All posts by Charlie Bilello

The Greatest Trick the Stock Market Ever Pulled

What if everything you thought was true about markets was a lie? That is the question everyone should be asking today.

It defies logic, but investors (if you can call them that) are now paying over 1% for the privilege of locking their money up in Switzerland government bonds for one year. You read that correctly: paying.

Trick1

Throughout history, we’ve been told that someone should pay you when you lend them money. Now you’re being asked to pay them. How can that be? Why would anyone do such a thing?

The only rational (if you can call it that) explanation is that investors are so afraid about the prospects for global growth that they’d rather pay to keep their money in a “safe haven” country like Switzerland than risk losing more money elsewhere.

The focus has once again shifted from return on your capital to return of your capital. But unlike 2008, investors are so concerned about the return of their capital that they are even willing to accept losing a portion of it (accepting a negative return).

Perhaps more alarming, investor fears aren’t limited to just the next year. Yields have gone negative in Switzerland as far out as 10 years.

Trick2

That’s right. For the peace of mind of owning Swiss government bonds, you have to pay 0.2% per year for the next 10 years.

Trick3

Now, if this backdrop wasn’t incredible enough, here’s where it really gets interesting. Rather than saying this is a troubling development for the global economy, most pundits are saying negative yields are a good thing.

Why? Because, we are told, it means additional central bank easing in the form of even lower rates and even more quantitative easing. And these easing measures (including the upcoming ECB QE), we are told, will continue to lift stock prices. And because we all know by now that short-term stock prices are an accurate representation the economy, the more negative the yields, the better.

I’m being facetious of course as the stock market is only the economy in the minds of central bankers. In the real world of slowing growth, stagnant wages, and a widening wealth gap the stock market is far from the economy. If it were, the economies of Europe and Japan would be booming with stock prices at new highs. Instead, Japan has fallen into its fourth recession since 2008 and Europe is not far behind.

The greatest trick the stock market ever pulled was convincing the world that negative yields are a good thing. How long will people fall for it? As long as stock prices are going up and the illusion of stability remains in place.

“You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time.” – Abraham Lincoln

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

facebooktwittergoogle_pluslinkedinmail  rssyoutube

Related Posts:

Is the U.S. really decoupling from the world?

One of the key themes of 2014 was this notion that the U.S. was decoupling from the world. The narrative – Japan may be in recession, Europe in a deflationary collapse, and China slowing – but the U.S. is strong and is an island unto itself.

The narrative, though, is not the same as reality. While the U.S. economy has certainly fared better than its global peers, an “acceleration” we have yet to see, with real GDP still showing the slowest post-war recovery in history and real wage growth telling the same story.

decoupling 1

What, then, are investors basing their decoupling theme on? Very simply, the U.S. stock market, which to put it mildly has been trouncing its global peers since 2010. Five years of outperformance is a long time and enough to build a strong case for just about anything.

decoupling2

If we look away from just the large cap stock indices, though, the U.S. story looks more like Europe and Japan than most investors may want to believe.

Falling Inflation Expectations

First, inflation expectations in the U.S. have been falling precipitously over the past year with breakeven rates (2-years through 30-years) back to their lowest levels since 2009.

decoupling3

Yield Curve Flattening

Second, the yield curve in the U.S. is flattening, down to a 129 bps spread between the 10-year yield and the 2-year yield.

decoupling4

Yields Plummeting

Third, like Europe and Japan, U.S. long duration yields have plummeted over the past year. The 30-year Treasury yield is at a new all-time low, below the crisis lows of 2008.

decoupling5

Credit Spreads Widening

Fourth, credit spreads in the U.S. are widening, with the high yield index showing a 542 basis point spread, up from 388 basis point one year ago and 335 basis points last June.

decoupling6

Defensive Sectors Leading

Fifth, within the U.S. stock market it is not cyclical but defensive sectors (Utilities, Health Care, and Consumer Staples) that have been outpacing the S&P 500 since the beginning of 2014.

decoupling7

Leading Indicators Turning Down

Sixth, if we look past lagging indicators like GDP and focus instead on leading indicators, they are telling a different story.

The growth rate on the ECRI Weekly Leading Index has moved into negative territory, at its lowest level in three years.

decoupling8

Similarly, the U.S. composite PMI Output index is showing its slowest rate of expansion in 14 months.

decoupling9

Unprecedented Fed Action (0% Policy)

Lastly, the U.S. Federal Reserve continues to behave as if we are very much like Europe and Japan, holding interest rates at 0% now for over six years.

decoupling10

Entering the year, many were predicting a rate hike by mid-2015, but the expectations for a Fed rate hike continue to be pushed out  as the stock market ticks lower. The futures market is now anticipating the first rate hike will not occur until October 2015 and we are not far from shifting to December 2015.

decoupling11

The Decoupling Myth

Collectively, these factors suggest that the U.S. is not immune to a global slowdown. Indeed, it is already starting to feel the effects if we look at anything except the S&P 500. From easy monetary policy to plummeting yields and inflation expectations, the U.S. looks very much like its global peers. Moreover, the widening of credit spreads and outperformance of defensive sectors suggest that market participants are already starting to appreciate this and position accordingly.

