Where Are The Markets Headed Now?

So the Fed yesterday announced that they will delay rate hikes YET AGAIN with a higher probability to hike later this year. That brings me to my ultimate question of where they are headed?

Some may be optimistic, while others, such as Larry Fink are a little more pessimistic. Fink believes that there could be a huge correction (15%) if governments don't take fiscal policy actions combined with aberrant results from referendums in Europe.

However,

" If governments move to spur their economies, then markets could go in the other direction and rise 10 percent, he told Erik Schatzker Thursday on Bloomberg Television."

There is persistently a growing anger from low rates hurting savers and pension plans while people with large sums of capital are benefiting.

Fink sees a Federal Rate Hike probable in December.

"We are in more dangerous water in Europe than we have been in years," said Fink. He pointed to the upcoming referendum in Italy where voters will decide on constitutional changes proposed by Prime Minister Matteo Renzi to limit the power of the Senate, the upper house of parliament."

Source

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Comments (19)

Best Response
Sep 22, 2016

keep in mind this is all through a US lens, and while I invest internationally as well, I'm most versed here at home.

by "where are they headed?" what time frame are you talking about? next week/month/year I haven't the foggiest idea, but I know long term, they're headed up. there are a few major themes going on right now, all somewhat related.

  1. low discount rates - in theory this was supposed to open up credit which helps spur the economy. it didn't. instead, it buoyed asset prices, directly in fixed income, which then affected equities, which brings us to...
  2. high absolute valuation, acceptable relative valuation - TINA is operative (there is no alternative). we have a positive equity risk premium as long as the 10y stays so low, and since the Fed appears accommodating, investors may not fear that rate hikes will greatly affect this premium, so stocks get bid up. all else held equal, what would you rather have: a 5-10y bond yielding less than 2%, or stock in a company like Cisco with a 3%+ dividend plus potential appreciation? that's the mindset right now.
  3. low earnings growth - nothing wrong with this fundamentally, companies have fits and starts, booms and busts, this is normal in the business world, the problem is valuations usually are indicative of companies' growth prospects. so the only reason valuations are high is because rates are low, not because growth is high. the problem is investment is low. spending is OK at best, gov't spending (despite what my conservative constitution says) is low (the parts that affect GDP anyway), and exports? fugeddaboudit.

amidst all this, there's a ton of noise that doesn't affect the US economy a ton, but will move markets nonetheless:

  • geopolitical conflict/nonfinancial disasters - except for EMPs, solar flares, yellowstone erupting, or a tidal wave sending NY and SF underwater, there's not much outside of financial markets that can do long term damage. syria is a mess, and the terrorist attacks worldwide will spook a lot of people, but even those aren't another 9/11. 9/11 was bad, but it was volatility on the heels of extreme valuations, not justified panic selling
  • anything related to china - I may be in the minority, but I think we can peacefully coexist. they need us as much as we need them
  • oil - important for earnings to be sure, but supply and demand will eventually rule. the saudis and persians can only continue this pissing match for so long before someone blinks.
  • Fed watching - when they move, it will be glacially, but as I'll expand on more below, they don't have as much control over markets as they'd like to believe.
  • political grandstanding - volatility around drug prices, bank regulation, arms sales, whatever it is this month is all crap. if it leads to structural change in certain industries, I'll bite, but until then, I'm keeping my biotech & financials holdings.

I see 2 outcomes possible:

  1. we see from the next president (regardless of who wins) the biggest infrastructure project since the interstate highway system, GDP goes over 3%, stock market goes up at least 10%, earnings somewhat faster, so multiples become more reasonable. there will be doubts along the way, so expect some corrections, but don't expect anything like 01/02 or 08.
  2. rates rising has an unexpectedly bad effect on credit. companies that got floating rate debt because of low rates see their now higher rates cripple them financially, and credit markets seize up, causing many follow on effects to the economy, on top of that I believe we'll get a 20-30% correction. eventually, the shitty credits get bought up/restructured, and the economy comes back healthier, but in more of the sideways manner we've seen in the past 15 years.

the problem is those outcomes are dramatically different, one calls for full investment in equities now, the other for a healthy cash cushion. if you want to know where to put your money, I'd be 70-80% invested in stocks right now, with the remainder in cash to pick up bargains as you see opportunities.

I also don't think the fed has as much control over the markets as they think they do. credit markets could freeze if people stop buying our bonds, regardless of what the Fed's policies are. they could say "yaknow, US isn't as great as it used to be, maybe I'll buy some stuff from Japan instead of the 10y," once foreign money leaves for any reason (higher rates abroad included), we could see the bond market implode, which would NOT be good. very few people (myself included) have lived through bond market stress (not counting HY in 08), but it won't be pretty.

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Sep 22, 2016

Nice summary... what % would you allocate to gold right now? I'm just wondering because I'm around 35% but I have a fairly pessimistic view of this Fed inflated market.

