Economy

What’s the Fed Put and Does It Mean the Stock Market Will Rally?

Traders and analysts are once again wondering if the Federal Reserve will provide the “Fed put” that can potentially limit the down side of a stock market sell off.

In this case, the term “put” refers to a put option, which is an option that increases in value when prices fall. The idea of a Fed put dates back to the chairmanship of Alan Greenspan who sat at the top of the Fed from 1987 to 2000.

“During Greenspan’s chairmanship, when a crisis arose and the stock market fell more than about 20%, the Fed would lower the Fed Funds rate, often resulting in a negative real yield.

In essence, the Fed added monetary liquidity and encouraged risk-taking in the financial markets to avert further deterioration.

The Fed did so after the 1987 stock market crash, which prompted traders to coin the term Greenspan Put, later termed moral hazard. In 2000, Greenspan raised interest rates several times. These actions were believed by some to have caused the bursting of the dot-com bubble.

The Fed also injected funds to avert further market declines associated with the savings and loan crisis and Gulf War, the Mexican crisis, the Asian financial crisis, the LTCM crisis, Y2K, the burst of the internet bubble, the 9/11 attacks, and repeatedly from the early stages of the Global Financial Crisis to the present.

The Fed’s pattern of providing ample liquidity resulted in the investor perception of put protection on asset prices. Investors increasingly believed that in a crisis or downturn, the Fed would step in and inject liquidity until the problem got better.

Invariably, the Fed did so each time, and the perception became firmly embedded in asset pricing in the form of higher valuation, narrower credit spreads, and excess risk taking.

[Nobel Prize winning economist] Joseph Stiglitz criticized the put as privatizing profits and socializing losses and implicates it in inflating a speculative bubble in the lead-up to the 2008 financial crisis.

In 2007 and early 2008, the financial press had begun discussing the Bernanke Put as new Federal Reserve Board chairman, Ben Bernanke continued the practice of reducing interest rates to fight market falls.

The decision by the Fed to lower short-term interest rates to 50 basis points (0.5%) on October 8, 2008, and thereafter a range from 0.00-0.25% rate in December 2008 suggests attempts to create a Bernanke put similar to the Greenspan put.”

Proof of a Fed Put

Economists at the University of California considered the question of whether or not the put exists or simply a legend created by Wall street traders. In a paper called “The Economics of the Fed Put,”

Anna Cieslak and Annette Vissing-Jorgensen noted:

“We document that low stock market returns predict accommodating monetary policy by the Federal Reserve. Negative stock returns realized between FOMC meetings are a more powerful predictor of subsequent federal funds target rate changes than almost all macroeconomic news releases.

Using textual analysis of FOMC minutes and transcripts, we argue that stock returns cause Fed policy and document the mechanism underlying the relation.

Consistent with a causal effect of stock returns on policy, FOMC participants are more likely to mention the stock market after market declines—a pattern that arises from the mid-1990s—and the frequency of negative stock market mentions in FOMC documents predicts target rate cuts.

The FOMC discusses the stock market mostly as a driver of consumption and, to a lesser extent, investment and broader financial conditions. Less attention is focused on the stock market simply predicting (as opposed to driving) the economy.

In a Taylor rule framework, about 80% of the Fed’s reaction to the stock market can be explained by the Fed revising its expectations of economic activity down following stock market declines.

The Fed’s expectations updating is roughly in line with that of private sector forecasters and with the stock market’s predictive power for growth and unemployment.”

The stock market does appear to be a popular topic of discussion at Fed meetings.

economics of the Fed put

Source: The Economics of the Fed Put

“Over the 1994–2016 period, there are 983 references to stock market conditions in FOMC minutes. This number represents 14% of times that minutes mention inflation, and 31% of times they mention (un)employment.”

The authors also looked at other factors to determine what seemed to be the largest influence on the Fed. The stock market is among the most important influences.

estimates of regressions chart

Source: The Economics of the Fed Put

Is There a Powell Put?

MarketWatch recently noted that the current Fed Chair, Jerome Powell, seems to be following a similar policy.

“The Federal Reserve’s decision last week to signal a pause in the rate-hike cycle, adopting a wait-and-see approach just six weeks after delivering its fourth rate increase of 2018, took investors by surprise.

For one analyst, the move has echoes of the late 1990s, when a nimble Fed led by Alan Greenspan arguably set the table for a final stock-market “meltup” ahead of the bursting of the tech bubble in 2000.

Dario Perkins, managing director for global macro at TS Lombard, finds himself in the middle. The Fed could cut rates by the second half of 2019 as exports weaken and the economy begins to feel the delayed, full effects of the previous tightening in financial conditions, he said, in a [recent] note.”

But he doesn’t expect the U.S. economy to fall into a recession, which means that the Fed could resume hiking rates as the global economy strengthens into 2020.

He believes the Fed followed this pattern before:

Fed pattern chart

Source: MarketWatch.com

The first time was in 1995, a year after the Fed caused a lot of carnage in the bond market — that reverberated unpleasantly in emerging markets and elsewhere — with an aggressive round of rate increases that ultimately took interest rates above the level at which they neither boost nor slow the economy.

That year, the impact of all that Fed tightening was being felt at home. That led policy makers to reverse course and cut rates three times, in 25 basis-point increments, between July 1995 and January 1996 — a move that simply got rates back to neutral. In March 1997, the Fed shifted back into tightening mode with a quarter-point rate rise.

He’s certain that another round of market turbulence would lead the Fed to cut rates even before any tangible impact on the U.S. economy materializes.

Given the market’s bullish reaction to the Fed’s about-face last week, it is apparent that investors “realize the importance of the ‘Powell put,’” Perkins said, referring to the notion that the Fed will respond by loosening policy and providing liquidity in the wake of market turmoil.

“It even raises the possibility of a late-90s-style ‘meltup,” he said. “The only question is whether we need another December-style meltdown and Fed rate cuts before markets get bubbly, or whether the policy shift announced so far is already sufficient.”

Investors need to keep an eye on the Fed since that could provide a source of gains in the coming months.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Stock market

Stocks Under $15 With Growth and Income

Low priced stocks can deliver large gains, if the company can be successful. When considering what makes a company successful, many investors turn to earnings. They might believe that increases in earnings per share (EPS) are the key to success.

But, for low priced stocks, that might not be true. EPS would, of course, be nice. But, there are many items that come before earnings on the income statement, a summary of a company’s financial operations.

At the top of the income statement is sales. This could be the most important factor to success for a low priced stock. Sales are necessary to produce earnings. Sales are needed to generate cash flow from operations. In short, sales are a critical component of success for a company.

