Happy Labor Day!

As we say goodbye to the unofficial end of summer, this Labor Day remember those who helped build our great country and celebrate the achievements of the American workforce.
Wishing you a safe and enjoyable Labor Day filled with family, friends and cookouts!
 
Heritage Capital LLC

Stocks Looking a Little Tired

The bull market remains alive and reasonably healthy. I am still long-term bullish. I am still fairly bullish over the intermediate-term.

With that out of the way, stocks are looking a little weary at all time highs, which should not be totally unexpected. The market has powered higher all month and started to struggle a bit of late. At least for now, I think risk equals reward or perhaps even slightly outweighs reward.

To refresh the rally, stocks can either decline over the coming few weeks or enter a sideways trading range for a few weeks to a month. Should the market continue higher here without participation remaining strong, I would have more intermediate-term concerns. For now, a mild, orderly and routine 2-5% pullback would be very welcome.

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Treasuries Sneak Quietly into Favor

As you know, I have been a treasury bond bull almost all year, putting me squarely in the severe minority camp. 2014 began with the masses all forecasting much higher interest rates across the spectrum. Astute investors know that the masses are usually wrong, especially at major turning points.

Jeff Benjamin from Investment News continues to listen to my usually contrarian side of investing and wrote a great article which you can click on below. Keep in mind that this market has rallied tremendously and is certainly due for a pause or outright decline at some point sooner than later. The easiest money has already been made.

Treasuries Sneak Quietly into Favor

In a few minutes Janet Yellen speaks at the Fed’s annual summit from Jackson Hole Wyoming which happens to be one of the greatest ski resorts on earth. People say they go for the winter, but stay for the summer. Anyway, unlike her predecessor who used Jackson Hole to lay the ground for further QE, Yellen is likely to say absolutely nothing meaningfully new.

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The Fed has It Wrong with the Taper

This is certainly not new news for my readers, but I continue to be in the very lonely camp that the Fed is misguided in tapering the $85 billion in monthly bond purchases and they should totally hold off raising interest rates until our economy gets to the other side of the next recession.

As you know, we have been in the slow growth and no inflation camp for years, a theme we still have a high degree of confidence in, hence our very large position in long-term treasuries this year in our Global Asset Allocation program.

Yields on the 10 year note have hit our downside target of 2.5% and even stretched to almost 2.3% before reversing. In the short-term, yields will probably rise and then at least revisit the 2.3% area next month or later.

Below is the most controversial of the three segments I did with the good folks at Yahoo Finance last week. Enjoy!

Fed Has It WRONG

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Rumors of the US Dollar’s Demise Have Been Much Exaggerated

The second segment I did on Yahoo Finance last Thursday was not a new one for long time readers. As many of you know, I turned very positive on the US Dollar right about the time Bear Sterns needed a bailout in March 2008. That was long before any QE (money printing) began.

Historically, the dollar spent most of its life oscillating between 80 and 120 on the US Dollar Index, an index containing a basket of currencies with the majority of the weighting against the Euro and Yen.

When the economy is strong and interest rates are typically in an uptrend, the index rises and vice versa. Usually, the US Dollar Index in anticipation of a weaker economy and lower rates and bottoms in anticipation of higher rates and a better economy. Remember, this is all relative against the rest of the world, but primarily against Europe and Japan. Additionally, in times of international crisis, the dollar is typically viewed as a safe haven.

For the past 6 years, the greenback has and continues to be one of the most hated investments, especially by the general public. They very wrongly assume that printing $5 trillion would devastate the dollar as the doomday’ers would have you believe. I can’t tell you how many times I have heard pundits talk about the “plunging dollar” or how Ben Bernanke’s money printing continues to punish it. The truth is, the US Dollar Index has never been lower than it was in March 2008.

Anyway, I didn’t mean for this post to be this long and go on and on. The segment I did last week on Yahoo Finance is below.

Why the Dollar Bears Have Been Wrong for the Past 5 Years

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The Most Hated Bull Market Continues

Yesterday, I spent a jam packed, fun filled day in New York City with client meetings and media interviews. Although I don’t enjoy the commute in and out of the city, I do enjoy the hustle and bustle as long as the weather is good since I like to walk as much as I can. I absolutely hate taking dirty, smelly cabs that take forever to get around, but I will hop on the subway when I have to go downtown.

