Weekend Notes

It has been quite a week in economic and investing news. Continued monetary policy in Europe has its many effects both real and anticipated. The attached file outlines this weeks news stories and other important investment decision making information.

In the letter

- Alibaba is set to join the list of publicly traded companies at $60 - $65
- The ECB continues to fear inflation and seeks to protect itself by a surprising decrease in interest rates.
- The ECB looks to stimulate bank lending and consumer spending by employing its own QE measures as the US looks to unwind their measures.
-Tesla looks to expand production to Texas.

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Trade well
-f-

Morning Notes: September 1, 2014

I am aware that it has been a while since the last morning note, but I intend to bring the segment back with more regularity. In addition, the monthly installment of Gross watch has been moved to our Seeking Alpha blog.

With that being said, here are the details to be found within your morning notes for today September 1st, 2014.

- Netflix complains that internet speed is causing them to lose customers.
- US investors looking to protect themselves against inflation for the first time in a while.
- Europe increases terror alerts amid growing tension in Syria and Iran.
- Countries continue to sanction Russia for its annexation of Crimea.

- Google is up to its world dominating antics again as they develop and test drone technology for uses that include competing with Amazon's proposed drone delivery.
- Three additional MacDonald restaurants have been closed in Russia for supposed sanitary concerns.


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Trade well
-f-

Gross Watch: Welcome Mr. Bond

Many things have happened in the capital markets since my last post. Markets have risen... and risen some more. Commodity prices have been volatile, and reflected in various commodity users and their alternatives. With the decisive move above $100/bbl for light crude, the demand for alternative energy sources seems to breathe life into companies like Solarcity (SCTY) and Tesla (TSLA). They say that a rising tide lifts all ships, this is evidenced in the fact that even my dark horse company Blackberry(BBRY) has experienced some resurgence in recent months, that is until Apple teamed with IBM to provide Enterprise solutions and effectively be the first direct challenger to blackberry in this market (might be time to revisit my faith in the turnaround story that is Blackberry). In all, there is a solid argument for an overvalued market, and reasonable expectations for a correction or worse. That has been the cry since the start of the bull market; it is infinitely more convenient to call for a correction when markets are making new highs than to justify their performance.

The principal thesis on an overvalued market is; the markets current CAPE Schiller P/E multiple of 26x is overvalued relative to the average P/E of 16X. Following this logic, as well as universal arithmetic rules, for the P/E levels to revert back to the mean, one of two things must happen:

- Earnings must increase at a faster pace than prices

- Prices must drop precipitously

According to Zacks.com investment research and most other market publications, the major earning trend this year has been anemic growth on the bottom line, lack of top line surprises, and weak guidance. These lead us to believe that the first criteria for mean reversion has little chance of coming to fruition, thus we expect the second. The ideas expressed above permeate throughout the investment community, and investors are approaching with caution. However, few have dared to challenge CAPE Schiller's P/E thesis, which has led to the subject of this Blog post. 

Enter fixed income guru, and co founder of the largest bond fund, Bill Gross. Over the past several months, Mr. Gross has set out to develop his BIG idea, and dispel the notion of extreme overvaluation. In this first instalment of “Gross Watch”, we briefly explore Mr. Gross's thesis and its implications on valuations. 

On a monthly Podcast offered by PIMCO’s founder Bill Gross, he details his views on a new normal in investing. Mr. Gross introduces a concept called the “new neutral”, this phrase is in reference to the feds fund rate - the interest rate at which depository institutions lend reserve balances to other depository institutions overnight- it is the basis for most interest rate calculations. In his theory, Mr. Gross challenges the market assumption that the long run average of the feds fund rate is and has been stable at around 2%. This is important to know in this instant (as it relates to relative market value) because this feds fund rate is the assumption used as the discount factor (r) to calculate the average CAPE Schiller P/E ratio using the fundamental equation. (P=CF/R-G) PIMCO’s contention is that this rate is near zero, as is determined by various factors such as equity markets, inflation and other items that aren’t quite quantifiable as the FED would have it.