This week, we focused on sales, requiring companies to have reported sales growth of at least 25% over the past five years.

Then, we limited our search to low priced stocks.

Individual investors understand that low priced stocks could be appealing for two reasons. One reason is that the low price means they have little down side risk in dollar terms. The second reason is that low priced stocks are generally the ones that deliver the largest short term gains.

One study looked at how low priced, or cheap, stocks performed relative to more expensive stocks. The study found that cheap stocks delivered more than six times the average return of the more expensive stocks in a typical quarter.

That’s why we limited our search for potential bargains by focusing on stocks priced at less than $15 per share. While we would like to see stocks at even lower prices, there just weren’t many that passed our stringent screening criteria so we had to use a cut off value of $15 to ensure some degree of diversification in this screen.

Finally, we required the stock to offer a dividend that is higher than the risk free rate of return of less than 3% available on Treasury notes maturing in ten years.

One way to find stocks meeting these requirements is with the free stock screening tool available at FinViz.com. At this site, you could screen for a variety of fundamental factors, high levels of institutional ownership and bullish institutional transactions. An example is shown below.

FINVIZ stock screening tool

Source: FinViz.com

Five Stocks Meet Our Strict Requirements

Remember, there is no guarantee any stock will increase in value. Also, it is important to remember when we search for stocks using quantitative measures, our goal is to identify stocks that meet those criteria. The screens we develop could be used as the cornerstone of long term investment strategies but any individual stock in the list could be a winner or loser.

Ellington Residential Mortgage REIT (NYSE: EARN) is a real estate investment trust. It specializes in acquiring, investing in and managing residential mortgage and real estate related assets.

It constructs and managing a portfolio consisting of residential mortgage-backed securities (RMBS) for which the principal and interest payments are guaranteed by the United States Government agency or the United States Government-sponsored entity (Agency RMBS) and, to a lesser extent, RMBS backed by prime jumbo, Alternative A-paper manufactured housing, and subprime residential mortgage loans (non-Agency RMBS).

Its Agency RMBS include residential mortgage pass-through certificates, collateralized mortgage obligations (CMOs) and to-be-announced mortgage pass-through certificates (TBAs). Its non-agency RMBS include investment grade and non-investment grade classes.

EARN weekly stock chart

Infosys Limited (NYSE: INFY) provides business information technology services comprising application development and maintenance, independent validation, infrastructure management, engineering services comprising product engineering and life cycle solutions and business process management.

It also performs consulting and systems integration services comprising consulting, enterprise solutions, systems integration and advanced technologies; products, business platforms and solutions to accelerate intellectual property-led innovation, including Finacle, its banking solution, and offerings in the areas of Analytics, Cloud and Digital Transformation.

Its segments are Financial Services and Insurance, Manufacturing and Hi-tech, Energy & utilities, Communication and Services, Retail, Consumer packaged goods and Logistics, and Life Sciences and Healthcare.

INFY stock chart

Jupai Holdings Limited (NYSE: JP) is a third-party wealth management service provider. The company focuses on distributing wealth management products and providing advisory services to individuals in People’s Republic of China (PRC).

JP serves as a one-stop wealth management product aggregator and is engaged in developing and managing in-house and third party products. It provides asset management services in the management and advisory of real estate or related funds, other fund products and funds of funds.

It offers its services to entrepreneurs, corporate executives, professionals and other investors through a network of 72 client centers in 46 cities of China.

JP stock chart

Orchid Island Capital, Inc. (NYSE: ORC) is a specialty finance company that invests in residential mortgage-backed securities.

The company’s business objective is to provide attractive risk-adjusted total returns to its investors over the long term through a combination of capital appreciation and the payment of regular monthly distributions. Its portfolio consists of two categories of Agency RMBS: pass-through Agency RMBS and structured Agency RMBS.

ORC invests in pass-through securities, which are securities secured by residential real property in which payments of both interest and principal on the securities are generally made monthly. The mortgage loans underlying pass-through certificates include fixed-rate mortgages, adjustable-rate mortgages (ARMs) and Hybrid ARMs.

ORC stock chart

Tarena International, Inc. (Nasdaq: TEDU) provides professional education services, including professional information technology (IT) training courses and non-IT training courses across the People’s Republic of China.

TEDU offers courses in various IT subjects and several non-IT subjects. It also operates two children education programs. It offers an education platform that combines live distance instruction, classroom-based tutoring and online learning modules.

The company complements the live instruction and tutoring with its learning management system, Tarena Teaching System (TTS). TTS has over five core functions, featuring course content, self-assessment exams, student and teaching staff interaction tools, student management tools and an online student community.

TEDU weekly stock chart

Any of these stocks could be a potential winner and all worth further research. However, each of these stocks also carries a degree of risk and that should also be considered. Based on the charts, momentum investors may find EARN and INFY most appealing.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

 

Stock market

Potential Stock Market Winners Under the Green New Deal

Recently, New York Democratic Rep. Alexandria Ocasio-Cortez and Massachusetts Democratic Sen. Ed Markey introduced a nonbinding resolution that calls for the U.S. to generate 100% of its electricity from zero-emission sources in 10 years.

According to MarketWatch, “The wide-ranging measure also backs investment in “smart” power grids and zero-emission vehicles, along with the elimination of greenhouse gases and the cleanup of hazardous-waste sites.

There is not a lot of detail on particular technologies or how to pay for the proposed changes, but long-term investors nonetheless may want to pay attention to the Green New Deal,” said Josh Price, an energy analyst at Height Capital Markets.

“If you start to see some more of these ground shifts in politics — veering toward renewables, veering toward addressing climate change — it’s definitely bullish for these renewable energy companies and power providers,” Price told MarketWatch.

“This isn’t a near-term catalyst for us by any means, but for some of those slow-money, long-time-horizon guys, the biofuels space and the renewables space are definitely interesting places to look,” he also said.

Specific Trades to Consider

NRG Energy, AES, Xcel Energy and other “more-forward-looking utilities” that are shifting away from fossil fuels could be winners if there is a continued focus on limiting climate change, according to the Height analyst.

NRG Energy, Inc. (NYSE: NRG) is an integrated power company. The company is engaged in producing, selling and delivering electricity and related products and services in various markets in the United States.

The stock has been in an uptrend for some time and this news could push the stock to even more gains.

NRG weekly stock chart

The AES Corporation (NYSE: AES) is a holding company that, through its subsidiaries and affiliates, operates a diversified portfolio of electricity generation and distribution businesses.

