Barron's: Next Stop Dow 30,000... On One Condition

The financial magazine which has made an art out of calling for big, round numbers in the Dow Jones Financial Index (as a reminder over 20% of the Dow"s surge since the election is due entirely to Goldman Sachs), most recently with its "get ready for Dow 20,000" call from just over a month ago, has done it again:

While there are still those - pretty much anyone who still cares about fundamentals - who are scratching their heads at Dow20K, according to Barrons "the Dow hitting 20,000 was no fluke. Today’s stock prices are well supported by solid prospects for corporate earnings and economic growth." 

In fact, Dow 30,000 is just around the corner... well by 2025. All President Donald Trump has to do, according to Barron"s, is "avoid stumbling into a trade war—or a real war." Some of the profound insight behind this forecast so reminiscent of the infamous "Dow 36,000" prediction which hit just around the time of the last market bubble.

Clearly, part of the propulsion behind stocks has been the Trump administration and its flurry of business-friendly edicts. If Trump can succeed in reducing regulation and lowering corporate taxes, stocks should surge further this year. An additional 5% or even 10% gain in 2017 wouldn’t be surprising. Our projection of 30,000 by 2025 is based on our analysis of historical data provided by Jeremy Schwartz, director of research at WisdomTree. This data, which looks at stock market returns for rolling five-year periods dating back to 1871, suggest stock market gains will fall below the market’s typical annual gain of 6% after inflation in the next five years before accelerating above the average in the years after that.

Then again, perhaps Dow 30,000, which would require China to inject in at least another $30 trillion in debt in the next decade without somehow hitting the Minsky moment tipping point, is not so certain: it all depends on whether Trump can avoid war, either literal of metaphorical:

"a few of the new administration’s policies pose a serious threat to the economy and stock market. The most evident one last week was the trade spat with Mexico, with the White House at one point floating the idea of a 20% border tax on Mexican goods entering the U.S. If Trump gambits like this were to trigger a trade war, the world economy would suffer. The Dow would have a hard time getting to 30,000 by 2025."

Alternatively, one can make the argument that a trade, or real war, would guarantee hitting the Dow 30,000 that much quicker: after all, it would force the Fed to resume QE, monetizing not just bonds, but ETFs, equities, and everything else in capital markets in order to preserve confidence in the global financial system.

Ironically, in the same Barron"s edition, we also read a more nuanced take of what Dow 20,000 really means from Randall Forsyth who notes says that "while the Dow is the gauge that regular folks use to keep track of the stock market, a columnist in the Financial Times condescendingly called the attainment of the 20,000 mark last week “fake news.” The flaws in the price-weighted DJIA are known to anyone who cares about such things, but it was the best method available to Charles Dow before the turn of the 20th century. As a result of its modus operandi, David Rosenberg, chief economist and strategist at Gluskin Sheff, observes that moves in Goldman Sachs Group (ticker: GS) have eight times the impact on the Dow as those in General Electric (GE).

So-called survivorship bias also has benefited the Dow. Since April 2004, Dave found that, if the eight companies that were replaced in the DJIA had been kept on, the blue chips would have been at just 12,885 now. That date, by the way, is the furthest back he could go to find former Dow companies that are still around. In the process, Apple (AAPL) was added in 2015, after a seven-for-one stock split that prevented the tech giant from having an outsize impact on the DJIA. While Rosenberg notes that tech stocks now account for a quarter of the Dow, up from 2% at the peak of the dot-com boom in 1999, the so-called FANG stocks— Facebook (FB), Amazon.com (AMZN), Netflix (NFLX), and Google parent Alphabet (GOOGL)—wait to be admitted to the blue chips.

Not surprisingly, President Donald Trump was more than willing to take credit for the Dow’s hitting 20,000 five days into his administration (arguably more deserved than President Barack Obama getting the Nobel Peace Prize months after taking office in 2009)—a reversal of his declaration that the market was in a “fat bubble” last September.

To a more dispassionate observer—in this case, Peter Berezin writing in the BCA Research Global Investment Strategy—the shift represented an evolution from undue pessimism about global growth to unbridled optimism.

And, as JPM has warned every single day in the past month, the next step in the market climbing the wall of optimism may be slippery:

The centerpiece of the Trump program—tax cuts and tax reform—can’t be enacted by executive order. That will take approval by Congress. However, the White House has widening rifts with GOP leaders, writes Greg Valliere, chief strategist at Horizon Investments and a four-decade Washington watcher: “Make no mistake—[House Speaker] Paul Ryan and [Senate Majority Leader] Mitch McConnell can’t stand Trump, and the feeling is mutual.”

While the Dow has been happy to stay above 20K for the time being, the next step may be determined by the Fed, which is meeting next week with the S&P over 200 points above where Janet Yellen warned sstocks are overvalued. As the Fed chair said in May 2015, "I would highlight that equity market valuations at this point generally are quite high," Yellen said.

"There are potential dangers there" Yellen said.

And the main one is that Yellen decides to finally pull the rug from under Trump"s market honeymoon. As Forsyth writes, "the FOMC could signal its readiness to raise its fed-funds target at the March 14-15 meeting. The fed-funds futures market puts only a 34.6% probability on a March move, according to Bloomberg’s analysis, instead pricing in the next boost for June and another in September, but not in December. The shock for the markets would be if the central bank actually delivers the three rate increases that it has signaled."

Trump was quick to take credit for Dow 20,000, and as long as stocks keep rising, nobody will complain or contest. But how will traders and politicians react after the first 5% or 10% correction, the first bear market, and soon thereafter, an economic collapse because without central banks injecting another $14 trillion in liquidity, real economic price discovery will finally happen. With Trump"s tendency to accelerate all timelines, we won"t have long to wait to find the answer.

US Stocks Are Now The Most Over-Priced Since The 2000 Crash

Submitted by Tim Price via SovereignMan.com,

On March 30, 1999, the Wall Street Journal’s front page headline blasted the good news across the world:

“Dow Industrials Top 10,000”

The day before, the all-important US stock index, the Dow Jones Industrial Average, closed above 10,000 for the first time in history.

It was a major milestone, and investors cheered.

A few investors, however, were concerned.

They felt that US stocks were too expensive, and the entire market was in a dangerous bubble.

But the Wall Street Journal answered those naysayers, as the headline of the second article on the front page ominously read:

“If this is a bubble, it sure is hard to pop.”

They were right. Sort of. The Dow Jones Industrial Average continued to climb for the next 8 1/2 months.

But on January 14, 2000, it peaked… and then started a horrible 2-year decline that wiped $5 trillion of wealth from investors.

