Monthly Archives: January 2016

The Stock Market Sets a New Record in 2016

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If you’ve been paying attention to your investment account balances, you’re probably scratching your head. What record could the stock market have set already? Just a handful of days into the New Year?

Well, you’ve just lived through the worst start to any January in the history of the Dow Jones Industrial Average (DJIA). It’s the first time that the market has ever posted -6% in its opening week… ever. And that’s going all the way back to 1896. That’s 120 years!

If you’re wondering what’s been causing this kind of volatility, you’re not alone. Scores of theories have been making the rounds, including a beleaguered Chinese economy to renewed geopolitical concerns in North Korea to the seemingly endless collapse in the price of oil.

Me, on the other hand? I am taking my cues straight from the horse’s mouth.

CNBC’s Squawk on the Street roundtable hosts – Becky Quick, Carl Quintanilla & Simon Hobbs — interviewed former Dallas Federal Reserve President, Richard Fisher on Tuesday, January 5, 2016. Here is a dictation of that live, 7-minute interview:

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CNBC (Becky Quick): You think this [market selloff] has to do with the Fed?

Richard Fisher: Well look, I think part of this obviously has to do with concerns about growth and whether China is a leading indicator or not. But, you know, I think we have to bear in mind that what the Fed did, and I was part of that group, is we front-loaded a tremendous market rally starting in March of 2009. It’s sort of what I call the “reverse Whimpy factor.” Give me two hamburgers today for one tomorrow. And I’m not surprised at almost every single index you can look at… if you take away dividends in the S&P last year – unweighted, it was down significantly. And all the other indices were down. In terms of the 10-year bond, there was almost no movement for the year. Basically, we had a tremendous rally and I think there’s a great digestive period that’s likely to take place now and it may continue. Because again, we front-loaded, at the Federal Reserve, an enormous rally in order to accomplish a wealth effect. So, I wouldn’t be surprised at what’s happening. I wouldn’t blame it on China. We’re always looking for excuses. China is going through a transition. It’ll take a while to perfect itself, but what’s new there? There’s no news there.

CNBC (Becky Quick): Well, a 7% plunge in their [China] market is a scary thing to wake up to.

Richard Fisher: Yeah but bear in mind, I’ve been going to China since 1979. I was part of the group that negotiated with Deng Xiaoping – the normalization of our commercial claims against each other – and closed that deal on March 1st of 1979. So I think I’ve got a little bit of experience in China. I invested in China for quite a period with my fund, in the B shares market. You have to remember, Shenzhen/Shanghai are basically domestic markets. They’re trying to manipulate those markets as much as possible. Jim Kramer was right on this morning in terms of the force that they used to prevent real animal spirits from emerging. But the real issue there is their underlying economic transition and the markets are not correlated with that in China. They’re achieving it, it takes a while – transitioning from poorly-run state-owned enterprises, a bad credit system, an emphasis on volume and production to quality and consumerism and profitability. This is going to take some time. It’s a good thing. And I don’t think there’s any news there whatsoever. But again, analysts are always looking for a tripwire. The fact is, we’ve had a great market movement since 2009. It’s going to take a while to digest this. I wasn’t surprised at last year and I wouldn’t be surprised at a rather fallow performance this year as well.

CNBC (Becky Quick): Well, I guess my question, Richard, is how ugly is it going to get? There was a point yesterday where the Dow was down 467 and everyone was trying to figure out to your point, why? Does the Chinese stock market really affect us? If you do see this as a big unwind from Fed policy, which fueled a six and a half year bull market, what does it look like on the way down?

Richard Fisher: Well, I was warning my colleagues- don’t go wobbly if we have a 10-20% correction at some point. The market is still overpriced. Everybody you talked to all morning long have been warning that these markets are heavily priced. We’re trading at 19.5x earnings. We’re not having the kind of topline growth we would like to have. We’re late in the cycle. Things are richly priced. They’re not cheap. They may not be overpriced any longer but they’re certainly not cheap. So, all of the managers that I talk to in my role at Barclays, and that’s quite a few across the world, a lot of people are building cash positions. I’m talking about the long only investors – those that are taking a longer-term view – are being extremely cautious here. They’re raising their cash levels. They’re nervous about the valuations that are in the market. And they realize the old dictum from Ben Graham and Warren Buffet, “Price is what you pay, value is what you get.” And the values are very richly priced here. So, I could see significant downside. I could also see just a flat market for quite some time. Again, digesting that enormous return the Fed engineered for almost six years.

CNBC (Carl Quintanilla): Richard, this “digestive period,” does it usher in an era where assets can’t perform in the absence of accommodation? Is there something new about this? Or is it the same old cycle regarding equities and rates?

