DAILY DIARY
The Short Side
I have been scaling, in a modest way, on the short side all afternoon.
Why I Plan to Buy the Weakness in Gold
* Mr. Market continues to totally ignore the runaway federal deficit
* The world is drowning in debt
* Central bankers are destroying the value of paper money (adding trillions of dollars of debt without improving the ability of repaying or servicing that debt)* President Trump is "Making Economic Uncertainty and Market Volatility Great Again"
* Over time the price of gold should rise
As the president wreaks havoc on the world in hastily crafted policy (conflated with politics), written on the back of a napkin and delivered by tweet, the globe continues to drown in debt and central bankers deliberately destroy the value of paper money - I want to buy back my (GLD) position (gold) below $140.
I have spent a lot of time in recent days discussing the inconsistent behavior of our president, global debt loads and off the rails monetary policy - I now want to revert back to a discussion of the U.S.'s burgeoning deficit.Our Federal Deficit Can No Longer Be Ignored
It is time that the Simpson-Bowles Commission be redrafted to address the runaway federal deficit. The new budget deal will add $1.7 trillion to the federal deficit between 2020 and 2029, according to the Congressional Budget Office (though it will most likely add much more).
This is $809 million more than the CBO projected last May, but what's another $1 trillion among frenemies? Overall, deficits are projected to rise by $12.2 trillion over the next decade, bringing it to at least $35 trillion (my pal John Mauldin puts the number at $40 trillion and I expect it to be higher - and remember this is the official figure but the actual number is much higher when you include off-balance sheet items).
As we know, deficits normally decline when the economy is doing well but today they are rising sharply, with the budget in the first 10 months of the current fiscal year running 27% ahead of last year. This is attributable to lower tax receipts due to the 2017 tax law, higher spending on the military (the military budget is bloated and needs to be dissected and reduced by a team of non-government experts), and retiree benefits and higher interest costs (despite record low interest rates). The Treasury will borrow another $1 trillion in 2019 for the second year in a row and will have no trouble finding buyers. The CBO projects annual deficits to average 4.7% of GDP over the 2020-29 period, higher than the 4.4% it estimated in May, and much higher than the 2.9% average of the past 50 years.
The gross neglect shown by Congress and the president in the face of this dangerous explosion in debt is inexcusable. It's not as though there aren't steps that can be taken to alter the arc of debt growth in a more favorable direction, but our so-called leaders (on both sides of the political pew) simply have no interest in doing so and voters share the blame for refusing to hold them to account.
We need to start means-testing entitlements, raising retirement ages for entitlements, significantly cutting unnecessary and wasteful government programs, and fixing the tax code to encourage growth. We are paralyzed by greed, selfishness, ideology and cowardice and our children should be deeply ashamed of us for leaving them with an unsustainable mess to clean up.
Dwyer on Bulls, Bears
My pal, Tony Dwyer, chimes in:
There was a slight decline in bullish sentiment and an increase in bearish sentiment in the latest poll from the Association of Individual Investors (AAII). AAII reported that bullish sentiment declined to 26.13% from 26.40%, while bearish sentiment increased to 42.21% from 39.72%, in the prior week. Neutral sentiment moved slightly lower to 31.66% from 33.64% (Figure 1). We highlighted in early August <https://canaccordgenuity.bluematrix.com/sellside/EmailDocViewer?encrypt=04e1ecb1-de99-4239-9913-49f8e26f868e&mime=pdf&co=Canaccordgenuity&id=CA-InternalResearchDistribution@canaccordgenuity.com&source=mail>, when the spread between bulls-bears dropped to at least -25, it turned out to be a positive intermediate-term signal for the market.
With four weeks of bulls below bears, the 4-week moving average has now dropped to under -19, a relatively low level as well. Since 2010, the 4-week moving average has dropped to -19 only two other times (1/28/16 & 1/3/19), and both instances provided attractive intermediate-term entry points for the market (Figure 2).
Figure 1: AAII % bullish, bearish and neutral
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Figure 2: S&P 500 with 4-week moving average of bull - bear spread
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The Market Now
Mr. Market has flatlined near the highs of the day.
Making some research calls but few are in!
The (Hopeful) Consistency of Analysis and Strategy
Lord knows I get it wrong often - and I don't shy from those mistakes nor sweep them under the carpet.
In my Diary I endeavor to be hard hitting in my analysis and consistent in my strategy (and explanations).
I hope the last several weeks is a good example of achieving these objectives and explaining my daily strategy within the context of an intermediate viewpoint. (If I am not understandable in process or trading/investing please detail your questions in our Comments Section.)
Currently I continue to see a market that is range bound (between 2700-2750 and 2900-2950) and that is overvalued on an intermediate term basis.
I am market neutral in exposure now.
Back to Market Neutral
I have lowered my exposure from small net long to market neutral.
I did this by shorting more individual stocks and not my shorting the Indices (yet!).
