Quarterly Investment Outlook: June 2019


  • Geopolitical risks have intensified since our last communiqué and will represent a material risk to the economic expansion should the trade war intensify. We still maintain that risks are likely to dissipate as President Trump is forced to focus on his reelection campaign.

  • Over the last year-and-a-half the dollar was bought as a risk-averse investment, despite its deteriorating fundamentals. Two catalysts may cause the dollar to depreciate: converging global growth and interest rates.

  • The yield curve has taken on a sinusoidal shape, indicating that growth is likely to slow over the next couple of years. We maintain that the steepening of the long-end may be forecasting a period of structural inflation.  We believe that this inflation will be driven by a debasement of the dollar.

  • The Fed will begin purchasing Treasuries by yearend. Shoddy forecasting and poor policy decisions have significantly impaired the institution's credibility. It is increasingly likely that their policy tools will be ineffective at stimulating the real economy during the next recession and may only serve to inflate asset prices further.

  • The healthcare sector experienced a statistically significant selloff in 2Q19. We initiated a position in Allergan PLC(AGN) to take advantage of sector's weakness. The company is a restructuring play and represents a deep value investment.

To access the full report click here

Quarterly Investment Outlook: March 2019


• The December 2018 selloff provided buying opportunities in stocks relative to bonds, and cyclicals (energy, basic materials, technology, and industrial sectors) relative to defensives (utilities, consumer staples, and healthcare sectors). The last time that a selloff of this magnitude occurred was at the beginning 2016, a period that warrants further examination due to the many historic parallels that can be drawn between then and now.

• The selloff was dramatic in volume. The ensuing rally has been strong and broadly-based. However the average active manager did not re-enter the market and has excessive holdings of cash.

• Leading economic indicators that we track signal a continuing domestic economic expansion. Given that ninety-five percent of bear markets occur during a recession, we have a high degree of confidence in forecasting the continuation of the current bull market over the next twelve months.

• Technical and fundamental analysis, however, indicates that we are in the late stages of both the investment and business cycles. Historic trends support overweight positions in stocks and commodities and underweight positions in fixed income securities.

• The Federal Reserve has changed their outlook for the future level of the Fed Funds rate and their balance sheet runoff. The dramatic scaling back of expectations for Quantitative Tightening supports our thesis that the Fed will be forced to monetize the federal debt. Past episodes of debt monetization have resulted in an periods of higher inflation.

• The airline industry has undergone a significant consolidation that has provided the big four with immense pricing power. We initiated a position in Delta Air Lines, Inc. (DAL) to take advantage of this trend.

To access the full report click here

Quarterly Investment Outlook: January 2019


· The US recession indicators that we monitor show no imminent signs of danger, although domestic economic growth is likely to decelerate to 2.5% as we enter 2019. We believe that the selloff since September is a sharp and violent correction, not the beginning of a bear market.

· Fears of a yield curve inversion have been overhyped by the financial media, exacerbating Wall Street's sense of despair.  Inversions since 1978 have been accurate forecasters of recessions, however economic contractions typically occur with a lag of almost two years.  Moreover, since the late 1970s inversions have never marked a peak in the bull market, but instead signal the beginning of the final risk-on phase that has generated average equity returns of 25.2%.

·  Investor sentiment is washed out.  The current reading from the State Street Investor Confidence Index is at a low that has only been matched twice in the last decade.  From a contrarian perspective this level of fear may indicate that the market's path of least resistance is higher.

· The Congressional Budget Office's (CBO) projection of deficit spending continues to deteriorate.  Moreover, an analysis performed by Hoisington Management highlighted the CBO's estimates have significantly underestimated the rate at which the federal government's debt balance has grown.  Our analysis indicates that a recession by yearend 2023 could increase the level of Federal debt to GDP from 107% currently to 129% by 2024.

· This issue marks the introduction of the Portfolio Additions section, which highlights the investment rationale behind Stuyvesant's recently added core holdings.  In this issue we discuss Las Vegas Sands Corp., Paccar Inc., and The Chemours Company.

To access the full report click here

Quarterly Investment Outlook: September 2018



  • The rate of domestic economic growth is likely to peak in either 2Q18 or 3Q18 based on the leading economic indicators that we monitor.  Growth should subsequently trend towards the Fed's projection of long-term growth at approximately 2.0%.  If this is true then a continuation of the Fed's rate hiking program may result in an overly restrictive monetary policy within the next twelve months.  We will not be surprised if President Trump attempts to influence the Fed in order to appease his constituency by promoting a policy that will allow for the continuation of the economic expansion.

  • Quantitative tightening is causing the Fed's balance sheet to shrink at an accelerating rate.  The Fed's balance sheet has been positively correlated with the decade-long equity bull market.  It is disconcerting that the balance sheet is now beginning to shrink since this correlation is backed by a fundamental causation.  We ultimately believe the long-term path of least resistance for the Fed will be to decrease the rate of tightening

  • The Federal Reserve's Underlying Inflation Gauge is forecasting that inflation is likely to accelerate to above 3.00% within the next six months.  Rising wages, fiscal stimulus and higher oil prices should cause inflation expectations to trend higher.  Our fixed income allocation towards Treasury Inflation Protection Securities will benefit if the rate of inflation accelerates.

