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Market Themes

Contracting Volatility

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• Quid pro quo Clarice: Iran seeks give and take on Islamic State militants, nuclear program (Reuters)
• Alibaba’s Banks Said to Boost IPO Size to Record $25 Billion (BBG)
• European Stocks Fall Amid China Concern as Tesco Slides (BBG)
• Tesco Suspends Executives, Probes Error That Triggers New Profit Warning (WSJ)
• Kurds say they have halted Islamic State advance on Syrian town (Reuters)
• Because luck and managing money is genetic: Financial Elite's Offspring Start Their Own Hedge Funds (WSJ)
• Islamic State Onslaught Spurs Mass Exodus of Syrian Kurds (BBG)
• Rockefellers, Heirs to an Oil Fortune, Will Divest Charity From Fossil Fuels (NYT)
• Merck KGaA to Buy Sigma-Aldrich for to Add Chemicals (BBG)
• China's Yahoo: SoftBank Falls After Alibaba Listing Removes Proxy Appeal (BBG)
• Ukraine President Sees Tensions Easing as Truce Tested (BBG)
• Relief over Scotland gives way to 'Great Stagnation' worries (Reuters)
• Sarkozy Says ‘Despair’ in France Reason for Return to Politics (BBG)... that and the money
• Beatles' Ringo Starr Lists Liverpool Estate For US$33 Million (Mail)
• You Too Can Clone Bill Ackman Without Buying His New Fund (BBG)
• Gap Between Manhattan’s Rich and Poor Is Greatest in U.S., Census Finds (NYT)

Overnight Media Digest

FT

More Phones 4u stores are to be saved as EE and Dixons Carphone Plc agreed to buy parts of the collapsed mobile phone retailer. The deal is expected to be announced on Monday.

SNPL pilots' union said on Saturday that it would push the Air France management even more to meet its demands by extending the week-long protest until this Friday.

U.S. private equity firm Blackstone Group LP is "giving up on Russia", underscoring that even the well-connected western investors are unwilling to conduct business in the country.

French insurance group Axa SA is to partner with IFC, the private investment arm of the World Bank, to encourage developing countries to take up insurance products.

Russia's natural gas exporter Gazprom could lose 18 percent of its revenue due to competition from the U.S. liquefied natural gas exports, according to New York-based think-tank Center for Global Energy Policy at Columbia university.

NYT

* The market debut of the Alibaba Group, the Chinese Internet titan, hit the stock markets like a meteor last week, and thanks to $500 million in investments made in Alibaba in 2011 and 2012, American investment firm Silver Lake now sits on a stake worth more than $5.1 billion, after having reaped $278.8 million by selling a fraction of its holdings.(http://nyti.ms/1tRanG0)

* Industrial conglomerate Siemens AG said late on Sunday it would buy U.S. oilfield equipment maker Dresser-Rand Group Inc for $7.6 billion, including the assumption of debt. (http://nyti.ms/1wExBi1)

* EMC Corp, the computer storage company now facing pressure from a big activist hedge fund, had held discussions with Hewlett-Packard about a merger, though those talks have since ended, a person briefed on the matter said on Sunday. (http://nyti.ms/1qlyLJC)

* Governor Jerry Brown of California has signed several bills to help build the market for electric cars in his state, two days ahead of speaking alongside world leaders at the United Nations this week for a summit meeting on climate change. The legislation is designed to make electric cars more affordable for low-income residents, and the intent is to have at least one million zero-emission and near-zero-emission vehicles on the state's roads by 2023. (http://nyti.ms/1tRd8qC)

* As magazines and newspapers continue to lose print readers, they are scrambling to secure customers for their digital products, and are finding them increasingly through social media. Pinterest has forged close relationships with magazines, especially those focused on women, who make up 71 percent of Pinterest users. It is a leading driver of traffic to certain magazines, and in some cases - like Self - it serves as a bigger source of reader referrals than either Facebook Inc or Twitter Inc. (http://nyti.ms/1B0J6RD)

Canada

THE GLOBE AND MAIL

** One of Parliament's most high-profile bills appears set to become law without major changes - as one senator says the committee considering Bill C-36, aimed at reining in the sex trade, is "highly unlikely" to call for changes. (bit.ly/1sUt33j)

** After hanging up the letters of the alphabet and making sure they have enough desks in their classrooms, British Columbia's public school teachers say they face the difficult task of returning to work after an emotionally bruising five weeks on the picket line. The experience was disheartening for many teachers, and some say they were exposed to heated rhetoric and public scorn daily. (bit.ly/Z8txf2)

** Prices of some Canadian homes are certainly too high, but there is no immediate catastrophe looming for the country's housing market, the head of Canada Mortgage and Housing Corp suggested in a speech on Friday. (bit.ly/1obTtvX)

NATIONAL POST

** The spokesman for the Islamic State of Iraq and Al-Sham called for attacks on Canadians on Sunday in an apparent attempt to deter members of the military alliance that has formed to challenge the terrorist group. (bit.ly/1v7f2lq)

** Candidates for the leadership of Ontario's Progressive Conservative party have until the end of February to sign up new members before voting is held next May. The party has decided all members will be eligible to cast preferential ballots on May 3 or May 7 and the official results will be unveiled on May 9. (http://bit.ly/1ucQZEM)

** Canada's finance minister is urging European countries to consider taking quick action to repair their flagging economies by following stimulus programs similar to the one that pulled this country out of recession. (bit.ly/1wF63sW)

China

CHINA DAILY

- Chinese investors complain that they have been largely left out of Alibaba Group Holding's share listing in New York, where the Chinese e-commerce leader surged 38 percent on its first day of trade on Friday, due to government restrictions.

CHINA SECURITIES JOURNAL

- Chinese banks and capital markets should take more steps to support the country's services sector, Zhou Xiaochuan, Governor of the People's Bank of China, said over the weekend at a meeting of finance ministers and central bank governors from the G20 countries in Australia.

- China needs to use a combination of measures to help guide interest rates lower to support corporate financing, in particular by small companies, as it tries to boost the slowing economic growth, the newspaper said in a commentary.

SHANGHAI SECURITIES NEWS

- The eastern Chinese city of Nanjing has become the latest to ease restrictions on housing purchases as local governments rush to take steps to boost the property market, which has been hit by a slowdown in the world's second-largest economy.

- The China Securities Regulatory Commission has issued guidelines to crack down corruption in securities supervisory organisations, in line with an ongoing official anti-corruption campaign in the country.

SHANGHAI DAILY

- Tropical storm Fund-Wong is set to hit mainland China soon after one man died as the storm pounded Taiwan with torrential downpours and powerful winds on Sunday.

People's Daily

- China will use various means to improve "socialist democratic politics", President Xi Jinping said at a meeting on political consultancy on Sunday.

Britain

The Times

STAY IN REFORMED EU TO KEEP ECONOMY ON THE RIGHT ROAD, MANUFACTURERS SAY

An overwhelming majority of manufacturers believe it is vital that Britain remains as part of the European Union and that any new government plays "a leading role in Brussels". (http://thetim.es/1wDUYID)

BUOYANT CITY BRACED FOR LISTING STAMPEDE Flotations worth about 3 billion pounds ($4.90 billion) are expected to be unveiled this week as London's main market heads towards a record-breaking year. Jimmy Choo Ltd <IPO-JIM.L>, the shoe brand, is expected to lead what could be a bumper week for financial advisers as it unveils plans for an estimated 800 million pound listing. (http://thetim.es/1uu3OqK)

The Guardian EE AGREES PHONES 4U SHOP DEAL TO SAVE HUNDREDS OF JOBS The administrators of stricken retailer Phones 4u are expected to confirm the sale of about 60 shops to EE in a move that will save hundreds of jobs. The final terms of the deal are still being thrashed out but an announcement is expected around noon on Monday. (http://bit.ly/1p95YbV)

CONSTRUCTION COMPETITION: LODHA PLANS 3 BLN STG PUSH INTO LONDON PROPERTY

British housebuilders could face aggressive competition in London from Indian developer Lodha Group, which is planning a 3 billion pound push into property in the country's capital city. (http://bit.ly/1sTy0cL)

The Telegraph

JOB CREATION AT RISK UNDER LABOUR'S MINIMUM WAGE PLANS, WARN BUSINESS GROUPS Job creation could take a hammering under the Labour party's plans to increase Britain's minimum wage to 8 pounds an hour by 2020, business groups have warned, as they told party leader Ed Miliband to steer clear of the issue. (http://bit.ly/1DroXbh)

COMET BACKERS IN TALK TO FUND MONARCH A secretive vulture fund that backed electricals retailer Comet before its collapse has emerged as a potential saviour for the troubled airline Monarch. Greybull Capital, based in London's West End, is in talks to take a stake in Monarch and potentially avert a cash crunch. (http://bit.ly/1rfx5GB)

Fly On The Wall Pre-Market Buzz

ECONOMIC REPORTS
Domestic economic reports scheduled for today include:
Chicago Fed national activity index for August at 8:30--consensus 0.33
Existing home sales for August at 10:00--consensus up 1% to 5.2M rate

ANALYST RESEARCH

Upgrades

Bill Barrett (BBG) upgraded to Market Perform from Underperform at BMO Capital
CenterPoint Energy (CNP) upgraded to Buy from Neutral at SunTrust
Dun & Bradstreet (DNB) upgraded to Outperform from Neutral at RW Baird
Enerplus (ERF) upgraded to Outperform from Sector Perform at RBC Capital
GlaxoSmithKline (GSK) upgraded to Buy from Neutral at Goldman
Hologic (HOLX) upgraded to Overweight from Neutral at Piper Jaffray
Leggett & Platt (LEG) upgraded to Outperform from Market Perform at Raymond James
MasTec (MTZ) upgraded to Buy from Hold at BB&T
PolyOne (POL) upgraded to Overweight from Equal Weight at First Analysis
Sirona Dental (SIRO) upgraded to Outperform from Neutral at RW Baird
Toro Company (TTC) upgraded to Outperform from Market Perform at Raymond James
TreeHouse Foods (THS) upgraded to Buy from Neutral at SunTrust

Downgrades

Actavis (ACT) downgraded to Equal Weight from Overweight at Barclays
Auxilium (AUXL) downgraded to Hold from Buy at Stifel
Finish Line (FINL) downgraded to Equal Weight from Overweight at Morgan Stanley
InvenSense (INVN) downgraded to Neutral from Outperform at RW Baird
Outerwall (OUTR) downgraded to Sell from Neutral at B. Riley
PSEG (PEG) downgraded to Hold from Buy at Jefferies
Realogy (RLGY) downgraded to Underperform from Neutral at Credit Suisse
Saba Software (SABA) downgraded to Neutral from Buy at B. Riley
Suburban Propane (SPH) downgraded to Market Perform from Outperform at Wells Fargo
Walgreen (WAG) downgraded to Equal Weight from Overweight at Barclays
Watts Water (WTS) downgraded to Neutral from Buy at Janney Capital

Initiations

Curtiss-Wright (CW) initiated with a Market Perform at Wells Fargo
Eros International (EROS) initiated with an Outperform at Wells Fargo
Global Eagle (ENT) initiated with a Market Perform at Wells Fargo
Inventure Foods (SNAK) initiated with an Outperform at William Blair
Mallinckrodt (MNK) reinstated with an Overweight at Barclays

COMPANY NEWS
Merck KGaA (MKGAY) to acquire Sigma-Aldrich (SIAL) for $17B
Siemens (SIEGY) said it would acquire Dresser-Rand (DRC) for $83 per share, or $7.6B
Dresser Rand (DRC) adopted a shareholder rights plan
Total (TOT) now sees producing 2.8M boepd in 2017 and looks to reduce operating costs by $2B per year by 2017
Tesco (TSCDY) said it overstated 1H profit by an estimated GBP250M
Corinthian Colleges (COCO) received grand jury subpoena on September 3. The subpoena seeks documents and records relating to an internal investigation of a former employee’s misconduct at the Everest Brandon campus and the company’s return of Title IV funds as a result of the investigation

EARNINGS
There are no notable earnings to report.

NEWSPAPERS/WEBSITES

EMC explores merger, holds talks with HP, Dell, WSJ reports
Clorox (CLX) turned down offer to sell or merge with rival, NY Post reports
Blackstone (BX) does not renew contracts to its consultants in Russia, FT reports
Microsoft (MSFT) delays China launch of its Xbox One console, Reuters reports
General Electric (GE) considered deal with Dresser-Rand (DRC), FT reports
Iliad (ILIAF) sets mid-October deadline for T-Mobile (TMUS) bid, Reuters reports
Google (GOOG) selects HTC to make 9-inch Nexus tablet, WSJ reports
Yahoo (YHOO) could have 35% upside, Barron's says
Bank of America (BAC) could climb over 50%, Barron's says
Vitamin Shoppe (VSI) shares could climb over 20%, Barron's says

SYNDICATE
CombiMatrix (CBMX) files $85.9M mixed securities shelf
Gramercy Property Trust (GPT) files to sell $100M of common stock
Limoneira (LMNR) files to sell $75M of common stock
Parkway Properties (PKY) files to sell 10M shares of common stock
Vital Therapies (VTL) files to sell $46M in common stock

Day after day, the status-quo hugging, momentum-chasing talking heads that infest the world of investing will pile their clients' money into 'what is working' with little regard for 'value', risk (as defined by Howard Marks), or business uncertainty. Precious metals are sliding so 'sell' anything related to the precious metals industry. Biotech and software are surging so buy it all with both hands and feet... However, as the following two charts from Harvard Business Review suggest that strategy is in fact the absolute 'riskiest' approach to managing money as they break down the most (and least) uncertain industries in America.

Although uncertainty is accelerating, it isn’t affecting all industries the same way. That’s because there are two primary types of uncertainty - demand uncertainty (will customers buy your product?) and technological uncertainty (can we make a desirable solution?) - and how much uncertainty your industry faces depends on the interaction of the two.

