Is the Party Over?

Markets usually soften just after a new President takes the helm but based on an unpredictable 2016, anything is possible in 2017.        

By Michael Kahn              


Saying 2016 was an unusual year is an understatement and I don’t even mean politically. On the charts, several of our cherished old saws failed to predict stock-market direction and that puts all of them in doubt for the upcoming year. However, for stock-market bulls, that might be a good thing.

To be sure, we’ve seen such mantras as “sell in May and go away” fail before, yet we still keep coming back to them as Delphian predictors.

This past year kicked off with a decline in the first week of January and a decline for the month as a whole. That led the “January barometer” to forecast a “not great year.” The theory says that “as January goes, so goes the year.”

Unfortunately, it is really only a strong January that predicts a strong year while a weak January is so-so at forecasting. The year that is now ending has seen the Dow Jones Industrial Average currently up 14% and that is near or above average, depending on how one determines what “average” actually means. In other words, the weak January predicted anything other than a strong year.

The annual stock-market cycle we call “sell in May” also did not fare well unless you count sleepless nights avoided. The Dow gained about 2% from the open on May 2 through the close in October, albeit with a few bouts of volatility.

Indeed, I wrote a column about this cycle last year where I said this cherished mantra “has gone the way of the dodo bird.”

This brings us to the Presidential cycle. Without any consideration to the specific occupant of the White House, the stock market seems to perform differently in different years of any President’s term. For Presidents in their final year we might see policies that try to goose the economy to keep the occupant and/or the occupant’s party in power. And for the first year of new Presidents, we might see the market suffer as tough new policies are enacted.

Tom McClellan, editor of the McClellan Market Report, actually breaks it down further by isolating first- and second-term presidencies.

According to his analysis, the final year of a two-term President is usually flat to down, and here is the key phrase: “on average” (see Chart 1). Cycle analysis does not guarantee any specific performance but over time it captures a tendency.

Chart 1

Standard & Poor’s 500

Referring to a new President, McClellan said, “Investors don’t know who they will get but they know it will be different. Investors don’t like change to unknown risks. They hesitate.”

Up until the election, most of the year was indeed spent moving sideways to lower, in accordance to the model. Then the pent-up energy of certainty and new hope was released.

Where do the cycles point for 2017? McClellan’s work pointed to the strong rally for the new President from a new party from the election through the end of the year. However, it looks for a soft first quarter. McClellan joked that when the new President has been in office for a whole week and has not solved all the country’s problems, investors get disenchanted.

After that, it looks for a resumption of the rally in the second quarter but in the third quarter things go a bit awry.

Just to be sure, I verified this with the work of Larry Williams, veteran trader, author and proprietor of Williams puts out annual forecasts based on many different cycles and also looks at the first term of a new President.

He also sees a soft first quarter followed by a strong rally into the middle of the second quarter.

From there, investors might want to pull back and sit on more cash.

Both of these cycles forecasts leave open the possibility for a run at 21,000 on the Dow as I suggested earlier this month.

The question is will these cycles work at all with a new President who is unlike any that came before him.

Certainty, the stock market reacted positively after the election as uncertainty was removed. But were all of the gains to be attributed to the first half year of the new administration already made so that the market will not follow the average path?

Considering that most other market patterns did not do what they were supposed to do it might be a hard to believe these cycles. But since there is no crystal ball we have to take the evidence the market gives us – which are cycles that are still working over recent memory – and stick with them.

Indeed, it is a brave new world in stock-market investing where the rules are changing and we need to adapt by following along, not hanging on, old saws.

