All posts by designmonsters

The Market: June 2018

The Federal Reserve raised rates this month. This was no surprise to the markets and continues the path the Fed has telegraphed. While the Fed and the stock market are behaving in a manner consistent with a belief that the economy is strong and inflationary pressures are building, the longer-end of the bond market, the 10-year to 30-year part of the curve, is apparently singing a different tune. Interest rates on the 10-year and 30-year Treasuries actually went down. Typically rates fall when the bond market expects an economic slowdown and low or falling inflation. It’s possible that the bond market is concerned about the global saber rattling over trade. Trade wars have been shown to reduce economic activity. Tariff barriers in the 1930’s may not have started the Great Depression but research indicates that they certainly contributed to the global slump. The stock market seems to be taking the tariff situation somewhat in stride, trading in a relatively narrow range. Perhaps the stock market believes that the probability that trade issues ultimately get resolved is higher than the probability that a trade war develops. More important than the trade talk bluster, the European Central Bank outlined a timetable for tapering its quantitative easing program. The ECB stated that starting in September, it intends to reduce bond purchases and stop altogether by December. This news was largely overshadowed by trade talk. I believe that US rates long-term interest rates have been kept low, in part, by European investors buying US paper to get higher yields than what they can get at home. If Europe begins to “normalize” their rate structure, money should flow out of US bonds and into European bonds. Under this scenario, long-term rates in the US should go up. I think we will re-visit the tug of war between higher interest rates and positive fundamentals for stocks that we experienced earlier in the year. That is to say that higher rates hurt asset valuations but a strong economy, solid corporate profits, increased buybacks and higher dividends help stock prices. Stock market watchers should note that while the S&P500 seems to be treading water, the small-caps have been moving up. The cumulative number of stocks advancing has been greater than the cumulative number of decliners. Companies are using the tax savings from the new code to yes, spend more on capital goods, but mostly to increase dividends and buy in shares. We will get a better picture of company profits as firms report their 2nd quarter numbers in a few weeks. Estimates are calling for a 19% quarterly year-over-year increase in S&P500 earnings. That’s pretty good. If the numbers come in, the market should be ok. So far, the evidence still supports The Bulls. However, keep an eye on trade. The bond market is. —Ian Green, Pendragon Capital Management

The Market: May 2018

I chose the cartoon for this month to provide not only humor but also a clue to figure out when this bull market will end.  Market cycles, to a large extent, are based on psychology and participation.  Bottoms occur when everyone is pessimistic and no one wants to own the particular asset.  Conversely, when everyone is excited and everyone has crowded into an asset class, a top is near.  Recall not long ago oil prices were falling and analysts were calling for a protracted bear market with prices per barrel potentially going into the teens. One popular commentator said that oil, “Would not go above $50 in my lifetime.” Well, a year after this prediction, oil is now $75-$80 per barrel.  Our squirrel friends are examples of when we should be worried about stocks. It’s when investors and pundits start saying that stocks will go up forever and predictions like Dow 100,000 hit the headlines, the bear is coming.  When you read stories of more and more people quitting their jobs, like Mr. Squirrel, to trade the market, clouds are on the horizon. In late bull markets, investors clamor for ever more risky stocks a la dot-com companies in 1999 where companies with no revenues and often no employees were richly valued.  I don’t think we are there yet. Since the 2008 financial crisis, investors may have been buying stocks but have done so warily and without enthusiasm.  There have been some high profile IPO’s but nothing close to a mania. There is data that shows that many have not gotten back into the markets even though 10 years have passed since the 2008 debacle.   The Crisis is still fresh in people’s minds. Now one could argue that there are other assets that have absorbed the market’s speculative tendencies. The cryptocurrency phenomenon comes to mind as do the high prices in commercial real estate and in the large flows to private equity and venture capital partnerships. There may be an argument that there are more asset classes than in the past for speculative money to flow and that stocks are less exciting and therefore the bull market in stocks can last longer.  In the first instance, markets go down not due to selling pressures but rather the result of everyone who is going to enter the market being in, leaving no one left to buy more.  The rock begins its roll down the hill due to its own weight. Once the market heads down, then the selling comes in.  As long as there is  appetite for stocks and there are buyers to come in, the bull run can last.  The Nasdaq Index gained 22% in 1997, 40% in 1998 and surged 86% in 1999 before the 2000-2002 bear market.  History may be a guide and we will see a big, blow off top like we did in the late 1990’s where buyers get sucked into the surging markets in big numbers before we reach the top of this bull market. If a big move up does occur, it may not be of the magnitude we witnessed in 1999 but it may nevertheless serve as a warning. — Ian Green, Pendragon Capital Management