It is organized into six strategic business units (SBUs): the United States; Andes; Brazil; Mexico, Central America and the Caribbean (MCAC); Europe, and Asia. According to recent regulatory filings, its United States SBU had 18 generation facilities and two integrated utilities in the United States.

The Andes SBU had generation facilities in three countries. Its Brazil SBU has generation and distribution businesses, Eletropaulo and Tiete. The MCAC SBU had a portfolio of distribution businesses and generation facilities, including renewable energy, in five countries.

The Europe SBU also had generation facilities in five countries and the Asia SBU had generation facilities in three countries.

The stock has been in an up trend for most of the past year.

AES weekly stock chart

Xcel Energy Inc. (Nasdaq: XEL) is a public utility holding company whose operations include the activity of four utility subsidiaries that serve electric and natural gas customers in eight states.

The company’s segments include regulated electric utility, regulated natural gas utility and other activities. Its utility subsidiaries include NSP-Minnesota, NSP-Wisconsin, Public Service Company of Colorado (PSCo) and Southwestern Public Service Co. (SPS), which serve customers in portions of Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin.

Other operations include WYCO Development LLC (WYCO), a joint venture formed with Colorado Interstate Gas Company, LLC (CIG) to develop and lease natural gas pipelines storage and compression facilities, and WestGas InterState, Inc. (WGI), an interstate natural gas pipeline company.

This stock has been in a consolidation after a rapid up move.

XEL weekly stock chart

Additional Opportunities

Action at the state level is key, Price told MarketWatch. The Green New Deal is likely to influence California, New York and other blue states, especially those that already have aggressive targets for their use of renewable energy.

California, for example, aims to get 60% of its electricity from renewable sources by 2030. So investors in companies tied to renewable energy could feel increasingly bullish because it could help ensure state action and then eventually lead to future nationwide legislation.

The resolution’s backers want to ensure that climate-change issues remain a priority as Democratic presidential candidates ramp up their 2020 campaigns, Price also said.

Contenders for the Democratic nomination who are co-sponsors include Cory Booker, Kamala Harris, Elizabeth Warren and Kirsten Gillibrand. Investors should be aware that there could be a political imperative to act on climate change if a Democrat wins the White House race next year, Price said.

While the resolution didn’t mention biofuels specifically, companies focused on these alternative fuels for cars appear set to benefit from the Green New Deal and related efforts, according to the Height analyst. Players in this area include Renewable Energy Group (REGI), Darling Ingredients (DAR), and Finland-based Neste.

“Between full electrification and what we have now, there’s space for these biofuels with low-carbon intensities to gain ground,” Price said.

Nuclear power initially looked like a Green New Deal loser, as a fact sheet for the plan that was circulated by Ocasio-Cortez’s office reportedly called for transitioning away from such plants.

Among those expressing concerns was Matthew Wald, a senior communications adviser for the Nuclear Energy Institute, an industry group whose board includes executives from American Electric Power (AEP), Duke Energy (DUK) and other companies with nuclear power plants.

“Is the #GreenNewDeal meant to stop #climatechange, or simply support natural gas and renewables?” Wald said in a tweet. “We need to use every tool that works, including #nuclear, our largest source of #carbon-free energy.”

But unlike the fact sheet, the Green New Deal resolution didn’t single out nuclear power. “The resolution is silent on any individual technology,” Markey said at a press conference, when asked about that particular industry.

The Green New Deal is far from legislation, but it could provide traders with opportunities. If it does nothing else, it could increase the attention of analysts and investors in the utility sector. That could be bullish for a conservative sector that, at times, garners little attention.

While there will be opportunities related to this news, there will also be risks.

This news could also add to the boom and bust tendency of emerging companies in the alternative energy space. This could mean biofuel stocks, for example, could become momentum trades and quickly lose their luster if news becomes less promising.

Whether investors agree or disagree with the politics of the Green New Deal, they should consider the investment implications of the news.

 

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Stock market strategies

Trade the Dogs of the Dow Strategy for 2019

You might be familiar with the Dogs of the Dow, a popular investment strategy that identifies stocks in the Dow Jones Industrial Average offering the best value. The strategy was first detailed in a 1991 book, Beating the Dow by Michael B. O’Higgins.

The strategy buys the ten highest yielding stocks from the thirty stocks that are included in the DJIA and trades just once a year. These ten stocks are known as the Dogs of the Dow.

Theoretically, high dividend yields are a sign of value in stocks as long as the dividend is safe. Large caps stocks included in the Dow are most likely safe and the committee that selects stocks for the index would almost certainly remove stocks before they fell into severe financial distress.

Dividend yields are usually viewed as providing information about income and most investors view them as an income screening tool. But in this strategy, dividend yields are identifying value just like the price-to-earnings (P/E) ratio or other popular ratios would.

When yields are used for valuation, the idea of relative valuation is being applied. We are not concerned with whether the yield is 1% or 10%. We are looking for the highest yields in a group of stocks that all pay a dividend.

Since each of the Dow stocks is an income stock, the dividend yield is a way to sort them and identify the most undervalued or overvalued stocks. This approach only works when applied to groups of stocks that all pay a dividend that is reasonably safe so yields have limited use in valuation screens.

Under the Dogs of the Dow strategy, in any given year some of the stocks should deliver market-beating gains, some will provide an average return and some will experience losses. Big winners are expected to significantly outweigh the losses. In the long run, the Dogs of the Dow strategy is expected to outperform the index.

The Data Supports the Theory

Results presented in the book showed simply buying ten stocks and trading once a year did in fact significantly outperform the market. Following the strategy from 1973 to June 1991 when the book was published would have resulted in a total return of 1,753%, more than three times better than the gains of the Dow which returned 559% over that same time.

That’s an annualized rate of return of 16.61% for the Dogs and 10.43% for the index. In the years since publication, the strategy has remained popular even though it has not really delivered the same types of gains.

In some years, the strategy outperforms and in other years the average does better than the Dogs. Since 2000, the Dogs have slightly outperformed the Dow, gaining an average of 8.6% a year while the Dow is up an average of 6.9% a year. Over other time periods, the track record is mixed.

Dogs of the Dow strategy chart

Source: DogsOfTheDow.com

Given the fact that the performance is so similar to the index in many years, some investors have looked for variations on the idea. Their thinking seems to be that the Dogs did so well in the original test there must be a way to succeed in the future.

One popular variation of the strategy is to buy only the five lowest priced stocks from the list of the ten high yielding stocks. This variation is sometimes called the Small Dogs of the Dow and after delivering great returns in the initial test period, it has also delivered mixed returns since publication, beating the Dow in some years and lagging in others.

