Seven Thoughts on the Markets

Photo Credit: t m || Seven sisters sitting on the hill

Photo Credit: t m || Seven sisters sitting on the hill

1) I started in this game as an amateur, and built up my skills gradually, reading widely.  My academic studies ended at age 25, and it was after that that I began learning the practical knowledge.  Though I had investment-related jobs, I never held a position in investing, until I was 38, and I never wrote on investing for the public in any significant way until I was 42, when Cramer invited me to write for RealMoney.  I’m now 55, and I think I am still growing in my knowledge of investing.

i write this to simply say that you don’t have to take a traditional path into the investment business.  I am grateful that I want through the circuitous path through the insurance industry, because it deepened my perspective on investing.  All of the asset-liability modeling, where I often tried to challenge existing paradigms, helped me to understand why often the conventional wisdom is true.  Where it is not true, there is usually an anomaly to profit from.

The other reason that I write this, is that it is possible to get significant knowledge as an amateur, and on a book basis, as good as many professionals.  You won’t get the respect from professionals until you are a professional, but who cares?  You can do better for yourself in investing.  Just don’t get arrogant and forget to put risk control forst.

2) After all of the political fights are over, OPEC nations will once again agree that they will cut production as a group.  Remember, much of OPEC has a low cost of production, and so when production decreases in a coordinated way, profits will rise for almost all OPEC nations.

In the long run, economics triumphs over politics.  The challenge comes in the short-run from trying to figure out who cuts how much from what baseline.  Even after that, discipline takes a while to achieve, because the incentive to cheat is high.

I stand by the view that in the intermediate term, crude oil prices will be around $50.  Demand for crude oil is growing globally, not shrinking, and marginal supplies would price out at around $50/barrel, if OPEC nations act to maximize their profits, rather than engage in a market share war.  (Prices would be higher still  if OPEC nations acted to maximize the present value of their long-run profits, but I doubt that will happen until the profligate producers deplete their reserves.

3) The ferment in high yield bonds is unlikely to peak before there are significant defaults.  It’s possible that we get a rally from here in the short run — yield spreads are relatively wide compared to earnings yields on stock.  At this point, it doesn’t pay so well to borrow money and buy back stock.  That isn’t stopping many corporations from doing their buybacks.  Buybacks should be tactical rather than constant.  Only buy back when there is a significant discount to the fair market value of the firm.

That said, it’s unusual for a large amount of credit stress to go away without defaults.  It’s rare to see a credit problem work out by firms growing out of it.  Thus what might be more likely than a junk rally is a fall in stock prices.  Perhaps the most optimistic scenario would be that only energy is affected — it has defaults, and the rest of the market continues to rally.  Not impossible.

4) Regarding F&G Life — congrats to holders, you won.  A dumb aggressive foreign buyer jumped on the grenade for you. (Now let’s see, has that ever happened before to F&G Life?)  Be grateful and sell.  Let the arbs take the risk of the deal not going through.

5) One phrase that all investors should learn is, “I missed that one.”  You can’t catch every opportunity.  Some will pass you by despite your best efforts.  Rather than jump on late, it is better to look for the next opportunity, lest you buy high and sell low.

On the opposite side of timing, if you tend to get to opportunities too early, maybe consider waiting until the price breaks the 200-day moving average from below.  Let the market confirm that it agrees with your thesis, and then invest.

6) Regarding the Fed, I think too much is being made out of them for now.  I will be watching the yield curve for clues, and seeing if the curve flattens or steepens.  I expect it to flatten more quickly than the market currently expects, limiting the total amount of Fed tightening.

As it is, every time the Fed tightens, the short interest-bearing deposits at banks reprice up, with some lesser amount pass-through to lending rates.  I would expect bank profits to be squeezed.

Aside from that, most of what the FOMC will say tomorrow will just be noise.  They don’t have a theory that guides them; they are just making it up as they go, so they wander and try to discover what their goals should be.

7) I’ve sometimes commented that at the start of a tightening cycle that those who have been cheating blow up, like Third Avenue Focused Credit, which bought assets far less liquid than the shares of its mutual fund.  At the end of the tightening cycle, something blows up that would be a surprise now, which sometimes jolts the FOMC to stop tightening.  The question here is: what could that group of economic entities be?  China, Brazil, repo markets, agricultural loans, auto loans, or something else?  Worth thinking about — we know about energy, but what else has issued the most debt since the end of 2008?

(As an aside, the recent moves to make China more integrated with the global economy also make it more subject to financial risks that are global, and not just local, of which it has enough.)