The subdued reaction to Apple (AAPL) and Starbucks (SBUX) earnings might be a tell that today's rally was a dead car bounce. I am putting on shorts in the after hours.
Just read Sarge's commentary and it triggered a thought. He questioned China's ability to meet the phase 1 "obligations" considering the slow down (screeching halt? ) to their economy due to the outbreak. Also that many analysts have argued that those numbers were not feasible to begin with. But what if the opposite is true? They have a desperate need to increase the food supply (pig problem) and their healthcare system is stretched and shown to be vulnerable. What if they decided to make agriculture & medical purchases with the reserves that are currently purchasing Treasuries? The result would be to reduce the trade imbalance, increase food supply/reduce food inflation, help the political problem caused by the perception/ reality if the health care system failure and at the same time create some pressure on an economic rival by increasing their financing costs by decreasing Treasury demand. The argument has always been the Chinese have to be concerned about destroying the value of their investments and that makes sense when considering a massive divestment. But a reduction in additional purchases?
I will be leaving at the close of trading today to run an errand so I won't be in my perch to analyze the Apple (AAPL) quarter. I will do that tomorrow morning.
I recently reduced my large (GLD) long down (at good prices) to tag ends. I have just eliminated my very tiny stake in gold with the expectation of buying back at lower levels.
* I am giving the market a wider than usual berth to rally before I reshort
"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance." - Chuck Prince (2007)
I am quite pleased with yesterday's short covers. This morning, breadth is +1500 but many stocks (e.g., Alphabet (GOOGL) and Amazon (AMZN) ) are up only modestly vis a vis yesterday's falls. That said, reflecting my lack of near term conviction I plan to give the market a wider berth than usual to rally. I just don't feel compelled, like Citigroup's (C) Chuck Prince did 13 years ago, to dance every dance. I have learned from history.
Core durable goods orders in December fell -0.9% month over month, worse than the estimate of up +0.2% and November was revised down by one tenth. This important measure of capital spending has basically flat lined ever since the trade battle and tariff fight with China ramped up in mid-2018. (See the chart below of Core Durable Goods).
With respect to a possible GDP revision for Q42019, core shipments also missed the mark with a 4 tenths decline vs. the estimate of up 2 tenths. With all of this, keep in mind that software spending is not included here and that has been the standout in terms of capital expenditure dollars being spent.
Bottom Line
The softness here is clear. The question now is how does capital spending inflect higher now that there is a Phase One trade deal and how much the continued presence of the tariffs will offset that.
* After the fall... now the hard part * Conviction levels are too infrequently discussed in these parts * There is nothing wrong with saying "I don't know" * I covered much of my short trading book in the belly of yesterday's market decline * Let me explain why...
"The best lack all conviction, while the worst are full of passionate intensity." - William Butler Yates
Conviction is something James "Rev Shark" DePorre and I often discuss in our columns and debate on private emails and on Twitter.
I don't think there is enough attention paid to this subject and I believe the right Rev agrees with me.
Let's first start with the notion that all investment views are not equal - though "talking heads" in the financial media tend to always appear confident. (As Grandma Koufax used to tell me, "They are often wrong but never in doubt." But enough of that, as I have too frequently made this point in my Diary!)
There is nothing wrong with writing/saying "I don't know," as Jeff Specoli did in Fast Times at Ridgemont High. Saying the phrase "I don't know" is real and honest. More should employee these words which represent a more realistic view - particularly in an increasingly more complex investment mosaic characterized by uncertainty in volatile and unpredictable times.
So, with your indulgence, I wanted to repost, modify and update a column on the subject of conviction that I initially wrote nearly two years ago:
(Up until) recently the market has been a powerful demonstration of:
* Its vulnerability. * Its strength.
Wait, how could it be both conditions at once?
Because it was.
Three weeks ago Monday, the S&P Index, up by over 10 handles on the opening, reversed to being down by nearly 35 handles (at its nadir) only to close down 10 handles at day's end. That's a 45 handle reversal from best to worst.
However, the close indicated that dip buyers remain very much alive -- indicative of an underlying strength.
The fact to me is (and what makes this game unusually difficult in current times) is that there is so much artificiality apparent in the market's structure that it is hard to believe, at any point in time, that prices are representative of natural demand and supply.