Demand uncertainty arises from the unknowns associated with solving any problem, such as hidden customer preferences. The more unknowns there are about customer preferences, the greater the demand uncertainty. For example, when Rent the Runway founder Jenn Hyman came up with the idea to rent designer dresses over the internet, demand uncertainty was high because no one else was offering this type of service.  In contrast, when Samsung and Sony were deciding whether to launch LED TVs, which offered better picture quality than plasma TVs at a slightly higher price, there was lower uncertainty about demand because customers were already buying TVs.

Technological uncertainty results from unknowns regarding the technologies that might emerge or be combined to create a new solution. For example, a wide variety of clean technologies (including wind, solar, and hydrogen) are vying to power vehicles and cities at the same time that a wide variety of medical technologies (chemical, biotechnological, genomic, and robotic) are being developed to treat diseases. As the overall rate of invention across industries increases, so does technological uncertainty.

If your industry is in the lower left quadrant, or in the bottom 10 in the above table, you face relatively low baseline uncertainty for both demand and technology.

If you’re in the upper right quadrant - or in the top 10 most uncertain industries as shown in the Table - you require greater innovation management skills than industries in the other quadrants or in the bottom 10. In fact, among the top 10 companies of the Forbes Most Innovative Companies list (since 2011 when we started the list), more than 80% of the most innovative companies compete in industries in the top right quadrant.  In other words, if you are in a high uncertainty industry, you must excel at innovation... or die.

Source: Harvard Business Review

Submitted by Tim Price via Sovereign Man blog,

“We are all at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know, by the rules, that at some moment the Black Horsemen will come shattering through the great terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no-one wants to leave while there is still time, so that everyone keeps asking, “What time is it? What time is it?” But none of the clocks have any hands.”

 

– From Supermoney by Adam Smith.

It was not supposed to be like this. As we highlighted last week, after the Great Debt Bubble, there has been no Great Deleveraging. In fact, as the McKinsey Global Institute showed in their February 2015 report,

“After the 2008 financial crisis and the longest and deepest global recession since World War II, it was widely expected that the world’s economies would deleverage. It has not happened. Instead…

“Debt continues to grow. Since 2007, global debt has grown by $57 trillion, raising the ratio of debt to GDP by 17 percentage points.”

Herbert Stein’s Law mandates that if something cannot go on forever, it will stop. The great Austrian economist Ludwig von Mises expressed the same sentiment and came to a somewhat gloomier conclusion:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

As the McKinsey data show, the voluntary abandonment of further credit expansion has clearly not occurred. If Mises is correct, and we are minded to consider that he is, then draw your own conclusions.

We have now become used to so many years of utterly extraordinary monetary experimentation and policy-making on the hoof that there is a danger that Alice-in-Wonderland central banking activity simply gets taken for granted as the natural state of affairs.

This is the same type of absurd but incremental behaviour that gets frogs in pans boiled alive with their tacit approval.

Blithe sceptics to this line of thought will no doubt argue that if seven years of making-it-up-as-we-go-along monetary policy hasn’t derailed the system, then perhaps the system won’t get derailed.

Perhaps it’s even un-derailable. But this sounds suspiciously like Ben Bernanke’s own flawed thinking when he suggested in July 2005 that: “We’ve never had a decline in house prices on a nationwide basis.”

In other words, because something has never happened before, it never will.

(This from the same person who observed in March 2007 that “At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”)

No, the insoluble problem facing every investor today is not just that the system is unsustainable. It clearly is. The problem is that we lack a means of forecasting accurately when the system is likely to break apart.

The financial market is a complex, adaptive system, reliant on confidence, the ongoing robustness of which is completely unforecastable. That confidence has been robust is not in question.

The creation of trillions of dollars, pounds, euros, yen and renminbi worth of ex nihilo money has yet to dent confidence entirely in an unbacked paper money system (notwithstanding the 345% gain in the dollar price of gold since the start of the millennium).

Just before the turn of the millennium, inside the late Peter L. Bernstein’s excellent history of risk, ‘Against the Gods’, we came across the following quotation by the Swiss mathematician and physicist Daniel Bernoulli: when managing money for wealthy people,

“The practical utility of any gain in portfolio value inversely relates to the size of the portfolio.”

Bernoulli (1700-1782) has a good claim to being one of the world’s first behavioural economists, in that he observed that investment performance for the wealthy is not exactly the same as investment performance for the non-wealthy.

For the objectively wealthy, or super-wealthy, any further gain in portfolio value has to be seen in the context of maintaining the original value of the portfolio. Since human beings are typically loss averse, maintaining the original purchasing power of the pot is much more important than generating further incremental gains, especially in an environment where the pursuit of those further gains risks existentially jeopardising that original pot.

US stock markets reached record highs last week. Question: does that make them riskier, or less risky? We think the former.

But for us the question is somewhat academic since we’re not remotely interested in index-tracking. Other investors, however, evidently are. Among the top 10 ETF purchases by customers of Barclays Stockbrokers last week were funds tracking:

• The S&P 500 (iShares and Vanguard)
• The FTSE 100 (iShares and Vanguard)
• The FTSE 250
• The Euro Stoxx 50
• Japan.

We foresee all kinds of risks in taking indexed exposure to stock markets close to or at their all-time highs. Index-tracking funds offer many things. Relatively low cost market exposure, for one.

But as and when stock markets go into reverse, purchasers of low cost trackers will find that they have been penny-wise and pound foolish, because low cost trackers offer precisely zero discernment or discretion when it comes to market direction. If the market goes down, they go down with it.

So rather than tag along for the ride, we much prefer to follow the ‘value’ route (to capital preservation and growth, in that order).

Index benchmarking is utterly inappropriate, we would suggest, for the private investor, for whom the ultimate reference rate should be cash, since cash remains the only asset that cannot decline in nominal terms. Or at least that used to be the case, before acronyms like QE, ZIRP and now NIRP (Negative Interest Rate Policy) steamrollered over all assets in their path, like financial terminators.

If we define ‘value’ as inherent quality plus attractive valuation, it has relevance to both debt and equity market investing today. Bond markets as a whole are clearly grotesquely overvalued but may remain so or become even more overvalued because there is an 800lb gorilla in the market determinedly gobbling them up.

As of March 2015, the ECB will be buying €60 billion worth every month. We doubt whether there’s that much quality debt on offer in the euro zone. But there may be elsewhere, not least because most of the world’s creditor countries lie outside the euro zone.

In equity markets, we see almost no compelling value in US stocks, which if nothing else are intensely well covered (we mean by number of analysts, not necessarily by quality of coverage) by Wall Street.

We see compelling pockets of genuine value, however, in markets like Japan, which simply aren’t well covered by the analyst community, which has been scared off by 20 years of bear market conditions.

We then supplement our debt and equity exposure with uncorrelated investments (namely systematic trend-followers), which we have always regarded as bellwether holdings, and with real assets, notably the monetary metals, gold and silver.

The result: four discrete asset classes that will behave in different ways under different market conditions.

• High quality debt offers income and a degree of capital preservation (especially in an environment of outright deflation).
• High quality ‘value’ equity offers income and the potential for attractive capital growth (especially in an environment of modest inflation).
• Systematic trend-followers are broadly market neutral, but with the potential to deliver outsized gains in an environment of systemic financial distress (most trend-followers generated double or triple digit percentage returns in 2008, for example).
• And real assets, again, offer the potential to deliver outsized gains in an environment of systemic financial distress or high inflation, or both.

Unlike most of our fund management peers, we accept that we can’t predict the future. Unlike many of them, we are at least preparing for it.

But that brings us back to our initial dilemma. We think the system is desperately unsound, so we take out what insurance we can, whilst still retaining a stake in a variety of markets (on our terms admittedly, rather than according to somebody else’s irrelevant benchmark).

But insurance only works if you have it when the crisis erupts. You don’t buy house insurance after the roof catches fire.

Submitted by Lance Roberts of StreetTalk

5 Things To Ponder: Odds And Ends

Earlier this week I discussed the oxymoron of the "bearish bull market" suggesting that the deterioration in the technical backdrop of the market acting in a manner only seen at previous major market peaks.

However, the real divergence is occurring within the market itself as shown in the chart.

 

Currently, every single internal measure of momentum and relative strength have not only deteriorated, but are behaving in a manner that only previously existing during the last two major market peaks.

 

This is what I meant by using the oxymoron of the "incredibly bearish bull market." 

 

Despite the significant number of economic, fundamental and technical data points that suggest risk has risen to elevated levels,the bullish exuberance in the market remains."

That last sentence is critically important. While there are many fundamental, economic and technical warning signs that suggest investor caution currently, the markets remain hovering near their all-time highs.

I was speaking at a conference recently discussing this very important point of managing money. When managing money we can make logical assumptions about what we think will happen in the future. While that logical outcome will eventually mature, the markets can, and do, act illogically for longer than logical analysis would expect. Therefore, investors who try and predict future market outcomes, and act accordingly, suffer the outcomes of being wrong.

Our job as investors is to make money, not by being right. This is why, despite the current evidence of deterioration, the markets remain bullishly biased for now suggesting the portfolios remain fully allocated. As investors we must be "patient"  in awaiting those market driven instructions. But patience, and complacency, are two entirely different things.

While there is little doubt that a major market reversion is on the horizon, there is no evidence that such a correction is in the immediate future. Therefore, we wait patiently, but not complancently.

So, while we wait patiently, this weekend's reading list is a collection of articles that I just found very interesting that I thought were worth sharing with you.   

1) The 7-Maleficent Behaviors Of Individuals by Robert Seawright via AboveTheMarket

"The Magnificent Seven is a terrific 1960 movie "western" about seven gunfighters hired to protect a small Mexican village from marauding bandits. A re-make is currently in the works and the "original is itself a re-make of Akira Kurosawa's Japanese classic, Seven Samurai. Meanwhile, Maleficent is the "Mistress of All Evil" in Sleeping Beauty who curses the infant princess to prick her finger on the spindle of a spinning wheel and die before the sun sets on her sixteenth birthday. Today I'm offering up a mash-up from these movies to outline what I'm calling the Maleficent 7 – seven inherent human problems and limitations that impede our ability to make good decisions generally and especially about money."

Read Also: The Great Bond SellOff by Bill Bonner via MoneyWeek

2) How's This For An Epic Fail by Cullen Roche via Pragmatic Capitalist

"This month marks the 36th straight month in which the Fed has missed its inflation target."

Read Also: New Retirement Age Is Not 65, 80 or 95: It's Higherby Eric Rosenbaum via CNBC

3) The Most Crowded Trade On Wall Street: Denial by Jesse Felder via The Felder Report 

"It just doesn't matter." This is the mantra of the bulls who, no matter what bearish evidence is presented, simply insist, "earnings don't matter. Valuations don't matter. Margin debt doesn't matter. Market breadth doesn't matter." You name it and they defame it. I was recently told by a bull who was dead serious that, not only do none of these things matter, there is an invisible magical force more powerful than any of these them which ensures stocks will continue to march higher. I was dumbfounded."

Read Also: When It Comes To Investing: It's Not Data Miningby Cliff Asness via AQR

4) Fed Urged To Delay Rate Hikes Until 2015 by Kasia Klimasinska via BloombergBusiness

"The Federal Reserve should delay raising interest rates until the first half of 2016, the International Monetary Fund said as it cut its U.S. growth forecast for the second time this year.

The lender also said that the dollar was 'moderately overvalued' and a further marked appreciation would be 'harmful,' in a statement released in Washington on Thursday on its annual checkup of the U.S. economy.""

Read Also: Odds Of A Bear Market Are High And Rising by Mark Hulbert via MarketWatch

5) 10 Bearish, 1 Bullish Chart by Meb Faber via Meb Faber Research

"10 charts or stats to mull over this weekend."

Read:  The Trend In Profits And GDP by Dr. Ed Yardeni via Dr. Ed's Blog

ANYTHING HAPPEN YET? OKAY, OTHER STUFF WHILE WE WAIT

Why Women Cheat by Noel Biderman, Founder/CEO Ashley Madison via CNBC

"At the heart of it is being the object of desire. Someone thought you were the greatest thing and wanted to spend their life with you. Ripping that away from someone feels awful. Now they don't even want to look at you, touch you, talk to you. But you have economic stability — A home. Kids. Family. You don't want to walk away from that just because you feel less than desired. People think, 'I'll just put myself out there in an anonymous way.'They want to rekindle that object of desire. You'll often find women seeking this attention by Facebooking with past lovers."

Liquidity Everywhere, But Not A Drop To Drink by Tyler Durden via ZeroHedge

"And yet almost every institutional investor, in almost every market, seems worried about liquidity. Even if it's here today, they fear it will be gone tomorrow. They say that e-trading contributes much volume, but little depth for those who need to trade in size. The growing frequency of "flash crashes" and "air pockets"– often without obvious cause – adds weight to their fears."

Chart Of The Week by Julie Verhage via Bloomberg Business

"'Are stocks overvalued, depends on which measure you use."

What do you get when a bursting equity bubble meets 5X leverage, structured finance, semi-literate banana vendors, and fund "managers" with less than one year of experience?

Harrowing margin calls, panic selling, and, in the end, massive losses. 

As WSJ reports, the relentless, limit-down trading in Chinese stocks that unfolded last week and continued into Monday (despite the PBoC's best efforts to arrest the slide with an emergency rate cut) has wreaked havoc on China's rookie money managers and their unsuspecting clients with losses amounting to as much as 80% in some structured funds.

In China’s market bust, rookie fund managers and their investors are among the biggest losers.

 

The 10 worst-performing funds the past month are so-called structured funds, which are essentially leverage plays tracking some indexes, according to Howbuy.com, a Chinese fund tracker. The three worst performers fell by an average of 77% during the period.

 

Those funds were all led by professionals with less than a year of fund-management experience, according to details on Howbuy.com. 

 

China’s mutual-fund industry was booming until recently. Structured funds were a star performer during a yearlong bull market. But they also have done poorly during the current market decline, which began over two weeks ago. The Shanghai Composite Index closed up 5.5% Tuesday, paring recent losses, but is still down 17% from a high in June. 

 

Similar to leveraged exchange-traded funds in the U.S., structured funds can give investors two or three times the performance of an index. When markets are falling, though, these funds rapidly lose value, and can accelerate a selloff... 

