June 15, 2018
By Steve Blumenthal
“So I think you’ll see rates go up and stocks go up in tandem at the end of the year.”
“If you asked me to think of similar time periods, I’d say 1987 in the U.S., I’m not saying we are going to have a crash. It was a time when you had a budget deficit and you had stocks and rates going up together for a period of time. 1999 in the U.S. also jumps to my mind where things got crazy at the end of the year. 1989 in Japan: they had strong fiscal and monetary pulses that worked their way through the stock market… So I can see things getting crazy and particularly at year-end after the mid-term elections. I can see things getting crazy to the upside.”
– Paul Tudor Jones, CNBC, June 12, 2018
I was driving to work on Tuesday morning and tuned into CNBC. My attention stood up when I heard Andrew Ross Sorkin interviewing Paul Tudor Jones, founder of Tudor Investment Corporation and the Robin Hood Foundation. I like to know what the brightest trading minds are thinking. Especially when they have serious skin in the game. I’m pretty sure you feel the same way. The interview didn’t disappoint. Today, you’ll find my notes from that interview along with some discussion about the Fed. I was interviewed on the floor of the NASDAQ Stock Exchange earlier today and share the video link with you as well.
The best seem to be able to cut through the noise and get to the meaningful points. As I read through piles of research each week, my head clicks, “Doesn’t matter, doesn’t matter, matters!” Put what Jones has to say in the “matters” column. This week I share with you what I found to be most important. Grab a coffee, block out the noise and let’s jump in…
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Included in this week’s On My Radar:
- CNBC’s Paul Tudor Jones Interview – Crazy to the Upside at Year-end
- NASDAQ’s Blumenthal Interview
- Trade Signals — Cautious on Market: Investor Bullish Sentiment Too Extreme, Negative Seasonality Patterns
- Personal Note — Happy Father’s Day!
CNBC’s Paul Tudor Jones Interview – Crazy to the Upside at Year-end
“There are three things that are driving the world today and all of them begin in the U.S. The action is in the United States… three things that are pushing asset prices:
- Fiscal Policy (taxes, government spending, debt)
- Monetary Policy (the Fed and global central bankers)
- And what I call a ‘Trade Irritant'”
Jones (PTJ) said, “… it is more of an irritant than a real trade problem though it has to be monitored closely… it could escalate.”
CNBC’s Andrew Ross Sorkin conducted the interview and asked, “Are you worried about a trade war?” Jones replied, “You have to put things into perspective: looking at our four biggest trading partners [if] you put a simple weighted average on trade tariffs you get about 6%. [SB here: The U.S.’s trading partners slap a 6% extra fee on top of the price on the goods we sell them.] We have an average tariff of 3½%. So there is 2½% gap in unfairness.”
Jones sums this up in a way that puts logic around the rhetoric. “If what the president [is] trying to do is normalize the tariffs, we are looking at a $30 billion problem in an $87 trillion world economy. [SB here: Here’s the rough math: the 2½% gap in unfairness times $1.2 trillion in total U.S. exports.] The danger would be that he is just not trying to equalize the playing field by equalizing the tariff discrepancy. The danger would be that he is trying to do away with the bilateral trade deficits country by country and there is a problem with that because we are running a structural budget deficit… if you just balance the accounts the way that typically balances, you run a trade deficit to do that. So, on the one hand, we have this massive budget deficit the Administration and Congress has [sic] engineered and on the other hand, he (Trump) is trying to do away with bilateral trade deficits and the accounts don’t balance. So, it could be dangerous if he is focusing not just on trying to get free and fair trade but to actually do away with that bilateral trade deficit because he is actually jamming a square peg into a round hole.”
Sorkin: “And then there’s the Fed. If you were running the Fed, what would you do?”
PTJ: “I think rates should be 150 bps higher right now. It’s where they should be. We’ve got 3.8% unemployment and negative real rates. And we have a 5% on the way to a 7% budget deficit.” [SB here: That’s like you spending 7% more each year than you are earning.] The last time we had unemployment where we have it now was in 2000 and we were running a budget surplus of 2.5%. We were talking about bond scarcity at that time and now we have the exact opposite so we’ve got fiscal policy (spending far more than we are earning) and monetary policy (the Fed is lax) and that brew is what has the stock market so jacked up.”
Sorkin: “When you wake up at 3 a.m. to check the London markets, what are you thinking about… what are the issues that have consumed you over the last several weeks?”
PTJ: “I have this running debate. Do I look at the prices first or do I look at my P&L first and I think dear Lord please not have let anything bad have happened. Has there been any significant change that I wasn’t anticipating when I went to sleep? It’s a good day when there has been nothing significant. And since I trade globally, I’m looking at what economic data might have come out that might affect prices.”
Sorkin: “Single best investment that’s working for you right now and single investment that’s not working as you hoped?”
