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Janet Yellen: The Grinch Who Stole Christmas
If you were thinking about a Santa Claus Rally, I am telling you that Santa won’t be visiting your door this Christmas season. The previous week’s rally has taken the sting out of an ugly December for North American markets with the INDU paring half its losses for the month. Just as Santa has been mysteriously absent this Christmas, so has the typical rally in stocks.
And there is one person you can thank for messing up markets this year… Janet Yellen.
She missed the expected rate hike in September which everyone was prepared for and instead choose to hike in December. Hands down, she got spooked by the drop in markets in August and September and dropped the ball letting the markets and largely the talking heads on the business channels control her behavior. If she had chosen to hike in September markets would have been oversold by December and we would have seen our typical counter cyclical rally in December.
So for the last 3 months the markets rallied on relief of continued QE with the same asset classes leading the rally which benefit most from a low rate environment. Oil rallied. Materials rallied. Tech and bio tech all came back. All the risk adjusted high growth assets shot back to life with an unexpected reprieve from Yellen.
This year has been counter cyclical in many ways because of the external forces of a weak kneed Yellen gyrating markets with weak kneed wishy washy comments about being data dependent and then changing the goal posts on data well within the statistical margin of error for revision.
Data dependent on a point or two from an estimate?
Are you seriously going to tell me the data between September and December is that much different? I call bullshit. The US is well into their economic recovery for which many think is getting long in the tooth for diverging global markets.
The biggest fundamental change for North American markets is the imminent rate hike. So here we are in December battling another counter cyclical trend because Yellen had no choice but to follow through with a rate hike. The writing is on the wall. QE is over. We are entering into a new era of raising interest rates and you can bet that this major fundamental change will have an effect on all markets going forward.
Yellens ineptness at managing the markets is showing when in fact Greenspan raised rates with little much as a slight correction until the sub-prime started showing its ugly head. So it is proof markets will adjust and if there is something ugly underneath the sheets, the raising rates will help flush it out and markets will adjust to whatever that new normal is. I think the problem in 2008 was no one understood the extent of subprime. I don’t think there is anything remotely in the USA which could trigger the collapse of the financial markets like in 2008, but with changing conditions you can expect a bear to takeover which is necessary for markets to be able to adjust and resume a new bull.
What is key is as much as these folks think they move markets, they affect daily gyrations and that is about it. The macro conditions are the macro conditions and raising rates in a high growth environment ultimately has only a short term effect and help smooth out problems building up in the system. Raising rates in a low growth environment will have again, little effect. The economy adjusts to whatever the conditions are and is just a cost of doing business. The trucking industry didn’t collapse when gas prices tripled in a decade and adjusted. So will the entire economy. Raising rates will do little to affect a global slowdown or depression. The conditions are already set for that. The biggest thing North American financial engineers need to do is to get on a track of normalization and stop worrying about daily or even weekly gyrations in the markets. The point is that without the conditions of subprime like in 2007 in the US. The effects of the rate hikes are extremely over blown in the USA and in fact most would benefit from normalization. Certainly the entire financial industry. One asset class that looks extremely enticing over the next year is the US banks.
And there is one person you can thank for messing up markets this year… Janet Yellen.
She missed the expected rate hike in September which everyone was prepared for and instead choose to hike in December. Hands down, she got spooked by the drop in markets in August and September and dropped the ball letting the markets and largely the talking heads on the business channels control her behavior. If she had chosen to hike in September markets would have been oversold by December and we would have seen our typical counter cyclical rally in December.
So for the last 3 months the markets rallied on relief of continued QE with the same asset classes leading the rally which benefit most from a low rate environment. Oil rallied. Materials rallied. Tech and bio tech all came back. All the risk adjusted high growth assets shot back to life with an unexpected reprieve from Yellen.
This year has been counter cyclical in many ways because of the external forces of a weak kneed Yellen gyrating markets with weak kneed wishy washy comments about being data dependent and then changing the goal posts on data well within the statistical margin of error for revision.
Data dependent on a point or two from an estimate?
