Month: February 2017

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

FEBRUARY 22 , 2017

 

Contact Richard Power with comments or questions. IntelDigest  is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

In recent issues of  IntelDigest, we have published economic analysis as it relates to the current market environment for Investment.

 

We have posited that small-cap stocks will do well this year, as primary beneficiaries of Administration and Congressional policies aimed at lowering business taxes, reducing government regulation, and increasing federal spending on infrastructure.  This would be supported by a continued expansion of the U.S. economy, which has been happening at a gradual pace for the last several years.

 

We have noted that global inflation has been rising of late … at a faster pace than expected … and that fundamentals have been improving in the Emerging Markets sector.  We believe that the BRICs markets (Brazil, Russia, India, China) are positioned to do very well in the next year or two, and we pointed to a BRIC investment fund where we have invested.

 

We have repeated our analysis that the fundamentals for Gold (and Silver) investment are positive, and that such Precious Metals should have a place in every portfolio … investors should consider Precious Metals for approximately ten percent (10%) of total holdings.

 

We have also warned of a Credit-Default Crisis on the horizon for 2018-2019.

 

 

Today, we will begin with a few more words on Gold, then move on to an analysis of The Long Bull Market, and why it still has legs in 2017.  Finally, we will discuss the looming Credit-Default Crisis of 2018-19, and what we can do to prepare for it.

 

 

 

More Gold Talk

In addition to the Gold fundamentals which we have set out in prior issues, there are a few more points to consider.

 

Inflation in the economy and a weakening of the U.S. Dollar are primary stimulants of the price of Gold.  The looming battle between the Trump Administration and The Federal Reserve over Inflation will take center stage in the coming months.

 

The Fed will want to keep Inflation in check;  typically, The Fed will opt to raise interest rates fast enough to moderate Inflation, which adds strength to the U.S. Dollar.  The Administration, on the other hand, wants a weaker dollar to help U.S. exports and create U.S. export-related jobs.  Donald Trump has railed against several of our trading partners … China, Germany, Japan … assailing them for using cheap currencies to hurt U.S. workers.  He is determined to fight back with a weaker U.S. Dollar.

 

A weaker Dollar will translate to Higher Gold Prices.  Gold is both a Hard Asset and a form of money, like the Dollar, Yen, Euro, Chinese Yuan.  When the Dollar is weak, the price of Gold (as measured in Dollars) rises.

 

How will Trump “trump” The Federal Reserve?  He will be in a position this year to appoint up to four of the seven members of the Federal Reserve Open Market Committee.  It is a sure bet that the “reconstituted” Open Market Committee will side with the President.

 

The resulting weakening of the Dollar will be good for Gold investments.

We also look to the actions of one of the top investors in the United States, Stanley Druckenmiller, for another sign of Gold strength this year.  Druckenmiller held extraordinary amounts of Gold investment in 2015-16, then sold much of it on the day after the presidential election.  However, he renewed buying in December.

 

When asked why he was buying Gold again, in the middle of the Trump Rally, he stated that he wanted to own some currency, but “… no country wants its currency to strengthen … Gold was down a lot, so I bought it.”

 

His reasons had nothing to do with fears of a recession or a stock market crash;  he bought Gold because (1) it’s cheap, and (2) central bankers are weakening paper currencies.

 

Gold should be considered a core holding in one’s portfolio, to be held for the long-term.

The Long Bull Market

Ultra-low Interest Rates are the dominant factor in the U.S. Equities Bull Market which has continued since the end of the 2008 Financial Crisis.  Although the Bull Market seems “long in the tooth,” and the National Debt is a gargantuan problem to overcome, the simple fact is that Interest Rates will remain low for some time to come.

 

That provides continued support for Investment in Stocks this year.
By many traditional metrics, equities are expensive. However, when the ultra-low Interest Rates are factored in, stock prices are reasonable.  With many markets and individual stocks hitting new all-time highs in the last few weeks, we expect that the Bull will run longer, probably through most of 2017.  Historical data supports the notion that assets which attain long-term highs will keep running higher.