 

During the run-up, Chinese fund-management companies rushed to issue structured funds... 

 

The problem has been finding mutual-fund managers to head these new funds. In recent years, many experienced mutual-fund managers have left their jobs to start their own private-equity firms, which are more profitable. “A lot of junior people were promoted to become fund managers,” said Haibin Zhu, chief economist for China at J.P. Morgan Chase & Co.

Here is a visual summary of the above:

As discussed in "The Biggest Threat To Chinese Stocks: Shadow Lending Crackdown," the structured vehicles that have played a role in allowing retail investors to skirt margin restrictions were partly (or even largely) responsible for the outsized losses posted by China's greenhorns. Here's WSJ again:

Retail investors and even some institutions like structured funds because they have earned outsize returns and it is an easy way to leverage their investments without having to borrow from securities firms or banks.

 

The funds are usually divided into two or more tranches. 

 

With structured funds, the B-tranche is typically forced to sell stocks and lower leverage in a falling market, to protect the interest of the A-tranche fund investors. This has accelerated stock declines and exacerbated B-tranche losses.

 

The May 27 launch of the 246-million-yuan ($39.6-million) Peng Hua High Speed Railway Fund, the third-worst performer the past month among China’s 2,879 mutual funds, according to Howbuy.com, is especially ill-timed. High-speed rail was a hot investment theme, but many of those stocks are now down 60% from their recent peaks.

 

The Peng Hua High Speed Railway Fund is managed by Jiao Wenlong. Mr. Jiao... He became a fund manager on May 5, the prospectus said.

Because we couldn't possibly come up with a better way to encapsulate the fantasy being sold to China's millions of newly-minted day traders by the country's newly-minted fund managers who apparently have just as little experience managing money as the people whose money they are managing have trading stocks, we'll leave you with the following from the aforementioned Jiao Wenlong: 

“Invest in the fund to leverage your dream.”

Shortly after we reported the latest market-rigging scandal, in which ITG was busted for frontrunning sellside clients in its dark pool in what has been since dubbed a "trading experiment" (because it sounds better than criminal conspiracy to defraud clients), and which will cost the company a record for a private Wall Street firm $22 million settlement, we had one question for AQR's Cliff Asness yesterday morning:

Hi @Cimmerian999, is Hitesh Mittal the AQR employee who was formerly at ITG and is part of the SEC settlement?

— zerohedge (@zerohedge) July 30, 2015

Here is a quick bio of Hitesh from FX Week:

Hitesh is the head of AQR's Global Trading Strategies group, running the firm's trading desk and overseeing the group that builds automated trading models and does transaction cost analysis for equities, futures and FX globally. Prior to AQR, he was the global head of liquidity management at Investment Technology Group, where he built its algorithmic trading platform and managed its crossing network, POSIT. He has published several papers on market structure, algorithmic trading, dark pools and transaction cost analysis, and is listed as a co-inventor on three patents. Hitesh earned a B.Eng. in computer science and engineering from JNV University in Jodhpur, India, and an M.B.A. from New York University.

We got no answer from the AQR head, who we assumes failed to noticed our inquiry, despite his notorious chattiness on Twitter where he regularly enjoys berating and mocking HFT critics.

Luckily, Bloomberg noticed, and as it turns out the answer to our question was a resounding yes.

As a reminder, the SEC accused ITG of two gross violations:

The investigation is focused on customer disclosures, Form ATS regulatory filings and customer information controls relating to the pilot’s trading activity, which included (a) crossing against sell-side clients in POSIT and (b) violations of ITG policy and procedures by a former employee. These violations principally involved information breaches for a period of several months in 2010 regarding sell-side parent orders flowing into ITG’s algorithms and executions by all customers in non-POSIT markets that were not otherwise available to ITG clients.

As ITG CEO Bob Gasser noted, "The problematic behavior was led by a senior employee who operated in a manner that violated ITG policy, Gasser said Thursday, without identifying the former worker."

In short, the "former employee" was frontrunning external orders in ITG's own prop-trading dark pool/HFT pod.

Previously, ITG Chief Executive Officer Bob Gasser made several references Thursday to a former employee he didn’t identify who was purportedly involved in the case. While apologizing during the conference call with analysts, the CEO highlighted the actions of the former employee, who Gasser said was “ultimately severed from the company.”

That former employee is precisely the Hitesh Mittal we inquired about: it turns out he quietly quit ITG by July in what Traders Magazine article reported then was a "cost-cutting measure." It now appears that he had merely been busted for engaging in what the SEC now confirms was illegal activity (and if ITG was hiding his criminal behavior it would explain why Kevin O'Hara, a former SEC enforcer, demonstratively quit the ITG board the same day).

But it's not what he did there that is notable. It's where he went after - the place: the world's 4th biggest hedge fund, AQR Capital with $136 billion in AUM, run by the outspoken Cliff Asness, who just happens to be one of the biggest supporters of HFT there is.

From Bloomberg:

Hitesh Mittal, the head of trading at AQR Capital Management, is voluntarily taking a leave of absence amid a regulatory investigation of his former employer, Investment Technology Group Inc.... Although ITG didn’t identify anyone involved by name, Mittal is a key figure in that inquiry, according to two people familiar with the matter, who asked not to be named because the investigation is private.

AQR was quick to distance itself from Mittal's allegedly criminal client frontrunning while at ITG:

“This investigation relates to alleged misconduct that occurred in 2010 and 2011 while Mr. Mittal was employed at his former employer, ITG,” according to a statement from Edelman’s Mike Geller, a spokesman for AQR, which oversees about $136 billion of assets. “Mr. Mittal subsequently joined AQR in 2012 and we had no knowledge of the issues in question. Mr. Mittal is taking a temporary paid leave from AQR while the firm diligently reviews the issues.”

Great job on the background check there guys. And while AQR will surely deny, deny, deny it knew anything about Mittal's prior trading record, and will certainly deny he was hired to implement a comparable strategy at AQR, he will no longer be in charge of trading over $100 billion in assets, most likely permanently:

During Mittal’s leave, AQR principal Brian Hurst “will assume the management of the firm’s trading operations,” Geller said. “AQR has an exceptional trading team with a deep bench of talent.”  Mittal didn’t respond to requests for comment.

And lest anyone gets the impression we are talking some tiny boiler room whose "principals" spend their time on CNBC every day instead of actually managing money, as a reminder, this is where AQR falls among the world's largest hedge funds according to the latest Institutional Investor AUM ranking: at #4!

So was the world's 4th largest hedge fund using an alleged frontrunning criminal as its head trader for 3 years? We won't know until the SEC investigation is complete. That said, rereading Cliff Asness's Op-Ed "Why I Love High-Speed Trading", with all of this latest information certainly leads us to believe that he may not have listed all the reasons why he loves HFT.

What we do know, is that AQR Capital will want to update Item 11 "Disclosure Information" of its Form ADV in the coming days.

Having told Jimmy Kimmel that he "would love to" appoint Sarah Palin to his cabinet, The Washington Post asks (and answers), just what would a trump cabinet look like?

Because Trump is busy poring over poll numbers and reviewing tape from focus groups, we went ahead and cobbled it together for him.

Vice President: Oprah Winfrey, per Trump's past suggestion. Would she run with Trump? If Donald Trump can convince the Hispanic vote to come out for him, which he insists he can, he can certainly convince Winfrey to join his ticket. He has great negotiators.

 

Secretary of the Interior: Sarah Palin. Granted, Palin would probably like something a little more substantive than this, but what other candidate can brag about having toured the country hunting various animals for a TV show? In case Palin declines, maybe reach out to that dentist.

 

Attorney General: His go-to counsel, Michael Cohen.

 

Secretary of Homeland Security: Joe Arpaio. Trump's campaign shot into the stratosphere after his appearance with Arpaio at an immigration event in Arizona. This has the added benefit of helping to keep the Department of Justice off Arpaio's back.

 

Secretary of State: We know that Trump thinks that Hillary Clinton was the worst secretary of state in American history. He clearly wants the opposite of that. So how about Vladimir Putin, whom Trump has repeatedly praised? He's pretty opposite.

 

Secretary of Housing and Urban Development: Ivanka Trump. Public housing is basically just a no-frills hotel, right?

 

Secretary of Health and Human Services: Dr. Oz.

 

Secretary of Transportation: Christophe Georges, president of Bentley Motors.

 

Secretary of Energy: Manoj Bhargava.

 

Secretary of Education: Michael Sexton, former president of Trump University, which was a thing.

 

Secretary of Agriculture: Secretary of Agriculture: Tom Fazio, Trump's golf course architect. Who knows more about proper watering and vegetation maintenance than this guy? Also, the imminent desertification of swaths of California sounds much better if you think about the process as "the creation of challenging new sand bunkers."

 

Secretary of the Treasury: Donald Trump. Sure, it's more common for the president to appoint someone else to this position, but who's better at managing money than Donald Trump? No one. He's the best.

 

Secretary of Veterans Affairs: Donald Trump. Sure, it's more common to etc., etc. But who cares more about the veterans than Donald Trump? No one.

 

Secretary of Defense: Donald Trump. Sure, etc., etc., etc., ISIS, etc. No one.

 

Secretary of Labor: Position will be left unfilled.

Interest in Trump is rising notably...

And finally...

Artist's impression of The Trump White House...

h/t ZH Member 38BWD22

Two days, ago we noted that hedge funds are now dropping like flies in a year in which generating alpha has become virtually impossible for the majority of the vastly overpaid 2 and 20 "smart money" out there (and where levered beta is no longer the "sure thing" it used to be when the Fed was pumping trillions into stocks) when we reported that Seneca Capital, the $500 million multi-strat hedge fund belonging to Doug Hirsh (of Sohn Investment Conference fame), is shutting down.

Then, in keeping with what has become a daily tradition, we asked a simple question: who's next:

Which hedge fund will close today

— zerohedge (@zerohedge) December 30, 2015

It turns out that despite our intention, the question was not rhetorical because just a few hours later Bloomberg answered when it reported that the latest hedge fund shutdown casualty was another iconic, long-term investor: Scott Bommer's SAB Capital, which as of a year ago managed $1.1 billion, and which after 17 years of managing money and after dropping roughly 11% in the first eight month of 2015, has decided to return all outside client money, and converting the hedge fund into a family office (after all one has to preserve one's offshore tax benefits).

According to Bloomberg, SAB Capital will return most money before mid January, Bommer said in an investor letter Tuesday, a copy of which was obtained by Bloomberg. The firm posted a 10.6 percent loss in the first eight months of the year in its SAB Overseas Fund, according to an investor document. Bommer started New York-based SAB Capital in 1998, and oversaw $1.1 billion as of the end of last year, according to a government filing.

“Over that time I’ve often thought this was one of the best professional opportunities one could imagine,” Bommer, who is a regular on the New York and Hamptons social scene with his wife Donya, said in the Dec. 29 letter. He didn’t give a reason for his decision.

As a reminder, Bommer is at least the third hedge-fund manager to announce plans this month to give back money to clients and focus on investing his own wealth after the previously noted Doug Hirsch said he’s returning money to investors of his Seneca Capital Investments after almost 20 years, a few months prior billionaire Michael Platt also said he was ending his 15-year career of managing client money, saying earlier this month that he wants to focus on trading his own capital and that of employees at his BlueCrest Capital Management. Joining them are Fortress Investment Group LLC, BlackRock Inc. and LionEye Capital Management among the firms who have shuttered hedge funds.

Bloomberg adds that SAB Capital’s move adds to a roster of hedge funds, both large and small, that have shuttered this year as managers struggled to navigate markets roiled by the Swiss franc’s unexpected surge, the devaluation of the Chinese yuan and declines in oil prices. According to data from Hedge Fund Research Inc., 674 hedge funds liquidated in the first nine months of the year, compared with 661 in the same period during 2014.

Hedge funds on average have returned 0.4 percent this year through November, according to data compiled by Bloomberg. Long-short equity hedge funds have gained 2 percent.

Patrick Clifford, a spokesman for SAB Capital at Abernathy MacGregor, declined to comment on the changes.

Just when traders thought that the biggest and most violent 3-day short squeeze in 7 years was about to end...

... a squeeze that has resulted in 3 consecutive 1%+ sessions for the S&P for the first time since October 2011, overnight we got one of the Fed's biggest faux-hakws, St. Louis Fed's Jim Bullard, who said that it would be "unwise" to continue hiking rates at this moment, and hinted that "if needed", the most natural option for the Fed going forward would be to do further Q.E.

At the time the algos ignored his comment, but once Europe opened, the local trading disks hit the buy button, pushing S&P futures from just above 1915 to 1931 where they were trading last.

It wasn't just Bullard: yesterday's Fed minutes were likewise as cautious, if not outright dour, about the future of the Fed's rate hike which was great news for markets as it means the rate hike cycle has been put on indefinite hiatus. "The Fed minutes show that it does look like they’re gearing up for a slower rate hike path, which is good” for risk assets, said Nader Naeimi, Sydney-based head of dynamic markets at AMP Capital Investors Ltd. "I think this rally has further to go, with the conditions set for the rebound to continue for a little while. Pessimism had got to extreme levels."

Actually, as we showed yesterday, what is really happening is one of the most violent unwinds of market neutral quant funds, who finds themselves forced to chase long higher as shorts continue to rip.

This could easily continue until the S&P rises back over 2000 only this time on forward earnings that are about 10% lower than the last time the market was in such perilous territory.

It wasn't all just a marketwide squeeze: food-related companies and miners weighed on Europe’s equity benchmark while Treasuries advanced, while the yen also climbed. Elsewhere, Emerging markets rose to a six-week high, while the Mexican peso gained a second day after lawmakers took unprecedented steps to protect the currency. Crude extended gains with Iran backing an output freeze by key energy-producing nations.

As Bloomberg writes, "while global stocks are rising for a fifth day, fueled by oil’s rally coupled with the Federal Reserve’s acknowledgment of market gyrations, the pace of gains slowed on Thursday." That sentence was written before the momentum algos were activated today: at the current rate futures are spiking we may see the first 4-day consecutive 1%+ daily streak in the S&P500 in over 4 years. 

