Here are some of my investment thoughts as the U.S. economy enters into a "late cycle" stage of historically-low unemployment levels, with the U.S. yield curve almost inverting as the Fed promises a total of three 25-bps rate hikes for the remainder of 2018.FWIW - I have been writing a macro newsletter since the early 2000s and as of today, am working as a portfolio strategist for a global Fortune 500 company. Here are some of somewhat scattered thoughts. Comments are highly welcomed.* There is no set timeline for the end of the current bull market. This is especially true today given: 1) it has taken a uniquely long time (based on post WWII standards) for the U.S. economy and for U.S. consumer confidence to recover. As of today - despite 4.1% U3 unemployment - higher wage pressures are still missing. This may be due to higher-paid boomers retiring and being replaced with lower-paid millennials; even if wage pressures increase, it may not necessarily translate to higher inflation since many millennials will likely use their higher income to pay down their historically high student loan indebtedness, 2) Europe and many EM countries are still operating significantly below potential output. The caveat here is that what happens in China today now has an impact on global and even U.S. asset prices, and the timing of the Chinese economic cycle is highly unpredictable.* Tech remains the leader - no surprise here. Stocks that are on my Watch List include some MF favorites, such as ANET, BKNG, AMBA, IIVI, IRBT, NVDA, CRM, AMZN, BIDU, BABA, FB, NFLX, EXPE, APPL, PYPL, ENV, MKTX, and WDAY. The accelerated appreciation in some of these stocks over the last 12 months is concerning, but I don't see an impending top just yet [tech bubble valuations aside - when Ross Perot's EDS IPO-ed in September 1968, it did so at a 118 P/E, while proceeding to rise another 900% until early 1970 - all of this while the U.S. 10-year yield rose from 5% to over 7%).* I speak to many macro strategists and many of them have been touting commodities. It's actually not a bad time to "invest" into oil futures, per se, given the backwardation in the WTI futures curve (you get a positive carry). But the world just experienced a "commodity super cycle" that stretched from 2001 to 2014 - with a brief pause during the 2008-09 GFC. This commodity super cycle was only able to manifest itself because of historically low oil & gas CAPEX during the 1980s-1990s, along with a once-in-a-lifetime, structural rise in demand due to China's industrialization. With the record amount of CAPEX having poured into the sector from 2001-2014, and with the Chinese economy now maturing, any demand increase is only cyclical in nature. As such - unless WTI declines to $40-$45 again - I don't have any particular interest in investing in oil-related stocks, especially if the holding period is several years or longer.* Natural gas is still not investable. I spoke to the CIO of a very successful commodity hedge fund a couple of weeks ago and he asserts the price of natural gas at the wellhead should be closer to zero, since a significant portion of the U.S. natural gas output is simply flared and possess no economic value.* Gold has been in a 7-year bear market. CAPEX has been slashed by more than 60% since the 2011 peak but mining supply remains steady. Marginal cost (AISC for marginal mines) is probably at around $900 to $1,000 and I see gold prices declining to that level as the Fed continues to hike rates over the next 12 to 24 months. Since gold acts as an insurance to a catastrophic economic scenario, one shouldn't expect to profit much from holding gold over time (after all, no-one expects or wants to make money from their insurance policies). With the rise of bitcoin as an alternative "safe haven" storage (mostly for ultra high net worth families that live in potential war zones) and untrackable cryptocurrencies such as Dash or Monero, gold has also lost some appeal as a storage of value.* U.S. retail remains very difficult. FIVE, TJX, and ROSS remain immune; SPG has stood firm over the last 12 months given the high-quality nature of its properties. But with AMZN ongoing improvements in brand selection and delivery times - and with the rise of size customization in apparel and shoes - traditional U.S. brick & mortar retail will continue to underperform.* Will the TSLA distribution model put pressure on the traditional U.S. auto dealer network over the next several years? Why can't most U.S. consumers go online and customize their automobiles and have their vehicles delivered to their door?* Perhaps most importantly - assuming the U.S. yield curve inverts as inflation spikes and the S&P 500 subsequently experiences a >20% correction sometime in the next 12-36 months, which companies or industries will lead the next bull market?Would welcome any thoughts or comments.