Following the basic strategy involves investing an equal amount of money in each of these 10 stocks, or 5 stocks in the case of the Small Dogs, once a year and holding them for one year.

You can buy the Dogs or the Small Dogs anytime during the year and hold for one year before rebalancing or you can even rebalance two or four times a year.

In the long run, the results are about the same no matter when in the year when you start or how many times you rebalance the portfolio.

It is also possible to use options with the strategy to lower the costs. Long term call options could be used to implement the strategy.

Dogs for 2019

Barron’s recently updated the strategy performance. “Last year, the Dogs of the Dow beat the market. If you bought the 10 highest-yielding stocks in the Dow at the beginning of 2018, then your total return for the year was just over zero. Not great, but better than the Dow overall, which returned minus 3.5%.

Zero is also better than the S&P 500 which returned minus 4.4%, including dividends.

What’s more, if you kicked out General Electric (GE) when it was removed from the Dow in June, then your return improved, to 3.5%. GE was unfortunately the worst-performing stock (that started out) in the Dow last year, losing about 55% of its value.

In 2018, the stocks (or the dogs) in this strategy were: Verizon, IBM, Pfizer, Exxon Mobil (XOM), Chevron (CVX), Merck (MRK), Coca-Cola (KO), Cisco Systems (CSCO), Procter & Gamble (PG) and GE.”

For 2019, Barron’s noted, “This year nine of the 10 remain. GE is out and JPMorgan Chase (JPM) is in. That is the only change to the portfolio.”

2019 Dogs of the Dow

Source: Barron’s

As noted, call options could also be used. The advantage of call options is that they would require less capital. The disadvantage of call options is that the investor will not receive any income and could face losses of up to 100% on each individual investment and for the total investment.

However, buying call options on the stocks, whether the investor is buying 5 or 10 call options, is likely to use 10% or less of the capital needed to buy the stocks. This means limited trading capital is not committed to a single strategy in a smaller account.

The capital not used for the strategy could then be applied to other strategies and potentially enhance returns of the overall account.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Economy

Now Could Be the Time for Gold

The headlines are a cause for concern. This is honestly true at any news site. It can be market news, global headlines or even local news. It is true that news services have always focused on bad news but there certainly seems to be more bad news than ever right now.

Many investors believe gold performs well when uncertainty rises. The chart below shows that could be true right now.

Gold weekly stock chart

Analysts point to a number of reasons to consider gold right now.

The Fundamental Explanation for Investing in Gold

TradeStops.com recently explained why gold stocks could be an investment opportunity:

“Why are gold and gold stocks doing well in the midst of market turmoil?

In historic terms, it’s no surprise to see the yellow metal zig when everything else zags. Gold stocks performed quite well in the 1930s, for example, due to rising profit margins as operating costs declined and the price of gold stayed fixed.

Heading into 2019, gold and gold stocks are channeling investor worries around slowdown, debt, and inflation. These things are all connected: In the event of global slowdown, debt levels are likely to rise as governments borrow and central banks stimulate.

But with debt levels already high, more borrowing and stimulus could spark inflation and a loss of faith in paper currencies — which benefits both gold and gold stocks.

There are multiple flashing red lights warning of global slowdown right now. One of them is the price of crude oil, the world’s most important commodity. The price for the two major crude oil benchmarks, Brent and West Texas Intermediate, has declined roughly 40 percent since the beginning of October — a historic collapse in such a short space of time. This suggests global oil demand is in trouble.

Then too, bellwether companies like FedEx, who have a finger on the pulse of global business, are talking slowdown. In its latest earnings report — a disappointment — Alan Graf, FedEx’s executive vice president and chief financial officer, said the following: “Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near-term.”

This is a worry because the typical response to slowdown is piling on more debt. Governments step up spending to help the economies, and central banks revert to easy money policies and stimulus.

But the world is already awash in debt, and the debt hangover from the last round of central bank stimulus hasn’t yet passed. According to IMF data, global debt levels are more than $180 trillion. And central banks already have trillions of dollars on their balance sheets, with interest rates at historic lows.

So, it’s not clear governments can borrow more trillions to fight yet another slowdown, or whether central banks can add trillions more in stimulus to their balance sheets, without leading to a pick-up of inflation and a loss of faith in paper currencies.

If that happens, it will benefit gold and gold stocks — possibly in a major way.

The positive trend in gold and gold stocks, even as global stock markets see red, shows investors are giving more weight to this possibility now.

That makes gold stocks increasingly attractive, but it might not be what the rest of the market hopes to find in its stocking.”

Uncertainty Is Also Rising

Along with gold, uncertainty is increasing. This can be seen in the next chart.

Economic Policy Uncertainty Index Chart

Source: PolicyUncertainty.com

This is the World Uncertainty Index (WUI). The WUI is an index calculated “for 143 individual countries on a quarterly basis from 1996 onwards. This is defined using the frequency of the word “uncertainty” in the quarterly Economist Intelligence Unit country reports.

Globally, the Index spikes near the 9/11 attack, SARS outbreak, Gulf War II, Euro debt crisis, El Niño, European border crisis, UK Brexit vote and the 2016 US election. Uncertainty spikes tend to be more synchronized within advanced economies and between economies with tighter trade and financial linkages.

The level of uncertainty is significantly higher in developing countries and is positively associated with economic policy uncertainty and stock market volatility, and negatively with GDP growth. In a panel vector autoregressive setting, we find that innovations in the WUI foreshadow significant declines in output.”

Notice that the authors call attention to previous spikes which were associated with identifiable crises. Then, you can notice in the chart that the index is at an all time high, even without a single identifiable event to explain. That indicates we could expect increased market volatility and decreased GDP growth now.

Gold Could Be a Hedge Against Uncertainty

It’s possible to directly trade gold. This can be done with coins, ETFs or futures. Coins are collectibles and can have tax consequences that are different than investments in stocks.

Many investors are surprised to learn popular ETFs that back their shares with physical holdings of precious metals face taxes at the higher rate for collectibles. This includes SPDR Gold Shares (NYSE: GLD).

Futures carry their own tax consequences and risks and many individual investors avoid these markets.

Publicly- traded stocks of gold miners offer an indirect way to invest in gold. Mining companies are taxed at the same rate as stocks which can be lower than the rate for gains in GLD or other ETFs.

In addition to offering tax benefits, gold miners also offer the benefit of leverage. An example might be the best way to explain the leverage miners offer.

