New Image Emerging

The sands are shifting.  The status-quot is giving way to market forces.   

Greece is going socialist or Marxist - and the economy is destroyed.  Germany and the ECB will use them to set an example. Venezuela - has imploded, but just needs a bit more time to collapse.  Russia is sinking - while it hopelessly uses its massive reserves to breath.  They're losing their world power status and rebuilding can't begin until Putin takes a long holiday - for good.  Oligarchs will buy his ticket and help him on the plane. 

The debts of both Greece and Venezuela have to be written down, by way of a default or some back door deal.  Either way, capital (money and talent) leaves, their markets are crushed.  Banks are run.  Game over.  But the phoenix will rise.  As it is finally going to do in Cuba.  

Spain, France and Italy look at the carnage and are determined to take a different path.  ECB draws the line and "does whatever it takes" to restructure their debts.  Seeing how turning back from reforms has hurt Greece, the ECB uses this as leverage to force faster progress on reforms but makes the pill more easy to swallow by using the printing press.  Together with Junker and the Economic Union, a new growth strategy is introduced.  It  involves reforms coupled with development funding.  In combination with low interest rates and E-QE, Europe takes a turn and their currency strengthens - at least it stops weakening.  This puts a floor under USA equities whose earnings are to hard to hedge otherwise with such a weak Euro. 

USA firms see the potential in Europe and put their reserve capital to work overseas. Plus, this works as another form of hedge to exchanges. Look at the difference this made for Ford who manufacturers in the region.  Rather than bringing reserves home, USA firms decide it is time to invest in Europe.  The Federal Reserve and Congress encourage USA investment in Europe. 

America's picture is changing.  Exchange rates are hurting earnings.  And, the oil industry is costing jobs faster than they're being created by the stimulus of low energy costs.  In an effort to curb costs, there is further downward pressure on expenses, which doesn't help USA growth. Raising rates is a non-starter until late 2015 at the earliest. More patience becomes the new operative way of thinking.  But we still need a new catalyst for growth in the USA!  Something has to come out of congress that is positive for growth.  Low rates, low energy help, but there needs to be a new picture that emerges for prosperity. I'm convinced it needs to be infrastructure - of all kinds - transportation, energy distribution (electric, natural gas and hydrogen), and a more secure Internet.

Along comes India.  Cuba might have been enough of a boost to our economy, had it not been for all the other negative shots. But new hope for the world economy, including China, is going to have the taste of curry.  I love curry!  Bring it on!!  They can take up some of the slack in materials - just in time to save miners from supply destruction.  Same to be said of shipping!  

I have to say, my compass has been spinning around trying to find North since 3Q 2014.  And, I'm still working this out in my head.  My investing starts with a macro-picture, so I've been having a very hard time lately with my compass spinning around looking for north.   Frankly, if I had just followed the plan that I blogged about months ago and gone to mostly cash, I'd be a lot happier at this moment. Costly lessons, hopefully learned!  At least it might be said that equities are looking more reasonably priced at this point.  That is unless you think we're entering a bear market.  

Do we need more capitulation before there is a massive turn?  Or is there a lot more pain to come first?  Couldn't tell you.  Only the market can answer that for sure.  Gotta love the intelligence of markets and chaos!  That's one of the things I love most about capitalism.

It appears tensions are building in the bond market for some sort of big turn.  It seems to me that another long super cycle of debt is coming to a head.  The sub-prime and US mortgage debt bust triggered the last financial crisis, and the solutions for that bought some time, while simultaneously contributing to the much greater super cycle of sovereign debt - national debt.  While the last crisis started in the USA, where we had the ability to move quickly and formulate a response, the next and larger crisis begins offshore.  And by the time it arrives here the worldwide damage will already be so enormous that a USA response will be like one plane attacking King Kong or Godzilla.

Of course there must be a response.  Mankind made this problem, so mankind can fix it.  It is in our DNA to try!  Maybe QE becomes QF.  E does follow F.  So maybe easing is followed by forgiveness.   After all, what's the real difference between debt which Greece can't possibly pay back and debt it doesn't have to?  In a word - inflation.  Hmmm, now isn't that the solution everyone is looking for anyway?!!