  • · We continue to forecast a recovery in G-10 ex-US economic growth in the closing months of 2018, where G-10 includes European countries plus Canada and Japan.  The current period of dollar strength is serving to reallocate growth away from the U.S. towards the G-10.  Chinese stimulus in the form of lower rates, a pickup in credit growth, and higher infrastructure spending should benefit growth in Asia ex-Japan.  Cyclical stocks have dramatically underperformed defensives over the last quarter.  Green shoots in the global economy relative to the US economy should serve as a catalyst in revaluing our cyclical and international holdings.

  • Oil production in the continental US is beginning to undershoot expectations.We believe this is due to insufficient investment in midstream assets, a lack of qualified laborers, and shortages of key drilling materials such as frack sands and water.These shortages are likely to continue into at least 2H19. A significant supply deficit is likely to materialize in oil as we enter 2019 due to continued OPEC production shortfalls, coupled with the re-implementation of Iranian sanctions.Oil stocks are cheap and remain a core holding.

To access the full report click here

Quarterly Investment Outlook: June 2018


  • In the May 16th FOMC policy statement, the Fed implied it will foster monetary policy that allows inflation to rise modestly above 2%, consistent with its symmetric objective.  This policy is equivalent to price-level targeting, which has been advocated in recent years by former Federal Reserve Chairman Dr. Bernanke.
  • The U.S. administration's recent announcement that it would be investigating tariffs on auto imports, as well as the lack of the clear trade policy with China, raises the risk of a "trade war".
  • 1Q18 earnings were strong, supported by an 8% yoy revenue gain.  While earnings growth is forecasted to slow into 2019, profits should continue to support equity prices, which should lead to another increase in the stock market into 2H18.  Normally the best gains in a mid-term election year occur in Q4.
  • Global growth is diverging.  The U.S. is strong while the Eurozone and China have lost momentum.  The recent decline in the euro should benefit European growth/equity markets in the second half of the year.  It should be particularly helpful to the weaker members.  China should be aided by a lower bank reserve requirement (with the release of additional reserves), coupled with the potential for more fiscal stimulus, which we are anticipating. 
  • We believe the dollar has entered a multi-year bear market driven by long-term deterioration in both our fiscal and current accounts.  Gold miners should be an excellent hedge against future dollar weakness and the growing possibility of monetizing the expected increase in Federal debt.             
  • We expect bond yields to resume their upward climb later in the year after a brief consolidation, driven by an increase in inflation.  This is supported by the trend in the Fed's Underlying Inflation Gauge, a leading indicator that is currently at 3.2% yoy.  BCA Research recently noted that for the first time in the 17 year history of the BLS JOLTS Survey, job openings exceeded the number of unemployed workers.  A surge in the proportion of workers willing to leave their jobs, at a time when it is getting more difficult for employers to find skilled labor, should also foster higher wages leading to increased inflation.
  • Our favored domestic sectors include Energy, Financials, Materials, and Healthcare.  Following a 16% gain in oil prices, the Saudi oil minister stated that OPEC was likely to increase production quotas at their June meeting, which has led to profit-taking.  We believe that OPEC production will increase by several hundred thousand barrels in the second half of the year in an effort to offset the expected loss of equivalent Venezuelan production.  With strong demand, oil prices should rise above $80/bbl with risk to the upside.  There has been insufficient investment in ex-shale energy producing assets, causing an increase in the fragility of the oil production system. 

To access the full report click here

Quarterly Investment Outlook: January 2018


  • The 2-10 year Treasury spread has flattened by more than 50% since yearend 2016 to approximately 60 basis points (bps).  Core personal consumption expenditure inflation (PCE) at 1.45% is struggling to trend higher and inflation expectations remain soft, despite wage inflation increasing 2.6% yoy.  The Fed could make a policy error by raising the Fed funds rate once in December (probability currently > 90%) and once more in March (probability currently > 60%), reinforcing market sentiment that inflation is unlikely to return to 2.0%.
  • We ultimately expect lower business taxes and expensing of capital equipment to survive a resolution of the House and Senate.  With the US economy operating at full employment, additional fiscal stimulus is likely to be inflationary to the extent that it is funded by increased deficit spending.  There may be some productivity benefits, but most businesses will use the increased cash flow to pay down debt or to increase shareholder returns via share buybacks and dividends.
  • In Germany, the 10-year bund yields a paltry 35 bps, which coupled with the strength of the economy and headline inflation at 1.80%, leaves financial conditions excessively easy.  Effectively, the real 10-year bund yields -145 bps.  The average spread between the US and German 10-year yield is historically 40 bps.  The current spread of 200 bps is unsustainable and should narrow in 2018, leaving the US dollar with further room to decline.
  • Our analysis of recession risk indicators (the rate of change in the Leading Indicator Series) continues to support the notion that the business cycle is unlikely to turn down over the next six months.  However, other measures of growth such as the ISM Manufacturing Index and the U.S. Economic Surprise Index are at elevated levels.  This is typically followed by a decrease, which may signal a slowdown in economic momentum.  This does not indicate a recession, but rather a decrease in the rate of growth over the next six months.
  • The US equity market is significantly overvalued.  The CAPE-10 P/E Ratio stands at twice its historic mean and median levels.  While valuation metrics are not good market-timing tools, they do suggest that real forward returns are likely to be nominal when viewed over a 10-year period. Market leverage is excessive and could exacerbate selling should prices drift significantly lower.
  • Preservation of capital is now paramount and value securities still trade at a significant discount to their intrinsic value and to the market. Our domestic equity holdings are geared towards late-cycle value plays, such as energy, financials, industrials, and miners.  Select foreign markets continue to offer relative-value and are better positioned to benefit from the global synchronized recovery.

