Betting Big on a Global Recovery?

Dan Strump and Josie Cox of the Wall Street Journal report, U.S. Stocks Rally Amid Recovery in Global Markets:
Stocks soared for the second day in a row, with the Dow Jones Industrial Average erasing its losses for the week, as renewed optimism about the U.S. economy eased concerns about the pace of global growth.

The gains came amid a broad rebound in financial markets, which had been pummeled by anxiety about China’s slowdown since the world’s second-largest economy shocked investors by devaluing its currency earlier this month.

Oil prices soared more than 10% to their biggest percentage gain in six years amid a surge in commodities.

The Dow Jones Industrial Average jumped 369.26 points, or 2.3%, to 16654.77. Coupled with Wednesday’s 619-point surge, blue chips are now up 1.2% for the week.

The gains are the latest in a week of wild swings for stocks. Traders say the deep declines of Monday and Tuesday left investors eager to snap up stocks on the cheap, although many remain concerned that bigger market swings are here to stay as uncertainty mounts over the course of interest-rate increases by the Federal Reserve.

“It certainly looks calmer, but it’s hard to know how sustainable these moves are,” said Patrik Schöwitz, a global multiasset strategist at J.P. Morgan Asset Management, which has about $1.8 trillion under management globally. “It’s definitely too early to say that the latest bout of volatility is over,” he said.

The S&P 500 gained 47.15 points, or 2.4%, to 1987.66, while the Nasdaq Composite added 115.17 points, or 2.45%, to 4812.71.

Investors have taken solace in the firming pace of U.S. economic growth, as emerging markets look increasingly shaky. Gross domestic product, the broadest measure of goods and services produced across the U.S., expanded 3.7% in the second quarter, the Commerce Department said Thursday, well ahead of expectations and up from an initial estimate of 2.3% growth.

The data showed upward revisions to consumer spending and business investment, while a separate report showed initial jobless claims fell more than expected last week, suggesting the labor market remains healthy.

Oil prices staged a rebound, rising 10% to $42.56 a barrel in New York. That helped spur a recovery in oil and gas stocks, with energy companies in the S&P 500 gaining 4.9%.

“The U.S. economy is still shining,” said Doug Cote, chief market strategist at Voya Investment Management.

The recent tumult in markets globally has left many investors questioning the Federal Reserve’s course on interest-rate increases. While the recent slide in stocks gives them leeway to keep interest rates lower for longer, the stronger pace of economic growth could place added pressure on the central bank, they said. Until recent weeks, many investors were gearing up for an increase in short-term rates at the Fed’s meeting next month.

“There is zero inflation across the globe, so the Fed has cover not to raise rates, but the economy is surging so I’m at 50-50 right now for September,” Mr. Cote said.

U.S. stocks snapped a six-day losing streak Wednesday and on Thursday the rally spread into Europe and Asia. The pan-European Stoxx Europe 600 closed 3.5% higher. The Shanghai Composite Index led Asian markets higher, closing up 5.3% after five consecutive days of losses.

Strategists at Rabobank said in a note to clients that markets were in a “fragile equilibrium.”

On Wednesday, Federal Reserve Bank of New York President William Dudley said the case for a September rate increase has grown “less compelling” given the market turmoil, reassuring investors who may have been concerned that higher rates would put additional strain on markets at a volatile time.

Ultralow interest rates since the global financial crisis have sent stocks sharply higher.

“Markets have for days been looking for some sort of positive cue,” said Paul Markham, an equity investor at asset manager Newton, which has $75.9 billion under management.

He said that cue had in part come from Mr. Dudley’s comments, but “it remains to be seen how long that shot in the arm will last.”

Investors will be watching for more clues from policy makers later Thursday when a conference of central bankers begins in Jackson Hole, Wyo.

Next week, the U.S. labor-market report for August will shed more light on the pace of jobs growth in the U.S.

In currency markets, the U.S. dollar rose against the euro and the yen following the stronger U.S. growth data.