Now OR Never for Mario Draghi

With European inflation at .3% versus the 2% target, the ECB head Mario Draghi had better start using actions versus words to stimulate growth in Europe.  My belief is that he knows his rhetoric and promises have lost their effect.

But I also believe Drahgi's been looking a better means of delivering financial stimulus than the traditional sovereign debt purchases the the ECB has used thus far.  To this point, QE has just been an enabler for the governments to continue with their old ways.

Draghi has pushed politicians to make the kinds of systemic changes to the conditions that have bogged down Europe - heavy regulation, businesses burdened with workplace rules and limited by Unions to restructure in order to be more competitive.

The strong dollar against the weaker Euro is giving European businesses a strong pricing tailwind, which should help them.  And a dramatic drop in oil is leaving more money for consumers.  But ultimately, more aggressive monitory policy is needed to really get the engine revving.  Especially, now with the drag that a slowing China and Russia's collapsing economy will have on Europe.

The solution Draghi has been waiting for has come in the form of the newly elected European Union President, Juan Claude Junker.  He's got the right ideas if you ask me.  Firstly, Junker's stated number one priority is

"... getting Europe growing again and getting people back to work. "

Those words could have been delivered by any politician, but Junker thinks more like a capitalist than the socialists who have kept Europe in the grips of terrible economy for decades!  Since taking office Dec. 10, 2014, Junker has listed clear objectives including "freeing small and medium-sized businesses from red tape, to promote entrepreneurship and job creation."  He wants the commission to "focus on cutting regulation, making smarter use of existing financial resources, and making flexible use of public funds - to provide up to 300 billion Euro in additional public investment over the next three years."

Here is list of ways Junker wants this investment to be targeted:

• Infrastructure – broadband, energy networks and transport infrastructure
• Education, research and innovation
• Renewable energy and energy efficiency
• Projects to help young people find work (building on the Youth Guarantee scheme).

At a recent December press conference, Mario Drahgi announced that the ECB has just agreed to prepare "for further measures."  The pundits, and even those who initially believed in Draghi seem to have written off Draghi's comments has more of the same "talk."  I'm not so sure.  Draghi, who earned his Doctorate in Economics at MIT, is smart enough to know when time as run out on rhetoric.  Drahgi's been waiting for a man like Junker - and now he has him!  

New Year's Call

One of the things I like about New Year's day is how it causes us to forward think. 

A thesis is forming in my mind. It goes like this. Commodity deflation leads to both producer cost deflation, consumer buying power AND consumer consumption. That leads to both rising corporate profits AND inventory draw down. That leads to increased productivity, hiring, and wage inflation. Which in turn leads to work force expansion, and with that comes greater household formation. The stage is now set for a surge in larger durable orders and new home purchases. Consumer borrowing and spending increase quite a bit. The economy moves into a stronger period of back to back hirer GDP quarters. Finally, the fears of deflation are whipped around and the Fed finds sufficient reason to let interest rates gradually tick up. Stocks enjoy this.

Russia can still spoil the party. The Euro can still unravel. Both would likely happen together. If so, that would be more than markets can handle = big sell off. 

Time will tell ... It always does. As we appreciate especially on New Years.

Going on the Record for 2015

The last time I went on the record with my economic predictions was in August of this year.  It's that time ... year end ... time to look ahead to next year ... and to go on the record about what I think the macro picture will look like in 2015.   Here it goes:

Finally.  It took long enough.  But I believe 2015 is finally the year when the economy truly and undeniably breaks out.  Here's my big seven reasons why:

1. Up till now the economy did well in spite of congress.  In 2015, I think it's going to do better thanks to congress.  Look for the possibility of:
    - corporate tax reform including a means for repatriating overseas cash
    - natural gas exports and the Keystone pipeline
    - compromises on immigration with a path to citizenship
    - a way to reduce college debt
(Notice I said "possibility," not "passage.)

2. Innovations take hold across numerous industries bringing about compelling reasons to replace most everything, from cars to hips, and invest to improve your business and your life.

3. Low cost energy continues to drive USA industry.  Lower costs factors on everything, from transportation to petroleum based products, save consumers, businesses, and government an enormous amount of money which provides massive stimulus.  (The flip side of this would be the negative effects caused by an even more severe decline in oil, below $70K a barrel.  If that happens, bankruptcies and slow downs in the industries built around exploration and production, and their suppliers, which would also put a strain on investors and financial markets.  Of greater concern is the potential crisis triggered in countries such as Venezuela, Russia, Iran, etc.  How that plays out can be very risky and unsettling.  Especially with Russia already under major strain from sanctions.)