Yesterday the Dow Jones Industrial Average hit another major milestone: 20,000.

You might even have heard the sound of champagne bottles being simultaneously uncorked by jubilant traders at 4pm Eastern Time.

But Dow 20,000 should give any rational individual pause to reflect on the possible consequences.

After all, the single most important characteristic of any investment is the price when you buy it.

It doesn’t matter how spectacular your investment is. If you overpay for it, you have no margin of safety.

And as the market affirmed yesterday, US stock prices can be expressed in a single word: expensive.

It’s not the fact that the Dow hit 20,000 that makes US stocks so expensive. The price of a stock alone doesn’t tell you much.

It’s important to look at the price of the stock relative to other important metrics, like cash flow, book value, sales, earnings, etc.

US stocks right now are selling at the HIGHEST price-to-sales ratio in at least 15 years, and far higher than it was before the 2008 crash.

Similarly, the cyclically-adjusted Price/Earnings ratio of the US stock market is now at its highest level since the 2000 crash, and higher than it was before the 2008 crash.

Looking at other metrics like Enterprise Value to EBITDA (a measure of a company’s core business operating cashflow), US stocks are also at their most expensive levels since the 2000 crash.

Certainly, US stocks could continue to become more expensive. Perhaps they go up forever.

Or perhaps an astute investor should start looking for a margin of safety.

Once significant measure of safety is a company’s Price/Book ratio. This is essentially a reflection of how much an investor is paying relative to the value of a company’s “net worth”.

This matters.

In his book What Works on Wall Street, author James O’Shaughnessy conducted an analysis of the investment strategies that were the most (and least) successful in the US stock market for a period of over 50 years.

One of the most successful strategies? Buying companies with LOW Price to Book ratios.

One of the least successful strategies? Buy companies with HIGH Price to Book ratios.

Over the long run, value investing beats just about everything. And these extremely high multiples in the US market clearly do not qualify as good value.

This is not to say that the entire US market is overvalued; there are still pockets of value in North America. But they are becoming much more difficult to find.

Looking abroad, however, there are a number of other markets overseas where valuations are MUCH more attractive.

If North America stands out by way of high valuations, for example, Japan stands out by way of low and attractive ones.

One third of the entire Japanese stock market has a cash flow yield (Enterprise Value / Cash From Operations) of over 15%.

No other developed market comes close to that.

And as analysts from European bank SocGen point out, Japanese companies also have more net cash than listed businesses in any other country:

More importantly, Japanese companies are being actively encouraged to pay higher dividends and buy back their shares.

Whereas the balance sheets of US companies are groaning with years of accumulated debt, Japanese balance sheets are the healthiest in the world, and they are awash with cash to give back to their shareholders.

Japan is very enticing to value investors, and it’s a great example of how looking abroad and expanding your thinking to the entire world can yield very compelling results.

Obama Fails To Breach $20 Trillion

Over the past several years, a raging debate among debt-watchers was whether Obama would leave the presidency with more than $20 trillion in US national debt. We now have the answer, and can report that Obama failed in this particular endeavor... but just barely. According to the US Treasury, as of the most recent update, total Federal debt was some $39 billion short of the key "psychological level", clocking in at precisely 19,961,467,137,973.64.

This means that both "Dow 20,000" and "Debt $20,000,000,000,000" accomplishments will belong to Trump. It is still unclear which comes first.

And while some may be disappointed, Obama"s achievement is still quite impressive: in exactly 8 years, total US debt has increased by $9.3 trillion, or 88% since Obama"s first day in office.

On Obama"s first day, Jan. 20, 2009, federal debt was $10,626,877,048,913.08.  As of the close of business Wednesday, it was $19,961,467,137,973.64. The final debt number for Thursday, Obama’s last full day in office, will not be released until after Donald Trump is sworn in as president on Friday, although it is unlikely to surge by $40 billion.

The total debt added on Obama"s almost doubled America"s total indebtedness, and was nearly double the $4.9 trillion piled up during the presidency of George W. Bush. It also means that the total debt "owed" by each of America"s 124,248,000 full-time employed workers amounts to $160,658, having increased by $75,129 during Obama"s tenure.

Why Everyone Is Complacent: "2016 Saw The Fewest S&P 500 Drawdowns Ever"

One week ago we were surprised to read that, in Tom Lee"s 2017 market outlook, Wall Street"s formerly most vocal cheerleader and its most prominent permabull had unexpectedly turned into one of the most skeptical bears. As a reminder, at a time when virtually every other Wall Street strategist, even the quasi skeptics, are convinced the market is going nowhere but higher, Lee now expects that the S&P 500 will finish the year virtually unchanged at 2,275, and roughly 3% lower than the median sellside forecast. His caution is the result of concerns about policy risk and a yield curve adjustment, which he sees translating into an S&P 500 decline to 2,150 by mid-year before a modest second half rebound.

"The bond market is signaling inflation confusion and a flattening long-term yield curve" Lee said, adding that this generally leads to a 5 to 7% selloff. He warned, however, that while "the bond market is less enthusiastic about the reflation trade than equities - since 1977, a flattening of the long-term yield curve sees equities weak over next 6 months— given the potential for a large rotation into stocks, equities could rally throughout 1H."

However, the main reason for Lee"s skepticism is not so much fundamental as technical.

In a slide in his latest market report, Lee notes that traders and market participants have been "lulled" into complacency by the near collapse in drawdowns, as 2016 was the year with the fewest number of days that saw the S&P drift more than 3% away from 52-week highs. From Lee"s observations:

• 2016 (we do 2016 after 2/11/2016, since early part was a continuation of 2015 selling) saw only 7 days - that is the lowest ever.


• And as noted below, the 4 years (2013, 2014, 2015, 2016) saw the S&P 500 trading so consistently close to 52-week highs - in fact, this is even more calm than the 1994-1999 period and at the time, the S&P was enjoying one of its best return periods ever.

To be sure, with VIX nearing a 10 handle again, and on the verge of record low single-digits, one wonders how much more complacency can this market take, especially if, as we showed on Friday, Dow 20,000 has become a virtually impenetrable resistance level, and it has now been one month since Bob Pisani said Dow 20K is "inevitable."

Gundlach Calls Gross A "Second Tier Bond Manager" And Other Highlights From His Presentation

While Gundlach spoke for an hour and a half in his first webcast of 2017, perhaps his longest presentation to the broader public yet, and covered many areas in the presentation titled "Just Markets", one line will be remembered: his direct attack at Bill Gross, whom he called a "second tier bond manager" for calling 2.6% on the 10 Year an important level.