miércoles, enero 04, 2017



Economists versus the Economy

Robert Skidelsky

LONDON – Let’s be honest: no one knows what is happening in the world economy today.
Recovery from the collapse of 2008 has been unexpectedly slow. Are we on the road to full health or mired in “secular stagnation”? Is globalization coming or going?
Policymakers don’t know what to do. They press the usual (and unusual) levers and nothing happens.
Quantitative easing was supposed to bring inflation “back to target.” It didn’t. Fiscal contraction was supposed to restore confidence. It didn’t. Earlier this month, Mark Carney, Governor of the Bank of England, delivered a speech called “The Specter of Monetarism.” Of course, monetarism was supposed to save us from the specter of Keynesianism!
With virtually no usable macroeconomic tools, the default position is “structural reform.” But no one agrees on what it entails. Meanwhile, crackpot leaders are stirring discontented voters. Economies, it seems, have escaped from the grasp of those supposed to manage them, with politics in hot pursuit.
Before 2008, the experts thought they had things under control. Yes, there was a bubble in the housing market, but it was no worse, current Fed Chair Janet Yellen said in 2005, than a “good-sized bump in the road.”
So why did they miss the storm? This was exactly the question Queen Elizabeth of Britain asked a group of economists in 2008. Most of them wrung their hands. It was “a failure of the collective imagination of many bright people,” they explained.
But some economists supported a dissenting – and much more damning – verdict, one that focused on the failure of economics education. Most economics students are not required to study psychology, philosophy, history, or politics. They are spoon-fed models of the economy, based on unreal assumptions, and tested on their competence in solving mathematical equations. They are never given the mental tools to grasp the whole picture.
This takes us back to John Stuart Mill, the great nineteenth-century economist and philosopher, who believed that nobody can be a good economist if he or she is just an economist. To be sure, most academic disciplines have become highly specialized since Mill’s day; and, since the collapse of theology, no field of study has aimed to understand the human condition as a whole. But no branch of human inquiry has cut itself off from the whole – and from the other social sciences – more than economics.
This is not because of its subject matter. On the contrary, the business of earning a living still fills the greater part of our lives and thoughts. Economics – how markets works, why they sometimes break down, how to estimate the costs of a project properly – ought to be of interest to most people. In fact, the field repels all but connoisseurs of fanciful formal models.
This is not because economics prizes logical argument, which is an essential check on faulty reasoning. The real trouble is that it is cut off from the common understanding of how things work, or should work. Economists claim to make precise what is vague, and are convinced that economics is superior to all other disciplines, because the objectivity of money enables it to measure historical forces exactly, rather than approximately.
Not surprisingly, economists’ favored image of the economy is that of a machine. The renowned American economist Irving Fisher actually built an elaborate hydraulic machine with pumps and levers, allowing him to demonstrate visually how equilibrium prices in the market adjust in response to changes in supply or demand.
If you believe that economies are like machines, you are likely to view economic problems as essentially mathematical problems. The efficient state of the economy, general equilibrium, is a solution to a system of simultaneous equations. Deviations from equilibrium are “frictions,” mere “bumps in the road”; barring them, outcomes are pre-determined and optimal. Unfortunately, the frictions that disrupt the machine’s smooth operation are human beings. One can understand why economists trained in this way were seduced by financial models that implied that banks had virtually eliminated risk.
Good economists have always understood that this method has severe limitations. They use their discipline as a kind of mental hygiene to protect against the grossest errors in thinking. John Maynard Keynes warned his students against trying to “precise everything away.” There is no formal model in his great book The General Theory of Employment, Interest, and Money. He chose to leave the mathematical formalization to others, because he wanted his readers (fellow economists, not the general public) to catch the “intuition” of what he was saying.
Joseph Schumpeter and Friedrich Hayek, the two most famous Austrian economists of the last century, also attacked the view of the economy as a machine. Schumpeter argued that a capitalist economy develops through unceasing destruction of old relationships. For Hayek, the magic of the market is not that it grinds out a system of general equilibrium, but that it coordinates the disparate plans of countless individuals in a world of dispersed knowledge.
What unites the great economists, and many other good ones, is a broad education and outlook. This gives them access to many different ways of understanding the economy. The giants of earlier generations knew a lot of things besides economics. Keynes graduated in mathematics, but was steeped in the classics (and studied economics for less than a year before starting to teach it).
Schumpeter got his PhD in law; Hayek’s were in law and political science, and he also studied philosophy, psychology, and brain anatomy.
Today’s professional economists, by contrast, have studied almost nothing but economics. They don’t even read the classics of their own discipline. Economic history comes, if at all, from data sets.
Philosophy, which could teach them about the limits of the economic method, is a closed book.
Mathematics, demanding and seductive, has monopolized their mental horizons. The economists are the idiots savants of our time.