4.  Low interest rates combined with low cost steel and energy costs to make this the time to do historic levels of investment in USA roads, bridges, and rail.  We're going to need those "illegal" immigrants!  I say let them earn their citizenship by rebuilding America's infrastructure!  (It's been done before during the war!)

5. Wage growth and the work force size both jump in 2015.  This is a double dose of GDP!

6. The consumer and business confidence lead to a spending spree.  Retail comes alive - just in the (saint) nic of time!

7. HOPEFULLY the Federal Reserve stops paying interest on reserves and some of the regulation that's been discouraging banks to lend will lighten up.  Equity markets are hot enough, we need the banks to get back into the business of lending!

Need I say ... all this is good for equities!

It also goes without saying that all these ideas can go out the window at any time by some unforeseen major event.  But I learned a few years back not to speculate.  At least not about "black swains."

One Man's Ceiling Is Another Man's Floor .... Until That Other Man Take the Stairs!

With all the talk of the recent stock market highs being a bubble, I submit an alternate view.  Suppose instead that we may be about to form new support.  I think it is possible that the highs on the S & P and the Dow will turn from being a ceiling to a strong floor.

This week is not our first run at the highs, as we keep testing resistance, and once we've broken through we will no doubt test these levels from the other side.  (Old resistance becomes new support.)  If the highs hold, I can envision a chart forming a floor with strong technical support at 2000 on the S&P and 17,000 on the DOW.  Large round numbers with lots of zeroes offer a strong psychological effect - drawing you in and then holding you above.

Literally speaking, the ceiling becomes the floor once you take the stairs.  And if the animal spirits, the technicians, and traders, all start to view these historic market numbers as support, rather than resistance, this is a powerful paradigm shift.  Which would draw substantial new money into the market and squeeze out the shorts. And if volumes are good to boot, such positive market action bodes well for adding to the averages.  Focus would then shift from the fear of an imminent correction in the near term, to a renewed sense that the risk is to the upside.  Then the stage is set for a new leg up!

If this is supported with fundamentals including broad sentiment from economists, consumer & business surveys, combined with acceleration in the economy and earnings, then the ripple effects of consumer spending, CapEx, hiring, wage growth, etc. will all provide a credible basis for unseen new highs in the market - just waiting for final corroboration by the NASDAQ as it too returns to its all time record high of 5,048 reached on March 10, 2000.

And, as we shift focus from the 4Q to 2015 forward earnings, and the market starts to calculate in price multiplier expansion, there will be less justification for calling the market overpriced.  Again, corroborating the market's strength.

By the same token, some stocks have high expectations already baked into their prices, and could even pull back as the market moves higher.  Other stocks, have plenty of room to run and/or have lagged the market and are undervalued.   A classic rotation, which is healthy.  Stock pickers love markets like this!

At some point we are due for a healthy correction. Nothing to suggest that the secular bull is over, but more than the short little dips we've been having. A good 8-12% drop would shake out the loose hands and take some froth out of stocks that got ahead of themselves. There have been plenty of calls for this to happen, and it will.  But I think we get it from a higher level. I am moving to the side as we approach 2050-2090 on the S & P to let the bears have a little party. What's going to hurt most is the tax consequences from selling winners, but the opportunity to buy on this correction once it settles down will make it worth while! I definitely want to exit my losers before then because tax selling on those is going to really put them in tank!

Of course, some massive Geo-political event, such as the unraveling of the Russian economy, a new regional military action, boiling over civil unrest in Europe, or even a large consequential natural disaster such as the likes of the tsunami that brought down Fukushima, could rock the boat. But there is always a potential "Black Swan" out there and it doesn't need the stock market to tell it when to strike.

As negative as things are in Europe, the ECB has been much slower than the USA or Japan to implement major quantitative easing and monetary stimulus.  With risks of deflation and a recession looming over Europe, Mario Drahgi and the ECB are becoming increasingly dovish.  If Drahgi were to go forward with some monetary "shock & awe" to kick start inflation and the European economy, then Europe would go from being a headwind on USA GDP to a tailwind.  Put that together with a long awaited housing boom and consumers heading back into the stores and things get extremely interesting for equities!  Especially, if inflation in the USA continues to hold to its low pace.