To access the full report click here

Stuyvesant Insight: The Market Is Broadly Overvalued

The S&P500 returned over 20% since the November 8, 2016 Presidential election.  The investment community attributes the increase to strong and synchronized global growth, earnings growth, and business optimism due to the possibility of corporate tax cuts and reduced regulation.

In fact, as determined by FactSet, analysts estimate that S&P500 earnings will grow by 11% in 2017 and 10% in 2018.  A back of the envelope calculation shows that an increase in earnings has already been discounted by the market (1.10*1.11=1.22 or 22%) through 2018.  This is also evident via the 12-month forward P/E multiple (below).  This multiple is calculated by taking a weighted monthly average of the Wall Street analyst's earnings estimates for the current and next year.  It then divides the price of the market by the 12-month forward estimate.  This year the multiple has expanded from 16.94 to 18.00, indicating that 6.3% out of the 17% advance YTD is attributed to multiple expansion.  This indicates that almost 40% of this year's advance is due to multiple expansion, not to a fundamental improvement in earnings.

Source:  www.stuyvesantcapital.com and FactSet

Source:  www.stuyvesantcapital.com and FactSet

The Stuyvesant Earnings and Dividend Discount Model uses a cyclical P/E ratio, 5 year earnings forecast, and 5 year dividend growth to calculate present value.  Since 2015, the price-to-present value metric trended upwards for the Dow30 (below).  Currently it stands at 104% of present-value.  Usually we avoid adding a stock to our core list unless it trades at 90% of present value.  As such, the Dow30 would have to decline by 14% before it qualified as a buy.    This indicates that the price of the Dow30 largely discounts Wall Street's 5-year earnings growth at the prevailing discount rate.

source: www.stuyvesantcapital.com

source: www.stuyvesantcapital.com

Moreover, the breadth of the Dow30 (below) confirms the overvaluation.  The percentage of constituents that are fully valued (PV > 100%) stands at  60%.  This indicates the overvaluation is not confined to a few outliers, but a majority of securities. Moreover, 24 stocks or 80% of the Dow30 trade at a premium to our 90% investment threshold.  

source: www.stuyvesantcapital.com

source: www.stuyvesantcapital.com

In a market that is broadly overvalued, it is pertinent to selectively take profits in order to reduce risk.

Quarterly Investment Outlook: September 2017

• According to market strategist Tom Lee of Fundstrat, stripping out the 10 largest weighted S&P 500 stocks, would result in a gain of 4% ytd.  This is evidence of how narrow and selective the market advance has been.  A tech S&P 500 weighting of 25% has bolstered the returns of these 10 top gainers, and propelled growth returns of +17.7% over value at +4.7% thus far.  With growth overvalued, we believe we are close to an inflection point where value will likely outperform, perhaps for the next several years.  This will negatively impact the returns of passive investment strategies, similar to what happened in l999 when  the dotcom stocks peaked. 
• The Fed should shortly announce its scheduled balance sheet reduction plan.  Initially, they will let $10 billion of treasuries and mortgage backed securities mature without reinvestment.  This will gradually rise to $50 billion monthly by yearend 2018.  The runoff of investments will cause a decline in excess reserves, but is unlikely to negatively impact risk taking.  For many years these reserves have been sitting dormant, earning interest but not used by commercial banks to increase lending.   
• Nevertheless this policy may have unintended  consequences.  A smooth running exit may engender "animal spirits," and lead to increase in risk taking.  An increase in borrowing would drive interest rates higher, causing the Fed to respond with its usual lag, by pushing up the Fed funds to perhaps 2% (FOMC dot target for 2018).  Under this scenario, Treasury yields on 10year maturities could hit 3%, a level that would increase volatility in risk assets. 
• Oil prices should rise over the months ahead, benefitting from declining inventories and flat production, which are offsetting seasonal demand weakness.  Meanwhile, geopolitical risks are elevated.  These include possible curbs on Venezuelan imports, a termination of the Iranian nuclear deal, and a possibility the Saudis will be forced to act alone, before their scheduled November 30th OPEC meeting, by cutting production to stabilize cartel compliance at 70%. 
• Ninety-five percent of equity bear markets are caused by U.S. recessions. While valuations are stretched, and the Fed is gradually removing liquidity, we see few signs of a recession beginning in the next six to twelve months. 
• As such, equities should outperform bonds, at least through the first half of 2018.  Foreign markets offer more attractive value, and should continue outperforming their domestic counterparts.  We prefer Europe, Japan (removed currency hedge), China "H" shares, and are looking to purchase South Korea on any weakness.  While U.S. tech/telecom are fairly priced, SK offers above average exposure to these sectors at more reasonable valuations.

To access the full report click here

Stuyvesant Insight: High Yield Bond ETFs Provide a False Sense of Liquidity

Exchange traded funds (ETFs)  securitize stocks, bonds, commodities, or currencies into funds that are subdivided into shares, which are tradable on exchanges.  They are often promoted for providing diversified exposure to an index at nominal cost.  I believe that investors are overlooking the inherent risk in securitizing certain assets into ETFs.  High yield bond ETFs might be at risk of significant underperformance during the next bear market due to the illiquidity of the underlying securities.