Are you seriously going to tell me the data between September and December is that much different? I call bullshit. The US is well into their economic recovery for which many think is getting long in the tooth for diverging global markets.
The biggest fundamental change for North American markets is the imminent rate hike. So here we are in December battling another counter cyclical trend because Yellen had no choice but to follow through with a rate hike. The writing is on the wall. QE is over. We are entering into a new era of raising interest rates and you can bet that this major fundamental change will have an effect on all markets going forward.
Yellens ineptness at managing the markets is showing when in fact Greenspan raised rates with little much as a slight correction until the sub-prime started showing its ugly head. So it is proof markets will adjust and if there is something ugly underneath the sheets, the raising rates will help flush it out and markets will adjust to whatever that new normal is. I think the problem in 2008 was no one understood the extent of subprime. I don’t think there is anything remotely in the USA which could trigger the collapse of the financial markets like in 2008, but with changing conditions you can expect a bear to takeover which is necessary for markets to be able to adjust and resume a new bull.
What is key is as much as these folks think they move markets, they affect daily gyrations and that is about it. The macro conditions are the macro conditions and raising rates in a high growth environment ultimately has only a short term effect and help smooth out problems building up in the system. Raising rates in a low growth environment will have again, little effect. The economy adjusts to whatever the conditions are and is just a cost of doing business. The trucking industry didn’t collapse when gas prices tripled in a decade and adjusted. So will the entire economy. Raising rates will do little to affect a global slowdown or depression. The conditions are already set for that. The biggest thing North American financial engineers need to do is to get on a track of normalization and stop worrying about daily or even weekly gyrations in the markets. The point is that without the conditions of subprime like in 2007 in the US. The effects of the rate hikes are extremely over blown in the USA and in fact most would benefit from normalization. Certainly the entire financial industry. One asset class that looks extremely enticing over the next year is the US banks.
- Bank of America @ $17.33
- JP Morgan JPM @ $66.84
- Wells Fargo WFC @ $55.04
The bond market bull is at an end
So now that we have got that over, every buy fixed income!!!
Well is it over? We got one quarter point hike. Hell no it aint over. It’s just the beginning…
With a series of rate hikes imminent you are entering into a new environment for investing. What precipitated the 30 bullrun in bonds? A trend of declining interest rates over the last 30 years to zero. What has keep the bond market going while rates are at zero? Seekers of yield. The problem is that the bond market is hugely overvalued because rates are artificially low. Prices of many bonds are a function of an equation, and are directly affected by rates. Clearly this is a fear the FED has, engineering a collapse of wealth in the bond market. Clearly what has been engineered for an entire generation is the run up in principle in the bond market well beyond anything reasonable.
Ask yourself this? Should you fear the collapse of something that was artificial and unsustainable in the first place? The bottom line is rates shouldn’t have trended in one direction for 30 years. Certainly Keynes would be rolling over in his grave at the twisting of his economic theory into the government manufacturing perma bulls instead of smoothing out economic cycles. And if the government wasn’t so concerned about smoothing out economic cycles, rates would have naturally bounced between 3% and 6% and not gone on a trend of dropping to zero from their peak above 10% in 1980. Rates have been largely inconsistent over the last 40 years creating huge paradoxes on financial markets. That is the major problem.
Irresponsible economic policy over the last 30 years.
The bottom line is we are entering into a new investing environment with a whole new set of rules and until we can figure out what those rules are and how they are going to affect global finances it is going to be a rocky ride. You are going to see a rollover of investing themes. One of those themes which has been imminently at risk for the last 5 years is the massive bull market in bonds. How is it going to unfold? Who knows, but these rates hikes will imminently hurt the bond market, it is simply a function of an equation. Unless someone decides to manipulate with the equation to smooth out principle valuations, you will see significant loss of principle as rates rise. We are entering into a period of normalization, rates have to raise and purchasing the appropriate insurance should help protect from a material loss in principle of fixed income without selling it.