It helps to explain why so many brilliant hedge hoggers have left the business and why so many are frustrated by the changing market structure in which ETFs and quant strategies dominate the landscape and, arguably, impact natural price discovery.
It also helps to explain why, as a matter of principle these days, start small in initiating positions and slowly build them up subject to a favorable upside/downside ratio. This does not prevent me from getting to large net exposures (short or long) that have longer term timeframes as prices more than ever get out of whack based on the influences below - as the "voting" of investors grows ever more extreme - as I am confident that the "weighing" will, in the fullness of time, reflect closer to intrinsic values.
Back in early January, 2019 in "Not All Investment Views are Created Equal," I covered the subject of my diminished conviction levels in a changing market structure:
It is said that opinions are like buttholes -- everyone has one (and that includes me!)
It seems that in today's investment world in particular almost everyone has an opinion and a view on nearly everything. In many cases these views are delivered by self-confident messengers who seem to never be in doubt but are often wrong.
It also seems, that the more anonymous the person is, the more confident is the view! The Twitter platform comes to mind.
Few say, "I don't know."
But this is not a representation of reality.
The fact is that a view invariably is associated with differing degrees of conviction.
Nearly every strategist, analyst and portfolio manager is first asked about a "view" in the business media, but I can't remember the important follow up question: "What is your conviction level associated with that view?"
This very simple concept gets little discussion, but it should as it is very important, sometimes as important as a given view itself.
As an example, last night I "liked" Clemson. Based on my analysis I thought the spread of six points (Alabama was favored) was too great given Clemson's talent (of a Trevor Lawrence kind) and momentum, among other factors. But my conviction level was not high, so I wagered a small amount with Badgolfer -- thanks, Mikey! -- on Clemson to win.
The Clemson Tigers easily won the college championship by a score of 44-16, blowing out the Crimson Tide.
It is also true when investing that not all views are equal.
Investment Convictions Today Should Be Lower Than in the Past
There are several factors that recently have contributed to rising uncertainty:
* The market structure has changed -- The dominance of passive products and strategies are also contributing to the new regime of volatility that began in early 2018. * The Orange Swan and political turmoil -- These factors are contributing to policy uncertainty, which in a flat world (see below) has broad ramifications to investors. The administration's hostility towards the other G-7 countries and a lack of sense of the world community (i.e., the abandonment of the post-World War II order) jeopardizes the U.S. leadership position and poses new economic and market risks. * The world is growing more flat, networked and interconnected -- Non-coordination and lack of cooperation among the largest countries in the world represents a profound and new risk. I continue to ask these three questions every day, as the answers might serve to raise uncertainties but also may be viewed as valuation busters in the fullness of time.
In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?
In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?
With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?
The reason I want you to remember these questions is that the answers might serve as valuation busters in the fullness of time..." - Kass Diary, "This Ain't No Seder, I Now Have Eight Questions" (2017)
Differing Conviction Levels and the Uncertainty of Views
"I'm astounded by people who want to 'know' the universe when it's hard enough to find your way around Chinatown." - Woody Allen
Besides the above three contributors that form the foundation of growing uncertainty, there are other factors that may reduce conviction of views.
Price is an important consideration.
For example, with the S&P 500 Index advancing by nearly 130 handles (adjusted for Tuesday morning's futures rise) since the close of trading last Thursday to almost 100 handles above my "fair market value," the conviction level of my many individual long holdings - many of which are up 20% or more in a brief period of time - is much lower than from three trading sessions ago.
For that reason and others, I have adopted a market neutral position, which is a manifestation of my lack of conviction in either direction.
The Rare Time of High Conviction Should Be Followed in Practice
"Soros has taught me that when you have conviction on a trade, you have to go for the jugular. It takes courage to be a pig. It takes courage to ride a profit with huge leverage." - Stanley Druckenmiller
I didn't want to end this missive without mentioning that, though uncertainties reign, when your conviction is high you should not be reluctant "to go large."
In the last 30 years, George Soros and Stanley Druckenmiller are the best practitioners of convicted and concentrated investment positions/bets.
This was also the case, at least for me (on a more limited scale), when the S&P in the last week of December 2018 collapsed to 2340 (now at 2560 only a week later) and I moved to a large net long exposure.