 

Investors have a choice in the current marketplace, between earning no interest in the bank, or taking risks in stocks … guaranteed safe returns vs. the risks of the stock market.  Today, the guaranteed safe returns don’t exist.

 

So, to understand if stocks are a good deal, you have to consider whether they’re a good deal relative to interest rates.  You must consider both stock valuations and interest rates when analyzing the true value of the investment.

Outside of the U.S., we believe that some of the best investment opportunities come from Japan, where the head of the central bank has taken extraordinary measures to get Japan’s struggling economy growing again.  The Japanese government is actively buying Japanese stocks, and is expected to continue money-printing.  The results should be (1) falling Yen, and (2) surging stock prices.

 

We are invested in the WisdomTree Japan Hedged Equity Fund (NYSE: DXJ), which will allow us to profit from the rise in stock prices without exposure to a falling Yen.

Investing in Real Estate

Don’t think that discussions of Gold and Emerging Markets and small-caps, et al, indicate that we are overlooking Real Estate.  Real estate in the U.S. is still a highly-valued asset class, and mortgage rates are still close to all-time low levels.

 

We would imagine that the Real-Estate-Mogul-in-Chief will work to keep the tax and investment climate supportive of real estate owners for years to come.

Credit-Default

In numerous issues of  IntelDigest, we have discussed the dangers in the Bond Market, and the crisis looming in 2018-19.  Consider the likelihood that bond values are on their way down, the vast amounts of Debt which many companies have taken on in the low-interest environment of the last eight years, declining corporate liquidity, and the growing risk of default.

 

U.S. corporations now carry on their balance sheets the highest level of financial risk in our history.  Companies took advantage of the historically-low interest rates served up by The Federal Reserve and other central banks, and borrowed unprecedented amounts of money.  In every year from 2010 through 2015, U.S. corporations borrowed at least a Trillion Dollars.

 

 

 

Servicing this amount of debt as interest rates rise next year will be impossible for many companies.  The soundness of the corporate bond market has been diminished, so that the threat of default is higher, and potential losses more severe.

 

The default rate on high-yield U.S. corporate bonds rose to more than 5% in August.  This has started a new credit-default cycle;  some believe that the default rate could rise to 10-15% over the next two-to-three years.

 

Credit quality of investment-grade debt has also diminished.  The lowest quality of investment-grade debt is rated “BBB” … which has increased from a norm of 10% of total investment-grade debt to more than 30% today.

Looking ahead to 2018-19, when Interest Rates will likely rise as the economy grows, this will likely lead to inability to service debt … leading to rising defaults … erasing profits entirely in some industries which rely on low interest rates.

 

As defaults grow, lenders across all industries will become more cautious.  Credit will tighten;  refinancing will become more expensive for some, impossible for others.

 

These are the dangers of a Credit-Default Cycle.

 

We have identified possible investment opportunities in this environment, in sectors which are particularly susceptible to default within the next couple of years, including shopping malls, car rental fleets, and some companies in the oil patch.  Here, companies will endure a fatal combination of falling asset prices, too much debt, and a growing inability to service the debt.

 

The opportunity is in “shorting” several companies in these sectors, starting this year and continuing through 2018.

We would be pleased to discuss strategies for managing and protecting your assets in the current environment, and going forward.

 

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

FEBRUARY 15 , 2017

Contact Richard Power with comments or questions.  IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

We continue our focus, in this issue of IntelDigest, on The Economy and Investing in the “New World Order.”  Today, we discuss the prospects for Gold this year. Next week, we will concentrate on Equity investing for 2017, and discuss preparing our portfolios for the 2018-19 Credit Crisis.

We have written on the case for Gold on several occasions in the past year, and the basic premise has not changed, despite the election surprise.

 
Fundamentals

We addressed the fundamentals of Gold investment in both the July 26 and November 9 issues.  Feel free to review the archive copies of those issues on our websites.

The basic arguments are:

1. Weak economic fundamentals in many countries around the world, ultra-low … even negative … interest rates, and enormous amounts of public and private Debt, all propel investments in Gold.