We have a series of quarter point hikes on the way where we will eventually see a normalization of FED FUNDS rate of about 2%. This is still artificially low, but we are in a low growth environment created in part by low rates. I believe the trend for the next decade is increasing interest rates to a target of 3% to 4% at the end of normalization by 2025. Clearly the world has adjusted to low rates for growth, but as boomers age and become increasingly risk adjusted, there will be increasingly more pressure from this group to create less risk adjusted income streams and we should return to a more normal investment portfolio of 60% bonds and 40% equities at the end of the normalization period.
China, a Depression in Store?
The biggest risk for global markets isn’t Yellen raising rates. Nope. The biggest risks for global markets are the headwinds which continue to blow up impending storm clouds on the horizon. The biggest threat to the global economy is the collapse of the Chinese economy. Brazil has fallen into a depression because of loss of trade with China and China’s pains are being felt throughout the global economy. From direct purchasing to the economic activity in Canada related to elevated commodities prices.
If you thought they manufactured data on the way up, I am telling you right now if they will do the same thing down. There is no way China is growing at 6%. In fact I have my doubts that China is growing at all right now with the depressed commodities prices and the trickledown effect the slowdown in China is having on direct trading partners like Brazil.
There are not too many models to fit China in to compare its current situation because China is unique in the fact a billion person population has never experienced such growth. One model in history does provide an example of what could be in store for China over the next decade. USA model of the “Roaring Twenties” turning into the “Great Depression” plays to mind of a major economic power who experienced major expansion and then contraction. China’s expansion and the growth of China’s domestic economy when matched to other periods with similar expansions, no economic unit has ever avoided similarly proportionate contraction to that expansion. I have my doubts that China will not be able to engineer themselves out of this contraction. They will however be able to lessen the effects with given economic policies. The last 5 years in China has been a sputter stop start economic momentum similar with a top in any economy and declining growth indicating a cyclical top in the expansion of the economy.
How can you tell China is in a depression? You really can’t and have to look at sum of China’s parts and certainly one of those is fuel and parts for that engine. Commodities. With depressed prices in just about everything including iron ore of which steel production is China’s bread and butter, and you have to figure these headwinds are ominous at best. With iron ore dipping below $40 per tonne, prices are back to 2005 levels and could go lower as iron ore entered the millennium priced at less than $20 per tonne. If iron ore prices aren’t any indication of the extent of China’s slowdown, I don’t know what else to show you without getting boots on the ground.
I also see another major conflict China will have to overcome to continue to mature and expand. There are also robotics and 3D printing trends in China which may see its workers turned obsolete over the next decade. One of China’s main goals is to transition to a consumer oriented economy but if they can’t transition manufacturing workers into service workers fast enough, robots and 3D printers could eat up huge swaths of the labor force compounding an employment problem which could emerge as a result. Clearly education and training workers into new areas of the economy, but if technology revolutionizes manufacturing before retraining can take hold en masse you could have compounded social problems in China with a largely out of work labor force. If these robotics and 3D printing trends continue in Chinese industry, you may see another huge mitigating factor in China’s impending depression. The unemployed worker. Manufacturing has been the life source of the Chinese economy and soon you may see the Chinese worker marginalized by technology.
2016… The Year of the Short?
Certainly in Canada, 2015 was the year of the short and it looks to continue into 2016 with the economy on the verge of dipping back into a technical recession.
The big question everyone wants to have answered is will the US markets follow suit?
Right now Brazil is in a severe recession due to the China slowdown. China is pretending they are avoiding one. The trickledown effect of what is happening in Brazil is going on in Australia and Canada but is less severe than in Brazil because both nations have more developed economies which provide a base making the economies more stable and resilient and dynamic to withstand a severe downturn. The problem with Canada is the country is seeing two key area of growth decline at once. Our oil boom which is considered much more significant than the materials boom was only partially due to Chinese demand and not solely ala the materials sector. Canada theoretically should get hit harder concerning where most of our growth came from over the last 10 to 15 years. It is a good thing that we have a distinct advantage here in Canada of being a key trading partner to the US where we still generate most of our economic activity and will continue to do so just because of geographical location.