The cherry on top was the OECD cutting its global growth forecasts, saying the economies of Brazil, Germany and the U.S. are slowing and warning that some emerging markets are at risk of exchange-rate volatility. Global gross domestic product will expand 3.0 percent in 2016, the same pace as in 2015 and 0.3 percentage point less than predicted in November, the Organization for Economic Cooperation and Development said Thursday in a report.

And now that rate hikes are increasingly off the table, bad news is one again great news. After all it means more central planner medling, and long-only algos love that.

Market Wrap

• S&P 500 futures up 0.5% to 1932
• Stoxx 600 up 1% to 332
• FTSE 100 down 0.4% to 6009
• DAX up 1% to 9468
• German 10Yr yield down 2bps to 0.25%
• Italian 10Yr yield down 6bps to 1.55%
• Spanish 10Yr yield down 5bps to 1.69%
• S&P GSCI Index up 0.7% to 302.4
• MSCI Asia Pacific up 2.2% to 120
• US 10-yr yield down 1bp to 1.81%
• Dollar Index up 0.02% to 96.81
• WTI Crude futures up 2.6% to $31.45
• Brent Futures up 1.7% to $35.09
• Gold spot down 0.3% to $1,205
• Silver spot down 0.3% to $15.23

Global Headline News Summary

• Starboard Said to Take Initial Steps for Proxy Battle With Yahoo: Adviser has been calling shareholders, people familiar say
• PBOC to Conduct Open-Market Operations Every Working Day: Seeks to improve effectiveness of operations
• Bullard Calls Raising Rates Unwise as Inflation Falls Short: Asset-price bubbles aren’t a worry amid turmoil, he adds
• Oil Extends Gain as Iran Backs Output Freeze Without Vowing Cuts: Saudi-Russia pact contingent on other major producers joining
• Ingram Micro to Be Bought by Tianjin Tianhai for $6b: U.S. networking supplier to become part of China’s HNA Group
• Credit Suisse Americas ‘One Bank’ Head Leaving Amid U.S. Retreat: Lender retreating from managing money for U.S. clients
• Wells Fargo Said Near Deal to Lease City of London Offices: 225,000 square-foot building scheduled for completion in 2017
• Gasoline Is Trading as If U.S. Nearing Recession, Goldman Says: Contracts for summer delivery are priced less than $20 a barrel higher than crude oil
• Apple Gains Silicon Valley’s Backing in Fight Against Government: Google’s Pichai says U.S. order may set ‘troubling precedent’
• Apple Joins With China’s UnionPay to Introduce Mobile Payments: Clients of 19 Chinese lenders can shop with Apple Pay
• Swiss Watch Exports Drop as Slowing Economies Curb Demand: Hong Kong, U.S. and China drag down global watch shipments
• Obama Said to Plan Cuba Visit in March 55 Years After Ties Cut: Opponents of easing relations fault president over trip
• Chevron Indonesia Plans to Cut at Least 1,200 Jobs, Kontan Reports: Cites Amien Sunaryadi, head of upstream oil and gas regulator, known as SKK Miga

Looking at regional markets, we start in Asia where equity markets traded higher across the board, tracking similar price action from Wall St, as gains in crude and FOMC minutes supported risk-appetite. Nikkei 225 (+2.3%) and ASX 200 (+1.9%) was led higher by the energy sector, after oil rallied around 8% yesterday on optimism regarding an output freeze, coupled with an API Inventory drawdown. Shanghai Comp (-0.2%) was mildly positive for a bulk of the session before paring gains heading lower into the close, after the PBoC upped its liquidity injections with price data also more encouraging after CPI printed a 5-month high, while casino gains added to the energy-led risk sentiment in Hong Kong. 10yr JGBs traded higher as yields continued to decline in the aftermath of the BoJ's negative rate policy with several domestic banks adjusting rates in reaction, although JGBs then reversed some gains after a weaker than prior 5- yr auction.

Top Asian News

• China Said to Guide Rates Lower Without Broader Policy Cuts: Offers to reduce medium-term borrowing cost it charges lenders in 2nd such move this year
• China’s Consumer Prices Climb in January as Food Costs Rise: Food prices rose 4.1% ahead of week-long Lunar New Year holiday, most since May 2014
• Goldman Sachs Top Analyst Says Don’t Panic as China Growth Slows: Most accurate forecaster on nation’s economy projects 6.4% growth this year
• Nomura Sees Yen Falling More Than 10% on BOJ Negative Rates: No intervention seen until dollar falls below 105 yen, Yunosuke Ikeda says
• Australian Unemployment Spikes to 6% as Full-Time Jobs Slump: Nation’s unemployment rate unexpectedly rises to highest since September 2015
• Japan’s Exports Drop Most Since 2009 as Sales to China Fall: Imports also decline, leaving a trade deficit slightly narrower than median forecast

European equities have kicked off the session in modest positive territory today (Euro Stoxx +0.3%), continuing on from the gains seen yesterday. Looking across the indices, FTSE (-0.6%) is among the worst performers after 6 Co.'s in the index went ex-div and knocked off 24 points from the index. Separately, the SMI (-0.5%) also underperforms this morning, weighed on by Nestle (-3.4%) who are among the worst performers on the continent. Elsewhere, Bunds remain bid this morning, all be it off their best level, underpinned by somewhat cautious FOMC minutes yesterday, with supply from Spain and France yet to have a meaningful impact on the price action.

Top European News

• Nestle Sees Sales Slowdown Extending Into ‘16 on Price Pressure: CEO says dividends, M&A outweigh buybacks for uses of cash
• Vodafone to Raise About $4.1 Billion Selling Convertible Bonds: Bonds to carry coupons of 1.2%-1.5%, 1.7%-2%
• Anglo Said to Work With Bank of America on More Coal-Mine Sales: Firm advising on sale of Moranbah, Grosvenor coal assets
• BMW Buoyed U.S. Sales Numbers by Paying Dealers to Buy Loaners: Other carmakers use similar strategy but not as aggressively
• Air France-KLM Gains on First Annual Operating Profit Since 2010: Reduction of 22% in fuel costs helps end run of losses

In FX, it has been a relatively quiet morning, with limited response to the FOMC minutes released late Wednesday. Few were expecting anything ground-breaking after last week's House/Senate testimony, with the wait-and-see mode underlined, so it was anaemic reaction from the USD pairs. Much of the same this morning, with USD/JPY back under 114.00. No panic from the earlier test on the mid 113.00's, but stock market gains have faded a little, though Oil prices remain on the front foot. CAD still well placed for further upside, though the spot rate is still holding off the early Feb lows. MXN took out 18.0000 yesterday, but is back above the figure today. GBP trade cautious with UK PM Cameron in Brussels today and tomorrow, but we have seen some adjustment to the upside a Cable tentatively reclaims 1.4300. It is all pretty tight elsewhere, with EUR/USD still holding off 1.1100 and AUD holding the mid .7100's despite a disappointing jobs report overnight. The Australian dollar declined at least 0.3 percent against all of its 16 major peers after a disappointing jobs report fueled investor doubts about whether the central bank is done cutting interest rates.

In Commodities, West Texas Intermediate crude climbed 2.5 percent to $31.41 a barrel after rallying 5.6 percent last session. U.S. inventories declined by 3.26 million barrels last week, the industry-funded American Petroleum Institute was said to report Wednesday. Oil’s 49 percent slump from a peak reached in June has shaken some crude-dependent economies, with S&P cutting the credit ratings of Saudi Arabia, Oman, Bahrain and Kazakhstan on Wednesday. Key oil producer Venezuela announced a currency devaluation, with the official exchange rate reduced by 37 percent, President Nicolas Maduro said on state TV. The Latin American country also raised gasoline prices for the first time since 1996 as it struggles to avoid defaulting on foreign debt. Copper in London slid 0.6 percent, while gold slipped 0.3 percent to $1,204.80 an ounce in the spot market after jumping 0.7 percent last session.

On today's US event calendar there will be some attention paid to the latest initial jobless claims number following the prior week’s strong data and also given that this will cover the survey period for the February employment report. Also due out is the Philly Fed business outlook for this month where a modest improvement is expected, albeit to a still lowly -3.0 (from -3.5). Later on we’ll get the index of leading economic indicators where a second consecutive negative reading is forecast (-0.2% mom). Earnings wise we’ll hear from 20 S&P 500 companies including Wal-Mart.

Bulletin Headline Summary

• In what has been a relatively tame session so far, EU bourses have extended on yesterday's gains amid outperformance in the Utilities sector.
• Asian equities followed the lead from Wall Street to trade higher, while Chinese CPI printed a 5-month high (albeit below expectations)
• Looking ahead, ECB minutes, US Philly Fed Bus. Outlook and weekly jobs data and comments from Fed's Williams.
• Treasury yields little changed in overnight trading as global equity markets mostly higher, oil rallies and gold sells off as risk sentiment improves.
• David Cameron heads to Brussels seeking to finish off months of negotiations on new European Union membership terms with a deal that he can put to the British people
• Cameron hopes to win concessions during the two-day summit that will pave the way for a referendum to be held in Britain as soon as June, in which voters will decide whether or not the U.K. should remain in the EU
• The final draft of the proposed deal has been leaked, according to the Financial Times
• The OECD cut its global growth forecasts, saying the economies of Brazil, Germany and the U.S. are slowing and warning that some emerging markets are at risk of exchange- rate volatility
• China’s central bank drained the most funds from the financial system in two years, mopping up excess cash from the financial system after flooding lenders with funds in the run-up to last week’s Lunar New Year holiday
• PBOC said it will start conducting open-market operations every business day, strengthening its influence on interest rates
• Oil extended gains above $31 a barrel in New York after industry data showed a decline in U.S. crude inventories, while Iran cautiously supported a proposal by Saudi Arabia and Russia to freeze production at near-record levels
• Iran’s qualified backing of an accord led by Saudi Arabia and Russia to cap output sowed doubts that the agreement can succeed in tempering a record global surplus
• Turkey’s prime minister blamed two Kurdish groups for a bombing in the capital that killed 28 people, ratcheting up tensions with the U.S., which has backed one of them as a major ally in the fight against Islamic State
• $8.1b IG corporates priced yesterday (YTD volume $213.35b) and $500m HY priced yesterday (YTD volume $10.125b)
• Sovereign 10Y bond yields mostly lower led by Greece (-25bp) and Portugal (-18bp); European, Asian markets mostly higher; U.S. equity-index futures higher. Crude oil rallies, copper and gold drop

US Event Calendar

• 8:30am: Philadelphia Fed Business Outlook, Feb., est. -3 (prior -3.5)
• 8:30am: Initial Jobless Claims, Feb. 13, est. 275k (prior 269k)
  • Continuing Claims, Feb. 6, est. 2.250m (prior 2.239m)
• 9:45am: Bloomberg Economic Expectations, Feb. (prior 47)
• Bloomberg Consumer Comfort, Feb. 14 (prior 44.5)
• 10:00am: Leading Index, Jan., est. -0.2% (prior -0.2%)
• 1:00pm: U.S. to sell $7b 30Y TIPS
• 3:30pm: Fed’s Williams speaks in Los Angeles

DB's Jim Reid concludes the overnight wrap

The S&P 500 (+1.65%) completed its first 3-day gain of the year yesterday, WTI Oil (+5.58%) is now 20% off the lows and at levels first breeched on the downside on January 11th. So we've had nearly 6 weeks of range trading rather than the relentless falls of the prior period. Also iTraxx financial senior (-9bps) and sub (-31bps) are 26bps and 65bps off their wides from last week.

US data continues to also hold up considering the recent market stress. Various economic surprise indices are pointing up for the first time in many weeks even if there are still some misses (yesterday’s housing starts an example). Interestingly industrial production (+0.9% mom vs. +0.4% expected) picked up strongly yesterday albeit with downward revisions to the previous month. As can be seen from the graph in today's pdf, despite yesterday's mom pick-up, industrial production (on a yoy basis) has never been this negative without it signalling a recession. Indeed IP has been a very reliable indicator of upcoming recessions. However we've been slightly dubious of this link in this cycle because it's been so obvious that the manufacturing sector has never before been so decoupled from the much larger service sector so it could be a false signal this time. Yesterday's rebound confuses this further, especially as we're still negative yoy. As a reminder we are fully paid up secular stagnation fan club members but we don't think the US is going into recession... yet!!!

Before we recap the highlights from yesterday, an update on the latest in China where the January inflation numbers have been released this morning. CPI was reported as rising +0.5% mom last month having been driven by a surge in food prices with non-food prices relatively stable. It’s worth warning that food prices tend to be subject to bouts of volatility and seasonality though. However, as a result that’s seen the YoY rate lift two-tenths to +1.8% although slightly less than the +1.9% expected by the market. That said, the data is trending in the right direction after CPI dipped as low at +1.3% in October and +0.8% twelve months ago. There is better news to come out of the January PPI print too which has risen six-tenths to -5.3% yoy (vs. -5.6% expected). That does however mark 47 consecutive months of factory gate deflation.

Looking at the market reaction, there’s been some modest gains for bourses in China with the Shanghai Comp and Shenzhen +0.52% and +0.56% respectively. Bourses elsewhere are trading with a decent tone meanwhile and seemingly following the lead from the US last night. The Nikkei (+3.02%) has gained despite some soft export data overnight (-12.9% vs. -10.9% expected) while the Hang Seng (+2.32%), ASX (+2.25%) and Kospi (+1.09%) are also up strongly. Credit markets are materially tighter while Oil is up another 2% this morning. That’s also keeping US equity futures in the green.

Yesterday saw the release of the FOMC minutes from the January policy meeting. While still a big focus, Yellen’s recent comments at her Semi-Annual Testimony meant a lot of the text was already pre-flagged. Overall the message pointed towards one of the Fed still being in a wait and see mode, keeping options open but with clear uncertainty around the outlook. A lot of the focus was on the factors driving the turmoil in markets in January with the text showing that ‘while acknowledging the possible adverse effects of the tightening of financial conditions that had occurred, most policymakers thought that the extent to which tighter conditions would persist and what that might imply for the outlook were unclear, and therefore judged that it was premature to alter appreciably their assessment of the medium-term outlook’. That being said, there was however the mention that ‘uncertainty had increased’ and so ‘many saw that these developments as increasing the downside risks to the outlook’.

