A lot has happened since our last letter. Last September J.P. Morgan’s CEO said that Bitcoin was a “fraud”. Last week he said he “regrets calling Bitcoin a fraud” after the digital currency tripled in price in three months. The next day Warren Buffett said in an interview regarding crypto currencies, “I can say with almost certainty that they will come to a bad ending”. Digital currencies are one thing but the Blockchain is another. Blockchain transaction verification/validation is here and it’s the future! We’ll write more about it in the future.
So, what’s in a name? An ice tea company on Long Island decided to change its name to Long Blockchain Corp. The stock rose 500% in a day. Kodak said it was looking into crypto currencies and blockchain while creating PhotoChain. The stock rose from $2.5 to $13 in two days. Both stocks have declined in dramatic fashion since the news was reported.
Unfortunately, as of this writing, the Bitcoin has had a slight pullback of about 50% from its December peak as Asian governments are cracking down on crypto-exchanges.
We could write a book on what has taken place in the last quarter of 2017 without mentioning politics. Aside from rising stock prices, interest rates are starting to rise. We view this as long-overdue welcome news. Bond markets are much larger in dollar size than equity markets. The Financial Times says, “now bond prices are wobbling. This week the 10-year US yield jumped to nearly 2.6 per cent, its highest level for almost a year, after speculation that the central banks of China and Japan might be scaling back their Treasury purchases. Yields later fell back. But the swing was sharp enough to prompt Bill Gross and his rival and fellow guru Jeffrey Gundlach to warn that the three-decade-old bull market for bonds might be coming to an end (although they differ on the precise timing.)”
Rising rates will eventually present a huge problem. As the FT went on to say, “the reason is that the long era of ultra-low interest rates has lulled many institutions into complacency. Investors have been reaching for yield, that is taking additional credit risks, on the presumption that rates will stay low, and using derivatives to magnify their bets. Nobody really knows how much exposure this has created, since the $400 Trillion over-the-counter swaps market is so opaque.”
Short Term Treasury Yields are at 10 Year Highs
So, what’s missing that could change the course of markets this year? QE to QT, Tax Reform, Volatility and Inflation to name a few.
QE – Goldman Sachs made a comment the other day that U.S. Treasury issuance is to more than double in 2019. That’s part of quantative easing reverting to quantative tightening. The Fed is going to let $30 Billion of Treasury bonds they have purchased over the years “roll off”, thus adding to the supply that needs to be issued. The national debt and budget deficits remain on their upward trajectory.
Tax Reform – will create significant unknowns. Bloomberg reports, “Apple Inc. and Microsoft Corp. have stashed billions of dollars offshore to slash their U.S. tax bills. Now, the tax-code rewrite could throw that into reverse. The implications for the financial markets are huge. The great on-shoring could prompt multinationals — which have parked much of their overseas profits in Treasuries and U.S. investment-grade corporate debt — to lighten up on bonds and use the money to goose their stock prices. Think buybacks and dividends.”
Volatility – remains at record lows for stocks. The ride in 2017 was as smooth as silk. There is an old saying that the longer a trend remains intact the more violent the change will be when it occurs. We have not seen such a consistently low level of stock volatility in decades. But as Morgan Stanley commented recently, “In April, it felt as if people were looking for a reason for the market to fail. Now, we have seen a total reversal with people having a hard time even imagining how the market could decline.”
Inflation – The Federal Reserve is as confused as any other economist about the lack of inflation in their analysis despite the tightest labor market in decades. Federal Reserve governors make fortune tellers look good!
2018 – will bring more volatility in asset valuations. That’s a given. Stocks are expensive on a forward earnings basis by any metric. Fourth quarter earnings for SP500 companies should be very favorable, possibly the best in six years. With Dow 26,000 I’d assume much of that has already been discounted.
A we’ve said in the past, “saddle up partner because we are going to be in for a wild ride!”
J.B.Hamilton January 2018