Category: Markets

Are U.S. Treasuries Jeopardizing Other Markets?

Posted on by aweinsoff@channelchek.com
Image Credit: Pixabay (Pexels)

How Liquid Has the Treasury Market Been in 2022?

The health of the US Treasury market impacts almost all other markets. This is because the “risk-free” market (US Treasuries) and its relationship to the US dollar is the foundation from which other markets stand. If it is in trouble, all markets suffer. The “health” measure most associated with securities like treasuries is liquidity or whether money can be raised when needed. Other measures include market spread between the bid and the ask, trading activity levels, and price impact or how a large transaction impacts the price.

A just released report by New York Fed economists Michael Fleming and Claire Nelson discuss the current state of the U.S. Treasury markets from the unique point of view and access to information of the New York Fed.

The report follows:

How Liquid Has the Treasury Market Been in 2022?

Policymakers and market participants are closely watching liquidity conditions in the U.S. Treasury securities market. Such conditions matter because liquidity is crucial to the many important uses of Treasury securities in financial markets. But just how liquid has the market been and how unusual is the liquidity given the higher-than-usual volatility? In this post, we assess the recent evolution of Treasury market liquidity and its relationship with price volatility and find that while the market has been less liquid in 2022, it has not been unusually illiquid after accounting for the high level of volatility.

Why Liquidity Matters

The U.S. Treasury securities market is the largest and most liquid government securities market in the world. Treasury securities are used to finance the U.S. government, to manage interest rate risk, as a risk-free benchmark for pricing other financial instruments, and by the Federal Reserve in implementing monetary policy. Having a liquid market is important for all these purposes and thus of great interest to market participants and policymakers alike.

Measuring Liquidity

Liquidity typically refers to the cost of quickly converting an asset into cash (or vice versa) and is measured in a variety of ways. We consider three commonly used measures, calculated using high-frequency data from the interdealer market: bid-ask spreads, order book depth, and price impact. The measures are for the most recently auctioned

(on-the-run) two-, five-, and ten-year notes (the three most actively traded Treasury securities, as shown in this post) and are calculated for New York trading hours (defined as 7 a.m. to 5 p.m.). Our data source is BrokerTec, which is estimated to account for 80 percent of trading in the electronic interdealer broker market.

The Market Has Been Relatively Illiquid in 2022

The bid-ask spread—the difference between the lowest ask price and the highest bid price for a security—is one of the most popular liquidity measures. As shown in the chart below, bid-ask spreads have widened out in 2022, but have remained well below the levels observed during the COVID-related disruptions of March 2020 (examined in this post). The widening has been somewhat greater for the two-year note relative to its average and relative to its level in March 2020.

Bid-Ask Spreads Have Widened Modestly

Liberty Street Economics chart plots the five-day moving averages of average daily bid-ask spreads for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.

Source: Authors’ calculations, based on data from BrokerTec.

Notes: The chart plots five-day moving averages of average daily bid-ask spreads for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Spreads are measured in 32nds of a point, where a point equals one percent of par.

The next chart plots order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices. Depth levels again point to relatively poor liquidity in 2022, but with the differences across securities more striking. Depth in the two-year note has been at levels commensurate with those of March 2020, whereas depth in the five-year note has remained somewhat higher—and depth in the ten-year note appreciably higher—than the levels of March 2020.

Order Book Depth Lowest since March 2020

Liberty Street Economics chart plots five-day moving averages of average daily depth for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.

Source: Authors’ calculations, based on data from BrokerTec.

Notes: The chart plots five-day moving averages of average daily depth for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Data are for order book depth at the inside tier, averaged across the bid and offer sides. Depth is measured in millions of U.S. dollars par.

Measures of the price impact of trades also suggest a notable deterioration of liquidity. The next chart plots the estimated price impact per $100 million in net order flow (that is, buyer-initiated trading volume less seller-initiated trading volume). A higher price impact suggests reduced liquidity. Price impact has been high this year, and again more notably so for the two-year note relative to the March 2020 episode. That said, price impact looks to have peaked in late June and July, and to have declined most recently (in October).

Price Impact Highest since March 2020

Liberty Street Economics chart plots the estimated price impact per $100 million in net order flow for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Source: Authors’ calculations, based on data from BrokerTec.

Notes: The chart plots five-day moving averages of slope coefficients from daily regressions of one-minute price changes on one-minute net order flow (buyer-initiated trading volume less seller-initiated trading volume) for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Price impact is measured in 32nds of a point per $100 million, where a point equals one percent of par.

Note that we start our analysis of liquidity in this post in 2019 and not earlier. One reason is to highlight the developments in 2022. Another reason is that the minimum price increment for the two-year note was halved in late 2018, creating a break in the note’s bid-ask spread and depth series. Longer time series of bid-ask spreads, order book depth, and price impact are plotted in this post and this paper. The longer history indicates that the price impact in the two-year note is currently at levels comparable to those seen during the 2007-09 global financial crisis, as well as in March 2020.

Volatility Has Also Been High

Pandemic-induced supply disruptions, high inflation, policy uncertainty, and geopolitical conflict have led to a sizable increase in uncertainty about the expected path of interest rates, resulting in high price volatility in 2022, as shown in the next chart. As with liquidity, volatility has been especially high lately for the two-year note relative to its history, likely reflecting the importance of near-term monetary policy uncertainty in explaining the current episode. Volatility has caused market makers to widen their bid-ask spreads and post less depth at any given price (to manage the increased risk of taking on positions), and for the price impact of trades to increase, illustrating the well-known negative relationship between volatility and liquidity.

Price Volatility Highest Since March 2020

Liberty Street Economics chart plots five-day moving averages of price volatility for the two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022.

Source: Authors’ calculations, based on data from BrokerTec.

Notes: The chart plots five-day moving averages of price volatility for the on-the-run two-, five-, and ten-year notes in the interdealer market from January 2, 2019, to October 31, 2022. Price volatility is calculated for each day by summing squared one-minute returns (log changes in midpoint prices) from 7 a.m. to 5 p.m., annualizing by multiplying by 252, and then taking the square root. It is reported in percent.

Liquidity Has Tracked Volatility

To assess whether liquidity has been unusual given the level of volatility, we provide a scatter plot of price impact against volatility for the five-year note in the chart below. The chart shows that the 2022 observations (in blue) fall in line with the historical relationship. That is, the current level of liquidity is consistent with the current level of volatility, as implied by the historical relationship between these two variables. This is true for the ten-year note as well, whereas for the two-year note the evidence points to somewhat higher-than-expected price impact given the volatility in 2022 (as also occurred in fall 2008 and March 2020).

Liquidity and Volatility in Line with Historical Relationship

Liberty Street Economics chart plots price impact against price volatility by week for the five-year note from January 2, 2005, to October 28, 2022. 

Source: Authors’ calculations, based on data from BrokerTec.

Notes: The chart plots price impact against price volatility by week for the on-the-run five-year note from January 2, 2005, to October 28, 2022. The weekly measures for both series are averages of the daily measures plotted in the preceding two charts. Fall 2008 points are for September 21, 2008 – January 3, 2009, March 2020 points are for March 1, 2020 – March 28, 2020, and 2022 points are for January 2, 2022 – October 29, 2022.

The preceding analysis is based on realized price volatility—that is, on how much prices are actually changing. We repeated the analysis with implied (or expected) price volatility, as measured by the ICE BofAML MOVE Index, and found similar results for 2022. That is, liquidity for the five- and ten-year notes is in line with the historical relationship between liquidity and expected volatility, whereas liquidity is somewhat worse for the two-year note.

Note also that while liquidity may not be especially high relative to volatility, one might then ask whether volatility itself is unusually high. Answering this question is beyond our scope here, although we will note that there are good reasons for volatility to be high, as discussed above.

Trading Volume Has Been High

Despite the high volatility and illiquidity, trading volume has held up this year. High trading volume amid high illiquidity is common in the Treasury market, and was also observed during the market disruptions around the near-failure of Long-Term Capital Management (see this paper), during the 2007-09 financial crisis (see this paper), during the October 15, 2014, flash rally (see this post), and during the COVID-19-related disruptions of March 2020 (see this post). Periods of high uncertainty are associated with high volatility and illiquidity but also high trading demand.