It was also highlighted that ‘a number of participants indicated that, in light of recent developments, they viewed the outlook for inflation as somewhat more uncertain or saw the risks as being to the downside’. Unsurprisingly China was also highlighted as a concern amongst policymakers as well as the broader effects of a greater than expected slowdown in other emerging markets. A telling stat was that the word ‘uncertainty’ or ‘uncertain’ was mentioned 14 times compared to seven times in the December minutes.

Meanwhile, Boston Fed President Rosengren provided his updated view yesterday. His comments echoed a lot of what was said in the minutes, saying specifically that ‘recent global events may make it less likely that the 2% inflation target will be achieved as quickly as had been projected in forecasts’. As a result, Rosengren said that ‘if inflation is slower to return to target, monetary policy normalization should be unhurried’. St Louis Fed President Bullard followed this up with comments late last night saying that ‘I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations’.

All said and done the combination of yesterday’s minutes and the economic data did see the probability of a Fed rate hike by the end of this year nudge up to 41% from 34% on Tuesday. 10y Treasury yields closed up just shy of 5bps at 1.820% although were lower post the minutes.

The other main focus yesterday was again on Oil where along for gain for WTI, Brent rallied +7.21% to $34.50/bbl. Attention was centered on the Iran meeting where we had confirmation (WSJ) from the Iranian Oil Minister that they would support a plan from Saudi Arabia and Russia to curb production at January levels. That being said it still feels like there is a lot of noise around this with Iran not actually committing to anything specifically and with little obvious signal that they will be taking part in the production freeze.

For now though the fact that talks are happening appears to be fueling the better sentiment with the moves for Oil enough to support a strong risk-on day yesterday. Along with the gains across the pond, European bourses finished with big moves of their own with the Stoxx 600 closing +2.62% which means it has now finished with a daily gain of at least 2.6% in three of the last four trading days.

Meanwhile in terms of the rest of yesterday’s economic data, along with yesterday’s strong IP report in the US, manufacturing production was also up a better than expected +0.5% mom in January (vs. +0.2% expected) which was actually the most since July, while capacity utilization rose six-tenths to 77.1% (vs. 76.7% expected) although it’s worth highlighting that we did see downward revisions to December reports for this, MP and IP. Elsewhere building permits declined by less than expected last month (-0.2% mom vs. -0.3% expected) to go with the steep fall for housing starts (-3.8% mom). January US PPI was better than expected at the headline (+0.1% mom vs. -0.2% expected) although the YoY rate is still in deflationary territory (at -0.2%). That said the core was up a better than expected +0.4% mom last month (vs. +0.2% expected), lifting the YoY rate to +0.6%.

Meanwhile in the UK the December ILO unemployment rate stayed unchanged at 5.1% (vs. 5.0% expected), although earnings data was a little better than expected with average weekly earnings ex bonus up +2.0% in the three months to December (vs. +1.8% expected).

Taking a look at the day ahead now, the early data out of Europe this morning will come in France where the final revisions to January CPI are expected (no change expected at -1.0% mom). Away from that and due out just after midday will be ECB minutes from the January meeting which will be worth keeping an eye on. Over in the US this afternoon there will be some attention paid to the latest initial jobless claims number following the prior week’s strong data and also given that this will cover the survey period for the February employment report. Also due out is the Philly Fed business outlook for this month where a modest improvement is expected, albeit to a still lowly -3.0 (from -3.5). Later on we’ll get the index of leading economic indicators where a second consecutive negative reading is forecast (-0.2% mom). Away from the data the Fed’s Williams is due to speak tonight on his economic outlook at 8.30pm GMT. The Eurogroup’s Dijsselbloem is due to speak this morning at the EU Parliament Panel while the leaders of 28 EU governments are set to begin a two-day summit in Brussels where the Brexit debate and refugee crisis are expected to be hot topics. Earnings wise we’ll hear from 20 S&P 500 companies including Wal-Mart.

They may end up being right, but they were all way too early.

Activists investors are that special breed of hedge fund managers known for their aggressive forays into situations few others would touch (especially if much, much debt can be issued) usually demanding management, business or board changes. And while sometimes they make a killing thanks to their aggressiveness, other times they themselves are crushed.

Like this time.

Activist investments in the energy space has been nothing short of a total disaster: as Reuters reports, those "brave enough to have ventured into the volatile energy sector are paying a heavy price for their courage, stuck with hefty paper losses and no near-term recovery in sight."

Among the more prominent names pounded in recent months are Corvex Management, Elliott Associates and ValueAct Capital - they are among the largest and most prominent activist firms that have seen the value of their energy holdings tumble in step with sliding crude prices and remain exposed to the price rout.

Southeastern Asset Management, an investment management firm and occasional activist, has seen the value of its energy bets fall $2.7 billion in the last year, which include holdings in Chesapeake Energy Corp and Consol Energy.

Corvex's $1 billion holding in natural gas pipeline company Williams Companies worth around 14 percent of the firm's total portfolio, represents the largest current exposure of any activist fund to a single energy stock, according to quarterly filings. Corvex's stake in Williams - which has an agreement to be purchased by pipeline rival Energy Transfer - lost $1.1 billion over last year, filings show. Corvex declined to comment.

The second largest exposure is Elliott's $863 million stake in oil and gas company Hess Corp which is worth around 10 percent of Elliott's portfolio, according to filings. The stake was valued at as much as $1.7 billion in the third quarter of 2014, filings show. Elliott declined to comment.

Fir Tree Partners lost $259 million, Symmetric.io data show, among various energy investments including Williams.

ValueAct, a shareholder in Halliburton since 2012, disclosed last January that it bought a stake in Baker Hughes, saying at the time that its belief in the deal was underpinned by the drop in oil prices. The two holdings together comprise nearly 10 percent of ValueAct's total portfolio and lost a combined $656 million in value in the course of last year, Symmetric.io data show. ValueAct declined to comment.

They are not the only ones: Thirteen activist investors with the largest fund exposure to the energy sector have suffered a combined $9.2 billion in unrealized paper losses in 2015, according to quarterly filings analyzed by hedge fund data firm Symmetric.io.

But nobody's combined loss is as big as that of Carl Icahn: the sum of the one-year losses includes a $2.8 billion drop in the value
of Carl Icahn's on seven energy industry investments, Symmetric.io data
show. While that is the biggest loss for any activist investor, Icahn
invests his own money and can ride out the oil downturn for as long as
he wants. Others do not have that luxury.

One has already shit down: Orange Capital, headed by a person who some say spends more time engaging in twitter spats than managing money, is already shutting down in part because of its exposure to a Canadian oil and gas driller.

"This is a cyclical industry. Everyone knows it comes back. But not everyone has the time to wait it out," said Kai Liekefett, a partner at law firm Vinson & Elkins who is head of its activism practice. "The problem is that activist hedge funds have to answer to their own investors, and the question is whether they will give them the time."

The problem for hedge funds, many of whom have investors who can demand their money back on a quarterly basis, was that many just had not foreseen such a long, steep fall in crude prices even after they began their slide in June 2014. "It is possible that certain activist investors in oil and gas stocks misjudged the severity and speed of the drop in oil and gas prices," said Osmar Abib, global head of oil and gas banking at Credit Suisse.

Of course, by now everyone knows that the meaning of the word "hedge" in "hedge fund" is mostly for show, and not to actually, you know, hedge in case something unanticipated happens... like the biggest commodity rout in history.

Here are the casualties:

Remember Rachel Fox? For those who do not, here is a reminder courtesy of this blast from the February 2013 past interview of the then-16 year old Desperate Housewives "TV star" who became a "star trader" using her acting money, and after returning 30% in 2012 and outperforming 99% of hedge funds, was promptly interviewed by CNBC, unleashing the whole "17 year old hedge fund manager"meme:

Forget Ackman, Einhorn, Bass, And Hendry. There is only one name in the world of equity market performance in 2012 - Rachel Fox, of 'Desperate Housewives' fame.

 

With a 30%-plus performance, the day-trading debutante has turned from actress to activist as she day-trades her way through the day. The 16-year-old actress who made 338 trades last year, based mostly on technicals, "...fell in love with the idea and the concept of being able to just buy something, have it go up, or have it go down, depending on which way you bet it and have it make you money. I thought, oh, my, gosh, that's amazing, and so easy, I have to do this."

 

If ever there was a sign of the extreme bubble that central planning has re-created for us - it has to be this.

 

Her advice: "you have to really just trade on your own instincts and not just be like, oh, this person says this is great, let me just go for it."

 

Our advice: next time readers are discussing stock tips with a random employee of Hustler Club, Scores or Spearmint Rhino - don't just stare, listen! Said 'random employee' is almost certainly outpeforming the "smart money", and the broader market, by a wide margin. Thank you Ben.

 

Three years later Rachel is back, all grown up at the ripe old age of 19, and still a star trader according to her latest interview this time not with CNBC but with ABC's Good Morning America.

In it she "shares her financial secrets", such as the following.

"When I was 16 I was like, I understand a lot about, you know, companies,"the "Desperate Housewives" actress told "Good Morning America" co-anchor Amy Robach. "And ... how they IPO on the stock exchange. I had this understanding and know-how. I had the skill of managing money...."

Armed with this skillset she not only generated a 30% return in 2012, nearly double the return on the S&P's paltry 16%, but put to shame virtually all hedge funds.

How did she do it?

"I have a couple different strategies," she said. "... With other investments, I will definitely pay attention to what's going on in pop culture a lot ... you can often take that information and kind of, arbitrage it before Wall Street knows about it. So, being a young investor, actually, has huge advantages and nobody even knows about that, because pop culture and, you know, all the things that influences certain companies to do very well, is right at your fingertips."

So for all those worried about fundamentals, technicals, and which central bank will buy junk bonds next, here is what you've been looking for: be young, ideally between the ages of 16 and 19; failing that, just keep an eye on the "pop culture" that fascinates young people and you are guaranteed to outperform the market.

"... If you're curious about something, just let that drive you and just go with it," Fox said. "Just let the enthusiasm take you 'cause that's what I did and I was like ... 'There's no females in this industry or this world, but I'm gonna do it anyway.'"

The last thing we would like to do is temper the young star trader's enthusiasm, but we would like to advise young Ms. Fox that the most prominent hedge fund manager (in the U.S. and the world) just happens to be female, and her name is Janet Yellen.

Her full array of "trading secrets" are revealed in the interview below.

Submitted by Lance Roberts via RealInvestmentAdvice.com,

80% Or Bust

Not surprisingly, the recent sharp reflexive rally has brought the bulls out in full force as noted by a recent comment on my post earlier this week on “4% From The Highs:”

“…by the time you get confirmation with the long term indicators above, you will miss out on 20 to 30% of the rally.”

It’s a fair point if you are a short-term trader looking to time the market. I’m not. As a long-term investor, and specifically as a manager of “other people’s money,” I am much more concerned with the specific inflection points where market dynamics change from a generally positive trend, to a negative one.

Yes, I will most definitely miss both the bottom and the top of markets. As shown in the chart below, the technical indications of a change in trend are slow to occur. However, I am only really concerned with capturing, or missing, the 80% between the tops and bottoms of major market cycles.

Further, the majority of the “Best-10” and “Worst-10” days are contained primarily within those 80% spans.

So, yes, I am absolutely going to be“wrong” at the tops of markets and at the bottoms while I await confirmation of a longer-term “trend” to emerge. For those that are inherently“bullish” who choose “hope” over what prices are “actually” doing, the historical outcomes have been brutal, to say the least.

As I have said before, my methodologies are my own. They are not new ideas. They are not innovative. They are simply the lessons I have been repeatedly taught over the last 30-years of managing money. If the markets reverse the current long-term sell signals, I will happily put a lot more money to work. Until then, I will wait rather than trying to “draw to an inside straight.” 

Think about it this way – if betting in the markets was really the way to build wealth, wouldn’t the vast majority of Americans be wealthy versus just the top 1%? Just a thought.

Mind The Gap

I have discussed the problems with earnings and earnings estimates in the past stating:

“In a 2010 study, by the McKinsey Group, they found that analysts have been persistently overly optimistic for 25 years. During the 25-year time frame, Wall Street analysts pegged earnings growth at 10-12% a year. Unfortunately, earnings only grew at 6% which, as we have discussed in the past, is the growth rate of the economy.”

“The McKenzie study also noted that on average “analysts’ forecasts have been almost 100% too high” which leads investors to make much more aggressive bets on the financial markets. “

My friend Salil Mehta from Statistical Ideas recently published a great piece on this issue.

“The gap between the 2016 forecasts and the YTD returns through January is 13% (8% target minus the -5% YTD). Annual returns have a nearly 20% standard deviation (or 19% if you only look from the end of January onward). So it is still plausible — though rather unlikely, with only a one in five probability — to reach the 8% target gain for 2016. (For statistics wonks, the test statistic decomposes the 13% gap to a ~9% move in addition to the typical 4.5% annualized return, and then factors in a 19% standard deviation.) Now that we are further into the year (mid-March), euphoria and complacency are back to extreme market top levels.

 

It’s also worth noting that strategists at major firms are consistently bullish, year after year. The sources of the most optimistic prognostications also don’t change. Sorted from most to least bullish, they are Federated Investors, JP Morgan, Prudential, Bank of America, and Columbia.”

“In the table below, two pieces of information averaged among the 10 firms listed above are presented:

1. The difference between the target and the January YTD returns.
2. The rest of the year returns.”

“If these analyst forecasts were mostly in the right direction, you would expect a positive linear relationship between 1 and 2. Regrettably, there is a negative relationship instead. Never mind that the market continued its drop in February, even after the revised forecasts, and the rebound leaves the market still below many firm’s 2016, 2015, and even 2014 targets!

 

In other words, the larger the gap in January between the YTD returns and the year-end target, the more unlikely the chance the market will recover to the target by the year’s end.

