Less Negative is Positive

"A negative times a negative equals a positive."
--Jaime Escalante (Stand and Deliver)

Negative interest rate policies (NIRP) enacted by central banks across the globe in the middle of last decade spawned a mountain of negative interest-bearing debt. It was hard to imagine who was buying it although, in reality, central banks themselves were hoovering much of it up as part of their quantitative easing (QE) programs.

The worm has turned dramatically as inflation has picked up and CBs are now raising rates. After hitting a peak of about $17 trillion in 2020, negative yielding debt has plummeted to less than $2 trillion. Most of that decline has come since the beginning of 2022.

As NIRP debt declines, it seems likely that broken conventional discounting processes get repaired.

Central banks become extra big losers as NIRP reverses. They bought $trillions of negative yielding bonds that have now been pounded as rates rise and bond prices fall. Many CBs are approaching the broke point on paper.

While these institutions can simply print more money out of thin air to rectify their upside down balance sheets, this would create quite the paradox of creating more money in an inflationary environment.

TINA Turning?

All I want is a little reaction
Just enough to tip the scales
--Tina Turner

During the era of interest rate suppression, people turned to stocks, particularly dividend payers, because it seemed there was no alterative (TINA). With yields presently moving higher, the TINA attitude should dissipate as investors switch out of stock in favor of the relative safety of high yielding bonds.

Today the 2 yr Treasury yields touched 4%. This more than 2x the S&P 500 dividend yield.

The higher this spread goes, the more pressure we should see on stocks as investors flock to 'risk-free' cash yields.

CAPE Fear

I'm a walkin' in the rain
Tears are fallin' and I feel the pain
Wishin' you were here by me
To end this misery
--Del Shannon

Although stocks have come in, Robert Shiller's CAPE index suggests much more downside work must be done before 'normal' valuations return.

Could be, although I wonder how massive market stimulus and, now, structural goods/services inflation factor in.

Much Higher

I have a picture
Pinned to my wall
An image of you and of me
And we're laughing
We're loving it all
--Thompson Twins

Yesterday 10 yr Treasury yields closed back above 3%. As long duration yields rise, I've been pondering just how high they would need to be before I was a serious bond buyer.

My answer is, "Much higher."

For me, fixed income competes with dividend-paying stocks. Currently I can put together a portfolio of dividend paying stocks that pays a 3% or more in cash annually. 

Plus, those dividend yields are likely to increase over time. If yields increased 5% annually (not far from historical averages for many dividend payers), then a stock that pays $5/share annually in dividends this year will be paying more than $8/share ten years from now. 

There is also the potential for share price appreciation. These features are especially attractive to hedge against inflationary pressures like we have now.

Bonds simply do not offer the same risk/reward profile--at least at current levels.

Where would 10 yr Treasury yields need to be for me to consider them? Maybe 10% or more to compensate for the risks and opportunity costs of foregoing dividend-paying stocks.

It should be noted that these levels would approximate T-notes yields in the early 80s when the last bond bull market began.

Falling FAANG Forecast

I see the bad moon rising
I see trouble on the way
I see earthquakes and lightning
I see bad times today
--Creedence Clearwater Rivival

Couple of interesting charts. First (Chart 3) presents a ratio of resource vs biotech ETFs alongside the yield on the German 5 yr bund since 2010. The relationship is readily apparent. Lower yields favor biotech ETFs (a proxy for speculative risk taking in 'tech') relative to price of resource ETFs (a proxy for inflation and conservative positioning in 'stuff' stocks). 

Now, as rates climb higher, the ratio is moving in favor of resource ETFs. Note that the ratio has lots of room to move higher, as suggested by the previous peak in 2010-2011.

The second chart plots central bank liquidity (presumably the aggregate assets on central bank balance sheets mostly due to asset buying programs associated with quantitative easing) alongside the market cap of the FAANG+ group which, due to their immense size can be seen as proxies for the overall market--particularly the tech side. This can be seen a slightly different take on this important chart.

