March 18th Weekly Recap

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(Articles from Jordan Wirsz and Nell Sloane)


FED HOLDING RATES – NEGATIVE RATES A REAL POSSIBILITY?

March 18, 2016
By Jordan Wirsz – Savant Investment Partners

Negative Interest Rates: After much research, I’ve come to my own conclusion on the possibility of negative interest rates in the U.S. My conclusion is that negative rates simply will not happen.
 
This week, the Fed held rates steady and reduced their expectations of raising rates in 2016. In Q4 of 2015, the Fed raised rates for the first time (which we accurately predicted) and forecast four rate hikes in 2016. Now the Fed has paired back their expectations of raising rates in 2016 to two raises, likely of 25 bps each. So, 2016 looks like a half point raise if it goes as the Fed expects, and I tend to think that is a realistic approach for now.
 
The pure pessimism in the market is gone, and now relief is abound. But the picture isn’t all rosy. Even though the Fed raised last year’s Q4 GDP output, they are lowering GDP forecasts for 2017 and 2018 from the mid 2% range to the low 2% range. The Fed is being incredibly cautious, even outright scared of what might come from raising rates too fast. Nell from CTG has a great article below which dives in deeper into the Fed’s conundrum.
 
EQUITY/STOCK MARKETS
Off to short we go….
 
Right or wrong, I’m short the market as of today. Last week I published a chart of the S&P emini futures with two resistance lines. We broke through one, and now we’re above the other. I expect us to fade back and move down. That is the easiest path for the market to follow at this point. A further rally to the 2100 + mark would signal an early market cycle top…Which I *DO NOT* want. Early cycles tend to be less aggressive cycles, and I’m in this one for the “big move.” The chart below shows the break above the top resistance line, and unless something unexpected happens, I think we’ll move below it decisively. Stochastics are also way overbought, and have been for the last month as this rally took off. So, my gut (right or wrong) tells me now is not a bad entry point to get short.

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The only troubling thing that keeps me up at night about a short position is the double bottom that formed between January and February. Technically, that will be a hard line to break below, so we may end up range bound for a while, and given the volatile year we expect in this election cycle, that would not surprise me. 2016 could very well prove to be another frustrating year for traders and investors in the U.S. equity markets.

ENERGY
It’s time to start picking your entry points into the energy sector. Yes, I said it…it’s time. The price of oil has decidedly bottomed. We have a double bottom from January to February, and technically, we have rallied 20% percent. I don’t think this is a “dead cat bounce,” I think it is a firm technical bottom that is in place, and now we are likely going to see some retracement after this relief and short covering rally. In the May NYMEX futures, crude rallied today to about $42.50 and then sold off, now trading at about $41.50. I think it’s safe to say that we’ll see it trade down into the mid to upper $30’s and hang there for a bit…that is when I’ll be entering my orders to buy into the energy sector heavily. Stochastics are also overbought and the big fade we had in trading today tells me that the rally is waning, and a nice retrace is in order.

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Several forecasts from really smart people in the industry estimate the average price of WTI crude in 2016 at about $50 and up as high as $75-95 by 2018-2020. That would be a spectacular recovery, and big money will be made by picking the right equities and entry points. Remember, the energy cycles are volatile, and fast…Boom, and bust in really short periods of time. Its not surprising that the energy cycle bottomed relatively quickly, and may be headed back up just as quick.
 
The oil fundamentals are relatively good – the supply (or lack of) has to drive this recovery. Obviously, the cost of production did little to stop the decline. Production declines are likely to drive demand back into balance. Many U.S. frackers have cut production, and foreign countries are not ramping up production and holding relatively steady…So as it always happens, “somewhere out of nowhere” we’ll have a big change in the news sentiment about production cuts that will push a hard rally in oil prices. Even a blurb about China doing better than expected could push prices higher on expectations of higher demand. Production declines could easily offset the resilience in POEC production.

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…Weak Global Oil/Products Demand

Although global demand for crude oil was high in 2015, Energy Aspects projects demand to decline in 2016 as a result of narrower refining margins and weaker refined products demand.