I would liken the risk that I see in high yield bonds to that of the securitization of mortgages into mortgage-backed securities (MBS) leading up to the Great Financial Crisis.  Those securities were championed for their diversification of the underlying issues and assigned investment grade ratings by credit rating agencies.  However, diversification did not address the fact that probabilities of default for all of the underlying issues would increase during a housing crisis (probability of default was conditional as opposed to independent).  Similarly, high yield bond funds are promoted as a liquid means to invest in illiquid high yield bonds.  However, I expect these securities will suffer steep declines if a liquidity event occurs in the event of a bear market.

I decided to examine the relative liquidity of high yield securities versus purported liquidity based on the inclusion of the same security in an ETF to determine if the ETFs provide a false sense of liquidity.

I began the study by assigning numbers to the 1,032 individual high yield issues that were held in the iShares iBoxx $ High Yield Corporate Bond Fund (HYG) on August 15, 2017.  Using a random number generator, I selected ten of the issues for further analysis.  I then followed a two step process to determine the relative liquidity between the individual issue and the ETF.

The first process was used to determine the actual average daily trade volume of each issue:

1.      Collect the daily volume per issue over the previous month (July 15, 2017 through August 15, 2017) from Bloomberg Finance LP.

2.      Aggregate the daily volume to determine the monthly volume and divide the monthly volume by the number of days that the exchange was open (22).  This produced the average daily volume per issue over the period.

3.      Count the number of days that each issue was traded and divide that number by the number of days in which the exchange was open.  This produced the percentage of days that the security was traded.

The second process was used to determine the effective trading volume of each issue as a constituent of HYG:

1.      HYG's net asset value (NAV) was recorded for August 15, 2017 at approximately $18.6 billion.

2.      Determine the dollar value of the issue as a percentage of HYG by multiplying the percent of the fund comprised of the issue by the NAV of the fund (data obtainable on iShares website).

3.      Divide the dollar value of the bond by the average price of the bond for the analytic period to determine the approximate quantity of bonds held per issue.

4.      Calculate HYG's average daily volume over the period and divide that number by the outstanding shares of HYG on August 15, 2017.  This approximately produces the daily turnover of the fund.

5.      Multiply the daily turnover of the fund by the quantity of bonds held per issue to determine the effective quantity of bonds traded per day.

I proceeded to divide the effective quantity of bonds traded in HYG by the actual number of bonds traded on the open market to determine the "Fund Liquidity Magnification Factor".  The results of this analysis are provided below:


The Fund Liquidity Magnification Factor  averaged 8.2x with a median of 6.4x.  Moreover, the individual issues only traded an average 67% of days that the exchange was open and a median 73% of days that the exchange was open.  I believe that this analysis indicates that ETFs for high yield bonds provide a false sense of liquidity for the underlying issue, which has given holders of the unit trusts a false sense of security. 

Thus far, the securitization of illiquid high yield bonds into liquid ETFs has not resulted in a market event.  Moreover, I admit that I am unable to identify at what point a problem might emerge, especially as the funds continue to benefit from ETF arbitragers.  ETF arbitragers are individuals or algorithms that, in times of great supply or demand for ETFs, will take advantage of the fund mispricing by buying (selling) the constituencies of said fund in order to create (break down) the ETF units and drive the price to the intrinsic value.  This arbitrage process has worked incredibly well over the last market cycle, which has reduced the volatility of ETFs the majority of the time (outside of flash crashes).

I expect that a problem will arise when volatility increases.  An increase in volatility decreases the certainty in calculating the intrinsic value of securities, which will negatively impact the price of high yield bonds.  It will similarly impact the certainty that arbitragers use in calculating the present value of securities to arbitrage.  Though spurts of volatility can emerge from geopolitical threats, such asa potential continuation of the Korean War, I believe that a prolonged increase in volatility will be caused by the next recession / bear market.  This will be the ultimate cause of a liquidity event in high yield bond ETFs.

In a period where the intrinsic value becomes more difficult to calculate, arbitragers will remove themselves from the market.  Heightened volatility will decrease their ability to forecast the intrinsic value of the bond, negatively impacting their ability to arbitrage.  At the same time, investor's will generally tend to become risk-averse.  As a result, I expect market for high yield bond funds to be dominated by sellers.  If there is a lack of buyers, the unit trusts may be broken down into their constituencies: high yield bond issues.  As depicted in our study, these securities are even less liquid, which should result in bids decreasing at a faster rate than for the ETFs.  Thus, breaking down the fund into the underlying securities in an attempt to realize the intrinsic value of securities will exacerbate the decrease in high yield bond prices.  HYG currently has approximately 1.5% of its assets held in cash that could be redeemed if the unit trusts experienced a sudden burst of selling.  After this cushion, the trusts will be broken down and sold on the open market.  HYG is only one example of a high yield ETF.  When you consider that there are more high yield ETFs and mutual funds that hold non-investment grade issues, the scope of a potential selloff magnifies.  Buyer beware.

Stuyvesant Insight: The CAD/USD Cross to Lead Oil Prices Higher

In a previous insight I highlighted the positive correlation between oil prices and inflation expectations. I asserted that oil prices would trend towards $55.00-60.00 by yearend due to decreased productivity in the Permian Basin, coupled with global restrained energy-related capital expenditures and OPEC's output cut.  I further asserted that this would drive the 10-yr Treasury yield higher due to an increase in the yield's inflation component.  This week we go to the foreign exchange market, which may be signaling that the recent advance in oil prices is sustainable.

