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Monday, March 3, 2014
T-Report The Valley of Death
The Crimean War
The Charge of the Light Brigade is from the Battle of Balaclava in 1854. Conspicuously missing in any reference from that war is Ukraine. In fact, Crimea was effectively "gifted" to the Ukraine in 1954 by Khrushchev. The Soviet Union had a strong policy of attempting to break up, or at least dilute, strong groups of a single, non-Russian ethnicity.
So, the big problem today is that Crimea doesn't look or feel Ukrainian, and it is home to one of Russia's most important naval bases. For many, this always seemed like a recipe for disaster.
You lease cars, not crucial military bases. Having said that, I will admit to never fully understanding Gitmo, which is where the US leases a Naval Base (or interrogation center) from Cuba, a country that has been the US's enemy.
So what does this all mean?
The "Best" Case -- Independent Crimea
At this stage, the "best" case seems to be a deal that creates an "independent" Crimea. Russia can do some chest thumping, and the West gives up relatively little that really it hadn't given up before.
I don't see this ending without an independent Crimea. The situation went too far, and there doesn't seem any way to reconcile. There does not appear to be much interest from Crimea to remain part of Ukraine, and Russia won't stop agitating until it gets what it wants. The Ukraine can get some gas concessions from Russia to save face.
I see that as the best case. I am not sure that it is the most likely case because it is difficult to determine the following two questions:
2. Will the Ukraine or NATO take steps to provoke Russia?
Let's hope that the best case occurs as it shouldn't have a big impact on the lives of most people, even in Ukraine, and the markets should remain pretty calm.
The Slippery Slope -- Eastern Ukraine
Much of the eastern part of Ukraine is Russian speaking. Vitaly Fiks (the F in TF), was born in Odessa and spoke Russian not Ukrainian. That is the norm. Much of the heavily industrialized east has strong Russian connections.
The demonstrations have been spreading to cities in this region.
So, will Russia be content with Crimea?
This is where you have to think like a Russian leader. I have seen a few articles on the subject and too many analyze Russia with a Western perspective and agree that is what leads to mistakes. Think about who are the players here:
- One is a former colonel in the KGB (which I assume you don't get to be by being soft and naive) who has managed to come out on top in a country of oligarchs. The 0.01% in Russia do extremely well, are happy to flaunt it, and they go to great lengths (legal and occasionally otherwise) to defend it. This is a hard man who is used to getting his way.
- Another is a constitutional lawyer and a community organizer who can barely get people to agree not to default on his country's own debt. He has a great ability to fundraise, but he seems tired of the job.
- Then you have a leader who has been able to hold together the EU and shape it to suit her and her country. She has done a great job of balancing internal and external pressure. She is very smart. She understands the mindset of the East having come from the former East Germany. Frankly, I think she is the best hope, but she has been extremely quiet, and while cobbling together a bunch of central bankers has been difficult enough within the framework of the EU, putting together something, military or otherwise that gives Russia a challenge seems very difficult.
So, the next biggest risk is a push into eastern Ukraine, and I think it is quite possible, and there is a good lesson from Georgia on this one.
There, Russia effectively pushed 10 miles further than they had to. Then, as part of its negotiations, it conceded the territory from that last push and pulled back to the borders that it had wanted in the first place.
Why not push and see what happens?
At TF Market Advisors, we see this is our base case . Russians will creep into eastern Ukraine. We expect a reasonably quick resolution that again leaves most people unaffected and can leave the markets calm.
This is where it gets a little more troublesome, at least for the markets.
Germany started with Austria and then moved into other primarily German regions of other countries before World War II really getting under way. Germany was allowed to annex small areas, not deemed essential, I guess, by the rest of the world where many of the inhabitants seemed to welcome the change with open arms.
Belarus? Belarus was one of the first regions to form part of the Soviet Union. I have never heard a single Westerner suggest a visit to Minsk. It is heavily Russian speaking, heavily industrialized, and struggling. Is that next?
While Estonia and Lithuania seem to have re-emerged with strong nationalistic pride, that seems less clear to me in Latvia. Is that another area where you could see the ethnic Russians try and create a situation that could be more to their liking? Latvia seems less likely than Belarus, but we have moved from "likely scenarios" to where this could lead.
I don't think the markets would respond well to Russia, which is resource rich, flexing its muscle in this format. We don't think this scenario plays out, but if Russia is allowed to encroach into eastern Ukraine, expect growing fears of a Russian Anschluss to weigh on markets.