The Trump Matrix

Ross Douthat

     Credit Eric Thayer for The New York Times        

Anyone who tells you, with perfect confidence, what a Trump administration will do is either bluffing or a fool. We have a prospective cabinet and a White House staff, but we haven’t got the first idea how the two will fit together or relate to Congress, or how the man at the top will preside over it all.
What we can do, for now, is set up a matrix to help assess the Trump era as it proceeds, in which each appointment and policy move gets plotted along two axes. The first axis, the X-axis, represents possibilities for Trumpist policy, the second, the Y-axis, scenarios for Trump’s approach to governance.
The policy axis runs from full populism at one end to predictable conservative orthodoxy on the other. A full populist Trump presidency would give us tariffs and trade wars, an infrastructure bill that would have Robert Moses doing back flips, a huge wall and E-Verify and untouched entitlements and big tax cuts for the middle class. On foreign policy it would be Henry Kissinger meets Andrew Jackson: Détente with Russia, no nation-building anywhere, and a counterterrorism strategy that shoots, bombs and drones first and asks questions later.
In an orthodox-conservative Trump presidency, on the other hand, congressional Republicans would run domestic policy and Trump would simply sign their legislation: A repeal of Obamacare without an obvious replacement, big tax cuts for the rich, and the Medicare reform of Paul Ryan’s fondest dreams. On foreign policy, it would offer hawkishness with a dose of idealistic rhetoric – meaning brinkmanship with the Russians, not a rapprochement, plus military escalation everywhere.
The second axis, the possibilities for how Trump governs, runs from ruthless authoritarianism at one end to utter chaos at the other. Under the authoritarian scenario, Trump would act on all his worst impulses with malign efficiency. The media would be intimidated, Congress would be gelded, the F.B.I. and the I.R.S. would go full J. Edgar Hoover against Trump’s enemies, the Trump family would enrich itself fantastically — and then, come a major terrorist attack, Trump would jail or intern anyone he deemed a domestic enemy.
Trump’s transition — the process, the appointees, the tweets — can be charted along both axes.

On policy, much of his cabinet falls closer to the conventional conservative end, with appointees like Tom Price and Betsy DeVos and Rick Perry who would be at home in a Ted Cruz or Marco Rubio or even Jeb! administration.
On the other hand, some of his cabinet picks are a little more ideologically unknowable (like Steven Mnuchin at Treasury), and his inner circle remains highly unconventional. Stephen K. Bannon is intent on remaking the G.O.P. along nationalist lines, Jared Kushner and Ivanka Trump seem eager for their paterfamilias to negotiate with Democrats, Peter Navarro is girding for a trade war with China. And Trump’s foreign policy choices — especially Rex Tillerson at State — seem closer to full-Trumpist realpolitik than to Reaganism-as-usual.
On the governance axis, the president-elect’s strong-arming of the private sector, his media-bashing tweets, and his feud with the intelligence community all hint at an authoritarian timeline ahead.
Likewise, other fact patterns — that Congressional Republicans are mostly supine, that the stock market has surged — suggest that Trump could be authoritarian, corrupt and politically effective.
But anyone who fears incompetence more than tyranny has plenty of evidence as well. Trump’s tweets might be a sign, not of an incipient autocrat, but of an unstable narcissist who will undermine himself at every step. He has no cushion in popular opinion: If things go even somewhat badly, his political capital will go very fast indeed. He has plenty of hacks, wild cards and misfit toys occupying positions of real responsibility — and his White House has already had its first sex scandal!
Then, finally, there is the question of how the axes interact. A populist-authoritarian combination might seem natural, with Trump using high-profile deviations from conservative orthodoxy to boost his popularity even as he runs roughshod over republican norms.
But you could also imagine an authoritarian-orthodox conservative combination, in which Congressional Republicans accept the most imperial of presidencies because it’s granting them tax rates and entitlement reforms they have long desired.
Or you could imagine a totally incompetent populism, in which Trump flies around the country holding rallies while absolutely nothing in Washington gets done … or a totally incompetent populism that ultimately empowers conventional conservatism, because Trump decides that governing isn’t worth it and just lets Paul Ryan run the country.
As for what we should actually hope for – well, the midpoint of each axis, the center of the matrix, seems like the sweet spot for the country: A Trump presidency that’s competent-enough without being dictatorial, and that provides a needed populist corrective to conservatism without taking us all the way to mercantilism or a debt crisis.
But this is Donald Trump we’re talking about, so a happy medium seems unlikely. Along one axis or the other, bet on the extremes.