As a reminder, earlier today Bill Gross issued his monthly outlook in which he suggested that 10Y yields rising above 2.60% would spell the end for the bond bull market, and would likely have further dramatic consequences on asset prices:

"This is my only forecast for the 10-year in 2017. If 2.60% is broken on the upside – if yields move higher than 2.60% – a secular bear bond market has begun. Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the Dollar/Euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017."

Gundlach, obviously, disagreed noting “the last line in the sand is 3 percent on the 10-year. That will define the end of the bond bull market from a classic-chart perspective, not 2.60%” as Gross suggested.  He then added that “almost for sure we’re going to take a look at 3 percent on the 10-year during 2017, and if we take out 3 percent in 2017, it’s bye-bye bond bull market. Rest in peace.” Such a jump would would have "a real impact on market liquidity in corporate bonds and junk bonds."

It would also hit stocks, as 3% on the 10 Year would spell "trouble for equity markets." He also said that "a 10-year above 3%, with the 30-year yield approaching 4%, would also be trouble for the equity market because they would start to look like "real" yields to investors." Previously Goldman reached the same conclusion, however when looking at 2.75% as the selloff bogey.

Gundlach said it"s not radical to forecast a 6% yield on the 10-year by 2020.

However, that won"t come quick: in predicting the next steps for the benchmark Treasury, Gundlach said "I think the 10-year Treasury will go below 2.25 percent ... not below 2 percent" before once again starting to rise.

It is unclear how such a move in rates would impact Gundlach"s own DoubleLine, which at the end of December had $101 billion in AUM: as reported previously, in December DoubleLine"s Total Return Bond Fund suffered a $3.5 billion net outflow, its biggest one month redemption in history.

Repeating a claim he has made before, and reiterating a theme voiced previously by Morgan Stanley which said to "Sell the Inauguration", Gundlach warned of a sell-off in the stock market around inauguration day as investors grasp that "Trump doesn"t have a magic wand to implement the growth plans they are optimistic about."

Previewing the Fed"s rate hikes in 2017, Gundlach said that "all things being equal, the Fed will hike in June" and said that he expects two hikes this year, with three possible.

Regarding the Trump presidency, Gundlach said there are two major risks regarding Trump"s presidency: shrinking global trade and Trump"s temperament, as Reuters reported.

Additionally, in a follow up interview with Fox Business, Trump had varioous other observations which he did not discuss during his webcast, first among which his dire forecast for the future of the Eurozone, which he predicted could face grave danger as early as this year.

"It was a bull market idea. A group hug of sorts but when push comes to shove, I knew Paris wouldn"t take orders from Brussels, Italy is a disaster, there are countries that will never pay their debts. I"d put a 35 to 40 percent bet that something could even happen this year.  (In the upcoming French elections) Marie Le-Pen could win. She"s said she"d put France"s membership up to a referendum and if that happens... I"d be surprised if it survive another 5 years," he said.

Some other observations, first on a future trade war with China: 

"I don"t see it. The possible happy scenario is that Donald Trump"s just a deal guy. He strikes deals. China doesn"t want a trade war so Trump dangles it out there and then softens his position on China in exchange for something. China has some control over North Korea. Maybe he strikes a deal to back off a trade war in exchange for China keeping a lid on North Korea (and its nuclear ambitions). But to start a trade war only makes things like apparel more expensive for consumers. Why would you want to do that?"

Trump"s effect on business sentiment and his attacks on U.S. companies doing business overseas:

"It"s incredible. We"ve seen a complete 180 degree change in sentiment since he was elected. Trump is  symbolic guy. He picks symbols like Carrier and Ford. They"re very small issues but he makes them seem very big. His pushing them leads to incredible optimism. Did you see uptick in Small Business sentiment?    

On forcing businesses to keep plants in America:

"(Trump) can impose tariffs, he can promise that America will get a bigger share of the pie. But that"s about it. Companies might stay here but they"ll use more robots. The robots won"t go away. Dark factories? It"s already happening. There"s a massive technology shift and you can"t stop it."

On President Obama"s relationship with business owners: 

"That was the most frustrating thing. People don"t want to be lectured to for being entrepreneurs. When Obama said in 2012, "If you"ve got a business, you didn"t build that, you didn"t create those jobs," I can tell you I"ve created 200 jobs. So I didn"t appreciate that."

On Trump"s plan to cut taxes and spend on infrastructure:

"It"s a very bad time to launch a deficit explosion.  It"s like drinking a ton of coffee in the morning. You"ll feel pretty good for awhile but in the afternoon, you"re gonna crash hard."

* * *

Some of his more notable charts:

A recap of 2016:

Where do bond yields go next? "I certainly expect that 2017 will be a third year of rising bond yields."

A particularly notable chart, Gundlach pointed out the divergence between the stronger dollar (inverted axis) and inflation expectations as shown by 10 year inflation swaps. A strong dollar should be disinflationary, but it isn"t.

The demographic and social challenges faced by Trump and Americans:

The trouble with US debt, and rising rates: "I do think we are going to see a deficit expansion."

Gundlach does not think a recession is coming as none of his favorite indicators signal that way:

Some advice for investors: shift from financial into real assets. “If you’re all financial assets and no real assets, you might want to peel off a piece and put into something that’s a real asset.”

Why is Gundlach expecting markets to reverse their post-election moves? This chart:

And so on.

His full presentation is below

For Bill Gross, This Is The Only Thing That Matters For The Market Right Now

While in previous monthly letters and public statements, Bill Gross has expressed a negative view of Donald Trump, warning his tenure would be damaging, and urging investors to move to cash, culminating most recently in a Bloomberg interview in which he compared the president-elect"s policies to those of Italy"s fascist dictator Benito Mussolini, in his latest monthly investment outlook he takes a more practical view of what Trump"s policies would mean for markets, and specifically the one variable he believes is the key for market action going forward. Specifically, he is focusing on what he thinks is the critical resistance level of the 10Y yield, which will set the tone for virtually every other asset class, from stocks, to FX and, of course, to rates.

But before he goes into that, he points out a tangent on the difference betweeen secular stagnation and actual growth, which he notes is the difference between 2% growth and 3% growth and defines it as  “critical” namely that “3% growth rates historically have propelled corporate profits to a somewhat higher clip because of financial and operating leverage dependent on higher growth. 2% or less typically has smothered corporate profits”

How does this fit into markets? "The critical question of interest rates and the future level of the 10-year Treasury is challenging" noting that “It is the key to interest rate levels and perhaps stock price levels in 2017” and then segues into what he dubs his "only forecast for the 10-year in 2017." To wit:

If 2.60% is broken on the upside – if yields move higher than 2.60% – a secular bear bond market has begun. Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the Dollar/Euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017.

