Downside Irrationality Continues
The past week had a few attempted rallies and one very good day on Thursday—but these were largely washed over the side along with much of everything else last week. The market is suffering relentless liquidation, and the one way action has taken the US senior index back to August lows, and the energy complex well below those levels. We did no buying last week in spite of our early intentions. Sometimes it is better to allow irrationality a bit of rope.
At times like this, the question is always the same: What is going on? In 2008, the answers were far from clear in the selling in January. But it became clearer in the next year that the financial system was filled with rot an utterly horrific leverage—which not only made the boom and bust real estate cycle so much more exaggerated—it spilled toxins all over every part of the economy when the synthetic multiplier effect of carbon copy ‘assets’ blew up in a way mortgage backed securities were never meant to become.
In looking at the world now, banks are nothing like what they were in 2008, and the real estate market has recovered, but in a normalized way. Prices in the blow-off regions of Florida, Arizona, and California are not where they were despite years passing by. Bear markets start for one of four reasons: Recession anticipation; extreme overvaluation; Geopolitical events; and Fed tightening action.
None of these are a factor at present. We have mocked the political class for their empty cheerleading of meagre 1.5% growth for years, and bemoaned the policies that have held the economy back from its real potential. But we have also said that there are no signs of contraction. Recent employment numbers continue to support our view. Secondly, markets are at 15x trailing earnings, and roughly 13.5x 2016 estimates. So we are at the long term average valuation of markets—and this is with competitive rates at roughly zero, which supports a higher multiple.
Geopolitical events? Not really. We certainly have issues with ISIS, but not the kind of trade war/shooting war like 1990 or post 9/11. And Fed action? Again, not really. Despite the Fed raising rates from zero to 0.25% in the first rise in years, there is certainly no fear that short rates are rising much further, if at all.
So what is it? Chinese growth concerns are not that big an issue for the US economy—aside from metals producers, and those are priced for depression. To me, it seems like another by-product of how vastly our capital markets have changed in 15 years. No more uptick rules, individual investors migration to passive ETF’s, and the rise of enormous ‘hedge’ funds and high frequency trading—that are all usually all on one side of crowded trades that periodically burst. I remain of the opinion that this selloff is creating a good opportunity to employ our cash reserve to buy many names we wanted a month ago that are now back in range.
Our longer term indicators are negative for all indexes, and are now below the 30% ‘green zone’, where reversals are especially relevant.
Short term signals are all negative and well oversold at this point. Only 10% of NYSE stocks are above their 50 day averages, and this is extremely low. Reversals up from this level are usually strong. History suggests that could be this week.
Bonds were stronger on the week, with the TLT’s finishing at 125.30, with the ten year yield at 2.10%. This is the usual bond strength in weeks when stocks are under pressure.
Utility stocks continued to outperform strongly this week, which helps us, as well as our cash buffer. We continue positive on them here, but our expectations on the upside are more modest than they were in the summer. Getting back to the top of recent range still represents a gain of nearly 15% from late December.
There is no change to my expectation that that more will come around to our long standing view that it is a lot better to get a 5% dividend than a 2% interest payment, though these shares are much more volatile than I expected to see.
Our dollar was lower again last week, finishing at 68.78. Our view on the dollar remains bearish, though it is now way oversold on a short term basis. The fact that now everyone is bearish in the Canadian suggests a bounce could happen at any time. Our hope is that an oversold bounce in energy back at least the mid 40’s might drag our dollar higher. We were hoping for the 80 level, but now would be happy to do further conversions at 75 or better.
The Euro was flat at 109.25, with not much real movement over the past few weeks. The US dollar remains strong on the back of the rate increase. Euro shares were weaker with all equities last week, but they could outperform Canadian shares in 2016.
Gold finished down slightly at $1,088, finding bids in a tough week for stocks. Gold shares held in well but have now rallied back to longer term resistance. I expect them to falter here as they’ve done many times after brief rallies in the past year.
Base metals shares also fell. Copper was lower at 1.94, nickel at $6.00, and zinc at $0.78. We still have no interest in the metals shares.
Crude finished at $30.64 which was down again on the week, in spite of mid-east tensions. Natural gas also faltered after its big rally, and closed at $2.10.
Energy shares were very weak, particularly the large caps, and many are now at fresh lows. The self-fulfilling prophecy of $25 crude may not make any sense, but in the land of momentum, it may just occur.
It is much more relevant to remember that at $30 crude, the oil production business in the United States—and much of Canada—cannot exist. Those who myopically point at a few tankers filled with crude have confused the trees for the forest. Real supply will collapse at these prices—not the occasional bankruptcy of high cost producers, but virtually all of it. Throwing energy shares away due to a short term market share war makes no sense.
Canadian Stock Focus
Stocks in buy range are: BCE, Liquor Stores, Martinrea, Keyara, Shaw Communications, Richie Brothers, and now most bank shares.
US Stock Focus
US Shares in buy range are: Amgen, Wells Fargo Bristol Myers, Nike, Home Depot, Starbucks, Amazon, Disney, Vantiv, Dycom, Integrated Device, CBOE, Munro, Nike, Visa, and Gilead.
Overall, the action was ugly again and has now taken the S&P500 down to the August lows. With the US holiday on Monday, all eyes will be on those lows on Tuesday morning. The beginning of the week could be very volatile.
But our opinion is that we will find support and rally across the board. This is not just due to the August lows, or the fact that many top quality names we have wanted to buy are now back at solid long term technical support. In addition, we have laid out the fundamental case on the first page, and always prefer to be buyers when others are despondent. It is worth remembering that we only have cash to be buyers because we were not pulled into the crowd bullishness in the last quarter of last year. This is the time when having a process pays off even more than usual.
We continue to think that the banks represent very good value given the pounding they have taken on both sides of the border. As mentioned last week, the minimal interest rate increase will have little effect on their businesses. The Canadian banks will have growth issues in our poor economy, which will limit their upside—but they should trade in a range in 2016, with current levels being on the lower side of the expected range.
We will be waiting for market to stop falling, but overall expect to be buyers in the coming week of great quality names that are unaccountably on sale.