Fear No Evil
As equity markets rallied on Friday morning, a couple of items struck me. It was almost as clear as if I could hear a ringing bell. The marketplace does not care, at least for now, about the state of chaos in Washington. We had already sort of figured that out as last week wore on. I get that. We have two examples to go off of in my lifetime where a sitting president came under the kind of political pressure that we potentially could currently see.
Markets did well in the late 1990s when President Clinton faced impeachment, and not so hot in the early 1970s when President Nixon was on the hot seat. In each case, market performance seemed more in line with economic performance, and not at all in line with what the politically astute might have expected. Now, the mid-terms... that's a horse of a different color.
So what does matter? My thought on this is that dollar strength certainly matters. There are days that the flattening yield curve certainly does matter, and other days where it seems not to. It certainly does seem to matter at least as far as sector rotation is concerned. The banks were broadly flat on Friday, while the S&P 500 was picking up about five-eighths of one percentage point.
Both currency valuations, and the steepness of the yield curve are driven by the level of aggression or lack thereof of both monetary and fiscal policy. We already know that Treasury needs to maintain an elevated level of borrowing, and has also indicated a new intention to focus on the long end of the curve. Very wise. Monetary policy? This is where Jerome Powell's speech on Friday comes in.
Markets are still pricing in a 96% probability of a September 26 rate hike. Write that one in stone, gang. Powell, in his own way, sounded a little more dovish in that Jackson Hole appearance than maybe some folks had expected. Yes, he made sure that we understand that he thinks the "economy is strong." Keep in mind that several key subordinates had expressed opinion over the last week or so that the Fed should not allow the spread between the yields of the two-year Treasury note and the 10-year Treasury bond to invert. This is the counsel that the chair is getting, at least from some corners.
Powell added on Friday "We have seen no clear sign of an acceleration above 2% [presumably regarding consumer level inflation], and there does not seem to be an elevated risk of overheating." Whoa. Does that mean that a December hike (still 66% priced in) is a definite maybe?
Don't forget though, that the current round of trade negotiations are likely to result in a positive announcement regarding Mexico early this week, that the next tranche of tariffs aimed at China ($200 billion) is in the comment period, and will be through next week. The Federal Reserve must work its way around not only domestic uncertainty, but the unknown outcome of a trade war that is still more a war of words than facts.
Think of this. With Turkey and the exposure of several European banks to the Turkish Lira already circling the drain, not to mention the well-publicized fiscal deficit Italy now faces, Powell must judge just how likely it is that the European Central Bank (ECB) actually moves toward policy normalization as planned. Dovish signals from that corner will put the U.S. dollar on a pedestal, which hawkish Fed policy would only exacerbate. This actually makes the comments supposedly made by President Trump on July 30 to Italy's Prime Minister Guissepe Conte quite understandable if you remember the president's preference for a weaker dollar. Let that sink in. It's potentially important.
Where Does This Leave Me?
From a strategic vantage point, quite honestly, I am glad that I have stayed quite decisively net long the U.S. equity market. Let's think about economic strength. The housing market is stalling. New Home Sales are at an eight-month low. Existing Home Sales are as weak as they have been in two and a half years.
They say it's a supply issue. I'll tell you right now that I think the problem is threefold. First and foremost, this is a pricing issue. The average Joe or Jane no longer sees the dream of home ownership as such a bargain in the era of wage moderation. Then there's the double whammy of a central bank well into a rate-raising cycle coupled with crushing real estate taxes -- particularly in blue states that, under the new tax laws, are no longer as subsidized by the federal government as they once were. Folks won't really feel this until April. For many, this is still a personal uncertainty.
However, it's those very same tax laws that have afforded the average American consumer a substantial increase in disposable income, even without a substantial increase in wages. Savings levels are up too, by the way. Those tax cuts, coupled with a deregulated environment, have also unleashed animal spirits in corporate America. This has allowed for margin expansion, as businesses meet this increased demand. Are valuations high? Not really, when understanding the environment provided.
Listen, the future is still unknown, and are these economic conditions sustainable? Very hard to say. The solution for the investor/trader is to stay rooted in the moment. Investors should live by a code of disciplined rules that include preparation for that rainy day, because it will come. For now, however, corporate performance is strong and expected to remain so throughout the rest of the year. For me, a balanced, yet biased approach based on my expectations seems appropriate. The level of bias in this approach must be in accordance with the investor's tolerance for risk. No way around that, but you have to think. No intellectual laziness permitted.
Jugglers and Plate-Spinners
Back in my youth, there used to be such a thing as a three-ring circus. Not the travelling variety that might appear in a mall parking lot near you, but the kind that you had to go to a hockey/basketball-sized arena to see. The main show would be centered in the middle of the floor.. in the "center ring" ... while on the outskirts, to keep people from being bored in between acts, there would be a continuous flow of smaller performances made by the likes of clowns, jugglers, and plate-spinners, etc. These smaller shows were meant to distract.
Back on August 7, nearly three weeks ago, Tesla (TSLA) CEO Elon Musk commenced with his now-famous tweet storm. In a series of tweets, Musk indicated that he might be taking the firm private, that funding had been "secured," and that all that was now need was a shareholder vote. Oh and the market price of $420 per share was thrown around as well, which would have valued such a transaction at $70 billion.
Speculators and short sellers who felt the squeeze ran the stock up on these tweets. The shares peaked at $387.46. Then, as the days progressed, the stock sold off just as hard as it had increased (bottoming at $288.20, before rising again early last week). What's the big deal about a $99 range over a short period of time anyway? Hmm.
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In truth, the stock has flat-lined for a couple of days now, as investors were left in a state of great inertia provoked by the unknown. Expect that stability to end immediately. What we now know is that Tesla will not be going private, at least not now. According to the Wall Street Journal, there did exist the potential for a deal last week that would have involved several deep-pocketed investors such as Volkswagen and Silver Lake Partners. The problem for Musk was allegedly that the investors would also wanted their share of say in the company. As the story goes, it was then that Musk pulled the plug. The story of how Tesla got to this point, however, is quite complex.
The Bottom Line
For me, what is clear is to avoid this name completely if one is already flat. Now, the focus for investors will turn in three directions.
1) Production Levels. These have long been the market focus, if only this were the only issue facing the firm.
2) Profitability. Perhaps the worst thing that could happen to Tesla would be turning in a positive quarter. At that point, the firm might be valued more like regular public corporations -- or heaven forbid, a normal automobile manufacturer, facing all of the margin pressures of that industry in general.
3)The SEC probe. Can't forget about this. The Securities and Exchange probe could lead anywhere. What the SEC in all probability wants to know is did Elon Musk have a reasonable basis for his "funding secured" tweet, and his insinuated take-out price. On top of that, depending on what the SEC finds, there could be shareholder lawsuits in the offing.
Plainly, I know nothing. What does Jim Cramer tell you about firms going through anything related to "accounting irregularities?" He tells you to stay away. My thought is that the same strategy would apply when it comes to SEC probes. Who needs this headache? We have our own problems without creating more by getting involved in what is impossible to fully analyze.
For those willing to gamble on direction, this is one of the few cases where purchasing options is a bit smarter than selling them. Depending of the speed and size of any move in the last sale of these shares, getting short options on either side of the market could leave the investor having to eat something truly awful. At least a purchase allows that same investor to precisely identify his or her level of risk. Your old buddy is going to play some other game today.
Economics (All Times Eastern)
Expecting 30.8, Last 32.3.
Today's Earnings Highlights (Consensus EPS Expectations)
After the Close: (PAHC) (0.42)