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Todd Harrison: A View of the Financial Universe

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The future is here and it wants its money back.

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I haven't written in roughly a year; not here, or anywhere. After fifteen years of sharing real-time thoughts all day every day, the economics of digital publishing changed and with it, my course in life. MV Products was sold to T3Live in October 2014 and I stepped away from the screens for the first time in 25 years.

When Minyanville.com launched at the turn of the century, there were no blogs or social media spigots and as is the case whenever supply outstrips demand, the value of the underlying asset depreciated in kind.  I prefer to believe the digital publishing model broke given the spirit and mission of Minyanville but I may be post-rationalizing our inability to build the Walt Disney of Wall Street.

Be that as it may, many believe Minyanville Media, Inc., the company, was sold but that's not true. The website, IP, archives, gaming engine, capital structure and other assets remain property of MV shareholders, of which I am the largest one. It's yet unclear how those assets will be utilized but we've got this platform so we might as well use it.

Before we dive into the world at large, I'll proffer that my perception of the digital media landscape changed when I was done chasing eyeballs (which prefer to click on salacious headlines) and selling subscriptions (many publishers employ scare tactics and fear-mongering). That methodology was never our bag and I suppose we paid the price. Still, I often shake my head at the varying levels of punditry, salesmanship and certitude with which views are presented as fact in the media.

So let me get this out of the way: Nobody knows what's going to happen in the global financial markets. Nobody. Not me. Not you. Not the guys using fancy verbiage on TV. Not the people offering a quick-fix solution. Not the advisors looking to leverage your political leanings into a business relationship. Nobody.

The best advice I can provide to a faceless audience is to rise above, hitch your wagon to people you trust and hold on for the ride. Or better yet, look at the last fifteen years as your training--High School, if you will--before you moved on to bigger challenges, lessons in tow.

So where are we? Not sure ...but let's discuss.

We've been talking about the evolution of social mood for the last decade, a discussion that was ratcheted higher in 2008 after "the government bought the cancer and sold the car crash." (That last link provides context for this next conversation)

I do believe the powers-that-be were forced to arrest what we'll call the first phase of the financial crisis. Corporate America--any company with a financing arm, really--would have been pulled into a derivative-laden overly-leveraged abyss. To this day, I'm not sure most people realize just how close we were to missed payrolls, non-working ATMs and let's face it--it would have hit home real fast once the kids got hungry.

So the great news is that we side-stepped that...or, more aptly, swallowed it. The US government facilitated the greatest transfer of wealth in history and trillions upon trillions of dollars shuffled from the balance sheets of corporate America to We, The People.

For every action, however, there is an equal and opposite reaction and more often than not, excess will breed excess.

If 2008 was all about putting a Band-Aid on a broken bone, the coming / emerging / eventual crisis will be akin to nuking the bone entirely. The magnitude of the dollars involved is mind-boggling and that was before the European Central Bank and Bank of Japan raised the stakes.

Through the lens of social mood, the resulting progression (after buying the cancer) can be over-simplified as follows: societal acrimony-> social unrest-> geopolitical conflict (Note: a more thoughtful discussion can be found here; to understand where we are, you must appreciate how we got here).

Social mood shapes risk appetites and by extension psychology, which is why psychology has emerged as the most critical of the four primary metrics used to shape financial price action (fundamentals, technical analysis and structural are the others).

How do we know this? Many of the issues being discussed didn't magically appear; they've been lurking beneath the surface of the rising tide of returns. I mean, why would anyone care about structural imbalances when the S&P has rallied 220% in six years? The answer is they wouldn't. People only care once when it hits them in the bottom-line (which begs the mention that the S&P is only 13% off all-time high, although most stocks have been hit far worse).

So where, exactly, are we, as we look ahead? A few analogies come to mind--dancing on the head of a pin, for one--but I prefer more basic language: After many years of leveraging the future on behalf of the present, the future is here and it wants its money back.

Most of what we're experiencing--market volatility, geopolitical tension, and economic war games--are mere symptoms of policy directives that remain cumulative in cause and effect.  It all has an end-of-the-Roman Empire-esque feel to it; the gravity of a historic transition of the world order.

Let's dig deeper, for purposes of a contextual backdrop. On one side, there is the internet, the single most deflationary invention of all-time (which is awesome if you're a consumer looking for a deal but terrible if you're a producer in need of profit margins). On the other, global central banks are trying to 'take the other side'  of that structural deflation with a dizzying array of stimulus and tough talk.

(Insert 1% rhetoric here but let's be real--career bankers, those pushing the policies, know that all else being equal, inflation, rampant inflation, borderline hyper-inflation even, beats the pants off watershed deflation, at least for those who actually own risk assets; all you have to do is follow the money). Here is a primer on deflation.)

At first, global central banks worked together to reflate the system in an attempt to spur the velocity of money, which they hoped would morph into legitimate economic growth. You know all about the velocity of money from your High School economics class; it's the grease that churns capitalism. Fannie and Freddie did that until um, they didn't and then central banks tried to fill their shoes.

What was there to lose, right? Worst case scenario, the outcome was pushed into the next news cycle, when it would then become a problem for someone else's legacy; you know, after all the checks cleared.

Setting the stage, foreign holders of dollar-denominated assets got crushed in the seven-year stretch between the internet bubble and the first phase of the financial crisis; the US Dollar index dropped about 40%. Think about if you owned gold and it went up 40%; you're psyched until you realize the measuring stick used to measure your wealth dropped by 40%, so you're actually flat.

Then 2008 arrived; economic fear and destruction, followed by reflate-city USA.  Central banks throughout the world would soon adopt the same script. "Trust us, we've studied the models," said someone somewhere knowingly. All of a sudden, the business model was suspended, the notion of recession became anathema, free-market capitalism failed and the world was squeezed into risk assets.