2. Gold is a traditional safe haven in times of insecurity;  it can provide insurance against cyber and political risks.

3. Demand for Gold is growing in the marketplace, from Russia and China to western markets, while supply has been dormant because new mining projects were delayed or closed down over the last few years, when the gold price was receding from its 2011 highs.

 

 

4. Only a strong U.S. Dollar has kept the value of Gold and Silver from rocketing higher in the last two years.  When the Dollar declines … and the Trump Administration is in favor of a softer Dollar … the price of Gold could shoot over $2,000 per ounce.

5. Historically, Gold has done well when “real” interest rates have fallen.  “Real” interest rates refers to the return one can receive when inflation is factored in. For example, in the 1970s and 2000s, inflation was high, essentially wiping out any return from normal interest rates on fixed income investments, as well as yields on equities.  Gold performed very well then, because the return from normal investments dropped to zero or went negative.

International Factors

We have also looked at three important international developments in the Gold market, which should propel the Gold Market this year.

The first is the Shanghai Gold Exchange.

China is the top consumer, importer, and producer of Gold in the world.  China probably has the largest Gold reserves of any country, as it has acquired massive amounts of Gold in the last decade, much of it secretly.  But, government actions are opaque, so outsiders can only make estimates of the reserves.

China is set on dominating the Gold market.  It established the Shanghai Gold Exchange in 2002, and would now like to make it the center of Gold trading and pricing for the world.  China has proposed that the Shanghai market would set the price on the basis of ACTUAL PHYSICAL GOLD, not on paper futures contracts.

Increased activity in the Shanghai Gold Exchange would be a significant factor in propelling growth in the Gold market.

The second development is a change in Islamic law which would allow massive investments in Gold by Muslims around the world, who number 1.6 Billion.

Some interpretations of Islamic law prevent Muslims from investing in trades considered “immoral,” such as alcohol and tobacco;  this ban has included investment in Gold bullion as a tradeable commodity for the last few decades.  As a result, approximately 23% of the population of the world has stayed out of the Gold market.

Now, however, the Accounting and Auditing Organization for Islamic Financial Institutions is working with the World Gold Council to set a standard allowing Gold trading by Muslims.  If the pent-up demand by this group of investors is unleashed, Trillions of Dollars could soon pile into the Gold market!

 

 

 

Finally, the third  international development in the Gold market is Peak Gold, the theory that the production of new Gold is shrinking around the world.  Declines in new Gold discoveries have coincided with a surge in the costs of mining exploration.  This has resulted in a reduction in mining operations and a steady decrease in Gold production.

Goldman Sachs has warned that there are “only 20 years of known mineable gold reserves.”  Blackrock, the largest asset manager in the world, has also warned about “Peak Gold,” and asserts that Gold production is likely to decline by 20% per year for the foreseeable future.

There is no way to predict if Peak Gold is a concept which will last for years, or if new technologies or discoveries will change the dynamic.  But, for now, the production of Gold is decreasing at the same time that Gold demand is about to soar!

Political Factors

As we discussed in the November 30 issue of  IntelDigest, the Gold Market in 2017 will hinge on the actions of the new President and The Federal Reserve.  We wondered what type of President would reside in the Oval Office, and the early indications are that it is the same Donald Trump who slashed his way across the country over an 18-month-long campaign.

The uncertain nature of Administration actions and policies will push many people into further Gold investment.

What of Trump’s legislative agenda, i.e., significant tax cuts and Federal spending on  Infrastructure?  If The Federal Reserve is accommodative to massive spending programs and higher federal deficits, we can expect much higher inflation in the near future and exacerbation of the Debt Crisis.  Gold investments should perform well in this environment.

On the other hand, if The Fed raises interest rates too much and too often, to keep ahead of inflation, it would push the Dollar higher and set off a stock market fall and a recession in the U.S.  Raising rates would make U.S. goods and services less competitive, resulting in lower profits and damaging our long, slow economic recovery.