The Canadian Dollar (priced in US Dollars) has been tightly correlated with price of West Texas Intermediate Crude Oil since 1999:

Source:  www.stuyvesantcapital.com

This relationship is derived from the fact that Canada is endowed with copious natural resources and is a net exporter of oil. Its economy is highly dependent on the natural resource sector and tends to outperform when the oil price is strong, supporting its currency.

From a technical perspective, the CAD/USD cross just violated a multiyear downtrend:

Source: www.stuyvesantcapital.com

Currency traders typically have a high degree of leverage assigned to their trades.  Most long-term downtrend lines have large blocks of available securities on the ask-side.  Breaking this would require significant volume from buyers.  The fact that the trend has been violated indicates that forex traders wagered vast sums that the Canadian Dollar would continue to appreciate relative to the US Dollar.  Based on the strong positive correlation between CAD/USD and WTIC that has existed since at least 1999, I expect oil prices will trend higher.  This should lend support to the 10-yr Treasury yield based on my past analysis.

Stuyvesant Insight: The Copper-Gold Ratio

An announcement that China is looking to ban copper scrap imports, coupled with higher than expected mine depletion, strong demand, and decreased mine productivity (strikes at world-class mines) caused copper to increase 5.7% this week through Thursday's close.

This week's roll-out of an affordable Tesla may have  also caused analysts to begin increasing their projections for the global demand of copper.  The average American car has approximately 55 pounds of copper wiring, while electric cars require closer to 150 pounds. As a result, the International Copper Association increased copper demand for cars and buses from 185,000 tons in 2017 to 1.74 million tons in 2027. The near ten-fold increase would represent 7% of today's global copper production.  Moreover, years of depressed copper prices caused copper miners to defer green field projects.  They, instead, increased output via smaller brown field expansion projects, which have already come on the market.  Freeport McMoRan's CEO, Richard Adkerson, highlighted on a recent conference call that the market would require prices to remain north of $3.00 per pound in order to incentivize new mine investment.  From there a new mine would take between five and ten years to start producing copper ore.  These projected changes in supply and demand fundamentals are beginning to have a material impact on both the absolute price of copper and price ofcopper relative to that of gold.

The copper-gold ratio is calculated by dividing the market price of copper by the market price of gold.  Copper is an industrial metal.  It is used in plumbing, electric wiring, and its anti-bacterial properties coupled with its malleability lend the metal to be used in medical equipment.  Demand increases during periods when economic output is rising.  Gold is a store of value.  It is molded into ingots, bullion, or displayed as jewelry.  Its actual industrial applications are limited.  The differing uses of the metals has allowed the copper-gold ratio to act as an accurate barometer of global growth.

The ratio began the year on the weak side, but recently trended upwards and made a new high as of July 27, 2017: 

Source: www.stockcharts.com

Source: www.stockcharts.com

This indicates that growth is strong, which is supported by global PMIs and today's second quarter US GDP print at 2.6%.

In his 2017 outlook, Jeffrey Gundlach of DoubleLine highlighted that the copper-gold ratio is a powerful coincident indicator of the 10-yr Treasury yield.  This is due to the fact that the copper-gold ratio and the real yield and inflation components of the 10-yr Treasury are highly correlated with global growth.  As you can see (below) the 10-yr Treasury yield has exhibited a trend similar to the copper-gold ratio this year:

Source: www.stockcharts.com

Source: www.stockcharts.com

However, the most recent upleg in the copper-gold ratio has been unmatched by an increase in Treasury yields.  We expect that the real yield will move higher given improving economic prospects.  We similarly expect that the inflation component will move higher given continued dovishness from the Federal Reserve coupled with higher oil prices.  This should continue to benefit value stocks relative to their growth counterparts.


Stuyvesant Insight: Reflation Before Inflation

Reflation implies an increase in the rate of inflation from below trend towards the Fed's long-run inflation goal of 2.0%.  It is often fueled by fiscal and / or monetary stimulus, which serves to increase aggregate demand.  The reflation trade that began in late 2016 was catalyzed by market hopes that deregulation, tax cuts, and infrastructure spending would be quickly implemented after the 2016 Presidential election.  This resulted in cyclicals / value stocks significantly outperforming their defensive / growth counterparts.  This trade reversed due to disappointing first quarter GDP (1.2%) and the now uncertain implementation of Trump's platform.  In spite of this a new reflation trade was born.

The new reflation trade is a result of the decline in the price of WTI crude oil, the US dollar, and long-dated Treasury yields in the first half 2017. This is a powerful combination for increasing for final demand.  Effectively, this serves as a tax cut to workers via an increase to real disposable income (decreasing the percentage of household income directed to the non-discretionary oil-related outlays); an increase in global demand for our goods and services via devaluation of the dollar; and a decrease in the cost of capital investment due to the decrease in borrowing costs, which should support fixed capital investment.  In fact, US economic conditions have become increasingly reflationary despite the Fed tightening monetary policy by increasing the Fed Fund's rate three times over the past eight months (December, March, and June) to a range of 100-125 bps.