Let’s assume it costs a miner about $800 an ounce to produce gold and they mine 1 million ounces a year. If gold is at $1,000 an ounce, the company should generate a profit of about $200 an ounce or $200 million.

This is a simplified example so we will assume the company has no other costs and no additional revenue.

If the price of gold increase by 30%, to $1,300 an ounce, assuming the costs of production stayed the same, the miner’s profits would increase to $500 an ounce or $500 million for the company, an increase of 150%.

The miner is leveraged, in this example, 5 to 1, and benefits immensely from higher gold prices. Even smaller gains in the price of gold have a large impact on earnings. A 1% increase in gold prices (to $1,010 an ounce) results in a 5% jump in the earnings of this hypothetical mining company.

Remember, leverage can help increase investment returns on the upside but can cause significant losses on the downside.

A 1% decline in the price of gold could result in a 5% drop in earnings for this gold miner and we would expect the stock price to reflect the diminished earnings potential of the company. A 20% decline in gold would push the miner from a profit to a loss.

This leverage makes gold miners an excellent way to invest in gold. Buying miners while uncertainty is high could lead to gains in the short run and in the long term.

 

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

 

Stock market strategies

The Future Looks Scary for Investors

Investors might be disappointed in the future. At least that is likely to be the case if Dr. Phil is correct. The popular psychologist is fond of noting “The best predictor of future behavior is relevant past behavior.”

For investors, this does mean that there are reasons to expect patterns seen in the past to at least hold partly true in the future. Many analysts apply this philosophy to develop long term forecasts of stock market returns.

Many long term models apply mathematical models based on mean reversion.

In finance, according to Wikipedia, “mean reversion is the assumption that a stock’s price will tend to move to the average price over time.

Using mean reversion in stock price analysis involves both identifying the trading range for a stock and computing the average price using analytical techniques taking into account considerations such as earnings, etc.

When the current market price is less than the average price, the stock is considered attractive for purchase, with the expectation that the price will rise. When the current market price is above the average price, the market price is expected to fall.

In other words, deviations from the average price are expected to revert to the average.

Stock reporting services commonly offer moving averages for periods such as 50 and 100 days. While reporting services provide the averages, identifying the high and low prices for the study period is still necessary.”

This method can also be applied to fundamental data including price to earnings (P/E) ratios.

One Model Suggests Lower Than Average Gains Ahead

One research firm that takes that approach is Crestmont Research, a firm that “develops provocative insights on the financial markets, including the stock market, interest rates, and investment philosophy.

The research focuses on the drivers and characteristics of secular stock market cycles, the impact of the inflation rate and interest rates on the stock and bond markets, and a conceptual approach toward investment strategy that is applicable to the current market environment.”

One study is called “Gazing at the Future” and notes,

“The starting valuation matters! When P/Es start at relatively lower levels, higher returns follow — paying less yields more. When investors have P/Es that start higher, subsequent returns are lower.

This graphical analysis presets the compounded returns that follow over the subsequent ten years based upon the starting P/E ratio. It’s compelling, primarily because it’s fundamental — starting valuations directly impact subsequent returns. From the current above-average valuations, below-average returns are likely to follow for the next decade or longer.”

The current state of this model is shown in the chart below.

Gazing at the future: Why stocks will be underperforming

Source: Crestmont Research

This chart tells us the past ten years were good for investors but the next ten might not be as favorable. P/E ratios at this level have generally been associated with lower than average long term returns.

Another Model Quantifies How Bad It Could Get

Another firm that provides forecasts is GMO, a global investment management firm committed to providing sophisticated clients with superior asset management solutions. This firm manages billions of dollars and follows a value based approach to the markets.

GMO regularly publishes a seven year asset class real return forecast from GMO. It was fairly accurate and useful from 2000–2007. Looking back from 2010, the GMO forecast was not as accurate or useful about future potential returns. This could be due to changes in central bank policies.

The GMO model assumes some mean reversion. Looking ahead, the model expects negative returns large cap stocks in the U. S., an average annual loss of about 2.5% is expected over the next seven years. Small caps are expected to do a little better with an average annualized gain of about 1.3% in the forecast.

GMO expects value stocks in emerging markets to be the best performing asset class with the potential to deliver an average annual return of about 8.2%.

A Look at Broad Asset Classes

Research Affiliates, LLC, is a global leader in smart beta and asset allocation. The firm’s investment strategies are built on a strong research base and are led by Rob Arnott and Chris Brightman. As of December 31, 2018, $170 billion in assets are managed worldwide.

RA also prepares models that show expected long term returns of asset classes. The full model is shown below.

expected returns charts

Source: Research Affiliates

The next chart highlights stocks and gives investors cause for concern.

portfolio and asset class expected returns

Source: Research Affiliates

The firm explains, “Equity expected returns are based on the Gordon Growth Model which focuses on dividend yield and price appreciation earned from a growth in cash flows such that yield remains constant over time. This return perspective can be seen by switching the ‘Model’ to Yield + Growth.

As a default, our return model is valuation aware and also includes modeling of time varying discount rates based on the CAPE ratio measuring prices versus 10-year average real earnings. The level of the CAPE when compared to fair value, or in our case a blended historical average across countries, can inform if markets are overvalued, fair valued or undervalued.”

Overall, there is reason to be concerned. Crestmont, GMO and RA all agree that below average returns are likely. GMO is the most pessimistic and RA’s research suggests that gains of less than 4% are likely.

GMO and RA agree that emerging market stocks are likely to be the strongest performers, and this could be useful information for investors to consider. Now could be an ideal time to consider investing in emerging markets or increasing exposure to those markets.

The outlook for bonds is also below average and investors should not count on a diversified model to help them escape the expected low returns of the next few years. It is also important to remember that these models suggest average returns, and there will be some stocks that deliver returns that are well above average.

Of course, these models could all be wrong. That is possible but investors should not hope that they are. They should accept that what worked in the past ten years may not work as well in the next ten years and they should consider other strategies.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Stock market

Earnings Peaked, And This Is Important, But Overlooked, News

Earnings season is underway. With about half of the companies in the S&P 500 having delivered their results for the fourth quarter, the results are mixed. There’s just no clear conclusion to draw from the news, but there is a clear pattern to the trading and to the future.

Let’s start with a look at what has been reported so far.

Earnings Summary

  • Of the companies in the S&P 500 that have reported, 70% beat analysts’ estimates for earnings per share (EPS). This is below the one-year (77%) and five-year average (71%).
  • EPS reports are 3.5% above expectations, on average. This is below the one-year (6.0%) and five-year average (4.8%).
  • Of the companies that have reported so far, 62% beat analysts’ expectations for revenue. This is below the one-year average (72%) and above the five-year average (60%).
  • Sales are 0.8% above expectations. This is below the one-year average (1.4%) and above the five-year average (0.7%).