Nothing to Be Concerned About?

Not exactly. While Treasury market liquidity has been in line with volatility, there are still reasons to be cautious. The market’s capacity to smoothly handle large flows has been of ongoing concern since March 2020, as discussed in this paper, as Treasury debt outstanding continues to grow. Moreover, lower-than-usual liquidity implies that a liquidity shock will have larger-than-usual effects on prices and perhaps be more likely to precipitate a negative feedback loop between security sales, volatility, and illiquidity. Close monitoring of Treasury market liquidity—and continued efforts to improve the market’s resilience—remain important.

Citation:

 “How Liquid Has the Treasury Market Been in 2022?,” Federal Reserve Bank of New York Liberty Street Economics, November 15, 2022, https://libertystreeteconomics.newyorkfed.org/2022/11/how-liquid-has-the-treasury-market-been-in-2022/.

Is This the Best Category of Stocks for Young, Long-Term Investors?

Posted on by aweinsoff@channelchek.com
Image Credit: Michelle Ress (flickr)

Large-Cap and Small-Cap Stock Return Probabilities

According to Ibbotson Associates’ Stocks, Bonds, Bill and Inflation, small Capitalization stocks outperform Large Capitalization stocks over the long term. (Although there is not a set definition for a Small Cap stock,  generally speaking Small Cap stocks are those with a market capitalization below $2 billion today, while Large Cap stocks refer to the S&P 500.) Over the 1926-2018 period, Small Caps produced an average annual return of 11.0% compared to 9.99% for Large Capitalization stocks. (1) But, since 2010, Small Cap stocks have underperformed their Large Cap brethren. From the beginning of 2010 through the end of 2019 the S&P 500 rose 185.2% while the Russell 2000 (a proxy for small cap stocks) was up 145.8%. Over the last decade, the S&P 500 outperformed the Russell 2000 in 6 of the ten years. In 2019, the S&P 500 produced a 28.9% return compared to 23.7% for the Russell 2000. Has the time come for Small Cap stocks to outperform Large Cap stocks?

Positives

Relative Valuation Levels. Valuations for Small Caps are at their most attractive levels since June 2003 relative to Large Caps, according to data from Jefferies Financial Group. Historically, Small Caps have outperformed Large Caps by an average of 6% over the following year when the valuation gaps widens this much. (2)

New Index Highs Are a Historic Positive Sign. This past Thanksgiving, the Russell 2000 hit a new 52-week high after nearly 15 months without breaching it. FactSet and LPL Research data indicate that of the last 11 times the Russell 2000 index hit a new 52-week high, returns for the index were up an average 17% over the next 12 months 10 of those times. (3)

Higher Rate of Earnings Growth. Small Cap stocks produce a higher rate of earnings growth over time than Large Caps. Over the 1987-2017 period, Small Caps average annual recurring earnings growth was 8.15% versus 7.44% for Large Caps. (4)

Positives of Small Caps. As one would expect, most Small Caps are young companies with less international exposure than Large Caps. (5) Small Caps have less research coverage than Large Caps, providing a greater potential of market inefficiencies. (6) Ownership of Small Cap stock is typically concentrated in the hands of founders or management, a group that may be more motivated to increase shareholder value than the highly dispersed ownership of Large Cap shares.

Drawbacks

Higher Returns are due to Higher Risk. According to Alpha Wealth Strategies, Small Caps higher return over time comes with a standard deviation (a measure of risk) of 31.28 compared to just 19.76 for Large Cap stocks. (7) So, yes, an investor is receiving a higher return over time from Small Cap stocks, but the investor is assuming higher risk to achieve those returns.

Greater Volatility. As an example of the greater volatility of Small Caps, the Russell 2000 posted 65 intraday moves of 1% or more in the first 10 months of 2019, double that of the S&P 500. (2)

More Susceptible to Economic Shocks. Given their smaller size, lack of business diversification, and limited access to capital, Small Cap companies have historically been more susceptible to economic shocks. In times of economic uncertainty, many investors flock to Lage Cap stocks that are easier to trade and do not suffer from Small Caps’ business limitations. (8)

Small Caps Risks Relative to Large Caps. Among the greater risks of Small Caps is they tend to be more leveraged than Large Cap stocks with less operational efficiency and pricing power. (3) Small Caps also typically have less liquidity than Large Caps, meaning it may be tougher for investors to either build a position or quickly exit a holding. (6)

The Balanced Case:

While Small Cap stocks make up roughly just 10% of the overall U.S. equity market capitalization, they constitute the vast majority of publicly traded firms. And while Small Cap stocks are more volatile than Large Cap stock, over the last 93 years Small Caps generated positive returns in 68% of the years, compared to 73% of the time for Large Caps. Over the period, Small Caps produced a best one-year return of 142.87% and a 1-year worst return of a negative 58.01%, compared to 53.99% and a negative 43.34% for Large Caps. (7) Given Small Caps superior long-term investment returns compared to Large Caps, Small Caps would appear to be fertile shopping ground for long-term oriented investors.

Channelchek

Sources:

http://www.nylinvestments.com/polos/Investing_Essentials_Growth_of_$11.pdf

https://www.cnbc.com/2019/10/09/small-caps-are-primed-to-outperform-large-caps-over-the-next-decade.html

https://fortune.com/2019/12/03/as-small-cap-stocks-hit-new-highs-some-see-evidence-that-the-bull-market-has-more-room-to-run/

https://fp.thriventfunds.com/insights/market-updates/whats-behind-the-underperformance-of-small-cap-stocks.html

https://money.usnews.com/investing/portfolio-management/articles/how-to-compare-small-caps-vs-large-caps-for-your-portfolio

https://www.firstwilshire.com/value-investing/

http://www.alphawealthstrategies.com/weekly-update/4428

https://www.cnbc.com/2019/08/13/small-cap-stocks-are-tanking-while-large-caps-hold-up-a-signal-something-is-wrong-with-economy.html

Artemis Program to Benefit Many Companies

Posted on by phoffman@channelchek.com
Image Courtesy of Aerojet Rocketdyne

Billions in Artemis Program Budget Could Cause these Companies to Rocket

What companies could gain from the Artemis missions to the moon?

The multibillion-dollar Artemis program has been unfolding over the past several years. The most recent success is the 322-foot-tall Space Launch System (SLS), the most powerful rocket NASA has developed, and the Orion spacecraft. This is all designed to, in time, safely carry astronauts to the moon’s orbit and provide a platform for the U.S. to return to the moon’s surface for the first time since 1972.

The mission of Artemis One is to test a powerful NASA rocket called the Space Launch System, as well as the Orion spacecraft that the rocket will ferry into orbit. After the Florida launch, NASA plans to use the SLS rocket to direct Orion on a route around the moon, after which the vehicle’s crewless capsule will return to Earth and parachute into the Pacific Ocean. Those steps represent another trial geared toward ensuring the Orion crew module can safely bring astronauts back from orbit.

The initial mission will help set the stage for a crewed mission to the moon that NASA hopes to conduct as early as 2025. These efforts will entail higher technology and special equipment designed especially for a unique purpose. With billions being spent, investors may ask what companies may benefit. Obviously, the major contractors, then subcontractors and material suppliers.

The cost of SLS is shown above. Additionally, the cost to assemble, integrate, prepare and launch the SLS and its payloads are funded separately under Exploration Ground Systems, currently at about $600 million per year. (Source:Wikipedia)

Major Contractors

Keeping in mind that an unsuccessful launch could weigh on these companies, as much as they may be propelled by continued success, these are prime contractors. NASA’s prime contractors for the rock launch system is Aerojet Rocketdyne (AJRD), Boeing (NYSE: BA), and Northrop Grumman (NOC). As a note, AJRD showed up as one of 5 portfolio holdings of hedge fund manager Michael Burry.