I began my day with the good folks at Yahoo Finance creating three controversial segments. Jeff Macke, my favorite regular host who loves to disagree, ride me and try to get me out of comfort zone was on vacation so Milanee Kapadia filled in and did a masterful job. I really enjoyed chatting with her. She has a way about her interviews that is unique in today’s fast paced environment.

The first segment is below and it’s certainly not new to my readers who know I have and continue to believe that this is the most hated and disavowed bull market of the modern investing era.

“Hated” Bull Market

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M&A Hot Means Market Not?

Merger and acquisition activity has long been a trusty sign of a maturing equity market cycle

By Jeff Benjamin

Jul 16, 2014 @ 11:55 am (Updated 3:54 pm) EST

Twenty-First Century Fox Inc.’s offer Wednesday to pay $92 billion for Time Warner Inc. is all the proof anyone needs that the M&A market is hotter than ever.

In mid-day trading, Time Warner shares were up almost 16% in an otherwise flat equity market.

As economic indicators go, merger and acquisition activity has long been a trusty sign of a maturing equity market cycle, which can now be added to a long list of frothy-market indicators.

The latest data from Intralinks Holdings Inc. show that 2014 merger and acquisition activity is on track for its first year-over-year increase since 2010. The estimated total of this year’s announced deals could be up as much as 10% over last year, according to Matt Porzio, vice president of strategy and product marketing at Intralinks. The company does not share data on numbers of deals, just movements by percentage.

“Now that we’re halfway through the year we can see what the announced deals are likely to look like,” he said. “The M&A market has been pretty much flat or down since the end of the financial crisis, but finally the announced deals will be up.”

According to the Intralinks Deal Flow Indicator, through June there was a 16% quarter-over-quarter and 12% year-over-year increase in early-stage global M&A activity.

The company’s forecast for increased activity in announced deals throughout the end of the year is based on due diligence activity that it monitors on its platform, which enables companies to quietly research and negotiate deals.

“The combination of a good lending environment and high quality assets and companies for sale are driving this growth,” Mr. Porzio said. “Deal volume continues to go up and we expect to see a good number of high profile deal announcements through the end of 2014, especially in sectors like manufacturing and telecommunications, media and entertainment.”

While M&A activity is a reliable indicator of market cycles and patterns, it doesn’t always translate well to investment opportunities, according to Paul Schatz, president of Heritage Capital.

“Merger arbitrage strategies are above most investors’ and most advisers’ pay grades,” he said. “But, typically, during the life of a bull market, seeing M&A activity steadily increasing suggests a maturing market, especially when the buyers are not paying with cash.”

In periods like right now, when equity market valuations are high and debt is inexpensive, acquisitions can be fueled by and easily financed with stock and debt, Mr. Schatz added.

“When money is so cheap, why pay with cash when you can float bonds and use company stock?” he said. “This is a normal progression of a bull market, but it doesn’t mean it will end tomorrow, just that it is progressing along.”

Joseph Witthohn, portfolio manager at Emerald Asset Management, agrees that the pace of M&A is strong and will likely get stronger as the economic recovery continues.

“I suspect all the recent activity is simply the case of companies realizing that they better get moving before some other company comes in, makes an acquisition and changes the playing field,” he said. “With the U.S. economic recovery appearing to be strengthening, not allowing competitors to increase market share becomes an even more important goal.”

Despite all the activity and indications of more to come, it remains a tough racket for most average investors, based on the performance of two of the highest-profile M&A-strategy mutual funds. The $2.5 billion Arbitrage Fund (ARBFX) has gained just 1% since the start of the year, while the $5.6 billion Merger Investor Fund (MERFX) has gained 2.8%.

Both funds, however, are “market neutral,” which means they are not expected to post outsized gains or significant underperformance.

Over the same period, the S&P 500 Index has gained 7.9%, and the market neutral category, in which the merger funds are categorized by Morningstar Inc., has gained 1.3%.