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    • 1
Sep 22, 2016

0%

unlike a stock or a bond where you can value the asset based upon future cash flows either from interest, maturity, dividends, earnings, rents, etc., gold's value is subject to the greater fool theory. if you're worried about the USD losing its value, buy multinationals (P&G and JNJ do well when the dollar falls because they're multinational). if you think all currencies are going down, buy currency hedged ETFs or funds (Tweedy Browne has a few).

there are times when gold is worth more, but gold is better as a trade, not as an investment. I'm very biased as you can tell, and I'm sure there are others @jankynoname for example (who is very intelligent and loves gold) as well as john mauldin who like gold, I just will never own it because it doesn't meet my definition of an investment (ability to be valued based upon cash flows)

edit: if you're worried about inflation, hard assets (MLPs, particularly midstream, real estate, and to a lesser extent BDCs) would be a good option.

double edit: for people who don't know what I mean by greater fool theory, it means your investment is only worth what the next person is willing to pay for it, since there's no underlying business, property, or debt claim on it. so in essence, you hope there's a "greater fool" willing to pay more for your investment than you did.

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Sep 22, 2016

Interesting take, thanks +1

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Sep 22, 2016

Appreciate your take

What is your view on commodities, as that class seems to fall somewhere in the middle concerning your views on trades vs investments? Just curious - I know you addressed oil from a macro standpoint. Do you view commodities as a viable currency hedge? When structuring a portfolio or recommending one (apologies, I do not know exactly what you do), what % weighted in that asset class might you be?

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    • 1
Sep 22, 2016

I view them the same way as gold, and just so you know, I'm talking about commodities like oil, ag, metals, and so on, not companies like exxon, kinder, or conagra, which are affected by commodity prices. I must admit I'm not a commodity guy, I'm less educated on it than I am equities and fixed income. @Eddie Braverman was a commodity guy, I'm sure he can give a good rationale for the asset class, but I'm just not a fan.

I also don't believe in the value of currency hedging long term. over time, it's a net neutral, so unless you're skilled enough to take the hedge on and off, I don't recommend fucking with it. on top of that, multinationals do their own internal hedging so I'd rather focus on buying the right companies and letting them deal with the hedging.

to answer your last question, we currently have 0% in commodities, unless you count midstream MLPs, which is more infrastructure than commodities. hope this helps

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    • 2
Sep 23, 2016

Hi, @thebrofessor, thanks for the breakdown. You mentioned financials, could you expand on that? Thoughts on long term index options?

Sep 26, 2016

Banks mostly, also payment processing which could be considered technology. despite regulation, well run and well capitalized banks will be profitable long term

edit: didn't answer the options question. we don't do options, though if I were to do so, it'd be covered calls only.

I firmly believe in the adage: the best way to make a small fortune in options is to start with a large fortune.

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Sep 23, 2016

oil - important for earnings to be sure, but supply and demand will eventually rule. the saudis and persians can only continue this pissing match for so long before someone blinks.

I'm in agreement on this, but to an extent. History tells us that following every down cycle in crude (and thus lack of CapEx by every major upstream player) crude spikes to previously unseen highs, either naturally, or synthetically through geopolitics.

However,in the short term, I see this being a point of principle for Saudi with respect to Iran, and Russia with respect to the USA. Many seem to have missed the fact that Russia are currently pumping at the highest levels seen since the Soviet Union, whilst looking to increase capacity.

Secondarily, I believe that China and Saudi holding so much US Govt Debt will inadvertently affect the Fed's hiking cycle.
With Saudi's capacity and market share of crude markets, they can synthetically create the 'global headwinds' that allow a dovish Fed/Yellen to leave rates on hold.

My gut tells me that we shall see a steady yet volatile rise to $60/$70 (WTI) by the end of next year, followed by an explosion to the upside targeting around $125-135.

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Sep 26, 2016

wow. I'm following some of what you're saying, but like you mentioned Russia is pumping at historic levels (as well as other top OPEC producers). And a slowing global economy leads to slowing demand. What are you saying would cause this upside explosion in the price of WTI? One of these countries to cut producing drastically or nearly all together? I was under the impression that as oil hits $50, several US shale producers (in the Permian Basin and surrounding areas particularly) can afford to produce and will ramp production back up. This combined with the fact that the Middle East has some of the lowest break-even prices in the world on producing a barrel means they have no reason to slow down and can continue to try to bleed everyone else out and gain market share. I'm just curious as to your reasoning to why you see oil going back up? (Besides the comment about historically crude spikes after down cycles.. I just don't see any fundamental Supply and Demand shifts that would cause this)

Sep 26, 2016

As I mentioned, I can see a sustained yet volatile drag from present pricing to $60 to $70/ barrel as more producers start to ramp back up to previous production levels.

However, the CapEx crash in upstream operations over the past few years comes into play in the longer term. If there are less confirmed stores, as a consequence of lower exploration (CapEx heavy) and demand remains relatively stable, I see an explosion based on supply and demand.

As a side note, I'm still dubious that US Shale producers would jump back into the market at break-even prices. I would see an aggressive ramp up in Shale production at $50 to hold much more risk for producers than a sustained increase, as it would have a much lower price/production impact on the market.