When the Cats Away, Syria Will Play
Syria has not yet delivered all of its chemical weapons to the authorities. From what I can tell, we are more in a lull than having seen any real resolution.
With all eyes on Russia, it could create an opportunity for Syria to cause serious problems. How could the US. go into Syria but leave Russia alone? Why wouldn't the Russians volunteer to help Syria?
This could happen in parallel with the events in Ukraine, and we don't think the markets would be comfortable with this. I think it is likely that we see some noise out of Syria, and this would be negative.
The Enemy of My Enemy -- Chinese Silence
China seems to be very quiet on the subject of Ukraine and territorial rights. Maybe this is because China has no interest in the outcome? Maybe this is because China isn't aware of what is going on? Those are both clearly not true.
Maybe China is watching the developments and deciding whether now is a good time to resolve its own territorial disputes. It seems that China has been getting more aggressive in and around the islands where it has an ongoing dispute with Japan. I doubt China does anything, but if it does, markets will be hit hard as that will create a question mark regarding global trade like we haven't seen in years.
It doesn't seem to be in China's interest to do anything, but then again, maybe the country's leaders think there won't be repercussions? So, we view this as unlikely, but will keep an eye out.
Other "Hot Spots"?
Are there other places, off our radar map, that might see this as an opportunity to be more aggressive?
We remain bearish on risk assets due to our view that they are overvalued. At this stage, we see very little from Ukraine priced into the market, and with our best case, that makes sense. Even with our base case (a quick and peaceful encroachment into eastern Ukraine) resolved, the impact should be minimal. This probably creates a little downside in the market, but that is it.
As some of the other scenarios potentially come into play, whether in reality or perception, the risk of further downside in the market is significant.
Since we are already recommending being short based on the economy and the misperception of the Fed's next steps, you effectively pick up the conflict for free.
With the Volatility S&P 500 (INDEXCBOE:VIX) being so low, picking up some downside protection makes a lot of sense here.
Tuesday, March 4, 2014
Turnaround Tuesday has arrived and on cue. The world has flipped its lid. War is peace. Down is up. Red is green. Heck, even Juan Pablo seems to be in a better place this morning.
The overnight catalyst was the softer side of Vlad Putin, who dialed back his rhetoric and said there is no immediate need for Russia to invade eastern Ukraine.
If he is to be believed, it was the first constructive sign offered by the Russian President since the escalation began. While he reserves the right to use military force to protect ethnic Russians, he said there is "no such necessity" at present, and it would only be used as a "last resort."
Is this the end of the most serious stand-off since the Cold War or a stall tactic as Crazy Ivan determines his next move? To borrow a quote from my favorite history teacher, "I don't know," and the early morning markets don't care.
We opined on the Buzz & Banter about the orderly nature of the tape yesterday, an almost begrudging pullback given the news. While the S&P (INDEXSP:.INX) and Russell (INDEXRUSSELL:RUT) closed below resistance at 1850 and 1182, respectively, and while the Nasdaq-100 (INDEXNASDAQ:NDX) held 3640, they remained within striking distance and will capture those flags on the opening.
Talk about false signals surrounding a massive technical level.
That's not to say that we're back in an Utopian environment. Signs of froth surround traders, and we'll reflect on them with a knowing look and an all-too-familiar familiar lesson.
Insofar that the specter of war was priced into the market yesterday, however, much of that will be unwound as the late-to-the-party bears get spanked and the "I knew I shouldn't have sold" bulls climb back aboard the Matador Express. That is, if no fresh headlines arrive to reverse that process again.
Headlines and levels make for frustrating bedfellows.
Wednesday, March 5, 2014
Many Banks Still Cheap
At Festivus 2012, Scott Redler, Peter Prudden, and I were standing around catching up on life and discussing finance. All three of us landed on Bank of America (NYSE:BAC). It was trading at around $10 at the time. Scott, being a wiser man than I was, said "That thing is going to $14." Peter chimes in with "$16," and I said, "$18 within 18 months." At the time, that meant gains of 40%, 60%, and 80%, respectively. Fast forward 15 months and Scott and Peter nailed it as I am watching my call basically come to fruition. I have spoken about this call countless times on Twitter (NYSE:TWTR) and even a few times on the Buzz. This was probably my highest conviction long-term trade of the last several years. I have happily watched Bank of America climb steadily over the months (with a few bumps along the way). So now that all of these targets have basically been met, do we, as investors and traders, just sell and walk away? Or do we double down?
