What the Hell Is Wrong With This Market?

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club
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Last week's stock market put a dent in my weekend.

Not because the S&P 500 suffered its largest weekly drop in two years. And not because on Friday, the Dow sank 665.75 points, the biggest one-day drop since June 2016.

(That's all trivia from a long-term perspective.)

No, it's because everywhere I went - from a dinner party to the golf course to a Super Bowl get-together - friends kept peppering me with the same question.

"What the hell is wrong with the market?"

"Too much good news," I told them.

How I wish I could provide photos here of the looks I got. But here - in a nutshell - is what happened last week...

We found out that January was the 88th consecutive month of job creation, the longest streak of continuous hiring on record.

This tightening labor market helped lead to the biggest annual increase in wages in eight years. Nationwide, average hourly earnings for all private sector workers in January were up 2.9%. (And the pickup in wages does not yet reflect the recent wave of announcements from companies that offered bonuses as a result of the new tax cuts.)

The news created fear that inflation may be stronger than expected. As a result, the yield on the 10-year Treasury note hit 2.85% on Friday. (It was near 2% in September.)

This caused investors to worry that the economy is so strong that the Federal Reserve may increase rates more aggressively than anticipated.

Dampening that expectation, however, is the fact that oil prices fell and the dollar rose last week. And there are good reasons to believe that neither move is temporary.

International investors shop currencies for yield the way CD investors shop banks for yield. U.S. rates are considerably higher than they are in Europe and Japan - and are almost certainly headed higher still. This will attract foreign investment capital and boost the dollar.

U.S. shale producers spent the last three years tightening costs and improving their efficiencies so they could make money at lower prices. Now they are set to flood the market with oil again.

In fact, they already are. In November, the U.S. Energy Information Administration announced that U.S. oil production exceeded 10 million barrels a day for the first time in nearly 50 years.

This will help push oil prices lower.

In short, last week's market action - and Friday's tumble in particular - was based on three factors:

  1. The threat of higher inflation
  2. The possibility of more Fed hikes
  3. The longtime absence of a normal and healthy market shakeout.

As this morning's market action clearly demonstrates, there will be more quakes and tumbles in the days ahead.

But let's put all this in perspective:

Is the longest hiring streak on record good news or bad?

Is the biggest jump in wages in eight years good news or bad?

Is economic growth so strong the Fed may have to raise rates sooner than expected good news or bad?

Are the higher rates you'll now earn on cash and bonds - including the reinvestment of mutual fund dividends - good news or bad?

And are lower energy prices and a stronger dollar good news or bad?

While you're contemplating this, note also that nearly half the companies in the S&P 500 have reported fourth quarter results. More than 80% of them have beaten Wall Street's revenue expectations, the highest percentage since the third quarter of 2008. (And the tax law will boost those profits further in the quarters ahead.)

Oh, and that 666-point "crash" in the Dow on Friday that punctuated a down week?

That means the Dow is now up only 27% over the past year.

If you have investor friends who are singing the blues, you may need the world's tiniest violin to accompany them.

Good investing,

Alex

P.S. Last week's market correction caused us to move my continuing commentary on "The Greatest Story That No One Knows" to this Friday. Stay tuned...

Thoughts on this article? Leave a comment below.

There's Nothing Like a Little Romance

The good, the bad and the ugly - last week's market gave it all to us. Although reporting season continues to be good, bond market news (warranted or not) continues to be bad. And Friday's demonic 666-point sell-off (hopefully not an omen) was downright ugly.

In an alert last week for the speculative portion of his Pinnacle Portfolio, Macro Strategist Eric Fry noted that some other surprising, seemingly bad news for Ivanhoe Mines (OTC: IVPAF) might actually have investors falling head over heels for it...

There was quite a bit of news to report last week...

The shares of Ivanhoe Mines (OTC: IVPAF) took a tumble on news that the Democratic Republic of Congo (DRC) is moving to enact a new law that would raise taxes and royalties on mining companies.

Although a move of this sort had been expected, the proposed taxes are higher than expected and would take effect immediately. That is contrary to a November 2016 agreement between Ivanhoe and the DRC government that would have given Ivanhoe 10 years to deal with any changes to the country's 2002 mining law.

The new proposed changes have not yet been signed into law by President Joseph Kabila, but his signature seems likely. That means Ivanhoe's future tax bill will be higher than expected.

Specifically, the revised law proposes to increase royalties on copper from 2% to 3.5%. It also would impose a "super profits tax" of 50% if prices rose 25% above those used in a mine's feasibility study.

So that's the bad news... And it has definitely been bad news for Ivanhoe's stock during the last three trading sessions.

But I believe the sell-off has created an attractive buying opportunity. Here's why...

First, a "Congo Discount" is already applied to Ivanhoe's stock. If its mining assets were located in a domicile like Canada or Australia, the stock would probably be trading around $10 a share, not $3.

Seasoned resource investors expect the unexpected from countries like the DRC. Throughout the last several decades, many countries have reneged on their agreements with resources companies and/or changed the tax regimes retroactively. As a shareholder in a company with assets in a country like the DRC, the risk of political kleptomania is paramount. It is a big and omnipresent risk.

That's why I believe the shares of Ivanhoe already carried a Congo Discount. And that's also why I believe the enactment of this new law might actually help the stock's valuation over time. The new regulations, as punitive as they are, remove most of the uncertainty about what the Congolese government might do.

Second, this new legislation imposes higher taxes based on the price of the metal, not on the volume of metal that is mined. Obviously, price and volume are related to each other. But Ivanhoe is a volume story, more so than a price story.

It is a compelling speculation because its copper deposits in the DRC are likely to be much larger than what has been proven so far. Therefore, Ivanhoe could substantially increase the volume of the copper it produces without paying a substantially higher tax. The "super profits tax" would go into effect only if the copper price moved much higher.

Third, this new mining legislation is not yet law. The president might not sign it in its current form. So if he was to request and receive significant revisions to the legislation, Ivanhoe's stock could jump right back up.

To be clear, I do not expect this outcome. I expect the president to sign the bill. But there is some possibility that he will not.

Bottom line: Ivanhoe is still an attractive speculation. And I believe the stock's current weakness is an opportunity to establish new positions and/or add somewhat to existing positions.

- Donna DiVenuto-Ball with Eric Fry

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