This past week has seen some tinges of activity that were quite ominously similar to events that happened in 2008 when the financial looked over the cliff. Quiet concerns were growing regarding the overnight lending market aka the Repo Market, specifically that there wasn't enough money flowing through the system. It got to the point to where the Federal Reserve had to step in and bank roll the deficiencies, dropping at one point $85 Billion to keep the overnight repo market from seizing up. This is not a normal thing.
It was surprising and then not surprising that this happened. Back in our May 5th email, I shared some analysis by JP Morgan and Bank of America that conditions were ripe for a shortage of US dollars and ultimately a reintroduction of policies to take interest rates lower. Here it is again:
From In The Loop - May 5, 2019
Everything is awesome! So why could interest rates FALL in the near future?
Before the Mad King's tweets earlier this week, the markets were back setting new record highs after throwing up last year. Job creation is bouncing nicely. US GDP is quite healthy. So why is JP Morgan feeling blue and putting out there a possibility that the Federal Reserve may have to cut interest rates in the near future? Their take revolves around the following:
The Financial Crisis of 2008 was triggered by banks running out of liquidity. Money.
One of the outcomes was banks made sure they had enough money on hand said they did so they have ample liquidity to manage another crisis. The Federal Reserve held them accountable by periodically stress testing them to see how they could behave in dire market situations to see if the amount of money they held was adequate. The outcomes have always been they have more than enough reserves on hand.
Since September 2018, the Fed stopped printing money and in fact has been removing money from the system. It has been up until recently also increasing interest rates. The goal is to "normalize" the lending/credit market. This has created this flattening yield curve dynamic that I've written about in previous emails which can be a precursor for recessions. This dynamic was well in play last year as the markets swooned, despite the fact the US ecnonomy in particular was chugging along nicely.
It forced the Fed to signal that it will be "patient" and will stop increasing rates and printing money. It's becoming harder to find US$ and it has taken the overnight lending rates up. The US$ has kept going up instead of down. Stock prices have done a 180.
The mainstream narrative is that the Fed has stopped increasing rates because they see the economy slowing down (some say he's taking orders from the Mad King but that's a whole other thing) . That's possible, there are a lot of global trade indicators pointing that way.
The other narrative that JP Morgan is pushing which isn't getting a lot of play is that what's driving the Fed move was that they are seeing overnight rates going up and the US$ continuing tracking higher. Observers are saying the next move in interest rates may be downward, to take down the upward pressure of the US$ to reduce demand for Greenbacks and also may start back up printing more money to keep the overnight rates lower. The fear is there could be another bank out there like Bear Sterns that runs into a crunch and could trigger another Financial Crisis. So far it doesn't appear were going there. JP Morgan's take is if the Fed does nothing and that overnight rate keeps tracking up it could be a canary in the coalmine signal that something's not right.
Should this play out, and if the Fed tries to get ahead of it and and rates do indeed go down instead of up, then it may provide enough of a Red Bull induced stimulus to keep stock prices high in the short to medium term. The Bank of Canada has also just signalled something similar and may be also on the verge of cutting rates, citing slower economic growth. Europe continues to deal in a negative interest rate world. Is it 2007 or 2017 all over again?
I don't think that's a good thing and I've said many a times how much I think asset prices have been distorted because of uber-low interest rates. That being said, I've learned though it is pretty hard to fight the Fed. If these are the cards that are being dealt, we have to play with them.
So fast forward to this past week. I have a suspicion that the Federal Reserve may have to continue to backstop the Repo and that it could be a precursor to a more broad based effort to print more dollars to keep interest rates low. Queue QE4. The question is will this iteration of money printing and lower interest rates (in a somewhat health economy by the way) be enough of a Red Bull infused buzz to keep stock prices floating?
As I said, all this has been going down at the same point in time as in 2008. I came across this article last week. Here's the opening that was quite a bit profound and scary...
"...Since last year real GDP growth in the U.S. has been slowing. The chair of the Federal Reserve has been signaling that while growth is slowing, there is no recession risk and the Fed is forecasting continued positive growth. Warning signs in the economy, including an inverted yield curve, have been ignored and stock markets continued to make new highs in July. In August a correction took a place and subsequently a rally ensued into early September. On September 18 the Fed cut rates.
Sound familiar? It fairly describes market and economic conditions in the U.S. over the past couple of months. Except that this paragraph would be as true for the U.S. economy and stock market in September 2007 as it is today. Consider that 12 years ago the yield curve was inverted and U.S. economic growth was markedly slower than it had been in 2006. Yet the Standard & Poor’s 500 SPX, -0.49% made a new high in July 2007 (same as 2019), there was an August correction (same as 2019), and then the Fed cut rates on September 18 (ditto — same day even).
U.S. stocks proceeded to make another marginal high that October — and that was it. Lights out. We all know what happened next...."
In the backdrop of all of this I kept going out there and buying and selling stocks.