'Buyers Live Higher and Sellers Live Lower'
* In a world dominated by machines and algos
* Use the new regime of volatility to your advantage
So expect market commentary to swing to the bullish camp next week after a few days of solid gains.
I will be shorting stocks - which are approaching the upper end of my expected trading range of 2700-2750 to 2900-2950. (Last sale in the S&P is 2920)
I will be fading the machines who know everything about price and nothing about value.
I plan to stick to my ursine market view and to my contrarianism (shorting strength) and especially to my calculator (and calculus).
While I remain net long (small) in exposure I have my red tickets out now - but I continue to give Mr. Market a wider berth owing to seasonal issues.
Tracking the Asset Allocation Program
* At times market positioning and asset allocation events are important
* This week is such a time!
We are now +50 handles in the S&P since the close of trading on Tuesday.
That's a gain of almost the median rise of +2.46% (in the last three trading days of the month) discussed on Tuesday and Wednesday when bonds materially outperform equities:
As posted - the possible scenario (and end result) in yesterday's column Month-End Rebalance May See Large Equities Buy, Bonds Sell Soon (owing to asset allocators' response to the massive outperformance in August of bonds over stocks):
This is important and helps to explain why I am a bit reluctant to short stocks now.The month-to-date performance of fixed income (+9%) -- that's the strongest returns since August 2011. With equities down by over 3%, August is only the 19th month in the last 32 years that bonds have outperformed equities by over +10%.Historically, this has resulted in relatively smart gains in stocks over the last three trading sessions of the month. (The median gain is +2.46%, more than 10-times the average of the last three trading days of all months since 1987 and delivers a positive return over 80% of the time, as you can see in this chart from Bespoke.):
Source: Bespoke
As a consequence I will likely stick with my small net long exposure.
Bottom Line
I don't mean to imply precision in the analysis above - its a guideline for my trading this week.
As we approach the "expected" (from the asset allocation program into stocks) I plan to reestablish my short book.
But I am giving this market a wider berth in a backdrop of increasingly lower volume as the week comes to a close and the beach goers go to the beach.
Stay tuned.
More Technical Analysis From NorthmanTrader
Sven, NorthmanTrader, just came back to me with another email on E minis:
Updated cleaner chart for reference...
Incidentally, my view: No trade deal and a global recession is likely unavoidable. A lot hinges on this now.
The Long and Short of It
If one is bullish (and I know many are) I would use the recent weakness in banks and in many of the FANG stocks to add.
I have written extensively about both spaces.
To repeat my recent thoughts on banks from mid-August column, "Banks Provide Unusual Value for the Patient Investor":
Yesterday I mentioned that I personally plan to buy the recent weakness in bank stocks.
Trading at 54% of the S&P Index multiple, yielding a bit more than 3%, trading at 0.90x book value and at a 12 month forward PE multiple of only 8.8x this group - under the weight of lower interest rates - provides significant value for the intermediate term investor.
With excess capital, managements are now taking advantage of the recent share price weakness and buying back shares (with accretive EPS consequences).
The banking industry no longer possesses a volatile profit base as it did in the last two cycles and now provide investors with much better than GDP growth as banking managements are more efficiently managing their constituent financial institutions.
I plan to personally buy the next dip (I did!) in this sector in the belief that a few years from now we will look at the bank stocks and recognize how timely today's investments might have been.
That said, and, as mentioned previously (and though shorting is not for most), "at some point" I will be shorting the ramp of the last two days.
From NorthmanTrader
I just received this email from Sven (NorthmanTrader) that I wanted to pass on:
Hi Dougie,
In response to your tweet a chart with some thoughts here.
First background/context we had the larger Sell Zone pegged at 3000-3050. I outlined this publicly on June 30:
We've been positioned swing short from there, and are like you we are navigating actively through the range with select longs for bounce trades following aggressive selloffs while maintaining swings (rescued exposure on these).
This rally here comes in context of a potential larger bear flag building. The futures chart (if we break higher above the current trend line resistance) has risk higher into 2950/60 or so depending on timing. If we reject from here 2917 $ES (weekly 20MA and trend line resistance) the flag could feasibly play out from here, but get one "tariff delayed" tweet from Trump we could of course see 2950/60. That's the risk.
General point is this pattern has potential for downside into the 2700 zone if a break confirms. Sunday night's break was of course averted by "phone calls" as you know.
More Night Moves
"Workin' on our night movesTrying to lose the awkward teenage bluesWorkin' on our night movesIn the summertimeAnd oh the wonderFelt the lightningAnd we waited on the thunderWaited on the thunder."
--Bob Seger, "Night Moves"
Benign (3 a.m. ET) trade comments out of China caused a -12 handle drop in S&P futures to reverse and, at around 6:15 a.m. ET, are back to +26 handles. That's a near 40-handle reversal from the early morning's lows!
As most are aware, I have expected a large asset allocation to favor equities (beginning yesterday and, perhaps into Friday's trading).
So far so good, as including the overnite futures action, the accumulated gain in the S&P index already exceeds forty points.