A bailout of Monte dei Paschi is not enough

So long as structural problems fester, more rescues will be needed

There is a difference between preventing a crisis and solving a problem. Italy has taken a step towards the former by setting the framework for a state bailout of struggling bank Monte dei Paschi di Siena. The plan is sensible in outline. The European Commission and the European Central Bank should allow some version of it to proceed. If, however, they do not want a repeat of this exercise — with MPS or another bank — the European authorities and Italy must work together on the underlying problem: the flawed structure of the Italian banking system.

MPS, Italy’s third-largest bank with €160bn in assets, is under significant stress. It had net non-performing assets of €23bn at the end of the third quarter, as compared to €9bn in equity.

A bailout of at least €5bn is needed, and soon. Depositors have been pulling money out of the bank all year and the pace of the flight picked up this month. Efforts to raise the money from private sources fell short by half, leaving the state little choice but to propose a bailout.

Under the Italian proposal, MPS shareholders will be wiped out. Institutional holders of the junior bonds will be converted into equity owners, implying that they will lose the lion’s share of their capital. Retail holders of the junior bonds will be compensated with grants of senior bonds.

Depositors will be protected. The state will put in capital — of an amount still to be determined — and provide emergency liquidity as needed, receiving full control of the bank in return.
It is to be hoped that the European Commission will allow a plan of this sort to go ahead as a “precautionary recapitalisation” of the kind permitted under EU rules from 2014. The guidelines were designed for banks that are solvent but undercapitalised. The other, much harsher option would be to insist on a full bail-in under the EU’s Bank Recovery and Resolution Directive, which are rules for the dismantling of failed banks. In a resolution, senior creditors, and even depositors, could face steep losses. Happily, the commission has signalled willingness to consider a precautionary recapitalisation of MPS. Some German lawmakers are voicing dissent, however.

The Italian authorities may be keen to inject as much capital as they can under European rules.

The key to any bank restructuring is to create a strong sense of finality. The impression that more capital might be needed increases the chance that it will be. Indeed, a muscular state contribution makes sense at this point. True finality, however, will remain out of reach as long as the underlying problems of Italian banking go unsolved.

Italy has too many banks and too many bank branches, which has led to chronic unprofitability. Costs need to be taken out and headcounts cut. Failing banks need to be shut.

Consolidation has barely begun. Along the way, a robust market for impaired assets must be developed. This may require more aggressive markdowns than have occurred to this point.

Finally, governance at small- and medium-sized banks needs to be made stronger and more transparent. Bank boards, local governments and local businesses are too closely intertwined.

Too many people serve on the boards of multiple banks. And the judicial system needs reform so it can handle bankruptcies more efficiently.

This will be slow, painful and politically sensitive work. All the more reason to start now. Given the persistent sluggishness of Italy’s economy, banks will continue to require periodic state bailouts if they cannot be run profitably. It is time to move from preventing crises to solving the problem.

Investing in Our Furry Friends

By Patrick Watson

We Americans love our pets almost as much as our children.

My wife and I became empty-nesters this year, but we still have two dogs, two cats, and some itinerant raccoons and armadillos, which technically aren’t pets but they seem to think they are.

More and more Americans seem to prefer pets to children… and the resulting demographic trend has massive economic and investment implications.

