March 29, 2018
By Steve Blumenthal
“I’m bullish on commodities because we are late cycle… You can argue how late we are in the cycle but we are late cycle.
The bond bulls will argue there is more room to run, but nobody is going to say we are in the first inning or the third inning of an economic cycle.
The current cycle is the second longest in post war history. And every time you get late cycle going into the front-end of a recession
you have a massive rally in commodities. Every time, there are no exceptions.”
– Jeffrey Gundlach, CEO, DoubleLine
Today continues a six-part series where I share my 2018 Strategic Investment Conference notes with you. I must say I am really enjoying going back over the notes, re-watching the videos and putting pen to paper… well, fingers to keyboard. It’s fun but please don’t tell my wife… best I keep this quant geek thing on the down-low. Anyway, Jeffrey Gundlach went on to say, “What I mean by massive is not a 30% gain, it is 100%, 200% or even 400%.” He likes baskets of commodities.
Give that some thought. Who do you know that is putting money in commodities today? David Rosenberg concluded his 2018 SIC presentation (you can find my notes here) saying:
The biggest constraint on the economy, and I’m sure Lacy Hunt would agree with this, it’s not just aging demographics. It’s the outstanding debt, another huge debt cycle.
The outstanding level of debt in America, in this cycle, went from $33 trillion to $50 trillion, to generate barely more than $4 trillion of nominal GDP. The credible multiplier is actually weakening. But we’re going to go into the next recession with this balance sheet. $50 trillion dollars of debt, and 250% of GDP.
And that’s why I think in the next cycle when you ask me what’s going to happen… read Bernanke’s “what if” speech he gave when he was governor in November 2002.
Think about the last cycle. Did anybody know what QE was? Everybody knows QE. I used to have to do teach-ins at Merrill on what QE was, back in 2007/2008. Now QE is in the vernacular. Every single acronym the Fed did, including QE, was right there (in that speech). People thought I was some sort of genius. But in full disclosure, I’m not a genius, I just know how to read.
And so, this guy was governor when he gave that speech, he went on to run the show. But the one thing he didn’t do is on page 16 of that November 2002 speech, which is the debt jubilee.
David said, “There ultimately will be a debt jubilee. And it’s got historical connotations as well. This will happen in the next cycle. We will basically have a situation where the Fed and the Treasury will do a swap. And then we’ll move on, reset the button, and we’ll be talking more about inflation then, than we are today. But that’s for another day.”
David concluded, “This is still very relevant in terms of having something on your night table to read. I would say, make sure you have some single malt in your glass beside you when you read it. But that’s where I think the end game is going to be in the next few years.”
Gundlach believes we are at an inflection point in yields. Saying there is a 60 percent chance we break higher while noting his calls are wrong about 30 percent of the time. Such is the game we are in. I believe rates are moving higher over the short term then lower in the next recession.
I’m growing more and more confident in my view that we will see recession in 2019. If correct, that recession likely drives rates down to test the July 2016 lows. Perhaps then we make the secular low in rates. But really, it may not play out that way.
I do believe we will see the Fed and the Treasury do a swap. It will be messaged to you and me as the Make America Great Again Debt Revitalization Act or something that sounds pleasing to us but really means something “huuuuge” is about to happen. That’s where we are going and I believe David is spot on.
Quick geek step-out: In plain English, it’s like you going to your bank and having them agree to reduce your mortgage due balance somewhere to the tune of 40% to 60%. Wouldn’t that be nice? Though it may be harder to convince your banker to agree with you than the Treasury and Fed to shake hands. Anyway, it will be inflationary.
In the “what you can do” category, be forward looking and keep an eye on what the markets are telling us. I was in NYC earlier this week doing an interview with my good friend, Robert Schuster from Ned Davis Research, and Ed Lopez from VanEck. Robert shared one of his favorite all-time great Ned Davis quotes. Ned says, “Listen to the cold, bloodless verdict of the market…” That is what priced based indicators accomplish. All buyers and sellers meet at the point price. I can tell you what I might think will happen but price tells us what is actually happening. Thus I lean heavily on price-based evidence. So let’s keep a close eye on the trends in asset prices.
