This Week's Reading

John P. Hussman 4/17/17 - The Value of Dry Powder

“The chart below shows the most reliable market valuation measure we identify, nonfinancial market capitalization to corporate gross value added, on an inverted log scale (blue line, left scale), along with the actual 12-year nominal annual total return for the S&P 500 Index (red line, right scale). As we observed during the severe market retreats that followed the tech bubble and the mortgage bubble, substantially higher expected returns are likely to emerge over the completion of this market cycle, as a result of interim losses in the next few years. Dry powder has considerable value here, not because of the return it currently generates, but because of the opportunity it may afford to establish constructive and even aggressive market exposure over the completion of this cycle, at higher prospective returns than are currently available. For that reason, whether investors choose hedged alternatives or cash, I strongly encourage investors to maintain a regular, disciplined saving plan.”

Business Insider 4/18/17 - Banks are suddenly scaling back lending, and Wall Street isn't sure what to make of it.

“Bank lending to consumers and businesses is slowing down.

As of last week, commercial and industrial lending had not increased since September 7, the first six-month period of declines since the aftermath of the financial crisis, Bank of America Merrill Lynch said.

Consumer-loan growth has also slowed, up by 1.4% since the November election versus 3.1% during the same period a year earlier.

Depending on who is asked, this slowdown is either an expected response to some preceding indicators or another reason to be worried about the economy.”

“The slowdown seemed to be a bit of a puzzle at the outset. One explanation, for businesses at least, was that they were awaiting the outcome of the election, and then of policies like tax reform and immigration, before deciding to borrow for big investments.

But that argument doesn't necessarily hold up for consumers, whose spending decisions are less reliant on Capitol Hill.”

“But from a business-lending perspective, the slowdown is a bit of a lagging indicator, considering the big drawdown in inventories last year, he said. Inventories, a major part of gross domestic product, slowed economic growth during much of 2015 and 2016.

Additionally, the first quarter was solid for bond issuance, suggesting that companies are relying less on bank credit, Baird said. High-grade companies issued a record $414.5 billion of debt in the first quarter, according to Dow Jones.

And from the supply side — why banks aren't lending as much — David Schawel, a fixed-income portfolio manager at New River Investments, argues that banks don't stand to miss out as much by not earning interest on lending.”

Mohamed A. El-Erian: Bloomberg View 4/19/17 - High Stock Prices and Low Bond Yields Can't Last

“Unless you believe the Federal Reserve will ease monetary policy, which I don't, it is getting harder to reconcile what are still historically low bond yields and relatively high stock prices. More consistent and sustainable levels probably lie somewhere in the middle. Exactly where, as well as when and how we would get there, depends primarily on the balance between geopolitical and economic-policy influences.

Stock markets repeatedly have proven extremely resilient in shrugging off both political and geopolitical worries. In doing so, they have relied on deeply anchored market beliefs regarding stable growth, supportive central banks and further liquidity injections. As a result, they view the prospects for stronger corporate earnings and economic growth as compensations for geopolitical fluidity.”

“The same isn't true of government bond markets. There, yields on 10-year Treasuries have languished recently below the 2.30–2.60 percent range that was established after the November presidential elections, as geopolitical worries have been compounded by concerns about both low inflation and subdued growth.

This is not the first time that government bonds and stocks have sent conflicting signals, and it won't be the last. Moreover, this inconsistency coexists with several others, including the divergence between emboldened measures of business/consumer confidence and hard data that remains sluggish.

Also, let us not forget the asymmetrical upside/downside prospects. Simply put, at current levels, stocks heavily dominate bonds when it comes to most current assessments of the upside return potential segment.

Yet this particular market inconsistency has persisted for some time, and it has outlasted many explanations, including those emphasizing the technical positioning of markets. Indeed, the only proper way to reconcile the two competing market signals at this stage is through a forecast of renewed monetary policy easing on the part of the Federal Reserve.

Absent a major economic downturn that would also rout stock markets, such easing is highly unlikely. Indeed, while the balance of risk may be shifting, the baseline still favors two additional interest rate hikes this year, together with an action plan for balance-sheet normalization.