As mentioned, I would welcome any additional thoughts or feedback. Schedule permits, I plan to update this thread on an ongoing basis.In my March 18, 2018 post, I mentioned I don't have any particular interest in investing in oil-related stocks unless WTI declines to $40 to $45. Goldman Sachs, however, thinks differently. In particular, Goldman is now advocating for an investment into Big Oil. They liken the current phase of the oil environment to be similar to that of the 1987-2002 "restraint" period, when:1) The 11 mm b/d of OPEC spare capacity created a sense of long-term abundance, resulting in a backwardated WTI futures curve;2) High and tight financing costs restrained CAPEX growth and resulted in Big Oil keeping market share; and3) Costs deflation - falling by 1% p.a. versus the U.S. CPI of 5% p.a.... resulted in Big Oil earning a total return that was 6% p.a. higher than the market. Note this also beat the returns of the E&Ps and oil services stocks. Conversely, Big Oil actually underperformed the market by 1% p.a. on average during the "expansionary" period from 2003-2013--a period when oil rose from $30 to over $100 a barrel, due to: 1) Big Oil losing market share from cheap financing, 2) rising CAPEX requirements, and 3) cost inflation (14% p.a. vs. CPI < 2% p.a.).I am coming around to this idea - Goldman also asserts that decarbonization and the rise of EVs may be the best thing that ever happened to Big Oil, as this has resulted in an exodus of both investors and lenders in the industry, resulting in a heightened equity risk premium which savvy investors could capture over the next decade or so.Disclaimer: I am long XOM and CVX.
Wonder what's happening in Big oil? Know anyone in Houston? I would think that folks in Houston would definitely be seeing some positive changes if Big Oil was starting to warm up....'38Packard
I used to live in Houston and I still have relatives, friends, and associates there. The general consensus is that the industry is rebounding; but because of efficiency gains and risk aversion due to the violence of the last downtown, there is little net hiring. Specifically, I have a friend that used to work at Aramaco in Saudi Arabia who was laid off about a year ago. He is in Houston and still looking for work. Other folks are in holding patterns.This is actually one of the main reasons why I am bullish on Big Oil in the longer term. Both CAPEX and labor costs are being kept down even as production recovers, unlike the 2003-2013 period when rising oil prices were accompanied by significant CAPEX and labor costs inflation. Perhaps XOM's declaration of >15% ROIC on their CAPEX plans isn't so aggressive, after all.
Reading my initial post, it appears that I may have "brushed over" some of the risks that may (naturally) arise as a result of a nine-year global growth cycle - albeit interrupted by the European Sovereign Debt Crisis, the slowdown in Chinese credit growth, the near-collapse of the Brazilian economy, the 2013-2016 collapse in oil prices, and the structural collapse of U.S. retail profit margins (FIVE, TJX, ROSS, and OLLI notwithstanding).As I implied in my initial post, I keep a close watch on the term structure of the U.S. yield curve, along with the change in U.S. unemployment and potential inflationary pressures. An inverted U.S. yield curve has nearly always led to a U.S. growth slowdown; at the very least, U.S. stock prices (e.g. 1998) have tended to underperform, even if no U.S. recession occurred. A major exception is the October 1987 crash--when the U.S. yield curve did not invert--but this was preceded by a 200 bps increase in the U.S. ten-year yield, and of course, an exponential rise in U.S. stock prices and margin debt outstanding leading into the August 1987 peak.The U.S. yield curve has not inverted, but there is increasing chatter that the Fed may hike 4 times this year, not 3. Worryingly, 10-year expected inflation, as implied by TIPS pricing, broke out to a new 4-year high last Friday. The Fed is now projecting U3 unemployment to hit 3.8% this year, and as low as 3.6% next year--the latter of which will be the lowest unemployment rate since 1969, or at the peak of Vietnam War troop deployment.Sorry, I may be wrong (and I often am) but I just don't think we could keep the inflation genie bottled up if U3 unemployment rate declines to below 4.0%. Perhaps when that happens, the Fed can engineer a "soft landing" but the Fed hasn't had great success in doing this.Another "weak link" that I am watching is the speculative short position in the U.S. dollar, which is now at multi-year highs. A prominent economist that I track asserts that for everyone 10% decline in the U.S. dollar, the U.S. economy receives the equivalence of 100 bps of Fed easing. EM economies also benefit from this indirectly through speculative flows into their economies, especially EM countries that are running structural current account deficits, such as India, Brazil, and South Africa. The IMF's April 2018 Global Financial Stability report briefly mentions this as a short-term risk--if the U.S. dollar stages a sizable rally, speculative flows could again flee EM economies. This is not another 1997 or 1998--given most EM economies have built up their FX reserves as a response to those crises--but it'd definitely put a dent to global asset prices/GDP growth in the short-run.Comments and questions are welcomed.
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