 

Think about this: For 2016, the 13% gap noted earlier (after the standardization adjustment) is the largest gap among this data.”

As Salil concludes. “That’s not a good omen.”

It’s A Bunny

Since it is Easter, I will leave you with a story about a bunny.

James Paulsen, Chief Investment Strategist for Wells Capital Management, recently penned an excellent piece with respect to the ongoing “bull/bear” debate.

“The accompanying exhibit illustrates the U.S. stock market since WWII with recessions shown by the grey bars. In the last two expansions (during the 1990s and again in the 2000s), the stock market was uninterrupted by a bear market posting solid and steady returns until the economic recovery ended with a recession. So far, despite some volatility in 2011, this has also characterized the contemporary bull market. Without a bunny market in more than 20 years (as shown in Exhibit 1, the last bunny market was in the mid-1990s), most investors currently seem to accept that either the bull market will soon resume or we are nearing the end of this expansion. Since there has not been one in some time, few consider that stocks could simply be headed for another bunny market.”

“Most bunny markets occur in the latter part of an economic recovery. Stocks initially recover aggressively after a recession. However, as the recovery matures, cost-push pressures, inflation, and higher interest rates begin to pressure the bull market. This often resolves into a bunny market for the balance of many economic recoveries.“

I have modified his chart to notate both secular bull and bear market periods. During secular bear markets, as we most likely currently remain in, volatility swings and prices declines are substantially larger than during secular bull market periods. This elevates the risk of emotionally driven investment mistakes during periods of markedly higher volatility which leads to lower rates of investor returns longer term.

Just some things to think about.

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Earlier this week, I noted that due to the technical breakout of the market above the downtrend line from last May, an increase in exposure to equity risk was required. To wit:

“With the breakout of the market yesterday, and given that ‘short-term buy signals’ are in place I began adding exposure back into portfolios. This is probably the most difficult ‘buy’ I can ever remember making.

 

As I stated, buying this breakout goes against virtually everything in my bones as the fundamental underpinnings certainly doesn’t support taking on equity risk here.

• We are moving into the seasonally weak time of year.
• Economic data continues to remain weak
• Earnings are only positive by not sucking as bad as estimates
• Volume is weak
• Longer-term technical underpinnings remain bearish.
• It is the summer of a Presidential election year which tends to be weak.
• The yield curve is flattening
• Bonds aren’t “buying” the rally

While I am increasing exposure here, I do suspect that price volatility has not been eliminated entirely which is why I remain cautious. 

Furthermore, the “bullish case” is currently built primarily on “hope.”

• Hope the economy will improve in the second half of the year.
• Hope that earnings will improve in the second half of the year.
• Hope that oil prices will trade higher even as supply remains elevated.
• Hope the Fed will not raise interest rates this year.
• Hope that global Central Banks will“keep on keepin’ on.” 
• Hope that the US Dollar doesn’t rise
• Hope that interest rates remain low.
• Hope that high-yield credit markets remain stable

I am sure I forgot a few things, but you get the point. With valuations expensive, markets overbought, volatility low, and sentiment pushing back into more extreme territory, there are a lot of things that can go wrong. “

In other words, it’s probably a trap.

I highly suspect that within the next week, or so, I will be stopped out of recent positions. That is the risk of managing money.

However, given the ongoing Central Bank interventions, verbal easing by the Federal Reserve and an excessiveness of “bullish hope,” it is likely that prices could indeed more higher in the short-term.

As John Maynard Keynes once famously quipped:

“The markets can remain irrational longer than you can remain solvent.” 

This weekend’s reading is the usual series of opposing views to reduce the inherent confirmation bias that exists by remaining too bullish and bearish. An honest assessment of the risks and rewards will always lead to better long-term outcomes. 

CENTRAL BANKING

• Keynesian House Of Denial by David Stockman via ContraCorner
• The Specter Haunting Our Monetary System by James Rickards via The Telegraph
• Negative Rates Are Hazardous To Your Wealth by Chris Brightman via Research Affiliates
• Rumpelstiltskin At The Fedby Harley Bassman via Pimco
• The Wrong Kind Of Savingsby Buttonwood via The Economist
•  

THE MARKET – BULL vs BEAR

• One Measure Says S&P Overvalued By 72% by Alex Rosenberg via CNBC
• 7 Investment Lessons From Peter Thiel by Jae Jun via ValueWalk
• The Financial Threats Machines Can See by Mark Buchanan via Bloomberg
• FOMO Is Driving The Market by Anora Mahmudova via MarketWatch
• Is The Profits Recession About To End by Bob Pisani via CNBC
• Stop Acting Like Sheep by Mark Melin via ValueWalk
• Rally Looks Like A Classic Investor Trap by Med Jones via MarketWatch
• Bond Love Up, Supply Down by David Keohane via FT Alphaville
• Leading Indicator Hints At Bear Market by Rob Isbitts via MarketWatch
• Investors Game A Broken Market by Doug Kass via Real Clear Markets
• DJIA’s Golden Cross Might Be It by Tomi Kilgore via MarketWatch
• Some Context For Shiller’s P/E by Larry Swedroe via ETF.com
• Charts Say More Upside By Markets by Michael Kahn via Barron’s
• 5 Reasons Stocks Are Back To Highs by Howard Gold via MarketWatch
• Little Sign Bull Run Will Stop Soonby Lawrence McMillan via MarketWatch
• Why Is The Market So Strong?by Pater Tenebrarum via ActingMan
• Beware Of Bull Trap As Breadth Breaks Downby Tyler Durden via ZeroHedge

ECONOMY & OIL 

• Saudi’s Don’t Like $40/bbl Oil by Panos Mourdoukoutas via Forbes
• If Saudi’s Open The Spigots, Watch Out by David Fickling via Gadfly
• Is $80/bbl The New Normal For Oilby Matthew Belvedere via CNBC
• Atlas Shrugged, Economy Feels The Weight by Jeffrey Bartash via MarketWatch
• A Financial Hockey Stick by James Hamilton via Econobrowser
• Economic Data Weakens, Supports Thesis by Joe Calhoun via Alhambra Partners
• Secret Shame Of Middle Class Americans by Neal Gabler via The Atlantic
• Oil Is About To Drop 30% Again by Brett Owens via Forbes

MUST READS

• Resisting The Siren Song Of Factor Timing by Cliff Asness via AQR
• 50% Return Coming In Commodities? by Meb Faber via Faber Research
• Earnings Headwind Bandwagon by Jason Zweig via MoneyBeat
• History Suggests 40-55% Correction by John Hussman via Hussman Funds
• 2015 Caused An Earnings Rift by Jeffrey Snider via Alhambra Partners
• Debt Pile IS The Elephant In The Roomby Carmen Reinhart via Project Syndicate
• No Reasonable Explanation by Tyler Durden via Zero Hedge
• Global Equities Stake Key Technical Ground by Dana Lyons via Tumblr
• More Signs Of Reversal In Wealth Effect by Jesse Felder via The Felder Report

“Risk taking is necessary for large success, but it also necessary for failure.” – Nasim Taleb

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Last week, I noted technical breakout of the market above the downtrend line from last May, such a move required an increase in exposure to equity risk. To wit:

“With the breakout of the market yesterday, and given that ‘short-term buy signals’ are in place I began adding exposure back into portfolios. This is probably the most difficult ‘buy’ I can ever remember making.”

I also stated that it was probably a trap and that I will be stopped out in fairly short order. But that is the risk of managing money.

Well, since then the markets have gone, as of this writing, roughly nowhere as the market traded between roughly 2075 and 2100 all week. However, the following chart is what has me worried. 

The chart of the volatility index measures the “fear of a correction” that currently exists in the market. As a contrarian indicator, the “time to sell” is when there is relatively little “fear” in the market.  As the yellow highlighted bars suggest, that time is likely now.

Is the recent turn higher in the VIX signaling a market correction as it has done in the past? Possibly. If so, the question will be the depth of that correction. Will it be a mild pullback as saw in early 2015, or a more major decline as seen in August of last year? My bet is that it will likely be the latter given the weakening fundamental backdrop.

However, given the ongoing Central Bank interventions, verbal easing by the Federal Reserve and an excessiveness of “bullish hope,” there is still no telling what the markets will do next. This is why in this upcoming weekend’s newsletter (subscribe for free e-delivery)I will be discussing the possibility of “shorting against the box.”

Keith Fitz-Gerald once wisely stated:

“Always sit in an exit row.” 

This weekend’s reading is focused primarily on the events from last week – The Fed and the markets. I suspect things are about to get much more interesting.

CENTRAL BANKING

• Dumbest Idea Ever Interview With Jeff Gundlach via Finanz und Wirtschaft
• Will The Fed Move The Markets Up Or Down? by Anthony Mirhaydari via Fiscal Times
• Global Tensions To Increase Before June FOMC by Marc Chandler via Real Clear Markets
• Will The Fed Taint The Election by Heather Long via CNN Money
• The Would Be Crazy To Raise Rates by Stephen Kalayjian via CNBC
• The Madness Of Negative Ratesby Richard Rahn via Washington Times
• Treasury, Fed & The Next Meltdownby Ike Brannon via Real Clear Markets
• Surprise, Fed Was Wrong Againby Scott Sumner via EconLog
• What The Fed Statement Signals & Whyby Mohamed El-Erian via Bloomberg
• FOMC Demonstrates Firm Grasp Of Obviousby Marc Chandler via Real Clear Markets
• Central Bankers – Let Them Eat Rate by Danielle DiMartino-Booth via Money Strong

THE MARKET & ECONOMY

• Is The S&P 500 About To Correct? by Brett Golden via MarketWatch
• Most Hated Rally Ready For A Correction? by Mark DeCambre via MarketWatch
• Smart Money Refuses To Buy by Tyler Durden via Zero Hedge
• Chart Says January Crash To Repeat by Ken Goldberg via The Street
• What’s Keeping This Market Up by Lucinda Shen via Fortune
• Mind The Stock/Bond Gap by Macro Man
• Troubling Signs For Big Tech by Michael Kahn via Barron’s
• The Slow Down Is Consumer Drivenby Jeffrey Snider via Alhambra Partners
• Another Weak Quarter For US GDPby James Hamilton via Econbrowser
• The End Of A Golden Age by Brett Arends via MarketWatch
• Why Is Productivity So Weak? by Neil Irwin via NY Times
• This Indicator Is Still Flashing A Warningby Jesse Felder via The Felder Report
• Why The 10-Year Is Going Below 1%via Kessler

MUST READS

• The Ugly Truth Of $15 Minimum Wage by Ed Rensi via Forbes
• How Have Stocks Fared Over Last 50 Years by Bill Barker via Motley Fool
• Echoes Of 1999 by Rob Arnott via Research Affiliates
• Teetering On The Edge Of Recessionby Ironman via Political Calculations
• Where The Worst Declines Come From by John Hussman via Hussman Funds
• Q1 GDP – Weak & Why by Michael Lebowitz via 720 Global
• SEC Begins Crackdown On Non-GAAP Earnings by Tyler Durden via Zero Hedge
• Something To The Positive Skew by Dana Lyons via Tumblr
• Krugman’s Fiscal Equivalent Of War by David Stockman via Contra Corner

“The market does what it should do, just not always when.” – Jesse Livermore

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Over the last couple of week’s, I have written extensively about the breakout of the market above the downtrend resistance line that traced back to the 2015 highs. To wit:

“With the breakout of the market yesterday, and given that ‘short-term buy signals’ are in place I began adding exposure back into portfolios. This is probably the most difficult ‘buy’ I can ever remember making.”

I also stated that it was probably a trap and that I will be stopped out in fairly short order. But that is the risk of managing money.

It was only a matter of time before the extreme short-term extension of the market begins to correct. Like stretching a rubber band to its limits, it must be relaxed before it is stretched again. The question is whether this is simply a “relaxation of the extension” OR is this a resumption of the ongoing topping and correction process?

Let’s take a look at a few charts to try and derive some clues as to what actions we should be taking next.

First of all, it is worth noting that despite all of the recent excitement of the markets advance, it remains extremely confined in a sideways trading range. This can either be good or bad news.

The Good:Sideways consolidations during bullishly biased markets provides the ability to work off excesses built up during the previous advance to provide the “fuel” necessary for the next leg higher.

The Bad:However, sideways consolidations can also mark the end of the previous bullish advance and the beginning of a bearish decline.

How do we know the difference? Normally, fundamentals tell the story. When earnings are still rising, market consolidations tend to resume to the upside. However, declining earnings have historically marked market topping processes much as we see today.

Back to our first chart above, I have denoted the previous declining market trend and an adjusted downward trend line to account for the most recent peak. Both of these downward trending price lines will now act as resistance to the next attempt by the market to rally higher.

With the markets still extremely overbought from the previous advance, the easiest path for prices currently is lower. The clearest support for the markets short-term is where the 50 and 200-day moving averages are crossing. I currently have my stop losses set just below this level as a violation of this support leaves the markets vulnerable to a retest of February lows. 

On a short-term (daily) basis, the current correction is still within the confines of a simple “profit-taking” process and does not immediately suggests a reversal of previous actions. As shown in the chart below, support current resides at 2040 with the 50-day moving average now trading above the 200-day. 

It is worth noting the similarity (yellow highlights) between the current rally and peak versus the rally and peak during the October through December advance. 

Better Smelling Breadth

The good news is that the advance-decline line, currently remains a positive backdrop to the recent price action. My friend and colleague, Dana Lyons, picked up on this last week:

“Thus, we looked at all days since 1965 that saw at least 75% advancing issues on the NYSE, with a gain in the S&P 500 of less than 0.6%. As it turns out, there have been 15 such days, prior to yesterday. Again, 3 of those have occurred just since February.”

“Interestingly, all 16 days have taken place within secular bear markets (if you consider the market to still be in one, as we do). However, all but 1, or maybe 2, took place during cyclical bull markets. Whether or not that is instructive as to the market environment we are in, we won’t be able to say for awhile. But we did find it interesting.

 

What we can say is how the market fared following these days. Now, whether or not the historical results are relevant certainly may be up for debate. However, we did find the results interesting enough to present here.

