I
have recently written about forthcoming declines that may be either of the
normal cyclical nature or the far less frequent abnormal declines. I don’t know
which type will be the next decline that we will be facing. In each case
declines are followed by recoveries. The key difference in terms of the
recoveries is the level of damage the declines cause due to the psyche of both
individual and institutional investors. The greater the damage the longer it
takes for the full recovery to do its restoration of capital.
Currently
there are a number of signals being produced. Some of them will have little or
no longer term impact. However, some will be signposts to the future. As a
contrarian I am going to be focusing on possible negative signals. This is
appropriate for two reasons. First in the current period of rising enthusiasm
and excitement there are fewer voices of caution. Second, I believe that I owe
to our managed accounts to look for possible problems on the horizon that are
not already in today’s prices.
In
no particular order the following are input signals to my thinking:
1. Before we awoke last Monday morning, Samsung
Electronics stock price in South Korea fell 5.1%. Over the next few days the
leading FAANG stocks were also weak. At times Ex-US markets can trigger US
markets.
2. Of the eight major ten year sovereign debt
yields, only Canada’s higher yield was greater than the 10 year US Treasury
bonds. This means that investors found that six countries’ debt was a better
investment than the US.
3. In the recovering repurchase agreements
market it is difficult to buy both US Treasuries and German Bunds in quantity.
I believe that this indicates that these markets are not being largely driven
by investment needs, but the need to find acceptable collateral. Today only
Bank of New York/Mellon is clearing repos.
4. Some believe in the run up to year-end banks
and some other financial institutions are dressing up their balance sheets by
reducing their loans and trading inventory. This may impact available
liquidity.
5. “Liquidity is that which moves the market,” said
Stan Druckenmiller, who is said to be one of the soundest investors for many
years.
6. The law firm Williams & Jensen is
tracking the SEC’s interest in Fixed Income Market Structure changes as are the
Federal Reserve Bank of New York and the Treasury Department. The current and
evolving structure is very different from what was in place during prior
financial crises even though the new Federal Reserve Board Chair-designate
believes that there is no longer any bank that is too big to fail.
7. The stock and bond markets are interrelated
in many ways. Fixed income investors and dealers are crucial to the supply of
short-term credit to finance dealers, authorized participants, Money Market
funds, derivatives and trading. They also play a role in the high yield bond
and loan market that is experiencing a wave of “covenant lite” issuance.
Further, fixed income investors are providing debt being used to both buy back
corporate shares and also to invest in their businesses.
8. Marathon Global Investment Review out of
London regularly discusses the impact of the capital cycle on corporate results
and stock prices. When borrowers can borrow cheaply in an undisciplined way,
they get too much money that expands capacity which eventually forces lower
prices to create demand or buy market share which is destructive to the
issuer’s stock prices. Recent examples include the oil industry and reinsurance
companies. Possible current longer term risks could be two stock market
darlings: Tesla and Amazon. A significant problem with either will not be
likely treated as an isolated event.
9. At the March 2000 peak of the MSCI Europe,
the ten largest stocks in the Index fell in the next 12 months twice as much as
the index declined and in the following 12 months fell four times what the
index did. Some 17 1/2 years from the peak, only one of the ten, Royal Dutch,
has regained its full value. This highlights the difference between a “normal “
cyclical decline and an absolute one.
10. Central Banks are utilizing stocks as a
substitute for bonds in their attempts to stabilize their economies. The Bank
of Japan owns 2/3 of the equity ETFs in Japan. The Swiss National Bank owns
$10,000 dollars of US stocks for every inhabitant in Switzerland. Perhaps the
ECB (if it continues to manipulate the market) could buy shares as it already
owns 3/4 of all the eligible bonds.
11. While Power Shares in its NASDAQ 100 ETF has gained
41% in the top five stocks (See point 1), perhaps connected, JP Morgan has
pointed out that some ETFs have short positions greater than the shares
outstanding due to re-lending.
12. Jason Zweig reports that the fifth most
popular stock among the brokerage customers of Fidelity Investments was Bitcoin
Investment Trust that holds bitcoins. The stock traded at a 70% premium over the
value of the underlying holdings. There were 40% more buyers than sellers.
( Is this a South Sea Bubble ?)
__________
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Michael Lipper, CFA
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