Financial Review

Timing is………..Everything

Financial Review

DOW + 54 = 17, 068
SPX + 7 = 1995
NAS + 34 = 4586
10 YR YLD + .03 = 2.53%
OIL – 1.13 = 91.67
GOLD – 6.80 = 1250.00
SILV – .12 = 19.04

Later today, at 6PM local time or 9PM eastern, President Obama will address the nation and lay out his strategy to degrade and destroy the Islamic State insurgency operating in Iraq and Syria. This will likely involve significant escalation of the US military role in the area, but we aren’t sure about the intervention in Syria; probably a combination of airstrikes, and support for more moderate Syrian forces willing to carry out attacks on both ISIS and Assad; along with regional allies providing on the ground support.

The president has pledged there will not be boots on the ground. He said: “This is not the equivalent of the Iraq war. What this is similar to is the kinds of counter-terrorism campaigns that we’ve been engaging in consistently over the last five, six, seven years.” Which sounds like a distinction without a difference.

Earlier today an administration spokesman said: “The president will discuss how we are building a coalition of allies and partners in the region and in the broader international community to support our efforts, and will talk about how we work with the Congress as a partner in these efforts.”

That doesn’t mean Congress would actually vote on going to war. For weeks, the administration, and particularly the Pentagon, has urged Congress to approve $500 million in funding to train and arm Syrian rebels to fight ISIS. The legislation has been stuck on Capitol Hill since Obama first sought it in May, but it could provide both Obama and Congress with an opportunity to tacitly enlist congressional support for a war without a formal vote ahead of the November midterm elections, something many politicians this week indicated they wish to avoid.

As one geopolitical hotspot heats up, another looks to be cooling. Ukraine’s president said today Russia had removed the bulk of its forces from his country, raising hopes a ceasefire might hold. Ukraine’s military recorded at least six violations of the ceasefire overnight but said there were no casualties. And Russia conducted military tests of a nuclear capable intercontinental missile.

Ukrainian President Poroshenko said he would propose a bill next week offering “special status” to parts of the Donetsk and Luhansk regions of eastern Ukraine now controlled by rebels, but he was adamant in rejecting the separatists’ demands for full independence for their regions and the kind of “federalization” favored by Russia.

Meanwhile Russia faces the threat of further sanctions; the kind that could actually strike at the heart of the Russian economy, its oil industry. Proposed new sanctions would cut off Russia’s access to the technology to drill its richest oil fields. Bloomberg reports the sanctions would bar companies like ExxonMobil, Shell, and BP from using their resources—such as advanced drills and experts—to work in the Russian Arctic and an enormous Siberian oilfield. Neither the US nor Europe have decided whether to proceed, but a European decision could come at any time. If Europe goes ahead with the new penalties, the US would match them.

On Wall Street there seemed to be no worries about war. Apple bounced back. This remains an Apple-dominated market, especially in a week where we don’t have a lot of economic data. After a couple of down days, the S&P bounced back. The S&P 500 hasn’t posted a four-day string of losses in all of 2014. Crude oil futures fell to a 16-month low; there’s plenty of supply and demand has been constrained.

Today is Internet Slowdown Day. You may or may not have noticed certain websites with the dreaded spinning wheel of death loading symbol. Several websites have banded together to protest proposed changes to net neutrality rules, which would allow Internet service providers to charge high traffic websites more or essentially force them to create a “slow lane” for customers. The loading icons lead users to the “Battle for the Net” website where they can sign a letter to Congress, the Federal Communications Commission and the White House. The hope is that the campaign will inspire millions of people to submit comments to the FCC on net neutrality before the public comment period ends on Sept. 15.

Commerce Department reports wholesale inventories rose just 0.1% in July, and inventories excluding autos was flat. This is an interesting economic indicator because it gives us a hint at future economic activity; you have to have wholesale inventory before you make the retail sale. Inventories added 1.4 percentage points to GDP growth in the second quarter. The slow pace of inventory accumulation, however led several financial firms to lower their estimates for third quarter GDP, down to the 2.5% to 2.8% range. Of course, inventories ebb and flow; so, if inventories are light in the third quarter that might force some businesses to restock for the fourth quarter. Still, for all the stories about the economy being poised for big growth in the second half, most of the data points to a slow, steady slog.

