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Short The Euro, Go Long Growthies

This article is more than 9 years old.

Some black swans do paddle around. If ISIS operators bomb the subway at Grand Central, the country goes on to a war footing. New York real estate turns down along with consumer sentiment. A terrorist induced market decline of 10% lurks in the bushes. Not my forecast.

If the Fed didn't meet monthly, what would The Street’s economists utch about? Next 12 to 18 months I see the euro approaching par with the dollar. Super growthies like Apple and Facebook levitating 2%, monthly, while Gilead Sciences sells at 12 times $12 a share in earnings, above $140. The thirst for growth stocks waxes insatiable while commodities, utilities, energy and industrials go nowhere in this harsh disinflationary setting.

Don't cry if interest rates escalate. Not the end of the world for our financial markets. It's true, 10 and 30-year Treasuries historically haven't been much lower in 50 or so years. But, they won't reattain trendline levels next couple of years of 4.5% and 5.5%, respectively. If they do, all my bets are off and tearfully, the price-earnings ratio for the market must come in.

Ask yourself:  Is the FRB ready to whisk away the punchbowl or does it react in a step-by-step reactive progression? Where's inflation in the country? Answer - it doesn't exist. Finally, what is the likelihood of a stronger dollar, attracting offshore capital? Answer - the money’s on the way here, earmarked for our financial markets and real estate. Strong dollar, no inflation.

Consider, the Saudis just cut the price of crude oil to hold onto share of market. It costs them nothing, because the dollar already has appreciated 4%. They’re still 3% ahead in terms of realizations with oil denominated in dollars.

Euroland sticks in its deep funk. They can't lower interest much closer to zero. But, no euro politician dares propose deficit financing to get his country off a zero growth rate. You can't get reelected as a pump priming advocate, anywhere.

In a yield starved world, commodities with few exceptions stick in the dumps. Coal and iron ore are disasters with price realizations barely keeping operators in business. Demand for oil goes nowhere. As the dollar strengthens, a lower oil price is painless for producer realizations.

Still a major importer, the U.S. benefits big time from lower oil quotes. Gasoline at the pump has peaked and we can look forward to lower heating oil prices this winter, a major plus for rising consumer discretionary spending. The corn harvest surplus precedes lower prices for meat near term as well.

Absent commodities inflation for at least a year, the sole inflationary factor left to consider is wages. So far, nothing much here. Capacity utilization for industry still holds under 80%, historically a recessionary reading.

If I'm right about commodity deflation persisting and tortuously slow recovery in wages and salaries, anything more than mild monetary tightening makes no sense. No excesses today in the home mortgage sector which remains quiescent even with rates a great historical bargain. Any spike in consumer debt that’s excessive dwells somewhere down the road.

How much heartburn is the bond market going to induce? Not much, but be aware the fixed income sector is as volatile as the Big Board. The resetting of higher interest rates can telescope itself into a matter of weeks, not several months. My feel is the resetting in bonds happens over 8 weeks, not 8 months, when it comes.

With disinflation, bond rates are unlikely to anticipate much more than a 100 basis points rise for 10-year and 30-year paper. My reference point is the real rate of return i.e. inflation adjusted. Hard to see 30-year Treasuries selling for more than 200 basis points above the rate of inflation. If you believe in 2% inflation for the foreseeable future any sinking spell in bonds is limited.

For stocks, beware sectors like utilities and master limited partnerships, any security yielding around 4.5%. Why keep your money there if long term Treasuries turn competitive? Unless your income properties can increase payouts between 5% and 10% yearly, they’re dead in the water.

Reciprocals of escalating interest rates embrace banks and brokerage houses, particularly Charles Schwab which carries money market funds earning zilch and customer debit balances presently under earning, tied to nominal money market rates. This changes as the Fed leans toward tightening in coming quarters, but probably takes until 2016 for fully realizable earnings power, only partially discounted in stock prices today.

Where do growth stocks come out? Most big cap growthies earn more abroad than domestically. Start with Apple and work your way down through Microsoft, ExxonMobil, Coca-Cola and Merck. Losses from currency translations could be sizable. My feel is the euro is still 20% overvalued relative to the dollar. This may take years to ripple into alignment, but currency losses for the internationals could range as high as 3% to 4% per annum for a couple of years.

The market may take some dollar strength in stride but it's not a given. I wouldn't pare down growth stocks just because of the dollar, but who knows? The escalation of money market rates is yet to come. Consensus puts this change nearly a year away, but bank stocks shortly should discount this happening. Money market rates could reach 2% some 12 months out.

Meantime, normalized net interest margins come into focus for major banks, adding at least 10% to current earnings power. If more players assume as I do that trading, brokerage volume, underwriting and deal activity strengthen you gotta own Morgan Stanley, Citigroup and Bank of America.

One of the easiest and painless moves is to underweight energy and overweight financials. On a macro basis we’re talking about shorting oil futures and going long the dollar. It even sounds patriotic. On a micro basis sell ExxonMobil and buy JPMorgan Chase.

Recently issued preferred stocks like Allstate and Morgan Stanley just eased back to issue price, $25, yielding almost 6.5%. Maybe, preferreds reach a 7% yield, but there Meyer’s a buyer. Don't expect more than 7% from the S&P 500 Index next 12 months. Owning Apple, I must worry about gross margins and smartphone market share, 2015 and 2016. Holding a preferred stock in the financial sector you just need them to stay in business, an easier call today than back in 2009 when Bank of America’s preferred sold at 5 bucks.

I’m still swiping my card and subwaying. Cars are clean, airy, well lit and on time, mostly. The market is good for another 5% to 10%. Straphangers, unite.

Sosnoff owns personally and / or Atalanta Sosnoff Capital, LLC owns for clients the following investments cited in this commentary:  Apple, Facebook, Gilead Sciences, Morgan Stanley, Citigroup, Bank of America, JPMorgan Chase and Allstate.

mts@atalantasosnoff.com

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