Lockheed Martin (LMT) is the prime contractor on the Orion spacecraft, while NASA’s prime contractors for the rocket launch system include Redwire’s (RDW) critical sun sensor components and advanced optical imaging technologies, they will be launching on NASA’s Orion spacecraft as a part of the space agency’s Artemis One mission. Aeva Technologies (AEVA) is also involved with a LiDAR-based mobile terrain-mapping and navigation system for lunar and other planet exploration, while KULR Technology Group (KULR) has a battery safety contract with NASA to test its lithium-ion cells going into battery packs designed for the Artemis Program.

Raytheon Technologies'(RTX) was selected to advance spacewalking capabilities in low-Earth orbit and on the Moon. Goodyear Tire & Rubber (GT) has been contracted to develop tires to perform on the lunar surface.

Rocket Lab (RKLB) has been called upon to test new orbits around the moon. For communications, Lockheed Martin (LMT), Amazon (AMZN), and Cisco (CSCO) are working in conjunction to develop a new voice, AI, and tablet-based video technologies for use around the moon.

The companies being called upon is expected to grow rapidly after scientific experiments begin on the moon’s surface.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://en.wikipedia.org/wiki/Space_Launch_System#:~:text=The%20Space%20Launch%20System%20(abbreviated,2022%20from%20Kennedy%20Space%20Center.

https://www.wsj.com/articles/artemis-i-launch-moon-mission-nasa-11668529576?mod=Searchresults_pos1&page=1

https://seekingalpha.com/news/3877127-nasa-is-going-to-the-moon-will-these-stocks-benefit

The Week Ahead – NY Fed’s Inflation Forecast, Michael Burry’s Holdings, and PPI

Posted on by phoffman@channelchek.com

There is Potential for a Change in Sentiment Spurred by this Week’s Wholesale Inflation Report

One economic number doesn’t make a trend. The members of the Federal Open Market Committee know this, and certainly, the Chair, Jay Powell, understands. As it relates to last week’s CPI report, he may wish that one lower-than-expected inflation data point could prevent him from needing to do more, but it simply isn’t enough info from which the Fed can glean any actionable information.

As we head into the first trading session of a new week, it’s uncertain what the reaction of interest rates will be. They dropped substantially in response to last Thursday’s inflation data coming in better than expected. However, there was no chance of follow-through or reversal as Friday’s Veteran’s Day holiday left the bond markets closed.

With this, inflation numbers continue to be the most significant for both stock and bond investors. On this coming Tuesday, November 15, wholesale prices will be reported as the Producer Price Index (PPI). This release could have more weight in trade action than usual.

Thursday is another big day on the calendar as the markets will be grappling with a larger-than-normal volume of economic releases.

Monday 11/14

  • 11:00 AM ET, The NY Federal Reserve Bank’s one and five-year inflation forecast. This is not an event that is usually paid much attention to by market participants. However, considering there are many parties interested in what members of the Federal Reserve System are now thinking, a dramatic shift from the previous forecast could inspire the financial markets to adjust accordingly.

Previously the one-year inflation expectation was 5.7%. The five-year inflation forecast was 2.2%.

Tuesday 10/15

  • 8:30 AM ET, The Producer Price Index (PPI) from the Bureau of Labor Statistics (BLS) is an inflation gauge that measures the average change over time in the prices received by U.S. producers of goods and services. The prices are typically considered input costs for final products and can impact CPI, it may also impact company costs of production and, therefore, profits. The trend has been lower, YOY PPI has been running at 8.5%, and last month, it rose 0.4%, the expectation is for another 0.4% increase.
  • Michael Burry, and Warren Buffet’s holdings. The SEC requires investment funds to file a 13-f disclosing their publicly traded security positions. It is required every 45 days, making all of the information a minimum of 45 days old. Looking at a successful investor’s 13F filings can be revealing, especially when looking at industries they’ve been hot on or comparing one holding period to another.

Wednesday 10/16

  • 11:00 AM ET, The Mortgage Bankers Association (MBA) creates a statistic from several mortgage loan indexes. The Mortgage Applications index measures applications at mortgage lenders. It’s considered a leading indicator and is especially important for single-family home sales and housing construction. Both are considered foundational in a strong economy. Last week the Purchase Index was 162.6.
  • 11:00 AM ET, The Mortgage Bankers Association (MBA) also provides an average 30-year mortgage level which is consistently calculated so that it is an oranges-to-oranges comparison from previous periods. Last period the rate was 7.14%.
  • 12:30 PM ET, Export Prices (MoM), this data set reflects changes in prices of goods and services that are produced in and exported from the United States in the given month compared to the previous one. Last reading, this came in at a negative 0.8%.
  • 12:30 PM ET, Import Prices (MoM) The import price index m/m measures the price changes of the respective month compared to the previous month. Last month they fell 1.2% (not adjusted for fx), this month, expectations are for a decline of 0.5%.
  • 12:30 PM ET, U.S. Retail Sales have been flat, neither rising nor falling. As we head toward Thanksgiving and Black Friday sales levels, the market will be taking more and more interest in how strong the consumer is. Expectations for October are for a rise of 0.8 percent overall, an increase from 0.0 percent. When excluding vehicles, the projection is for an increase of 0.4%, up from 0.1%. and up 0.4 when also excluding gasoline.
  • 1:15 PM ET, Capacity Utilization is expected to remain unchanged at an 80.3% use of available manufacturing capacity. Reading well above, this may be considered inflationary as production could be using less efficient means.
  • 1:15 PM ET, Industrial Production is expected to have been weaker at a 0.2% increase compared to a 0.4% increase.
  • 2:00 PM ET, NAHB Housing Market Index this is expected to continue weakening, the October number was 38.
  • 2:00 PM ET, Business inventories are expressed in dollar value held by manufacturers, wholesalers, and retailers. The level of inventories in relation to sales is an important indicator of the near-term direction of production activity. Rising inventories can be an indication of business optimism that sales will be growing in the coming months. However, if unintended inventory accumulation occurs, then production will probably have to slow while those inventories are worked off. Last month’s inventories increased by 0.8%.

Thursday 10/17

  • 12:30 PM ET, Housing Starts, last month housing starts had declined for the seventh consecutive month by 8.7%. 

Friday 10/18

  • 2:00 PM ET, Leading Economic Indicators are expected to show a decline of 0.3% vs. a decline of 0.4% the prior month.

What Else

The focus on signs of economic weakness or receding inflation will be high, and reactions may be extra sensitive. The following week is shortened in terms of trading. The focus will be on how strong the consumer shows they will be for the holidays.

Paul Hoffman

Managing Editor, Channelchek

To Sell or Not to Sell (Your Stocks)

Posted on by phoffman@channelchek.com

Image Credit: QuoteInspector.com (Flickr)

Advice is Plentiful on When to Buy Stocks, But When Should You Sell?

During the fourth quarter of 2022, stocks have climbed dramatically. The Russell 2000 small cap index is up double-digits in percentage, and the S&P 500 is approaching a ten percent increase. This is a welcome run-up over such a short period of time. The sudden move has investors, some of whom still hold paper losses, asking themselves, do I sell now, do I add to my positions, or should I sit tight and wait?

Information on when to buy into a position is abundant. Advice on when to decide your assets are better off elsewhere is much less available. There is just less demand from readers on the topic.

Selling Considerations

First off, one does need to consider their financial plan. Is this money that is needed within the next few months, or can the value of the position or positions change without much impact on future plans? Also, is there a better use for the proceeds? If the position one is holding is still the best use of funds, then the answer, net of any emotions, may be to hold.And emotions can make for bad decisions.

Some investors that were about to pull the trigger on the sale of a position weeks ago when stocks were falling may find their position has regained much of the loss, but now they are back in greedy mode, hoping for more, despite being able to get more.

Let’s take a level-headed look at the factors involved in making the decision regarding selling.

Opportunity Cost

One fundamental question should ask themselves regularly is, do I think the risk-reward of each position and all positions taken together are best for the portfolio? If not, depending on tax consequences, if it’s determined that other opportunities might perform better, then it should be of little concern if the stock is up or down from where it was purchased. In fact, depending on what kind of investor you are, it may make sense to lighten up with the plan to re-evaluate if prices fall again.