Ok, grab a coffee and find your favorite chair. My notes on Gundlach’s “Inflation is Inflationary” presentation follow when you click through below. There are lots of charts but I’ve tried to share just the ones I feel are most important to share with you. Jeffrey makes the case for higher rates in the near term and advises us to keep a close eye on the best recession indicators. I hope you find the material helpful. And lastly, before you dive in, as it relates to price-based indicators, I am hosting a free webinar on April 4, 2018 at 2 pm (ET). We have over 300 people registered and room for 500. Click on the link below if you are interested in joining. If you are unable to attend live, a link to the replay will be sent to you if you register. We’ll be discussing one of our favorite strategies.
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
Included in this week’s On My Radar:
- Jeffrey Gundlach — “Inflation is Inflationary”
- Trade Signals — Testing 200-Day MA, Fixed Income Bearish, High Inflation Pressure
- Personal Note — “In the Middle of Difficulty Lies Opportunity” (Einstein)
Jeffrey Gundlach — “Inflation is Inflationary”
After Jeffrey presented, he sat down for a Q&A session with my friend, Matt Osborn. Let’s start there as it best sums up what you and I should be on the lookout for. Think from the conclusion first and then we’ll evidence that conclusion as storied through my notes of Gundlach’s outstanding presentation.
Matt Osborn: Jeffrey, you said the big question is will 2.5% inflation be ok with the market? What is your answer to that question?
Gundlach: No! I think the lead inflation indicators (SB here: that you’ll see below) become true and with so many of the indicators telling the same story, I think it is a good bet…, we, at DoubleLine, have a propriety indicator that tells us, we believe, that CPI will come in at 2.6% in June 2018. Based on this indicator, it is much more accurate than most of the economists on Wall Street. So if that’s the case, I don’t believe you can keep things together. That’s why I believe yields break out to the upside. The markets will not be ok with 2.6% inflation that looks to be trending higher.
On the margin Gundlach sees rates breaking higher. Let’s begin… lots of charts:
Leading Economic Indicators (“LEI”) – Year-over-year change heading into recession:
Gundlach is pointing out that since January 1960, the year-over-year change in LEIs drops below zero prior to recessions. The dark blue line is the current path and the lighter blue shaded area are the various paths of prior recessions. The vertical black line in the middle shows you when recession occurred. Note the lighter blue zone showing all prior LEI readings dropped below zero prior to recessions. Note the number of months prior.
Bottom line: LEIs are rising – we are nowhere near a recession.
Same is true with ISM PMI:
Yellow line is current path. Drop below 50 in all cases prior to past recessions.
Bottom line: No sign of recession.
Near and dear to my heart are High Yield spreads prior to recession. I’ve been trading the price trends in the HY space since the early 1990s and it’s my experience that the HY market is a great economic indicator. This next chart measures the spread between HY bond yields and safer Treasury note yields. When they go up, it means HY bond prices are going down and HY bond yields are going up much more than Treasury note yields are going up. A sign of mounting risk in the system…
Here is what Jeff had to say:
- The granddaddy of them all, for me, a bond person, is the spread between high yield bonds and Treasuries. So, what you have on here (next chart) are the past two recessions.
- ’01 is the blue. The gold line is the ‘07 recession. That shaded area is the official recession.
- So, that left edge of the shaded blue area, that’s the front edge of the recession. And then on the x-axis, those negative numbers, that’s how many trading days before the recession.
- So, let’s start with the ‘01 recession. You’ll notice that the blue line started to rise very observably, and not by 25 basis points, more than a year prior to the recession. In fact, it rose by about 300 basis points before the recession came.
- Then you look at the ‘07 recession and it started to rise about six months before the recession came. And again, extremely easy to see that the gold line was rising before the front edge of the recession.
- The black line is where we are today on junk bond spreads, if we assume, not a prediction, just an analysis tool, that the recession starts six months from now.
- Well, the black line would have to be rising for that. And it has gone up a tiny, little amount, but you need a magnifying glass. In the past, you don’t need magnification. Lines go up to the naked eye.
