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How to kill a Unicorn

Brouwer & JanachowskiNovember 13, 2015

The market was strange this week. No real direction in credit or equities. The Fed turned from mildly dovish to decidedly hawkish with several Governors advocating the December rate rise. It's like watching a debate team convince themselves that they are absolutely right, so let’s do it right? All with me? There were also announcements of new Fed governors. Next year’s voters are more hawkish which means we’ll hear less about “one and done” and more about stepped increases through 2016.

Here are a few things that will happen when rates rise:

  1. In a land far away: Well, Europe. Overnight LIBOR rates for the Euro are (0.18%). For the US dollar they’re 0.19%, so a 0.37% dollar premium. A year ago they were at parity and the Euro at a very uncompetitive €1.40. It’s now at €1.07. If the Fed packs on another 0.25%, and the ECB stays with negative deposit rates, the dollar will soar. And that will hit industrials and the 40% of overseas sales of S&P reporting companies.
  1. Credit: Spreads of corporate investment grade debt will widen. Not to the point of putting companies in financial risk but certainly at the margin of raising borrowing for things like share buybacks.
  1. The 10 Year Treasury: probably won’t move from its 2.10% to 2.3% range. There just doesn’t seem to be the same demand for borrowing. This week we saw some dreary numbers from the NFIB, which represents companies with less than 500 employees who, in turn, employ 50% of Americans.

Elsewhere, we saw:

  1. Employment: The more we looked at last week’s NFP report, the less we liked. About 259,000 of the 271,000 new jobs were in the age 55-65 category, which are a lot of service and temporary positions. And this week we saw the Job Openings (JOLTS) report. Quit Rates, which measures voluntary labor turnover, were down. Here it is

  1. Equities: Quick hits are:
    • The market is becoming less and less impressed with buy-backs; they again underperformed.
    • Square, a San Francisco tech company, is coming to market at a 30% discount to its pre-IPO valuation (it has never made money), which turns the spotlight on the whole Unicorn and IPO debate.
    • S&P earnings are still down 2.2% year over year. Here is the percent of stocks trading above their 200 day moving average. Chart types (which we’re not, but you have to keep an eye on them) favor those blue lines as trading signals. And the next direction could be down.

Bottom Line: All the above does not mean we’re making big allocation changes. We like equities and there is a good chance of a year-end bounce. It’s just that we’re entering some very uncharted waters.

Christian Thwaites

--Brouwer & Janachowski, LLC

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