This is corroborated by Stuyvesant's Reflation Study, a leading indicator:

The Stuyvesant Reflation Study is calculated as the inverse of an equal-weighted index of Z-scores that are computed for oil prices, 10-year Treasury yields, and the US dollar on a monthly basis.  When this index trends above the zero-bound, it indicates that the economy is undergoing a reflationary impulse and when it is below the zero-bound it indicates that conditions are becoming restrictive.  A powerful up thrust began in late 2016 and continues through June of 2017.  Our study has historically been a leading indicator for the US Economic Surpirse Index shown below:

Citi's U.S. Economic Surprise Index measures the difference between expected economic versus actual data, smoothed over the past three months, weighted for the most recent releases.  When data beats analyst expectations the index trends up and when data misses the index trends down.  Given the propensity of our reflation study to lead the economic surprise index, we expect that the strong reflationary impulse will lead to positive economic surprises.

The New York Nowcast currently forecasts 2Q17 GDP growth at 1.90% and the Federal Reserve Bank of Atlanta's GDPNow model forecasts 2Q17 GDP growth at 2.5%.  We expect US GDP to grow at approximately 2.2% for the second quarter.  This is a long ways away from President Trump's 3.0% goal, but is greater than the Fed's projection of 1.8% potential growth.  The reflation trade should cause domestic growth to  accelerate into the back half of this year.  With second quarter economic growth already running above potential and tightness in the labor market (U-6 at 8.6%, which is near the low prior to the Great Financial Crisis), we continue to anticipate that yields will rise in the back half of 2017, led by inflation.  Any additional fiscal stimulus, financed through deficit spending, should be construed as a positive surprise and will exacerbate the reflationary trend.




Stuyvesant Insight: An Oil Price Reversal Should Benefit TIPS

The West Texas Intermediate Crude Oil price declined from a peak daily close of $54.04(02/27/2017) to a trough daily close at $42.53 (06/22/2017), a decline of 22%.  This was, in part, caused by the net-long speculative positioning in oil futures that were put on after OPEC agreed to reduce output for the first time in eight years in November of 2016 being unwound.  This liquidation began in March 2017 as global oil inventories proved more resilient than most analysts had anticipated  (below).

Source: investing.com

Source: investing.com

Analysts appear to have revised down their estimate for yearend 2017 WTIC prices.  In fact, many sell side analysts appear to have capitulated and stated that oil may break $40 per barrel since risk remains to the downside.  We believe that the en masse downgrade of oil service and exploration / production firms by sell-side analysts is indicative of a contrarian buy signal.

Over the last two weeks US inventories have begun to decline at an accelerating rate, while new-well productivity gains in the prolific Permian basin have declined (below).

Source: EIA Drilling Productivity Report

Source: EIA Drilling Productivity Report

This indicates that, without the addition of rigs to this basin, total basin production would have declined since the start of 2016.  The recent decrease in oil prices should lead to the deceleration in the rate that rigs are deployed, which could cause total US production to underwhelm analyst estimates and support oil prices.  In fact, we expect oil prices to close the year somewhere between $55.00 and $60.00 per barrel.  This could catalyze inflation expectations higher, which would lead to a pickup in the moribund inflation level and pressure bond prices.

This is due to the high correlation between WTIC oil prices and the 5-Year, 5-Year Forward swaps, a proxy for inflation expectations (below).

source: www.stuyvesantcapital.com

source: www.stuyvesantcapital.com

The coefficient of determination (R2) where inflation expectations are the dependent variable and oil prices are the independent variable registers 0.71.  This indicates that 71% of the level of inflation expectations are dependent on the price of WTIC.

We performed a simple exercise to determine where inflation expectation could end up if oil ends the year in our forecasted range of $55.00-60.00 per barrel.  To do this we determined the percent advance that oil would make from its 2017 trough to our high and low estimates.  We then adjusted that percent change by our R2 calculation to determine what percent change inflation expectations should experience due to the increase in oil prices, which allowed us to forecast a range for inflation expectations (below).

source: www.stuyvesantcapital.com

source: www.stuyvesantcapital.com

We expect that, if our oil forecast come to fruition, the 5-Year, 5-Year Forward Rate of Inflation Expectations will advance by approximately 37 to 52 basis points to a range of 2.15 to 2.30.  Since inflation expectations are known to lead inflation, we expect that a comparable increase in the 10-year Treasury yield could ensue caused by an increase inflation component.  This forecast could be enhanced or dampened by extraneous factors that are responsible for the, approximately, 30% of movement of inflation expectations not explained by the price level of WTIC.  As per our previous writings, given that the US economy is growing above potential and that the U3 unemployment rate is below the Fed's estimation of NAIRU, we would expect surprises to remain to the upside.  This leads us to expect Treasury Inflation Protection Securities to outperform nominal Treasuries.

Stuyvesant Insight: Private Credit Demand Trends Higher

Loans and leases of all commercial banks is a data series that is reported by FRED on a weekly basis.  This series tracks the total outstanding loans and leases within the commercial banking sector, including: mortgages, auto loans, consumer credit, commercial and industrial loans.  It is highly indicative of private sector activity.

Bank shares stalled the first six months of this year due to both a narrowing in the net interest margin (spread between banks assets and liabilities that determines its profitability) as well as a flat-lining in total bank credit (quantity of loans made, which are banks assets).  Recently, the 2-10 Treasury spread, which is a proxy for the NIM, has begun to expand.  It currently stands at roughly 98 bp after contracting to 78 bp on June 26, 2017.  More importantly, lending appears to have accelerated.