U.S. 10-year Treasury yields were at 2.168%, down marginally. Yields fall as bond prices rise.
At this writing on Friday morning (10:00 am), you can see that oil prices, stocks, yields are all down  but the U.S. dollar and gold are up (click on image):

So what is going on? Why is it such a crazy volatile week for stocks and bonds? There are a few things going on at the same time but let me walk you through some of my thoughts.

First, as I've repeatedly warned you, be prepared to see violent countertrend rallies in the sectors that have been clobbered over the last three months, ie energy (XLE), oil services (OIH) and metal and mining stocks (XME).

Countertrend rallies are particularly violent when stocks in unfavorable sectors are massively shorted by big trading outfits betting on stocks, bonds, currencies and commodities. These are the same trading outfits that love to put on huge carry trades to leverage up their returns.

But when stocks are heavily shorted as traders bet on more decline, they are vulnerable, especially when there's a buying panic going on. What happens then is a massive short squeeze as short sellers are forced to buy back shares to cover their margins.

Now, take a look at some stocks in the commodity and energy sectors which rallied sharply on Thursday (click on image):

I  took a snapshot of these stocks on Thursday evening just to show you how powerful these countertrend rallies can be. You will notice the primary trend for almost all these stocks is down and if you look at their one year chart, you'll see despite the rally, they're way below their 200-day moving average.

And yet these shares all rallied huge on Thursday fueled by short covering, panic and legitimate buying where investors are betting on a global recovery (thus the title of that portfolio above I created on Yahoo Finance last night).

[Note: On Friday, the biggest gainers were small cap oil and gas exploration stocks which got decimated over the last year. The two top gainers were Midstates Petroleum Company (MPO) and Emerald Oil (EOX), up 101% and 55% respectively in one day, but if you look at their one year chart, it's a bloodbath!]

Now, the trillion dollar question all portfolio managers and traders are wondering is this the real deal or is it another head fake where the market goes up and then drops right down to new lows or to retest lows?

My own thinking has been to steer clear of energy and commodity shares, especially after China's Big Bang, fearing that there will likely be further devaluations out of China and this will heighten global deflationary pressures.

But there are some big moves happening in markets, some of which are definitely signaling a potential turnaround in the global economy. Take the huge and unbelievable rally in coal stocks going on right now in companies like Arch Coal (ACI) and Peabody (BTU). The former hit a low of $1 earlier this month and is now trading above 8$ while the latter more than doubled during that time.

These are huge moves for coal shares in a sector that has been obliterated and where many companies have filed for Chapter 11, wiping out shareholders (I lost a ton when Patriot Coal went under but Alpha Natural Resources and Water Energy also wiped out shareholders when they filed for bankruptcy).

Is King Coal coming back from the dead? With China slowing down, I strongly doubt it but clearly there are big investors betting on these shares. Billionaire investor George Soros bought stakes in the two coal companies I mentioned above but the dollar amount is peanuts relative to the size of his overall stock holdings. I don't know if he's still buying coal shares this quarter but clearly momentum traders are having fun playing these shares (be very careful trading and investing in this sector, you can get killed).

More interestingly, another famous investor, Carl Icahn, announced on Thursday his fund is taking a significant stake in Freeport-McMoRan (FCX), a major copper miner who has been clobbered this year. That announcement sent shares of Freeport soaring on Thursday after the close even after the stock ran up almost 30% (click on image):

Of course traders are selling the news Friday and the stock is well off its highs in the after-hours session on Thursday evening. If anything, I suspect short sellers covered and then resumed their shorts on Friday and other traders used this news to get out and lock in profits.

So why is Icahn, a well-known activist, taking an 8.5% stake in a copper giant like Freeport? I don't know but it's a ballsy move by a legendary investor as the trend is clearly not in his favor just like it hasn't been on another major holding of his, TransOcean (RIG) which announced a cut in its dividend earlier this week and hit a 52-week low. I can say the same thing about Chesapeake Energy (CHK), another big holding of Icahn Associates.