One way to get a handle on this is to determine, does the stock underperform in a rising market. Does it fall at a faster pace than the market when the market is falling? The answers to these questions can help identify if the position should be cut loose and may be replaced by a better performer.

Moving Averages

Investors can look to moving averages for a hint as to whether the position might be overbought or oversold. Which moving average you use should be based on the expected holding period and also what works best for the stock you are reviewing. For a seldom traded portfolio with longer-term positions, its common to use a 200-day moving average, but depending on the stock’s past performance, the investor may wish to overlay different averages to guide their thoughts on whether the stock might give back recent gains and fall back in line with past performance.

Time Horizon

Many investors skip the step of determining the expected holding period before a purchase of an investment. This is like leaving for a trip without any directions to get you started. If you didn’t do this before your purchase, do it now. Ask, when do you think this will pay-off, what is the anticipated pay-off, and how do I identify if something has changed and the holding period should change? Investors with a long-term time horizon could find that over the years, they can avoid missing the up periods if they don’t get too intent on missing down periods. If your holdings closely follow the S&P 500 index, it may be down 18% this year, but last year it was up nearly 27%, and that could be a compounded increase from the 16% it was up the prior year.

If instead, your holding period is short, you may know within weeks, days, or minutes if you met your goal or if it is not playing out as expected. At that point, if you would not enter the position (whether you made money or not), getting out may be wise. Smart traders know that if they don’t stick to their plan, even if rewarded, they might be reinforcing a bad behavior that will cost them down the road.

Other Considerations

A large percentage of portfolios managed by self-directed investors are qualified accounts; that is, they are tax-deferred, so any gain does not cost the account holder until funds are taken from the account. This largely takes the tax impact question out of the decision to sell or not. However, if it is a taxable portfolio, it’s important to consider whether the tax consequences and the sale are still worthwhile. In some cases selling at a loss may even help offset gains in some other area of the portfolio owner’s financial condition.  

It’s wise to consult a tax professional to review your specific financial and tax situation before selling a stock or investment for tax purposes.

If you have made a mistake and purchased the wrong ticker, it isn’t likely the shares fit your parameters and the best time to sell is usually immediately.

Change in Ownership

Sometimes it may make sense to sell a company if it has been acquired or merges with another company. Often before an event like this, the stock price rises well above the overall market movement. The question once again is, is this the best use of one’s investible assets? The new fundamentals and cost-saving synergies between the two companies may place it in a more competitive or more profitable position, in this case, not taking the sudden profit could pay off long term.  

Selling a Portion

Did the stock you are holding just shoot up 5%-10%, and you think it is likely to back-off but don’t want to miss out if the euphoria surrounding it continues? Why not make selling a portion, perhaps with the idea that you will re-enter for that portion if the price does drop? In this way, you stand the chance of capturing some of the original run-up, and while you may miss further upward momentum, you have left yourself the opportunity of buying the shares back at a lower price from which they were sold.

Take Away

The decision on whether or not to sell an investment should be held up against the plan you had when you purchased it. Far too many investors make sensible plans entering a trade, but once in and it is either rising or falling, a less sensible side often takes over. Fear and greed are powerful emotions that can undo a good strategy.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.thestreet.com/dictionary/m/moving-average

https://www.thestreet.com/retirement-daily/your-money/consider-tax-loss-harvesting

https://www.bankrate.com/investing/when-to-sell-stock/

Is the Coming Political Gridlock Good for Specific Market Sectors?

Posted on by phoffman@channelchek.com
Image Credit: Kelly Bell (Flickr)

A Return to Gridlock in Washington Could be Healthy for Stocks

Political gridlock has historically been associated with higher stock market prices. So, while staunch supporters of either political party did not become overjoyed by the Election Day outcome, those invested in stocks may wind up better off. With President Biden (D) in the Executive branch, and at least the House of Representatives in the legislative branch holding a Republican majority, a split government is assured. This is true no matter the final outcome of the Senate races. A split government, with its accompanying gridlock, has been accompanied by positive long-term stock market performance.

A Smoother Road

The battles in Washington may take on a more heated tone with a split government, for investors, the gridlock scenario eliminates a lot of uncertainty. In the inflationary period we are in, a government with less ability to institute spending plans, and a reduced ability to change tax rates in an effort to pay for spending, is far less of a concern to market participants – less change will be enacted.

For businesses, there is more visibility to plan, budget, and implement plans to build their business. A split government should lead toward fewer dramatic changes or government intervention that bolsters one technology or product over another. With a lower risk of playing field changing legislation, tax change, or regulations, businesses are more likely to spend and invest as the risk of change is lower.

Historically, stocks have tended to do better under a divided government when a Democrat is in the White House. The average one-year S&P 500 returns have been 13% in a Republican-held Congress under a Democratic president and 14% when the Congress is split. This compares with 10% when Democrats controlled the White House and Congress.

Under the current situation, less spending on Build Back Better initiatives and a lower likelihood of passage of more plans like The Inflation Reduction Act help reduce spending and stimulus, which may allow the Federal Reserve to end its tightening cycle sooner.

The increase in Republicans could bring more attention to several stock market areas, such as biotech and pharmaceuticals. Their increased presence lowers prospects for price controls on prescription drugs. Big tech stocks could benefit from less of a threat to regulate the industry.

Some Choppiness Ahead

In 2011 the credit rating agency Standard & Poor’s downgraded the U.S. credit rating over the long gridlock battle that delayed increasing the Federal Debt ceiling. A possible downgrade, or “credit watch” category, could lead to an increase in rates, not just in U.S. government debt but all loans tied to these benchmark rates.

The enhanced power of Republicans could also slow infrastructure outlays, particularly the momentum in spending that has lifted so many alternative fuel stocks. Incentive plans and grants funded through borrowing and taxation have grown dramatically with both the executive and legislative branches under single-party control, those sectors that were expecting the pace to continue may find growth prospects slowing. Marijuana legalization on the Federal level may also be less of a priority now among lawmakers.

Stocks Post Mid-Terms Track Record

The S&P 500 has recorded a gain in each 12-month period after the mid-terms since World War Two. The markets have been clobbered with declining values since 2022 began; perhaps this is the turning point where the unfairly beaten-down sectors and companies begin to make up for lost ground.

Take Away

The election outcome wasn’t overly satisfying for either party but may lead to stronger stock market performance. Also, just getting past the mid-term elections without regard for the outcome has a stellar record of gains. If history is any indicator, a repeat of what the markets have experienced in the past, along with a slight shifting of those more positioned to take advantage of changes, should put investors in a positive mood as we approach year-end and enter 2023.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.reuters.com/markets/us/futures-steady-midterm-results-roll-2022-11-09/

https://m.economictimes.com/markets/stocks/news/investors-prepare-for-government-gridlock-as-republicans-seen-gaining-in-u-s-midterms/amp_articleshow/95393951.cms

https://www.fidelity.com/news/article/default/202211082056RTRSNEWSCOMBINED_L1N3242PI_1

Choices Presented to Voters on Ballots are Presented to Investors as Opportunities

Posted on by phoffman@channelchek.com
Image Credit: Joe Shlabotnik (Flickr)

The Consequences of this Year’s Voting Should Create Opportunity for Investors

Once inconceivable in most voting districts throughout the U.S., ballots across the country this year will ask voters to decide on gambling measures, drug laws, and extra taxes based on defined demographics. While this is of interest to investors as it shows how trends are forming or continuing and can point to more potential for growth. Of the 130 ballot measures being decided upon on Tuesday, many will alter spending patterns and bolster industries.

What’s Being Decided Upon

Each year a number of states, including Maryland and Arkansas, are asking voters to decide upon legalizing recreational marijuana. Fully five states could move toward ending the use of involuntary prison labor. Nebraska and Nevada are asking voters if they should increase the minimum wage statewide. Gambling, firearms, and immigration are also the subject of state-level referendums.

A proposition in California would legalize online sports betting in that large potential market. Gaming companies, including DraftKings (DKNG) and FanDuel (DUEL) have poured nearly $160 million into the measure. It is not expected to pass, if it does, the news may cause a rally in these and other online gambling companies. Over $375 million has been spent by supporters and those against this measure.