I start the day small net long in exposure and plan to unemotionally (but aggressively) short a continued rally, which is moving towards the higher end of my expected trading range -- reflecting my ursine fundamental market, economic and profit views.
Tweet of the Day (Part Trois)
Tweet of the Day (Part Deux)
Tweet of the Day
Something Is Rotten in Denmark
More economic observations from Danielle DiMartino Booth:
- According to the Mortgage Bankers' Association, the benchmark 30-year fixed mortgage rate broke below the 4% level in August, repeating what's occurred three other times since 2012; in the first two episodes, purchase applications jumped by double-digits while in the third episode and also in the current episode, activity slowed
- Consumer expectations for lower interest rates spiked to a 10-year high in August; though falling rates have flowed through to a bump in new and existing home sales, the lack of urgency communicated in falling rate expectations will likely pressure housing activity
- In the second quarter, "tappable" home equity rose to a record $6.3 trillion, suggesting refinancing activity, up 167% over the last year, should continue to benefit; while refinancing bolsters consumption, a six-month low in perceived job availability and the trade war could crimp home sales
"Something is rotten in the state of Denmark" is one of the most recognizable lines of all time. What's key is that Shakespeare wrote this line into Hamlet, but it was not spoken by Hamlet. Marcellus said it to Horatio after the ghost of Hamlet's father appeared and Hamlet exited stage left with his dear old floating dad. The iconic phrase called out political corruption, a subtlety that high school students must glean from their required reading. Or, if you prefer the obvious, it flags something that's gone awry.
Today, something really is negative in the State of Denmark. As per this CNBC headline: "Danish bank offers mortgages with negative 0.5% interest rates -- here's why that's not necessarily a good thing." On Monday, August 5, Jyske Bank A/S, Denmark's third-largest bank, announced that big carrot on a 10-year mortgage. Banks offering negative mortgages are willing to take a smaller loss compared to lending at higher interest rates where they risk less creditworthy borrowers that may not be able to pay them back in the future.
The good news? Something is positive in the State of America. Positive mortgage rates are still all the rage in the good ole U.S. of A. That doesn't make lenders any less nervous. According to the latest weekly report from the Mortgage Bankers Association (MBA), in August, the benchmark 30-year fixed rate made its fourth foray into sub-4% territory. The only three other periods where 30-year mortgages dabbled in 3-handles occurred from May 2012 to May 2013, January 2015 to April 2015 and February 2016 to October 2016.
Was '3' a magic number for mortgage brokers? In the first two instances, mortgage loan applications to purchase homes ignited, growing by double digits on a year-over-year basis. In the third episode, growth slowed from double digits to single digits.
The jury is still out on the here and now. We fear the law of diminishing returns is at play. Over the last three weeks, purchase applications have slowed by more than 5% even as mortgage rates fell from 4.01% to 3.94%.
We know this short span does not constitute a trend, but homebuyers might be holding out for even lower rates. As you can see above, in August, consumer expectations for lower interest spiked to a 10-year high. Why lock in today when you'll get "paid" to wait for an even lower rate?
This lack of urgency implies disappointing home sales. To that end, through July, we've had three consecutive misses in new home sales. Despite this, new home sales are still up 13% thus far this year. Meanwhile, existing home sales broke their losing streak, rising by 0.6% over the prior year for the first time since February 2018.
Pending home sales' track record has been more mixed in recent months and we'll know more this morning with the release of July's data. For context, commitments to buy homes have risen by a tenth since bottoming in December 2018.
These developments smell like a turning point. Enter Richard Curtin's take on consumer interest rate expectations from the August University of Michigan consumer survey:
"The main takeaway for consumers from the first cut in interest rates in a decade was to increase apprehensions about a possible recession. Consumers concluded, following the Fed's lead, that they may need to reduce spending in anticipation of a potential recession. Falling interest rates have long been associated with the start of recessions."
The silver lining for lenders and households alike will be refinancing. Fresh data from Black Knight finds that the equity homeowners can pull from their homes rose by $355 billion to a record $6.3 trillion in the second quarter, a quarter more than the mid-2006 $5 trillion prior peak. The money to cushion household budgets as the economy slows is there for the taking -- of the 45 million with excess equity, half have mortgage rates north of 4.25%. Little wonder, refinancing activity is 167% above its year-ago level.
While this will help boost consumption, it's new digs that drive the economy. With households' perceptions of job availability at a six-month low, the risk is rising that home purchases will be postponed despite falling mortgage rates, frustrating policymakers at the Federal Reserve. With rates so low, and precious little in the way of easing capacity at the Fed, rebooting residential real estate could prove futile in the current easing cycle.
That brings us back to what is rotten in the State of America. What started here -- the trade war -- has already transitioned into rising costs among employers. As these drag on top-line growth, labor cost cuts will increasingly be in focus, threatening to enflame households' growing anxiety about the sky-high expense of putting a roof over their head.