Thursday, April 30, 2015

Is “Secular Stagnation” causing poor U.S. economic performance?

The news headlines announced 1Q GDP growth of 0.2% on April 29, 2015.  Anemic would be a compliment.  Why isn’t the U.S. economic engine roaring ahead?  There is a large tailwind of lower energy prices.  The major market stock market indices recently reached new all-time highs (SPY) (DIA) (QQQ).  Apple (AAPL) and Amazon (AMZN) stocks continue to grind to higher and higher plateaus.  Why is the mainstream economy so “disconnected” from the stock market?  And why is the cost of money on government debt so low in the U.S. (0 to .25% on short-term Treasuries) and even negative in the Eurozone.

Larry Summers, Former Secretary of the Treasury for the Clinton Administration and Former Director, National Economic Council for the Obama White House has put forth the economic concept known as “secular stagnation” as a significant factor in the current poor performance in the U.S. economy.  (See article - On secular stagnation: Larry Summers responds to Ben Bernanke)

Secular stagnation is defined as an economic situation created when there is a chronic excess of saving over investment.  The economic prescription proposed when this situation occurs is to expand fiscal policy in general and public investment in particular to promote growth.  Is the chronic saving situation real or is it just a consequence of prior political actions which now need to be corrected?  And if so, how did the U.S. and the world get into this predicament?

Wednesday, April 15, 2015

Oil Likely to Signal Next Major Market Correction, Eventually

The trading pattern of the major U.S. stock indices (DIA) (SPY) (QQQ) during since the beginning of 2015 is best described as sideways and volatile.


A review of the equity market indices shows the 50 day moving average of DOW and the S&P500 barely maintained a positive slope in the first quarter, while the trading range showed a loss YTD of almost 5% in early February only to recover to a positive 2% by early March, a range of 7%.  The tech heavy NASDAQ was a better performer in the first quarter, providing relative gains of 2% for the 1st quarter, and currently up 3% for the year.  This pattern is indicative of a market in which stock buyers are increasingly wary of the valuations of large capitalization stocks which are expected to suffer earnings hits in the coming quarters because of a strong dollar, while riskier bets on technology that derive benefit from lower overseas cost of goods paid off.

The market dichotomy of technology out-performance while more commodity based industries suffer is not unusual.  There are two instances in recent history where the major market indexes were driving to new highs while commodities, and in particular oil, suffered major corrections - the mid 1980s and the late 1990s.  The actual market characteristics are decidedly different today; for one neither of these last two points in history had a zero-bound interest rate policy at the Fed.  In addition, there is no major technological discontinuity today  such as the analog to digital transformation in the 80’s or the dot.com boom of the late 1990s.  However, the investment pattern is similar.  And the tendency of investors to see relative value in technology over alternatives is evident, not only in the U.S., but also in foreign markets, particularly China (U.S.Dot-Com Bubble Was Nothing Compared to Today’s China Prices – Bloomberg, April7, 2015).

Why are market investors currently bidding up the values of technology firms which are characteristically cash burning bets with a few big hit survivors, versus continuing to plow money into the more conservative stocks?  It is within the context of this market scenario that is beginning to play out in 2015 that investors need to continue to assess the likelihood that the U.S. equity market will “correct” from its lofty relative valuation levels before the new tech bets being placed can pay-off.

Friday, April 10, 2015

Zero Interest Rates - A Restrictive Monetary Policy for the Masses

When the zero-bound rate policy was implemented by the Federal Reserve after the 2008 financial crisis, it was readily accepted by investors that the policy was being implemented on the pretense of making monetary policy “easy”.  Six and ½ years into the policy, it is becoming increasingly clear that the interest rate policy is best described as “low”, but the term “accommodating” is not a proper way to described the actual policy which has been implemented.

Ben Bernanke has started a blog which I believe is an ingenious way for a former Fed Chairman to engender public discussion about financial market policy issues.  The first topic that he tackled was the question of why interest rates are so low.  (Ben Bernanke Blog - Why are interest rates are so low?)

After studying his very compelling arguments, it is now more apparent than ever that the current Fed zero bound rate policy (ZIRP), particularly given the extended length of time it has been utilized with only marginal results, is targeted to solve economic problems which in isolation the Fed does not appear to be best suited to solve.  The result has been a policy that has morphed into a restrictive monetary policy that is now taxing the mass U.S. market.

Why is Current Fed Policy Restrictive, Not Easy?


Saturday, January 10, 2015

Financial Relativity Metrics Signal Deflation Troubles for Stocks in 2015

The first full week of trading in 2015 has shown a trend that is likely to be the harbinger for the year as a whole – volatility fueled by a tug of war between deflationary fears and hyped growth expectations in the U.S. economy.  In this type of environment, option trading or taking short-term positions can make you a investing super-hero one day, and a goat the next.  Trying to stay the course as a long-term stock investor will be difficult for those who are more risk-averse.

The known variables which can readily be used to grasp where stocks will gravitate in 2015 are much harder to decipher than the past two years.  The reason it is getting more difficult is that stocks have now entered what I call the “borrowed time” phase of valuation expansion.  Many of the economic variables that are strongly correlated with continued inflation of U.S. equity prices are now stressed and the signals are growing that a deflationary pressure release sell-off is in store for the U.S. equity markets.  The seven major metrics I use to make this assessment are highlighted in the table below, and are backed by on-going research explained in my book – Theory of Financial Relativity.

 
The financial metrics as 2015 begins are increasingly cautious, as exhibited by the number of yellow and red markers. The model over the past two years has become progressively more “colorful.”, another way of saying the trend is not your friend at the present time. Based on the research I have done in each categorical area, I expect more of the metrics to reach a red level before the stock market is likely to undergo a sustained severe downturn. The increased areas of caution in many of the metrics, however, set 2015 up in my opinion to be a very volatile year for equity values, with a likelihood of a major intra-year drop at some point.