But, beat or miss, stocks are rallying on the news.

Market Reaction

According to FactSet,

“Market Rewarding Positive and Negative Earnings Surprises

To date, the market is rewarding both positive and negative earnings surprises. Companies that have reported positive earnings surprises for Q4 2018 have seen an average price increase of +2.3% two days before the earnings release through two days after the earnings release.

This percentage increase larger than the 5-year average price increase of +1.0% during this same window for companies reporting positive earnings surprises.

Companies that have reported negative earnings surprises for Q4 2018 have seen an average price increase of +0.8% two days before the earnings release through two days after the earnings release.

This percentage increase is an improvement relative to the 5-year average price decrease of -2.6% during this same window for companies reporting negative earnings surprises.”

In other words, traders seem to be buying anything. That is a potential indicator of exuberance and could show that the bounce in the S&P 500 index since the end of December has gone too far. This would be especially true if earnings growth is to slow.

Looking Ahead

Overall, FactSet notes the last quarter of 2018 is looking like a strong quarter for earnings. “For Q4 2018, the blended earnings growth rate for the S&P 500 is 12.4%. If 12.4% is the actual growth

rate for the quarter, it will mark the fifth straight quarter of double-digit earnings growth for the index.”

But, FactSet reports that the outlook for the current quarter is less promising.  Analysts now expect a decrease in earnings for the first quarter of 2019.

Because of the downward revisions to EPS estimates during the month, the S&P 500 is now projected to report a small year-over-year decline in earnings (-0.8%) for the first quarter. However, earnings estimates for the first quarter have been falling for the past few months.

On September 30, the estimated earnings growth rate for Q1 2019 was 6.7%. On December 31, the estimated earnings growth rate for Q1 2019 was 3.3%.

estimated earnings growth chart

Source: FactSet

“During the month of January, analysts lowered earnings estimates for companies in the S&P 500 for the first quarter.

The Q1 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for all the companies in the index) dropped by 4.1% (to $38.55 from $40.21) during this period. How significant is a 4.1% decline in the bottom-up EPS estimate during the first month of a quarter?

How does this decrease compare to recent quarters?

During the past five years (20 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 1.6%. During the past ten years, (40 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 1.8%.

During the past fifteen years, (60 quarters), the average decline in the bottom-up EPS estimate during the first month of a quarter has been 1.7%. Thus, the decline in the bottom-up EPS estimate recorded during the first month of the first quarter was larger than the 5-year, 10-year, and 15-year averages.

In fact, the first quarter marked the largest decline in the bottom-up EPS estimate during the first month of a quarter since Q1 2016 (-5.5%).

If the index reports an actual decline in earnings for the first quarter, it will mark the first year-over-year decline in earnings since Q2 2016 (-3.1%)

MarketWatch noted the changes have carried by sector. “The following table shows what analysts expected through Friday in terms of year-over-year EPS growth for the S&P 500 and each of the S&P 500’s 11 sectors for the fourth and first quarters, as well as the change in estimates since Jan. 11 and Sept. 30.”

index earnings summary

This is all an indication that caution is warranted in the current market. Indiscriminate buying is unlikely to be rewarded in an environment when earnings growth is slowing and, in fact, many companies are likely to report year over year declines in earnings in the current quarter.

Some of the decline can most likely be attributed to robust earnings in 2018 due to the passage of tax reform that changed a number of accounting factors. Those were, in effect, one-time gains. Now, there is a reversion to normalcy and that comes at potentially a bad time for investors.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Economy

Time To Look At This Sector Again

After the most recent meeting of the Federal Reserve, traders started reviewing their assumptions about rate hikes. Within days, futures of Fed Funds, a critical short term interest rate market, were pricing in the likelihood that there would be no more rate hikes.

This marked a reversal in the outlook of just a few months ago. The reversal can be seen in other interest rate markets as well. The chart below shows the interest rate on ten year Treasury notes and the recent trend is down, reversing a longer up trend.

10-year T-note index chart

Lower rates would be likely if the pace of economic growth is slowing and mounting evidence indicates that is a possibility. If this trend continues, it could have important implications for the stock market and in particular for certain groups within the stock market.

Banks Could Be Turning

Interest rates always present a puzzle to investors in the financial sector. Some analysts argue that lower rates are bearish for banks while others argue the opposite. A recent article in Barron’s highlighted the view of one of the most well respected analysts in the sector.

“The market for banks stocks is fickle,” says Wells Fargo analyst Mike Mayo, a bull on the sector. “Investors always seem to be viewing the glass as half empty.”

Industry sources cited Mayo as “a prominent bank analyst when Wells Fargo & Co. hired him in 2017. The analyst was hired to “make calls on large-cap bank stocks in its securities business, according to a statement released on Monday.

“Mike’s stature in the industry is well-recognized,” Diane Schumaker-Krieg, global head of research, economics and strategy at Wells Fargo Securities, said in a statement. “We are thrilled to have such an influential voice in this critical sector join our growing platform.”

Now, his view on some banks is bullish.

According to barron’s, “Mayo’s view is that major banks represent a bargain, trading for an average of just 10 times projected 2019 earnings, and many yielding 3% or more. He sees bank profits rising 8% to 10% this year as the industry boosts revenues and keeps a tight lid on costs.

“The negative sentiment has created an opportunity with uniquely attractive valuations,” he says.

Banks have the most aggressive capital-return plan of any major industry group, at around 100% for the 12 months ending in June. That is providing a major lift to earnings per share.

Some banks like Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC) are expected to return more than 100% of their earnings to holders in dividends and stock buybacks.

Yet bank stocks were among the worst performers in a strong stock market Thursday afternoon. The KBW index of 24 leading banks was down 1.7%, while the S&P 500 index rose 0.7% to 2,699. Banks also were down Wednesday in the face of a big gain in broad market indexes, with the S&P up 1.6%

Among top banks Thursday, Bank of America (BAC) was off 96 cents, or 3.3%, to $28.11: JPMorgan Chase (JPM) fell 1.5% to $102.89; and PNC Financial Services Group (PNC) declined 2% to $121. Morgan Stanley (MS) was off 1% to $42.05 and Goldman Sachs Group (GS) lost 2.4% to $197.65.

The downdraft in bank stocks comes after a strong start to 2019. Even with the losses Thursday, bank stocks are ahead of the overall market with a nearly 12% gain, versus less than 8% for the S&P 500. Banks, however, were whacked in 2018, losing about 20% on average, while the S&P 500 declined 6%.”