However, I'm just a rates trader, there will be many more informed guys on the energy desks.

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Sep 26, 2016

No this is cool. I just like hearing other's opinions. FWIW, I'm just a student with an interest in the energy space. I can definitely see how current heavy capex cuts will lower supply in the long run. I don't understand how producers starting to ramp back up production levels would make the price rise up to 60-70, shouldn't that increased production (supply) have a negative effect on prices? (I guess the key words to your point would be sustained yet volatile drag) And for US shale producers I hope they learned from last time not to ramp up production so aggressively, but they did it before and a lot of them (in the region I mentioned) have break even prices in the mid 30's. I just think it would take a major shift either macroeconomically or geopolitically for us to see a rise in prices within the next few years. The new technology of fracking gave us much more oil then we ever knew we had, new drilling methods and technology since then has allowed us to pump these wells for years longer and produce more oil, for cheaper, than we originally thought possible. This combined with OPEC showing no signs of slowing (the proposed Doha talks of capping current levels, which were historically high, would have had no material effect on S&D and seemed to be more of a ploy for the markets to respond positively to the news). In summarization, the decrease in production has been minimal at best and the deteriorating economies of the world show no signs of helping the demand side of the equation. I think $100 was way above equilibrium price and we will continue to see oil hover around $50 (at least until next summer) as producers will flood the market when it is profitable for them, even if that cannibalizes their own future profits by pushing the price back down.

Sep 26, 2016

As more players join / increase output, prices should be depressed. However, I'm pretty confident that most of the traditional wells (which take longer to bring online) won't be brought into action immediately. I feel that the Shale space, with a shorter time to market, will drive the volatility through short term S&D in the sustained drag, however, we will still see a movement to the upside.

To respond to the pricing issue, I would look at how crude has behaved this year. No real fundamental change in S&D, however we have tacked on ~$10/barrel. I feel more confident about hitting $60-70 over the next 12-18 months than $25.

I do agree with your point on technology advancements, however I would expect to see the effect of the improved tech accurately priced into the futures curve by producers. I'm also in agreement regarding demand.

In my opinion, Doha was nothing more than Saudi reasserting it's authority/ gaming Iran in the crude markets. I am intrigued to see what Khalid al Falih offers as Saudi's energy minister. Al Naimi was largely viewed as a rational, stable figure in the crude markets, yet having spoken informally with Saud nationals, the same cannot be said for al Falih.

Also of note is how much US Govt debt is held by Saudi, and what they stand to loose from an aggressive tightening in Fed policy. Hence some of their announcements/policies seem to have been timed to create the 'global headwinds' that are holding Yellen back.

Just my $0.02.

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Sep 28, 2016

Okay yeah I can buy that with shale coming back online much quicker than traditional wells and causing some volatility as we continue to see movement upwards on prices.

Definitely see what you're saying in the 2nd paragraph; my only counter would be the general seasonality of crude prices, which historically hit their highs in the summer and lows in the winter. I think that could have something to do with the $10 increase we've seen and could mean a slight decrease in prices this winter. But overall yes $60 seems more likely than $25 in the next year and a half.

Definitely agree on Saudi flexing on Iran with the Doha talks. I never knew about the change in energy ministers, that could definitely play a huge role if this the new guy is as you described. Very interesting and something to keep an eye on.

Interesting point as well with the Saudi's financial incentive to keep our rates low. Is their large holding of US Govt debt due to the 'petrodollars' agreement? I just recently even learned about this, and it seems like that system has made huge macroeconmical shifts in the currency and commodities market for decades.

Thanks. I love hearing this stuff and find it all fascinating.

Oct 3, 2016

Whilst I agree with crude seasonality (which I forgot to mention), I think the recently released production cuts by .5million bpd is more of a psychological signal than any real change in crude supply, although it will act to pull forward the global market rebalance to 2017, instead of 2018 as some were suggesting. Damien Courvalin & Jeff Currie recently put together a research note where they expect crude to add $7-10pb by the end of the year, it's worth a read.

Apologies for the slow reply, I am currently in the Gulf on vacation!

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Sep 22, 2016

Oh boy oh boy I can't wait to put that ''No'' in the referendum ballot.

Sep 23, 2016

This is going to be completely non-controversial, but I agree with @thebrofessor 100%. I used to be quite the gold and silver bug and did extremely well (even shared a few trades publicly here on WSO). That said, it's a trade, not an investment (exactly what @thebrofessor said).

As a former commodities trader you'd think that I'd have some now but I don't. That isn't to say there aren't decent trades out there (there always are), I just haven't put in the work to figure out which way is up in this interest rate environment vis a vis commodities prices. There are the trades I'll do every year regardless (short coffee in May, etc...), but aside from those I'm flat.

Mostly I've gone deep into the startup realm over the past five years and that's where I make all my money now. Not particularly helpful when it comes to answering OP's question.

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Sep 23, 2016

As someone that knows zero about the coffee market could you expand on why you always short it in May? I'm interested.

Sep 23, 2016

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