- And there’s another kind of light’ish line, it’s really hard to see. Kind of tan-colored. That assumes that the recession will start one year from now. And again, we would need these junk bond spreads to start widening, like, this afternoon to be talking about a recession six months from now.
- So, no recession as far as we can see. However, the visibility, unfortunately, is not as long, typically, as a year or so. But we don’t see one.
Gundlach: Let’s talk about some strange things that are going on.
- Here’s (next chart) the budget deficit as percentage of GDP. And I talked about this a lot. A lot of people were wringing their hands back in 2010 and 2011 about debt-to-GDP ratios.
- And I was talking about it in 2012 that we’re not going to worry about that for a while. Because debt-to-GDP will stabilize thanks to economic growth and thanks to a lack of real trouble in compounding in the entitlement programs. But, what I said at the time was once we get to about 2018 or 2019, we’re going to have to start worrying about this.
- Well, here we are. Here we are in 2018 and fiscal ’19 is going to be a real doozy and that starts in October of this year (the 2019 fiscal year for the federal government starts in October). So, you’ll notice the shaded red areas. Those are recessions.
- So, you’ll see that typically the budget deficit expands in a recession, during a recession, and sometimes it goes on a little bit after the recession—the shaded area.
- But here we have a new bold experiment. As if we haven’t had enough experiments yet with negative interest rates and central banks buying Treasury float and stuff like that.
- We now have an expanding budget deficit in one of the longest durations of economic expansion since the end of World War II.
- Basically, if we go all year in 2018 without a recession, it’ll be the longest expansion in post-war history. So, that’s what’s happening. Yet, (chart above) we see the budget deficit is already expanding and this is even without the tax plan that just went through, which is going to cut almost $300 billion dollars out of the tax take and is likely to increase spending by a significant amount as well.
Projected Annual Budget Deficits – next chart:
- But, already, the deficit’s been expanding because economic growth has not been sufficient to pay for the compounding, which is starting to occur, in a very troubling way, of the entitlement programs. So, budget deficit is about to explode.
- We were down there at about $500 or $600 billion a couple of years ago and now here’s the projection for $1.1 trillion in fiscal 2019.
- I’m going to take the over. I say we’re going to have more like a $1.3 trillion budget deficit unless we have substantial expansion beyond what’s happening right now, which is probably not a great bet.
- Growth may get a little bit better, but I doubt it’s going to really save the day. And so we have maybe $1.3 trillion of bonds coming our way from the Treasury in fiscal ‘19.
- And oh, by the way, the Fed is starting quantitative tightening in earnest, which could get to the point of $600 billion for fiscal 2019 if they go all the way. Note in next chart the orange line – showing total for the collective balance sheet contraction (Quantitative Tightening or QT) and the big three global central banks plus the Bank of England.
- And we see that the Fed obviously is now reducing the size of its balance sheet with quantitative tightening. We see the ECB may start doing that. And then you’ve got the Bank of Japan.
- You’ll notice that the orange line goes negative in 2019. And obviously, quantitative tightening has already started to have some effect, it appears, on interest rates and markets.
- Clearly, if quantitative easing was a boost, QT is going to be less of a boost to the economy and markets.
- So, we could be talking about round numbers in $2 trillion of Treasury bonds coming our way and oh, by the way, corporate bond maturities are coming our way too, because corporate treasurers understandably and appropriately took advantage of low interest rates and tight corporate spreads and extended out their maturities.
- But there are significant maturities that are coming in ‘19 and ’20 (next chart). So, we could be looking at $3 trillion in government bonds and that does not assume a recession.
- Now, if we have a recession, obviously the budget deficit will expand, but my guess is that quantitative tightening will go away if a recession comes in the next year or so.
- And so maybe that $600 billion gets saved for the future and maybe we still only get $2 trillion even with the recession.
- It just is a real deficit and not just quantitative tightening. But the financial markets have clearly been boosted by central bank balance sheets.