The chart of Invesco KBW Bank ETF (NYSE: KBWB) is shown below.

KBWB daily chart

Interest Rates Could Change the Trend

Barron’s continued, “Banks are viewed as beneficiaries of higher rates because they generally can boost loan rates faster than deposit rates and a higher-rate environment normally occurs when the economy is robust. Economic strength is good for loan demand and credit quality.

The most “asset-sensitive” banks, meaning those that tend to get the biggest earnings boost from higher rates, were among the worst performers Thursday. Bank of America and Comerica are viewed as being particularly asset sensitive. Other asset-sensitive regional banks showed similar losses.

Bank-deposit “betas,” or the percentage increase in market interest rates that is passed on to depositors, is around 50%. That means that the higher rates do tend to fatten bank profit margins, although Mayo says that is often overstated as a factor behind earnings growth.

He argues that Bank of America is benefiting from a 25-year effort to build a national banking footprint and that its major investments in technology should continue to allow it to outpace the industry. Bank of America trades for around 10 times 2019 earnings and yields 2.1%.”

Industry leader JPMorgan (NYSE: JPM) also trades for 10 times 2019 earnings and yields 3.1%. The S&P 500 index is valued at about 16 times forward operating earnings.

The long term chart of JPM is shown below.

JPM weekly chart

The chart looks similar to the bank ETF. This is true for most banks. The recent lows, below the previous lows, could be a bear trap and a bullish reversal would push the stocks in the industry to new highs.

Other analysts agree with Mayo according to Barron’s. “Bernstein analyst John McDonald recently wrote that the earnings baton for banks is passing to loan growth from rates. He sees 3% growth in net interest income in 2019 and 2020. driven by a 65%/35% mix of loan volumes and rates, against a 35%/65% mix in 2018.

He noted that banks like SunTrust Banks (STI) that have shown accelerating loan growth have been outperformers. Loan growth in recent months has accelerated to a rate of 4% from 2% in the middle of 2018, McDonald wrote.”

Of course, this demonstrates why it is difficult for individual investors to make sense of analyst expectations. ETFs can be helpful to avoid the need to identify individual stocks that are likely to be winners.

In addition to KBWB, investors can consider Financial Select Sector SPDR ETF (NYSE: XLF) or SPDR S&P Bank ETF (NYSE: KBE) as diversified investments offering exposure to the banking industry.

 

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

 

Stock market strategies

Monetary Theory Is Suddenly Important to Investors

Monetary theory, according to Investopedia, “holds that change in money supply is the main driver in changes in economic activity. When monetary theory works in practice, central banks, which control the levers of monetary policy, can exert much power over economic growth rates.”

Central banks have historically managed monetary policy for governments for the past century. But it wasn’t always that way.

Now, “it is the job of the Federal Reserve Board to control the money supply. The Fed has three main levers: reserve ratio, discount rate and open market operations. The reserve ratio is the percentage of reserves a bank is required to hold against deposits.

A decrease in the ratio enables banks to lend more, thereby increasing the supply of money. The discount rate is the interest rate that the Fed charges commercial banks that need to borrow additional reserves.

A drop in the discount rate will encourage banks to borrow more from the Fed and therefore lend more to its customers. Open market operations consist of buying and selling government securities. Buying securities from large banks increases the supply of money while selling securities contracts money supply in the economy.”

In the past, Congress and the President often had a say in monetary policy. In fact, monetary policy was an important issue in the Presidential election of 1896.

monetary policy was an important issue in the Presidential election of 1896

Source: Wikipedia, public domain.

The issue was bimetallism, the economic term for a monetary standard in which the value of the monetary unit is defined as equivalent to certain quantities of two metals, typically gold and silver, creating a fixed rate of exchange between them.

Gold advocates argue cheaper silver will permanently depress the economy, but that sound money produced by a gold standard can restore prosperity. That led to the image above which is an 1896 Republican poster warning against free silver.

In recent years, monetary policy has been less important to the public but that may change with the emergence of a new theory.

MMT

Modern Monetary Theory, or MMT, according to TheMacroTourist.com economic blog, “is a macroeconomic theory that contends that a country that operates with a sovereign currency has a degree of freedom in their fiscal and monetary policy which means government spending is never revenue constrained, but rather only limited by inflation.

MMT’ers believe that government’s red ink is someone else’s black ink. Sure, the government owes dollars, but they have a monopoly of creating those dollars, and not only that, the creation of more and more dollars is essential to the functioning of the economy.

Here are the policy implications of accepting MMT:

  • governments cannot go bankrupt as long as it doesn’t borrow in another currency
  • it can issue more dollars through a simple keystroke in the ledger (much like the Fed did in the Great Financial Crisis)
  • it can always make all payments
  • the government can always afford to buy anything for sale
  • the government can always afford to get people jobs and pay wages
  • government only faces two different kinds of limitations; political restraint and full employment (which causes inflation)

The government can keep spending until they begin to crowd out the private sector and compete for resources.

And in fact, Stephanie Kelton argues it is immoral to not utilize this power to fix problems in our society. From an interview she gave,

“if you think you can’t repair crumbling infrastructure or feed hungry kids, unless and until you find some money somewhere, it’s actually pretty cruel because you leave people who are struggling in a position where there are still struggling and they are hurting, and they are not properly taken care of…”

In one of the interviews I watched with Professor Kelton, she said that the idea of deficits being funded with bond issuance is purely a self-imposed limitation. It’s required by law, but in reality, it doesn’t need to be done. The law can be changed. The government could simply spend $100 while only taking in $90 and directly writing cheques against the Federal Reserve to pay for the $10.”

This could become inflationary and that has implications for investors. The author concludes that, “MMT would scream that the best course would be to buy real productive assets hand over fist.

Ben Hunt of Epsilon Theory believes MMT will gain traction in the coming years:

“Like I said, you may not have heard about MMT yet. But you will. You won’t be able to avoid it. Why? Because MMT is the post hoc justification of both easy fiscal policy and easy monetary policy. As such, it is the new intellectual darling of every political and market Missionary of the Left AND the Right.”

And, he notes it is gaining rapid acceptance.

The chart below is “a map of all non-paywalled US media articles on MMT over the past year, colored by recency (blue older and red more recent). Only 272 unique articles over this span (although 3x from the prior year), but you can see where this is going.

Twelve months ago, this was a fringe issue, negatively portrayed in the press.” That’s shifted dramatically in recent weeks.