Then there is the rare bird, Berkshire Hathaway's (BRK.B) Warren Buffett, who, more than anyone in modern investment history, has a documented history of confidence and large, concentrated portfolio investments that have manifested in the delivery of remarkable investment returns over the last five decades.
"Our destiny is frequently met in the very paths we take to avoid it." - Jean de La Fontaine, Fable 16
For the reasons addressed in this morning's missive, my conviction levels over the last few years are far lower than they have been in the past, especially when compared to when I started out in the investment business more than four decades ago.
For me, my conviction is strongly a function of rising uncertainties -- in policy, politics, market structure and interconnectivity -- as well as the difference between current share prices and my calculus of intrinsic or fair market value. While it is counter-intuitive to momentum-based strategies, my conviction rises when the spread between current share price and intrinsic value widens. As the spread contracts, my conviction is reduced.
These factors help to explain my weightings -- small, medium and large -- which tend to be a reflection of my varying conviction levels and the consideration that it is increasingly hard to find the ideal entry point!
In the final analysis, all investment views are not equal.
Updating For Now
* It's not necessary to have a strong view at every market level
* Nearly every investment view has a different level of conviction
As to the current market condition, we have had a whopper of a selloff over the last two trading days - with the proximate cause, explained by many, to be the possible contagion of the coronavirus which has taken a toll on entertainment and casino company stocks (like Disney (DIS) and Wynn (WYNN) ), transportation stocks and many market sectors. It is tough (at least for me) to have a high level of conviction in "newsy" markets that gap (up or down, depending on the nature of that news). When, as I have been structuring my portfolios for the Bear and the market breaks, its especially hard. I tend to be opportunistic, as I did yesterday - and covered a large portion of my short hedge (which was predominately consisting of a very large (SPY) put position with an expiry of a rather short, 40 days). After all, as negative as I am over the intermediate term, it is still hard to argue (technically) with Rev's view that we have broken the uptrend. In support, here is Sarge's chart from his morning commentary:
Whether this is THE market break and inflection point lower - we will only know with the benefit of hindsight. For now, I will continue to treat my short hedge/book as a trade and not a state of mind. The essence of this post is that not all investment views are equal - and, in all honestly (and transparency) given the news backdrop, my conviction level for the near term is not high. In terms of the intermediate time frame, now that is a horse of a different color!
Since we're basically flying blind here in the markets with the corona virus dominating the news and market moves it's a good thing earnings reports are here to deflect some attention and to hear about what companies are seeing out there. The only thing for sure right now is the Chinese economy will have an awful Q1 which then begs the question of what that means for the rest of Asia, Europe and parts of the US economy. At least for now it's an impossible question to answer but I remain of the belief that Q2 will normalize regardless as the virus flames out.
The other big event this week is tomorrow's Fed meeting with all eyes on what they say about their balance sheet. It's important to see an acknowledgement on the part of Jay Powell in his press conference that there is an inextricable link between the balance sheet and asset prices (whether directly via flows and/or psychological) and whether that more quickly ends the expansion of the former while the rest of us then get to watch what that means for the latter.
Not that it has any market relevance right now but the economic data from overseas was almost non existent today. The only thing of note was the UK CBI retail sales survey where its index was zero for the 2nd straight month which happens to be the highest since April. CBI said "Both official data and business surveys are painting a picture of subdued activity for retailers. A challenging Christmas has extended into the New Year, with little expectation of any improvement soon." It's been business confidence that has rebounded immediately following the December PM election while the UK consumer will continue to reflect its current finances.
CBI RETAIL INDEX
The BoE meets Thursday and I continue to believe it would be a mistake to cut rates as they should clearly wait now that the UK is much further along the Brexit process with it being official in a few days. Yes, getting the trade deals done this year will be a long slog but what would a rate cut do to address any economic slippage from it? Nothing with short rates already close to zero. Rate cut odds are about 50/50. The pound is lower but still is above $1.30.
