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Market Update – 18 Months In Review

2014 began with an intense implosion of overpriced tech stocks that destabilized players and set us up for nasty knock off effects. Months afterwards, energy names began to turn downward and started an at first slow descent; a black omen for anyone looking for a forward indicator.

Saudi Arabia decided to play the world’s worst move (effectively maiming OPEC), spiked the oil markets when they could least handle it, and sent oil into the abyss touching off a second massive sector implosion in oil and gas names. But not just oil & gas, as the market became terrified of economic stagnation led by fears out of Europe and Asia, and the entire energy sector followed oil down the hole.

We are now experiencing what I view as the third wave of the same phenomenon that began in early 2014, more than a year later, as the entire stock market collapses 10% in a short span of time, led by China’s markets and the intensely poor decision making of a command/control economy trying to have their cake and eat it too.

That being said, I haven’t yet seen any indication that the real economy is retracting.

Job growth seems present and in my own local markets where I have a good ear to the ground concerning hiring and pay policies, I am actually hearing talk of wage hikes. The last five years, our local job market at least was terrified of the HR monsters that were federal regulations (chiefly PPACA), not to mention we are still reeling from 2009 in some respects. But I think as we clear away from the implementation of these federal regulations, especially with rigid conservatives now holding fast against, we are going to start to see some wage growth. Employees are actually demanding it now, voting with their feet when they can.

This should do wonders for the economy.

With regards to oil specifically (which is chiefest of my concerns) the EIA is suggesting that the current imbalance between consumption and production of oil is 2 million barrels per day. This is the cause of our stockpiling and the foremost reason oil has sunk so far. Saudi Arabia’s move to curtail US production has been a failure and so far the long feared wave of insolvencies has held to a slow drip, even from the most precarious of businesses.

A 2 million barrel imbalance is not all that bad and I believe that, barring some sort of real demand destruction, we’ll just float along at these levels until the market becomes more comfortable with oversupply. I don’t think oversupply necessarily will force pricing lower as it would take a very specific set of circumstances which include not having a merger & acquisition brokerage occur. Yet we see M&A activity is very healthy in this current time period and I have to believe that if oil goes much lower you would see US markets consolidate aggressively.

Besides this, the global imbalance is equivalent to about one major oil producer globally. And in this current environment, we also should be aware that civil unrest is a powerful destabilizer of oil production (via civil war) with positive likelihood.

Sources of new supply are questionable. New well development at these oil prices are unprofitable and only large state sponsored development is probable. Yet, economic weakness is harming state budgets and may make it difficult to attain approval for unprofitable ventures. The largest foreign state controlled sources of oil are also some of the most sensitive to this oil price shock.

Altogether, I continue to believe that the most likely outcome in oil markets is unknowable yet still predictable production locations going offline from internal unrest. Venezuela is pegged as the most likely location for such an event, do to the extreme nature of their current state of affairs, and because their leadership is proven incapable of handling the situation. But Venezuela is hardly the only candidate; just the best.

Outside of that, the economic uncertainty that hit everyone’s radar earlier this summer is now coming back under control. Bond yields continue to subside across all major foreign issuers, and I would not be surprised if the EU crisis in particular remains hidden from view for another full two years.

Domestically, I expect monetary policy to remain accommodating, but would not be surprised if Yellen raises interest rates some token amount, to try and claim some victory for the Federal Reserve. I cannot expect how the market will react to his, but believe the raise will be mostly symbolic anyway, so any effects should be temporary in nature.

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The Big Question Then: How To Play EU QE?

The Swiss bank just announced that the ceiling they have been maintaining against the euro is to be dropped. That would make sense, since the euro is now trading below 1.17, down from almost 1.40 just earlier. In terms of the exchange rate, that had to be getting very expensive.

But the timing here should be viewed as a sign that the ECB is really about to start QE. This should be the stance because if they don’t, the impact would be minimal, but if they do you can’t be on the wrong side of the trade.

In terms of what this QE will look like…well, that is the question. What is the ECB going to buy? Not public debt, surely. How much more financing can these governments stomach with yields already negative in many countries. Even the worst countries, like Greece, are borrowing at rates that an average citizen would envy.

My guess here is two fold: (1) they buy up private financial assets similar to the mortgage program the Fed had in place, but that it will center on short term bonds, while also working with banks to create a long term financing window (EU companies and banks in particular have notoriously short term financing arrangements) and (2) they take the opportunity to absorb whatever mechanisms exactly they have been using, before now, to hide the massive debt loads that should have been coming due over the past three years.

If you forgot, Europe ended up pulling some master BS, using a combination of trade accounts to gobble up the garbage so that the markets wouldn’t have to see it default. I’m hazy on the exact specifics, but I would gamble that those imbalanced accounts are still outstanding; and my guess is they’re about to get totally monetized.

So the big question now is, where do you park money? I think that it would be very stupid to try and be short right now with central banks making big noise and seemingly readying the cannons.