Refining margins were exceptionally wide last year as a result of lower inventories. This resulted in higher refinery runs/crude oil demand in 2015, which served to refill inventories. Going forward, crude oil demand is likely to return to more normalized levels (i.e. “baseload” demand growth of ~1 MMBbls/d) but down from 2015 levels.

Energy Aspects projects oil demand to decrease in Europe, slow in China, and grow in India (partially due to filling strategic petroleum reserves). From a refining perspective, U.S. Gulf Coast refiners are at high risk as a weak global diesel market could make it challenging for refiners to maintain annual diesel exports of roughly 1 MMbbls/d.

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I believe oil prices could spike higher in 2018 – even up close to the $100 mark for a short period. The basic premise is that the current slowdown in drilling activity could result in production declines overshooting demand, resulting in a temporary spike in oil prices. While there is some uncertainty around labor availability, U.S. producers should still be able to quickly increase production if oil prices improve. However, the rest of the world could take significantly longer to ramp production even if oil prices improve.

Longer-term (2020+), countries higher up on the cost curve will be called upon to raise production to meet global growth in oil demand. These higher cost producers would likely require an oil price in the range of $70-80/Bbl to support new drilling. While producers have been able to lower costs in the current environment, part of the cost reduction could be from high grading capex budgets (i.e. drilling the most economic wells first). As these core drilling locations are depleted over the next few years, drilling could shift to more fringe locations, likely requiring higher oil prices.

One reason that I’m so excited about investing into the energy sector is the fact that we (the U.S.) have already spent uncountable billions of dollars in infrastructure and drilled wells…And all we need to do is complete them and start sucking out the oil. When we get to a profitable price point, producers will be doing extremely well. Here is a bar graph showing how many wells we have drilled but not completed in the various oil drilling regions. Quite extraordinary. We’ve put thousands of wells on hold, but they’re ready to complete when the price makes sense again. The one thing I do give oil companies credit for is their ability to move quickly to cut costs, then ramp up and start producing quickly again on a moment’s notice when prices rise. They have learned this art through the most difficult of trials.

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CURRENCIES
Well, this week the dollar continued its decline, as expected:

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The Euro, which operates opposite of the USD, rallied. The EURUSD chart shows this perfectly. The big rally in the Euro came at the FOMC meeting notes and rate decision along with the Eurozone CPI revision.

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World currencies are going to experience short term trend changes as we’ve discussed in previous issues of the Savant Report. We expected (and were proven right) that the Canadian Dollar, the Australian Dollar and the Euro would bounce. However, we still believe that longer term, the USD index will get to 1.00 +++, the Canadian dollar and the Aussie dollar will continue to sink to new lows. If you have assets or dollars denominated in anything but the USD, you may consider moving those assets into USD terms to take advantage of the currency moves that are likely forthcoming.

We have a good number of Canadian investors who have been waiting for exactly this, a bounce to the mid .70’s to take advantage of the exchange rates to invest more in U.S. assets. The same set of circumstances apply to the Aussie dollar. All three of the Euro, Aussie and Canadian dollars are easing back today, with longer term trend indicators showing the trend change may be near its end.

GOLD
It is so incredibly easy for newsletter authors and publishers to take the middle ground. Wordsmithing and writing style often leaves openings to be loosy goosy on subjects. I try to never underestimate a market’s ability to spin on a dime or prove me wrong. However, gold is one market that we get constant questions about and everyone wants to know the million-dollar question: “Up, or down???” The straight answer is, both. The technical signs in gold right now seem pretty weak on this rally. ADX (a strength indicator, how I have it programmed) is pretty weak, momentum moving average of the close price is declining, and MACD is weak considering the rally we’ve had. I think we are likely to see lower prices in gold, and of course I await the unexpected news that will rally it over $1300. We could be range bound this year given the political climate, commodity prices, interesting Fed position on raising rates, and the European and Chinese issues at hand. But as far as I’m concerned, gold is not near a price point that I would feel comfortable buying at. The possibility does exist for it to get to $1500 sometime this year or next. And, even though I would miss out on that 20%+ rally, I’d be grateful I wasn’t a part of it. There is too much uncertainty surrounding gold for me to feel comfortable placing a trade one way or another. Ultimately, the commodity super cycle is done and so is the “great recession.” I don’t feel compelled to do anything but sit on the sidelines of the gold trade, and wait for a much better day to buy. For now, MY assets will be in other, higher growth and income producing assets.

