Unleashing Those Animal Spirits?

Alistair Smout of Reuters reports, World stocks hold near 16-month highs after strong week:
European shares hit their highest level for 11 months, and were set for their best week since February, following the ECB's decision to trim the size of its bond-buying program while also extending it for longer than many analysts had expected.

The ECB said it would reduce its monthly asset buys to 60 billion euros ($63.7 billion) as of April, from the current 80 billion euros, and extend purchases to December from March - three months longer than some analysts had forecast.

That dragged down two-year yields across Europe and sharply steepened the yield curve, a gift for banks that typically borrow short maturities and lend long.

European bank stocks pulled back on Friday, dropping 0.5 percent, but were still up nearly 10 percent for the week, with the sector set for its biggest weekly rise since December 2011.

One month on from November's U.S. presidential election, world stocks have gained nearly 4 percent, with Wall Street spurred to all time highs on hopes of higher growth and inflation as a result of President-elect Donald Trump's planned fiscal stimulus.

Analysts said that signs the ECB would continue to provide monetary support for as long as needed complemented the promise of fiscal stimulus, in a welcome cocktail for investors.

"Markets already excited by the prospect of a fiscal stimulus wave via a Trump election look in line to get more of both fiscal and monetary stimulus from next year," said Mike van Dulken, head of research at Accendo Markets.

"(That's) the best of both worlds for investors."

In all, Europe's STOXX 600 was up 0.6 percent.

The euro dipped for a second day, after Thursday's ECB announcement drove its biggest daily loss against the dollar since Britain's vote to leave the European Union in June.

It was trading around $1.0576, down nearly 0.4 percent against the dollar, having spiked as high as $1.0875 on Thursday in initial reaction to the ECB move.

The dovish tone of the ECB also saw a fall in euro zone borrowing costs, led by Southern Europe, though some said 2016 was the high water mark for monetary easing.

"You have to say central bank stimulus has peaked in 2016," said Charles Mackenzie, chief investment officer, fixed income, at Fidelity International. "The ECB are committed to keep quantitative easing continuing, and Bank of Japan has some way to run, so there’s still a lot of QE going into 2017, but you have to say it has peaked."

The ECB's bond purchase changes came less than a week before the Federal Reserve's policy meeting next Tuesday and Wednesday.

Interest rate futures implied traders saw a 98 percent chance the U.S. central bank would raise interest rates by a quarter point next week, and about a 50 percent chance it would raise rates by at least another quarter point by June 2017, according to CME Group's FedWatch program.

The dollar index, which tracks the greenback against a basket of six major rival currencies, was up 0.2 percent on the day at 101.32, up 0.6 percent for the week.

The dollar was up 0.6 percent at 114.72 yen, moving back toward last week's 10-month high of 114.83 yen.

Asian shares edged down on Friday but were on track for weekly gains. MSCI's broadest index of Asia-Pacific shares outside Japan dipped 0.2 percent, posting a weekly gain of 2 percent.

Japan's Nikkei stock index ended 1.2 percent up at its highest closing level since December 2015. The Nikkei earlier topped the 19,000-level for the first time in a year, as investors saw both the weak yen and prospects of Trump adopting reflationary policies benefiting Japan's major exporters.

Oil built on its gains after rebounding overnight on growing optimism that non-OPEC producers might follow the cartel's lead by agreeing to cut output.

U.S. crude added 0.9 percent to $51.32 a barrel. Brent crude rose 0.7 percent to $54.23.

Spot gold was down 0.4 percent to 1,166.1 an ounce and was set for a weekly decline of 0.9 percent, pressured by the stronger U.S. dollar and expectations that the Fed will raise interest rates next week.
It's Friday, so I get to relax my mind a little and focus on what I love focusing on, stock markets and global macro trends.

Before I get into it my market analysis, please remember that the comments I provide you are free but institutional and retail investors are kindly requested to show their support by subscribing or donating via PayPal under my picture on the right-hand side (view web version on you cell phone to see PayPal options).

Now, let's get into it the markets and have some fun. I'm going to teach you how to read charts and make sense of macro trends so you can be more aware of all the moving parts that drive stocks, bonds, and currencies as well as what risks still lurk out there.

I view the world as a constant struggle between inflation and deflation. If policymakers fail to deliver the right amount of monetary and fiscal stimulus, then deflation will eventually take over and that will clobber risk assets (stocks, corporate bonds, commodities and commodity currencies) but benefit good old US nominal long bonds (TLT), the ultimate diversifier in a deflationary environment.

Where has deflation been most prevalent in the world? Japan, Euroland and China. Notice the article above states that the US dollar index (DXY) is rising and now stands at a five-year high relative to a basket of currencies (click on image):

As you can see, the US dollar has been on a tear since early August when I told my readers to ignore Morgan Stanley's call that the greenback is set to tumble (my best call of the year and their worst one ever). It is basically hitting a multi-year high.

So what does the US dollar rally mean and why should you care? Well, the US dollar has rallied mostly versus the euro (close to parity which is another call I made back in March) and the yen.