Also being decided by California’s voters is a proposition that would raise taxes on personal incomes of $2 million or more. The revenue would be set aside to fund the state’s electric-vehicle production and help prevent wildfires. This is a very contentious measure that pit many from the same political party against each other.

In general environmental groups and companies perceived to benefit from a quicker evolving EV infrastructure support the “yes” campaign. Governor Newsom, and the California Teachers Association, a powerful state union, have joined business groups to oppose the measure, saying it would benefit a select number of large corporations as they transition to electric vehicles.

Recreational weed in Maryland? The pollsters seem to think it stands a good chance of passing. There are four other states (Arkansas, Missouri, North Dakota and South Dakota) where recreational cannabis is also on the ballot, those outcomes won’t be known until after the votes are counted.

To date, 19 states and the District of Columbia have legalized the adult recreational use of marijuana. Colorado could become the second state behind Oregon to legalize the personal use of psilocybin, the active ingredient in psychedelic mushrooms and other plant-based hallucinogens.

Massachusetts voters get to decide if they raise their income taxes by 4% if they have personal incomes of $1 million or more. This would leave the total rate for that bracket to 9%. Should this pass and bring in additional funds, they are earmarked for education and transportation.

Voters in five states will weigh whether to explicitly outlaw involuntary servitude as part of the punishment for a crime. Alabama, Louisiana, Oregon, Tennessee, and Vermont will all consider these questions on the topic; there is a growing movement to change the 13th Amendment so it no longer allows slavery as a form of criminal punishment. This could potentially benefit the industry in these states.

On immigration, Ohio voters are considering whether to ban all local governments from allowing noncitizens to vote. San Francisco and New York have passed laws allowing noncitizens to vote for local offices and ballot measures. These face legal challenges.

Elsewhere, ballot measures will ask voters whether to extend certain benefits to immigrants in the country illegally, including the ability to obtain a driver’s license in Massachusetts and pay in-state college tuition in Arizona.

Take Away

They say elections have consequences. As various states elect to adopt or deny changes in the running of their state, investors may be able to position themselves to benefit from trends, changes, and additional funds being made available.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.wlwt.com/article/election-results-2022-ohio-kentucky-indiana-senate-governor/41781051

https://www.wsj.com/articles/midterm-elections-2022-results-ballot-measures-referenda-11667864143

https://www.wcvb.com/article/voter-information-massachusetts-election-2022-midterm/41890411

https://www.cnbc.com/2022/11/04/draftkings-shares-tumble-after-monthly-users-fall-short-of-estimates.html

The Week Ahead – Inflation Data Worries and Election Outcome

Posted on by phoffman@channelchek.com

Federal Reserve President Speeches With Elections and CPI to Shape the Week’s Trading

Yes, the stock markets are open on Veterans Day (Friday). But bond trading, which the stock market has been more keenly focused on this year, will be taking the day off along with other U.S. government services. Equity traders can get a sense of interest rate sentiment on Friday by turning to the Chicago Board of Options and viewing tickers ZF=F (5 yr. USTN), ZN=F (10 yr. USTN), ZB=F (30 yr. USTB).

All markets are open on Election Day, and the outcome, as measured by House seats and Senate seats distributed among the major political parties, has the potential to be market-moving.

It’s a quiet week for economic numbers, except for Thursday, when the CPI report is released. This has the potential of changing those calling for a 50 bp hike at the next meeting to up their expectations or those still forecasting 75bp to lower their call. Certainly, the Fed governors will be watching this and all measures of inflation up to the December 14-15 meeting. There are a number of Fed governors speaking this week; this could alter the tone; however, the next meeting is far out into the future.

Election Day.

Monday 11/7

  • 3:00 PM ET the amount of consumer installment credit for September, including credit cards, auto loan, and student loans outstanding, indicate current consumer spending and borrowing patterns. The markets tend to ignore this number as we are already in November and this report measures September
  • 3:40  PM ET, the Federal Reserve Bank Presidents Mester (Cleveland) and Collins (Boston), will be speaking. Both are considered fairly hawkish.
  • 6:00 PM ET, the Federal Reserve Bank President Harkey (Philadelphia) will be speaking.

Tuesday 11/8

  • Election Day.
  • Meet the Management; Noble Capital Markets hosts Management of Entravision Communications (EVC) in West Palm Beach, FL. This is a no-cost-to-attend, in-person breakfast meeting with investors. If interested, click here.
  • Meet the Management, Noble Capital Markets hosts Management of Entravision Communications (EVC) in Boca Raton, FL. This is a no-cost-to-attend, in-person lunch meeting with investors. If interested, click here.

Wednesday 11/9

  • It can be expected that the newswires will be filled with Election Day outcomes and market-moving conjecture.
  • 7:00 AM ET Mortgage Applications. The Mortgage Bankers Association (MBA) creates a statistic from several mortgage loan indexes. The Mortgage Applications index measures applications at mortgage lenders. It’s considered a leading indicator and is especially important for single-family home sales and housing construction. Both are considered foundational in a strong economy.
  • 10 Year Treasury Note Auction is held in the middle of each month and settles on or around the 15th (depending on weekends). The yield is a benchmark for 30-year mortgages and has recently been noted by investment markets because it has been trading at a yield lower than shorter maturities. This inversion of the yield curve has some market players suggesting a recession is expected in the future. Any surprises at the auction will reverberate through the stock market.
  • 10:30 AM ET, EIA Petroleum Status Report.
  • 11:00 AM ET, Federal Reserve President Barkin  (Philadelphia) speaks.
  • Meet the Management; Noble Capital Markets hosts Management of Entravision Communications (EVC) in Winter Park, FL. This is a no-cost-to-attend, in-person breakfast meeting with investors. If interested, click here.
  • Meet the Management; Noble Capital Markets hosts Management of Entravision Communications (EVC) in Orlando, FL. This is a no-cost-to-attend, in-person lunch meeting with investors. If interested, click here.

Thursday 11/10

  • 8:30 AM ET, U.S. Consumer Price Index (CPI) is the inflation indicator most widely broadcast. With inflation being a primary focus, this will be the big number coming out this week. The number represents a basket of goods considered typical for an urban consumer and is taken as the change in the cost of that basket of goods. A percentage is derived from the change. CPI is also reported with food and energy removed as it is considered that other non-economic factors influence these prices. The September report indicated CPI rose 0.4% for the month and 8.2% YOY. Expectations are for an increase to 0.7% for October and a YOY rate of 8.0%.
  • 8:30 AM ET U.S. Jobless Claims which represent the prior week’s employment are expected to have increased to 221,000 from 217,000. From jobless claims, investors can gain a sense of how tight or how loose the job market is. If wage inflation takes hold, interest rates will likely rise, and bond and stock prices will fall. Remember, the lower the number of unemployment claims, the stronger the job market, and vice versa.
  • 10:30 AM ET, EIA Natural Gas Status Report.

Friday 11/11

  • Veterans Day, the stock market is one, the futures markets are open, and the bond market and other U.S. government-related offices are closed.
  • 10 AM ET Consumer Sentiment, November (preliminary). This barometer, reported by the University of Michigan,  questions households each month on their assessment of current conditions and expectations of future conditions. This “preliminary” release is for the month of November and is expected to have fallen to 59.6 versus 59.9 last month.

What Else

It is a light week for economic releases and Fed governor addresses, but the election outcome and CPI have the potential to whip markets around.

We’re entering the holiday shopping season when there will be a number of measures that investors focus on that will give a hint as to how strong the consumer is in the current economy.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/calendar.htm

http://global-premium.econoday.com/byweek.asp?cust=global-premium

https://www.channelchek.com/news-channel/noble_on_the_road___noble_capital_markets_in_person_roadshow_series

https://www.econoday.com

The New Effort to Re-Anchor the US Dollar to US Gold Stock

Posted on by phoffman@channelchek.com
US Sailors, Coastal Riverine Group, Restoring Command Anchor with Gold Paint, Credit: US Pacific Fleet (Flickr)

Can the Dollar Once Again Be Anchored by Gold? One Congressman Believes It Can

On October 7, 2022, US congressman Alex Mooney (a Republican from West Virginia) introduced a bill (the Gold Standard Restoration Act, H.R. 9157) that stipulates that the US dollar must be backed by physical gold owned by the US Treasury. The initiative clearly indicates that the increasingly inflationary US dollar is triggering efforts to get better money.