And, once the Federal Reserve ends its asset purchases in October as scheduled, and we find that the economy can stand on its own. That will send an extremely positive message to the street!  Skeptics needs to see that the markets can withstand the punch bowl being pulled away. 

Keep in mind that we've had one of the slowest recoveries on record, so just maybe it's time for this economy to finally breakout.  And, if/when it does, the most hated stock market rally in decades may give the naysayers even more reasons to hate it.  Or, better yet, maybe the hold-outs will take the stairs and join us on the new floor!

Could This Be The Moment We've Been Waiting For?

JP Morgan just released their second quarter financial results.  I'm sure people in the financial industry will be combing over them. Its a strong beat. And a good sign for your industry, financial markets, and the direction of the economy. 

From my point of view, one of most interesting components of what came out was Jamie Dimon's remarks about seeing encouraging signs in all aspects of his business towards the end of the second quarter. Thats when weather changed, and the sense that the animal spirits changed with it.

I think JPM results signal an upturn in business activities. My belief is that now we will see greater investment by businesses and that investment is also going to include wage growth and hiring.

Even negative international events can turn into a positive impact on the economy. Here are examples of why I said this. Competing with Russia for new markets and a hold on existing markets means both countries will be spending more money to generate relationships and do business. Tensions in the Middle East translate into greater expenditures on defense products and other national security related investments such as energy independence. Stresses in the European banking system, their economy and unemployment problems mean that the ECB will stay very aggressive with monetary policy that is stimulative. And Europeans will start to look for ways to move structural reforms which lead to growth.

I'm not going to worry about inflation yet. After all, before that the market has to heat up and start to test the supply side. Growth will come before worrisome or overwhelming concerns with inflation. If anything, news from the second quarter is probably going to affirm that the Federal Reserve and Janet Yellen have been on, and are on, the right track. Practically perfect when you consider that they are on track to taper purchases completely by the beginning of 4Q. And I think the taper coincides perfectly with incentives for the banks to dramatically increase lending starting in the second quarter, and that we're going to see future investment financed though debt and equity markets continuing to rise throughout the year. Considering this will be leveraged on a ridiculous amount of cash that businesses and others have, we're talking some serious coin! 

And not to be overlooked, is how all this leads to tax revenue which can the used on something we all agree is needed - that is infrastructure! If the Federal government would just change the tax code to reinforce corporations commitment to the good ol' USA we would have a remarkable growth cycle. And given the rhetoric out of Washington these days from both sides, partly as a result of the worrisome trend of corporations moving their domiciles overseas, it is not entirely far-fetched that we could see something happen on corporate tax reform which is backed politically by both parties. Holy shit, wouldn't it be nice if Washington finally doing something smart for change!

Watch guidance on the 2Q earnings reports. If what I'm saying is accurate, then there will be a lot of talk about things picking up in the second quarter and translating into better guidance for future quarters.

Inflation That Is Good For Your 401K

We have entered a long term cycle of inflation.  Now hold on, because I am not talking about your garden style inflation.  No, this is not your father’s inflation!

Inflation is caused when you have too many dollars chasing too few goods.  Fortunately we have plenty of labor, lots of industrial capacity, and enough materials. Plus, technology is contributing to supply of all of those.  So CPI is under control. I am not talking about inflation in the cost of living.  That's good! 

So what inflation am I speaking about?  Where are there too many dollars chasing to few goods?  Answer: Investments! 

The rise in millionaires, billionaires, and corporate cash around the world is astounding.  According to the 2014 Hurun Report on the global rich: 

WORLD’S BILLIONAIRES EXPANDED BY 414 TO 1867 INDIVIDUALS IN RECORD-BREAKING YEAR.

946 SAW WEALTH INCREASE, OF WHICH 152 BY MORE THAN 50%. ONLY 318 SAW WEALTH DECREASE.

1867 BILLIONAIRES FROM 68 COUNTRIES. OF 414 INCREASE, USA LEADS WITH 72, FOLLOWED BY CHINA 41, UK 22, JAPAN 21.
 
Record number of billionaires in 2014 - the number of billionaires in the world increased 7% over 2013.