Which, incidentally reminds us of an article we wrote back in November asking "How Far Can Bond Yields Rise Before Hurting Equities", and the answer, not surprisingly was just around 2.60%

That said he remains skeptical: “Trump’s policies may grant a temporary acceleration over the next few years, but a 2% longer term standard is likely in place that will stunt corporate profit growth and slow down risk asset appreciation.”

* * *

His latest investment outlook is below.

Echoes from Africa

If I sang a song about Africa
Of the spotted giraffe, the hyena"s laugh
Of the fiery sun rising to meet the day
With a stillness belying the lion"s evening meal;
Would Africa sing a song about me?

If I remembered a time once in Africa,
Bride at my shoulder, chasing a leopard"s shadow
With human eyes and Nikon shutters wide apart
Invading the solitude of blackened ancestors;
Would Africa remember a time once with me?

If I knew a story of Africa
Capturing a disappearing continent for a moment in time
Fleeting – far briefer than the earth"s reign;
At least until its dusty death,
Would Africa know a story of me?

Bill Gross

- With appreciation for Isak Dinesen

* * *

I traveled once to Africa, as you might have guessed by now, and it"s been a part of me ever since. Being perhaps the cradle of civilization, if not life itself, Africa casts an eerie glow over the entire history and, indeed, meaning of existence. There"s a strange beauty to it – this eat and be eaten land – brutal, yet fair and loving underneath its violent surface. I think it"s how I view my own life. I saw myself in Africa and, of course, through my own eyes I saw you there, too. The question however, that ends every stanza of my poem is whether Africa saw and will remember me. Are we just passing through without a trace following our dusty deaths? Will anyone, or anything, at the end of the line be the better for our time on earth? I,myself, know nothing of a grand scheme of existence, but I wish there to be one – if only to give meaning to our precious moments of happiness and frequent hours of despair.

Happiness has dominated risk markets since early November and despair has characterized global bond markets. Hope for stronger growth via Republican fiscal progress/reduced regulation/and tax reform have encouraged risk. The potential for higher inflation and a more hawkish Federal Reserve lie behind the 100 basis point move in the 10-year Treasury from 1.40% to 2.40% over the same time period. Are risk markets overpriced and Treasuries overyielded? That is a critical question for 2017.

The assessment of future growth and associated risk spreads is still uncertain of course. President-elect Trump tweets and markets listen for now, but ultimately their value is dependent on a jump step move from the 2% real GDP growth rate of the past 10 years to a 3%-plus annual advance. 3% growth rates historically have propelled corporate profits to a somewhat higher clip because of financial and operating leverage dependent on higher growth. 2% or less typically has smothered corporate profits. The 1% difference between 2 and 3 is therefore critical. We shall see whether Republican/Trumpian orthodoxy can stimulate an economy that in some ways is at full capacity already. To do so would require a significant advance in investment spending which up until now has taken a backseat to corporate stock buybacks and merger/acquisition related uses of cash flow.

I, for one, am skeptical of the 3 and more confident of the 2. The longer term negatives of my "New Normal" and Larry Summer"s "Secular Stagnation" may have disappeared from the business front pages of the FT and the NYT, but they have never really gone away – Trump or no Trump. Demographic negatives associated with an aging population, high debt/GDP now more at risk due to rising interest rates, technology displacement of human labor, and finally the deceleration/retreat of globalization pose negative ongoing threats to productivity and therefore GDP growth. Trump"s policies may grant a temporary acceleration over the next few years, but a 2% longer term standard is likely in place that will stunt corporate profit growth and slow down risk asset appreciation.

The critical question of interest rates and the future level of the 10-year Treasury is equally challenging. While the Fed has begun to tighten policy after abandoning Quantitative Easing several years ago, other major central banks continue to stoke the fire with as much as $150 billion of monthly buybacks. With the pinning of Japanese JGB 10-year yields at near 0% and the ongoing dovishness of Draghi"s ECB, global arbitrage effectively caps the 10-year at 2.4% to 2.6% levels. Currency adjusted yield pickups of 70 basis points by selling 10-year JGB"s or German Bunds and buying U.S. Treasuries, outline the artificial pricing of our 10-year, even as inflation moves higher and short term yields are raised by the Fed once, twice, or three times in the next 12 months.

So for 10-year Treasuries, a multiple of influences obscure a rational conclusion that yields must inevitably move higher during Trump"s first year in office. When the fundamentals are confusing, however, technical indicators may come to the rescue and it"s there where a super three decade downward sloping trend line for 10-year yields could be critical. Shown in the chart below, it"s obvious to most observers that 10-year yields have been moving downward since their secular peak in the early 1980s, and at a rather linear rate. 30 basis point declines on average for the past 30 years have lowered the 10-year from 10% in 1987 to the current 2.40%.

Source: Bloomberg.

Now, however this super strong, frequently tested downward trend line is at risk of being broken. 2.55% to 2.60% is the current "top" of this trend line, and over the past few weeks it has held and reversed lower by 15 basis points or so. BUT----------. And this is my only forecast for the 10-year in 2017. If 2.60% is broken on the upside – if yields move higher than 2.60% – a secular bear bond market has begun. Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the Dollar/Euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017.

The Problem With Forecasts

Submitted by Lance Roberts via RealInvestemntAdvice.com,

The Problem With Forecasts

We can’t predict the future – if it was actually possible fortune tellers would all win the lottery.  They don’t, we can’t, and we aren’t going to try. However, this doesn’t stop the annual parade of Wall Street analysts from pegging 12-month price targets on the S&P 500 as if there was an actual science behind what is nothing more than a “WAG.” (Wild Ass Guess).

In reality, all we can do is analyze what has happened in the past, weed through the noise of the present and try to discern the possible outcomes of the future.

The biggest single problem with Wall Street, both today and in the past, is the consistent disregard of the possibilities for unexpected, random events. 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 when in reality earnings grew at 6% which, as we have discussed in the past, is the growth rate of the economy.

Ed Yardeni published the two following charts which shows that analysts are always overly optimistic in their estimates.

This is why using forward earnings estimates as a valuation metric is so incredibly flawed – as the estimates are always overly optimistic roughly 33% on average. Furthermore, the reason that earnings only grew at 6% over the last 25 years is because the companies that make up the stock market are a reflection of real economic growth. Stocks cannot outgrow the economy in the long term…remember that.