The graph (below) highlights the 52 week rate of change in loans and leases of all commercial banks and the annualized 13 week rate of change in all commercial banks. 

loans and leases.PNG

While the 52 week rate of change of loans and leases of all commercial banks (henceforth loans and leases) has only stabilized and trended sideways, the more volatile 13 week rate of change annualized of loans and leases has shown a rapid acceleration.  In fact, it is now running at a level commensurate with its average between 1Q14 and 3Q16.  This series has been a leading indicator for the 52 week loans and leases series, which implies that yoy loan growth should improve.  This indicates that private activity is strengthening.

This is supported by today's nonfarm payrolls report which showed an increase of 222,000 in June and an increase in labor force participation to 62.8% , this week's ISM non-manufacturing index at 57.4%, and the ISM manufacturing index at 57.8%.  Moreover, the Atlanta Fed GDP Now model currently forecasts a growth rate of 2.7%, which is significantly greater than the Federal Reserve's estimate of long-run potential growth.

Even though wage inflation was today reported at a tepid 2.5%, it is still in excess of May's trimmed mean PCE inflation rate of 1.5%.  This indicates that real wages are rising, an inflationary phenomenon.  If energy prices can stabilize, inflation expectations should begin to increase.  I would therefore expect that the upward trend in bond yields to continue given strength in both the real and inflationary component.  Positive trends in private credit demand and an expansion in the net interest margin bodes well for bank profitability

Stuyvesant Insight: Value to Outperform Growth

Below is a screenshot of the performance of the S&P 500 value index relative to the S&P 500 growth index:

V to G.PNG

There has been a dramatic underperformance of value year-to-date (-9.83% through May).  However, the RSI (measure of relative strength) and the MACD (measure of momentum) have perked up from deeply oversold levels and are trending higher.  Moreover, the value index began an outperformance phase in early June.  We expect this phase to continue.

Growth stocks' earnings increase at a stable rate.  As a result, investors will assign more certainty to earnings forecasts and will discount them further into the future when computing their present value.  This causes growth stocks to have a longer duration, a measure of risk used in computing certainty of cash flows.  An increase in bond yields results in an increase to the discount rate applied to the company's future cash flows, which has a disproportionately negative impact on the net present value of growth stocks.  Investors are less willing to pay up for growth stocks if their earnings aren't positively impacted by improving global growth and their valuations are more susceptible to rising interest rates.

The earnings ofvalue stocks are cyclical.  Their earnings accelerate during periods of strong global growth and decelerate during periods of weak growth.  As a result, investors discount their earnings over a couple of years, resulting in shorter duration securities.  Therefore, a period of rising yields, due to accelerating growth, tend to disproportionately favor both the earnings and valuation of value stocks relative to that of growth stocks.

These observations have supported the relative outperformance of growth to value this year.  Firstly, weakened 1Q17 domestic growth negatively impacted projected earnings of value stocks relative to growth stocks.  Secondly, the yield of the 10-year Treasury peaked in February at 2.60% and has since trended lower in a parallel fashion with the value-to-growth ratio:

Stuyvesant's June 3Q17 Investment Outlook highlighted that the path of least resistance for bond yields is up.  A powerful rally in yields has since ensued, catalyzed by hawkish international central bankers and strong global economic data.  We expect this trend will continue,  favoring the continued relative outperformance of value stocks.

Quarterly Investment Outlook: June 2017


  • Stronger domestic growth is needed to validate the expansion in p/e multiples since year-end, which is our base-case given 2Q17 growth is projected to be 3%.


  • Inflation rates and breakevens have declined in 2017, but we view this condition as temporary.  Despite a moderation in U.S. economic growth, financial conditions remain accommodative and global activity has gained momentum.  Brexit talks could be contentious. Weighing all of the above, we see little reason for the Fed to alter its rate hiking path.  We continue to expect one hike in June to be followed by another in December.  The September meeting could feature preliminary discussions on downsizing the balance sheet.


  • A rebound in economic growth and inflation will depend on an improvement in money velocity.  We are somewhat encouraged that the momentum of velocity is slowly improving.  An increase in business borrowing would accelerate this trend.  Loans and leases in all commercial banks are expanding at 3.9% yoy.


  • We expect any correction to be brief, possibly to the 2250 level on the S&P 500, and to be followed by a resumption of the cyclical bull market.  Looking out into early next year, we see some potential dark clouds on the horizon.  Specifically we are concerned about the Fed's desire to reduce its $4.5 trillion balance sheet.  Should this result in a reduction in excess reserves, it would lead to a significant tightening in financial conditions.  Stay tuned!

