Hi alex, I have read some of your posts and saw some videos. If I am not wrong you forecast negative interest rates as a normal standard for the future. Could please explain the main reasons that lead you to such conclusion? Regards, Stefano

My post from March 22 “Orbiting Economic Singularity” I discussed that the new economic paradigm: permanent labor redundancy. I think the rates will tend to be negative for as long as the central banks are actually trying to create inflation.  Should they give up and except deflation – the rates might normalize close to zero.

Hi Alex, saw your video on real vision which was awesome :) just wanted to get your opinion on dollar yen, bears are starting to build up alot of reasons to get back in, and so far I have seen a few fundamental reasons for this, and from a technical stand point 1.22 double top that formed as well… would like your opinion if possible?

I have outlined my USDJPY strategy in my post of January 1, 2015. I have not changed my approach since. My bias is to be still long USDJPY, but due to less favorable level my commitment is lower. I put very little wait on technicals, such as double-top, but I respect long-term trends. And the trend is still towards weaker yen.

If the market is a bubble, why so many stocks look cheap?

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“The stocks in my portfolio are precious gems, immune to any problems in the system”. Yes, I know it’s a fallacy.

So, please, help me sort it out. I have been dragged into the raging debate on stock valuations. I have to confess, I feel out of my league on this issue, when engaging with such thorough experts as @Jesse_Livermore (http://www.philosophicaleconomics.com), a moderate bull, or @jessefelder (http://thefelderreport.com), a moderate bear.

When I write about interest rates or currency, I possess (or at least project) much authority and experience. But I know relatively little about corporate valuations. My inclination to stay long equities over the last few years has been a function of my observing historical patterns and trends and my long-term portfolio strategy, but had little to do with whether I thought the overall market was still cheap.

So let me share my confusion. Reading various pieces on the overall US stock market valuations, I find the analysis ranging from fair to very expensive. Yet when I look at individual companies I know, so many of them still look like a bargain.

What DO I know? I mostly follow banks, tech, and social media. I know nothing of consumer, retail, utilities, biotech and so on.

Let’s start with banks. (I source P/Es from Yahoo! Finance).

$JPM  11.24;  $WFC 13.29;   $GS 10.97

Those guys seem to be priced for various degrees of bankageddon. Indeed, they don’t need any growth to justify their valuations, all they have to do is not to have all their earnings taken away by fines.

Established tech.

$IBM 13.49; $INTC 13.02

What is going out style? Computers or computer chips specifically?

All of the above enjoy a healthy growth of EPS via buyback and cheap funding. Some scoff at buybacks, but to me buying your own shares, when they are cheap, and locking the funding seems like a great investment.

Now let’s move to the growth sector.

$AAPL 16.82;  $GOOGL 26.85; $FB 74.65; $TWTR N/A

Are those the culprits of overvaluation?

$AAPL is certainly not as dirt cheap as it was a couple of years ago (similar to $INTC), but still doesn’t look stretched at all, given the power of their brand and continuing revenue growth.

In fact, all four companies above have virtually indestructible brands. There monetization is at different levels of maturity. But it’s hard to imagine any of them to be a terrible long-term gamble.

So where does the overvaluation lie? Is it all the biotech’s fault?

Help!

Orbiting economic singularity

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Inflationary apocalypse or deflationary apocalypse? Which way is the United States heading?

Both doves and hawks have their arguments, and their statistics, and their indicators.

Those, who pay attention to strong dollar and headline inflation, argue that a rates hike by the Fed would be a terrible mistake, pushing the country into recession and the negative yields hell experienced by Europe and Japan.

Those, who view the improving labor market as an undeniable indicator of imminent wage pressure and inflationary spiral, consider the Fed to be way behind the curve.

If we take one side of this debate, let’s not call the other side stupid. They have their points. Let’s also not automatically assume that the Fed is stupid. Janet Yellen’s carefully hedged language from the last policy meeting and the press conference reflects that she is aware of the complexity of this puzzle.

As a sideline, I think the Fed is often forced to be somewhat disingenuous, because  “we have no idea what’s going on, so we’ll just try to wing it”, might not go over well with the public.  They are forced to appear to have an opinion, when I believe they have none (in the very least no consensus opinion).

Having said that, the markets are made of people who think they recognize something that others don’t. So let me respectfully share some of the things I think I recognize.

There is a common problem in partisan politics that tends to surface in financial markets debates. Opinions get packaged.