The McKenzie study noted that on average “analysts’ forecasts have been almost 100% too high” and this leads investors into making much more aggressive bets in the financial markets. Wall Street is a group of highly conflicted marketing and PR firms. Companies hire Wall Street to “market” for them so that their stock prices will rise and with executive pay tied to stock-based compensation you can understand their desire.

However, if analysts are bearish on the companies they cover – their access to information to the company they cover is cut off. This reduces fees from the company to the Wall Street firm hurting their revenue. Furthermore, Wall Street has to have a customer to sell their products to – that would be you.

Talk about conflicted. Just ask yourself WHY Wall Street spends BILLIONS of dollars each year in marketing and advertising trying to keep you invested at all times.

Since optimism is what sells products, it is not surprising, as we head into 2017, to see Wall Street’s average expectation ratcheted up another 4.7% this year. Of course, comparing your portfolio to the market is a major mistake to begin with.

As I wrote previously:

“Comparison is the cause of more unhappiness in the world than anything else. Perhaps it is inevitable that human beings as social animals have an urge to compare themselves with one another. Maybe it is just because we are all terminally insecure in some cosmic sense. Social comparison comes in many different guises. ‘Keeping up with the Joneses,’ is one well-known way.

If your boss gave you a Mercedes as a yearly bonus, you would be thrilled—right up until you found out everyone else in the office got two cars. Then you are ticked. But really, are you deprived of getting a Mercedes? Isn’t that enough?

Comparison-created unhappiness and insecurity is pervasive, judging from the amount of spam touting everything from weight-loss to plastic surgery. The basic principle seems to be that whatever we have is enough, until we see someone else who has more. Whatever the reason, comparison in financial markets can lead to remarkably bad decisions.

It is this ongoing measurement against some random benchmark index which remains the key reason why investors have trouble patiently sitting on their hands, letting whatever process they are comfortable with, work for them. They get waylaid by some comparison along the way and lose their focus. If you tell a client that they made 12% on their account, they are very pleased. If you subsequently inform them that “everyone else” made 14%, you have made them upset. The whole financial services industry, as it is constructed now, is predicated on making people upset so they will move their money around in a frenzy.

Money in motion creates fees and commissions. The creation of more and more benchmarks and style boxes is nothing more than the creation of more things to COMPARE to, allowing clients to stay in a perpetual state of outrage.”

Focus on what is important to you, your goals and your money. In the end, this is why you started investing in the first place.

---

A Note On Risk Management

This is why I always focus on the management of risks. Greater returns are generated from the management of “risks” rather than the attempt to create returns. Although it may seem contradictory, embracing uncertainty reduces risk while denial increases it.

Another benefit of acknowledged uncertainty is it keeps you honest.

“A healthy respect for uncertainty and focus on probability drives you never to be satisfied with your conclusions.  It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference.”  – Robert Rubin

The reality is that we can’t control outcomes; the most we can do is influence the probability of certain outcomes which is why the day to day management of risks and investing based on probabilities, rather than possibilities, is important not only to capital preservation but to investment success over time.

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This Is Interesting

If you didn’t happen to read Friday’s reading list, I want to repeat this little blurb.

As I stated in the weekend newsletter entitle “Dow 20,000” the market was beginning to take on an eerily similar feeling:

“If this market rally seems eerily familiar, it’s because it is. If fact, the backdrop of the rally reminds me much of what was happening in 1999.

1999

• Fed was hiking rates as worries about inflationary pressures were present.


• Economic growth was improving 


• Interest and inflation were rising


• Earnings were rising through the use of “new metrics,” share buybacks and an M&A spree. (Who can forget the market greats of Enron, Worldcom & Global Crossing)


• Stock market was beginning to go parabolic as exuberance exploded in a “can’t lose market.”

If you were around then, you will remember.”

With Janet Yellen and the Fed once again chasing an imaginary inflation “boogeyman” (inflation is currently lower than any pre-recessionary period since the 1970’s) the tightening of monetary policy, with already weak economic growth, may once again prove problematic.

“But Lance, this is the most hated bull market ever?”

If price acceleration in the market is a sign of investor optimism, then the chart recently published by MarketWatch should raise some alarm bells.

The only other time in history where the Dow advanced 5000 points over a 24-month period was during the 1998-1999 period of “irrational exuberance” as the Fed was fighting the fears an inflationary advance, while valuations were rising and GDP growth rates were slowing.

Maybe it’s just coincidence.

Maybe “this time is different.”

Or it could just be the inevitable beginning of the ending of the current bull market cycle.

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Decennial & Presidential Election Cycles

As I noted in last weekend’s newsletter we are heading into 2017 with:

• Markets pushing historic levels of extreme overbought conditions,


• 2nd highest levels of valuation on record,


• Extreme deviations from long-term growth trend lines,


• Investor sentiment and confidence pushing extreme bullishness,


• Investors fully committed to the market with low levels of cash, and;


• High levels of leverage in terms of margin debt and corporate debt.

In other words, after 8 straight years of a bull market advance, what is the risk you are taking to garner additional returns?

With markets pushing overbought, overvalued, and bullish extremes the future outcomes have not been terrific

However, what does the Decennial cycle have to say about 2017?

As we enter into the 7th year of the decade, what do the decennial trends tell us about the probabilities of stock market returns in the coming year? Here is the entire history back to 1833.  Interestingly, you will note at the bottom of the chart the 7th year of the Decennial cycle is the WORST performing year of the decade.

You will also note the 7th year of the decade has been negatively biased over its history turning in an average return of -4.08%.  Furthermore, the negative return years matched the positive 9 to 9, or rather it was a coin flip (50/50) as to the outcome.

However, as noted by the highlights, the market has been NEGATIVE 7 of 9 times when the 7th year of the Decennial cycle coincided with the 1st year of a Presidential election cycle. Like this year.

With a win/loss ratio of 50%, the odds are equally balanced on the guess of an outcome. However, while the average return of an up year has been 11.29%, the average of down years has been a more damaging -20.29%  

Help From The Oval Office?

The stock market is also moving into the first year of the Presidential election cycle. With President Obama completing his final year of his term – the market, and the economy, are dealing with higher costs and taxes from the Affordable Care Act combined with reduced liquidity from the Federal Reserve. Furthermore, the ongoing debate and drama from Washington is unlikely to end soon, and fiscal policy will likely fall short of current expectations.

The good news is the first year of the President’s term sports an average return of 3.10%. However, the return has to tempered with just a 47.83% winning percentage. Since 1833 the market has been positive 22 out of 46 post-election years.

While the odds of a positive year in 2017 are more, or less, evenly balanced, one should not dismiss the potential for a decline. With the current market already well advanced and pushing overvaluation levels and extreme deviations from long-term means, the risk of a decline like outweighs the potential of a further advance.