PTJ: “I am currently as light on my positions as I’ve ever been. I can’t remember how many years it has been since I’ve been this light. Meaning I don’t have a lot of macro positions on right now because I think the reward-risk on a large variety of things is diminished at this particular point in time. I like to have significant leveraged positions when I think there is an imminent price move directly ahead. I don’t like having positions and it’s probably a fault of mine just because I think interest rates are going up or I think the dollar is going to go higher. I much prefer to be leveraged at the point in which they (prices) move the most so I’m not subject to events overnight or events over the course of weeks or months.”
Sorkin: “Is there something you’re waiting for?”
PTJ: “Yes, there is a lot I’m waiting for. I have a sense that the third and fourth quarter are going to be phenomenal trading times. I have a feeling we are going to go into a summer lull.”
Sorkin: “What do you think we’ll see in the third and fourth quarter?”
PTJ: “I think we’ll see rates move significantly higher beginning late third quarter early fourth quarter and it will be interesting because I think the stock market also has the ability to go a lot higher at the end of the year.”
CNBC’s Becky Quick: “Normally people say that when rates go up, that is not good for stock prices. Why do you think both interest rates and the stock market will go up in the fourth quarter?”
PTJ: “Let’s put things into perspective where interest rates are. We are negative in interest rates (compared to inflation). If you look at what has historically shut off the stock market, it has been real rates of something like 2% or 2.5%. We are negative right now so when you’ve got a lot of tech companies growing at 20% per year, who cares about 100 basis points (1%)… who cares! So, I think you’ll see rates go up and stocks go up in tandem at the end of the year. If you asked me to think of similar time periods, I’d say 1987 in the U.S., I’m not saying we are going to have a crash. It was a time when you had a budget deficit and you had stocks and rates going up together for a period of time. 1999 in the U.S. also jumps to my mind where things got crazy at the end of the year. 1989 in Japan: they had strong fiscal and monetary pulses that worked their way through the stock market… So I can see things getting crazy and particularly at year-end after the mid-term elections. Yeah, I can see things getting crazy to the upside.”
Sorkin: “You’ve been talking about a bubble in the equity market and the risk to the downside.”
PTJ: “Have you seen the movie, Pumping Iron?”
Sorkin: “…Arnold Schwarzenegger, I know the movie…”
PTJ: “Right. So Arnold… the guy looked flipping amazing but he was roided (steroids) out of his brains. That’s not sustainable. So here we’ve got negative real rates, we’ve got interest rates that look unlike anything we’ve ever seen at a stock market top before and we’ve got a 6% budget deficit during peace time with 3.8% unemployment.” [SB here: with employment humming so strongly, we shouldn’t have a budget deficit. The government should be pulling more in tax revenues than they are spending.]
“So yes, I think this is going to end with a lot higher prices which will force the Fed to shut it off. And yes, the reason I’ve picked a couple of those years is that when you look at the valuation of the stock market relative to GDP, we are at levels that historically lead to some type of economic contraction. It’s an old story… we’ll probably play it again.”
Sorkin: “What are you looking for as the top or the tipping point?”
PTJ: “We’ve got (corporate) buybacks right now that, like Arnold in the Terminator, they don’t stop. And we are retiring equity as a percentage of total market cap at an unprecedented rate this year. Rates have got to go up enough to either shut the economy down and overwhelm those buybacks or make it economically less viable for companies to issue debt and buyback stock. It’s real simple.”
Sorkin: “ETFs… All of the money has flooded into the ETF world, how do you think that is going to impact things if and when we do have a downturn?”
PTJ: “Things will be extraordinary constrained.” [SB here: Paul then went on to talk about his new ETF.] “It will affect the retail investor and I think the retail recession is going to be great.” [SB here: My two cents… over concentration of money into similar stocks combined with panic selling and margin calls is what he means by “retail recession.” But I could be wrong with my attempt to interpret what PTJ is saying.]
That essentially ends the interview. I found the conversation helpful and hope you did too.
BTW – the ETF that Jones is involved with is ticker symbol “JUST.” I’m going to have my research team take a look at it and see how it models into our portfolio strategies. The corporate do right, socially responsible story is a good one.
Also, check out the chart I posted in Trade Signals last Wednesday. It shows the DJIA chart pattern during the four-year presidential election cycle. Note the strong seasonal pattern at year-end (after the mid-term elections). It supports Tudor Jones’ year-end rally thesis.
Click on the picture below to watch the entire CNBC-PTJ interview:
NASDAQ’s Blumenthal Interview
A short interview where I shared my thoughts on the Fed’s recent rate hike and plans for many more. I think Tudor Jones is right. The Fed will eventually end the party.
Here are my pre-interview bullet points:
On the Fed:
- Fed funds rate is now 1.95%.
- My best guess is that they eventually move to 3% to 3.50% by sometime in 2019.
- Ten of the last 13 rate hike cycles landed us in recession – this one will too.
- Our starting conditions are about as bad as they can get – uber-high valuations and ultra-low interest rates.
- Two big issues on the horizon: how we deal with the debt problem and how we deal with the ever more evident underfunded pension problems – both are headwinds to growth so I believe the Fed goes 11 for 14 and I predict recession next year.
- Why that matters to investors is that in recessions the stock market declines 38% on average. The last two delivered -50%. I see no reason why the next one won’t be equally challenging. The good news is there is no sign of recession in the next six to nine months. I post my favorite recession watch charts in OMR each month, so we’ll keep watching the data together.