On Corporate Bond Maturities:
- I just want to kneel down on the corporate debt maturities. You’ll notice (next chart) in 2017 for the S&P 500, this is just a subset of the corporate bond market but the pattern is the same.
- You’ll see in 2017 there weren’t any maturities. And then we’re looking at a couple hundred billion. And then when you get out to 2019, you’re up to 350 and this is just the S&P 500.
- You can double that for the rest of corporate debt and junk debt. And meanwhile, with all these bonds coming, foreigners don’t really like our bonds anymore because our dollar is going down and our yields have been going up more than the Japanese yields or the European yields and so holding bonds, the United States for foreigners has been a real losing proposition.
Next chart: Japan U.S. Treasury Holdings 12-month rate of change:
- And the Japanese here, their cumulative holdings of our bonds have been shrinking. You’ll notice it’s been going on for a while now. So, will our interest rates break out to the upside? I don’t have a ton of conviction on this. We’re going to get to that later.
- My guess is yes, but I don’t feel like I did in July of 2016 when I was massively bearish on Treasuries at a 132 10-year. But I think we’re going to let the market tell us because we’re right at a critical juncture, as we’re going to see.
Fed Funds and the Market Forecast:
- Now the market has started to believe in the Fed. It really started about a year ago. For years, the Fed said we’re going to raise rates and bond markets said oh no you’re not. And the Fed had to capitulate red-faced and embarrassed every single time, until all of a sudden last year when the Fed said we think we’re going to raise rates three times and the bond market had to get in sync with that.
- Bond markets are starting to believe that Jay Powell may be able to raise rates four times this year. Obviously, that idea was bolstered by the jobs report almost exactly one month ago when every job earnings came out at 2.9% and kind of blew everybody’s mind because it was such a big increase relative to expectations.
- And that kind of set everything in motion for the most recent selloff in bonds and the high volatility in stocks that have sort of changed the paradigm of the market.
Gundlach on market volatility – the VIX:
- It is interesting that the VIX, we all know about the VIX. The VIX has been around for about 30 years or so and prior to 2017 the VIX had exactly nine closes below a level of 10. Nine closes in 27 years or so. And then in 2017 there were 52 closes below 10.
- Since then, since the VIX has exploded to the upside… it’s interesting, this year there has not been a single day that the VIX wasn’t higher than any reading of 2017.
- The lowest reading so far in 2018, it’s about 50 trading days we have, so it’s not that trivial, the lowest reading is higher than the highest reading of last year.
- This is a real paradigm shift, folks. This is one of these things where when you go from a very low-volatility base in any market, even the market of volatility, once you break above that base, it’s Katy bar the door, and things really change.
- We have quants all over America and around the world that don’t want to talk to each other. They’re all in secret rooms at firms and they all think they’re doing some super-secret work but they don’t even want to talk to each other because they’re afraid of sharing their so-called secrets. But the fact is they’re all doing exactly the same thing. Because they’re all working with regression tools and the same data set. And part of their data set was a set of assumptions, and it’s the weakest assumption that ends up exploding the derivative quant operation. (emphasis mine)
SB here: that’s an important point. There is a bubble in passive products. Investors are heavily all in on the same side of the trade. There are strategies such as “risk parity” where quants set portfolio weightings tied to volatility. Leverage is used. The drivers to how they weight their portfolios are by in large very similar. Because they are all using the same data set, their trading is likely to be similar. The size on the sell side should volatility spike may be enormous. I believe the February vol spike – market sell-off was just a warning.
On inflation indicators:
The quote in the cartoon is “I hope you remember how to drive this thing…)
- When I was growing up, we were all afraid of inflation. We hated it. We were sick of it. We saw gasoline go from 25 cents a gallon to a dollar a gallon quickly. They were changing the prices of perishable items in supermarkets like bread, even intra-day.
- But anyway, we hated inflation and now the Fed chairman and other significant people say we wish we could get more inflation.