It should be noted that there have already been many legislative changes to make precious metals more attractive as a means of payment in recent years: in many US states, the value-added and capital gains taxes on gold and silver, but also on platinum and palladium, have been abolished. Mr. Mooney’s proposal is divided into three sections.

The first section of the bill establishes the need for a return to a gold-backed US dollar. For example, it is said that the US dollar—or more precisely, the bill refers to “Federal Reserve Notes”—that is, banknotes issued by the US Federal Reserve (Fed)—has lost its purchasing power on a massive scale in the past: Since 2000, it has dropped by 30 percent, and since 1913 by 97 percent. The bill also argues that with an inflation target of 2 percent, the Fed will not preserve the purchasing power of the US dollar but will have it halved after just thirty-five years. Moreover, the bill points out that it is in the interest of US citizens and firms to have a “stable US dollar.” The bill highlights that the inflationary US dollar has been eroding the industrial base of the US economy, enriching the owners of financial assets, while endangering workers’ jobs, wages, and savings.

The second section of the bill describes in more detail the technical process for re-anchoring the US dollar to the US official gold stock. It states that (1) the US secretary of the Treasury must define the US dollar banknotes using a fixed fine gold weight thirty days after the law goes into effect, based on the closing price of the gold on that day. The Fed must (2) ensure that the US banknotes are redeemable for physical gold at the designated rate at the Fed. (3) If the banks of the Fed system fail to comply with peoples’ exchange requests, the exchange must be made by the US Treasury, and in return, the Treasury takes the Fed’s bank assets as collateral.

The third section specifies how a “fair” gold price in US dollar can develop in an orderly manner within thirty days after the bill has taken effect. To this end, (1) the US Treasury and the Fed must publish all of their gold holdings, disclosing all purchases, sales, swaps, leases, and all other gold transactions that have taken place since the “temporary” suspension of the redeemability of the US dollar into gold on August 15, 1971, under the Bretton Woods Agreement of 1944. In addition, (2) the US Treasury and the Fed must publicly disclose all gold redemptions and transfers in the 10 years preceding the “temporary” suspension of the US dollar’s gold redemption obligation on August 15, 1971.

What to Make of This?

The bill’s core is the idea of re-anchoring the US dollar to physical gold based on a fair gold price freely determined in the market. (By the way, this is an idea put forward by the economist Ludwig von Mises (1881–1973) in the early 1950s.) In this context, the bill refers to US banknotes. However, banknotes only comprise a (fractional) part of the total US dollar money supply. But since US bank deposits can be redeemed (at least in principle) in US banknotes, not only US dollar cash (coins and notes) could be exchanged for gold, but also the money supply M1 or M2 as fixed and savings deposits could be exchanged for sight deposits, and sight deposits, in turn, could be withdrawn in cash by customers, and the banknotes could then be exchanged for gold at the Fed.

As of August 2022, the stock of US cash (“currency in circulation”) amounted to $2,276.3 billion. Assuming that the official physical gold holdings of the US Treasury amount to 261.5 million troy ounces, and the market expected US cash to be backed by the official US gold stock, a gold price of about $8,700 per troy ounce would result. This would correspond to a 418 percent increase compared to the current gold price of $1,680. If, however, the market were to expect the entire US money supply M2 to be covered by the official US gold stock, then the price of gold would move toward $83,000 per troy ounce—an increase of 4.840 percent compared to the current gold price. Needless to say, such an appreciation of gold has far-reaching consequences.

All goods prices in US dollars can be expected to rise (perhaps to the extent that the price of gold has risen). After all, the purchasing power of the owners of gold has increased significantly. Therefore, they can be expected to use their increased purchasing power to buy other goods (such as consumer goods, but also stocks, houses, etc.). If this happens, the prices of these goods in US dollar terms will be pushed up—and thus, the initial purchasing power gain that the gold dollar holders have enjoyed by being tied to the increased gold price will melt away again. Moreover, if US banks were willing to accept additional gold from the public in exchange for issuing new US dollar, reanchoring the US dollar in gold would increase the upward price effect.

A re-anchoring of the US dollar in the US official gold stock will result in a far-reaching redistribution of income and wealth. In fact, it would be fatal for the outstanding US dollar debt: US dollar goods prices would rise, caused by a rise in the US dollar gold price at which the US dollar is redeemable for physical gold, thereby eroding the US dollar’s purchasing power. In the foreign exchange markets, the US dollar would probably appreciate drastically against those currencies that are not backed by gold and against currencies which are backed by gold, not as fine compared to the fineness of the gold backing of the US dollar. The purchasing power of the US dollar abroad would increase sharply, while the US export economy would suffer. US goods would become correspondingly expensive abroad, while foreign companies gain high price competitiveness in the US market.

Once the US dollar is re-anchored in gold, today’s chronic inflation will end; monetary policy–induced boom-and-bust cycles will come to an end; the world will become more peaceful because financing a war in a gold-backed monetary system will be very expensive, and the general public will most likely not want to bear its costs. However, there is still room for improvement. A “Gold Standard Restoration Act” will deserve unconditional support if and when it paves the way toward a truly “free market for money.” A free market in money means that you and I have the freedom to choose the kind of money we believe serves our purposes best; and that people are free to offer their fellow human beings a good that they voluntarily choose to use as money.

In a truly free market, people will choose the good they want to use as money. Most importantly, in a truly free market in money, the state (as we know it today) loses its influence on money and money production altogether. In fact, the state (and the special interest groups that exploit the state) no longer determine which kind of gold (coins and bars, cast or minted) can be used as money; the state is no longer active in the minting business and cannot monopolize it anymore; there is no longer a state-controlled central bank to intervene in the credit and money markets and influence market interest rates. That said, let us hope that the Gold Standard Restoration Act proposed by Mr. Mooney will pave the way to reforming the US dollar currency system—and that it will eventually move us toward a truly free market in money.

About the Author

Dr. Thorsten Polleit is the Chief Economist of Degussa and an Honorary Professor at the University of Bayreuth. He also acts as an investment advisor.

Why the Bullish Behavior of the Past May Return

Posted on by phoffman@channelchek.com
Philippe Petit walks Tightrope between buildings one and two of WTC, Manhattan, 1974 – Robert.Dearie (Flickr)

Analyst Team Point Out Asset Classes that Slingshotted in the 1970s

While the traditional fine print usually says, “past performance is no guarantee of future results,’ we all know trading decisions, whether the stocks are to be held for seconds, or decades, are based on probabilities. And market probabilities are rooted in past performance. What does past performance tell us about the chances that the markets can survive high inflation and low growth? Well, if the stagflation of the 70s repeats, there may be a small section of the markets to keep a solid footing.

Michael Hartnett is the chief investment strategist at Bank of America/Merrill Lynch. Hartnett sees in our current economy the ingredients in the macroeconomic picture that lead to the difficult economic combination of high inflation and low growth. His team, in their Flow Show note on Friday, wrote:  “Inflation and stagnation was ‘unanticipated in 2022…hence $35 trillion collapse in asset valuations; but relative returns in 2022 have very much mirrored asset returns in 1973/74, and the 70s remain our asset allocation analog for 2020s.”

 If the conditions of the 1970s are being mirrored and we are creating a foundation similar to 1973/74, Hartnett and team have a list of assets that could springboard off the stagflation cycle.

The assets with potential include taking long positions in small-caps, value, commodities, resources, volatility, and emerging markets. The group also highlights the short positions that worked well in the 1970s, the note indicates these are larger stocks, bonds, growth, and technology.