The relationship could not be more obvious. The trillion$ of money printed out of thin air to fund central banks asset purchases has goosed stock prices higher.

With central banks now signaling a reversal of QE programs as they address surging prices of goods and services, the ramifications of doing so are ominous for stocks--particularly those of the speculative FAANG variety.

Freak Tweets

All that pressure got you down
Has your head spinning all around
--Chic

Elon Musk has upped his ante on the Twitter saga (TWTR) by offering to buy the entire company for $54.20/share, or about $41.4 billion. That constitutes a 20% premium over Thursday's close.

Not surprisingly, leftists extended their previous freak out over the prospect of losing control of the platform to someone who differs from them ideologically. Matt Taibbi discusses some of their absurd arguments.

Many leftists trotted out the wealth card, railing against the idea of a rich person buying/controlling a media outlet. Ironically, several of these screeds were floated by people affiliated with the Washington Post, a newspaper by Amazon (AMZN) founder Jeff Bezos. Bezos has a net worth north of $150 billion. 

What leftists are saying, of course, it that it's ok to own a media company if you're a rich leftist. Otherwise...

More irony streamed from leftists screaming that Musk's bid should spark more government regulation of media companies. Follow the logic: We need regulation...to prevent rich people from controlling our channels of communication.

It gets weirder. 

Another tranche of leftists complained that they are terrified that Musk will censor people less. One leftist tweeted, "He seems to believe that on social media anything goes. For democracy to survive, we need more content moderation, not less."

Although this is wholly consistent with previously shared survey data on censoring, I find myself pausing to let this train of thought sink in.

The most laughable reaction may have come from former Clinton labor secretary Robert Reich--known for his forays into socialist drivel (e.g., here, here). Reich suggests that a Musk-led Twitter "wouldn't be accountable to anyone for facts, truth, science, or the common good." 

Censoring, you see, is for the common good. And, as we have witnessed over the past few years, it is the censors who determine what facts, truths, and science are fit for you to see. Media outlets must be held accountable--accountable to the censors.

Because he threatens their charade, the left must oppose and, if necessary, seek to destroy Musk.

Allegorically fitting on this Good Friday.

no positions

Monetary Cease Fire

It's 2 am, the fear is gone
I'm still sitting here, the gun still warm
Maybe my connection is tired of taking chances
--Golden Earring

Last week the Fed made a final bond purchase before shutting down its fourth round of QE operations. 

During the most recent round of QE, which was instigated during the CV19 panic, the Fed has added an additional $5 trillion to its balance sheet--on top of the roughly $4 trillion from the previous QE junkets.

As shown above, QE programs by the Fed and other central banks around the world have lit a fire under asset prices. Any attempt to unwind QE balance sheet assets has led to lower prices.

This begs questions about the durability of this monetary cease fire. What will the Fed do with those $trillions on its balance sheet? And how long will it be until QE5 fires up?

Dividends Bid

So much for your promises
They died the day you let me go
Caught up in a web of lies
But it was just too late to know
--Johnny Hates Jazz

Rising interest rates should put pressure on dividend paying stocks, as market participants swap out of riskier equities for fixed income streams perceived as more secure. So far, however, it hasn't been working out this way from where I sit. In fact, quite the opposite.

Most dividend-paying stocks that I follow have been catching bids and are at/near their highs.

One possible explanation is that higher rates are causing many fund managers to sell bonds in order to manage risk (bond prices decline as rates rise). To recoup some of the lost cash stream, perhaps some managers are plowing the proceeds into dividend-paying stocks.

Far fetched? Maybe, as one would think higher coupons of new bond issues would entice the opposite trade: sell stocks in favor of higher yielding bonds. 

But am have trouble coming up with plausible rival theories that explains the current bid underneath dividend payers given the current field position and macro backdrop.

