Not all is Rosy

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What we had hoped would not come to pass is now becoming reality. Perhaps it was hope rather than math, that drove optimistic perception. I have a saying, which I probably don’t repeat enough; “You can choose to ignore the math, but you can’t avoid it!” We tend to ignore real economic data, math and fundamentals. Instead we embrace headline data as the media, politicians, and economic bias wonks spin it to always make it sound better than it is. Yet, the underlying currents of math and fundamentals move effortlessly forward and eventually the day comes when we just can’t ignore it anymore. Are we there yet, probably not – the Fed can certainly buy more time (more QE, negative interest rates, increase money supply, and expand the pool of asset classes they are buying). Yet it is only time they are buying and not the fundamental realities that have cemented in to the economic foundation of the western economies.

Not all is rosy

Ignoring headline data of Jobs for a minute, the fundamental data we are seeing in earnings, trade, and consumption certainly do not reflect a robust economy or for that matter a growing economy. Certainly one can make an argument for stagnation, but that is still more of an optimistic view.

This morning Durable Goods fell over 5% in December. While the strong dollar and decline in oil certainly play a factor, one can’t help at looking at the flow of commodities to finish product and ultimately at the consumption rate.

The life blood of any civilization has always been commodities. We eat, we need shelter, clothes, and tools. From the ground to a finished product is a pipeline that moves quickly and slowly. Driven by the supply and the demand. Numerous factors impact the flow, but ever the flow must move forward.

Since the rise of Keynesian economics hand-cuffed to fiat currencies, the value of commodities have become skewed and in many cases radically. Leverage, margin, debt financing, deficit spending, money creation, fixing interest rates, and fractional reserves has ultimately made the true value of commodities an unknown.

Has the price of oil and gold fallen or is this just a mirage of a strengthening fiat currency of the dollar, against a basket of other fiat currencies? Certainly actual supply & demand play an important factor, but one can’t help but take into account the rally in the dollar against the basket of currencies as the large factor at play. Ask the people in India if oil is expensive or cheap? It is all relative to your own fiat currency and it’s relation to the dollar.

Puerto Rico

Courtesy of wikipedia

Society has also played a significant role, as we have become reliant of government interventionism, entitlements, and the ever march forward to socialism.

I have been spending a lot of time in Puerto Rico, establishing an office and doing business here. It is a beautiful island, great people, delicious food, and salsa music. Why the trouble in paradise? The news media in the states is myopically focused on the public debt. True it is a significant problem and much of the focus is on short-term relief, haircuts, and refinancing. However, much like Greece, Detroit, and other places in which financing public debt and deficit spending is a problem – there is no consideration, no plan, and new long-term view. Some would argue (Keynesians) that Puerto Rico’s debt problem (much like Detroit or Greece) would not be a problem if they could just print their own money.

I recently found out (but have not confirmed) that over 60% of the work force in Puerto Rico work for the government or government related entity (utility). They are also the highest paid, best pensions, most vacations, and fewest working hours. Those unemployed, a family with 2 children, receive over $1700 a month in subsidies, while full-time minimum wage pay is in the $1500 a month range. No wonder no one wants to work. Puerto Rico has a high unemployment rate, if you don’t count the government.

Politicians cannot run in this country and expect to win if they are not promising more free stuff. There is a young socialist movement here, wanting more – free college, free medical, even free housing. Yet where is the money going to come from.

One anecdotal story I heard recently was from a foreigner who moved here to start a business. He has lived in six countries and traveled around the world. As the real estate agent drove him into some neighborhoods he couldn’t help but see all the coconuts on the ground. The next day they were still there. He told me, anywhere in the world those would be taken, sold, processed, or something – they are a commodity. For the people to walk by them and not see the value (money) is a people that have become dependent on government subsidies.

Puerto Rico is rich in people, land, infrastructure, and opportunity. Isn’t the saying you buy low and sell high. Buy when everyone else is selling, and sell when everyone else is buying. I am not talking about buying government debt, but the private sector is the land of opportunity. There is risk and it will take time, but the rewards are certainly there.

I have traveled around the world, including East Germany, Soviet Union, Yugoslavia – (which do not exist anymore after the failure of socialized central planning). Puerto Rico is no different and if you want to know what is in store for the future of the U.S. under the likes of Bernie Sanders or more socialism, come to Puerto Rico.

