Like many of you, I participated in track and field in high school. Like many of you, I'm sure, I still compete - although in a somewhat recreational - way, locally, in my age group. I had an excellent coach back in the day. Didn't appreciate it at the time, but after having run above the high school level, and having witnessed the coaching that my children experienced, I came to realize just how spectacular my own high school coach had been.
I only ran distance (which in high school is not very far at all), and the high jump. My coach was so good though that everyone on the team practiced every event... just in case an athlete developed over time, or had to fill in for someone else at a meet. We all became as good as we could get at every single event. Though I was never good enough (top seven kids competed in every field event) at it to compete at the city-wide (NY) level, I always enjoyed practicing what was then known as "The Hop, Skip, and Jump", now known simply as "The Triple Jump." This event just seemed silly, but was so goofy to someone not especially good at it, that it was fun. Could hardly compete the movement without giggling.
Jumps in Time, Space, and Pricing
There are so many factors that work into market pricing that one who ponders these things can always think of one more thing after they had thought that perhaps they were done. Hmm. We all know that the proliferation of of passive style investment funds have increased demand for equity, while at the same time supplies of equity have run a bit dry as there are simply less publicly traded firms present in the universe. Due to corporate buybacks, these fewer in number public firms in turn have smaller floats. A low interest rate environment gets the credit and certainly would have to be considered a key ingredient as equity valuation has evolved over time, but the fact is that fundamentally, input - supply and demand - have been structurally altered, so common sense requires that output (valuation) would also change in such a way as to render an honest linear historical comparison not just incorrect, but close to impossible.
Let's get away from this conceptual interpretation of market valuation and simply make our own assessment of the environment in which this structurally altered equation must be applied. Keeping in mind that real-time pricing is now done by algorithmic response to headlines that is timed in micro-seconds and not by a handful of traders thinking about what they are doing timed in minutes. Now understand, though we have largely replaced five guys with calculators Velcro-ed to their order pads with heat seeking algorithms that over time, these algorithms have gone from being quite easy for traders to reverse engineer to something far more complex through the applications of machine learning, artificial intelligence, and the many ways that the use of "Big Data" is both used and interpreted.
Where does that kind of "progress" stop? The answer is that it never will. The growing use of data science techniques will only expand in size, scope, and undeniably in complexity. What this does, now think with me here, we're all smart guys and gals... is make pricing in the potential for unanticipated (and perhaps not thought of) negative outcomes that much more difficult. You dig? Human traders can be as smart as an algorithm. Heck, we can be smarter. We can not be as complex as what is developing before our eyes. Price discovery has devolved from an aggregate result of demand and supply created at a centralized point of sale to the fractured result of minimally exposed demand and supply at any given micro-second across a multitude of points of sale.
What is Truth?
That said, there are still eternal truths. Now, like then, markets still respond well to economic growth. We still have that, and globally there seems to be a growing possibility that this particular input is improving. Markets respond well to consumer level demand. There is no consumer without a strong labor market. The one thing that the U.S. economy has been consistent at has been in the creation of demand for labor.
To complete this "triple jump" the markets obviously like that strong consumer to be able to put their own resources to work in a low inflation environment. While an increase in consumer level inflation might be desirable for the heavily indebted, at the ground level, these consumers who are just now making serious wage gains at the lower bound, and just now saving more of their disposable income most certainly do not welcome higher prices at the grocery or in the products they need to run a household, fuel a vehicle, or clothe a family. The financial marketplace has enjoyed its place as one of the few outlets for overt inflation as the forces of disinflation (deflation is different) have impacted Main Street far more so than Wall Street. This is truth.
A Spoonful Of Sugar
Got you humming along now? Go ahead. Admit it. Julie Andrews is in your head. While Julie Andrews runs around inside your cranium, its the PBOC (People's Bank of China) that has global markets (to include U.S. equity index futures) humming overnight. As Beijing prepares for the annual cash drain brought about by the Lunar New Year (January 25th), the central bank has announced that Reserve Ratio Requirements (Triple R's) will be reduced for commercial lenders come January 6th. This move will release an estimated Y800B ($115B) into the Chinese economy just days after the banks in that nation had been ordered to switch to the new Loan Prime Rate as the reference rate for short term credit, away from the old Benchmark One year rate.