Forbes Magazine reports that China is "minting billionaires at a phenomenal rate. --- China registered a record 152 billionaires in the 2014 list, up near 25 percent from 122 last year, while Hong Kong clocked up 45." Still, the U.S. remained home to the largest number of billionaires at 492.  And, Europe boasted the most billionaires outside of the U.S., with 468 billionaires."

One study by PWC predicts Assets Under Management (AUM) to grow 56% over the next 6 years.  That wealth needs to be invested because try as a billionaire may, they can't “consume” fast enough - they literally don't have enough time in the day.  They have a problem 99.999% of us on the planet will never experience - their money is growing faster than they can consume the “stuff” their money can buy.  Isn't that sad!  What's a billionaire to do?  Or, a corporation with billions in cash with the same dilemma.  And frankly, it is a bigger problem for a company because they are under pressure to generate a return on that cash!  They have two CHOICES. 1) Donate to charity. 2)  Invest.

I can hear some people thinking, Wait!!  There is a third choice - higher taxes!!!!  I will speak very briefly to that misguided thought. To begin with that is not a “CHOICE.” And even if it were, it is a bad one.  And in case you forgot, they WILL pay more taxes because that IS HOW THE SYSTEM WORKS NOW!  Secondly, what makes you think that when government taxes wealth that it will spend the money in ways which are better for the rest of us.  Chances are greater that the government will buy a war ship or fighter jet with those found tax dollars.  But the best reason to let the wealthy invest their spare money, rather that to excessively tax it, is that they will produce more wealth, more jobs, and more taxes anyway.  Otherwise you could make the argument to tax 100% of profit and let government pay for everything.  Besides, if you haven't noticed, when a good cause is looking for support, be it a hospital or a research organization fighting a disease, or whatever, they target big donors, not big government. So CHOICE #1, “donate to charity" is quite valid.  And America is blessed to be the most charitable nation on the planet. Therefore, let me get back to choice #2.

In the financial news we hear a lot about Corporations buying their own stock.  Stock buybacks and cash dividends totaled $214.4b in the fourth quarter of 2013. That is the highest level since the record high of $233.2b in the final quarter of 2007, according to the Wall Street Journal. Compare that to the second quarter of 2009, when buybacks and dividends totaled a mere $71.8b.   Buybacks reduce the supply and raises the value of their stock. In addition, nearly every time you hear about a merger or acquisition of one company by another, that translates into a lower supply of equities.   Another strong demand side factor is coming in the form of inflows from international wealthy investors looking to get a piece of our equity markets, as well as foreign businesses looking to establish operations in America and see acquisitions/mergers as a efficient way to do so. 

So, what if investment dollars are running short of investment options?  What if too many investment dollars are chasing too few investment goods - you get inflation in stocks and business values!  Some call it a bubble. And if we do get runaway inflation of stock valuation that would be a troublesome sign of a bubble.  But thus far, with some notable exceptions, the valuation of equities is in line with earnings. And, if growth keeps accelerating, there is a valid argument that equities are cheap. Read Jeremy Siegel.

I do not buy the argument that stocks are at all time highs so they have to come back down!  Since when did that argument apply to population, or patents, or even the wealth of any country?  The lid on these things is not a justification for the reduction of these things. 

One area that benefits from investment is innovation and business formation. Which in turn increases the demand for jobs and helps to lift personal income. That in turn increases consumption. All of which a reason for optimism and feeds into the trends which support rising equities.

And let's not exclude the fact that billionaires, not to mention millionaires, which there are more of around the world than ever and growing, are trying to spend their money. OK, so you and I may not get to board one of their new yachts or private jets. And the closest we may get to a joy ride in a Lamborghini is hearing about Bieber's bust on the entertainment news. But building those things creates jobs. I know better than to call it "trickle down economics."  That would be too inflammatory, and then the whole point of my post would be lost in a debate about the 1% and how wealth disparity is destroying the world. Since that is NOT what this article is about, I will sum it up.

This article IS about the possibility of your stock investments going up.  (Or, they could go down.)  But if they are going up, and if the cost of living is not going up faster, that is good for your 401K.  Thank you very much.