After the disappointing comments from Janet Yellen and the Fed after its meeting on September 16th, all eyes turned to Janet Yellen's September 24th speech in Boston.
If you remember, the Fed failed to raise rates after this meeting and spoke rather pessimistically about the harmful impact of weakness abroad on domestic growth and inflation. Instead of instilling confidence, the Fed instilled fear and pessimism. I immediately made some strategic changes with my trading positions and hedges to reflect this new, more negative Fed view, as I mentioned in last week's blog. The stock markets around the world reacted negatively to the Fed comments while bond prices rose. Deflationary fears crept back into the marketplace. I hit it!
It became quite evident right away that the Fed and Janet Yellen made a huge mistake in talking down the economy and inflation. I wasn't the only one to say this. I started thinking that Fed governors and Janet Yellen are smart people so for sure they would change their commentary and paint a more optimistic view of the economy. After all, the Fed should have declared victory last week and raised rates espousing optimism.
The key event to get the "right" message out was Janet Yellen's speech Thursday night. During the day before the speech I went out on a limb and reversed some of the hedges that I put in place after the Fed meeting. I went longer on the dollar, reduced some of my short DAX and JAX positions and added meaningfully to financials. Financials are the clear winner of a rising sloping yield curve; were yielding over 4% and selling at discounts to the market and real book.
Once again, let's review, region by region to see if there are any changes in our core beliefs that would impact my asset allocation, regional selection, industry emphasis and specific company investments.
1. The United States remains the engine of the world especially with the slowdown in China. I have already discussed in general terms Janet Yellen's speech at the University of Massachusetts, but here are some of the specifics: the slack of the economy has diminished to the point where inflationary pressures could build over time; the Fed needs to be ahead of the curve and prevent speculative forces in the financial markets; the strong dollar, lower energy and commodity prices are understating normalized inflation; and her most important comment was that the domestic economy is key and the Fed should look past headwinds abroad. She concluded that the Fed should begin raising rates this year and at a gradual rate. She did comment on the risks abroad and the Fed has to be willing to adjust policy as the data points indicate. While she did not say it, clearly the Fed wants rates normalized, as it is time to declare victory. The U.S. economy, led by the consumer is in good shape.
2. I remain relatively optimistic on the Eurozone, especially if the dollar increases in value over time, which remains one of my core beliefs. Remember that exports are very important for countries in the Eurozone. The general consensus is that the ECB stands ready to increase QE if needed to stimulate growth and higher inflation. The ECB injected 15.5 billion euros to banks, the fifth tranche of a long-term loan program to stimulate lending and economic growth. Personally I do not see the need for such a program as the system is awash with low cost liquidity.
Weakness in Asia is a near-term risk to growth as exports may decline. The purchasing managers index fell to 53.9 in September from 54.3 in August while the manufacturers PMI fell to 52.0 from 52.3 in August. Readings above 50.0 are still pretty good! And new orders rose at the fastest rate in five months as well as orders for materials: both good forecasters for future activity. As you would expect, inflation continues to fall below forecasts for all the reasons we have mentioned before most notably lower energy and commodity prices plus global competition. The annual rate of inflation declined 0.2% in August. The ECB long-term target for inflation, like the Fed, is 2.0%. As you know one of my core beliefs is that low inflation is NOT transitory.
I need to mention that Alexis Tsipras was re-elected in Greece and is committed to his agreement with the ECB for more funding. Will it work? I doubt it!
3. China just cannot catch a break. It is fascinating how the glass went from full to empty with few stops in between. I remain one of the optimists on China's future prospects. Maybe it is because I have visited the country many times and have met with government and corporate executives and have been impressed with their acumen and will to succeed. I also like that they take a longer-term view of things. Let me suggest that you read Chinese President Xi Jinping's interview with the Wall Street Journal as he expresses his view of China better than I ever could. I also take into account comments from the heads of Apple and Honeywell who operate in China and remain optimistic. Both men attended meetings in Seattle last week with the Chinese President and his staff.
China is going through a major transition moving away from the dominance of exports to more domestic consumption. Another good read is China's Beige Book, which came out last week. The bottom line is that global investors are overreacting to China's near-term problems. I agree!
Energy and commodity prices fell last week due to the earlier Fed comments concerning foreign economic weakness. It is amazing how fast things change and revolve around Fed and Janet Yellen's comments. Let me remind you that I remain bearish on energy prices today and longer term as global production will outstrip demand growth BUT I also remain optimistic that the bottom in industrial commodity prices is near as producers continue to cut near term production and future capital spending plans. I have several fundamental long and short positions in these areas. Remember that I look for increasing rates of return on sales and capital for longs and the reverse for shorts.
So where does all of this leave us? Are there any changes in our core beliefs?
It is rare that I change the trading and hedging portions so quickly as I did over the last week. I was very discouraged by the Fed and Janet Yellen's comments after the last Fed decision. More importantly, I felt that their negative comments on economic growth and low inflation could have become a self-fulfilling prophecy; so I reduced my net long exposure by increasing my puts on the DAX and JAX, reduced my trading long positions like AAPL and DIS and lowered my long dollar position.
As the week progressed, I became more confident that the Fed and Janet Yellen realized that their comments were overly negative and would take the next opportunity to clarify their position, which was more positive than generally assumed. Knowing that Janet Yellen was speaking Thursday night, I decided to go back to my core beliefs and reversed what I had done the previous week. In addition, I increased my financial exposure as the prime beneficiaries of a rising yield curve and higher rates. The bottom line is that my core beliefs for the most part remain intact. It is virtually impossible to trade this market as it is so volatile and can reverse fields on a dime as it did Friday. I was fortunate and traded wisely. You must have core beliefs; monitor them every day; be open minded and able to shift gears if the facts support change; and do hard research as I have never seen so much change at the corporate and individual levels.
Opportunity remains everywhere, but only as an investor, as it takes time and patience. I remain disappointed by the politicians who fail to come together to do what is right for our country and its people. John Boehner just happily quit, as he could not take the games any longer. His resignation assures a short-term budget deal but a problem down the road.
My first webinar will be in October. I will send out information on how to participate mid-week. I envision an open conversation much like the investment committee meetings that I headed at Century, then Quantum and finally at EGS. Each Monday this blog will serve as an outline for that week's webinar. Your participation will help each listener participating. My vision is to have fun while we learn from each other.
I want to finish by thanking all of you for reading my blogs and following up with questions and comments. I know doing this has helped me tremendously. My funds finished the week at a new high, up 19% year to date. We are 93% net long.
Remember to review all the facts, pause and keep and open mind, do some in-depth research, control risk, maintain excess liquidity and...