This is NOT what The Fed intends, so it will NOT be able to raise interest rates very much or very quickly.  Many long-term investors realize this, and continue to buy Gold to protect their wealth.

We believe that Gold and Cash act as excellent portfolio insurance against the uncertainties of both the Trump Administration and Federal Reserve policy.

 

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

FEBRUARY 8 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

We continue our focus, in this issue of IntelDigest, on The Economy and Investing in the “New World Order.”  Today, we discuss new opportunities in Emerging Markets, Infrastructure proposals in the United States, inflation and interest rates.  Next week, we will revisit Gold, and explain its resurgence in the new year.

As we pointed out last week, we expect small-cap stocks to outshine multinational corporations this year.  Small-caps would benefit from increased earnings produced by reduced government regulation and lowered corporate income tax rates.  Most small-caps should be generally unaffected by conflicts over trade policy.

 

Several sectors which rallied following the election … including multinational corporations in financials, industrials, materials, and energy … will likely underperform in 2017.  These sectors have been characterized by lackluster or negative earnings and sales growth … investors can see that these companies don’t have the fundamentals to support the year-end surge.

 

These sectors have already experienced a pullback from their frothy market highs post-election, as investors see extreme contentiousness from the new Administration, and reluctance in Congress to dive head-first into the Trump Agenda.  Markets have been spooked by potential bottlenecks on tax reform, healthcare reform, and the vaunted Infrastructure spending spree (which we discuss later in this issue).

 

Combined with concerns about the fundamentals in these sectors, investors have taken profits on the year-end market surge.

Emerging Markets

We believe that one of the best opportunities in the markets is to look overseas.  Emerging Markets have lagged American markets since the 2008 Financial Crisis, but fundamentals are improving and the situation looks promising for 2017.

 

Emerging Market fundamentals are illustrated by the Purchasing Managers Index (PMI) for the Eurozone, which recently rose to its highest level in nearly six years. Manufacturing growth is up in Germany, France, and Italy; this is a good indicator that the long battle against deflation in Europe is coming to an end.

Inflation is now rising faster than expected for the first time in years.  The “Global Inflation Surprise Index” at Citigroup has been surging higher in recent months, along with consumer prices.  The index compares actual consumer price data with market expectations, and has been in positive territory in the last few months.

After years of falling short of analyst expectations, global inflation is suddenly moving much faster than predicted, which should be bullish for equities (in the short-term) and precious metals (in the long-term).

BRICs

Like the rest of the Emerging Markets, the BRICs markets (Brazil, Russia, India, China) are due for a rebound from the Financial Crisis, and they have significant advantages over other countries.  The BRICs are the four largest Emerging Markets, and have the potential to be among the largest economies on the planet in future decades.  Their stock markets soared in the early years of this century;  a moderate recovery in these markets now would be profitable for investors.

China is now the second largest economy in the world, behind only the U.S.   India is seventh largest, and Brazil is number nine.  Even Russia, with all its financial troubles and the decline in the oil market, is the twelfth largest economy in the world.

The BRICs Bull Market in the early-2000s followed a decade of underperformance compared with the U.S. in the 1990s. During that Bull Market, the the MSCI BRIC Index rose 745% from its low in 2002 to its high in 2007.

We believe that this year will be good for The BRICs, so we have invested in the iShares MSCI BRIC Fund (BKF) which tracks that Index.

Infrastructure Projects in the U.S.

Both the Trump Administration and the Democratic opposition have new Infrastructure Proposals on the table, so it is relatively certain that Billions of Dollars will be spent on Infrastructure over the next four years.

The Administration has published its “Priority List: Emergency & National Security Projects,” which lists 50 projects to be tackled early in Trump’s Presidency (originally put out by the Transition Office).  Total federal spending would exceed $137 Billion Dollars, and The Administration would encourage the private sector to add a similar amount for vital national projects.