Yield Signs

When it gets too much
I need to feel your touch
--Bryan Adams

Ten year Treasury yields are now north of 1.9%. While not high by historical standards, T-note yields are beginning to challenge stock dividend yields. The yield on the S&P 500 is only about 1.3%.

Higher bond yields will slowly pry income-seeking investors away from stocks.

One more thing for the Fed to worry about...

Holing Out

Oh no, no, no
I'm a rocket man
Rocket man burning out his fuse
Up here alone
--Elton John

Nice stick save by Hoofy's Heroes to pull market out of the abyss yesterday. The short covering rally that began midday reversed a -1000 down day on the Dow and even added the better part of percent.

The rebound leaves a sense of more unfinished downside business pending. Perhaps we're seeing it this am, with the Dow down nearly 800 this am.

Personally, used yesterday's melt to pretty much top off where I wanted to be in the miners. Also picked here and there at small positions and pockets of value. 

Will look to do more of that if prices head lower.

De-FANGed?

Dark in the city
Night is a wire
Steam in the subway
Earth is afire
--Duran Duran

Like markets as a whole, the FANG complex has run up alongside central bank balance sheets.

However, in early 2022 this group has sold off hard (above graph precedes the decline), presumably in anticipation of a hawkish Fed. 

Because of their huge market caps, FANG stock weakness is beginning to weigh heavily on the major indexes. The NASDAQ is down more than 10% thus far in January and is poised for its worst annual start since the 2008 credit crisis. 

It's easy to imagine how this situation could snowball. If it does, then prepare for the Fed, beholden to stock market performance, to begin backing off their hawkish stance.

As always.

Important Chart

There's a room where the lights won't find you
Holding hands while the walls come tumbling down
When they do, I'll be right behind you
--Tears for Fears

Have been looking for an updated version of this chart for a while. Finally found one courtesy of maven Stephanie Pomboy.

The chart continues to tell an important, if not THE, story behind the huge rise in stock prices (as well as other asset prices) since the 2008 credit crisis.

The graph plots balance sheet assets of the Federal Reserve alongside the S&P 500 Index (SPX) from 2009 thru the end of 2021. The correlation between the two series is unmistakable. Increases in the Fed's balance sheet, which has more than quadrupled in size since 2009, correspond to increases in overall stock prices.

What has caused the Fed's balance sheet to increase so dramatically? The primary driver has become known as 'quantitative easing' (QE)--a program designed to, among other things, stimulate economic activity after major calamities such as the 2008 credit collapse. 

When conducting QE operations, the Fed purchases securities (mostly Treasury and agency bonds) from financial institutions that deal in those securities. For instance, the Fed might observe $100 million in Treasuries sitting in J.P. Morgan's (JPM) inventory, and then buy them all by placing a credit of $100 million with JPM in exchange for the bonds. The $100 million in Treasuries is added to the Fed's balance sheet.

Where does the Fed get the $100 million to buy those bonds from JPM? Out of thin air, baby. It creates the money with a few clicks of a mouse. 

The freshly minted cash now in the hands of financial institutions can be used to fund everyday operations, including trading and speculation in financial securities. As implied by the above graph, a sizable fraction of this cash has gone into stocks over the past decade or so.

It should be noted that the relationship works in reverse as well. When the Fed has halted QE operations over the past decade, stocks generally move sideways along with the value of the Fed's balance sheet assets. And, although you have to squint to see it, on the rare occasion that the Fed has attempted to unwind (read: sell) assets from its balance sheet (which has the effect of removing some of that magically printed money from the financial system), stock prices have fallen.

The only time this relationship did not hold was 2018-2019. Despite Fed efforts to curtail QE and even unwind balance sheet assets during this period, stock prices continued to rise. However, as indicated by Stephanie on the graph, this period also corresponds to a time of tax cuts and deregulation that was favorable for stocks. Stated differently, the bullish backdrop essentially overpowered the bearish forces of Fed actions on stock prices.

