Investing’s Latest Magic Number

Posted on Sunday, November 4th, 2018

If you are looking for an answer as to why the market fell in October look no further than Jay Powell’s remarks in the first week of the month. On October 3rd Federal Reserve Chairman Jerome Powell said the central bank has a ways to go yet before it gets interest rates to where they are neither restrictive nor accommodative. Powell also said that the economy no longer needed extremely accommodative interest rates.

“Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral,” he added. “We may go past neutral, but we’re a long way from neutral at this point, probably.”

Over the next seven trading days the S&P 500 would fall over 200 points or 6.8%. The market eventually fell to its lows of October which were 10% lower than when Powell made his remarks. This market is trading on central bank policy and most everything else is noise. China is noise. The mid terms are noise. It is all about higher rates and a more restrictive balance sheet. As all assets have risen with the tide of central bank largesse over the last decade so they will fall as central bankers take away the punchbowl. Now, central bankers will not take away all that they have given nor will they take away as aggressively as they added but investors must keep close tabs on the Fed and invest accordingly.

Powell’s comments unnerved the market because he will consider going above the neutral rate. That would mean that he is specifically trying to slow the economy.  The latest employment report backs him up, in that, it shows wage gains in excess of 3%. We have not seen that since 2008. 3% is the magic number where the Fed starts to get concerned. With the unemployment rate considered to be at “full employment” inflation could start running hot. (Full employment in layman’s terms means that everyone who wants a job, has a job, and workers now have leverage with which to bargain for a raise.)  Understand that the Fed is obsessed with wage gains. Wage gains are considered sticky inflation. Oil goes and goes down as do prices on food. They don’t consider that inflation. Higher wages tend to stick and people spend those higher wages engineering higher inflation.  There had been hope that Powell and friends would back off their plan for higher rates but the wage gains make it look like they are committed to higher rates for now. Anecdotally, all I hear from employers is that they can’t find people and people are asking them for people. The end result is that we see higher rates for longer and that will put pressure on stocks and bonds.

Markets moved lower in October as you know but you also need to keep an eye on other asset classes and especially interest rates. As Powell made his comments in the beginning of October the yield on the US 10 year moved from 3.05% to 3.25% in 3 days. As the stock market fell the yield on the 10 year came down to 3.05%. Once markets found their footing rates moved right back to 3.22% over the next 5 trading days. Higher rates are symptom of the draining of central bank largesse. Higher rates will put a drag on the economy and corporate earnings. Keep an eye on rates.

Oil has fallen almost 20% from its highs on October 3rd of $76.90 a barrel. There is that date again! We are firm believers in the theory that when oil goes up the stock market goes up. Oil earnings help buoy the market but the market goes up  because  higher oil prices mean that the economy is humming. That hum got a lot quieter after Powell started speaking on October 3rd.

We read a ton of research – basically everything that we can get our hands on. However, there are a few outfits that go right to the top of our in box. One of those is Ned Davis Research. They play both sides of the investing game and are not seen as perma-bulls nor perma-bears. They just call them as they see them. We have been taking down risk and now see that Ned Davis is calling for the same.  Ned Davis Research just went bearish on global stocks for the first time since 2009. They have taken their exposure down to 50% in equities.

 Investors should sell stocks and buy bonds because the equity decline is only halfway done, according to Tim Hayes, the firm’s chief global investment strategist.

… we are recognizing that the global market downtrend has not led to the levels of panic and capitulation needed to start a bottoming process,”.

We agree with Ned Davis. The market did not see capitulation which would have tested the levels of 2550. Selling was very orderly and we have not seen signs of a significant bottom. We didn’t get the capitulation selling that we were looking for and that may mean are stuck trading around this range for some time. We noted last week that are in the middle of a very large trading range and that range stretches from 2550 – 2880 on the S&P 500. The S&P closed on Friday at 2723.  We are basically right in the middle. We have retraced almost half the down move which will serve a resistance as will the 200 DMA. They are clustered together at 2765-2770.

Here is a big data point that was making the rounds on Friday. Since WW II there has been a 100% instance of post midterm election rallies. Certainty freaks me out. Good luck to your team on Tuesday. I will be trying to make money for my clients no matter who wins.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .

 

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill

 

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.