After years of holding interest rates at near zero percent, with no hikes in about a decade, the U.S. Federal Reserve hiked rate last December.
They managed to crash the market in doing so.
And then just this month, they did it again (without crashing the market yet), raising the benchmark rate to a new range of 0.5% to 0.75%.
Yet, by historical standards it’s still low. It has to be.
We’re not ready to give up our much-needed crutches.
On the surface, the rate hike is great news. It means the Fed is showing signs of strength again, more than six years after the subprime-fueled crisis.
It means the Fed can now begin to roll back its assistance.
We’re back on solid ground. The economy can be self-sustaining.
But is everything really okay? Not really.
While I’d like nothing more than to tell you all is well, I wish I could.
Global markets are hitting new highs. The press is clamoring for Dow 20,000… even 21,000. There’s this incredible wave of euphoria that we’ve seen since Trump was elected. The US dollar has been skyrocketing. Companies are announcing they’re bringing jobs back to the States. Financial stocks are running on speculation of lax laws.
And we’re witnessing what may be the biggest post-election rally in history.
The Dow, the NASDAQ, the S&P 500 – even European markets – are rocketing.
But do the markets deserve such valuations? Are we being set up for a crash?
We have to remember the euphoria can’t last forever.
Analysts point to the cyclically adjusted P/E (CAPE) – a valuation metric created by Robert Shiller. According to reports, CAPE is now at 27.
The last three times it was a high – or exceeded – was in 1929, 2000 and 2008.
And we know how well that turned out.
History also reminds us there is no logical way stocks can remain at these elevated levels. Just as we saw with the Crash of 1929, too much speculation and borrowed money created a nightmare situation.
Even now, after nearly eight years and 28 record highs, we’re running into the same issue. There’s no support.
Equally troubling is the absence of true growth in unemployment and GDP. There’s hope, though, that both can and will improve as we move forward.
The Fed believes unemployment is now at 4.6% form 4.9%.
Unfortunately, 95 million Americans now off the labor participation rate, would disagree. Once we look at the U-6 –instead of the relied upon U-3- we can easily see true unemployment is closer to 10% than 4.6%.
The Fed also believes GDP is strong after averaging 1% to 1.5% growth in multiple quarters.
That’s not strength.
Despite the reality of the situation, markets are still challenging new highs.
But what’s really interesting is just who has missed the rally.
The markets may have exploded in recent weeks, but for hedge funds (still commanding top dollar with 2 and 20 fees), it was more of the same.
In November, the S&P 500 ran 3.7% higher.
Hedge fund returns were up a whopping 0.9% for November with many funds long one of the worst sectors to hold in recent months — technology.
Thankfully, they were also in financials, which helped slightly.
Believe it or not, hedge funds managed to miss the oil rally, too.
While some funds did well with oil, some didn’t do as well. In fact, many money managers shifted their sentiment on oil and went short.
In November, they were as bearish as they were in September before oil rallied 10%.
On November 14, 2016, the U.S. Commodity Futures Trading Commission (CFTC) released its “Commitment of Traders” report. It found that hedge funds had decreased their net long positions in crude for the third time in five weeks for the week ending November 8, 2016. Hedge fund bullish positions in crude fell to a seven-week low.
Then it happened.
OPEC agreed to cut by 1.2 million barrels a day to 32.5 million – the first such cut in eight years.
After weeks of intense back-and-forth, OPEC’s three biggest producers – Saudi Arabia, Iraq and Iran – resolved their differences. Most notably, the Saudis accepted Iran’s desire to raise production as high as 3.9 million barrels a day.
Then non-OPEC countries (including Russia) committed to cutting an additional 558,000 barrels a day. Russia agreed to cut 300,000 barrels. Mexico will cut 100,000.
And then something even odder happened.
As oil prices began to run higher, hedge funds shifted their sentiment again. As the rally began, many funds began to race to close their shorts. Now, the hedge fund community has turned its bearish position into one of the largest bullish positions on record.
The shift from short to long amounted to 228 million barrels in a week, taking the total net long position in crude to 728 million barrels.
No one has seen a shift like this in 25 years.
Sadly, hedge funds may have taken the wrong side of the trade again, as oil and many related names like Exxon Mobil (XOM) and Chevron (CVX) are over-extended.
Also not under consideration is the demand side of the oil equation.
Even as oil rallies to multi-year highs on OPEC and non-OPEC cuts, slowing demand could pull prices right back down. In fact, demand could increase at its slowest rate in nearly three years.
China for example isn’t increasing demand for oil as they once were.
Analysts also expect for higher U.S. interest rates to hit emerging market demand, too. Higher rates have historically weighted on crude consumption in those parts of the world.
The International Energy Agency (IEA) said that global demand for 2017 would rise only 1.3 million barrels a day, down from 1.4 million this year and 1.9 million in 2015.
Worse, Chinese oil production soared in November 2016.
The country – which is not part of the OPEC agreement – increased production by 3.4% in November to 3.93 million barrels – its largest since October 2013.
That could dent the oil party, too.