Now with that said, there are moves investors can make:
- For now, the trend in the equity markets remain favorable. Participate but do so in a way that meaningfully protects your downside.
- I favor diversifying to several risk-managed trading strategies… to get from here to the other side of the next event. Then more offense than defense. Now – more defense.
- Imagine the opportunity that presented in late 2008.
- Think entirely differently on your fixed income…
Trade Signals — Cautious on Market: Investor Bullish Sentiment Too Extreme, Negative Seasonality Patterns
S&P 500 Index — 2,789 (06-14-2018)
Notable this week:
Investor optimism is extreme. That’s a short-term negative for the equity markets. The Fed is likely to lift interest rates another 1/4% today and odds are near 50% for a total of four rate hikes in 2018. That would likely push the 10-year Treasury yield to the 3.50% to 4% range. As you’ll see below, the Zweig Bond Model fixed income signal remains in a sell.
The longer trend models for equities (Ned Davis Research CMG U.S. Large Cap Long/Flat signal remains moderately bullish, signaling 80% large cap exposure and the 13-week EMA vs. 34-week EMA trend remains positive. Our shorter term momentum/trend models are signaling more caution. Overall, equities remain above the important 200-day MA line, while the yields on the 10-year and 30-year Treasury yields remain below 3.07% and 3.22%… important levels to watch. A break above those levels likely presents additional challenges for both the equity and fixed income markets.
Lastly, keep the seasonality patterns front of mind. Here is a look at the four-year presidential cycle. The shaded area (blue/grey box) highlights the current year. We sit in the second year of the presidential cycle. The historical pattern shows that the second presidential year is, on average, the weakest of the four years. The pre-election year has been the strongest historically, and the election year has been the second strongest. The top section shows the historical pattern of with data back to 1-2-1900. The bottom section (red line) plots the current election cycle performance of the S&P 500 Index. You can see how the current election cycle tracks the historical cycle pattern.
From Ned Davis Research: “Cycle composite charts are designed to provide perspective on how repetitive historical market patterns could indicate a potential pattern for the current year. These cycle charts are based on the idea that multi-year cycles have patterns that tend to repeat over time in the stock market. The four-year cycle (reflecting the time frame of a U.S. presidential term) has been found to have significant repetitive tendencies over history.
The top clip plots the Dow Industrials Four-Year Presidential Cycle. The four-year cycle is calculated by finding the average percent change in the DJIA for each day of a calendar year, based on only every fourth year since 1900. The average daily percent changes are accumulated to produce a representative “average year” pattern.
As the chart label indicates, the actual values (level) of the lines plotted are not significant by themselves, rather the trend of the lines indicating the potential direction of the market is where the focus should be. As always, we do not rely on cyclical patterns as primary market timing tools, instead basing analysis on factors such as the tape, the Fed, crowd sentiment, etc.
However, knowing the historical tendencies of the market can often provide useful perspective on potential turning points and trends, which gain added weight when confirmed by primary NDR timing models and indicators.”
Bottom line: The overall weight of evidence continues to support a moderately bullish market outlook. Yet, keep in mind that the cyclical bull is aged and valuations are high. This coupled with extreme optimism and the four-year cycle pattern suggests considerable caution. Participate and protect. Have a stop-loss risk management process game plan in place. I favor diversifying to trading strategies. More defense today. After the next recession when valuations and forward returns become attractive again… then more offense.
The next section walks you through all of the Trade Signals charts.
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.
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.
Personal Note — Happy Father’s Day
I’m really looking forward to the weekend. A Philadelphia Union soccer game with Susan and the kids on Saturday night… great fun for dad and golf is planned with the kids on Sunday. Brianna is coming home for the weekend and hopefully we can convince her to join us for at least nine holes. She’s coming home to find a quiet place and study for the CFA exam. The test date is fast approaching… one week to go. Dad’s most proud of her effort. A good outcome is a bonus.
The World Cup has begun (absent the USA unfortunately) and the U.S. Open is this weekend. I see my favorite spot on the couch and a cold IPA in hand Sunday afternoon. Here’s a new one that has made it into my top five. Funk Citrus IPA. It’s yummy… but I better hit the gym first.
It’s Father’s Day and I’ll be holding that IPA up high in toast of my old man. I sure do miss him. Pop was an avid sports fan and was crazy about the Phillies. I too love the Phillies, but let’s not let him know I’m also a Yankees’ fan. To which my good friend, Rory Riggs, took me to last Wednesday night’s game at Yankee Stadium. His seats were amazing. A great night… Following are a few shots.
The Yankees lost a close one by a score of 5-4. As we exited, a long-time reader of On My Radar recognized me. “Hey, CMG,” he said… It was nice of him to say hello. (Dominick, please send me your contact information).
And this was pretty cool:
Wishing you and your father a wonderful Father’s Day. Moms are by far the most important human beings on earth, but I’m checking in really happy to be a dad. Wishing you and your family the very best.
Have a wonderful 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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