I would not be the first one to point out that there is no particular reason why, if a person is for tighter financial regulations, they should be also be pro- choice, anti- death penalty, pro- marriage equality, pro- gun control and so on. I don’t think that the majority of people package their opinions for political expedience. Rather, I suspect, they are unconsciously programmed to bundle their views according to a template laid out by our political history and media dialog.

Traders have no political reason to package their views, at least no rational reason. Yet decades of observing the economy and the markets have taught us to associate:

  • Stock rally with wage pressure
  • Economic growth with inflation
  • Corporate profits growth with expansion
  • Government bonds rally with recession
  • Deflation with stagnation
  • Flat yield curves with economic pessimism
  • Low commodity prices with economic slowdown

I could go through many such pairs. Needless to say, those relationships went a little haywire in the last few years. In the very least, we have a strong stock market with decent economy accompanied by lackluster wage growth and very low interest rates.

I feel that market players are choosing between roughly three packages:

1. Stocks are grossly overvalued, We are heading towards a deflationary disaster. Rates are going down.

2. Stock market is reasonably valued. The economy is in a cyclical expansion. Rates are going up.

3. The Fed is far behind the curve. The inflation is about to get out of control, the expansion will stifled by rising rates.

As I have stated above, all of those positions have historical precedents and cyclical arguments to back them up.

My own SECULAR view, however, unpackages those positions.

I am very bullish on long-dated US Government Bonds, but I am also cautiously bullish on stocks. I think there are risks on the near horizon, China slowdown being an obvious one.

But I recognize the following secular trends:

  • Global labor redundancy
  • Lack of wage pressure
  • Global disinflation
  • Global explosive economic growth
  • Explosive growth in corporate profits

In fact, I allow the possibility of us heading into the future where deflation and negative rates (as a price for safe dynamic liquidity) will be a norm. And despite disinflation, I believe that future trillionaires are already born.

Clearly, the burden of proof is on me. I have to make an argument that “this time is different”. And usually “this time is different” story has an ending “well, it turned out to be just like the last time”.

The disinflationary jobless growth scenario hinges on the interpretation of globalization and automatization. And history so far has shown that when progress eliminates one kind of jobs it creates others.

I think this history is no longer applicable. People were speaking of accelerating science and technology for centuries. But up until the recent decades they mere moving and accelerating at the pace set by human intelligence.

We were designing new tools, but those tools were requiring humans to manufacture and operate them. The more complex the tools were, the more highly trained the humans were required to be. And with tools humans were able to make more impact thus, in fact, maintaining demand for their labor in the exponentially growing economy.

It is still mostly true. Computers aid our thinking and research, but the bulk of changes and innovation is driven by human creativity. Yet the balance is shifting.

Singularitarians (such as Ray Kurzweil)  believe that we are on the brink of explosive self-acceleration led by computers designing better computers, which design better computers even faster, and rapidly surpassing every aspect of human intelligence.

Singularitarian philosophy is migrating out of the province of science fiction writers into the  mainstream, and can no longer be ignored by long horizon investors.

I don’t know when we will be uploading our minds or merging them with artificial intelligence.

But I do see that we are shifting into the world where more and more able-bodied competent adults do not have sufficiently marketable skills.

And those of us who are still doing well, say trading, shouldn’t get too comfortable. The algos are breathing hot on our heels.

I want to be clear. My core strategy over the last couple of years – long dollar, long bonds, long stocks – is not predicated on any conviction about “economic singularity”. Rather, I am following market patterns and trends that I currently observing. And questioning some old economic paradigms doesn’t equate to disregarding historical market patterns (such as strong performance of the long end of the curve in the tightening environment).

In fact, my portfolio strategy does not require an over-arching philosophy. But the idea of economic singularity allows me to have a clear and consistent theory of unfolding events.

  • I can be positive on stock market without being scared of valuations
  • I can be long bonds without fear of job growth
  • I can anticipate the Fed tightening without conjuring an imminent global depression
  • And even when I contemplate the possibility of catastrophic China collapse, I can see light on the other end of the tunnel

The Fed doesn’t have have the luxury of including the singularity into their discourse. They have to appear serious and academic.

Alex, terrific posts. Not exactly global macro but your thoughts on US corporates ? Still leveraged and arguably in a much tougher revenue and earnings environment than the last few years while deploying debt capital on less than productive endeavors, i.e., share buybacks and questionable very “L”BOs. We’re in the midst of a $ regime change. Although one can argue that flows will be favorable toward US-based debt, seems default risk is “under-appreciated” w/global debt contagion ? Thank you

As you have correctly guessed I am not an expert on corporate valuation. I offer no equity investment advice.

My personal strategy dictates that I stay modestly long global stock markets at this juncture.

