Good morning,

Stocks moved higher this week, setting records in the DJIA, S&P 500, NASDAQ and Russell 2000.  Although the DJTA didn’t set a price record this week, Dow Theory fans were happy with the 1.69% rally of the transportation index outpacing the 0.60% move higher of the DJIA.

The BKX, however, conspicuously didn’t participate in this week’s record-setting rally of the major indexes, dropping 1.59% to close at $89.38 on Friday.  And Deutsche Bank, my proxy for the health of the global banking industry, fell again this week, this time by 3.05% to close at $17.66 and above its 50-day MA.  The divergence of the bank stocks this week was the fly in the ointment for stocks, as the index has been a problematic sign since early March of an unhealthy banking sector in the midst of a bull market.  

The rally in stocks this week appeared independent of the yen, the currency of which rose 0.84% against the US dollar to 110.40 yen.  The euro, too, was strong against the US dollar with its 0.88% move higher against the US currency, closing at 1.1283.  

And the USD Index traded poorly again this week, closing at 96.67, down 0.71%, with more than half of the index’s decline following a disappointing jobs report from the US Department of Labor on Friday.  Technically-speaking, I expect a test of the 94.50 level and again at the first major support level at 93.00 in the coming weeks.

Before I move on, I noticed, that after watching stocks rally and the dollar selloff on Friday, the market action indicated to me that the odds just dropped for a rate hike by the Fed on June 14.  And I was not a bit surprised to see Goldman come out and suggest the same thing.  Revisions down to previous labor reports suddenly turned the market’s assessment of the labor market in the US into one of much less cheer.  The US dollar took the hit, not stocks.  

Stocks want no competition from bonds, but currency traders see a weaker US economy as a sign that Europe’s relatively better economic outlook (only in the short term, I assure you) may be a better place to invest for now, especially with the momentum from Macron’s victory in France still raising hopes of a more stable EU than what was recently feared as a EU ‘on the ropes’.  

And speaking of the competition in the bond market, the action in the UST10Y caught my eye following the jobs report, as the 10-basis-point drop of the yield this week to close the trade at 2.15%, moving away from DoubleLine’s CEO Jeffrey Gundlach’s expectation of a 2.25% floor.

I’ve mentioned in previous LT Weekly reports of my disagreement with Gundlach’s thesis for a bottom of the UST10Y bond yield at 2.25%.  I’m not stating that we are about to test 2.00%, tomorrow, although I wouldn’t be surprised of a follow through of the momentum trade during the coming week; I do state, however, that unless the Fed starts clearing its balance sheet of UST10Y notes, I expect rates to remain pressured to the downside.  

In this market, lower yields suggest higher stock prices, with all else being equal.  But in defense of Gundlach, we know he has a relatively large exposure to gold bullion.  The thinking there, of course, is, that an inflated US dollar may keep his holding in the ‘black’ anyway via gains to his gold holdings.  But his overall performance will surely lag those money managers who have heavily weighted their portfolios with stock assets during a period of a speculative topping.  In other words, Gundlach assesses a below average chance of another 1999-style rally coming, with risks to the downside much greater than any gain he could reasonably expect to achieve.  I certainly believe Gundlach will be shown to be right in the end, whenever that day will be.

Back to my thoughts about the bond action this week.  

What has been a huge advantage to the US Treasury (and Fed) and global investors, who seek out US Treasury securities during times of crisis, has turned into a problem for the Fed, in my opinion, and this problem should be a focus of your attention for the remainder of the year.  I know, you may be rolling your eyes and thinking, “But Jason, bonds are boring.”  Sure, to trade, of course.  But what happens to bonds affect stocks, and the knowledge of how the two markets affect each other is an important tool in your toolbox for assessing underlying pressures exerted upon international capital flows and, therefore, aggregate stock prices.

In short, as bond rates trend lower, today’s yield-starved long-term investors and managed money professionals whose goal is wealth preservation are compelled to hold shares of the DJIA—which on average yields 2.70%—than to hold a UST10Y note, which yielded 2.15% at the close of Friday’s trade.  That’s the good news for shareholders.

But, the bad news about interest rates trending lower is, that a lower UST10Y note suggests to me that the Fed’s narrative of a ‘slowly but surely growing’ US economy may change to a narrative of a ‘slowly turning over’ US economy.  If the trend of deteriorating hard economic data continues along the lines of Friday’s jobs report and the slew of retail data of the past months, pressure on the US dollar may result (and has, so far), spooking global investors into rethinking their long positions in US assets.  

So, suddenly, higher currency risk now plays into these overseas investors’ thinking.  And the trade here?  Gold and gold stocks, as the US dollar takes it on the chin.  Gold stocks may outperform any juice remaining in this bull market.  The lagging bank stocks are making me nervous, so a switch to gold stocks might turn out to be the antidote in the coming months.   

But the big day to test my thesis comes June 14, the closing day of the FOMC meeting.  And if you noticed, the dollar-gold price settled 20 cents above a very key level of resistance at $1,280 on Friday.  This tells me that the gold market is positioning for the FOMC meeting.  Whether the NY Fed comes out of the shadows to ding the gold market on June 14, or not, June 14 may turn out to be the day of a change in market tone in the gold market.  That’s a hunch, nothing more.   