Neither energy nor materials may ever come back into prominence as they have been over the last 10 years. The only thing that may start another commodities boom is the urbanization of India which currently has an urban population of about 35%. It was the same trend to urbanization of rates from 30% to 50% which was largely responsible for the China boom and the same type of urbanization plan in India could potentially start another commodities bull sometime down the road. The trend is still not in place and estimating when India may decide to urbanize its population is a guessing game at best and not an investment theme for anyone to be waiting to unfold.
The TSX closed below 13,000 last week is significantly over valued and is having a problem moving above the 50MA. It looks like a great index to continue to short in anticipation of lower lows and lower highs in 2016. The American markets are also showing signs of a technical breakdown similar to the washout in August. With a break in a multiyear trend back in August, it is safe to say there is much less chance the markets will continue higher in 2016. What makes this an even safer bet is we have begun a period of normalization of interest rates in the US. The US markets have certainly become a stock pickers market in my mind’s eye until the indexes have gone through this initial period of normalization. There will be a period of adjustment and markets will need to correct in order to adjust properly.
The headwinds are different since the least bear market and economic slowdown triggered by subprime. I doubt we see similar price action in 2016.
With oil at multi-decade lows, emerging markets in a protracted slump, a material change in trend to raising rates; macro conditions have set the stage for a concerted global slowdown of which no economy will be immune. A tightening of monetary policy affects everyone. The free money period for everyone is over and nations which continue to follow a QE policy could become extremely exposed to downgrades once the USA has fully changed course.
Zimbabwe’s and Greece’s could be the name of the game for many nations who don’t follow suit and adjust to USA monetary policy. You don’t raise your rates… your currency will drop. Your currency drops and it becomes much harder to pay your debt and it becomes much more unserviceable and then you enter the debt death spiral where the creditors vie to financially enslave your country.
Or you choose the route Zimbabwe did and print money and impoverish everyone. Fun choices ahead.
Certainly the bond vigilantes are starting to corner the high yield market which could be a signal of potential implosion. If a lot of this high yield paper is tied to the shale gas industry then it could be just an isolated event. The problem is yields have been compressed for so long that they have been pushed out on to the risk curve into the stock market and other places most would not normally go. The high yield instruments could consistent of anything and like subprime re-packaged and re-sold several times.
If the global economy is truly extended, there could be significant risks throughout this sector similar to the sub-prime market when housing was over extended. It doesn’t mean markets will implode and shut down like in March of 2009, but we are clearly entering a phase which rhymes and could send markets reeling over the next few months and maybe even years. This economic slowdown looks like it will be much more protracted, but less volatile than in 2009; when the financial world actually stopped.
- Risk of extended and protracted slowdowns in China
- Australia, Brazil, and Canada showing signs of Chinese slowdown ‘trickledown effect’.
- Europe continuing in a slow growth environment
- A collapse of the commodities sector across the board wiping out trillions in capital and growth.
- Entering a period of interest rate ‘normalization’.
- The continued deflation of the price of oil.
- US retail bellweathers significant earning misses associated with lower and mid-range spending including Walmart.
Beat the Market Top Stocks
I can’t write a year end letter without making some stock picks. Since we are biased towards a major correction in 2016 picking stocks making new highs is a dangerous activity at this point in the cycle unless it’s a day trade. Generally I like momentum because its easy fast money playing on investors’ emotions but the market is dictating a different type of strategy.
Value.
If you think the market will tank in 2016 then the easiest way to deal with your 40% equities allocation is to look for value. Look for names that have been beaten up for 18 to 24 months and you will find a name that is completely oversold in an overbought market.
3D Systems Corp - $10.50
NYSE - DDD
Market Cap - 1.18B
Shares Outstanding - 112,077,951
I started talking about 3d Printing 2 years ago at the height of the initial run-up. I mentioned at the time that valuations were extremely generous and it was a time to do research and trade the sector at best. After 2 years of declining prices and volumes, this stock is looking extremely oversold and due for a huge bounce in 2016. 3D printing is the wave of the future for manufacturing and will revolutionize manufacturing as well as consumerism. How the landscape will change is still up for debate, but the Chinese are 3D printing entire houses, so the changes are real and significant and already in the works and indicate that this revolutionary manufacturing technique will change human life more than anything else to date. 3D Systems Corp is the preeminent company in the space in North America and is our top pick going forward.