To summarize, China cut its benchmark for short term rates by 20 basis points without officially announcing a rate cut. The main thing this morning though, is the reduced reserve requirement. What now? Reserve ratio requirements are already approaching 12 year lows in China. Estimates for the cash drain related to the Lunar New Year are for at least three times what this January 6th move creates. One might think that maybe the PBOC has more to do in preparation for the holiday in the way of injecting liquidity. At least, global markets appear to be latching on.
On that note, the New York Fed provided $25.6 billion in overnight funding on December 31st in addition to $230 billion in longer-term repo operations that will mature through January. It would appear (fingers crossed) that the Fed has provided enough liquidity, as financial institutions also found alternative ways to mimic repo market type trades with clients as a way to keep the cost of overnight cash needs lower. Crisis averted? Well, we never count our chickens, but for now, the water seems safe. The sky is not falling. On to the taper tantrum. Oh yeah.
What Makes Sense?
While I now enjoy my seventh decade of participation in this human ecosystem (No, I'm not 70, but I did get cracking in the 1960s.), what works? What makes sense? We still have negative real interest rates in too many nations to count. We still run fiscal deficits in the U.S. that only seem to grow, with no budgetary discipline even suggested on either side of the aisle in DC. Most developed economies are at least considering a debt fueled expansion of already irresponsible fiscal policy. The Trade War is now a Trade Truce. I think. Treat that input as subject. Brexit offers great potential for the UK in my opinion. I think we need to add the letters UK to the USMCA.
One would think that being long equities, and yes, industrial commodities, to be wise if economies are growing. One would think that if maybe the world turns away from negative longer-term rates that all 10 to 30 year yields will rise as central banks (the Fed) nail down the short end, that perhaps the U.S. dollar could decrease in value versus its key peer group. After all European rates have more pricing in to do than U.S. rates. That would be accretive to euro or yen valuations. Ugh, just swallowed some tobacco juice. Give me second. Never gets old.
I'm back. So there are a number of trades that make sense. Yet, they all seem so crowded. Don't they? I would think we see a diminished "January Effect" in 2020 as there was very little tax-loss selling to be seen in late 2019. My personal belief is that markets will experience volatility through the first quarter of the year, as earnings fail to catch up to valuation, as the dollar refuses to cede ground very quickly, and as the Fed heads toward a tapering of the current balance sheet expansion program. Are there calm seas behind that? This is an election year. The current administration has been a friend to business. The answer to that lies in the polls. In swing states. In six months. Being forced to price in higher taxes and increased regulation, well... it doesn't take a genius.
I think Healthcare names provide earnings momentum and value that could exacerbate through the political season as the group's will find itself as a key topic going into November. This could provide buy-able dips for the pharmaceuticals. I like the Financials if the Treasury curve is going to be permitted to steepen. I also like Energy, which is far trickier due to massive debt loads across the industry. My plan there is simply to stick to the cash flow names that can support excessive dividend payouts.
In short, you face a challenge. I can't guarantee a darned thing, except that you will not be bored. I leave you today with two quotes to ponder as the "roaring twenties" get under way. You get these, and at least I think, you're half way there.
"In the midst of chaos, there is also opportunity."
"Two qualities are indispensable: first, an intellect that even in the darkest hour retains some glimmerings of the inner light, which leads to truth; and second, the courage to follow this faint light wherever it may lead."
-Carl von Clausewitz
Dogs of The Dow
Just for those wondering... The list this year includes Dow (DOW) , Exxon Mobil (XOM) , International Business Machines (IBM) , Chevron (CVX) , Pfizer (PFE) , 3M (MMM) , Walgreens Boots Alliance (WBA) , Cisco Systems (CSCO) , Coca-Cola (KO) , and Caterpillar (CAT) .
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 226K, Last 222K.
09:45 - Markit Manufacturing PMI (Dec-F): Flashed 52.5.
The Fed (All Times Eastern)
No public events scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
After the Close: (JEF) (.25)