If this is like past central bank action, then any longs will do – equity, commodities, debt, whatever you like. Oil could get a huge boost since it’s been so ravaged. ECB action will give the Fed room to play, especially if deflation keeps up. Yellen is no Bernanke…yet, but she also hasn’t been tried either. If the Fed coordinates, all boats get lifted.

But the safest low key play is probably just to hug U.S. dollars until things are a little more clear.

I am ~78% cash, with positions in CCJ, BAS and VOC, down roughly 3% in the first two weeks of the year.

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nOPEC

Oil just got beat again when it became public that OPEC is a dysfunctional organization. Who could have imagined that disparate oil producing nations with deep, cultural differences (read racism) might have trouble working through competition?

I never would have guessed it would crop up this quickly. But the demise of OPEC is hardly unforeseen. I myself penned an article this July discussing the possibility of the oil markets being upended.

But it is funny, reading through those thoughts going on just five months old, and seeing how violently they have diverged from what I expected.

I expected the development of US oil and gas reserves would create trouble for the old guards. I did not expect that oil would collapse 30% in two months. While you could say that those price swings were to be expected – just simple economics – I had expected the US might actually do more legislatively to erect a wall between us and the oil nations altogether. Obviously this happened much too quickly for any of that.

I had also guessed that when things started to get tough, OPEC would at least try to band together first. They’ve been successful at this in the past, so failing to construct even symbolic production cuts this round is certainly worse off along than I would have ventured.

The fallout in oil and energy names, following August, is not something I truthfully believed in. This may sound strange, but I was actually betting against myself when I made those sales of my oil and gas positions. And I never would have believed we’d fall so far. BAS is off 60% peak to trough, for crying out loud. Even when I knew we were experiencing a correction, I didn’t think it would be this extreme.

Now let’s put some context into all of this. Some of these energy names are trading at prices as bad as or worse than they were in 2010-2011 (when oil prices were pretty much where they are now); and lots of these energy companies were losing money back then, whereas they are making money today. I’m talking about BAS explicitly as an example.

So what happens now?

Well, I think that the prices of oil & gas plays are pretty compelling here. Yes oil is a bummer and there is big talk about $30 oil being right around the corner. And it’s no coincidence that I think this talk is stupid and that those responsible should be viciously ridiculed. I think the price drop is temporary, unremarkable and indistinct from any other major selloff that has gripped the price of oil in the past five years.

I think competition will continue to do real damage to the major oil nations in the world bringing about the greatest power shift of our lifetimes. But as apart from my peers, who seem to believe that a Venezuela or Russia has the ability to ramp up production into this price drop, leading to a deflationary spiral that ushers in 1990’s prices for all Western nations, I tend to feel this is silly.

You can’t call for the death of the Bakkens and simultaneously think that oil stays this low. Actually I have a hypothesis that the events that would have to converge to keep oil this low are few and far between. The big question here is timing as to when oil goes higher.

So my guess – and this is definitely just that – is that the US shale boom lives. And here’s what will enable that to happen.

These oil exporting countries have all made brazen moves with their budgets. Places like Russia, Saudi Arabia, or Iran are barely holding it together. Places like Venezuela can’t even muster that; oil prices for Venezuela are kind of like mattresses or trampolines to a guy already falling off a roof – a point of hope.

But if oil prices keep falling, you’re going to see one of these places – and Venezuela is definitely near the top of my list – buckle. Venezuela is probably the easiest case to get back to $100 oil, because one Venezuela is good enough to offset new US production. But it could just as easily be a combination of other smaller oil exporters. A half dozen of the smaller to mid size guys, or even a combination of Syria and Iraq plunging back into darkness. IS is obviously a possible trigger here; a bunch of pissed off twenty year olds, armed with rocket propelled grenades, trying to operate oil machinery? Sounds like a nice, safe combo.

What we’ve seen, repeatedly, is that when a place like, oh, Syria or Libya plunges into anarchy, it’s not just a small setback. Rather, the entire oil infrastructure gets taken offline for years at a time.

Another civil war or resurgent fighting could easily get us back to lower oil production in these places. Some US legislative work (now freed from the concerns about access to supply thanks to the US domestic advances) could help keep our own oil expertise from setting those places back up again after they tumble.

Why would we want to do this? Rome is sick of Carthage.

Just think about the sheer number of problems that these countries have dealt us over the past fifty years. We already know that the US can withstand $100 oil. We’ve been doing it for a few years now. And $100 oil benefits the US economy directly, whereas $80 oil is the worst of all worlds; too cheap or expensive to care about.

With the GOP in Congress and looking to juice the US a little, and with Obama increasingly looking for a major win, sticking a stake in the middle east is probably the lowest hanging fruit around. Kill IS by letting them destroy their own oil infrastructure, then restrict the companies that have usually bailed that region back out (Shell, Exxon, etcetera) from doing that. Lower Russia back into 1993 conditions, then tell Blankfein to keep out this time.