I like US markets a lot, but I recognize that they are getting expensive on the currency-adjusted basis.

I am a big believer in buybacks as the best way to create shareholder value in a low interest rate environment, but I have no tools to evaluate the extent of the leverage risk.

The global debt contagion is always a concern, as I have emphasized in my post on March 8th. I would look for companies with good CFOs to minimize the blow-up risk.

Rotating into lower risk long dollar trades

The dollar chart is no longer parabolic. It’s vertical.

This by itself is not an indicator, that we have to close the long dollar trade. My general feeling is “Why give up on a good trend, while it lasts?”

On January 1st, 2015 I posted that I had reduced my short Yen risk and focused on short Euro. My relatively conservative risk commitment at the beginning of the year allowed me to build a short Swiss (long USDCHF), after the SNB surprise action had sent the currency into the opposite of freefall.

But now both EURUSD and USDCHF trades have moved enough to be considered mature along with USDJPY. 

Even the secular dollar bulls, who are calling for EUR to go back to 0.80 and JPY to 150, have to admit that more than half on the move has already taken place.

When EURUSD was at 1.35, it was easy for to say “I will stay short no matter what. If it goes a few % against me, I will just wait it out.” Now there is a lot to lose from 1.05.

So, are you prepared to sit on your short EUR position, if it goes back to say 1.15? Maybe you are. But it is not crazy for even the greatest dollar bulls to think of some risk management. For some it means reducing positions, for some trailing stops. Personally, I prefer the former.

As I am taking some profits on EUR and CHF, my thoughts are turning to currencies that haven’t moved quite as much and still have space to catch up in the devaluation race.

You might have guessed what part of the world I am thinking of from the picture upfront. China, Taiwan, Australia, New Zealand, Korea, and so on.

Australia in fact has already moved a lot as well. But New Zealand, as I have written before, looks very expensive against its larger neighbor. So I have recently decided to swallow the negative carry pill and establish a small NZDUSD short.

China is the focus of raging debates and what is actually going on there is beyond the scope of this post.

I would like to have a better look at South Korea, which delivered a surprise rate cut last week, confirming its participation in the race to the bottom.

Indeed KRW has weakened somewhat against the US dollar. But the 10% retreat to the highs is not that substantial. If you substitute USD by the currency of their closer neighbor – JPY, you will see a very different picture (lower number means stronger KRW).

So we have a theme similar with China and New Zealand: the carry is not great (though closer to zero in the case of Korea), looks weaker relative to USD, but strong relative to some key counterparties.

I have to confess, I am not at all an expert on Korean economy. 

Rather than to analyze specific countries, I want to focus on the general theme. How much downside is really there in being short USDNZD, long USDCNY and USDKRW? 

Yes you might have to eat some negative carry, but are you worried about catastrophic appreciation of any of those currencies?

So now that we have (hopefully) booked some profits on easy positive carry trend trades in EUR, JPY, and CHF; is it worth to pay some carry in places where the downside is not that big?

I find it hard to imagine the world in which the broad dollar continues and the “catch-up” currencies do ont devalue as well.

Hi Alex, How do think XAU will perform if we end up in a scenario of negative front-end rates in the USD especially if accompanied by a strong deflation? Thx

Some consider gold to be the best indicator of excess liquidity and thus future inflation. I prefer to look at it as a leading indicator. XAU rally would indicate higher likelihood of the return of inflation.

So the back end of the UST curve tends to flatten during Fed tightening, as you have indicated. My question is what does this mean in the context of Dudley’s comments last month in a speech in NY that the Fed will keep tightening until forward rates start rising? Why is the Fed so honed in on term premium measures as the explanation for low long-term forward rates? Is this representative of a reaction function “policy error” to you?

It’s a matter of view: do you think low rates are cyclical or secular? The Fed tends to operate on cyclical assumptions. Cyclical moves are more common. The burden of proof is on us, bond bulls.

What are the prospects for a mortgage deleveraging in economies like Australia & Canada? The high debt burdens, commodity headwinds, concentrated banking sectors, & (in Australia’s case) new credit skew toward IOs all catch my eye. Does such a prospective dynamic however require a yield shock (similar to how the oil shock in 08 was the nail in the coffin for US mortgage credit growth)? Without a yield shock, can there be a “Minsky moment” at prevailing yields?

Australia may be a serious risk in the event of China collapse. Don’t have a good sense of what’s up in Canada, but I generally assume that they would follow US economic lead.

I think a global collapse could occur even at current yields in DM, especially if EM countries have to keep raising rates to defend their foundering currencies.