The more likely outcome is a reconciliation of market signals with government bond yields moving up and stock prices down. When this happens, where the two settle, and the orderliness of the process will be mainly a function of two influences: the extent to which geopolitics has an adverse effect on the outlook for growth, and the extent to which U.S. policy reforms improve the prospects for actual and potential growth. In the meantime, investors should be increasingly wary about betting on durable market inconsistencies.”

CNBC 4/19/17 - Santoli: Stocks have been in a 'quiet correction' for months

“Yet by last week, nearly half of all stocks in the broad S&P 1500 were down at least 10 percent from their 52-week high, the popular bank sector remains down that much and economically attuned groups such as transportation and steel have lagged badly.

Since around the time of the market high, the 10-year Treasury yield has ebbed to 2.2 percent from 2.6 percent, the CBOE S&P 500 Volatility Index (VIX) has climbed into the mid-teens from around 11 and the Atlanta Fed's GDPNow forecast model for first-quarter growth has tumbled to 0.5 percent from 2.5 percent. Investor attitudes have also run from excessive bullishness to a warier outlook, with weekly investment-advisor polls, the CNNMoney Fear & Greed Index and the Bank of America Merrill Lynch Global Fund Manager Survey suggesting that the so-called wall of worry is gradually being rebuilt.

This subtle but noteworthy change in market character means we're again at a point where market handicappers are asking whether the market's internal weakness has been dramatic enough, with enough "oversold" conditions popping up, to set up a strong rebound. So far, according to close students of tactical market clues, the answer is "Close, but not quite."

Katie Stockton, technical strategist at BTIG, says last Thursday's high-volume sell-off sent some of her preferred indicators to extreme readings that often set up a good rebound. Yet, she concludes that "down-volume was strong enough to suggest the pullback still has a hold on the market." Confident that the longer-term market uptrend remains intact, she says, "We remain on the lookout for a buying opportunity, which appears more likely after a shakeout in high-beta areas of the market."

Similarly, BAML's Stephen Suttmeier sees this little downside reset in the market as incomplete. One notable shift is the arrangement of the short-term and longer-term VIX futures prices, with immediate volatility expectations appearing puffed-up relative to more distant ones. Without getting into the statistical weeds, it's another "oversold" condition, one that says traders are paying up aggressively for a possible sudden spike in market risk, despite the still-placid behavior of the indexes themselves.

While this is a start, Suttmeier argues that broader measures of downside hedging with options "are nowhere near the oversold levels that have coincided with important S&P 500 lows." He figures the index has another 2 to 4 percent of risk to the downside in the fairly near future based on the weight of the evidence.

The quirk this time is that when the VIX makes a five-month high (as it did in recent days), the S&P 500 is usually down a whole lot more than 2 or 3 percent from an all-time high. Does this mean traders are overreacting to modest weakness, or are the options guys foretelling a stormier period ahead? Worth watching is the corporate-credit market: It remains firm, but risk spreads have modestly widened in recent weeks, slightly weakening one of the stock market's key sources of strength in the past year.

Even the strongest years tend to have one or more declines of more than 5 percent from a high, so this would be consistent with the rhythm of an ongoing market advance – one that is strongly suggested, based on historical patterns, by the impressive start to the year. If the late-March lows were as deep as this quiet correction gets, it might be comforting, but it also likely means the market won't have built up sufficient fear or reloaded with enough fresh buying power to vault the market too quickly on a powerful new leg higher. This is often the trade-off traders face – muted volatility can contain the market in both directions for long stretches of time.”

OilPrice.com (via The Fiscal Times) 4/20/17 - Why the Oil Markets Are Headed for a ‘Decade of Disorder’.

“But investment fell by over $300 billion in the two-year period of 2015 and 2016 – “an unprecedented occurrence,” the IEA noted in a 2016 report on energy investment. 2017 could show marginal increases in spending, but the industry is not returning anywhere close to the pre-2014 levels of investment.

That could set the world up for a supply shortfall by the end of the decade when large deepwater projects that were not given the greenlight over the past three years would have started to materialize. The lack of new production will mean that suppliers struggle to keep up with demand.

