Sage Weekly Letter – 7/8/2012

• Posted by Robert Sinn
• on July 8th, 2012

While Europe may have temporarily removed itself from the market spotlight, the shine from the EU Summit has already rapidly begun to dull. Meanwhile, US market participants used the July 4th holiday week to refocus on the domestic economy and, albeit briefly, look ahead to earnings season and individual equity selection.

With Friday’s weak non-farm payrolls report marking the third consecutive month of disappointing employment growth and the consensus holding firm that the Fed is out of the equation at least until after the election, equities appeared to have been left for dead as the week dragged to a close. That was until a predictable Fed rumor hit the wires about an hour before the close:

 

This continues a common theme which market participants have had to deal with during the last several years: Unsatisfactory economic growth/deflationary threats/market turmoil which prompts central bank and/or policymaker action or threat of action. 

The entire global macro picture can be summarized in a few bullet points:

• Slow/stagnant growth in developed economies
• Enormously high developed market debt levels which have prompted a debt de-leveraging/liquidity trap cycle
• Central banks that continue to ease monetary policy in order to promote economic growth and combat dis-inflationary forces
• Unprecedented global macroeconomic headwinds simultaneously emanating from a slowing Chinese economy and the highly uncertain, almost chaotic situation on the European continent

It is in the context of this environment that the battlelines have been drawn between those who say that equities are cheap based upon historically high equity risk premiums and low price/earnings multiples versus those who continue to point to the unprecedented global macro headwinds and the idea that US equities are in a primary bear market which began with the bursting of the dot com bubble in 2000.

What we do know for certain is that dis-inflationary forces, as evidenced by treasury yields and commodity prices, have grown stronger during the last several months:

 Click to enlarge 

 

We also know that of all the economic evils that have the potential for keeping the Fed Chairman up late at night, there is nothing more disturbing than the thought of too low inflation, or God forbid, deflation. Despite occasional references to the contrary, FOMC members almost certainly understand that monetary policy is extremely limited as to what it can do to ameliorate the high structural unemployment challenge currently facing the United States. However, there is nothing more pernicious to an economic recovery than the threat of deflation; therefore, if economic price data (import/export prices, PPI, CPI) comes in on the cool side over the next ten days it would not be far fetched to believe that Chairman Bernanke might drop a subtle hint of additional LSAPs during his July 18th Humphrey Hawkins testimony in front of the House Financial Services Committee.

Moreover, the recent strength in the dollar and last week’s fresh 2-year low in $EURUSD must be making some Fed officials a bit uncomfortable, particularly given that manufacturing exports have been one of the bright spots in the economy recently. A new $500 billion round of MBS focused QE would almost certainly knock the dollar back a few notches and help to soften some of the blows that are likely to be delivered to the economy later in the year from the uncertainty surrounding the 2012 elections and the dreaded “fiscal cliff”.

In summary I believe that Friday afternoon’s Hilsenrath Fed rumors are credible and likely to prove prescient over the coming weeks. However, with earnings season beginning Monday the focus for equity investors should not be on handicapping the Fed but rather on finding opportunities to buy attractively priced stocks in sectors that stand to benefit over the long run regardless of the assorted macro headwinds – in my view natural gas exploration & production ($XOP) is one such sector as natural gas offers a cleaner burning bridge fuel to our energy future while creating tens of thousands much needed domestic jobs:

 

$CHK, a stock which I wrote about a couple of weeks ago, has been faced with a panoply of headwinds over the past several months. However, as evidenced by the chart below the market appears to believe that the worst may be over and the 2013 NYMEX natural gas strip price of $3.55/mcf offers some light at the end of the tunnel.

 

 

Best Ideas

•  $GLD August bull put spreads, use premium intake to finance upside call purchases – gold is in a seasonally weak period until mid-August, however, a fresh round of Fed QE combined with simultaneous global central bank easing is likely to put a bid into gold ahead of schedule
• Long energy equities ($XLE $XOP) for a rotation into these names which have badly underperformed during the first half of 2012 – can also use a relative value pairs trade such as long XLE/short SPY or long XOP/short IWM
• The euro reminds me of bank stocks during 2007-2008 – everyone was bearish on the banks, they were heavily shorted, yet they kept going lower. Although I am not making a long EUR/USD call here, I want to point out the potential for a tactical long trade given Friday’s marginal new 2012 low and the Fed QE3 rumors – A sizeable new round of Fed QE could easily send EUR/USD 500+ pips higher.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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