By no means is it the only 3D printing company. We have mentioned many in the past, but 3D Systems Corp is a screaming buy trading off close to 70% its 52 week high and why not just buy the cream of the crop when it is trading at such a discount from its multiyear highs. It may take a while for the 3D printing theme to gain real traction and several year to make new highs, but the trading range DDD has created for itself and the current value for one of the preeminent growth themes in investing cannot be ignored.
Stratasys Corp SSYS at $26.79 also gets an honorable mention as an excellent place to park money in 2016. I love 3D printing and this developing theme because there is nothing more revolutionary for the 21st century than this new production technique. The valuations have come to a point where everything is a screaming buy and I hold 3D printing as the number 1 growth theme over the next decade. Better than Biotech, better than tech… 3D printing is where you will want to be.
In a short side to Biotech. The industry has some huge overhanging issues and until they collectively fix its business model of price gouging or government fixes it for them. The bloom has come off this rose for the next little while. What bothers me about bio techs, is you don’t need to price gouge to make billions in what is a maturing industry where prices should be coming down and not going up. Especially with potentially volumes of sales with gaining baby boomers. Gouging insurance companies and taxpayers for the essential medicines will only last so long until you get legislative intervention like we are starting to see in the states with their out of control health care system and associated costs. Now that the government is paying large portion of the bill, you are going to see even greater scrutiny of costs going forward in all aspects of this industry. Until the biotech industry is fixed, 3D printing offers lucrative potential capital gains with most stocks sitting at 5 year lows with a human element of liberating people unlike biotech which likes to feed off of people, sick people.
Blackberry - $12.61
TSE – BB.TO
Market Cap - $6.63B
Shares Outstanding – 525,700,706
Blackberry was a victim of the last of a tech cycle in which it couldn’t adapt and keep up. The company used to dominate the business world communication platform and practically invented text messaging by making it mainstream with BBM messenger more than a decade ago. While Apple was still making iPod’s, Blackberry was the dominant player in the mobile communications industry.
Then someone came along with the idea to turn an ipod into a phone and viola…!!! You have the iphone and the dominant tech piece for the next decade.
Will Blackberry ever be at the forefront of mobile communications? I doubt it. Samsung and Apple’s market share in this space will only be chipped away at over the next few years unless Blackberry comes out with disruptive technology. It doesn’t mean there isn’t room for another solid phone franchise like the Galaxy or the iPhone, but to truly disrupt this space you will have to change it. Which their current phone offering of a slide out keyboard is not. Although it is a nice phone and maybe next year after a generation or two of upgrades I might switch to the Android based PRIV of Blackberry, considering the only thing ever holding me back from buying a Blackberry was their refusal to use Android and push to market a third mobile operating system the market did not want or need.
What killed blackberry wasn’t inferior devices, but their stubbornness to not use Android as the ecosystem. 5 years ago Android and Apple won the mobile operating system race. As a result of no one wanting the BBM ecosystem sales of Blackberry devices artificially lagged as a device maker. If you make an inferior device, you can always find a price point to sell your product. But if you are making a device with a system no one wants to use, you want won’t sell it at any price point simply because you can’t compete on the ecosystem. They couldn’t attract developers, they couldn’t develop a niche that the business community needed, and before long the company saw itself entirely marginalized as device marker.
Blackberry as a device maker is coming back and I predict in 5 years Blackberry will be a top 5 mobile device maker globally again. It took a lot of eating crow, but management finally figured out what was wrong with the device making division, its refusal to adopt the Android ecosystem. Now Blackberry is using Android and adapting its own software to the android ecosystem so Blackberry’s extra security features and messaging ecosystem now make it a plus instead of a “but have this instead of” which was a tough sell to anyone when all we wanted was apple or android apps and games.