MMT diagram

Source: EpsilonTheory.com

Hunt also contends that MMT will switch QE’s inflation in financial assets to inflation in the real world. This is potentially bullish for gold and commodities and potentially devastating to fixed income investments.

Now could be the best time to prepare for this shift, before the mainstream media starts covering the story in detail.

One strategy would be to simply buy gold which already appears to be moving to the up side.

GLD weekly chart

The chart above uses weekly and includes the stochastics indicator at the bottom. Stochastics is a popular momentum indicator that often moves higher at the beginning of an up trend and remains elevated for extended periods of time.

 New highs in gold, or the SPDR Gold Trust (NYSE: GLD) ETF shown in the chart above, could be bullish for gold in the long run. Other investments could be silver, industrial metals or miners and producers of precious and industrial metals.

Oil and natural gas companies could also benefit from inflation as could agricultural commodity producers. Financial stocks and utilities, safe havens in noninflationary environments, could be among the largest losers if inflation takes hold in the long run.

 

Did you know that dividends have rewarded investors for at least 100 years, at least since John D. Rockefeller said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

We have prepared a special report about dividends that you can access right here.

Cryptocurrencies

It Could Be Time to Reconsider Bitcoin

Not that long ago, bitcoin was considered the next big investment. According to NewsBTC.com, a crypto industry news site,

“In September 2017, Bank of America Merrill Lynch had asked 200 institutional investors what they believed was the most popular investment. A majority of them responded with “Long Bitcoin.” That does not mean that participants were actively investing in the digital currency.

But it allowed a nascent market to realize its potential in Wall Street.”

Many may recall that bitcoin was doing well at that time. Futures were being introduced and the chart below shows bitcoin at that time.

Bitcoin daily chart

 

But the good times didn’t last.

The Crash Could Signal New Opportunities

“A price boom and its subsequent crash later, the Bitcoin market is still waiting for the same thing: institutional investment. As it does, it has also experienced a glimmer of hope in various instances.”

The longer term charts shows both the boom and crash.

Bitcoin weekly chart

Now, there could be renewed interest in the cryptocurrency market. “Established financial institutions have started laying down the first foundation of mainstream bitcoin market. There is Fidelity, one of the world’s largest asset manager, that will launch its cryptocurrency custody and trading services in Q1 2019.

There is Intercontinental Exchange which is close to starting the first physical bitcoin futures exchange dubbed as Bakkt. Meanwhile, the endowments of prestigious American universities (Harvard, MIT) feature crypto funds. The accomplishments go on.”

These developments could be bullish for cryptos.

“Despite the strong fundamentals, the bitcoin market reflects tiny bullish sentiment these days. Following a crash action during November 2018, the Bitcoin-Dollar exchange rate had broken below $6,000-support, which many believe was the entry level for institutional investors.

However, the BTC/USD rate is now struggling to float above $3,000. No institutional investor is anchoring market whales. In short, the bitcoin hype is cracking.

Regulations Could Help Cryptos

One of the most significant issues preventing bitcoin’s penetration into the mainstream is the lack of sophisticated infrastructure. According to P.A.ID Strategies, 68% of bitcoin exchanges across the US, and Europe is not KYC compliant.”

KYC stands for know your customers and the rules associated with that are important to financial institutions.

Wikipedia explains, “Know your customer, alternatively known as know your client or simply KYC, is the process of a business verifying the identity of its clients and assessing potential risks of illegal intentions for the business relationship.

The term is also used to refer to the bank regulations and anti-money laundering regulations which govern these activities. Know your customer processes are also employed by companies of all sizes for the purpose of ensuring their proposed agents, consultants, or distributors are anti-bribery compliant.

Banks, insurers and export creditors are increasingly demanding that customers provide detailed anti-corruption due diligence information.

Pursuant to the USA Patriot Act of 2001, the Secretary of the Treasury was required to finalize regulations before October 26, 2002 making KYC mandatory for all US banks. The related processes are required to conform to a customer identification program (CIP).”

Many brokers and banks refuse to do business with firms that are not KYC compliant.

For the crypto market, NewsBTC continues, “Many of these exchanges cannot process larger transactions due to liquidity issues. For an institutional investor, the retail platforms are not enough.

“Cryptocurrency wallets and exchanges want to enjoy the same trust as the wider traditional financial services, but for this to happen they need to rise above the sometimes-dubious reputation of cryptocurrencies’ past and be seen as ‘model citizens’ of the economy,” said John Devlin, chief analyst at P.A.ID.

That leaves cryptocurrency exchanges to do the hard work to avoid their inherent ills of poor custodianship and market manipulation.

Tony Sio, head of regulatory surveillance and marketplace at Nasdaq, revealed that bitcoin exchanges were showing more initiatives to improve their services.

Sio told Business Insider that a lot of them reached Nasdaq for its SMARTS Trade Surveillance platform. Exchanges in traditional markets, as well as broker-dealers and regulators, use the platform to supervise trading and flag possible acts of manipulation.

However, Nasdaq also puts potential SMARTS customers through a screening process. Sio revealed that many a time they found crypto startups with weaker KYC/AML procedures.

“If you are a startup, it is quite hard to set up because it requires a fair bit of work to set it up fully in place,” said Sio. “That is probably one of the sticking points.”

Meanwhile, some of its crypto clients gained approval to install some Nasdaq technology, whether it be surveillance, clearing or trade matching engines. It proves that exchanges are putting efforts to match up to the sophisticated standards of traditional trading platforms.

As soon as they can offer that, institutional investors could find these crypto platforms more trustworthy and attractive.

The odds appear to be in favor of Bitcoin in the long-term. After all, a majority of institutional investors did choose “Long Bitcoin” as their favorite option. All they need is a more secure gateway.”

Finally, A Buy?

This means now could be the time to consider crypto again. The chart below shows the recent price action.

Bitcoin daily

The price action appears to be consistent with a consolidation pattern that is often seen before a large move. The momentum indicator is also potentially bullish.

Momentum is shown as the stochastics indicator at the bottom of the chart. This indicator is at a low level and has been for weeks. This indicates the price level is oversold on a technical basis. Technical analysts expect oversold extremes to be followed by price moves to the up side.

Technicals argue that bitcoin could break out to the up side. This would be bullish for the crypto market since many of the currencies move in the same general direction as bitcoin.

In addition to technicals, the news supports a potential buy. Improving compliance with KYC rules could make the market more attractive to large investors. Fidelity’s entrance into the markets could also boost credibility and acceptability.

It has been said many times that bitcoin looks bullish. But this time could be different and the long down trend could be near a reversal point.