Puerto Rico will change, it has no choice. The debt problems will be resolved and most likely painfully. The government and people will realize that free handouts and the fountain of money will end. They will have to become responsible and accountable for their own actions and prosperity. They will have to attract businesses here (and have under several programs). It will take time – and it may get worse before it gets better – but there is a future.

The problem in Puerto Rico has only become real because they can’t hide behind printing their own currency. Yet the problem here is really no different than what is currently happening in the United States. Just because we do not see any problems right now in the U.S., one can’t help but look at the math and wonder how much longer can one print money, expand debt, and monetize their own deficit. $1 trillion, $10 trillion, $100 trillion?

Equity Markets?

The equity markets are facing similar problems. While we would love to make investments based on the growth, earnings, revenue, and the rest of the fundamental values of a company, it almost doesn’t matter anymore. Part of the rally in the equity markets over the years has been driven by Fed Policy. Much like citizens of a socialist nation becoming reliant on government subsidies and entitlements, the financial markets have become dependent on Fed subsidies and low rates. A combination of zero rates (thus making no return on fixed income) and the ability to borrow (leverage up), has driven money into equities. We are even hearing the silly term “unicorns” being bantered around again.

We continue to live in an investment world in which we must make decisions based on Fed policy and not fundamentals. Earnings, if you remove the buy-backs, look like CRAP. Sure there are some sectors and companies, but over-all the revenue growth is not great. Earnings have been manipulated because of buy-backs, cost-cutting, and one-time write-downs to boost forward reports. Tearing into the math behind the headlines makes you ponder if things are really as rosy as the headlines.

Government Data Utopia

In the past I have shredded the Labor Report, CPI changes, and GDP changes. The three biggest government headline economic data points are about as accurate as a Democrat Congressman Hank Johnson predicting that Guam would tip over if too many people were on it.

My chief concern is the inflation and the speed in which it will come. The recent market volatility is currently driven by perception as to whether or not the Fed will raise rates, combined with the flavor of the week geo-political headline. However, with the amount of leverage capital in the equity markets, a sharp down turn could trigger margin calls and that could turn into an epic shit-show.

Courtesy of Fred

So for now I suspect volatility with bouts of calmness as people believe the Fed will save the day. I don’t expect more rate hikes and while the dollar could move higher – when the chair is pulled out is when we see inflation rocket. Then the Fed will be chasing their tails and we could have a rout in the dollar and a commodity spike.

Hedge those positions, if you don’t you are a fool. Also if you believe that credit ratings offer safety, I have some old GM stock to sell you.

Support & Resistance

INDU 16,000
We could see a bounce back up to the 16,400 range before selling pressure resumes. Of course a drop to 15,600 is in the cards. Now is not the time for long-term investing, but rather hedging and trading the action.

NDX 4100
Thanks Apple, I thought you were going to save the world. This index has seen some huge gaps and if you are paying attention you can get hammered. The earnings data has been poor, a couple of stars shined through – but for the most part we are seeing a growth slow-down.

SPX 1900
We could get a dead cat bounce out of this hole and hit 1950 or even 2000. However it is a rally based on Fed action and not fundamentals, which means a short-lived rally.

RUT 1000
It was July of 2013 that we last saw the broad based index this low and unlike the narrower based indices that have a few overweight’s that can keep the indices from falling, the Russell has no savor. It is the most pure form of order flow into the general equity markets and right now nothing is flowing in. The outflows have stopped for now and we are seeing consolidation. I would use the Russel as a gauge to determine how best to move forward.

Better Hedged than dead!

Now is a time to stay hedged. Using listed put options to insure long equity positions is the only bright idea for those in equities. Hoping is not a strategy and when someone asks me about using “stop-loss” for protection, my response is what is that called again, “stop-LOSS”? I think its name speaks for itself. It also doesn’t cover you in a gapping market and we are in a gapping market.

2 Responses to “Not all is Rosy”

  1. Mike says:

    epic shit-show. Love it!

    I would like to chat with you about P.R.

  2. Chase Jordan says:

    Excellent article, thank you. What do you make of the current 10 yr TSY yield being below the current S&P 500 yield? Every time this has occurred in the past, we’ve had a sharp recovery in equities.