 

Here is the S&P 500′s performance following the prior 15 occurrences.”

“Obviously, again, we’re dealing with a limited sample size – and with 1-day phenomenons. However, statistically significant or not, the trend has been for the S&P 500 to show consistent strength, from 2 days to 6 months out. 3 weeks (not shown) following these occurrences, the S&P 500 was higher 14 out of 14 times.

 

These are the kinds of results that we wondered if we would see following days like last Friday. Obviously, that was not the case. And considering the similarities between the 2 days, the conflicting results cause us to take these results with a grain of salt. However, at least this time, the results do heavily lean to the bullish side.”

Risk Still High

Given the fundamental and earnings backdrop, the longer-term market dynamics are still heavily weighted against the bulls. As shown in the next chart, despite the recent surge higher in prices, the technical backdrop still remains bearishly biased.

With the exception of the number of stocks trading above their 200-dma, which still remains well below levels when prices were last at these levels, every other indicator is at levels and behaving as if we are in a more protracted bear market decline. 

The question remains whether the markets will continue to “buy” the Federal Reserve’s “forward guidance” long enough for fundamentals to play catch up with the fantasy, or not. Historically speaking playing “leapfrog with a Unicorn” has tended to have painful outcomes.

A Note On Oil, The Dollar & Rates

Last week, I wrote a fairly extensive post on why I think oil prices are nearing their peak and made a case for trimming back on oil & energy related exposure. To wit:

“In a nutshell, the very easy near-term gains have likely already been seen. As I will explain below, the fundamental and technical backdrop suggests there will be plenty of opportunities for patient, long-term investors to pick up oil/energy exposure at cheaper levels in the months ahead.

 

With supply and demand imbalance likely to remain for years to come, it is very likely that we will once again return to a long period of volatile prices within a very confined range as seen during the 1980-1990’s. Therefore, for those wanting to invest in oil and energy related positions, the shorter-term price dynamics are going to be substantially more important.

 

If we take a look at the “Commitment Of Traders” report we see that exuberance over the recent surge in energy prices has pushed the number of oil contracts back to the second highest levels on record.”

“As with the past, these surges in contracts have typically denoted short-term peaks in oil prices. This time is likely going to be no different.”

A technical look at oil prices also suggests near-term profit taking in energy-related positions is likely a good idea. As shown, oil prices are not only trading at the top of a long-term downtrend channel but are also pushing 2-standard deviations above the mean.

With momentum and prices at extreme overbought conditions, a near-term reversion is very likely. I have noted each previous peak price in oil with vertical blue-dashed lines.

Of course, one of the main drivers of such a reversion would be a reversal of the recent weakness in the dollar. Like the advance in oil, the decline in the dollar has also been just as extreme. As shown below, denoted by yellow highlights, each previous downside extension of the current magnitude has resulted in a fairly sharp reversal.

With the Federal Reserve caught in their own “trap” of “strong employment and rising inflation” rhetoric, the markets may stay to worry about a rate hike in June. A perception of higher interest rates would likely reverse flows back into the dollar, and by default U.S. Treasuries, pushing the dollar higher and rates lower.

Speaking of rates, I suggested a couple of weeks ago as rates pushed 1.9% that it was time to once again add fixed income to portfolios. That call has been prescient and was even supported just recently by Jeffrey Gundlach at Doubleline.  However, a recent article by Kessler Companies picked up on a key reason why I continue to suggest rates will fall to 1% in the future.

“But, the labor market is a subset of the economy, and while its indicators are much more accessible and frequent than measurements on the entire economy, the comprehensive GDP output gap merits being part of the discussion on the economy. Even with the Congressional Budget Office (CBO) revising potential GDP lower each year, the GDP output gap (chart) continues to suggest a disinflationary economy, let alone a far away date when the Federal Reserve needs to raise rates to restrict growth. This analysis suggests a completely different path for the Fed funds rate than the day-to-day hysterics over which and how many meetings the Fed will raise rates this year. This analysis is the one that has worked, not the ‘aspirational’ economics that most practice.”

“In an asset management context, US Treasury interest rates tend to trend lower when there is an output gap and trend higher when there is an output surplus. This simple, yet overlooked rule has helped to guide us to stay correctly long US Treasuries over the last several years while the Wall Street community came up with any reason why they were a losing asset class. We continue to think that US Treasury interest rates have significant appreciation ahead of them. As we have stated before, we think the 10yr US Treasury yield will fall to 1.00% or below.”

I couldn’t agree more which is why I continue to buy bonds every time rates approach 2%.

Okay, enough for now.

Next week should give us more information about what to do next.

“A mariner does not become skilled by always sailing on a calm sea.”– Herber J. Grant

If we take a look at volume-by-price we also see a surge in volume at current levels which is suggestive of distribution by traders as markets reach primary inflection points.

These warning signs are worth paying attention to.

As I have repeatedly stated over the last couple of weeks the current market setup feels like a “trap.”  I remain cautious and already have an “inverse market” position loaded in our trading system to move portfolios quickly back to market neutral if markets break support. 

I suggest you prepare as well.

“If the weather forecast suggests it might rain, wouldn’t you carry an umbrella?”

After a poor start to the year, Dan Loeb's Third Point redeemed itself in the second quarter, in which it posted a 4.6% return, bringing the YTD net P&L to +2.2%

True to his narrative form cultivated during his early activist "Mr.Pink" days, Dan Loeb second quarter letter starts off where his infamous Q1 "Carnage" story left off, and starts of with an almost literal bang, providing the most vivid visual of what it means to run money in 2016. As he puts it, "watching Jon Snow’s epic “Battle of the Bastards” scene in the penultimate episode of this season’s Game of Thrones gives investors a sense of how it has felt to manage money during some periods over the past year. Surging enemies forming a seemingly impossible perimeter, a crush of fellow soldiers on the field, arrows coming in overhead, and the need to avoid panic and deftly use sword and shield to fight your way out of a seemingly impossible situation is a good analogy for the emotional experience of managing assets since last summer."

He continues:

Nearly one year into this market cycle, a few truths of hedge fund investing are evident: 1) portfolio positioning matters as much as stock picking skill; 2) factor risk, not beta, has driven hedge fund underperformance in an up market; 3) crowded trades are a symptom of the prevalence of copycat investment frameworks practiced by hundreds of funds formed over the past decade to mimic the success of many of their investing legend mentors and therefore naturally share the same outlooks and biases; and 4) putting money to work in equities and credit today requires a thoughtful perspective on global events. Macro analysis is no longer just for macro traders.

He uses Brexit as a case study of investing against the crowd and "being able to make decisions about the real impact of political and economic events in the midst of market turmoil."

The Brexit vote was a good example of the importance of being able to make decisions about the real impact of political and economic events in the midst of market turmoil, and many market participants were caught flat?footed. The idea that the outcome was unforeseeable is incorrect – the polls correctly forecast a coin flip – but elites dismissed the possibility. There is a lot to learn from this group?think pitfall, which we nearly fell into ourselves. Over the weekend following the vote, we investigated the actual impact of Brexit and, after concluding the average predicted scenario was too severe, we quickly repositioned our equities portfolio by covering shorts, adding to several long positions, and initiating a new position in a European event?driven situation. This helped generate positive returns for the month, for Q2, and so far in July.

An interesting observation: Loeb flipped on his energy shorts and starting in February, he went long $1 billion in energy credit:

As the Brexit episode showed, investing in this market must be viewed through a different lens. This year, we have applied our views about global risks to portfolio management and maintained a highly flexible, opportunistic approach. Our net equity exposures have ranged from ~40% to ~55% in 2016, allowing us to be proactive in periods of market selloffs while still taking enough risk to generate returns. We came into the year with a short credit portfolio that we reversed sharply in February, getting long over $1B in energy credit, a trade we discuss further below. We have reduced our  structured credit book of housing?related bonds from its highs and focused increasingly on new areas of opportunity in consumer lending. The year’s positive performance reflects contributions from nearly all of the strategies we employ; the top five winners include a constructive long equity position, a sovereign debt investment, high?yield debt investments in energy companies, an event?driven long position, and a short equity position in the pharmaceutical industry.

Why the flip on energy? This is what he says:

Investments in energy credit drove positive returns for Third Point during the first half of the year. We began 2016 short corporate credit with modest exposure consistent with our 2015 portfolio and an overall bearish market. There were a few signs that the market’s degree of pessimism was misplaced, as Goldman Sachs highlighted in a January note to clients:

 

“HY E&Ps are pricing in more losses than anything ever experienced, even in the CCC space…HY E&P spreads are implying a cumulative loss rate of 86%, assuming a buy and hold strategy on the current universe. This means an investor would still break even if 86% of the current HY E&P portfolio were wiped out. For context, data from Moody's show that since 1985, the worst cohort of Caa?rated firms experienced a five?year cumulative default rate of 71%.”

 

Early in the year this (prescient) observation provided little comfort to investors who, having suffered through the 4th worst year in the history of the high?yield market in 2015 (only exceeded by the credit crisis years of 1990, 2000, and 2008), watched as oil plunged through $30/bbl and natural gas traded with a one?handle.

 

We shifted our portfolio in late Q1, driven in part by our analysis of the energy markets and our approach to cross?capital structure investing. In late January, Moody’s revised its 2016?2018 Brent forecasts to $33 / $38 / $43, triggering multi?notch downgrades for many E&Ps. Forced selling by index funds following such downgrades caused many bonds to gap down in price as a large portion of the space transitioned from trading on yield to expected recovery in a bankruptcy scenario. In mid?February, days after rumors of Chesapeake’s imminent Chapter 11 filing, another rumor surfaced that OPEC was willing to cut production. This led oil prices to bottom, finally.

 

Around this time, we saw the potential for a modest commodity price recovery and also believed the market was underappreciating the potential of a broad?based “equitization” of the energy sector (asset sales, equity raises, dividend cuts). As creation value through various credits reached levels that were too cheap to ignore and our view on commodities strengthened, we covered shorts and added quickly to opportunities on the long side.

 

While our team also evaluated expressing our view on energy via equities, and made some modest investments there, we chose to invest the bulk of our energy exposure in credit because we believed that the “fulcrum” securities available offered the best relative risk/reward based on the range of scenarios we analyzed.

 

We recently have monetized several investments that imply a more optimistic commodity price outlook than we are willing to underwrite. We are currently focused on debt of companies with high?quality assets and deleveraging catalysts where we can make good returns while limiting downside risk should commodity prices stagnate. As credit markets continue to reflect overall skittishness and volatility, we are optimistic that our flexible approach to investing in the space will continue to provide more opportunities for meaningful returns like the ones we generated during the first half of this year.

Finally, Loeb's "constructive" outlook reveals that Loeb is a big believer in the Fed Model:

Looking ahead, we remain constructive on US markets and are primarily invested here. While observers claim the S&P is expensive, its dividend yield currently is greater than the 30 year bond yield, a relatively rare occurrence not seen since 2009. The dollar’s strength earlier this year had weakened overall S&P earnings and when combined with its softening, the Fed’s signals that another rate hike this year is highly unlikely, and tailwinds from low energy prices, we expect to see earnings improve in the second half. Share buybacks and M&A remain robust. Viewed from this perspective, alongside the observation that very few other asset classes or regions offer more attractive returns, we are content to have our capital in a well?diversified portfolio of US?centric credit and equities.

Full letter below.

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Yesterday, media headlines rang out:

“The Markets Just Did Something It Hasn’t Done Since 1999.”

It’s pretty amazing when you think about it for a moment. All three indices hit simultaneous new highs at a time when earnings, profitability, and economic data are deteriorating.

While much of the media analysts continue to suggest there remains a bearish attitude towards stocks, price action of the markets as compared to fundamental data suggests quite the opposite.

The chart below compares the current S&P 500 to both earnings and the annual ROC in GDP.

Notice any similarities?

Despite a “belief” that “This Time Is Different (TTID)” due to Central Bank interventions, the reality is that it probably isn’t. The only difference is the interventions have elongated the current cycle, and has created a greater deviation, than what would have normally existed. What is “not different this time” is the eventual reversion of that extreme will likely be just as damaging as every other previous bear market in history.

But, of course, “TTID” is the old Central Bank driven mantra, today it is “There Is No Alternative (TINA).” As stated, regardless of what you call it, the results will eventually be the same.

Let’s review where we stand currently.

Chart updated through Friday’s open.

While the market has continued to consolidate gains over the last few weeks, the overbought conditions still remain. As I stated earlier this week:

“The market, on a short-term basis, remains in extreme overbought territory. This needs to be relaxed somewhat before additional equity exposure is added to portfolios. As shown, a reversion to the current bullish trend line, which coincides with the market’s recent breakout levels, is a likely target in the short-term.

 

However, there is a more than reasonable chance, as I laid out two weeks agofor a deeper correction in the next 60-days. The chart below shows the potential drawdowns from current levels.”

“Here is the point. It would take a correction from current levels to break 2000, which is very important support for the markets currently, to even register a 10% correction.

 

Given the current bullish exuberance for the market, this is probably unlikely between now and the election. Therefore, even a “worst case” correction currently would likely be an 8.5% drawdown back to major support.  Of course, for most individuals, even such a small correction would likely feel far more damaging.“

Let’s take a look at some of the issues that suggest a reversion in prices is likely coming sooner rather than later.

VIX & Junk Bond Spreads Out Of Whack

The level of “complacency” in the market has simply gotten to an extreme that rarely last’s long.

The chart below is the comparison of the S&P 500 to the Volatility Index. As you will note, when the momentum of the VIX has reached current levels, the market has generally stalled out, as we are witnessing now, followed by a more corrective action as volatility increases. 

Eric Bush, CFA from GaveKal Research had an excellent piece this week discussing this same idea but also looking at junk bond spreads. 

Taking this one step further, Dana Lyons took note of the “Smart Money” hedging against exactly the kind of volatility increase I am discussing. To wit:

“As we have discussed on many occasion, these hedgers are often considered ‘smart money’. This is a bit of a misnomer which causes some confusion every time we use the term. It is not that these hedgers (e.g., banks and large financial institutions) are always right. In fact, they can be wrong for long stretches at a time in a strong trending market. However, we know what typically occurs when the speculators’ positioning becomes too one-sided or extreme – the market reverses on them. And as they are on the other side of the position, these commercial hedgers are typically correctly positioned at major market turns. Thus, the ‘smart money’ moniker.