I read most of the mainstream analyst’s predictions to get a gauge on the “consensus.”  This year, more so than most, the outlook for 2017 is universally, and to some degree exuberantly, bullish.

What comes to mind is Bob Farrell’s Rule #9 which states:

“When everyone agrees…something else is bound to happen.”

The real economy is not supportive of asset prices at current levels and further elevations in prices increase the potential for a future market dislocation. For investors that are close to or in retirement, some consideration should be given to capital preservation over chasing potential market returns.

Will 2017 turn in another positive performance? Maybe. But, honestly, I don’t really know.

Traders May "Sell The Inauguration" But BofA Is Not Calling For "A Big Short" Yet

Along with most of his Wall Street peers, BofA"s Chief Investment Strategist Michael Hartnett flipped his outlook on risk assets shortly after the election, turning from quietly bearish to vocally bullish and forecasting a substantial rise in US equities, and even more substantial bounce for Japanese, European and UK stocks as well as oil.

So far, Hartnett has been correct, and according to recent fund flows, much of the investing community agrees.

Some specifics: in the last week, according to EPFR, there were both strong bond inflows ($6.3bn) as well as equity inflows ($5.5bn) offset by modest commodity outflows ($0.2bn). Curiously, unlike in the earlier part of the reflation trade when buying of equities was funding from bond liquidations, last week we saw the strongest week of bond inflows in 3 months, which followed $41.5bn of redemptions in past 8-weeks - the largest redemptions since taper tantrum.

A more nuanced look into bond flows shows that investors added risk, with another week of redemptions from Treasuries but 1st inflows to EM debt funds in 9 weeks, 2nd week of renewed inflows to IG bond funds, and 6th consecutive week of inflows to HY bond funds. In other words, "risk proxies" in the bond world are getting hot again.

Perhaps nowhere is this more obvious than what is going on in the primary issuance market. Here, as Bloomberg notes, debt sales are blowing through all records, with the biggest volumes of issuance ever for the first week of January, as top-rated U.S. companies are selling bonds at the fastest pace ever to start a year

And while gold & EM equities remained shunned, which gold posting an 8th consecutive week of outflows, the longest outflow streak in 3 years, as well as European & EM equities, which are largely ignored by investors, US equities remain quite hospitable, attracting $5.5 billion in new funds in the past week. By sector, EPFr notes that there were 15 straight weeks of financials inflows ($0.8bn); first inflows to REITs in 9 weeks ($0.7bn); 6 straight weeks of healthcare outflows ($0.2bn)  Sadly for the active management community, there was more bad news as ETFs attracted $9.2 billion in the first week of the year, offset by $3.7 billion in long-only fund outflows.

In fact, as the chart below shows, the amount of funds that has flowed into US equities is starting to be of concern to some analysts who see in this unprecedented inflow signs of euphoria.

In a report last week, TrimTabs Investment Research also noted this unprecedented fund flow euphoria when it reported that U.S. equity ETFs issued a record $59.9 billion in December, easily surpassing the previous record of $50.7 billion in November.

So after this unprecedented deluge in new funds chasing stocks, where are we now? According to Hartnett, there are two answers: a tactical and a structural one:

Tactically: a wobble in risk assets would be no surprise in coming weeks; traders looking to play a pullback (on “sell the inauguration” or “here comes the Fed” or “CNY-reversal” themes) should note since US election the big inflows (and pullback risks) concentrated in US stocks, financials, bank loans, US value stocks, High Yield (see Chart 1); in contrast, EM, US growth stocks, Treasuries, Gold & IG have less vulnerability to profit-taking.

As a reminder, it was Morgan Stanley"s chief equity strategist Adam Parker who last week called to fade the Trump rally and "Sell the Inauguration" as "the world has materially changed". On Friday, none other than Wall Street"s most famous permabull Tom Lee suddenly became its biggest bear when he said the S&P would like slide to 2,150 by June 30, before rebounding modestly to 2,275, ending the year largely unchanged.

Hartnett disagrees because while he notes that a tactical selloff may come, "structurally" the rally will continue.

Structurally: we remain bullish risk in coming quarters (expecting double digits for Japan, Europe, UK stocks, and oil; single digits for US stocks, commodities, the USD & Emerging Markets; low/negative returns for corporate & government bonds).

What would change his mind? Even more euphoria: "We will wait for unambiguous signs of bullish investor Positioning, bullish Profit expectations & hawkish Policy from Fed/ECB, as well as outperformance from laggard risk assets in 2016 (e.g. Europe/UK – Table 1) before calling for The Big Short."

Then again, if Dow 19,999.63 can"t do it, we wonder if Dow 20,000.01 will be the long-awaited catalyst that finally unleashes the final euphoric spasm into US stocks.

Broad Market Gauge Still Hasn’t Broken Out... Yet

Via Dana Lyons" Tumblr,

One of the few indices yet to break out, the NYSE Composite is threatening its all-time highs.

One of the characteristics of the “Trump Rally” has been its breadth of participation. Sure, there have been a few sectors that have lagged badly. However, from a market cap standpoint, most indices, from micro-caps to mega-caps, have scored new all-time highs. It isn’t unanimous, though. A few broad market gauges have not quite made it to new high ground. The Value Line Geometric Composite is one that we mentioned last month. The NYSE Composite is another.

As the chart shows, the NYSE topped in May 2015 at the 11,240 level. After a tumultuous 19 months, the index finally returned to that level in December. And after a couple weeks of a pullback, it is back testing that level again, closing yesterday at 11,246.

A couple observations: First, we do not ever want to anticipate a breakout. That is, don’t buy something with the assumption that it will break out in case the resistance is too much to overcome. Think about the whole “Dow 20,000″ focus that seemed like an inevitability. Sure, it may still happen but the Dow has spent 4 weeks within inches of the level without yet attaining it. Rest assured that if a security or index does finally break out, there will be plenty of time and profits to reap should it indeed prove to be a successful breakout.

On the other hand, there is reason to be optimistic that the NYSE will indeed breakout. That optimism may partially be fueled by a potential cup-&-handle formation on the NYSE chart. As we’ve discussed on several occasions, this is considered to be a bullish pattern. What does it look like and why is it bullish? The pattern involves 2 parts, generally showing the following characteristics:

The Cup (May 2015-December 2016): This phase includes an initial high on the left side of a chart followed by a relatively long, often-rounded retrenchment before a return to the initial high.

The Handle (December 2016-January 2017): This phase involves a shorter, shallower dip in the security and subsequent recovery to the prior highs.

