offs? I know what I would do--I would engineer a rally that pushed the S&P 500 (SPX) to a new high, above 2,134. This would negate all the Bearish chatter about "no new highs in over a year" and crush any short sellers, the majority of whom will have stops (orders to cover their short bets) above the all-time high level of 2,134.
As I write this, a new closing high in the SPX is a mere 11 points away. (The SPX has already climbed 25 points today.) It's safe to assume a new high is baked in, and so the question becomes: how high? I've seen technical targets of 2,150 and 2,250.
If we get a new high in SPX in July, that could be the high-water mark that precedes another sharp decline. The global picture is clearly bearish; China is in a monumental debt bubble, Europe's banking sector is crumbling, and trade traffic suggests global recession is imminent.
Forecasting the post-election markets is tricky. By all rights, global recession should weigh heavily on U.S. stocks. But the counterweight to recession is the U.S. market's role as a safe haven. U.S. Treasury bonds are already being scooped up as a safe way to secure a positive yield, and the same argument could be made for U.S. stocks.
If the banking/political crisis in Europe deepens, or China's devaluation of its currency gets away from its central bank's control, global stock markets could trace out 40%+ declines similar to 2000 and 2008. Various cyclical analyses suggest such a major decline is either overdue or coming up.
But it's also possible that the safe-haven status and the usual post-election rally (somebody will win, so at least some uncertainty goes away) could push U.S. stocks higher, despite declining profits and global slowdown/recession.
Such as rally is possible, but is it prudent to place big bets in such a precarious setting? In my view, prudence favors safe havens.
What are we buying when we seek a safe haven? We’re buying one of two things: scarcity or income. Scarcity and demand create value; whatever’s scarce and in demand increases in value.
Any asset that generates income creates its own demand, for in a world of declining profits, income is intrinsically scarce.
Whatever is scarce and in demand will hold its value over time. As the global slowdown morphs into global recession, net income (profit) will become increasingly scarce. Those who own reliable income streams will own something that is scarce and in demand.
Whatever is scarce and in demand that isn’t entirely in the control of central planners will be a safer haven than whatever is at the mercy of central planners.
Diversity offers a hedge, but in a world of highly correlated assets, even diversity offers only relative safety.
“Whatever is scarce and in demand will hold its value over time” is awfully general, but it may well be the best than we can manage in an era of rising instability and uncertainty.
Analyst Paul Nathan recently shared a story from hyper-inflationary 1930s Germany that illustrates the value of productive assets versus government-issued currency. Once people lose faith in their money, as has happened in Venezuela, only assets that can't be created out of thin air (gold, for example) or productive assets (such as land, factories, etc.) will hold their value as money loses trust and thus value.
"Back in the 70s I was invited to a round table discussion on inflation and the world's monetary problems. We broke for lunch and six of us sat around a table and continued a more informal discussion. I happened to be seated next to the distinguished professor and economist Hans Sennholz.
The subject turned to inflation and Hans talked about his experiences in Germany. He told us of a man that bought a business, actually a factory that made nails. As the great inflation began to grip Germany the value of his factory grew, he got an offer and couldn't refuse such a tidy profit, so he sold.
Six months passed and property values continued to climb. The former owner of the nail factory was growing bored but knew nothing other than nails, so he sought another factory to buy. The problem was he could only buy a factory three quarters of the size of his previous factory. But knowing nothing other than nails he bought it.
Not long after that the value of his factory soared! It virtually doubled in value. He once again decided to sell for what must have been the highest priced factory of its kind that had ever sold. Time went by. The man grew bored once again and looked around for another factory. But prices had continued to soar.
To his dismay he could only find a factory that produced 10% of what he had been producing, but regardless he bought it. Then there came an offer that was so outrageous that he figured if he took it he couldn't go wrong -- he would be rich beyond his wildest dreams. He took the millions of marks offered and retired.
It wasn't long before he realized that he couldn't make ends meet; that everything he bought was going out of sight. He realized that if he didn't do something he would be impoverished. In a panic he went for the only thing he understood -- nails. When he went to repurchase his factory, he was offered only one nail in return for the amount of money he offered. The man with all his millions -- was broke.
Han Sennholz paused. I asked what did the man do? He said he hammered the nail into a nearby wall and hanged himself.
Hans had just taught us all the difference between price and value and the illusion of inflation."
Summary of the Blog This Past Week
A Precarious State 7/8/16
Neofeudalism and Peasants with Pitchforks: Corporate Power Destroys Democracy 7/6/16
Governments Change, the Corporatocracy Endures 7/5/16
The Paper Waist Test (and a July 4th Message) 7/4/16
Best Thing That Happened To Me This Week
Stir-fried the first crop of scarlet runner beans. Yum!
Market Musings: Gold
After years of decline, the consensus is that gold has entered a long-term uptrend. Evidence for this is easy to find: for example, here is a post from Chris Kimble noting that the gold/S&P 500 ratio is breaking out of a long-term declining channel.
But wait--not so fast. As tempting as it is to revel in the confidence that it’s only going to be onward and upward from here on, other equally respected technical voices are sounding calls of caution. Tom McClellan recently called for a multi-year low in gold in late 2016 or early 2017.
What could possibly cause gold to lose its upward momentum? I don’t have any plausible candidates (and don’t say the U.S. dollar might rise—as recent price action shows, both the USD and gold can rise as capital seeks safe havens).
Should we dismiss McClellan’s prediction as an outlier? Perhaps. But what gives me pause is the central planners’ desire to push gold down as part of their perception management campaign, and the potential for hot money from China and elsewhere to drain out of precious metals.
Perhaps gold will run to $1,500 and then settle back to $1,350 to mark McClellan’s multi-year low. I cannot hazard a guess with any confidence about the price of gold going forward. Odds certainly favor a gradual increase in the value of whatever cannot be inflated away by central planners, but this doesn’t mean hair-raising declines aren’t possible.
From Left Field
"China Is Headed For A 1929-Style Depression" -- Any Xie is always worth reading...
Naypyidaw | Exploring Myanmar's bizarre empty capital by drone (via John F.)
Where are we now? Responses to the Brexit Referendum -- no real consensus, sands are still shifting...
Brexit voters are not thick, not racist: just poor -- ignored and despised...
The strange death of liberal politics: The world is changing in ways the British left cannot comprehend. (same goes for the Democratic left in the US)
What do other EU states think about Brexit? (via Atreya)
Something Huge Is Coming From Japan -- good charts...
Chinese Day Traders Are Behind Silver Frenzy Moving Prices -- online gambling is very popular in China...
Goldman Warns Of A Sharp Plunge In Stocks In "Next Few Months"
These 2 Forces Will Crush the San Francisco Housing Bubble -- tens of thousands of new luxury units adding to inventory as jobs erode...
How China Took Center Stage in Bitcoin’s Civil War --mining server farms--amazing...
The Secret of Swiss Success Is Decentralization -- this can't be emphasized often enough...
"It is better to fail in originality than to succeed in imitation." Herman Melville
Thanks for reading--
charles |
|
|
|
|
|