Richard Fisher: Well, first of all, I don’t think there can be much more accommodation. The Federal Reserve is a giant weapon that has no ammunition left. So, what I do worry about is it was “The Fed. The Fed. The Fed. The Fed.” For half of my tenure, which was a decade there. Everybody was looking for the Fed to float all boats. In my opinion, they got lazy. Now we go back to fundamental analysis – the kind of work that used to be done – analyzing whether or not a company truly, on its own, is going to grow its bottom line and grow its shareholder value; and price accordingly; and not just expect the tide to lift all boats. So we are going to find out, indeed, when the tide recedes we’re going to see who is wearing a bathing suit and who is not. We’re beginning to see that. You saw it in junk last year. You also saw it even in the mid-caps. You saw it in the S&P – stripped of its dividends, on an unweighted basis – you had a negative return. The only asset that really returned anything last year, again if you take away dividends, believe it or not was cash, at 0.01%! That’s a very unusual circumstance.

CNBC (Simon Hobbs): Mr. Fisher, this has been an absolutely extraordinary interview. For you to come on here and for you to say “I was one of central bankers who engineered the front-loading of the banks, and we did it to create a wealth effect.” And then to go on and tell us, with a big smile on your face, that we are “overpriced” – which is the word that you used in the market – that there will be “digestive problems.” Are you guys going to take the rap if there is a serious correction in this market? Will you equally come on and say “I’m really sorry, we overinflated the market,” which is a logical conclusion from what you’ve said so far in this interview?

Richard Fisher: Well, first of all, I wouldn’t say that. I voted against QE3. But there was a reason for doing this. Let’s be fair to the central bank. We had a horrible crisis. We had to pull it out. All of us unanimously supported that initiative under Ben Bernanke. But, in my opinion, we went one step too far… which is QE3. By March of 2009 we had already bought a trillion dollars in securities. When the market turned in that first week of March, to me, personally, as a member of the FOMC, that was sufficient. We had “launched the rocket.” And yet, we piled on with QE3, understandably, worrying – the majority did at least – that we might slide backwards. So, I think you have to be careful here, and frank, about what drove the markets. Look at all the interviews you had over the last many years since we started the QE program, the quantitative easing, and it was “The Fed. The Fed. The Fed. The European central bank. The Japanese central bank. What are the Chinese doing?” – all quantitatively driven by central bank activity. That’s not the way markets should be working. They should be working on their own animal spirits. But they were juiced up by the central banks – including the Federal Reserve – even as some of us would not support QE3. So I think you have to acknowledge reality.

CNBC (Becky Quick): Richard, we’re totally out of time. One more answer… the Fed forecasts 4 rate hikes this year. The market says it will only be half of that. Who will be right?

Richard Fisher: I thought John Williams’ interview was very good yesterday. I’d bank on that.

CNBC (Becky Quick): Well, he thought they were going to go through with their forecasts. Richard Fisher…always a pleasure. Thanks for joining us. The former president of the Dallas Fed.

Richard Fisher: Thank you.

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Front-loaded, at the Federal Reserve, an enormous rally in order to accomplish a wealth effect? That the markets are overpriced because of it? That there will be “digestive problems” because of the Fed’s actions? You can almost hear the turning of the stomachs of investors everywhere.

Mr. Fisher served as a voting member of the Federal Reserve throughout the 2008 global financial crisis. His tenure continued during the controversial Fed monetary policy programs – QE1, QE2, Operation Twist & QE3. And he made no bones about what the goal all along was… ”I think we have to bear in mind that what the Fed did, and I was part of that group, is we front-loaded a tremendous market rally starting in March of 2009.”

He continued with…

“It’s sort of what I call the “reverse Whimpy factor.” Give me two hamburgers today for one tomorrow.”

How cute. Then later in the interview, he reiterated…

“Because again, we front-loaded, at the Federal Reserve, an enormous rally in order to accomplish a wealth effect. So, I wouldn’t be surprised at what’s happening.”

Obviously, the Fed created one of the strongest stock market bulls in the history of U.S. market-based trade. The artificially infused wealth effect has allowed stock prices to recover approximately 130% of their prerecession highs and home prices have recovered 95% of theirs.

Now I’m not professing to moonlight as an economist, but I’m pretty sure every economist – from Adam Smith to Arthur Laffer – would have some reservations about “reverse Whimpy factor” economics. For starters, one has to wonder what exactly happens to a stock market that has been artificially propped up for so long. Will the artificially wealthy need to pay back Whimpy’s hamburgers once he realizes he has been hoodwinked?

If the answer is a definitive “No,” you can breathe a sigh of relief. This recent bout of volatility could be nothing more than a run-of-the-mill, corrective lull. If the answer is anything other than a definitive “No,” you should be worried… very, very worried.

It would appear that Mr. Fisher is, in fact, worried. And just in case you didn’t catch it in his interview, I will spell it out for you. His ominous message comes in the response he gives to Simon Hobbs’ question, which causes the interview to take an interesting turn.

CNBC (Simon Hobbs): Mr. Fisher, this has been an absolutely extraordinary interview. For you to come on here and for you to say “I was one of central bankers who engineered the front-loading of the banks, and we did it to create a wealth effect.” And then to go on and tell us, with a big smile on your face, that we are “overpriced” – which is the word that you used in the market – that there will be “digestive problems.” Are you guys going to take the rap if there is a serious correction in this market? Will you equally come on and say “I’m really sorry, we overinflated the market,” which is a logical conclusion from what you’ve said so far in this interview?