The relationship quickly got back on track in early 2020 when the Fed embarked on a gargantuan QE program in response to the onset of COVID-19. The Fed's balance sheet has more than doubled since then to over $8 trillion. The value of the SPX has commensurately doubled as well. 

Moving forward, the relationship between QE and stock prices has important policy implications. As inflationary pressures grow, the Fed may be tempted to curtail or perhaps even reverse its bond-buying practices. Although doing so would relieve inflationary pressures that the Fed itself helped to create, stopping or reversing QE is likely to put downward pressure on stock prices. Any policy that tanks the stock market promises to be politically distasteful.

Whatever the Fed and other central banks who have engaged in QE decide to do from here to address the inflation that they themselves brought about, you can bet that they are looking at the same chart we are...

no positions

(In)efficient Markets

I know I could break you down
But what good would that do?
I could surely never know
That what you say is true
--Information Society

The 'efficient market' hypothesis (EMH) posits that investors process new information quickly and accurately, resulting in prices that quickly adjust to the news. In fact, that news is often anticipated in advance of it actually happening.

There are several problems with the EMH. One is that it treats investors as a monolithic entity rather than segments and individuals who tend to process information differently. Fund managers, for example, are likely to process new financial information differently than retail investors.

Another problem is that the effect of new information may be difficult to determine. Is, for example, the Fed's recently announced initiative for combating inflation bullish or bearish for stocks? Moreover, is it likely that the Fed will actually follow through on what it says, or is this merely another example of the 'open mouth committee?'

A third problem relates to how long it takes to process information. Some information may be complex, taking a long time to chew through before actionable conclusions can be drawn. Consequently, considerable lags might precede market price movements. 

Immediately after the FOMC's announcement yesterday, for instance, gold didn't move much. However, this morning the metals and miners are ripping higher. Perhaps investors needed time to digest the announcement overnight in order to come to judgment about the macroeconomic implications of the news before acting.

These problems have prompted some theorists to posit that markets are only 'semi' efficient. Perhaps, but semi efficiency vs outright inefficiency seems only a matter of degree.

position in gold

Forty Year High

And when I'm lost 
You'll be my guide
I just turn around
And you're by my side
--Madonna

The CPI printed at +6.8% YOY this am, the highest annual rate in almost 40 years. The inflation gauge has now exceeded 5% for six consecutive months.

In what may retrospectively be perceived as one of the larger market disconnects on record, gold continues to languish in this environment. Bullion has more or less flatlined on the news and the miners have been sold, with many names marking new lows for the move.

I continue to add to the sector on weakness, and to shift bullion ETF funds into miner shares, as it seems the stars are favorably aligning the risk/reward relationship for precious metal producers.

position in gold

After the Masquerade

I can only stare
You make me feel
Like I don't care
--Pete Townshend

Over the past year or so I've had recurring feelings of dotcom deja vu. It hit me again a couple of nights back while I was watching the after-hours tape slide by on CNBC (something I rarely do anymore). As the stock names travelled across the bottom of the screen, I realized just how few of them that I had heard of.

It turns out that many of the underlying companies sport little or no sales, much less profits. Yet, they regularly sport markets cap in the tens of billions of dollars.

Similar to the eyeball propositions of the dotcom names twenty years ago, extreme optimism has pumped up these 'concept stocks.' As Fleck recently opined, many of these stocks represent "business plans masquerading as companies."

Of course, those participating in masquerades usually have to reveal who they really are at some point. Twenty years ago, investors didn't like what they saw when the costumes came off.

They may be in for a similar awakening.

Positioning for Retirement

Doing the garden
Digging the weeds
Who could ask for more?
--The Beatles

With retirement coming up fast I've been doing a few things w.r.t. personal finance. I've been saving more and spending less in order to build cash. Have also been selling some stuff on ebay and elsewhere to collect extra 'juice.' Also helps thin things out at the house--much needed.