The paper and its details can easily be found on the Internet.  Highlights of the Plan include: road and bridge repair and replacement; updating and expansion of the electric grid; energy storage projects; upgrades to airports in St. Louis, Seattle, and Kansas City; modernizing the Air Traffic Control System from radar to satellite-based tracking; rail and transit projects, including the Washington-New York corridor; reinstatement of the Keystone and Dakota Access pipelines; addition of the Atlantic Coast Pipeline from the Marcellus Shale in Pennsylvania to utilities in Virginia and North Carolina; and various other projects, including dams, waterways, et al.

The Democrats’ Plan is set out in the “Blueprint to Rebuild America’s Infrastructure,” which would spend A Trillion Dollars on the Trump projects and many more.

Infrastructure spending obviously has support from both parties.  Whatever combination of projects comes out of Congress later this year, Billions of Dollars will be spent and many jobs will be created.  We will discuss possible investment opportunities later this year as the Plan begins to take shape.

Long-term Credit Problems

As we have written in several issues, a long-term Credit Crisis looms over the horizon, which will make investing very challenging in 2018 and 2019.

The Wall Street Journal recently published an interesting analysis of The Federal Reserve, highlighting an unusual consequence of the Fed’s Quantitative Easing (QE).  Recall that, in the wake of the 2008 Financial Crisis, the QE program involved The Federal Reserve buying up Trillions of Dollars of bonds (mostly government securities) in an attempt to lower interest rates and increase the money supply to spur the economy.

The program did not achieve the stated goals, but some would argue that it stopped the world economy from plunging further into crisis.

The Fed stopped buying new debt in 2014, but it still holds more than $4 Trillion in debt, including nearly $2.5 Trillion in U.S. Treasury securities.  The Fed holds mostly longer-term debt, meaning relatively little of this debt has matured.  The Fed has been reinvesting the cash from maturing bonds back into new Treasury debt.

The Journal notes that the average duration of the Fed’s Treasury holdings has fallen from nearly eight years in 2014 to just six years today.  In other words, the Fed has been reinvesting in shorter-term debt than it had been.  And this has helped push interest rates higher.
Janet Yellen, the current Fed Chair, asserts that this has had the same impact as if the Fed had raised short-term rates two additional times.

According to the Journal, The Fed now intends to cut the size of its bond portfolio … it will stop reinvesting the cash from maturing bonds back into Treasuries.  This would put even more upward pressure on rates.

Moreover, much of The Fed’s Treasury debt is set to mature over the next five years.

Long-term rates will soar higher as inflation begins to stir for the first time in years and the Bull Market in bonds rolls over.  This would result in much higher borrowing costs in the next few years.  High-grade borrowers would be forced to pay unusually high rates;  many firms will be unable to borrow at all

Expect the benchmark 10-year Treasury to rise from 2.35% to 6% over 2-3 years.

Next week, we’ll address this problem in more detail … the time frame for onset of such a crisis … steps to be taken ahead of time to protect our assets.

 

 

 

 

InnOvation Capital & Management, LLC

 
IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

FEBRUARY 1 , 2017

Contact Richard Power with comments or questions.  IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

In this issue of IntelDigest, and for the next few weeks, we will focus on The Economy and Investing in the “New World Order.”  We will start with a general overview today, and analyze specific sectors in the coming weeks.

Most market analysts expect that the Trump economic program will be positive for the American economy, in general.  A particular beneficiary of Trump policies would be small-cap stocks, primarily because the Trump Administration intends to continue challenging other nations on the subject of “fair trade,” which could upset some trade relationships and invite retaliation against American multinational companies trying to do business in various countries.

 

Small-caps will have two advantages in the new environment:  (1) they generally earn a larger percentage of their income in the United States, compared to larger companies and multinationals, and would be injured less by trade-related controversies; and  (2) small-caps are less likely to be impacted by Trump-inspired U.S. laws aimed at large U.S. companies which have moved operations and jobs overseas.

Then there is the intention of Trump and the Republican-controlled Congress to lower corporate income taxes.  This is another initiative which should be a greater benefit for small-cap stocks … small-caps have been paying higher U.S. tax rates for years compared to certain multinationals which could hide profits in foreign countries and avoid U.S. corporate income taxes.