Michael Cohen, head of energy markets research at Barclays, told the Platts Capitol Crude podcast that a supply shortfall could hit as soon as the 2020-2022 period, assuming annual oil demand growth of 0.8 to 1 mb/d, which is lower than the 1.3 mb/d of demand growth the IEA expects for this year. Of course, if demand grows each year at a more than 1 mb/d rate – not an unreasonable scenario – the supply shortage would be even more acute. “The question is whether the market will see that eventuality and try to price it in beforehand,” Cohen said on the Platts podcast. “It is our view that prices need to rise” in order to incentivize new supply coming online to cover that eventual gap, he added.

Bloomberg 4/20/17 - The Real World of Oil Has a Warning for Financial Markets

“The Brent physical oil market is flashing signs of weakness again as dwindling Asian purchases, an influx of American crude to Europe, and supplies flowing out of storage all combine to recreate a glut in the North Sea.

The weakness comes at a time when speculators have started rebuilding bullish positions after a sell-off last month, betting the market will tighten in the second quarter. Yet, Brent physical oil traders say the opposite is happening so far, according to interviews with executives at several trading houses, who asked not to be identified discussing internal views.

“We need to see the market going really into deficit for oil prices to rise,” Giovanni Staunovo, commodity analyst at UBS Group AG in Zurich, said. “If this is temporary, it could be weathered, but it needs to be monitored.”

The weakness is particularly visible in so-called time-spreads -- the price difference between contracts for delivery at different periods. Reflecting a growing surplus that could force traders to seek tankers as temporary floating storage facilities, the Brent June-July spread this week fell to an unusually weak minus 55 cents per barrel, down from parity just two months earlier. The negative structure is known in the industry as contango.”

“In the world of contracts for difference, which allow traders to insure price exposure for their North Sea crude shipments week-by-week, the one-week CFD spread plunged this week to minus $1.84 a barrel, the weakest since late November and just before the Organization of Petroleum Exporting countries and allied nations announced their first joint effort to manage supply in over a decade. A month ago, the comparable CFD traded at just minus 50 cents barrel.

"It will not take much before we see headlines about floating storage starting to increase again," said Olivier Jakob, head of oil consultant PetroMatrix GmbH, in Zug, Switzerland.”

“The differentials between physical grades and benchmarks have also weakened in recent weeks. Glencore Plc, the world’s largest commodities trader, on Thursday bought from French oil giant Total SA a cargo of Brent crude at $1 a barrel below the main North Sea benchmark, the widest discount in 22 months, according to a trader monitoring deals.

Oil traders said OPEC was initially successful, driving oil prices higher and tightening time-spreads. But the group was a victim of its own success, as those same spreads forced crude out of storage, flooding an already weaker physical market with supply. Higher headline prices also boosted U.S. shale producers.”

CBS Money Watch 4/21/17 - It’s a scary stock market, but opportunities may soon beckon.

“Through April 13, only 30 percent of the 148 subindustries in the S&P Composite 1500 stock index were trading above their 10-week, or 50-day, moving averages, noted Sam Stovall, chief investment strategist at CFRA Market Advisor. “While this is certainly an indication of recent weakness, it may also be viewed as a source of near-term optimism, since it implies that the market may be oversold,” argued Stovall.

He also noted that in any given week since Dec. 31, 1995, 60 percent of the subindustries in the S&P 1500 traded above their 10-week moving average. And whenever S&P 1500 had 30 percent or fewer of its subindustries trading above their 10-week averages, the S&P 1500 outpaced its average for all periods over the coming three, six, and nine weeks. “Indeed, the S&P 1500 rose in price 1.5 percent, 2.7 percent and 3.5 percent during the subsequent three, six and nine weeks after touching 30 percent or lower,” Stovall pointed out.

And if you’re worried that the market may weaken further, you have more gains to look forward to, he added. That’s because whenever the percentage declined to 25 percent or less, the S&P 1500 improved during the following three, six and nine weeks, rising 1.7 percent, 3.2 percent and 4 percent, respectively, and posting higher frequencies of advance during all periods.”

Joseph S. Kalinowski, CFA

Email: joe@squaredconcept.net

Twitter: @jskalinowski

Facebook: https://www.facebook.com/JoeKalinowskiCFA/

Blog: http://squaredconcept.blogspot.com/

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