Preparations are being made to rollover my 401(k) from work. I'm looking forward to allocating this capital among far more choices than those available thru the current fund administrator.

In both my brokerage and IRA accounts, I've been buying dividend paying stocks. Dividends are real cash that can provide a significant, and perhaps under-appreciated, income replacement in retirement.

Inflation is particularly bad for retirees as it erodes purchasing power of savings. To hedge against the prospects of Big Inflation, I've been building stock positions in the oil complex (e.g., ENB, XOM) and miners (e.g., AEM, AGI, PAAS). 

The miners appear particularly attractive. The financial strength of many in this group has perhaps never been better. Solid balance sheets and cash flows. Many are paying significant, and increasing, dividends (which helps me kill two birds with one stone). The sector has been pounded down to attractive valuation levels--particularly given the growing inflationary environment.

I've been swapping funds out of precious metal ETFs such as PHYS and into the miners to more fully express my perception of this situation--albeit at a slightly higher risk profile. 

positions in AEM, AGI, ENB, PAAS, XOM

Dividend Geese

Billy Chapel: Are you saying I should retire?
Gary Wheeler: Why not? It wouldn't hurt the negotiations. And it would serve those sons of bitches right.
Billy Chapel: I, uh. I don't know. I don't know what to say.
Gary Wheeler: Well, you can't tell me that you haven't thought about it. And you've been smart with money, right?
--For Love of the Game

Until recently, dividends didn't matter much to me. Like most investors, I focused on price appreciation potential. 

A few years back my brother reacquainted me with the value of cash dividend payouts. Managing my mom's portfolio, he invested primarily in stalwart dividend paying stocks. Over time, he built an income-producing machine capable of covering a large share of monthly living expenses. Yes, the portfolio gradually increased in value as well. But so did the dividend payouts.

The capacity of a well-designed stock portfolio to generate income--particularly 'replacement' income for retirees--impressed me, perhaps in part because I'm approaching retirement myself.

In the olden days, common wisdom was that aging people in need of income replacements should invest in bonds and other fixed income instruments. Being traditionally less volatile, fixed income was seen as less prone to big capital loss. Moreover, many fixed income instruments tended to offer yields superior to stocks.

In the late 1970s/early 1980s, for example, 10 yr Treasury yields traded north of 10%. Those cash payouts were far higher than dividend yields on stocks. Of course, inflation was also flying which negated much of those cash gains.

Since then, of course, T-note yields have been in secular decline--due largely to interventionary policies of the Federal Reserve. Dividend yields on stocks have also declined as shown by the yield in the S&P 500 since 1900.

Overlaying the two trends reveals a couple of things. One is that stock dividend yields have not always been lower than bond yields. In early decades of the 1900s, stocks generally yielded more than bonds by a couple of percent. The other note is that, more recently, the offset between stock and bond yields has narrowed to the point where cash returns on stocks once again looks attractive.

Index-to-index comparisons tend to understate the superior cash-yielding capacity of stocks. For example, the yield on the S&P 500 Index currently stands at about 1.3%. However, many stocks in the SPX pay tiny or no dividends. Investors can readily assemble a portfolio of reliable dividend payers from the SPX with an overall yield north of 3%. This handily beats the current 10 yr Treasury yield of about 1.5% (and nearly all other fixed income alternatives for that matter).

If Treasury yields should rise relative to stocks then the calculus changes, of course. That said, because central banks worldwide are determined to suppress sovereign yields, large increases in bond yields seem unlikely unless policy makers lose control of the interest rate markets. While this could certainly happen, it is likely to occur in the context of Big Inflation. Big inflation jeopardizes the attractiveness of bonds. Moreover, companies may be able to navigate inflationary environments in a manner that preserves value. Dividend payouts might even increase.