However, as I stated last week, I’m not yet convinced of the strength of the gold rally until we break $1,297, decisively, and soon after the results of the June FOMC meeting.  And so far, the traders of gold stocks aren’t yet convinced of the gold rally either (See chart, below).

Now, look at an important chart, below, of the relationship between the rate spread (between the UST10Y minus one-month LIBOR) and the dollar-gold price.  This chart illustrates my point about preparing for a rally in your favorite gold stocks, if the dollar-gold price of $1,297 is cleared.  The relentlessly rising LIBOR rate is headed into the declining UST10Y rate at a pretty good clip.

By following this chart (stockcharts.com), or the current one-month LIBOR rate here and UST10Y rate here, you can monitor whether the spread is narrowing further during the trading day.  A narrowing spread implies that the eurodollar market rate is tightening relative to the US Treasury market, which then drive buyers of gold to step up their buying.  A further narrowing of the spread and a concurrent break above the dollar-gold price of $1,370 would become a huge signal that the gold bull market that began in December 2015 is alive and kicking.  The gold stocks would therefore be expected to soar higher.  Let’s see what happens.

The other market of interest this week is, of course, is the oil market, the elephant commodity of the commodities complex.  My call for the WTIC price to retreat from closing above the $49 per barrel level of two weeks ago has been ‘spot on’, as WTIC fell another $2.14 per barrel this week to close at $47.66.  I don’t expect any bullish trend in the oil market until well into 2018.  

Why?  

The overhang of oil supply and rising production have been overwhelming demand for months.  The talk of China picking up slack demand though  purchases for the purpose of increasing its strategic crude reserve supply is pure speculation, and smells of the typical rumor mill operation and misunderstanding of what drives global oil prices.  My bet is we’ll see $45 again until global supplies begin to draw down significantly.  We’re not even close to that day.

Okay, let’s move on to my holdings.    

My current portfolio: LQMT, CROX, LC, SIEN, GRPN and short SC

This Week’s JBP Stock Ideas

This week’s trade was kind to my portfolio.

The gains (or loss) to my portfolio this week are as follows: SC +4.14%; GRPN -1.01%; SIEN +1.08%; LC +0.18%; CROX +5.31%; LQMT +2.09%.  GRPN was the only stock not performing for me, but I bought 15,000 at the bottom tick of this week’s price action.  The drop of 4.14% in the share price of my short position in SC, and the 5.41% gain in my long position in CROX supercharged my weekly performance, and easily beat the overall market returns this week.

Also, this week, I bought an additional 15,000 shares of GRPN.  I’m averaging down in a stock that has become bizarrely depressed.  My thinking about GRPN is as follows:

GROUPON, INC. (GRPN)

Originally, I purchased 5,000 shares of GRPN on March 1.  I bought the stock with the bet that the persistent rumor of Alibaba having an interest in buying Groupon made a lot of sense to me, whether the rumor was in fact true, or not.  A takeover of Groupon actually makes sense for Alibaba in a strategical sense, in that it’s well-known that Alibaba must expand globally to achieve meaningful growth.  And why not enter the largest economy of the world?  The US.  Right?

Alibaba is looking at Groupon’s Price/Book of a measly 0.37-times.  And it appears that Groupon most certainly qualifies as a potential buyout target by anyone at this price level.  The company’s earnings have been better than expected since Q3 of 2015, except the most recent quarter’s revenue miss (Q4 2016).

After the Q4 revenue miss, I haven’t been sure of this stock’s appreciation potential outside an Alibaba, or alike takeover, deal.  But the stock’s Price/Book is awfully low to give up on the stock just yet.  With approximately 30 million customers on Groupon’s books, Alibaba may be mighty tempted to buy a customer book of this great size ‘on the cheap’.

But, in the meantime, Groupon is in the process of pruning its most unprofitable markets and accentuating its best markets, of which the US is no. 1.  Over time, I expect gross margin to increase and trickle through the p/l in the August earnings report.  

In May, two research firms have announced two diametrically different assessments of GRPN.  On May 4, Maxim Group rated GRPN a ‘buy’, with a target price of $5.50.  But on May 31, UBS rated GRPN a ‘sell’, with a target price of $2.85, which is not far from my latest $3.03 purchase of this week.

How strange it is that two research analysts see GRPN is such different lights.  UBS has stated that Groupon’s gross margin won’t be enough to facilitate the company’s growth initiatives.  I say, UBS states the obvious, and the stock already more than reflects this concern, with an upside surprise as the more likely scenario as we head into the August report.

So, I have two scenarios that I’m betting on.  One is a suitor, and the other is an operational surprise from the August earning report.  

The short position in GRPN has risen to 9.63% of float, with 4.58 days to cover, indicating sentiment among traders is quite low.  I like that; a possibility of a sizable short squeeze only adds to my reasoning for owning the stock.

Until next time…

Trade Wise and Green!

Jason Bond