Take a look at the next chart: Here are the corresponding notes:
- Let’s take a look first at global inflation very quickly. The thing that’s really amazing is the crazy policies in the ECB. I really liked the last speaker when I was watching backstage. Really interesting stuff. I mean, Germany has the same economic reality as the United States thanks to the artificially low euro for the Germans. And their GDP’s about the same as ours. Their nominal GDP is exactly the same as ours in Germany. Their inflation rate isn’t that much different. Their manufacturing PMIs are just as strong as ours. They show many of the same characteristics and yet we have diametrically opposite monetary and fiscal policies.
- We have the Fed doing quantitative tightening, the ECB committed to quantitative easing to the tune of 30 billion-ish euros a month all the way through September at a minimum of this year. Negative interest rates, the pledges, they will stay in place for well past when quantitative easing is done. And so we see this incredibly low interest rate in Germany being manipulated down at 70 basis points.
- Yet, their CPI, the red line, has historically always the yield has been higher. The blue line has been higher than the red line but now the inflation rate is very, very much higher than the German bond. I think that what’s really driving the markets in the United States interest rate market is a combination of the German yield acting as a little bit of a pulldown on the US 10-year rate, and then we have nominal GDP which is acting to elevate yields in the United States.
Gundlach showed several more slides that detailed the inflationary pressures in Germany and noted, “German capacity utilization is really strong. So, it’s really odd that they have this interest rate and fiscal policy and quantitative easing, but of course it’s because of other countries in the Euro zone and the desire to keep things glued together as long as possible, as the last speaker spoke to at some length.
Japanese core inflation and headline inflation are actually rising. The year-over-year is now actually at 1.4 which is high by Japanese standards, and they’re rising, and the G4 producer prices are rising in tandem.”
More inflation evidence: “We see that our average hourly earnings print in the United States, that looked like it was going sideways and maybe even rolling over, and then the last two clicks came out and suddenly we are at a new local high for wages in the United States and people are starting to feel a little bit about the Phillips curve again with the unemployment rate so low.”
He concluded: “All of the indicators he follows suggest at least near-term lift in inflation and that’s certainly been flushed out by the bond market with yields having gone up by 93 basis points from their low last summer to their high in the last month or so.
He noted the NY Fed’s UIG is at 3% (red line) and pointed to how the blue line follows the red line. Point is inflation pressures are rising.
- So, it’s interesting how the Fed says, I think it’s almost comical when I hear Fed people say, we wish we could get inflation to 2%. Because the CPI is at 2.1%. So, what’s the deal about we can’t get to 2%? We are at 2% in the inflation rate. So, we’ll see what happens next.
- It’s interesting when the bond market cleared 2.50% yield on the 10-year, and in particular when it cleared 2.63% which was a really big level, all of a sudden the world seemed to change.
- The stock market didn’t like it anymore.
- The stock market didn’t like bond yields rising.
- For a long time bond yields rising was not bad for stocks, and bond yields falling was actually bad for stocks. It was a classic negative correlation of bond prices and stock prices. And this goes back quite a while. On this exhibit (next chart 10y Bond Yield and Stock Bond Correlation), all these dots, you can see there’s this basic correlation of 10-year yields and US stock and bond correlation. You’ll notice the red oval on there, that’s the most recent period. So, suddenly without bond yields going up that much, we see increased correlation. It’s still negative, but if we used less than a 12-month time window it would be a positive correlation—stocks and bonds—if we just looked at the last month.
- So, suddenly something has changed. It seems like the stock market doesn’t like rising bond yields anymore. And if we go over three, you’ll see that down on the x-axis, it seems quite likely that we will start to have a very high correlation between stocks and bonds which would be of course both of them going down together which is not a great environment for people who are invested exclusively in stocks and bonds, or particularly those who are trying to use their risk parity idea of offsetting their risk in stocks by being long on bonds. That isn’t working right now. And it may continue not to work. And we can take this back further.
- Here we have the bond/stock correlation going back to the 1960s even (next chart – Bond-Stock Correlation and Inflation). And you’ll notice that when the inflation rates above 3%, and it’s on the right-hand scale, above 3%, you’ll notice that we have bond yields, we have CPI, rather, in gold and then we have the correlation rolling one year stock and bond. You’ll notice when the CPI was above 3, you had positive correlation between stocks and bonds. And then once you got past ‘00, suddenly we were in a deflationary mindset and we’ve been in a disinflationary mindset for 18 years. And you can see that… you can see that with CPI being so much lower and suddenly the bond correlation to stocks has been negative. I think that may be … I think that it’s already in the process of shifting.