Preparing for retirement, then, I view the cash-generating capacity of dividend paying stocks as central to creating 'replacement income' when the paychecks no longer roll in. Essentially, the dividend payers write the checks instead of an employer. The more I can draw on steady-to-rising dividend payments, the less I will have to cut in on the principal that generates the cash.

Stated differently, I don't want to kill the dividend-paying geese that lay the golden eggs.

Bad Breadth

The news is blue
It has its own way to get to you
What can I do?
I'll never remember my time with you
--Sniff 'N' the Tears

Despite new highs in major equity indexes, stock market breadth has been weakening. This means fewer and fewer names are propping up the averages.

When investors become more risk averse, they first rotate out of higher beta, racier names and into stocks deemed 'safer.' Money flows to mega caps thought to be market stalwarts and less susceptible to big declines. This means names like Google (GOOG), Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), et al have been attracting disproportionate funds at the expense of smaller issues. 

Because of their huge market caps, these stocks can move the indexes higher even though most issues aren't going up. The bulls still feel good, however, because the indexes are still increasing.

As sentiment continues to shift, however, investors decide that even the big names are vulnerable and begin to unload them. When that happens, there is nothing left to support higher prices.

The bears then slide into the driver's seat.

no positions

Lagging Value

Then you say
'Go slow'
I fall behind
The second hand unwinds
--Cyndi Lauper

In trending markets like this one, finding value is difficult. However, there's usually a name or two on an investor's watchlist that has been lagging. Sometimes for good reason. But often for trivial reasons.

On my watchlist, Merck (MRK) fits this profile. The company just spun off some over the counter assets which subtracts from its market cap a bit. Plus, investors seem constantly worried about the staying power of its blockbuster oncology drug Keytruda.

The spinoff means that the remain Merck is more focused on high impact medicines. Very much inline with the company's historical mission.

Short term chart show the stock as oversold and on support.

Longer term chart suggests a rounding top pattern (bearish), but with a couple layers of support below.

As a long term investor, I've always liked this stock as an anchor position. The stock currently yields 3.6% to boot. Have been adding here and there.

position in MRK

Letting It Fly

Time keeps on slippin,' slippin,' slippin'
Into the future
--Steve Miller

The always insightful Stan Druckenmiller zooms with the USC student investment fund group. In the first 20 minutes he offers prepared remarks, primarily concerning his current macro view, while the remainder is Q&A.

Druck lets it fly in part one. After unprecedented monetary and fiscal intervention in response to CV19 last spring, he contends that both the federal government and the Fed are being reckless on a historic scale by continuing to pump stimulus into the system after indicators show that the economy no longer needs assistance. Debt has exploded and prices are rising. He is preparing his family trust fund (a few $billion large) for Big Inflation with bets against the US dollar and on commodities. 

Although he remains long stocks, Druck says that he'll be surprised if he isn't out of equities before year end. I'm not sure whether he thinks inflation will hurt stocks or whether he believes prices are too high (he mentioned that he sees bubbles in nearly all assets classes).

Several interesting notes from the Q&A. On lessons learned from his mentors, Druck highlighted the advice he received about envisioning what things will look like in 1-2 years rather than where things are today. Today has already been priced in. Also enjoyed the Soros story about sizing positionss accordingly. Attractive opportunities should be well funded.

Re digital currencies, he suspects that the dollar et al will be headed electronic. However, he isn't keen on Bitcoin or its brethren being the chosen one.

On unequal wealth distribution, Druck suggests there has been no greater facilitator than central banks--a point these pages has made before.

In prepping for inflation, was surprised there were no questions or comments on gold. I'll take that as a bullish contrarian indicator...

His remarks on shorting also surprised me. While the last 10-12 years have been 'miserable' on the short side, Druck said that recently his shorts have been doing better than his longs. Moreover, given the historic macro situation, he suspects that upcoming years may be very friendly to shorting assets that are wildly overpriced. 

This inspired me to start thinking about setting aside modest short side space in my taxable account for some put projects. Also set up a short candidate watch list. 

position in gold