Reading the Short-Term Tea Leaves

To reiterate a comment I think I have made each and every week for at least three years, the bull market may be old and wrinkly, but it’s not dead. It continues to be the most disavowed and hated bull market of the modern investing era and that’s why it will live on. On an almost daily basis, another “market professional” comes out of the woodwork on why stocks should not be at these levels.

Several good friends of mine in the industry have been calling for a 20% decline since early 2012. They tell me that the stock market is manipulated and is heading for doom. Those are the same people who when on the correct side of the market, tell me that it’s all just the normal functions of the capitalist system. To me, it all sounds like sour grapes and rationalizing a wrong position. I have been wrong many times in my 25 year career and will be wrong many more times before all is said and done. It’s okay to be wrong, but it’s not okay to ignore the evidence and stay wrong.

Given my long-term view, that doesn’t mean that the stock market won’t pullback or correct from time to time. It’s been just about three years since the last full fledged 10%+ correction which ended up being roughly 20%. Stocks are long overdue for significant downside, but that doesn’t mean it will happen tomorrow. I have been in the pullback (4-8%) camp for several weeks and remain there today.

At this point I see three possible scenarios for stocks over the coming months, two of which can be seen below. The first one is labeled “bullish scenario” as it has the current bounce running out of steam sooner than later, followed by a decline that exceeds last week’s low by a small margin into the “cushion zone”.

The “cushion zone” is an area where the market spent most of its time between mid February and late May recharges its batteries for that powerful spring rally to all time highs. On the way back down, it’s also the area where stocks should find some cushion as if someone leaped off a ledge and into a giant mattress. That zone should cushion the market’s fall and start a new rally to all time highs next month.

On the other hand, the chart below is the “bearish scenario” which has the stock market actually rallying further than the “bullish scenario” in the very short-term, but stopping before hitting new highs. From there, stocks roll over again, similar to the path we saw in 2011, falling more than 10% and through the “cushion zone”.

 

The good news is that we won’t have to wait long to eliminate one of the aforementioned scenarios. There is a third path that is also possible, but I won’t fully flesh that out for now.

Is your portfolio properly positioned this year? If you are not sure, don’t hesitate to hit REPLY or call the office to schedule a meeting, call or Skype.

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The Bounce The Bounce The Bounce

In the spirit of Herve Villechaize telling Ricardo Montelban on Fantasy Island, “Da Plane Da Plane Da Plane”, here is the bounce, the bounce, the bounce.

After writing about the market bouncing and what was “supposed” to happen in several posts, stocks cooperated on Friday with what has been described as a “huge rally”. I am always keenly aware of what questions I am asked by the average investor as well as the comments. Over the weekend, folks I spoke with were in more of a celebratory mood,  believing the pullback is over and all time highs are in store this month.

I hope to have a Street$marts out later today, but in short, the evidence does not suggest an immediate return to all time highs on the way to Dow 18,000, at least not yet. I am watching a few different scenarios which I will share shortly after I am able to eliminate one.

With the anticipated bounce here, it’s important to watch how far price rallies and what the market internals suggest. High yield bonds were hit very hard and if they do not bounce very hard, that will indicate a more complex and deeper pullback than just 5%. Also, with so many sectors seeing significant damage, this bounce is vital for the intermediate-term trend.

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Getting Anywhere?

Early Monday I wrote about the market setting up for a bounce. And that was certainly the case on Monday. Tuesday, however, was a different story as stocks gave back all of Monday’s gains and then some. Wednesday’s solid action, once again, puts the stock market on bounce alert.

I keep using the word “bounce” instead of rally because it looks like there needs to be some more work on the downside before the current pullback wraps up. With each successive red day, the markets seem to be rebuilding the wall of worry necessary to begin the next meaningful rally. The problem is that this does not happen overnight.

Stocks are “supposed” to make some upside headway right here and now. Treasury bonds are “supposed” to pullback right here and now. Gold is “supposed” to rally right here and now and the dollar is “supposed” to decline right here and now. That’s the short-term scenario, some of which I positioned clients for while some isn’t worth the risk.

I am still keenly watching which sectors lead the bounce and which cannot get off the carpet. Right now, very few look enticing for more than a quick trade.

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