- If the bond yield goes above 3 it’s almost certain to shift. And, of course, the US equity market is valued based upon very low interest rates. I keep hearing people say it’s okay for the PE to have been 20 on a forward basis—forward basis back in January because interest rates are so low. But interest rates aren’t as low as they were. Interest rates aren’t zero anymore. One-year LIBOR is at 2 ½%. I know that’s not high by historical standards but it’s a far cry from 50 basis points. A lot of rates are up 200 basis points. The two-year is up over 200 basis points. The 2s, 3s, 5s, 7s, and 10s in the US bond market have been rising at a 200-basis-point annualized rate for the past six months. So, they’re up by about 100 basis points in the past six months or so.
Gundlach: You know, we all remember the manias of the ’00 and ‘07 period. In ‘00 it was technology, in ‘07 it was kind of financial. A lot of people said we’ll never see this type of thing again. Never? These levels are insane.
- Well, let’s take a look at three popular ETFs. Here’s one that’s called XLK, and this one is technology. And you’ll notice something very interesting has happened. We’ve crawled all the way back exactly—and I’ll throw over to the upside—back to the 1999 insanity level of price.
- Now, of course, the economy’s grown since then and so on, so there’s some caveats to this, but it’s fascinating that we’ve made it all the way back to that breakdown point.
- Financials, the mania was ‘07. That will never happen again. We’ll never have that kind of an environment. Well, here we have financials exactly back to the peak of ‘07. This is why I say there’s so many things right now that are absolutely crucial and fascinating levels where either we’re going to bust through this on the upside, which seems really hard to believe after the run that’s happened, or else it should be a resistance point.
- And then we have another ‘00 sector: semiconductors. The SOXX ETF. Again, all three of these right back exactly to their mania type of price levels.
- So, I don’t really like these types of things. They seem to be horrible in terms of trade location. Maybe we do go into some different environment and these explode to the upside. But this is horrifically bad trade location. It’s as bad as it could possibly get. It’s great to be a short seller from a trade location basis.
- You might do it with a very tight stop because if it busts through it could go a ways, but this is great trade location. But there are markets that aren’t nearly as rich. And, of course, some of them are emerging markets. Here we have Dr. Shiller’s CAPE ratio which is one of the reasons that he won the Nobel prize about four years ago with his work, or five years ago, now, on the CAPE ratio.
- It basically gives a long-term valuation framework for looking at stocks. And the red CAPE ratio’s United States S&P 500 where the CAPE ratio is at the same levels it was in 1929. And I don’t have it on the exhibit but the only level that was higher, and it was quite a bit higher, was in ‘99/2000, was at 44. So that’s what the melt-up folks are hoping for, that we could have a 44 CAPE ratio?
- However, it’s very elevated, particularly relative to the blue line which is emerging markets CAPE ratio where it’s about half even though emerging markets have been killing the US market for the past really two years. But certainly the past year and change, it hasn’t done anything substantial to narrow the gap. It’s been a bit of a narrowing but there’s a long way to go and if you look at this chart carefully you’ll notice that there’s historical periods where the CAPE ratio in emerging markets is higher than the S&P 500 so it is not lunacy to expect these lines to completely converge. It’s happened before. It’s happened twice, actually, in the past 12 years, even. So emerging markets look much better and the dollar trend, I believe, is down. And so I turn bearish on the dollar, really, at basically 102 on the dixie. And everybody was so bullish. Everyone’s highest conviction trade for 2017 was the dollar would go up. ‘Course it didn’t do that. It basically has gone down by 15% since then and doesn’t seem to have an easy time rallying.
- So, emerging markets probably are relatively safe as long as the dollar doesn’t surprise to the upside.
He added, I’ll point out some other sort of interesting things that are happening in the bloodless verdict of the market. One is the price action of the S&P 500 contrasted to the price action… compared to and contrasted with the price action of the high yield ETF, with high use (I use JNK for this).