Danielle DiMartino Booth says the Empire might strike back:
Texas and New York command 15% of the nation's jobs -- driven by Texas, as the largest exporter and New York as the top concentration of services; employment in the Dallas Fed manufacturing and New York Fed service surveys have recently moved in lockstep
The trade war has manifested in a drag on Chinese real estate investment and depressed tourism in New York; the impact in Texas has been more direct via trade-- and risks spreading to depressed crude oil prices, as the fallout from the coronavirus catalyzes a demand shock
Cumulative bankruptcy debt has risen from $25 billion in 2015 to over $200 billion in 2019; West Texas Intermediate south of $60 promises to accelerate the trajectory of consolidation and bankruptcies, and with it rising joblessness in the Lone Star State
Got kids? U.S. Census Bureau's Statistics in Schools website provides more than 100 activities that teachers use to invigorate learnings across many subjects. The State Facts for Students program is a great resource for state demographics. And added bonus -- it boots your tweens off YouTube. This clever tool can also pit one state against another a la Texas vs. New York. Did you know 81% of Texans drive to work alone, compared to 53% of New Yorkers? And while this (won't) shock, 21,201 fast-food restaurants call Texas home, making New York, with its 17,778, seem downright healthy by comparison. And at 58, Texas has more than double the number of amusement parks compared to New York's 26.
For the second and fourth most populous states in the U.S., there is one thing that both states have in common -- jobs, and lots of them. Texas closed out last year with 12,976,700 employees on nonfarm payrolls while New York clocked out of 2019 with 9,821,800 collecting paychecks. Together, the Lone Star State and the Empire State accounted for 15% of all the jobs nationwide.
If such stats entrance the terrible tweens, keep it coming with the Bureau of Economic Analysis' BEARFACTS website for even more contrasting views of Texas and New York, one of which reveals an interesting parallel. The two largest industries by share of each state's gross domestic product (GDP): #1 Finance, insurance, real estate, rental and leasing and, #2 Professional and business services. Both states have large banking and real estate footprints and broad service economies. And you thought it was Big Finance vs. the Oil Patch.
There are, however, critical distinctions. Texas is the largest exporter while New York has the highest service sector intensity of any state in the nation. These particularities place Texas and New York at opposite ends of the tariff spectrum. Share that with your thirsty for knowledge offspring. Astute followers of current affairs that they are, they would jump on the trade war hitting Texas a lot harder than the less-exposed New York State economy.
That brings us to today's colorful lower panel chart which should have you cocking one eyebrow in Mr. Spock fashion. Ask yourself: Why are employment trends in Texas manufacturing and New York services both slowing and converging? These two states' economies couldn't differ more.
And yet, since December 2018, the monthly differentials between the employment indices of the Dallas Fed manufacturing and New York Fed service surveys have been miniscule. In the 16-year history of the surveys, these two metrics have never hugged each other as closely as they have these last 14 months.
Blame it on coincidence? Ever heard of "I NY"? The Big Apple has long been a tourist mecca. In the current cycle, it's also been a darling of foreign nationals, including the Chinese, bedazzled by the idea of owning a pied-à-terre on Central Park or in Soho, albeit not so much lately buttressed between Chinese capital controls and yes, the trade war. Just see Broadway ticket revenues if you need another case in point.
Diversified as both states' economies are, oil still matters to the Texas economy whose industrial sector is married to the energy sector. Since early 2016's low, West Texas Intermediate (WTI) crude futures prices (blue line) has had a 0.76 correlation to the Texas manufacturing employment index, TWICE that of the 0.38 tied to New York's service employment index. Note the dispersion between the two surveys during the last energy bust.
The coronavirus attack on the Chinese economy will catalyze a demand shock as the largest marginal buyer of oil is brought to a virtual standstill with the virus now in all 32 Chinese provinces. WTI closed yesterday at a 3-month low and is now in bear market territory after having fallen 20% from its April high of $66.60 a barrel. For more recent perspective, prices fleetingly dipped under the $50 mark during the massive risk-off that walloped financial markets in December 2018.
Many energy firms' viability will be challenged the longer WTI trades south of $60. According to international law firm Haynes and Boone, cumulative bankruptcy debt has risen from $25 billion in 2015 to north of $207 billion in 2019. By the end of last year, the number of filings had pierced 200. Yesterday's spectacular collapse of private-equity-backed Fort Worth based Southland Royalty Company was the third energy bankruptcy of the year. More are to be expected.
The difference between the last energy bust and the present episode is that private equity would be remiss to rush in as they did several years back, burned as they've been. Moreover, sustained weakness in WTI will be less idiosyncratic and more reflective of punk global oil demand. "Energy Bust: The Sequel" won't likely be demographically contained to one state.