(Thank you, Mr. Hobbs. I’m not sure I could’ve stripped the sugar coating as well as you did.)

At this point, I think Mr. Fisher begins to feel the true weight of what he had just acknowledged. He begins to backpedal. He answers Mr. Hobbs’ question with what I call “a guilty party’s closing argument.” His response is made up of equal parts denial, “cover your a**” (aka CYA), excuses, and blame.

Richard Fisher: Well, first of all, I wouldn’t say that. [denial] I voted against QE3. [CYA] But there was a reason for doing this. Let’s be fair to the central bank. We had a horrible crisis. [excuses] We had to pull it out. All of us unanimously supported that initiative under Ben Bernanke. But, in my opinion, we went one step too far… which is QE3. [more CYA] By March of 2009 we had already bought a trillion dollars in securities. When the market turned in that first week of March, to me, personally, as a member of the FOMC, that was sufficient. We had “launched the rocket.” [even more CYA] And yet, we piled on with QE3, [blame] understandably, worrying – the majority did at least – that we might slide backwards. [more excuses] So, I think you have to be careful here, and frank, about what drove the markets. Look at all the interviews you had over the last many years since we started the QE program, the quantitative easing, and it was “The Fed. The Fed. The Fed. The European central bank. The Japanese central bank. What are the Chinese doing?” – all quantitatively driven by central bank activity. [more blame]

Clearly, at this point, Mr. Fisher is not feeling too confident about what transpired while he was a voting member of the FOMC. He then follows up his response with some ominous remarks about the markets.

He continued with…

That’s not the way markets should be working. They should be working on their own animal spirits. But they were juiced up by the central banks – including the Federal Reserve – even as some of us would not support QE3. [one more CYA for good measure] So I think you have to acknowledge reality.

We have to “acknowledge reality?” What does that mean, exactly? Are you telling us that the piper (or in this case, Whimpy) finally needs to be paid? If so, how much can we expect the markets to fall to get back to where they are “working on their own animal spirits” again?

Earlier in the interview Mr. Fisher brings up the point by which traditional fundamental analysis shows the pricey nature of stocks. Specifically, he points out the fact that the S&P 500 is currently trading at roughly 19.5x TTM earnings. This is well above the historical TTM P/E average of 14.6. For the S&P 500 to be in line with its fair value historical average? The S&P 500 would have to fall to 1550 – a 27% decline from the S&P 500’s record highs.

The bad news is that analysts are already revising their year-end earnings estimates down for 2016. If earnings do stagnate, the S&P 500 might not drop to a fair value average… the market could fall even further. 1500? 1450? 1400? Coincidentally, that would put the market right about where it traded just prior to the announcement of QE3, a proposition Mr. Fisher says he vehemently opposed.

What’s more? The market is currently trading where it was nearly 20 months ago, in May of 2014. There has only been one other period during the bull market cycle where the market struggled to advance for a similar length of time: January of 2010 – September of 2011. And that period included the Eurozone Crisis.

So what’s the difference between then and now? Back then, the Fed was nowhere near raising its target rate. Furthermore, the Fed was only halfway to its $4.5 trillion balance sheet.

Today? The Fed has stopped spending money and has already begun raising the target rate.

Unless the Fed decides to change course and reverse its current monetary policy direction (moving from tightening to loosening), we can expect the markets to continue to find it difficult to ratchet higher. Previous periods of market weakness were met with some form of Fed accommodation, but you may not want to bet the farm on the Fed saving the day this time around.

Just listen to Mr. Fisher:

“I don’t think there can be much more accommodation. The Federal Reserve is a giant weapon that has no ammunition left.”

This revelation brings up one final point. Albeit at a snail’s pace, the Fed’s concerted effort to tighten borrowing costs while simultaneously keeping the artificial wealth effect afloat may be an act of desperation. Only time will tell.

If you think Mr. Fisher’s interview warrants some consideration with regard to your investments, consider the chart below. It represents a comparison between the S&P 500 and our FTSE Custom Multi Asset Stock Hedge (MASH) index.

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As you can see, since the Fed’s announcement to raise its overnight lending rate by one quarter of one percent back on December 16th, the MASH index has outperformed the market by 10.7%. Where the S&P 500 has fallen by 8.8%, the MASH index has risen by 1.9%.

If you’d like to discuss hedging your portfolio against stock risk, please give us a call at (888) 500-4279. Likewise, if you are interested in learning more about the FTSE Custom Multi-Asset Stock Hedge (MASH) Index and whether it is appropriate for your portfolio, please click here.

 

Disclosure Statement: Pacific Park Financial, Inc. is a Registered Investment Adviser with the SEC. Pacific Park Financial, Inc. and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising on this website. StockHedgeIndex.com is created independently of any advertising relationship.