The decline in the yen and euro is actually good for Euroland and Japan because it means European and Japanese exporters will benefit from the devaluation in their respective currency. This is why Japanese and European stock markets have rallied sharply. It's also good news for fighting deflation in these regions because a decline in their currency increases import prices there, raising inflation expectations in these regions.

Unfortunately, raising inflation expectations via a declining currency is not the good type of inflation. It's a temporary reprieve to a long-term structural problem. The good type of inflation comes from rising wages when the labor force is expanding because that increases aggregate demand and shows a strong, vibrant economy.

Now, what does the rising US dollar mean for the United States? It's the opposite effect, meaning it will hurt US exporters and lower inflation expectations in the US. In effect, the US is taking on the rest of the world's deflation demons trying to stave off a global deflationary calamity.

Will it work? That is the multi-trillion dollar question which is why I began talking about global deflation and currencies because as Bridgewater's Bob Prince noted in his presentation in Montreal, with interest rates at historic lows and central banks pushing on a string, currency volatility will pick up. I would add this is where the epic battle versus global deflation will take place.

But again, currency devaluation is only a temporary reprieve to a long-term structural problem fueling global deflation. The six structural factors that I keep referring to are:
  1. High structural unemployment in the developed world (too many people are chronically unemployed and we risk seeing a lost generation if trend continues)
  2. Rising and unsustainable inequality (negatively impacts aggregate demand)
  3. Aging demographics, especially in Europe and Japan (older people get, the less they spend, especially if they succumb to pension poverty)
  4. The global pension crisis (shift from DB to DC pensions leads to more pension poverty and exacerbates rising inequality which is deflationary)
  5. High and unsustainable debt (governments with high debt are constrained by how much they can borrow and spend)
  6. Massive technological disruptions (Amazon, Priceline, and robots taking over everything!)
These six structural factors are why I'm convinced that global deflation is gaining steam and why we have yet to see the secular lows in global and US bond yields.

But now we have a newly elected US president who has promised a lot of things, including spending one trillion in infrastructure and cutting personal and corporate tax rates.

What will this fiscal thrust do? Hopefully it will help create more jobs and fight some of the chronic problems plaguing the US labor market. But if you really think about it, this too is a temporary boost to economic activity because once it's all said and done, those infrastructure jobs will disappear and US debt will explode up, which effectively means higher debt servicing costs (especially if interest rates keep rising), and less money to stimulate the economy via fiscal policy down the road.

This is why some people think Donald Trump's new Treasury secretary, Steven Mnuchin, is just kicking the can down the road if he goes ahead and issues Treasurys with longer maturities in an effort to cushion the US economy from rising interest rates.

The above is a condensed version of the major macro themes that are on my mind, but there is another one that bothers me a lot, what does a rising US dollar and Trump's presidency mean for emerging markets (EEM)? As the US dollar rises, it will hurt commodity exporting emerging markets and raise dollar-denominated debt but some think if handled correctly, emerging markets can thrive under President Trump.

That all remains to be seen and my biggest fear is that if a Trump administration follows through with protectionist policies which will antagonize others to retaliate with their own trade tariffs, it will cost American jobs and wreak havoc in emerging markets. And another crisis in Asia will basically cement global deflation for a very long time.

This is the global macro backdrop every investor needs to bear in mind. So far markets don't seem to care. Trump's victory has unleashed animal spirits in the stock market and boosted consumer confidence to a 12-year high.

It's all good, reflation is back, deflation is dead, Trump will make sure of it. Unfortunately, it's not that easy and as I keep warning you, President Trump could feel the wrath of the bond market (just like Bill Clinton and others have done in the past) and if his administration isn't careful, it will make a series of policy errors that will spell the decline of the American economy for a very long time.

But the stock market doesn't think so, it's rejoicing. The three sectors leading this rally are financials (XLF), industrials (XLI) and energy (XLE), and to a lesser extent, metal and mining shares (XME).

Interestingly, these were the worst sectors at the beginning of the year when deflation fears reigned but as you can see below, this is where the juice is coming from driving stocks to record highs in the post-election rally (click on each image):

These are five-year weekly charts which you can easily reproduce in Stockcharts using a 50-week, 200-week and 400-week simple moving average which is my simple way of gauging longer-term technical trends to see if any stock or sector is extremely overbought or oversold.

I know a lot of day traders like using 30-minute candle charts to day trade stocks but the big money in trading stocks (bonds, commodities, currencies) comes from big swing trades not day trading, but you have to choose your stocks and sectors very carefully and be willing to accept the volatility as you ride the wave up if you're long (or down if you are shorting them).

Go back to read my comment on Warren Buffett from a couple of weeks ago where I explained how he loaded up on Goldman Sachs (GS) and Deere (DE) shares and held on for huge gains (I wouldn't touch either of them now and would take profits and short them at these levels). Sure, Buffett has the deep pockets to wait patiently as his positions appreciate but the point is you don't need to be Warren Buffett to start emulating his trades and if you are really good, you will figure out what shares he is buying and when he's buying them before quarterly data becomes available.