To access the full report click here

Quarterly Investment Outlook: March 2017


  • We continue to expect a grinding cyclical recovery with an upward bias to bonds yields.  However in the near term:  equity markets are extended, momentum is rolling over, and sentiment is elevated, pointing to a period of consolidation/correction.  Bond yields are correcting their 4Q16 advance and could test 2%, at which point we intend to move to below average duration.
  • The slowing growth in non-farm hours worked, lack of upward momentum in non-defense capital goods orders, and the elevated level of Economic Surprise Index makes us skeptical of analysts' earnings forecast of 10% growth in 2017.
  • Monetary policy is set to tighten over the next two years.  The forward 12 months  p/e ratio at 18x is at a decade high.  Eroding margins and rising interest rates will limit further multiple expansion.
  • CBO budget projections forecast that deficits/debt should trend higher over the next ten years, reflecting increases in both health and retirement benefits.  This assumes modest growth and no recession, which most analysts, including ourselves, believe is far too optimistic.  As of this writing there is little clarity regarding Trump's fiscal plans, including the extent to which they will be deficit neutral.  In the end, tax relief and infrastructure spending are pro-growth.  However they could be largely offset by a border tax and/or targeted tariffs.  Tariffs can be implemented by executive order and would represent a potential roadblock to our cyclical recovery thesis, and a continuing bull market in risk assets.
  • The equity market is fully valued as shown in our proprietary earnings and dividend discount model.

To access the full report click here

Quarterly Investment Outlook: January 2017


• The essence of Trumponomics appears to be 1) a tougher stance on immigration, 2) to  renegotiate existing trade agreements if possible,  3) implementation of tariffs on Mexico/China ranging from 35% - 45%, 4) to reduce marginal personal tax rates from 39.6% to 33%, while simplifying the income tax bracket from seven to three, 5) to reduce corporate rates from 35% to 15%, 6) an increase in infrastructure and military spending, 7) to curb regulation. 
• Since 2009 real GDP has averaged 2.1% CAGR.  Measured on a yoy basis, the gain for 2016 is a meager 1.7%.  The Federal Bank of Atlanta GDP tracker is currently forecasting Q4 growth of 2.4%, bolstered by rising consumption, residential investment and equipment purchases.  The outlook for increased fiscal stimulus, noted above, could result in GDP growth of 3% in 2017. 
• Business confidence feeds off of the consumer.  In this regard it is encouraging that the Michigan Consumer Sentiment, a measure of consumer confidence, came in at 93.8 for November, up from a forecasted reading of 91.6.  This is a positive development as the initial reaction of the consumer to Trump's victory was to express optimism about their personal finances and improved prospects for the economy. 
• The reaction to Trump's election was immediate and was expressed in higher stock prices, rising treasury yields, and a stronger U.S. dollar.  The S&P 500 at 2213 now trades 5.2% above its 200day moving average, which indicates an overbought market.  We are concerned that the advance has been narrow, with the NYSE Advance/Decline Line, a measure of market breadth, failing to confirm the recent new highs in the S&P 500.  In addition, our valuation analysis shows the market has already largely discounted expected earnings growth of 9% for 2017. 
• Dollar strength is pressuring corporate earnings, which just recorded their first positive yoy gain in seven quarters.  Margins are under pressure from rising unit labor costs and nominal revenue growth.  Rising interest costs will also pressure forward earnings with corporate leverage having risen in the past several years, due to companies buying back shares.  Domestic companies are in the best position to benefit, especially those with pricing power.  Oil and gas shale producers are our favorite industry choice. 
• In order to move from a defensive to cyclically biased strategy, we need to see more evidence of 1) real fiscal stimulus, 2) clear signs of a recovery in global growth, 3) a pause or reversal in the dollar's advance, with strength in EM currencies, 4) a steepening in the yield curve, 5) continuing advance in the stock/bond ratio.  Preliminary signs point to increasing economic momentum in both China and the U.S., which are major drivers of global growth.

To access the full report click here

Quarterly Investment Outlook: September 2016


·Fed policy appears to be shifting toward price level/nominal GDP targeting.  A price level targeting policy is geared to raising inflation expectations, thereby creating a backdrop conducive to increase spending.  Maintain core TIPS holdings as a hedge.

·Treasury yields are at risk of moving higher.  We calculate "fair value" at 2.3%, using the 10-year maturity.  An overshoot to 2.5%+ would create a buying opportunity.

·The oil markets have largely rebalanced according to energy analyst Matt Conlan, at BCA Research.  We believe there is increasing risk of a spike upwards in 2017.

· Global growth is stagnant, but marginally positive.  Policymakers in the U.S./China, which collectively account for roughly 38% of global GDP, are slowly shifting to targeting more stimulus via fiscal thrust.

·The S&P 500 has entered an overshoot phase, which could ultimately reach 2400.  Over the intermediate-term the market is overbought and may consolidate/correct its recent gains above 2050.

· We are maintaining our defensive industry core holdings, while selectively adding cyclical exposure.  Our foreign holdings in China "H" shares, Japan (currency hedged) and Europe offer better value.

To access the full report click here

Stuyvesant Insight: The Flight to Safety Makes Treasuries Expensive

Recent flows into long duration Treasuries has resulted in yoy out performance of Treasuries relative to the S&P 500 that is currently approaching the one sigma mark, a sign of statistical significance (68% of data are observed between the one σ bands).  This is indicative of a prevailing pessimistic outlook with respect to both growth and inflation that has only occurred over two periods in the past decade, The Great Financial Crisis and The European Debt Crisis.

We believe that the current search for safety, resulting from the Brexit Vote, is becoming overdone and that the political response will be looser monetary and fiscal policy out of Europe, Japan, the U.S., and China.  This is likely to put a floor under depressed yields.  We believe that this valuation metric is evidence that the time is approaching to be sellers rather than buyers of domestic sovereign debt and will continue to look for opportunities to take profits in bonds.