That’s how I see things playing out. Sure we could watch the US shale revolution just go to waste completely. But I think at this junction the US has a pretty vested interest in not letting that happen. It’s a new dawn, after all.

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The March Of War

Timidity begets aggression.

There are two primary takeaways over this weekend.

The first takeaway is, everything you have ever been told about empathy and compassion leading to a more peaceful world is a complete crock of shit. Six years into this nonsense, if anyone following this code still believes in it, do us all a favor and off yourself.

At this stage, we aren’t even “uninvolved”; but our prior actions were so discrediting, it’s going to take a discontinuous push to shock people back into order. The cost to us, whether we embrace the challenge or give up, will be great either way.

I can appreciate the desire to keep US lives out of harms way, but on the other side, those few thousand volunteers who tragically lost their lives were keeping at bay something much worse. They were heroes and deserve the designation.

And past the immediate body count, tell me: what do you suppose the long term cost will be to having such an important piece on the board like NATO getting publicly emasculated in front of an audience of seven billion people?

What do you suppose the cost to peace will be when no one is left who trusts NATO’s guarantee of defense to allies and members? Russia is targeting this covenant on purpose.

The second takeaway is, despite the USA cutting our own balls off, people are still very afraid of us. Why else would so many plans be put into motion in the middle of a US holiday weekend, when our citizens are distracted? US public opinion can still turn the tide, but only if we can shake this internal depression that has crippled us into a state of sloth.

Watching Russia casually declare that neighboring countries were never really countries at all, as they roll back the clock manually with tanks; I can’t help but worry about where this takes us. I very much do not want the USSR reincarnating itself – the Russians are dicks and deserve to be treated as such. I’ll treat them with respect when they craft a form of government not predicated on keeping an iron toed boot on their people’s throats.

Too many hardliner nationalists in Russia seem to feel it is their God given right to create terrifying empires that lay waste to entire continents; as if this is somehow a privilege for the rest of us.

The place that should be most up in arms about this – Europe – has so far more or less lain down and is waiting to be dominated. The Europeans have spent the past fifty or so years fattening up, condemning self-defense, dismantling their armies, building a state of submissiveness. They’ve put social concerns like personal health & safety or identity politics before national security, eroding their own identities in the process. Now, no one will be safe.

Before this is over, I won’t be surprised if all of Europe is faced with a terrible choice of throwing off the safety nets, or being ensnared by them. Re-militarizing will put a strain on state programs. It will be very hard and painful; rediscovering one’s spine.

The only bright light is that much of the damage here is reversible. Not that this is any comfort to you if you’re under the curtain. But the places causing the most trouble are also the least self-sufficient and most prone to terrible accidents. I have trouble seeing Putin succeed for very long; his country’s legacy was assembled from the willing, back when the ideal of communism was embraced by millions. It collapsed in disillusionment. He’s trying to reassemble the unwilling with violence. That is a sure recipe for rot.

But why should this be happening now at all? If not for the weakness of wannabe leaders, it wouldn’t be. They threw away a century of hard fought gains, for ridiculous, self-righteous reasons.

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This Changes Nothing

What a dumb reason to sell off. Israel began a ground invasion and Russia probably smoked an airliner full of children. So what, I ask you, outside of the obvious moral quandaries posed there?

How does this effect US business?

If I thought for a minute the US was about to go to war, this might change something. But we’re not. Look at our chief executive – the man ate barbecue and “had a conversation” with Putin. Is that the posturing of a man itching to enter a war (or possessing a spine)?

I say to you, “no”.

These global events are fascinating to watch, and I’ve been having quite the time on Twitter watching Vox make complete asses of themselves.

But I seriously question any lasting impact either of this has on the US stock market.

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The Market Sure Looks Terrible

We open our week where once beloved technology companies continue their unfolding tragedy, sinking otherwise well to do enterprises and frustrating the market at large.

I shouldn’t even have to deal with this crap, do to a longstanding decision to shun big multiples tech firms and keep that trash out of my portfolio. Sadly, thanks to a wanting of such self restraint on the part of co-shareholders in the positions that I do have, I get to participate in the selling right alongside the rest of you; as if I owned a start up tech IPO that was knee-capped to the tune of 50% out the gate, anyway.

BAS was given a relief rally of about 4% today, which of course cratered into lunch. That led TheStreet to confidently assert that BAS is merely “dead cat bouncing”. Of course, TheStreet has been equally confident that BAS was dead money from $14, so my personal opinion of their articles related to BAS should be easy enough to guess.

The only positions I own that aren’t dragging me lower seem to be the multifamily themes – AEC and MAA (and technically speaking my hedging…but only because the losses on my PGJ and TSLA puts have already been had).

In summary, the 9th floor is smarting today and I find myself fearing a bloodbath, derived solely from a selloff in positions I would never own anyway.

Huzzah…

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