When I go over top funds' activity every quarter, I tell you to be careful never to buy and sell based on this information but use it as a tool. There is a lot of information there -- A LOT! --  which in the hands of an expert trader is golden but in the hands of an amateur will lead to ruin.

For example, yesterday I was looking at oil drillers and noticed that both Renaissance Technologies and Citadel, two top hedge funds, significantly increased their position in Ensco (ESV) in the third quarter when shares kept sliding lower and there are other top hedge funds holding big positions in this company (click on image):

Great, so what? Then I looked at the long-term chart of Ensco to see if it is turning around (click on image):

The chart tells me it's still early but maybe shares of Ensco are going to surge higher, especially if oil prices continue to climb. It's on my watch list of potential turnarounds as are other drillers but to be honest, given my macro concerns, I remain cautious on cyclical shares (banks, energy, miners, drillers) and while I am watching them, my stock market views haven't changed.

I continue to be long the greenback (but would take some profits ahead of the Fed meeting next week) and would take profits or even short emerging market (EEM), Chinese (FXI),  Metal & Mining (XME) and Energy (XLE) shares on any strength.

In a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials). The latest run-up in financials is an opportunity to lock in profits and wait and see how things play out in the coming months (Hint: If everything is so bullish, why are bank insiders dumping their shares at record pace?).

As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they have gotten hit lately with the backup in yields but also because they ran up too much as everyone chased yield (might be a good buy now but be careful, high dividend doesn't mean less risk!).

Interestingly, however, high yield credit (HYG) continues to perform well which bodes well for risk assets. As long as high yield bonds are rallying, it's hard to get very bearish on markets.

And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds. My call to go long biotech before the elections was also one of my best calls all year from a swing trading perspective and I still see more upside (and volatility) in biotech (click on image):

I can even give you a sample of biotech shares I track and trade:

Again, this is a small sample of biotech stocks I track and trade. To be very honest, I wish I had just loaded up on Cliff Resources (CLF), Teck Resources (TECK) and US Steel (X) when they hit bottom in early January and rode the wave up, but hindsight is 20/20 (click on images):

Like I said, hindsight is 20/20 and I think it was hard to predict such a powerful V-shaped recovery in many stocks that got pummeled early on.

Clearly the reflation trade got started early on in the year and smart investors kept adding to their shares. I remain short and would short all these stocks and plenty more going into 2017 if they continue surging higher.

One thing is for sure, the Trump reflation rally is getting long in the tooth but animal spirits being what they are, this can continue longer than people think. All I know is that from a risk-reward perspective, US long bonds (TLT) look very appealing at these levels:

In fact, David Moadel shared this on Stocktwits last night which caught my attention (click on image):

When it comes to stocks and bonds, you have to know when to buy the dips and when to sell the rips. The backup in yields is way overdone in my opinion and I think a lot of investors worried about the "great rotation" out of bonds into stocks playing the global reflation theme are going to get whacked hard once the Trump honeymoon ends.

That is it from me, enjoy your weekend, I will be back on Tuesday (need to recharge my batteries). Whether you are a retail or institutional investor, please remember to kindly subscribe to the blog on the top right-hand side under my picture (click on web version on your cell to see the whole site properly). I thank all of you who support my efforts via you financial support.

Below, Robert Shiller, Yale University professor of economics, discusses why the current market environment is reminiscent of the stock market crash of 1929, and how Trump's presidency can bring about a different outcome. Listen carefully to his comments on stocks and bonds over the long run.

Second, David Rosenberg, Gluskin Sheff chief economist and strategist, explains why he thinks the Trump rally may be a "honeymoon rally."

Third, Richard Bernstein, Richard Bernstein Advisors, weighs in on what's driving the markets to record levels. I like Richard and he raises good points on tax cuts and fiscal stimulus but the question is how much of this is already priced in and will it be enough for the US to avoid a recession in 2017 & 2018?

Fourth, Bill Nygren, Oakmark Investor Fund, weighs in on asset allocations and says it's not too late to get in the stock market. I would say tread very carefully and pick your stocks and sectors even more carefully here because if you buy the best performers thinking the trend will continue, you will get destroyed.

Fifth, Jason Seidl, Cowen Group transports analyst, weighs in on the transportation sector and says he wouldn't be surprised to see a pullback here. I couldn't agree more.

Sixth, Savita Subramanian, BofA Merrill Lynch head of U.S. equity & quantitative strategy, shares her 2017 outlook, explaining why BofA's S&P forecast for 2017 is between 2,700 and 1,600. The way stocks swing throughout the year, I wouldn't focus too much on these forecasts but listen to her comments, she's a smart strategist.

Lastly, CNBC's Bob Pisani discusses the ongoing market rally and why half of U.S. households are missing out on record stock gains. America needs an enhanced Social Security based on the Canada Pension Plan and Canada Pension Plan Investment Board. That is a topic for another day.

Please share this comment with your friends, family and whoever else. Thank you and have a great weekend, I will be back on Tuesday with more great insights on pensions and investments.