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SUMMARY:

  1. Short Equities
  2. Long Energy
  3. Long the US Dollar for the long-term, take advantage of this short-term trend change to exchange assets
  4. Sidelines on gold

Until next week…

Jordan Wirsz


FOMC Decision Day – March 17, 2016

March 18, 2016
By Nell Sloane

The FOMC was a big no show this week. Here are a few of the headlines from Reuters:

  • Fed leaves target interest rate unchanged at 0.25-0.50 pct, policymakers see two rate hikes in 2016
  • Fed says global economic and financial developments continue to pose risks; does not assess balance of risks in statement
  • Fed says continues to monitor inflation closely; repeats still sees inflation rising to 2 pct target over medium term as transitory effects fade
  • Fed says recent indicators point to additional strengthening of labor market, but business fixed investment and exports soft
  • Fed says market-based measures of inflation compensation remain low, survey-based measures are little changed
  • Fed repeats with gradual adjustments to monetary policy, economic activity will expand at moderate pace, labor market will strengthen
  • Fed repeats expects economic conditions will evolve in way that warrants “only gradual increases” in fed funds rate
  • Fed repeats anticipates keeping existing policy of reinvesting principal payments until normalization of rates is “well under way”
  • Fed repeats when determining timing, size of future changes in rates it will assess realized and expected conditions relative to employment, inflation objectives
  • Negative rates are not something they are actively considering

Unfortunately, the FED failed to back up their global growth rhetoric with actual policy moves. Essentially, they report that numbers are improving, employment is improving, inflation is subdued, but yet they are unable raise rates. Therein lies a significant contradiction. Either the economies are improving and rates should move higher, or the “improvement” is just a façade. Obviously we know the reality. The investment world has been slow to see the truth, but it seems everyone is finally realizing that there is no reason to see rates higher any time soon.

This is the reality and what it says is that the global economies are predicated upon the aide of $150 Billion in QE from BOJ and ECB every month, on top of a few billion a month from FED MBS roll off reinvestment. It seems as if the very survival of our current economic system relies solely on financialization, meaning without QE and negative rates, the global economies will crumble. What this also means is that you can toss out any economic model or textbook because we have a controlled global economy predicated on a very few individuals decisions to actually do the right thing or do as they feel is the right thing. We view this as a very dangerous precipice none the less.

This chart should tell you the real job of the FED is simply to imply greater future forward rates.

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In general, many people’s perception of time is very limited in scope, so the FED knows it can play this game for a while, longer than people can actually realize their true intent. For our readers, this shouldn’t come as a surprise. We have often stated that the FED’s job is to buy time, and as of late, they certainly have done a stellar job. You see in order to reward all these debtors; you have to do two very important things:

1. Keep rates near or at Zero, indefinitely
2. Keep implying higher rates and constantly deliver lower rates

You see the real work of the FED is to steal interest from savers and give it to debtors. Intelligent investors wouldn’t dare loan dead beat money, unless they weren’t any other options (i.e. everyone is offering the same low rate, and therefore you do not have a significant choice). In fact, some of the worst debtors actually get PAID to borrow money. The FED knows you can’t increase debt and leverage and, at the same time, increase real rates. What they hope is that the world doesn’t notice that by default and through counterfeiting the central banks are allowed to acquire real private assets. The fact that few have taken issue with this is a testament to the lack of true understanding of how our modern monetary system truly works.

This is the other tragedy and one the Rothschild’s know all too well, for he who controls the currency controls the world. Forget armies, bombs and weapons, financialization is a far more efficient and inconspicuous tool.

As for the market effects: The US yield curve exploded as the 5s10s steepened +8bp to 53bp, the 10s30s +7bp to 80bp The Euro fut. up to 112-53 +114, SP500 fut. 2018 +11.50 and the Yen fut. 8907 +42 and it looks like Yen shorts aren’t going to be too happy!


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