The bullish theory is predicated on the idea that after taking a long time for a stock to return to its initial high during the “cup” phase, the “handle” phase is much briefer and shallower. This theoretically indicates an increased eagerness on the part of investors to buy since they did not allow it to pull back nearly as long or as deep as occurred in the cup phase. Regardless of the theory, the chart pattern has often been effective in forecasting an eventual breakout and advance above the former highs.

Now, many technicians may take exception to the fact that the “handle” in this case is too short and too shallow in proportion to the cup. That is a reasonable protestation on technical grounds. However, the spirit behind the pattern’s typical bullishness remains valid, in our view, and it suggests an eventual breakout.

The post-election “Trump Rally” does not need any more confirmation for purposes of its “validation”. The emphatic new highs in many segments of the market, from small-caps to large-caps, speak for themselves. However, if the NYSE Composite is indeed able to break out to new all-time highs, it would be another feather in the cap for this market. And as with the Value Line Composite, it would certainly mean more than Dow 20,000.

*  *  *

More from Dana Lyons, JLFMI and My401kPro.

GOOD NEWS EVERYONE: Sovereign Bond Yields Are Blowing Out Again

If this doesn"t deliver us to Dow 20,000 burger, nothing will.

What"s not to like over soaring sovereign bonds yields for some of the most indebted nations the world has ever known? Brace yourselves, inflation is coming.

Did you ever wonder how sharply higher borrowing costs for an economy with $20 trillion in debt might work out for proposed fiscal stimulus projects? We"ll soon find out!

The euro crapping out v the dollar is a daily occurrence.

And here"s Germany, land of the migrant. Bunds are up an astounding 10bps, a 53% move. Bankrupt Italy surging ahead too, all boolish news, apparently.

Lastly, here a small reminder of debt/GDP ratios. Economics. It used to matter.

Dow 20,000 here we come.

Content originally generated at iBankCoin.com

Bitcoin Soars Above $1000 In China

2017 is off to a good start if you are holding Bitcoin as volumes continue to surge through Chinese Bitcoin exchanges amid fears of increased crackdowns on foreign exchange transfers in the new year. In the last 24 hours, BTC China has seen prices spike above 7,100 yuan (well over $1000 at the onshore rate exchange) as Bitstamp reports prices over $990.

Bitcoin in China topped 7,100 this morning - and with USDCNY at 6.945, that is over $1000...

Though it is not quite there in dollars...

So we now know, Bitcoin $1000 arrived before Dow 20,000.

Bitcoin in China approaches record highs...

As we noted recently, according to Bloomberg sources, Chinese officials are considering policies including restricting domestic bitcoin exchanges from moving the cryptocurrency to platforms outside the nation and imposing quotas on the amount of bitcoins that can be sent abroad. Further indicating that Chinese regulators were "just a little behind the curve", they allegedly noticed only recently that some investors bought bitcoins on local exchanges and sold them offshore, evading rules on foreign exchange and cross-border fund flows, the report further reveals.

A quick look at the uncanny correlation between the decline in the Yuan and the rise in the bitcoin, confirms that the digital currency has indeed been largely used to evade capital controls.

And it appears Bitcoin implies a notable devaluation of the yuan is looming.

As a reminder, back in 2013, the government classified bitcoin as a commodity and not currency, placing it outside the purview of the foreign-exchange regulator, the people said.  That does not mean, however, that China is powerless at limiting bitcoin"s upside.

Several Chinese government bodies including the People’s Bank of China and the financial regulators said in a joint notice that year that bitcoin functioned like a digital commodity without the legal status of a currency. The central bank said in January it is studying the prospects of issuing its own digital currency and aims to roll out a product as soon as possible.

While China dominates bitcoin mining and trading, the government has shown caution over its spread in the nation. In 2013, the PBOC barred financial institutions from handling bitcoin transactions.

The Fed's Fantasy Vs. Reality

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Dow 20,000

Last week, I noted the market’s push toward the market milestone of 20,000. To wit:

“The Dow broke above 19700 and is within striking distance of the ‘psychological’ summit of 20,000. With just 250 points to go, it is extremely likely traders will try and push stocks to that level by Christmas. Woo Hoo!”

The markets came just 30-points shy of hitting that number before retracing slightly mid-week. As “Get Smart” used to quip:

Seriously, it really was just that close.

I still suspect there is enough bullish exuberance currently to push the Dow to 20,000 and the S&P to 2,300 by the end of the year. However, I am more concerned about what happens next.

In Tuesday’s post, “Bullish Or Bearish,” I discussed several charts with respect to the market. However, this was the most important with respect to what I believe may occur after the inauguration in January.

“I have discussed previously the importance of ‘price’ as an indicator of the market ‘herd’ mentality. One of the major problems with fundamental and macro-economic analysis is the psychology of the “herd” can defy logical analysis for quite some time. As Keynes once stated:

‘The markets can remain irrational longer than you can remain solvent.’

Many an investor have learned that lesson the hard way over time and may be taught again in the not so distant future. As shown in the chart below, the momentum of the market has decidedly changed for the negative. Furthermore, these changes have only occurred near market peaks in the past. Some of these corrections were more minor; some were extremely negative. Given the current negative divergences in the markets from RSI to Momentum, the latter is rising possibility.”

In the near term, as we head into holiday-shortened trading weeks, performance chasing and end of year “window dressing,” a push higher is extremely likely. However, given the underlying detachment between “sentiment” and “reality,” the risk of a negative surprise has risen sharply.

As Bob Farrell’s rule #9 states:

“When all experts and forecasts agree, something else is bound to happen.” 

Currently, everyone agrees:

Furthermore, Spencer Jakeb made a very good point about Dow 20,000 in his latest WallStreet journal piece.

“Yale professor Robert Shiller’s cyclically adjusted price/earnings ratio now stands above 28 based on a decade of inflation-adjusted earnings for the S&P 500 stock index, which tracks the Dow closely.

That puts stocks within the most expensive 5% of all observations in 135 years.

At some Dow milestones that took years to break through decisively—100, 200, 1000 and 10000—valuation also has been elevated at an average of 24 compared with a little less than 13 when the market finally left those marks behind.”

“At the long-run rate of inflation-adjusted earnings growth, it would take about 14 years for the Shiller P/E to fall below 20 at current stock prices. That would be par for the course as it took an average of 15 years for Dow 100, 1000 and 10000 to be visited for the first and last times.

Past isn’t prologue, but keep those Dow 20000 hats around—they may come back into fashion around the year 2030.”

As shown above, the “Trump Trade” has become extremely crowded on expectations about what “might” occur rather than what has. However, much like we saw in 1999, investors piled into stocks with expectations the market advance would never end.