There was so much money in fact; it needed a place to park--so foreign holders of dollars bought high-end real estate (which presumably came with its own parking spot).  Buy it in their currency, they must have thought, and eliminate the currency hedge. Smart!  Except that that marked the low-tick for the dollar and it has rallied higher since.

Imagine how frustrated you would be as an individual investor if that happened to you. As a sovereign government--an aspiring super-power even, it must have been maddening.  Do you think the Chinese government would stand for that? No shot.  Putin? Nope. OPEC? Ha, no.

In fact, in my view--and remember, nobody knows--WW3 already began without a single shot being fired. Contrary to popular opinion, the end-goal of war is not death, it is economic destruction and it feels like that memo is making its way around the world.

Russia has been saber--rattling for some time. Crimea, for starters, but it was more about how Crimea went down. Putin has made two things quite clear: he is his own man--straight out of an Old Spice commercial, really--and Russia, through his eyes, deserves better; they've got muscle and motivation and it would seem, something to prove.

OPEC, meanwhile, flooded the markets with oil; a nose-scrunching maneuver at first but its easy enough to understand their decision to inflict as much damage as possible on future competition (US producers, many of whom remain levered through high-yield, increasingly unserviceable debt). Get crude to a level that won't clear the market and let your competition vanquish, or something along those lines.

There's China, which began to devalue their currency as their own policies imploded (and accounting issues emerged and real estate crashed and...), putting even more pressure on the global financial system, particularly the emerging markets still reeling from the crude crash.  There is economic espionage too, which is a direct extension of this discussion.

Then there's Japan; after losing the decades-long war on deflation, they adopted negative interest rates (NIRP) as a test balloon for a world where banks charge people to hold money. There are lots of unknowns with NIRP--the government-dealer relationship shifts from -"counter-party" to competition (for assets), there is the natural propensity to hoard cash, thereby increasing crime, and other inconsistencies but we'll leave that for another time.

Point is, what started out as a central bank Kumbaya has splintered into disparite policies as countries protect themselves; and the Federal Reserve, which raised interest rates in the face of the collective / continual easing, is the odd man out.  It remains to be seen how a finance-based *global* economy will work when central banks don't work together.  I say "remains" but truth be told, the markets already answered that question since the December FOMC meeting.

Follow me all the way back now. Those petrol-dollars were parked in illiquid high-end real estate and when crude crashed lower it created a "sell what you can" mentality in an effort (need) to shore up liquidity. Not only did that create pressure on the sources of funds, it forced (and continues to force) dealers to re-mark inventory (by setting a bid), which has illuminated the dark underbelly of shadowy markets where bids are assumed so long as nobody sells.

With upwards of 80% of NYSE volume high frequency trading (HFT), we can sense the potential for these multi-linear dynamics to produce air-pockets of illiquidity during periods of uncertainty.  Especially in a world where the top talent long-ago migrated from the sell-side (banks) to the buy-side (hedge funds), bringing with them the (ability to provide) liquidity in the marketplace.  

That's right, the same hedge funds that are perceived to be acceptable casualties in The War on Capitalism are the same shops that will save, or at least buffer, the process of price discovery that continues to evolve.  Ironic, isn't it?

Field Position in Pictures

Bottoms are points; "rounding tops" are processes--check the top right corner of the S&P chart below



This is the same chart over 20 years; S&P 1500/1600 is almost too intuitive as the first downside target.



The banks continue to scream for attention--and that can't be good.  Big resistance up to BKX 65/66.



Biotech price action suggests a secular shift away from that complex; massive resistance at IBB 280




And Finally...

In 2000, I wrote that I wanted to buy energy and metals, sell tech and financial, open a taco stand in Costa Rica and return in ten years. I had a similar sense last month, as memorialized on my Twitter feed (@todd_harrison).  I would include grains this time, but really anything we "need" vs. things we "want."  Gold was part of the discussion as an upside hedge against NIRP; if it can't rally on that, it's not going to rally period.

While I do believe there are more shoes to fall in the energy patch--lots of debt coming due; not every company will make it, and most -of them are tied together somehow--I'm inclined to trade that complex from the long side and high-multiple tech from the short side, with an eye toward a lower base-line for the overall markets.

I've operated surgically, right-sized risk and I certainly respect the market but I will note that as of this post, I own two stocks that don't honor the above thesis.

Twitter ($TWTR), with a cost basis ~$15.40, and GW Pharmaceuticals ($GWPH), a name I used to own in a space I love (cannabis) but it got too bubbly for my taste when it ran from $10 to $133; cost basis there is ~$44.50.

Both have binary events coming up--Twitter has earnings on Wednesday, which everyone expects to be Gawd-awful following two analyst downgrades.  Given the environment (even good reports have been taken out back and shot), there is kitchen-sink quarter risk that could reset the price lower.  For and with my money, however, and ever the contrarian, I sense much of the bad news is reflected in the 80% decline in the last year or so.  The stock trades heavy (doesn't rally with the tape) but those are my thoughts. 

GW Pharama, for its part, is expecting phase III trial results for Epidiolex which, according to Morgan Stanley, will result in a stock price anywhere from $25 to $190 (they are putting 70-30 odds on a successful trial; Bank America ($BAC) also covers the stock with a $150 price target).  So why is trading at $45?  The company has been dogged by accounting irregularities and owning the stock isn't just a bet on the trial, it's a vote of confidence that management cleaned up their act.  I'm on the outside looking in, but that's what I see.

Both extremely high risk and potentially high reward so I'll say it one last time-nobody knows; do your own work and good luck.

R.P.

Twitter: @todd_harrison


Position in TWTR,GWPH
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