New Blog and Podcast: Summer Investing Decisions Part 2 and Part 3
This week I continue my 3-part series where I share my investment decisions I made over the summer. After several uneventful months where I stood on the sidelines, I decided to make a fair number of decisions in July, even with all the trade-trash-talking going on. The big trigger for me I think was that it was becoming very clear that interest rates are going to track downward and that may put a floor on stock prices in the short to medium term. So I thought this would be a good time to build up some positions. I still think stock prices are overvalued and continue to have a short position, however we can’t fight the Fed. Maybe I decided to jump in because I haven’t done anything in the past few months and I was itching to put some more money to work? I’m not going to deny that emotions and a certain level of a Fear of Missing Out (FOMO) could be at play here.
Part 2 Blog, Podcast, Apple Podcasts
Then August came
August arrived with a bang. The market barely had a chance to digest the recent lowering of interest rates by the Federal Reserve, and the subsequent strange messaging that this would be a one time deal. The market did not like that. To make this even more crazy, the Mad King decided to drop the bomb of threatening to put tariffs on all China imports, only to see China counter with lowering the Yuan and triggering a trade/currency war. The market threw up on the possible scenarios. Then the Mad King walked back the threat. Essentially he blinked, leaving with US with no cohesive strategy. The Chinese are now fine to wait the whole thing out which is may put more pressure on stock prices…until…they started to walk it back and then the market got all happy again.
If that’s not enough the US 2yr-10yr yield curve inverted and all of a sudden the countdown to the impending recession was joined. The Dow Jones plunged 800 points, marking the 4th worst daily drop in history. In early August the Dow dropped the first 6 sessions.
Are you following this? What a time to be investing!
Stocks? Who wants stocks?
I started to go through my wish list to see if anything appealing. There were a lot of stocks on my wish list that started to look really good. A few items popped up and despite the roller coaster ride the markets were going through, I decided to dip my toe in a few names and I also decided to bank some profits in a few other names.
Part 3 Blog, Podcast, Apple Podcasts
New Position: Bought shares in Alphabet (Ticker: GOOGL)
New Posiition: Bought shares in Amazon (Ticker: AMZN)
Bought more shares in iShares Pharmaceutical ETF (Ticker: XPH)
New Position: Bought shares in CVS Health (Ticker: CVS)
Bought more shares in iShares Germany ETF (Ticker: EWG)
Bought more shares in Vanguard Emerging Markets ETF (Ticker: VEE)
New Position: Bought shares in Square Inc. (Ticker: SQ)
Bought more shares of Canadian Natural Resources (Ticker: CNQ)
Sold shares in iShares Gold Bullion ETF (Ticker: CGL.C)
Sold shares in Vanguard Consumer Staples ETF (Ticker: VDC) for 19.5% gain (net Forex)
New Position: Bought Shares in Under Armour (Ticker: UAA)
What I'm Reading
Going with the crowd is an expensive occupational hazard
Over the summer I came across some interesting analysis by Bank of America highlighing the perils of following the crowd and buying what that crowd is buying.
"...In one extreme example tied to the vogue for momentum trading, shares with the fastest price appreciation over the past 12 months are trading at valuations that are almost 25% higher than normal, the bank’s data showed....While risk aversion and herding are nothing new, the extent to which active funds are willing to pay up for popular stocks is at extreme levels. Three mantras seem to dominate their thinking, say BofA strategists led by Savita Subramanian. “Buy what’s working,” “don’t be different,” and “valuation doesn’t matter.”..."
Groupthink and following the herd is one of the most common behavioural biases that negatively impacts our ability to make successful investment decisions. We're just wired to being associated with winning teams. Unfortunately it can be detrimental to our savings. In my Everyday investing course I spend an entire module focusing on how to manage group think biases that cloud our investing judgement.
External Environment Mind Maps
US Unemployment = down = more consumption =more profits = higher stock prices
Inflation US = Up = higher interest rates = lower company valuations = higher financing costs = lower profits = lower stock prices
US Dollar = Up = cost of exports higher = lower profits = lower stock prices = lower commodity prices
US Yield Curve=5bp = flattening = higher financing costs = lower profits = lower stock prices
Conclusions: That noise you hear is the machines dusting themselves off and getting ready to crank up and print US dollars.
Canada Unemployment = down = more consumption = more profits for businesses = higher stock prices
Canada Dollar = Up = cost of exports higher = lower profits = lower stock prices
Canada Yield Curve=17bp= inverted = lower financing costs = lower profits = lower stock prices
Conclusions: While election mudslinging and makeup wearing continues, the yield curve continues to invert, global growth around it continues to slow. No big deal apparently.
AIII Sentiment Survey = Neutral (Previously Bullish)
CNN Fear and Greed Indicator = Greed (previously Greed)
Conclusions: Investors might be a tad exhausted, preferring to wait.