Why Small-Caps

As it applies to the smaller companies, the note points out that stagflation persisted through the late 1970s, but the inflation shock had ended by 1973/74, when the small-cap asset class “entered one of the great bull markets of all-time.” The Hartnett team sees small-caps set to keep outperforming in the “coming years of stagflation.”

The current year-to-date status has the Russell 2000 small-cap stock market index (measured by iShares ETF) down 19.8% in 2022. At the same time, the Dow Industrials are down 11%, S&P 500 lost 21%, and the Nasdaq Composite gave back 33%.

The current state of the Fed and Chairman Powell is they continue to be adamant about tightening, Powell said he’d prefer to overdo withdrawing stimulus than do too little. He also knows that until the market believes this, his tightening efforts will have a lower impact.

The BofA team isn’t helping market expectations as they noted, despite Powell’s clear signal that the Fed isn’t ready to declare even a slight victory from its raising rates; the analyst team says, don’t give up on that pivot.

After tightening interest rates through 1973/74 amid inflation and oil shocks, the central bank first cut in July 1975 as growth turned negative, Hartnett points out. A sustained pivot began in December of that year, and importantly, the unemployment rate surged from 5.6% and 6.6% that same month.

The “following 12 months, the S&P 500 rose 31%. The note suggests the lesson learned is that job losses when they occur, will be the catalyst for a 2023 pivot,” said Hartnett and the team.

We’re not there yet. Today’s economic release on jobs showed the U.S. added a stronger-than-expected 261,000 jobs during October. This is a slower pace than the prior month’s 315,000 job gains but still shows the Fed can comfortably notch rates up more and continue reducing its balance sheet.

Take Away              

The team of analysts at BofA/Merrill Lynch, reporting to Michael Hartnett, drew conclusions from the stagflation and financial markets’ performance of the 1970s. They shared their thoughts in a research note with investors. Looking at past performance, their expectation is that the Fed will pivot away from aggressively raising rates when it begins to negatively impact job creation. At this point, many markets will have already reacted to inflation expectations and would then react to a more accommodative monetary policy.

The asset sectors to avoid or short are larger stocks, bonds, growth, and technology. The preferred sectors that, in past situations, have done well are small-caps, value, commodities, resources, volatility, and emerging markets.

Be sure to sign-up at no cost for small and microcap company research sent to you each day by Channelchek.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.morningstar.com/news/marketwatch/20221104397/the-next-big-thing-is-small-get-ready-for-some-bullish-history-to-repeat-with-these-stocks-says-bofa-analysts

The Next Few Months for Oil May be the Most Volatile Yet

Posted on by phoffman@channelchek.com
Image Credit: JoeCabby2011 (Flickr)

How the U.S. and its Allies Plan to Put the Squeeze on Russian Oil Profits

Volatility in oil prices this week has been extreme, even by the standards already set this decade. The price of WTI rose nearly 5% just today. The month ahead promises to create even more volatility as Saudi Arabia just cut prices to Asia; meanwhile, the US and its allies have agreed to put a cap on Russian oil. Details on many of these influences have not yet been worked out or announced. What is known is that the price cap and other sanctions against Russia begin in one month. The commodity trading days leading to the planned December 5 start date and the weeks that follow ought to create a great deal of speculation and price movement. Here is what we do know the allies have agreed upon.

The Cap Map

Sales of Russian oil to the participating countries will be subject to a price cap. The cap pertains to the initial purchase of a load of seaborne Russian oil. The agreement settled by the US and its allies doesn’t subject any subsequent sale of crude as falling under the same cap. The cost of transporting Russian oil is not included in the calculation of the cap. However, these rules only apply once the load of oil makes land. Out at sea, the rules are different.

Source: Koyfin

Trades of Russian oil that occur once the load is at sea are expected to still fall under the cap. However, if the Russia-originated oil has been refined into products such as diesel or gasoline, then it is not subject to the cap.

Restrictions and Jurisdictions

Under the expected price-cap plan, the Group of Seven and Australia are planning to restrict firms in their countries from providing insurance and other key maritime services for any Russian oil shipment unless the oil is sold below a set price. Because much of the world’s maritime services are based in G-7 countries and the European Union, the Western partners are aiming to effectively dictate the price at which Russia can sell some of its oil on global markets.

The Precise Price

The US and its allies have yet to set the price for the scheme, but they expect to define the level or range well before the December 5 implementation date. The slow pace of finalizing the plan have left some oil-market participants concerned that shipments of Russian oil at sea on December 5 could face the cap restrictions. The US Treasury Department, earlier this week, has clarified how this would be determined. The agreement rules that Russian oil shipped before December 5 would be exempt from the cap if it is unloaded at its destination by January 19.

It’s expected the price cap would not bring a crushing blow to banks, insurers, shippers, and traders that help make Russian oil available on global markets. The goal is to cut into the profits Russia earns from its oil sales, the hope by participants is to keep global markets supplied with Russian oil and keep energy prices steady.

The precise price is unknown, however a price range in the mid-60s has been discussed as the possible cap range, as it represents levels in line with where Russian oil had traded before the big run-up.

What Else?

Officials speaking for Russia have threatened to cut their oil production in retaliation for any price cap. It remains seen whether this game of each party partaking in ugly medicine for the survival of both will play out in unexpected ways.  

The plan for the price cap for Russian crude will go into effect on December 5, while two separate price limits for refined Russian petroleum products will kick in on February 5.

Expect volatility in oil prices, leading up to and after the caps go into effect. At the same time, expect the unexpected as it relates to energy.

Paul Hoffman

Managing Editor, Channelchek

https://oilprice.com/Latest-Energy-News/World-News/The-G7-Will-Set-A-Fixed-Price-On-Russian-Oil.html

https://oilprice.com/Latest-Energy-News/World-News/Saudi-Arabia-Cuts-Oil-Prices-For-Asia.html

https://www.wsj.com/articles/u-s-allies-set-parameters-for-price-cap-on-russian-oil-11667554203?mod=Searchresults_pos1&page=1

https://oilprice.com/Energy/Energy-General/Oil-Prices-Rise-As-Bullish-Sentiment-Builds.html

https://www.aa.com.tr/en/energy/oil/oil-prices-show-over-3-rise-in-week-ending-nov-4/36809

How the Fed’s Balance Sheet Trimming Impacts You

Posted on by phoffman@channelchek.com
Image: Press conference following November 2022 FOMC meeting – Federal Reserve (Flickr)

Fed Faces Twin Threats of Recession and Financial Crisis as its Inflation Fight Raises Risks of Both

The Fed raising the overnight rate is only half the reason the economy may be driven into a recession and create a financial crisis according to a Mississippi Professor of Finance. He believes the Fed’s interest rate approach, which is most talked about, may create problems, but Professor Blank also points out and defines the Fed’s balance sheet changes and what they could mean for markets, the economy, and the world of finance.

There is wide agreement among economists and market observers that the Federal Reserve’s aggressive interest rate hikes will cause economic growth to grind to a halt, leading to a recession. Less talked about is the risk of a financial crisis as the U.S. central bank simultaneously tries to shrink its massive balance sheet.

As expected, the Fed on Nov. 2, 2022, lifted borrowing costs by 0.75 percentage point – its fourth straight hike of that size, which brings its benchmark rate to as high as 4%.

At the same time as it’s been raising rates, the Fed has been quietly trimming down its balance sheet, which swelled after the COVID-19 pandemic began in 2020. It reached a high of US$9 trillion in April 2022 and has since declined by about $240 billion as the Fed reduces its holdings of Treasury securities and other debt that it bought to avoid an economic meltdown early in the pandemic.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of D. Brian Blank, Assistant Professor of Finance, Mississippi State University.

As a finance expert, I have been studying financial decisions and markets for over a decade. I’m already seeing signs of distress that could snowball into a financial crisis, compounding the Fed’s woes as it struggles to contain soaring inflation.

Fed Balance Sheet Basics

As part of its mandate, the Federal Reserve maintains a balance sheet, which includes securities, such as bonds, as well as other instruments it uses to pump money into the economy and support financial institutions.