Lower taxes will certainly improve earnings of small-caps, with an expected stock market boom as a result.

These factors, plus Trump’s commitment to reducing government regulation, have already spurred a rally in small-cap shares since the election.  Investors are anticipating lower taxes, more favorable trade deals, less regulation, and pro-U.S. business policies which should be favorable for American companies.

 

 

 

Even before the anticipated corporate tax cuts, companies in the S&P 500 are expected to see earnings rise by up to 8% in 2017.  With the tax cuts, forecasted earnings growth could be as high as 20%!  Add to that the expectation that new tax legislation will give multinationals the opportunity to repatriate Billions of Dollars of profits at a low rate, and the outlook for U.S. corporations is looking positive for the next few years.

Economic optimism is now widespread, even if the new administration will likely be embroiled in political controversy for an extended period of time.  Even so, American influence in global financial matters has not abated, Wall Street indices are close to all-time highs, and consumer confidence is at its highest point in 12 years.

At least from an economic standpoint, the uncertainty which accompanied Trump’s surprise election has gradually abated.

The International Monetary Fund (IMF) expects the U.S. economy to grow 2.3% in 2017, and 2.5% in 2018 … higher than its previous forecasts.

Other economic metrics support favorable growth forecasts.  Inflation stands at just over The Federal Reserve’s target (2% per year), and crude oil prices are stabilizing.  December housing starts jumped 11.3% to an annual pace of 1.23 million homes … for the year, housing starts rose 5.7%, the second-highest annual pace since 2008.  Existing home sales rose 4.0% in 2016, and the supply of existing homes is now at a 17-year low.

The housing market should remain strong as long as interest rates remain relatively low.

 

 

On the negative side, not all sectors have a rosy outlook, and there are other areas of concern.

Several sectors rallied following the election, including multinational corporations in financials, industrials, and materials.  These sectors have been characterized by lackluster or negative earnings and sales growth.  Investors need to be wary about these sectors, and will have to work hard to extract the few diamonds from the mass of overvalued companies.

The strength of the U.S. Dollar over the last three years has cut into the bottom line of most U.S. companies doing significant business overseas.  Even with the pullback in the Dollar this week, the stocks of the aforementioned financials, industrials, and materials are likely to be hurt as investors see that these companies don’t have the fundamentals to support the year-end surge.

 

There are serious concerns that the Trump controversies in non-economic areas could easily disrupt the financial world.

Both Chancellor Angela Merkel of Germany and China’s President Xi Jinping have openly warned the U.S. against pursuing protectionist policies.  Clearly, big exporters like China and Germany want to protect their current trade surpluses

Trump’s aggressive first ten days in office have created more uncertainties which have halted the rise in interest rates and Treasury yields (now 2.48% on the 10-year).

Analysts have downgraded some multinationals, such as Coca-Cola (KO) and Procter & Gamble (PG), which were both downgraded to a “sell” rating by Goldman Sachs.  We would expect downgrades of most multinationals in the coming weeks.

 

Then there is the daily barrage of extreme nonsense from the White House which is likely to put investors and business owners in a state of unease going forward.
For example, is the U.S. going to build a multi-billion Dollar wall at the Mexican border?  The Mexican government claims that it won’t pay for such a thing, so the Administration put out a plan involving a border tax, which would ultimately put the American consumer on the hook for the cost.

From a Republican retreat which brought together the President and
Congressional Republicans, The Wall Street Journal reported that the executive and legislative branches “struggle to understand each other.”

 

 

The downside of such spectacles is that they can quickly erode the confidence of Corporate America … will business owners go forward to hire more workers and expand their businesses in such an environment?

By the way, a major impediment to economic growth could occur in March when the Congress and President have to seriously consider raising the Debt Ceiling … that promises to be a donnybrook for the ages!

 

The bottom line is that the economy is looking up, at least for certain stocks in certain sectors, but there is a high probability of confusion and controversy in the next 90 days.  It is a stock picker’s market, so we’ll use a good deal of digital ink in the next few issues to discuss the areas where opportunities lie in the immediate future.