Relapse is the rule of the recovery, and it’s a global relapse. The US, Japan, and Europe continue to see GDP growth falter. In the US we had a first quarter contraction; part of the blame was weather, but that was just part of the problem. Europe’s fragile economy has similarly failed to recover strongly enough to ward off periodic growth setbacks. As a result, annual growth in the 18-country eurozone slipped to just 0.4% in the first half of 2014. Earlier this week, Japan reported a 6.8% contraction in second quarter GDP.
The Bank of Japan has pushed a short-term interest rate below zero to try and stimulate the economy and fend off deflation. The BOJ bought three-month bills for more than their redemption value this week, essentially paying to lend money to the market. Giving away money, as the BOJ will be doing if it holds the paper to maturity, is basically subsidizing Japanese banks. Lenders that buy debt from the government stand to make an easy profit if the government pays above par for the paper.

The European Central Bank recently decided to go negative on reserve deposits held by banks, trying to push money back into circulation. Meanwhile, the Federal Reserve FOMC meets next week, and you have to wonder how they’ll respond to the negative rates from the ECB and the BOJ. It is pretty certain the Fed will continue to taper, and stop buying bonds in October; but the next question is when they will start raising targets on interest rates. For several months the Fed has been sticking with the somewhat vague guidance that it will be a “considerable time” before we see rate increases.

Next, consider the performance of the S&P 500; after the crash in 2008, the S&P bottomed in 2009, and then went on to double. For the past 34 months the S&P 500 has not seen a correction of 10%, the third longest correction free stretch in the past 25 years. A chart of the past five years is the very picture of a relentless uptrend. Some people have been lulled into believing that this is typical market behavior; it is not. If you are looking for a reason for the bull market, look no further than the Federal Reserve; they have thrown a lot of money at Wall Street. But now they are promising to stop the flow of easy money, and eventually raise rates. This is not a guarantee that the equity party is over, but just a reminder the party won’t last forever.

The stock market is near an all-time, but economic activity is not. Corporate earnings have been good but revenue has been weak; this reflects the distortions of stock buybacks, but even more, it shows a lack of demand. Weak demand does not bode well for earnings growth. Meanwhile, the global economy wobbles, with the EU and Japan propped up by negative interest rates; China seems doomed to repeat the mistakes that hobbled Japan’s economy for a decade, and emerging markets still suffer from the last beat down. The US looks good by comparison but that’s just the prettiest horse in the glue factory argument. So, you probably think the market is ready for a pullback at the very least, and maybe even a good old fashion crash. But, as always, timing is….. everything.

This is not the time to go short. Picking tops is more a matter of luck than science. There may be many indicators of a top, but it’s smart to listen to the market because you can’t dictate to the market. So, rather than going short, now seems like a good time to lock in some gains and take out some insurance, or hedge some bets.

There are several hedging techniques, including inverse ETFs and shorts. The problem is that the past five years have not been a good time to be short, and we don’t know if the bull market will end tomorrow, or next month, or next year. Shorts and inverse ETFs are great only after the uptrend ends and you see a clear indication of a reversal. Markets can sometimes defy gravity; markets can remain irrational longer than you can remain solvent.

Other popular hedges include options, which can be very effective, but you have to pay a premium for the option. Options are a form of insurance, but they are like term insurance, you pay the premium every month, and if the market doesn’t die, you have to pay again next month. If you stop paying, you lose your coverage.

Locking in gains just makes common sense. You are not in the market for the long haul, you are in the market to make money. The way you make money in the market is to buy low and sell high, and not lose money. It’s really not complicated. One of the easiest things you can do is use stops. If the price falls, you get stopped out, and you collect your profits. Another way is to harvest gains; the idea is that if you have doubled your original investment, sell part of it. Now you’re playing with the house’s money.

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