Entering Phase 1 - January 27, 2016

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Greetings,

The upcoming reversal in global monetary policy will be a two-stage process. Phase one is really just about the Fed, which needs to signal a “timeout” on further rate hikes while it evaluates the collapse in oil and the stress that puts on emerging markets. That could come as early as today when Yellen & Co. release their statement from the January FOMC meeting. If they insinuate that this month’s market volatility hasn’t impacted the “four hikes in 2016” narrative, expect another material drop in the stock market. The market never came close to pricing in four rate hikes this year, but it needs some reassurance that policymakers are oblivious to what’s going on.

The second phase will involve actively engaging in further stimulus. Last week, Mario Draghi intimated we should expect further action from the ECB in March. He gave few details, but that’s probably because the easiest option is more QE, which has proven to be ineffective at best. On Thursday there’s probably a 50-50 chance the BoJ expands its QE purchases. If not, they’ll pull a Draghi and signal action in March or April. But phase two won’t be complete until the Fed starts expanding its balance sheet again. Until then, the S&P 500 is capped at 2,100 on the upside and exposed to major declines on the downside.

I make the distinction between phase one and two because, unlike the other major central banks that haven’t raised rates, the Fed can’t backtrack so soon after a hike in December. It would be a major blow to their credibility and markets need time to price in the ramifications of such a shift. A pause from the Fed will be enough to lift the stock market closer to its 2,100 upper limit, but investors are tired of hearing “lowering for longer” from the Fed and the rally will get snuffed out after a month or two. On top of that, a Fed pause in conjunction with further ECB and BoJ easing is just going to make USD stronger – exacerbating all problems that sparked the sell-off starting January 4.

From there it will be up to markets to force the Fed’s hand and choke financial conditions to the extent that Yellen is forced to do something. It could be QE4, but Bernanke has already said that they’ll probably try negative rates before resuming further asset purchase because - as mentioned earlier – there’s no evidence that QE does anything. However, to think this is the fall of Rome and Treasury’s will start spiraling lower is a mistake. The Fed still has plenty of firepower to support financial markets, even if the 2016 election turns into a debacle.

This is really just an extremely broad playbook for how 2016 could play out. My monthly investment letter for February will have a lot more specifics with some trade ideas to make money in this environment, but if you’re just looking for protection, gold looks awfully reasonable here. Size the position so that a move below $1,000 doesn’t knock you out, because deflation is a fickle beast. But if you can hold the yellow metal for 2-3 years (maybe less) you should do more than fine.

The Cup & Handle Fund is up around +1.5% YTD, and +10.0% Y/Y. It’s the same story here. My view is that this performance is disappointing, but I’m still reading that hedge fund indices are -3.5% YTD. As outlined above, I still think there are big time opportunities to profit this year, so we’ll stay patient. As discussed, my February letter is going to be a little difference with several recommendations. We’ll see how y’all like the format and make a decision for going forward. Your feedback, as always, is appreciated. If you’d like to start receiving these letters click here.

With that I give you this week's letter:

January 27, 2016

As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro

Posted to Cup & Handle Macro Research on Jan 26, 2016 — 4:01 PM
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