- But, you see, it’s very interesting—in 2017, 2016 rather, the blue line S&P 500, and the red line, the JNK ETF, had almost exactly the same experience. I mean, the wiggles and jiggles are the same, you end up in almost exactly the same place, they had the same return on a price basis.
- And it’s like somebody rang a bell at the end of 2017 and the junk bond market suddenly started to deteriorate in price using the JNK ETF where the S&P 500 exploded higher. This is a huge divergence.
- This type of thing I think is really unprecedented. So, it’s kind of interesting how this has developed. One of the ways I think about this, it seems to me that junk bonds just don’t yield enough. I think they got decoupled from the S&P 500 simply because a yield of 5 ½% pre-defaults on junk bonds, understandably, doesn’t get investors excited. Just like a yield of 2.02% on the 10-year doesn’t get a lot of people excited and that’s where it got to last summer.
- In fact, I would make the argument, and I know that there’s some diehard bond bulls in this room, but I would make the argument that not many people find 2.85% all that attractive on the 10-year either with the CPI at 2.1%, potentially going higher.
On the dollar:
- So, here’s the dollar (next chart below), and the dollar goes in sweeping trends that persist and go on for repeated duration. So, we take this back to the ‘70s and the trends for the dollar seem to last six or seven or eight years with regularity. So, we saw the bottom in the late ‘70s and that lasted into the peak about 1985. It was about seven years. And then we see the depreciation into 1992 or so, about seven years. And then we see the appreciation into ‘00 and so on.
- And so we see we had an appreciation of the dollar from around 2010 to around 2016 or ‘17 which is that typical length of time. And now the dollar has rolled over.
- Also, when you get a lousy year in the dollar, like last year, it’s very typically followed up by another year that’s bad just after. And we’ve already started out … it’s not really tanking, the dollar, but it’s not strong either this year.
- So, I think this dollar trend… base case, I think dollar goes lower.
Here’s the long-term dollar trend.
- And so we see it’s been in a downtrend ever since 1985 and we basically got above that downtrend line in 2014, and then we kicked up to the 103 level at the beginning of 2017 and down we go, but we’ve just kissed that line on a check-back.
- So, it’s going to be very interesting to see if this can bounce off that and regain the bull trend or if it cracks through and we go into another leg of weakness. We’re right at the juncture.
- We’re also at the juncture in gold, not surprisingly, because it is negatively correlated with the dollar. We see that gold broke above its downtrend line, it’s got the same look. But now we see a massive base building in gold. Massive. It’s a four-year, five-year base in gold. If we break above this resistance line one can expect gold to go up by, like, a thousand dollars.
- Will it happen? Well it’s not happening right now but it’s a very interesting juncture. It’s a great time to be buying gold straddles. Because one way or the other this baby’s got to break in a big way.
And here’s one that looks just like gold, kind of shockingly. It’s the ratio of the 10-year yield to the S&P 500 price which is really interesting because if this thing breaks out it probably means the 10-year yield is going higher.
- And as I said before, the correlation is positive and it’ll probably shift more positive and you would see both the numerator and the denominator fueling this line to explode to the upside. So, we’ll see if it happens.
People have been asking me for years, when are rates going to start rising and for years I’ve been saying, pal, they already are. The 2-year Treasury bottomed seven long years ago and this, I’ll go out a limb and say looks like an uptrend.
Here’s the 5-year Treasury which didn’t have quite the same uptrend look but it bottomed six years ago in July of 2012 and it broke its downtrend line and certainly this also looks to be in something of an uptrend.
Here we’ve got the 10-year Treasury which has been a little bit better behaved.
- It looks like those other charts where it breaks its uptrend then it checks back. That’s one, two, three times checking back to its downtrend line and the boom, third time’s the charm and up we go on the 10-year.
- We’ll see what happens here. We’re at extremely important levels.
His line in the sand for the 10-year Treasury:
- I believe it’s game over for the bond bull market, and I think we’re going to go above 3% on the 10-year, and I think we’re going to see a lot of action in declining prices in bonds and stocks because at that point they’ll be highly correlated.