In addition to BB finally turning around its device making division with key strategic decisions, the software division continues to show strong revenue growth with a 120% quarter over quarter increase in software and services revenue which now consists of 29% of the company’s $550M quarterly revenue.
When looking at a turnaround in Blackberry and a move back to profitability you cannot discount the hardware division. It consists of 40% of Blackberry’s current revenues and potentially solid launch of a franchise of phones like the PRIV could dramatically increase BB’s revenues. Key to launching Blackberry’s stock to $20 or $30 is the development of a successful mobile phone franchise and right now BB’s hopes are pinned on the PRIV. A solid phone from initial reviews. The development of a successful franchise even a quarter to half the success of iPhone could mean an additional $20B to $30B in enterprise valuation. That is the cherry on everything in Blackberry’s turnaround if they launched a phone with as much demand as a Galaxy or an iPhone.
I always thought becoming a second tier phone company and sliding into the $100 to $300 range could be an option like ACER and others have quietly done, but the lucrative revenues of a successful franchise launch like Samsung’s Galaxy or Apple’s iPhone are too much to pass up to more cut and slash pricing. I do believe that if John Chen cannot develop that franchise within the next 24 months he will most likely retreat to a lower pricing and lower margin phones.
What looks to me is happening at Blackberry is the perfect storm for a turnaround.
- Expert turnaround management in place continue to deliver on vision for the company.
- They finally got the handset right (not with the keyboard but with adopting Android).
- They are experiencing exponential growth in the enterprise software division at over half a billion in revenue looking forward growing 120% Q over Q.
Newalta Inc. - $3.75
TSE – NAL.TO
Market Cap - $210.9M
Shares Outstanding – 56,236,548
Newalta Inc. is a mess. It is a flyer on the O and G sector at least finding a bottom the next 6 months and was only picked because it technically looks ripe for a bounce early in 2016 on seasonal strength for O and G stocks. Fundamentally it is hard to look at this company with high debt and high production costs, but technically the company looks like it has found a bottom with a volume reversal. So Newalta is a recommendation on trading this stock only.
Stocks rarely go to zero, yeah, sometimes they do or get refinanced at such low prices previous investors get diluted out, but generally stocks do make it out of the panic zone. Currently Newalta is in the panic zone. Teck Resources hit $3.50 in 2009 and then raced back to $50 and Newalta could be a similar type dog in the oil panic. High debt loads tend to worry investors.
In Newalta’s case we have a $14 stock in July which now trades at 25% the price less than 6 months ago. Oil may not make it much back up above $40 and Newalta looks to be impaired to the point of fundamental stock damage, but any rise in oil price or even signs of stability will benefit many names including a debt ridden junior like NAL.
At any rate, this company looks ripe for a trade back up to $5 to $6 area given oil doesn’t collapse to $20 in January.
Some key technical trading indicators here is the gap down in NOV. Gaps generally will fill back up and if this is the case you can expect the gap from $7.50 to $6 in November to get filled back this spring which represents a double from current levels. Of course it doesn’t have to. NAL could continue a downward trend but gaps are key patterns in swing trading that many successful traders use. Another key indicator is the increasing volume in the stock as it dipped below $5. This generally shows high interest in the stock when interest would normally be decreasing below $5 because of the stock losing criteria for many portfolios. Similarly the Teck experienced a similar trading patterns back in 2009 and could really be a bottom fishing winner in 2016. If oil bottoms. Newalta is the most technically damaged but at the same time the most potentially rewarding of the 3 picks over the next 3 months.
Christopher Pattison
Beat the Market Stock Picks
Once my hiking partner and I got caught in terrible conditions fording a swollen Lynn Headwaters and hiking up past the snowline to ‘The Camel’ in October. To make matters worse I had fallen on shale scrambling up scree and was bloodied, but we still pressed on. By the time we reach the lodge on Grouse Mountain, my partner and I both had hypothermia, we had to strip down to our underwear to warm up and dry out by the fire in the lobby at the lodge. You would think we might call it a day at the lodge? Nope. Down the BCMC to the Baden Powel and over to the Lynn Headwaters to complete one of the most gruesome day hikes ever endured in just over 12 hours.