The balance sheet has grown substantially over the last two decades as the Fed began experimenting in 2008 with a policy known as quantitative easing – in essence, printing money – to buy debt to help support financial markets that were in turmoil. The Fed again expanded its balance sheet drastically in 2020 to provide support, or liquidity, to banks and other financial institutions so the financial system didn’t run short on cash. Liquidity refers to the efficiency with which a security can be converted into cash without affecting the price.

But in March 2022, the Fed switched gears. It stopped purchasing new securities and began reducing its holdings of debt in a policy known as quantitative tightening. The current balance is $8.7 trillion, two-thirds of which are Treasury securities issued by the U.S. government.

The result is that there is one less buyer in the $24 trillion treasury market, one of the largest and most important markets in the world. And that means less liquidity.

Loss of Liquidity

Markets work best when there’s plenty of liquidity. But when it dries up, that’s when financial crises happen, with investors having trouble selling securities or other assets. This can lead to a fire sale of financial assets and plunging prices.

Treasury markets have been unusually volatile this year – resulting in the biggest losses in decades – as prices drop and yields shoot up. This is partly due to the Fed rate hikes, but another factor is the sharp loss of liquidity as the central bank pares its balance sheet. A drop in liquidity increases risks for investors, who then demand higher returns for financial assets. This leads to lower prices.

The loss of liquidity not only adds additional uncertainty into markets but could also destabilize financial markets. For example, the most recent quantitative tightening cycle, in 2019, led to a crisis in overnight lending markets, which are used by banks and other financial institutions to lend each other money for very short periods.

Given the sheer size of the Treasury market, problems there are likely to leak into virtually every other market in the world. This could start with money market funds, which are held as low-risk investments for individuals. Since these investments are considered risk-free, any possible risk has substantial consequences – as happened in 2008 and 2020.

Other markets are also directly affected since the Fed holds more than just Treasuries. It also holds mortgages, which means its balance sheet reduction could hurt liquidity in that market too. Quantitative tightening also decreases bank reserves in the financial system, which is another manner in which financial stability could be threatened and increase the risk of a crisis.

The last time the Fed tried to reduce its balance sheet, it caused what was known as a “taper tantrum” as debt investors reacted by selling bonds, causing bond yields to rise sharply, and forced the central bank to reverse course. The long and short of it is that if the Fed continues to reduce its holdings, it could stack a financial crisis on top of a recession, which could lead to unforeseen problems for the U.S. economy – and economies around the globe.

A Two-Front War

For the moment, Fed Chair Jerome Powell has said he believes markets are handling its balance sheet rundown effectively. And on Nov. 2, the Fed said it would continue reducing its balance sheet – to the tune of about $1.1 trillion a year.

Obviously, not everyone agrees, including the U.S. Treasury, which said that the lower liquidity is raising government borrowing costs.

The risks of a major crisis will only grow as the U.S. economy continues to slow as a result of the rate hikes. While the fight against inflation is hard enough, the Fed may soon have a two-front war on its hands.

Will Equity Investors Return Back to the Future?

Posted on by phoffman@channelchek.com
Image: Statue of Liberty Torch, Circa 1882 – Ron Cogswell (Flickr)

Current Technology May Be Leading the Next Shift in Stock Market Investing

Investor exposure to the stock market has grown and evolved through different iterations over the years. There is no reason to believe that it isn’t evolving still. The main drivers of change have been the cost of ownership, technology, and convenience, which are related to the other two drivers. There seems to be a new transformation that has been happening over the past few years. And with each change, there will be those that benefit and those that fall short. So it’s important for an investor to be aware of changes that may be taking place around them.

Recent History

Your grandfather probably didn’t own stocks. If he did, he bought shares in companies his broker researched, and he then speculated they would out-earn alternative uses of his capital – this was expensive. Mutual funds later grew in popularity as computer power expanded, and an increased number of investors flocked to these managed funds – the price of entry was less than buying individual stocks. Charles Schwab and other discount brokers sprang up – they offered lower commissions than traditional brokers. Mutual funds were able to further reduce fees charged by offering easier to manage indexed funds or funds linked to a market index like the Dow 30 or S&P 500. Indexed exchange-traded funds (ETF) took the indexed fund idea one step further – they have a much lower cost of entry than either mutual funds or even discount brokerage accounts. An added benefit to indexed ETFs is they can be traded at intraday prices and provide tax benefits.

Just as Schwab ushered in an era of low-commission trades, Robinhood busted the doors open to no-commission trades, and most large online brokers followed. This change allows for almost imperceptible costs in most stock market transactions. It also changed the concept of a round-lot, or transacting in increments of 100 shares. In fact, the most popular brokers all offer fractional share ownership now.

Are Index ETFs Becoming Dinosaurs?

Funds made sense for those seeking diversification of holdings, it used to take a large sum of money to do that; investors with a $10,000 account or more can easily achieve acceptable diversification with odd-lots and fractional shares ability.

Today investors can create their own index-like “fund,” or as they called it in your grandparent’s day, “portfolio management.”

One big advantage to creating your own portfolio, even if you rely heavily on stocks from a specific index to choose from, is that you can adapt it more toward your sector or company expectations. Indexed funds are stuck with their index holdings, they have no ability to change. One may increase or decrease risk by leaving out stocks or even whole industry groups. Also, it can be managed with greater tax efficiency than an index fund tailored to your situation.

There is also the DIY thrill that one gets from creating anything themselves rather than to just buying one off the shelf. There have been a number of renowned investors like Peter Lynch and Michael Burry warning that indexed funds no longer provide expected diversification and that many of the stocks are valued higher because so many dollars are on “auto-invest” into indexes that the bad has been pushed up with the good.  

An example of what added demand does to the valuation of a company when being added to an index can be seen over the last month when it became clear that Twitter would be leaving an empty slot that would be filled by Arch Capital (ACGL). The added demand for ACGL pushed up the value by an estimated 25%. Was it undervalued before (when stand-alone), or is it over-valued now? Some stocks that are getting more attention because they are in an index could, as Michael Burry warned, be in bubble territory.

Source: Koyfin

Setting Up a Portfolio

The more you do to ensure your portfolio weightings mimic an index, the closer your performance is likely to be to that index. You may want to limit your holdings to names that are actually in the index and shift the weightings for return enhancement. Another concern often cited with indexes is the way that they weight holdings; you may choose to weight your portfolio using the market capitalization of each company to own the same percentage of the company’s value or use another method like pure cost measures or cost per P/E.

Picking Stocks

While studies suggest that market diversification can be achieved by owning as few as five stocks and doesn’t improve much after 30 holdings, the more you own, providing they aren’t overweighted in a sector, it stands to reason the more diversification protection you can achieve.

As a DIY, self-directed investor, it makes sense not to chase after whatever YouTube influencer, loud-mouthed-TV analyst, or Stocktwit tells you. This is your baby, and the results, good or bad, are yours. Do what you can to make informed decisions, even if some turn out unexpected. The benefit of this is you can lean away from stocks that are still in indexes that don’t have good future prospects and lean into more companies that do.

I’m hearing from more of my self-directed investor friends and investment advisors that more people are looking to own companies that have non-financial objectives they, as an investor, support. And for some of them, there is no standard ESG framework that they support. They have decided, because they do care, to do more portfolio management with individual stocks than before. This is so they can individually look under the hood at employee policies, or environmental stature, etc. While ESG funds exist, the investor or client of the investment advisor would prefer not to own anything they oppose if they can avoid it. What better way than being able to say no to $XYZ company because they do this, this, and this that is against my own fabric?

Channelchek is a great resource for any percentage of your personally managed fund that includes stocks in the small-cap or microcap categories. These stocks could add a bit more potential for return but could also change your risk characteristics. Sign-up to get research from FINRA-licensed analysts.

Take Away

Stock investing has evolved and become more inclusive. But the future may be more like the past, with individuals creating portfolios of stocks for themselves. You don’t have to be rich anymore to buy stocks, and you don’t have to own a fund to get affordable diversification on nearly any size account. There’s a trend toward building one’s own personalized, diversified, low-transaction portfolio. Channelchek is helping investors find possible fits with its free research platform.

Paul Hoffman

Managing Editor, Channelchek