Should that be the case, the barometer with which the market is measured against is using an incorrect discount rate. Using a discount rate adjusted to reflect the near zero feds fund rate as well as 2% inflation, the CAPE Schiller adjusted P/E average should look more like 22X rather than 16X which would show the market to not be as nearly overvalued as otherwise thought. The new neutral feds fund rate has been put in place to stimulate 5% GDP growth, however time has shown this to have failed over the last 4 years, instead there are what people see as asset Bubbles. The expansion from 12X PE in 2008 to 26X PE just 5 yeas after justify Mr. Gross's implication that asset returns will be low (not catastrophically negative), even as there is a slow crawl to adopting the theory new neutral. These bubbles need the rates to stay as is in order to not be popped. A levered economy requires a low policy rate. Should rates return to 2%+ there is a significant risk of recession.

That’s been all for “Gross Watch.” Remember, in an environment such as this, with markets making new highs, it is easy to get lost in the fray and want to jump in. But remain steadfast in your belief in the old adage, “buy when there’s blood in the street.” Right now the bulls are still running, exercise patience search for value and act when the time is right.

Trade Well 
        -F- 
        

Macro Directed Markets

Few macroeconomic trends resonate in our current investment climate and with the stock markets being driven by Marco-economics rather than valuations, it is important that we seek to understand where the macroeconomic tides are headed. Government policy, emerging market health, interest rate movement and geopolitical risk affecting commodities are all important macroeconomic themes to be explored further in this climate. Most are interrelated and should be considered in whole when making investment decisions.

Perhaps most observable quantifiable is the government policy and interest rate climate we are in. The loudest macro theme seen for the better part of 4Q 2013 into Q1 2014 is government policy impacting interest rates. Recent trouble in emerging markets has forced central banks of emerging economies such as the Reserve Bank of India, the Central Bank of the Republic of Turkey, and the South Africa Reserve Bank to implement emergency rate hikes as their currencies tumbled. Strangely enough, these interest rate hikes are being touted as consequences of the loose interest rate policies most mature economies have enacted over the previous years. These rates are being increased in order to combat weak economic conditions – not growth. The move precipitates the continued chatter of global monetary policy tightening spanning from the U.S to China. The below chart shows the top 20% of the world’s GDP and their recent monetary policy decisions.

Source: Business Insider

Beyond government policy and interest rates, the U.S jobs numbers puts together an interesting macroeconomic story. Though we have seen a general decreasing unemployment trend in the US over the past year, December numbers reported in January proved to be uninspired, thus giving the market and economists reason to question the FED’s decision to taper its bond buying program. A non-voting member of the Federal Reserve stated “even as the 6.5% unemployment threshold approaches, labor-market conditions remain far from where they would need to be in order to justify raising short-term.” Furthermore, North America is experience record lows in the number of unemployed who are not actively seeking jobs, the labour participation rate in Canada and US have been well below 70% for over a year now, indicating the true unemployment rate is well above the reported 6.6% in US and 7.0% in Canada.

Source: www.fxstreet.com

The economic calendar shows that while the unemployment rate that the Federal Reserve bases its interest rate and monetary policy judgement is moving in the expected direction, non-farm payroll growth is underwhelming as is the job participation rate.

In general, we are seeing aversion to risk in the capital markets. We are experiencing a softer stock market, a recovery in commodities, increasing interest rates, and less accommodation monetary policy. All these add up to a reversion to the capital markets norm, where monetary policy was not the sole driving factor in the direction of capital markets, and company performance was the deciding factor in asset pricing. We are experiencing the return of growth in the developed markets with the U.S at 3% and the U.K at over 2%, and the cooling of emerging markets after a period with low yields and a quest for performance. The climate is clearly one for flight to quality, so consider quality in all your portfolio decisions.

For portfolio advice and more insight checkout my affiliates HMS Asset Management. We have an in-depth look at emerging markets, macro environment and micro environment weekly.

Look for cheap stocks with a solid balance sheet and a viable business strategy. exercise patience as the market takes a breather, then pounce once the timing is right.

Trade Well
-F