They were horribly wrong. 

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Fed’s Fantasy Vs. Reality

This past week, Janet Yellen and the Federal Reserve finally did something they have been promising to do for an entire year – raise interest rates.

Mind you, the lift in interest rates from .50% to .75% has hardly moved the Effective Federal Funds Rate BUT the London Interbank Offered Rate (LIBOR), which is what affects a variety of actual interest payments, has already risen sharply in recent months. In other words, the Fed is already well behind the actual market in terms of tightening monetary policy. 

Here is Janet’s statement on the rate hike:

“The committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen.“

And with that, the Fed’s “Dot Plot” shows the Fed plans to hike rates 3-times during the next year moving the Fed Funds Rate to 1.5%.

Oh, wait a second, that was what she said in 2015.

Here is what she said this past week:

“Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made and our judgment that will continue.”

And once again, the Fed’s “Dot Plot” suggests the Fed hopes to hike rates 3-times within the next year. 

The problem, and as I will dissect in a bit more detail, is the expanse betweens the Fed’s “fantasy” and economic realities. This is shown in the table below which documents the median of the Fed’s economic projections versus reality. In every single year, they have been wrong.

Yet, besides being the world’s worst economic forecasters, the market still believes statement she makes. Let’s analyze her comments and compare them to reality for a moment.

Employment

“Job gains, averaged nearly 180,000 per month over the past three months, maintaining the solid pace that we have seen since the beginning of the year. Over the past 7 years, since the depths of the great recession, more than 15 million jobs have been added to the U.S. economy. The unemployment rate fell to 4.6 percent in November, the lowest level since 2007, prior to the recession.”

Depending on where you start counting, 15-million jobs may have been added to the U.S. economy. However, there is an important distinction to be made. As shown below, the actual number of jobs created is 4.77 million fewer than the increase in the working-age population. (June 2009 to Present).

This explains why, outside of mandated minimum wage and Supervisory employee salary increases, wages and economic growth have remained exceptionally weak.

And inflation-adjusted hourly wages are also headed back to zero growth which hardly suggests economic acceleration.

Even the Fed’s own Labor Market Conditions Index (LMCI) suggests that something isn’t quite right in the economy as its 12-month moving average has now dipped below zero for an entire quarter. As I noted Thursday, she is right about one thing:

• YELLEN: LABOR MKT LOOKS LIKE IT DID BEFORE RECESSION

“Historically speaking, peaks in the 12-month average of the LMCI index have been coincident with declines in employment and the onset of weaker economic growth.

While the Fed raised it’s longer term interest rate forecast, and projected three more hikes to the Fed Funds Rate in 2017, there is a strong probability this is the same wishful thinking they have had over the last two years.

As shown in all the data above and the EOCI index below (a broad composite of manufacturing, service and leading indicators), the current economic bounce is likely another in a series of temporary restocking cycles. These cycles have been repeatedly witnessed after cyclical slowdowns in economic growth. Furthermore, as shown below, with the broader economy operating at levels more normally associated with recessions than expansions, there is little suggesting an ability to support substantially higher rates or generate inflationary pressures above 2%.”

Inflation

“Core inflation which excludes energy and food prices that tend to be more volatile than other prices, has risen to one and three-quarters percent. As the transitory influences of earlier declines in energy prices and prices of imports continue to fade, and as the job market strengthens further we expect overall inflation to rise to 2 percent over the next couple of years.”

Here is the problem.

The only inflation in the market currently is coming from spiking health care costs and rental rates as shown in the breakdown of the Consumer Price Index. It is clear where inflationary pressures have come from over the last 5-months.

Inflation can be both good and bad. Inflationary pressures can be representative of expanding economic strength if it is reflected in stronger pricing of both imports and exports. Such increases in prices would suggest stronger consumptive demand, which is 2/3rds of economic growth, and increases in wages allowing for absorption of higher prices. That would be the good.

The bad would be inflationary pressures in areas which are direct expenses to the household. Such increases curtail consumptive demand, which negatively impacts pricing pressure, by diverting consumer cash flows into non-productive goods or services.

If we take a look at import and export prices there is little indication that inflationary pressures are present. 

In fact, there are more deflationary forces in the economy currently than inflationary. Furthermore, with Housing and Medical Care extracting dollars from consumers into areas that do not boost economic growth, expectations of higher “good inflation” that leads to stronger employment, wage and economic growth are likely misplaced.

Economic Growth

“The median projection for growth of inflation-adjusted gross domestic product rises from 1.9 percent this year to 2.1 percent in 2017, and stays close to 2 percent in 2018 and 2019, slightly above its estimated longer run rate.”

Unfortunately, she will likely be proved wrong once again as she has been in every year since 2011 as “hope” is eventually faced with economic realities.

First, “record levels” of anything are records for a reason. It is where the point where previous limits were reached. Therefore, when a “record level” is reached it is NOT THE BEGINNING, but rather an indication of the MATURITY of a cycle. While the media has focused on employment, record stock market levels, etc. as a sign of an ongoing economic recovery, history suggests caution.  The 4-panel chart below suggests that current levels should be a sign of caution rather than exuberance.

Paul Kasriel summed the problem up as well:

“Notice the green line in Chart 1. It represents the year-over-year percent change in quarterly-average observations of the sum of commercial bank credit (loans and securities on the books of commercial banks) and the monetary base (reserves held at the Fed by depository institutions and currency in circulation). As regular readers (are there still two of you?) of this commentary remember, this sum is what I refer to as thin-air credit because it is credit that is created by the commercial banking system and the Fed figuratively out of thin air. The unique characteristic of thin-air credit is that no one else need cut back on his/her current spending as the recipient of this credit increases his/her current spending. Notice that growth in this measure of thin-air credit, as represented by the green line in Chart 1, has been trending lower since hitting a post-recession peak in the fourth quarter of 2014.”

“Based on published data so far for Q4:2016, the Atlanta Fed is forecasting real GDP annualized growth in this current quarter of 2.4%, down from the previous quarter’s 3.2% annualized growth. With current growth in thin-air credit already very weak and likely to get even weaker after the Fed contracts the monetary base more in order to push the federal funds rate 25 basis points higher, real and nominal U.S. economic growth is likely to slow further in the first half of 2017.”

So, if you are betting on a strong economic recovery to support excessive valuations and extremely stretched markets, you could be setting yourself up for disappointment.

Oh, and don’t think for a moment that rising interest rates, combined with a strongly rising dollar, is somehow “good for stocks.”

It isn’t.

It has never been.

Hedging portfolio risk remains prudent.