3rd Quarter Client letter

There are very polarized views of the market lately. Many shifting there opinion on a short term basis. it is times like these that you need to really understand the timeframe of the writer that you are reading.

Amidst all this back and forth I thought I would share with you the Macro piece of the letter I sent to Investment Management clients at the end of the 3rd Quarter:

New Highs but for How Long?

It turns out that the April letter nearly perfectly marked bottom in the market. A very technical breakdown pulling back to Fibonacci levels and building up out of a Double Bottom. If you have no idea what I just wrote not to worry. Read instead that the place where the pullback stopped and reversed signaled a strong market ready to continue. The confirmation of this did not happen until late August though. So we have had just 6 weeks for the strength to set up. And now as we are growing accustom to it there is yet another test of market participants’ belief in the strength.

This one is being attributed to rising interest rates. The argument 6 weeks ago to move to the sidelines came from macro investors suggesting a flat set of interest rates, from 3 months to 30 years, was an antecedent to a recession. This despite the broad economic situation as measured by GDP showing a 4% annual growth pace. Needless to say there was no imminent recession and markets went higher. Now those same macro investors are upset that the yield curve is getting steeper with long term rates rising. Isn’t this what they wanted just 6 weeks ago? This time rising rates are supposed to choke off the economy. The thing is though it is not showing up in earnings estimates.

My friend Nick Raiche of the Earnings Scout measures this for thousands of companies over time. His research shows that for nearly every quarter following the end of the Great Recession earnings estimates would be revised down as the next quarter approached. This changed earlier this year, probably as a result of the corporate tax cuts. And as we approach the latest round of earnings reports beginning Friday the estimates have not been cut. This bodes well for continued earnings growth not a recession.

That could result in yet another move higher in the market out of its current consolidation. We all knew rates were going to go up. The Fed told us they were going to go up and when it would happen. It is much more likely this latest dip is positioning into this round of earnings and nothing more. But as a protector of your capital I also know that any scenario can play out. Hedges remain in place and are now extended through then end of the year. There are also many fewer positions using common stocks where there is more capital at risk, and more positions in options which tend to put less than 10% of the capital required for stocks at risk. This will continue to be the case until a clear trend prevails, moving out of consolidation.

There is one clear trend that has confirmed though, and that is that bond rates have reversed after a more that 30 year trend to the downside. I will be looking for trades to take advantage of this as time goes on. For equities, the pump is primed for yet more upside, maybe even a move to 3000 in the S&P 500 by year end. The rotation from big to small cap stocks and back and from tech to healthcare and then basic materials has masked that over the past 6 weeks since the equity break out to new highs. The end of the third week of the season, at the beginning of November, would be a perfect time to pull the mask off, after Halloween passes.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.