 

This is relevant now due to the aforementioned speculator position. As such, commercial hedgers currently own their largest net long position in the 10-year history of the VIX futures contract.”

As always, timing is everything.

The point here is simply the “risk to reward” dynamic for either adding to current long-positions or maintaining overweight equity positions in portfolios will not likely pay well.

As I have noted repeatedly in the past, maintaining your portfolio through a disciplined investment process will reduce risk and increase long-term profitability.

1. Tighten up stop-loss levels to current support levels for each position.
2. Hedge portfolios against major market declines.
3. Take profits in positions that have been big winners
4. Sell laggards and losers
5. Raise cash and rebalance portfolios to target weightings.

Still Waiting On A Correction – AGAIN

From last week:

“So, am I buying equities to move portfolios to the current target allocation?

 

Not yet.”

I know.  Boring.

It has now been FIVE weeks since the market broke out of its 18-month consolidation process at which time I laid out the case to increase equity exposure in portfolios. I have been repeating that case here each week, primarily for new readers, with not opportunity to adjust exposures as of yet.

“But Lance, you just laid out a very bearish case for stocks. Why are you talking about increasing exposure?”

That is a fair question.

Managing money is about managing the risk of loss. Notice that I did not say “creating returns.” 

If I manage portfolios against the potential of long-term impairment of capital, the creation of returns becomes a byproduct of that effort.

Currently, while there is a very bearish case to be made from the deterioration of economic and fundamental variables relative to the market, the current technical price dynamics are both bullish and positively trending.  Therefore, as a money manager, I want to maintain exposure to the equity markets until such time as the technical price dynamics change from bullish to bearish.

I have stated repeatedly over the last couple of weeks that the breakout of the market above the 18-month consolidation range was bullish and demands an increase in equity exposure. However, such an increase must be done when the risk-to-reward ratio is favorable which is what I am currently patiently waiting for. I have laid out the potential price corrections needed to both warrant, and negate, such an equity exposure increase.

As Doug Kass noted this past week, there is a trio of factors pushing stocks higher.

• “Central-bank policies are succeeding in encouraging risk takers to take more risks in long-duration financial assets, while central-bank purchases have sent financial-asset prices spiraling upward and reduced volatility (as measured by the VIX). This has created what I call the Bull Market in Complacency — an almost universal view that any drawdown in market prices will be limited.
• Many U.S. corporations that face lackluster top-line growth are repurchasing stock in record amounts at record prices rather than doing capital spending to bolster their physical plant. This boosts stock prices, satisfying large shareholders and feathering insiders’ portfolios.
• While many retail investors are long gone from the stock market, volatility-trending strategies, risk-parity trading systems and other quant programs keep pushing stock prices to new all-time highs.

All this feeds on itself, but what’s surprising is that few question how the above factors contribute to higher asset prices. They fail to recognize that if there were no adverse consequences low or negative interest rates, massive liquidity injections and central banks buying stocks, these would have become permanent and continuous monetary-policy strategies decades ago.“

Bingo.

The “big chart” of technical underpinnings clearly suggest that while prices are bullish, the underlying “health” of the market remains weak.

What Can Go Wrong? A Lot!

Unfortunately, several factors could cause an unceremonious change in the market’s direction at any moment. As Doug notes:

• “An Abrupt Growth Slowdown. Low U.S. interest rates have pulled forward demand, and from my perch, we’re already seeing ‘Peak Autos’ and ‘Peak Housing.’ I wonder whether U.S. consumer spending’s recent strength is sustainable … or just the last gasp of growth?
• A Possible Deeper ‘Earnings Recession.’ Will corporate profit margins get squeezed even further going forward?
• An Abrupt Reversal for Stocks. This could ‘just happen’ out of the blue, or it could stem from an exogenous political or geopolitical shock. Or it could follow something else that investors aren’t even thinking about. My concern is that an abrupt change in sentiment or stock prices could ignite a selling stampede from the influential quant community, just as ‘portfolio insurance’ precipitated the October 1987 Wall Street crash.
• A Quick Climb in Interest Rates. This could, among other things, curtail mergers and acquisitions and/or stock-repurchase programs.
• An Abrupt Rise in Inflation or Inflationary Expectations. This could spark higher interest rates.
• A Federal Reserve Policy Mistake. We can never rule this out.
• A European Banking Crisis. This could have a “contagion effect” around the world.
• Policies that Destabilize Currencies. Again, this is always a possibility.
• A Zika Virus Outbreak or Other Health Event. Few investors are even thinking about this.
• A Monumental Hacking. A major computer hack of the U.S. banking and investing complex could disrupt everything.
• Something Else. We face all sorts of other risks that no one is even considering.”

The Bottom Line

I agree with Doug. The view of “TTID” or “TINA” will likely end very badly for investors over the longer-term time frame. Distortions of price from reality are short-term, emotionally driven, cycles.

With the S&P 500 trading at more than 25x GAAP earnings, 18x non-GAAP profits (one of the largest differentials between GAAP and non-GAAP in history), risk vs. reward is simply not present in the long-term.

However, in the short-term, we must recognize the potential for the markets to remain “irrational” longer than logic would currently dictate. This is why I am cautiously managing portfolio risk and allowing the markets to “tell me” what to do rather than guessing at it.

What happens over the next few days to weeks is really anyone’s guess. The data continues to suggest some sort of corrective action over the next two months (as discussed previously) which will provide a better risk/reward setup for increasing equity exposure in the short-term.

But, over the longer-term time horizon, I am unashamedly bearish as the current detachment between prices and fundamental reality can not last forever.

Eventually, something’s gotta give.

“A bull market lasts until it is over.” – Jim Dines

• Global stocks nudge higher after final U.S. presidential debate (Reuters)
• Trump, Clinton Double Down: Final Debate By the Numbers (BBG)
• Will Trump accept election's outcome? 'I will keep you in suspense' (Reuters)
• After Sedate Start, Trump Takes the Bait (WSJ)
• ‘Rigged’ Election Charge Takes Spotlight (WSJ)
• Debate highlights: Trump calls Clinton a 'nasty woman' (Reuters)
• Draghi Set to Stay Tight-Lipped as Investors Look for Cues (WSJ)
• Draghi Seen Keeping Up Suspense on Future of ECB Stimulus Plan (BBG)
• Philippine President Duterte announces 'separation' from United States (Reuters)
• Plummeting Newspaper Ad Revenue Sparks New Wave of Changes (WSJ)
• The Tech Bubble Didn’t Burst This Year. Just Wait (BBG)
• How ISIS Used Chat Apps to Direct Attacks in West (WSJ)
• What It Takes to Be the World’s Biggest Crude Producer (BBG)
• New Front Opened in Battle for Mosul (WSJ)
• Turkish Lira Advances After Central Bank Holds Interest Rates (BBG)
• Turkey Central Bank Unexpectedly Holds Rates on Weaker Lira (BBG)
• It's Better to Buy Than to Rent, and It Probably Always Will Be (BBG)
• New Caterpillar CEO Faces Tough Decisions as Company Digs Out (WSJ)
• Broken Indicators Mean It's Growing Harder to Spot Troubles in the Market (BBG)
• Americans Work 25% More Than Europeans, Study Finds (BBG)
• ‘Passive’ Investing: A Lot More Active Than You Think (WSJ)

Overnight Media Digest

WSJ

- About 150 Iraqis were among the first to escape across the front line south of the city amid the campaign to oust Islamic State militants from their stronghold in Iraq. http://on.wsj.com/2eliKX0

- Donald Trump refused Wednesday to commit to respecting the results of the presidential election if his Democratic rival Hillary Clinton wins, hinting at a challenge to one of the longtime traditions of American democracy. http://on.wsj.com/2emAUIf

- Banks and investors flocked to buy Saudi Arabia's first global bonds, a milestone in the giant oil producer's efforts to diversify its economy and embrace global financial markets. http://on.wsj.com/2e7fd3p

- Among Jim Umpleby's first tasks as Caterpillar Inc's chief executive will be cleaning up the fallout from his predecessor's expansion plans. http://on.wsj.com/2ejhfKA

- After spending nearly $50 billion in the summer of 2015 to acquire DirecTV, AT&T Inc is preparing to roll out an internet video service that could upend its satellite-television business along with the rest of the pay-TV industry. http://on.wsj.com/2emzihh

- Google Inc. reached an agreement with CBS Corp to carry the broadcast network on its soon-to-be-launched web TV service. http://on.wsj.com/2emAD8b

- Carlos Ghosn, chief executive of Renault SA and Nissan Motor Co is about to add a third big car industry job to his current duties in a move that could put his pay above rivals at the Detroit Three car makers. http://on.wsj.com/2emxvsH

- The flagship fund of Platinum Partners filed late Tuesday for chapter 15 protection, the section of the U.S. code that deals with international insolvency. http://on.wsj.com/2emyFog

- UK Prime Minister Theresa May heads to her first Brussels summit of European Union leaders on Thursday as she wrestles to balance demands at home on how to extract the U.K. from the bloc. http://on.wsj.com/2emANwi

FT

- Anglo-Australian miner Rio Tinto cut its iron ore estimates for this year. It expects shipments of 325 million to 330 million tonnes this year, from a previous estimate of 330 million.

- London property market slowdown has cut into revenues of real estate agency Foxton, a 13.8 percent fall from the previous year. The company said it was carrying out "tight cost control".

- Chancellor Philip Hammond defended Bank of England's independence and told MPs that there were "no plans to change the way that monetary policy is delivered".

- The House of Lords committee said that the parliament should be able to intervene in Brexit negotiations "as they happen" after U.K. Prime Minister Theresa May said on Wednesday that Brexit negotiations would take "two years and more" and that she will "not give a running commentary" on the talks.

NYT

- Tesla Motors Inc said it would equip all of its new vehicles with technology that enables fully autonomous driving, but would not activate the system until it undergoes further testing. In a blog post, the maker of electric cars said the new hardware included cameras, sensors and radars that allow the vehicles to operate without a human driver. http://nyti.ms/2dp7Lz7

- Airbnb said on Wednesday it was willing to crack down on individuals in New York City who rent out multiple homes, bowing to pressure from politicians and tenants' rights groups who say the company has worsened affordable housing issues in the city. http://nyti.ms/2dp6E2j

- Steven Cohen, a billionaire-investor barred from managing money for others, is one step closer to making his return to the hedge fund industry. Cohen, whose former hedge fund pleaded guilty to insider trading charges, has confirmed that a new investment firm he opened this year will probably begin raising money from outside investors in early 2018. http://nyti.ms/2ea1mt2

- Investigators pursuing what they believe to be the largest case of mishandling classified documents in the history of United States have found that the huge trove of stolen documents in the possession of a National Security Agency contractor included top-secret NSA hacking tools that two months ago were offered for sale on the internet. http://nyti.ms/2dBh8dD

Canada

THE GLOBE AND MAIL

** The senior chairs keep shuffling inside Toronto-Dominion Bank, the latest being Tim Wiggin's return to TD Securities, where he will run its equities business. (http://bit.ly/2e3Hnc5)

** Builders who have constructed "net-zero" houses are urging Ottawa to go slow with any proposal to change the building code to require super-energy-efficient buildings to ensure the rising costs don't add to Canada's housing affordability problems. (http://bit.ly/2e3HxzU)

** Auto parts giant Magna International Inc has as of now scrapped plans to move out of its headquarters in Aurora, Ontario, to a new head office in nearby King City. (http://bit.ly/2e3GZKE)

NATIONAL POST

** The head of Canada's central bank acknowledged that policymakers came close to the tipping point on Wednesday's interest rate decision. (http://bit.ly/2e3G5xC)

** Mountain Equipment Co-op is opening five of its cavernous outfitting stores this year, the most in a year since a group of outdoor enthusiasts founded it 45 years ago. (http://bit.ly/2e3F9ta)

** Canexus Corp directors termed a hostile takeover offer as "inadequate", setting the stage for a long proxy fight with Chemtrade Logistics Income Fund. (http://bit.ly/2e3IcBH)

Britain

The Times

- The chancellor has sought to end talk of a rift between the government and the Bank of England by quashing speculation about plans to tamper with the central bank's independence. http://bit.ly/2doBUi3

- Travis Perkins Plc has issued a profit warning and announced plans to close branches and cut 600 jobs because of slow sales and falling demand. http://bit.ly/2doErZq

The Guardian

- Barratt Developments, one of Britain's biggest housebuilders, is engulfed in a corruption scandal after one of its top executives was arrested on suspicion of bribery following an investigation into the awarding of contracts to suppliers. http://bit.ly/2doH0Lk

- The European commission will redouble its crackdown on multinational tax avoidance with the relaunch of proposals to create an overarching corporation tax regime across all member states. http://bit.ly/2doGGMk

The Telegraph

- Malaysia Airlines is in talks with Airbus Group SE about converting its fleet of A380s to each carry 700 passengers on dedicated flights to service demand for the Islamic pilgrimage to the Saudi Arabian holy city. http://bit.ly/2doHzVh

- Handelsbanken, the Swedish lender that is growing quickly in the UK, has boosted profits, lending and deposits in Britain, shrugging off the uncertainty caused by the Brexit vote. http://bit.ly/2dBeXXn

Sky News

- Travis Perkins Plc is cutting 600 jobs and closing more than 30 branches as it warns of "uncertain" trading in the year ahead. http://bit.ly/2doGBby

- Housebuilder Barratt Developments Plc says police have arrested its London boss following an internal probe into the awarding of contracts. http://bit.ly/2doG0a4

The Independent

- The head of financial development for Luxembourg said a string of overseas banks and fund managers had explored moving London staff to the tiny country since the Brexit vote. http://ind.pn/2doGP2o

- Chancellor Philip Hammond has sought to quash the suggestion the Government is seeking to encroach on the independence of the Bank of England. http://ind.pn/2doJ31X