I like to fall back on Paul Tudor Jones quotes in times like these:
Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum drawdown.
Don't be too concerned about where you got into a position. The only relevant question is whether you are bullish or bearish on the position that day.
What I mean here is this: I need to look at this in the light of where the market is today, not where the market has been. So all that being said, I will run the analysis again.
The fundamentals scream that it is cheap. Bank of America is still trading at a discount to book value, meaning that the price-to-book value is less than one, and it's actually close to 0.8. Cash flows are still strong. Loan losses are coming down. Liabilities are managed properly. Trading profits are stabilizing, and the bank has reduced its reliance on Fed Funds. All of these things are healthy for the company going forward and should also reduce the uncertainties around its future. Don't forget the the history of bank pricing. Banks have historically been a buy at 1.0 to 1.5x book value, and you sell them in the 2.5 to 3.0x book-value zone. I fully recognize that the market is still only five years away from staring over the cliff of the "impossible," but we are well away from it now. Banks should be returning to normal and historical pricing, meaning I continue to think that Bank of America will move much higher. The fear of collapse is still prevalent, as even today, I had someone ask me, "Aren't you concerned of another financial bubble?" This fear, particularly in several banks, is overstated and over-discounted. I can see Bank of America over $30 within the next 26 months, and within three years, I think it will have doubled again from this level. That means I still expect in excess of 30% per year out of it. Others that fit the mold are Citibank (NYSE:C), Zions (NASDAQ:ZION), and SunTrust Banks (NYSE:STI).
I am still a buyer of cheap banks here, and that list has my prime candidates.
Thursday, March 6, 2014
In the initial comments at the European Central Bank press conference, ECB President Mario Draghi made no changes in policy, but he reiterated the ECB's dovish language that an accommodative policy is still needed in light of lackluster economic data. He also firmly reiterated its forward guidance that rates will stay at present or lower levels for an extended time, and he reiterated that the bank is monitoring money-market volatility closely and that it stands ready to take decisive action with all available instruments. Talk of lower levels is new, though at 0.25% that means the ECB's board considered negative deposit rates or 0% main rates.
In his initial question, Draghi noted a number of stronger economic data over the past four weeks (since the last meeting), which caused the ECB to not act.
Bottom Line: Things aren't THAT bad just yet, and the ECB wants to keep a little bit of ammunition in our back pocket while things remain relatively calm. Euribor futures are falling with the March 2015 future moving to 0.345% from 0.315%. The market was expecting the ECB to be a bit more dovish than just using words. There is about 10 S&P points built into the market right now for the ECB to cease sterilization of its bond holdings and add the cash back to the system, but odds are traders won't see that taken out.
The ECB also released its updated forecasts through 2016:
- 2014 GDP raised to 1.2% from 1.1% prior
- 2015 GDP unchanged at 1.5%
- 2016 GDP forecast at 1.8%
- 2014 inflation lowered to 1.0% from 1.1% prior
- 2015 inflation unchanged at 1.3%
- 2016 inflation forecast at 1.5%
- ECB predicts inflation will accelerate to 1.7% in the last quarter of 2016
Addendum: Draghi noted in his Q&A that due to the high EUR levels that there is about 0.4% of disinflation in the Eurozone. Don't see a central bank talk about that very often, unless it's an emerging market central bank.
Friday, March 7, 2014
Japan Setting Up To Explode Higher
The bottoming process in Japan appears to be complete. Japanese equities should re-engage, and they potentially could even lead global equities in the intermediate period (2 to 3 months) immediately ahead.
The first chart shows an intermediate-term trend model for the TSE FIRST SECTION ISSUES (INDEXTYO:TOPIX). This model held perfectly at significant trend support. We at Archaea Capital think that it is rolling towards an upside break.
Click to enlarge
The second chart shows the TOPIX with a long-term "greed-panic" model. The urge to sell has remarkably increased despite prices going sideways and higher over the last few weeks. This should be strongly supportive of higher prices.
Click to enlarge
The third chart shows the TOPIX with a very long-term trend model. Japanese stocks have held this trend perfectly so far. If the resistance line is broken, we think that this could mark the end of the entire corrective phase in Japan (May 2013 to February 2014) and identify the next meaningful rally of this ongoing cyclical bull market.
Click to enlarge
We are now overweight Japan.
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