A lot of people are getting excited over Icahn's latest move but I would temper this enthusiasm. Freeport-McMoRan (FCX) isn't Apple (AAPL) or Netflix (NFLX) and it remains to be seen how Icahn will use his clout to shake things up at that company to unlock value.

But there might be another reason to buy Freeport, energy and commodity shares and it has nothing to do with activism. What if the world economy isn't falling off a cliff? What if fund managers are overly pessimistic on global growth going forward?

These are the questions I grapple with every day as I trade and observe the crazy gyrations in markets. Sure, China is slowing down but I think investors need to take a step back here and remember who China sells its products to and who leads the global economy.

Importantly, it's the U.S. and eurozone that still wag the tail of the global economy, not China. And even in China, too many investors listening to Jim Chanos on CNBC are blowing things way out of proportion.

People need to take a step back and think a little and stop reacting to all this negative news. Ambrose Evans-Pritchard of the Telegraph recently discussed why China is in a serious bind but this is not yet a 'Lehman' moment and how reflation threatens eurozone bonds as money supply catches fire there.

Evans-Pritchard ends his latest comment on this note:
While the ECB is in one sense capping yields by buying bonds, this effect could be overwhelmed by fundamental forces if the markets start to price in higher growth. Yields rose rather than fell with each episode of QE in the US.

Bill Gross, the legendary bond guru at Janus, said in April that German Bunds were the “short of a lifetime”. Yields surged threefold and he made a windfall profit.

The great question for the bond market is whether Europe and America are caught in a permanent Japanese deflation trap, or whether their economies are breaking free and returning to normal after six years of chronic malaise. If the latter, the bond sell-off has barely begun.
When it comes to bonds, I prefer heeding the dire warning of the bond king than listening to Evans-Pritchard, but he raises a good point, namely, if the global economy isn't as bad as everyone fears and if growth in the eurozone follows that of the U.S. and starts coming back strong, we might see a significant backup in global bond yields.

I've said it before and I'll say it again, there's a lot of stimulus out there as central banks across the world slash rates and engage in quantitative easing. All that global liquidity is highly accommodative and supports risk assets. The drop in the euro also helped stimulate growth there as will the drop in yuan and emerging market currencies. It will eventually feed into growth.

But the world still suffers from major structural headwinds which are deflationary and bond friendly. This is why I'm not taking bond bears like Alan Greenspan or Paul Singer too seriously at this time. Unless we see major growth and the return of high paying jobs with great benefits, deflation still rules the day. Period.

So you can follow George Soros and Carl Icahn, betting on a global recovery, but be careful trading these sectors (take profits along the way!) as the structural problems that plague this world still haunt us. I'm still sticking with my biotech call knowing full well it will be extremely volatile but I'm convinced the secular uptrend in this sector is far from over.

One thing is for sure, these are brutal markets for everyone, including big name hedge funds that have taken a beating this year.  If the flash crash of 2015 rattled your nerves, don't worry, you're in good company. Try to stay focused and stop listening to the noise, it will only drive you crazy.

Below, Caroline Bain, senior commodities economist at Capital Economics, told CNBC on Thursday that the rout in commodities is overdone.  "We certainly think that the authorities in China have the firepower in terms of monetary and fiscal policy to enact enough stimulus for the economy to at least meet the growth rate they're targeting," says Bain. She may be right but the ominous sign from commodities is still weighing heavily on global markets.

And CNBC's Steve Liesman talks with Federal Reserve Bank of Minneapolis President Narayana Kocherlakota, about the challenges of zero-bound rates and tail risks to the U.S. economy.  Listen carefully to Narayana Kocherlakota, in my opinion, he's one of the best Fed presidents and understands the real risks of raising rates too early.

On that note, I wish all of you a great weekend. Please remember to kindly donate and/ or subscribe to this blog using PayPal at the top right-hand side under the "click my ads" banner which I also appreciate. I work hard to provide you with the latest on pensions and investments and would like to see more institutions step up to the plate to donate and subscribe.