Read more

Thursday, January 8, 2015

Saudi's Oil Shock Therapy Hits Permian Trust Hard

The price movement in Permian Trust units (PER) since the beginning of September 2014 thru the beginning of January 2015 has been dramatic, dropping from over $12 per unit settling at just above $6 per unit at the 1/5/2015 close.  The severity of the move can be traced primarily to an adjustment in the market to a radical downward shift in the expectations for future oil prices.  During the summer months as the price of oil spiked up above $110 per barrel on geo-political tensions, the market sentiment was that $100 oil was here to stay, and that there was an implied floor of about $90 per barrel below which spot prices in the market would probably not breech.  However, during September rumblings in the industry began to surface that the Saudi’s were going to change the playing field.  The resulting “oil shock therapy” reverberated throughout the industry, affecting most severely the drilling services and E&P companies in the U.S. shale oil industry. 

Permian Trust units, which are heavily dependent on the future price of crude oil, were driven down in traded value because of the expected price shift.  The price movement can be visibly traced in the following chart.


One of the more intriguing aspects of the chart is the defense of $6 as the current floor as the price of oil has approached $50 on the front month contract.  Is this a potential sign that the market is entering a bottoming phase?  Or, is there another leg down possible, and if so, what is the fair value of the Permian Trust Units if this happens?  This report provides insight about the expected change in intrinsic value of the Permian units as the price war continues.

Thursday, December 18, 2014

Linn Energy: A Shale Play Challenged at $55 Oil

Linn Energy (LINE) (LNCO) traded closed below $10 a unit on December 15, 2014, marking both a 52 week low, and lows not experienced since the December 2008 financial crisis.  During the 2008 crisis, oil reached a bottom in the $35 range, whereas currently we are just reaching the $55 per barrel range.  Why is the panic so much more acute today than the time period politically labeled as the “Greatest Recession since the Great Depression?”  Are we entering an even bigger Depression?  That question I may have an opinion, but will not attempt to answer in this article.  What I will provide readers is a clear nuts and bolts view of why there is a run on the Linn Energy units, and why as the market approaches $55 oil per barrel on the front-end of the curve, the investor sentiment is warranted. 
 
The big issue facing common unit holders of Linn Energy is the over-extended financial structure of the business, i.e. financial leverage.  While Linn Energy is well hedged with favorable $90 oil derivative contracts for the next several years of production, the reassessment of the value of its proven reserves is expected to severely stress its financing capacity in the very near future.  In addition, even with the hedge program, the drop in oil price will still place a burden on cash flow to pay distributions while continuing to maintain a steady capital expansion program.  If drilling is constrained for any period of time at Linn Energy, the current high oil production rate will decline rapidly given the characteristics of the proven undeveloped reserves that Linn Energy owns (light oil, high concentration of NGL and Natural Gas).  The cost structure of the company makes the oil production “cliff” a particularly onerous problem.  Based on an assessment of the financial position of the company contained in this article, investors should expect a radical down-sizing, or even complete elimination of the $.24 monthly distribution level which is currently a 28.76% yield.

Wednesday, November 5, 2014

SandRidge Permian Trust – Struck by the Saudi Oil Shock

On October 30th SandRidge Permian Trust (PER) announced its quarterly distribution for production during the time period of June through August 2014.  During the summer the energy market showed high oil prices throughout that benefited the Permian Trust which has 86% its production in crude oil.  The spread between WTI and WTS crude oil widened during the quarter causing a slight decline in price level realized by the Trust.

The distribution announcement was greeted with a rally in the market as the units traded up from $9.50 to $9.93 per unit on the day after the press release.  However, the information released may not have been the primary factor in share price movement during the day.  On Halloween the entire market experienced what is being reported by experts as a massive global shortcovering rally because of the announced changes in Japan monetary policy and pension fund allocation.  The unit price movement in Permian Trust units in the five day period leading up to the announcement was probably more indicative of the change in short-term sentiment about the Trust units, rising from $9.00 to the most recent $9.93 closing price on October 31st.

Thursday, October 30, 2014

Stocks Post QE3 - Pay Attention to this Data

For years the Fed Funds rate has been the sacred measure that investors followed to determine if the Federal Reserve was promoting and accommodative or restrictive policy.  Fed rate hikes were a signal that the market was a little too juiced on the punch, and margin calls or a reduction in lending in the market was considered prudent.

What about today?  The Fed Funds rate has been at 0% since December 2008 yielding the rate meaningless in understanding just how Fed policy is influencing the financial markets, much less the economy as a whole.  I separate the stock market from the economy because increasingly, and particularly since the new Fed policy of using excessive amounts of QE as a tool in its policy, the two have diverged in correlation.  In fact, from a pure numbers standpoint, it can be argued that over the last 6 years, Fed policy has been an outstanding success in pumping up the stock market.  Stocks have risen from the depths of 666 on the S&P500 to over 2000.  Economic growth, however, has struggled to exceed 2% in real terms, and 3%-4% nominally.

The Fed has announced that it will now end for the foreseeable future, its bond buying program known as QE3 in the market (the program followed QE1 in early 2009 and QE2 in early 2011).  Stocks went progressively higher with QE as a backstop.  With the QE program ending for the time being, will the stock market suffer from the change?  Logically given the correlation one might suspect trouble; but what indicators should an investor monitor?

The answer to these questions is completely up to what happens to the bubble the Fed has created on its balance sheet, and correspondingly the high level of excess liquidity that it has created within the U.S. banking system.  One such indicator that is likely to become useful in the post QE3 distorted financial market is the level of excess reserves in the U.S. banking system. (Excess Reserves of Depository Institutions)