The numbers are startling and affect everyone, whether you are a parent, a pet owner, neither or both. They’re also an investment opportunity you might try in 2017.

Photo: Getty Images

4 Million Missing Babies
While the memories of the Great Recession may be fading, the effects are still very much with us. Among other places, the impact shows up in demographic data.

Last summer I ran across some fascinating analysis by University of New Hampshire sociologist Kenneth M. Johnson. He found that US fertility levels dropped sharply beginning in 2008 and have yet to recover.

All those babies we didn’t have add up to a big number.

Professor Johnson calculated that if births had continued at the pre-recession rate, Americans would have had 3.4 million additional babies in 2008–2015. He found no evidence to suggest that this trend changed in 2016, so the total is likely near 4 million by now.

This happened even though the number of women of childbearing age actually increased during this period.

It’s no mystery why. People who are experiencing economic and financial difficulty are less likely to have children.

The missing babies have a macroeconomic effect. All those jobs that would have been created in hospital maternity wards and eventually day care centers, kindergartens, and public schools aren’t materializing. And then there’s the billions of dollars that aren’t spent on baby food, diapers, and clothes. Plus, sometime around 2025, we may start noticing fewer new workers entering the labor force.

This plunge of birthrates is not a new phenomenon, by the way. Contrary to what many people believe, the developed world has been on the fast track to population decline since at least the 1970s—a trend visible in many countries, from Germany to Japan.

However, even without children, the primal human urge to care and nurture has to find an outlet. Which is where our furry friends come in.

Photo: Getty Images
A Recession-Proof Industry
For many people, pets serve as a less expensive and less burdensome substitute for children. You get an idea just how much Americans adore their pets when you walk into PetSmart and see how much people spend on animal food, beds, and toys.

I myself am a prime example. My little dog Chloe consumes fuzzy rubber balls at an astonishing rate. Every few days, I bring out a new one, we play fetch, then she either hides it or chews it to pieces. Then I have to buy more. I buy dog toys just like young parents buy pacifiers and sippy cups.

Pets make our life better… but they definitely aren’t free.

According to the American Pet Products Association (APPA), US consumers will spend $62.75 billion on pet food, supplies, and services this year.

Even more interesting is the growth curve in pet spending. It’s been rising at the same time as human birth rates have been falling.

The APPA data shows that pet spending in 2007, before the Great Recession, was $41.2 billion. That means the market has grown over 50% since then, far faster than most other sectors of our sluggish economy.

Furthermore, pet spending has grown steadily every year for more than two decades.  

You would think people cut back on pet expenses in recessions, but amazingly, that’s not the case. It’s that caring instinct again. Just as parents put their children’s needs ahead of their own, many pet owners will tighten their own budget in order to provide for their animals.

That’s not crazy, by the way. Recessions are tough. I know my dogs and cats helped me through some dark times. However much we spend on them, they always give back more.
Put-Selling Pets

Aside from making great companions, Fido and Fluffy can actually point us to good investment opportunities. They’re part of a constantly growing economic sector that shows no sign of slowing down. And because it’s based on a hard-wired human instinct, it’s more or less recession-proof. Those are all positive signs.

I first had this investment idea last summer and wrote about it in Macro Growth & Income Alert. After research, my co-editor Robert Ross and I found a very promising stock in the pet healthcare segment.

The only problem: it was way overpriced. So rather than buy it, we advised subscribers to sell cash-secured put options with a strike price closer to fair value. This let them earn premium income without actually owning the stock, unless it came down to the price we liked.

The stock price dropped, but not enough—so recently the first set of puts expired, and our subscribers kept all the premiums. It was about 2.1% of the cash reserved to buy the shares. That’s not bad for just five months, plus they kept earning interest on the cash. We recommended another round of put options last week.

I hope we’ll be able to buy the shares this time. This is a fascinating company, and I think it will be a great long-term hold if we don’t pay too much. But meanwhile, we’re doing quite well just by writing options.

It’s not too late to get in. If you want to join us in this growth opportunity and learn how to use conservative options strategies to boost your income, you should try Macro Growth & Income Alert today.

See you at the top,