SB here: That was a lot to take in. He sees us at a tipping point on yields with clear signs of rising inflation pressures. He’s confident we’ll see consumer price inflation at 2.6% by June of this year. That will keep the Fed in the interest raising mode. Affecting both stocks and bonds as he sees them declining together.
Trade Signals — Testing 200-Day MA, Fixed Income Bearish, High Inflation Pressure
S&P 500 Index — 2,612 (03-28-2018)
Notable this week:
The daily investor sentiment reading has moved to “Extreme Pessimism,” which is short-term bullish for equities. While we see deterioration in the overall trend evidence as measured by the CMG NDR Large Cap U.S. Long Flat indicator, it continues to suggest the overall weight of evidence supports a moderately bullish environment. Additionally, the 200-day moving average line on the S&P 500 Index is being tested. The fixed income trade signals remain bearish and notable is the move in our “Inflation Watch” indicator to “High Inflation Pressure.” This is typically not a favorable environment for bonds. Fixed income signals are bearish. Stay risk focused and alert. Seek growth opportunities while maintaining a level of protection in down markets. I see no recession risk on the near horizon but believe 2019 will prove challenging. Risk is high and the market is both aged and extremely overvalued.
Long-time readers know that I am a big fan of Ned Davis Research. I’ve been a client for years and value their service. If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at 617-279-4876. John’s email address is email@example.com. I am not compensated in any way by NDR. I’m just a fan of their work.
Important note: Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note — “In the Middle of Difficulty Lies Opportunity” (Einstein)
I do believe it is time to think about how we get to the other side of the great debt mess and what the “reset” might look like. Winston Churchill purportedly said, “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” Let’s remain optimistic and continue to seek growth opportunities. I was on a call this week about a seed company that believes it can grow its revenue 50 times in the next seven years and 100 times within the next 10 years. I think they can do it. Full disclosure: I’ve been an investor in the company since 2006 and I tell my kids if something happens to me, don’t sell the stock. But, of course, there are no guarantees. The point is there are always opportunities. The key is how you size the risk in your portfolio. (If you’re an accredited investor, email me and I’d be happy to share more. Unfortunately, you must have a net worth of more than $1 million per U.S. securities regulations.)
What if we invest our core allocations and add in several growth opportunities around the edges? Risk manage the core and diversify to several opportunities so our risk isn’t concentrated in one big bet. Size them in a way that fits your needs, risks and time horizon.
Commodities and value stocks have been underperformers. Who do you know that looks at the last number of years of commodity returns and says “Yeah, buy me that.” But that’s the point. I like Gundlach’s commodity idea. Especially when we reset the debt. A great inflation play. Gold looks to be in a long-term bull market cycle. I believe it makes sense to add to active managers: long-short strategies may benefit and I like tactical ETF trading strategies. Both tend to be longer-term, all weather-like plays.
My good friend, John Mauldin, favors diversifying to liquid ETF trading strategies using experienced strategists with a mandate to invest globally into all kinds of liquid assets. Yet I openly admit I’m biased. The point is there are many opportunities. I just don’t think the opportunity today is in passive buy and hold 60-40 stocks and bonds; yet that is what the majority seem to be believing today.
- Game plan: #MoreDefenseThanOffense2018-2021.
But enough about that, let’s move on to far more important things. Important holidays. Easter and Passover are important holidays to so many of us. While I’m not an overly religious person, I do love many of the teachings from many different religions. For me, it is about kindness, compassion, empathy and love. I tell my kids they are here to create great things for themselves, to love and to seek joy. Do that well and everyone you touch will benefit as will you.
So this holiday weekend, here’s a toast to all you create and to the people you love the most and to the joy you experience together. Happy Easter and Happy Passover! Enjoy your weekend!
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With kind regards,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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A Note on Investment Process:
From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.
My objective is to position in line with the equity and fixed income market’s primary trends. I believe risk management is paramount in a long-term investment process. When to hedge, when to become more aggressive, etc.
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