What we have yet to see is large cap U.S. stock indices reflect this risk but as I wrote recently, that too may be changing here. Narrative follows price. If the v-bottom pattern that has persisted in the U.S. since the beginning of 2013 ends in the coming weeks, expect confidence in the narrative of “U.S. decoupling” to end with it.

At Pension Partners, our Beta Rotation and Inflation Rotation strategies remain defensively positioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

facebooktwittergoogle_pluslinkedinmail  rssyoutube

Related Posts:

  • No Related Posts

Real Wage Growth and Fed Policy: The True Story

Non-farm payrolls in the U.S. beat expectations (251k vs. 240k consensus) last week and the Unemployment Rate fell to 5.6%, its lowest level since June 2008. This was the 51st consecutive month of job gains, the longest streak in history.

wg1

Given this backdrop, investors must be expecting the Federal Reserve to raise interest rates sooner than expected, right?

Wrong. Expectations for the first Fed rate hike actually shifted further out in time after the report. Investors are now expecting the Fed to keep rates on hold at least until September of this year.

wg2

Why the shift in expectations, even after what was supposedly a strong jobs report? Weak wage growth, we were told, with average hourly earnings dipping to 1.7% over the past year. With CPI at 1.3%, real wages fell to 0.34%.

wg3

The Fed is watching this indicator closely, we are told, and will wait until real wages rise before raising interest rates. They will ignore any continued improvement in payrolls and the unemployment rate and focus instead on real wages.

Ok, sounds reasonable enough; we all want higher real wages.  But is this consistent with what the Fed has done in prior cycles? After prior recessions did the Fed wait until real wages moved significantly higher before raising interest rates?

As it turns out, no they did not.

1990-91 Recession

The 1990-91 recession ended in March 1991. The Fed cut interest rates until October 1992, down to a low of 3% (from as high as 9.75% in 1989). They initiated their first rate hike in February 1994, a 25 basis point move to 3.25%. What were real wages in the month prior to the first rate hike?

At 0.11%, they were actually lower than they are today. The Fed would hike rates from 3% to 6% from February 1994 to February 1995, and only after these hikes did we start to see a significant rise in real wages.

wg4

2001 Recession

The 2001 recession ended in November 2001. The Fed cut rates until June 2003, down to a low of 1% (from as high as 6.5% in 2000). They initiated their first rate hike in June 2004, a 25 basis point move to 1.25%. What were real wages in the month prior to the first rate hike?

Again, at -0.88%, they were actually lower than they are today. The Fed would hike rates from 1% to 6.5% from June 2004 to June 2006, and only after these hikes ended did we start to see a significant rise in real wages.

wg5

From these examples it is clear that real wage growth has only come later in the cycle, and that there is no precedent for the Fed waiting for real wages to increase before raising rates.

But maybe it’s not real wages that the Fed is targeting after all. Perhaps it’s the unemployment rate. Here too the historical precedent fails us, as the Fed rose rates at 6.6% Unemployment Rate in 1994 and at 5.6% Unemployment Rate in 2004. Today, we are already down to a 5.6% Unemployment Rate and the expectations for a rate hike are still being pushed out.

wg6

The True Story

Still, some might argue that there is no harm in keeping rates at 0% for even longer if this brings about real wage growth. I might agree with that if there was any evidence of a correlation between the two. The truth is that the historical relationship between real wage growth and the Fed Funds Rate has been tenuous at best.

real wages7

Which brings us to the unspoken elephant in the room: real wage growth during this recovery has been the slowest in history while the one constant during this period has been 0% interest rates. To say that keeping interest rates at 0% is going to help real wages, then, is an unbelievable leap of faith.

wg7

After six year of 0% rates, shouldn’t the onus now be on the Fed to prove that their policies aren’t actually hurting real wages?

Shouldn’t they be asked to explain how encouraging stock buybacks, M&A, and speculation in the stock market helps real wages? Or how a widening wealth gap created by 0% policy help real wages? Or how delaying older workers from retiring because of 0% rates helps real wages? Or how a massive misallocation of capital created by 0% rates helps real wages?

I don’t pretend to know what the appropriate level of the Fed Funds Rate is, but neither does the Fed. As I have illustrated, they have been letting the short-term movements of the stock market dictate policy in recent years, not economic data and certainly not real wages.

What I do know is that after six years the appropriate level is not 0% (negative real rates) if your goal is anything other than creating another financial bubble. By some metrics, we may already be there with the median P/E multiple for U.S. stocks at a new all-time high.

median pe 1-13-15

Source: James Paulsen, Wells Capital Management

Some might support such a goal of inflating bubbles, borrowing from the future to satisfy the whims of today. I personally don’t believe this is good long-term economic or monetary policy but it’s certainly a debate we should be having. In the meantime, let’s be clear and open about what the Fed is really targeting and not pretend that higher real wages are the ultimate objective.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

facebooktwittergoogle_pluslinkedinmail  rssyoutube

Related Posts: