In my many years of commodity speculation, the most important lesson which I have learned is humility. The second most important lesson is to look beyond the obvious. And the third most important lesson is that price action leads the fundamental news. In this case, I suggest everyone looks to all of Nat Gas, Coal, RBOB and Heating Oil crack spreads, and the shape of the yield curve, for far more interesting market information than whether a particular price point triggers some short term or long term stops.
Nat Gas has given back its entire rally since January without so much as a minor bounce. This would equate to Crude moving to 90$/bbl without any meaningful bounce. Coal has also taken out the price equivalent of Anatoly's stop level on the downside.
The gasoline (RBOB) crack spread has been negative or near zero for some weeks now. This is unprecendented for the summer driving season and shows the extent of true end user demand destruction. Refineries will obviously reduce their runs rather than process crude at a negative crack spread. Crude is a completely useless commodity. It's the products that really matter!
The heating oil crack spread, in contrast, remains extraordinarily wide. Some attribute this to Chinese hoarding post snowstorm/earthquake and pre-Olympics. So the gasoline and heating oil crack spreads are giving us contradictory signals. While I'm open-minded on the outcome (although short right now), if I see the heating oil crack start declining, I'll know for sure that it's game, set and match for this phase of the crude bull market, and I'll aggressively press my shorts.
The Crude yield curve recently moved to contango from backwardation. Producers are now motivated to build even more inventories, and this is a self-reinforcing feedback loop. When the crude curve goes into contango, it is predictive of declining prices in the spot contract for the following three to six months.
The price volatility of crude is around 40% now. So, as a pure probability statement, one can easily envision a 40% decline from the "high" and we'd still be in a "secular" bull market! More importantly, given 40% volatility, one would expect daily swings of around $7 per barrel — just as random noise.
I am unaware of any rigorously backtested studies which show that the COT open interest is predictive in crude. They are only a coincident indicator of trend. Perhaps Anatoly has different studies available that he can share?
Lastly, and most importantly, many commodities do trend for good economic reasons. I suspect even Vic and Laurel will concede this point. One can ridicule the trendfollowers but I reckon the good ones have been long crude from $90 and started exiting when we broke through $135.
Right now the entire energy complex appears to be breaking down after a remarkable multi-month and multi year-bull market. If you are buying the dip for a quickie bounce — good luck! But if you hold your positions for weeks or months, as I do — it's frivolous to declare your entire market view based on whether one particular price prints. Markets are far wiser than that.
Wednesday, July 30, 2008
Sunday, July 27, 2008
Stocks Tumble, But Hope Holds Its Ground
THE STOCK MARKET'S RALLY OFF ITS JULY 15 LOW SPUTTERED, yet Wall Street heaved a small sigh of relief.
For a start, last week's pause was just benign enough to keep the recent bounce alive, even if the bullish momentum had begun to flag. The biggest setback came Thursday when the Dow Jones Industrial Average skidded 283 points after the release of data showing sales of existing homes had plunged in June toward a decade low. Yet the blow was blunted by uninspired volume; 6.05 billion of New York Stock Exchange shares traded, compared with volume topping 7 billion when stocks turned around.
Financial stocks that had just pulled off a 31% six-day surge began to falter, absorbing a 6.7% drubbing that accounted for nearly half of the Standard & Poor's 500's Thursday decline. But a pullback like this "is not unusual following a rebound off a climactic low," notes Miller Tabak's chief technical market analyst, Philip Roth.
Most crucially, crude oil continued to burn off its recent speculative fumes and fell 4.8% to $123 a barrel. This third straight weekly slide left crude 15% off its recent peak and snapped a pernicious rise that had threatened consumers and weighed down stocks. These breaks in oil's uptrend and stocks' downtrend could still carry "enough momentum to rally the S&P 500 into the 1320-1340 range," argues Bespoke Investment Group.
The Dow ended the week down 126, or 1.1%, to 11,371, while the S&P 500 relinquished 3, or 0.2%, to 1258. The 500-stock benchmark had bounced nearly 5% from its mid-July intraday low of 1200 but remains 20% off its October peak. Technology and small stocks fared better: The Nasdaq Composite Index rallied for a second straight week after its six-week losing streak and added 28, or 1.2%, to 2311. The Russell 2000 index rose 17, or 2.5%, to 710.
Stocks' ginger footing leaves much to worry about. The mid-July bounce was spurred by a rule change some traders dismiss as a "government-orchestrated short squeeze," and it robbed stocks of the chance to reach a natural trough. Home prices continued to decline, banks aren't lending, global economic growth has slowed and job cuts are rising. But an uptick in big-ticket items ordered, and a wee 0.6% ebb in new-home sales in June offered some reprieve, as did a minor lift in consumer confidence as rebate checks are spent.
Might oil fall further to give stocks a boost? Refiners' earnings reports this week will offer a preview. Results are expected to be terrible, squeezed as refiners were by pricey crude and waning domestic gasoline demand. But the stocks' trajectory serves up a hint of how long and how far the market expects crude oil to retreat.
Meanwhile, companies continued to prime investors for the worst, and warnings from American Express (ticker: AXP) to Costco (COST) showed the rot sparing no segment of the income spectrum. Clog-maker Crocs (CROX), which traded as high as 75 last October and which Barron's has consistently warned against, plunged below 5 after it slashed estimates.
But how much of the profit outlook is already priced into stocks? According to Bespoke, the 64% of companies that have beaten estimates so far have rallied 3.2% immediately after, while the 26% missing the mark have slid 4.9%. Overall, the average stock has clung to a slim 0.6% gain -- the paralysis a measure of how far the market has already fallen and its inability to advance.
ANYONE WHO DOUBTS EXPECTATIONS are heightened still need only look at Chipotle Mexican Grill (CMG). The Mexican-food restaurant chain reported a 23% rise in net income that nonetheless missed estimates by a penny, and the stock was pummeled.
The drubbing left the one-time high-flyer -- flagged here in October as over- priced -- down nearly 56% this year. At about 66, shares now fetch just over 20 times forward earnings, down from a jalapeño-hot 53 times last fall. One analyst after another surrendered and downgraded the stock last week, worried about compressed margins and slowing growth as menu-price increases failed to offset the surging cost of ingredients. It doesn't help that the jalapeno has joined another key ingredient -- tomatoes -- on the salmonella-scare list.
Sometime soon, a better risk-reward profile will nudge Chipotle onto the Buy list. After all, sales and profits are still growing, and the company plans to open more restaurants this year than it did last. But one senses the selling could get worse before the bears exact their toll and things get better.
Yum Brands (YUM), too, recently saw second-quarter revenue rise 12% and net income improve 4%, but alas, commodity costs pushed expenses up 14%. While the operator of KFC and Taco Bell beat estimates (thanks to a lower tax bill), its weakening margins worried investors enough to knock shares down to 34, off 16% since May.
Considering the unprecedented pressure on consumers, its same-store sales look commendable, and 14% growth in China and plans to open 450 restaurants there helps Yum capitalize on the overseas consumer boom and the Third World's sad but growing hankering for American fast food. In 10 years, Yum reckons 70% of its growth will come from overseas, which makes this pullback a buying opportunity -- especially if the rabid rise in commodity costs begin to ease.
FIVE YEARS AGO, Lehman Brothers (LEH) bought Neuberger Berman to diversify its revenue stream beyond its fixed- income roots. But will they still be together to celebrate the deal's anniversary in October? A question making the rounds is whether Lehman will have to sell its asset- management unit to buttress its balance sheet. The Wall Street firm raised some $12 billion in equity capital recently, but a still-foundering housing market renders future mark-to-market losses likely.
Lehman's asset management unit could generate $2.07 billion in 2008 revenue and earn nearly $750 million in pre-tax income, estimates Keefe Bruyette Woods analyst Lauren Smith. A price tag of 11 to 12.5 times pretax income would value the entire asset management business -- of which Neuberger Berman is an integral piece -- be-tween $8 billion and $9 billion.
Rally Interrupted: The Dow's bounce off its mid-July low ran out of steam as companies braced for slower growth. The benchmark is 20% off its October peak.
Such a sale would let Lehman raise capital without diluting shareholders. But Neuberger, with its clutch of wealthy clients and burgeoning assets under management, helped prop up the firm. Even as revenue from debt underwriting and fixed income grew in recent years, Lehman was able to expand the portion of its revenue drawn from the stock markets and from overseas.
That has helped Lehman's credit ratings, while closing its valuation chasm with its peers -- advantages the firm must hold dear in these jittery times. Not for nothing that Merrill Lynch (MER) recently opted to sell its stake in Bloomberg rather than relinquish its holding in BlackRock (BLK). In the long term, Smith thinks Lehman may be better off keeping asset management intact and selling a minority piece to private equity investors -- assuming it has a choice.
For a start, last week's pause was just benign enough to keep the recent bounce alive, even if the bullish momentum had begun to flag. The biggest setback came Thursday when the Dow Jones Industrial Average skidded 283 points after the release of data showing sales of existing homes had plunged in June toward a decade low. Yet the blow was blunted by uninspired volume; 6.05 billion of New York Stock Exchange shares traded, compared with volume topping 7 billion when stocks turned around.
Financial stocks that had just pulled off a 31% six-day surge began to falter, absorbing a 6.7% drubbing that accounted for nearly half of the Standard & Poor's 500's Thursday decline. But a pullback like this "is not unusual following a rebound off a climactic low," notes Miller Tabak's chief technical market analyst, Philip Roth.
Most crucially, crude oil continued to burn off its recent speculative fumes and fell 4.8% to $123 a barrel. This third straight weekly slide left crude 15% off its recent peak and snapped a pernicious rise that had threatened consumers and weighed down stocks. These breaks in oil's uptrend and stocks' downtrend could still carry "enough momentum to rally the S&P 500 into the 1320-1340 range," argues Bespoke Investment Group.
The Dow ended the week down 126, or 1.1%, to 11,371, while the S&P 500 relinquished 3, or 0.2%, to 1258. The 500-stock benchmark had bounced nearly 5% from its mid-July intraday low of 1200 but remains 20% off its October peak. Technology and small stocks fared better: The Nasdaq Composite Index rallied for a second straight week after its six-week losing streak and added 28, or 1.2%, to 2311. The Russell 2000 index rose 17, or 2.5%, to 710.
Stocks' ginger footing leaves much to worry about. The mid-July bounce was spurred by a rule change some traders dismiss as a "government-orchestrated short squeeze," and it robbed stocks of the chance to reach a natural trough. Home prices continued to decline, banks aren't lending, global economic growth has slowed and job cuts are rising. But an uptick in big-ticket items ordered, and a wee 0.6% ebb in new-home sales in June offered some reprieve, as did a minor lift in consumer confidence as rebate checks are spent.
Might oil fall further to give stocks a boost? Refiners' earnings reports this week will offer a preview. Results are expected to be terrible, squeezed as refiners were by pricey crude and waning domestic gasoline demand. But the stocks' trajectory serves up a hint of how long and how far the market expects crude oil to retreat.
Meanwhile, companies continued to prime investors for the worst, and warnings from American Express (ticker: AXP) to Costco (COST) showed the rot sparing no segment of the income spectrum. Clog-maker Crocs (CROX), which traded as high as 75 last October and which Barron's has consistently warned against, plunged below 5 after it slashed estimates.
But how much of the profit outlook is already priced into stocks? According to Bespoke, the 64% of companies that have beaten estimates so far have rallied 3.2% immediately after, while the 26% missing the mark have slid 4.9%. Overall, the average stock has clung to a slim 0.6% gain -- the paralysis a measure of how far the market has already fallen and its inability to advance.
ANYONE WHO DOUBTS EXPECTATIONS are heightened still need only look at Chipotle Mexican Grill (CMG). The Mexican-food restaurant chain reported a 23% rise in net income that nonetheless missed estimates by a penny, and the stock was pummeled.
The drubbing left the one-time high-flyer -- flagged here in October as over- priced -- down nearly 56% this year. At about 66, shares now fetch just over 20 times forward earnings, down from a jalapeño-hot 53 times last fall. One analyst after another surrendered and downgraded the stock last week, worried about compressed margins and slowing growth as menu-price increases failed to offset the surging cost of ingredients. It doesn't help that the jalapeno has joined another key ingredient -- tomatoes -- on the salmonella-scare list.
Sometime soon, a better risk-reward profile will nudge Chipotle onto the Buy list. After all, sales and profits are still growing, and the company plans to open more restaurants this year than it did last. But one senses the selling could get worse before the bears exact their toll and things get better.
Yum Brands (YUM), too, recently saw second-quarter revenue rise 12% and net income improve 4%, but alas, commodity costs pushed expenses up 14%. While the operator of KFC and Taco Bell beat estimates (thanks to a lower tax bill), its weakening margins worried investors enough to knock shares down to 34, off 16% since May.
Considering the unprecedented pressure on consumers, its same-store sales look commendable, and 14% growth in China and plans to open 450 restaurants there helps Yum capitalize on the overseas consumer boom and the Third World's sad but growing hankering for American fast food. In 10 years, Yum reckons 70% of its growth will come from overseas, which makes this pullback a buying opportunity -- especially if the rabid rise in commodity costs begin to ease.
FIVE YEARS AGO, Lehman Brothers (LEH) bought Neuberger Berman to diversify its revenue stream beyond its fixed- income roots. But will they still be together to celebrate the deal's anniversary in October? A question making the rounds is whether Lehman will have to sell its asset- management unit to buttress its balance sheet. The Wall Street firm raised some $12 billion in equity capital recently, but a still-foundering housing market renders future mark-to-market losses likely.
Lehman's asset management unit could generate $2.07 billion in 2008 revenue and earn nearly $750 million in pre-tax income, estimates Keefe Bruyette Woods analyst Lauren Smith. A price tag of 11 to 12.5 times pretax income would value the entire asset management business -- of which Neuberger Berman is an integral piece -- be-tween $8 billion and $9 billion.
Rally Interrupted: The Dow's bounce off its mid-July low ran out of steam as companies braced for slower growth. The benchmark is 20% off its October peak.
Such a sale would let Lehman raise capital without diluting shareholders. But Neuberger, with its clutch of wealthy clients and burgeoning assets under management, helped prop up the firm. Even as revenue from debt underwriting and fixed income grew in recent years, Lehman was able to expand the portion of its revenue drawn from the stock markets and from overseas.
That has helped Lehman's credit ratings, while closing its valuation chasm with its peers -- advantages the firm must hold dear in these jittery times. Not for nothing that Merrill Lynch (MER) recently opted to sell its stake in Bloomberg rather than relinquish its holding in BlackRock (BLK). In the long term, Smith thinks Lehman may be better off keeping asset management intact and selling a minority piece to private equity investors -- assuming it has a choice.
Thursday, July 24, 2008
It's a Rally - but in Bear Market
THE STOCK MARKET HAS FOUND A BOTTOM -- but not the bottom. So enjoy this rebound while it lasts, because it looks like a bear-market rally.
Reasons to expect further gains include the intensity of buying seen over the past week in the most beaten-down sectors -- banks, brokers, mortgages and even home building. While former leaders, most notably energy and basic materials, have had a very rough month, money leaving these groups has found new homes. This sector rotation is a very healthy condition for the stock market.
But the most compelling argument for continued short-term strength I see is the dollar. As I wrote in this space a week ago (see "The Dollar Holds the Key," July 16), as long as the greenback stayed weak, U.S. financial assets were fighting an uphill battle. But the technical breakdown in the dollar failed, and now the currency is showing signs of strength.
It seems to be all about confidence right now, and currencies reflect confidence in the economy and its stewards. But as noted last week, whatever gains we've seen in the dollar are a "ripple in the ocean" in a very long bear market. Dollar gains remain very much a short-term phenomenon at this time.
If that is the case, my conclusion is that the stock market has not reversed to the upside either. We have seen a bottom, and current stock gains are part of a bear-market rally.
The increase in prices has not been accompanied by a true swelling in demand. The desire not to be short this market seems to be greater than the need to be long. All over the financial media we can find stories about the stock market experiencing "the mother of all short squeezes," or the scramble to buy stocks to pay back losing bets that prices would continue to fall.
Phil Erlanger, president of the research firm that bears his name, has been following short selling in the market for many years and has quantified its technical meaning. "Clearly there was a short covering rally in the financials but as a sector, short [selling] intensity rankings for financials were below average with the exception of issues like Fannie Mae." He adds, "The key is not that there was excessive short selling, but excessive SEC pressure put on the shorts by singling out selected financials for more stringent rules."
In other words, it was an extra-market condition that triggered the buying. When the shorts are covered, or bought back, the sector will head back down, he adds. To which I would add that the rest of the market will, too, as this fuel runs dry.
Another technical reason why the current rally is of the bear-market variety is that the market has yet to signal the urgency to buy and not just bottom-fish for a quick trade that usually accompanies major changes of a trend from down to up.
Richard Dickson of Lowry's Reports says that there have been no intense buying days, what his firm labels "90% upside days," since the market's lows were notched.
And notwithstanding talk that a "follow-through day" (FTD) has been triggered, it has not. According to this signal's creator, Investor's Business Daily founder William O'Neil, an FTD signals the influx of true demand and not just bottom-fishing. Prices must rise more than 1.5% on increased volume between four to seven days after the rally attempt begins. That's yet to be seen.
But the market is the final arbiter. A chart of the Standard & Poor's 500 shows just how many roadblocks lie ahead for the bulls before we can even consider that the tide has truly turned (see Chart Above).
Not only is the index very far from challenging its major bear-market trendline from the October peak, but its key 50-day moving average also is still falling. Investors, on average, who bought what they thought was a cheap market anytime in the past 10 weeks remain underwater; that creates the impetus for them to sell at their first chance to break even.
With money flowing into financials and very strong relative performance by small-capitalization stocks, this rally should have some legs, possibly reaching the trendline highlighted on the S&P chart in the 1350 area.
Just be forewarned that it's also been more than a week into a huge rebound without a significant corrective dip, so expect some reverses.
The market enjoyed a nice run from its March lows into May. Can this bounce match that one? For now, the evidence favors the bulls. But it would still be a rally in a bear market.
Wednesday, July 23, 2008
Banks, Airlines: One Extreme, Then Another; Decent Q From Hershey?; Frothy Bud
BEATEN SECTORS GO FROM OVER-SOLD TO OVER-BOUGHT
In retrospect, we owe the SEC an apology. The agency said there was a short trade on in the financials. And we expressed skepticism about the plan to deal with it. With the benefit of a full week’s worth of hindsight, it’s apparent there - in fact - was a short trade on for some of the worst-beaten stocks and bloodied sectors. The remarkable thing, though, isn’t how desperate the straits got. It’s how quickly the recovery has taken hold. In some cases, it could be argued, oversold has given way to over-bought conditions in the span of about a week. To wit: dating all the way back to July 15, the KBW Bank Index (BKX) has improved 40%. In five trading days. To turn that figure on its head, take a look at the Ultrashort Proshares Financials (SKF), the ETF that increases leverage to declines in the underlying sector. It’s declined 40% in that same span, plus another 3% in Wednesday’s trading. How about airline stocks? The Airline Index (XAL) has realized a gain of 52% in five sessions. Some of that may have been leveraged off fundamentals: promises of capacity cuts that would could help stoke demand, increase customers’ willingness to pay higher prices, and bring the revenue generated by a ticket sale more in line with the costs of flying that passenger. The retreat in oil prices the last several trading sessions likewise helped. But if ticket prices and costs could be brought into some kind of harmonic convergence, why are airlines waiting until the fourth quarter to make that happen? Wouldn’t they use the high-traffic summer season as their window of opportunity? Meanwhile, none of the big sector moves can compare with the recovery mounted by some casino operators. After fears that Vegas was, effectively, going out of business, gambling house names dropped to multi-year lows last week. Since July 15, however, shares of Las Vegas Sands (LVS) have risen 85%. Now that, folks, is how to cover a bet.
HERSHEY - YUP, THAT HERSHEY - BEATS EXPECTATIONS
Either we’ve slipped into some sugar-induced state of a separate consciousness, or what would generally appear to be unthinkable has transpired. We’re talking right up there with alien incursions, a Chicago Cubs world championship, a business journalist passing up free food. That’s right: Hershey (HSY) had a good quarter. Call it the ultimate triumph of reduced expectations, if you must, but the chocolate maker - battling rising raw materials prices, steep market share losses, and a long tradition of dunderheaded management and ownership - actually beat forecasts for the quarter it reported Wednesday. Granted, it talked down some expectations just a month ago. But, still, a win is a win. And by indications, the company showed some progress in margins, despite cranking up the spending on marketing. Whatever the reason, it appeared to have succeeded: market share losses showed signs of flattening out. Its high-end Bliss bar debuted as the best-selling new product in the chocolate category. And new management’s ambitions would seem to be realized, though all management would admit to on the conference call was that it was off to a good start. Of course, there were a few lumps in the confection. And, no, those weren’t almonds. Its cash position declined 65% from a year ago. And the fundamentals aren’t going to completely silence the contingent that would like to see Hershey partner up to better compete globally in the battle for consumers’ sweet tooth. Shares rose 5% Wednesday.
In retrospect, we owe the SEC an apology. The agency said there was a short trade on in the financials. And we expressed skepticism about the plan to deal with it. With the benefit of a full week’s worth of hindsight, it’s apparent there - in fact - was a short trade on for some of the worst-beaten stocks and bloodied sectors. The remarkable thing, though, isn’t how desperate the straits got. It’s how quickly the recovery has taken hold. In some cases, it could be argued, oversold has given way to over-bought conditions in the span of about a week. To wit: dating all the way back to July 15, the KBW Bank Index (BKX) has improved 40%. In five trading days. To turn that figure on its head, take a look at the Ultrashort Proshares Financials (SKF), the ETF that increases leverage to declines in the underlying sector. It’s declined 40% in that same span, plus another 3% in Wednesday’s trading. How about airline stocks? The Airline Index (XAL) has realized a gain of 52% in five sessions. Some of that may have been leveraged off fundamentals: promises of capacity cuts that would could help stoke demand, increase customers’ willingness to pay higher prices, and bring the revenue generated by a ticket sale more in line with the costs of flying that passenger. The retreat in oil prices the last several trading sessions likewise helped. But if ticket prices and costs could be brought into some kind of harmonic convergence, why are airlines waiting until the fourth quarter to make that happen? Wouldn’t they use the high-traffic summer season as their window of opportunity? Meanwhile, none of the big sector moves can compare with the recovery mounted by some casino operators. After fears that Vegas was, effectively, going out of business, gambling house names dropped to multi-year lows last week. Since July 15, however, shares of Las Vegas Sands (LVS) have risen 85%. Now that, folks, is how to cover a bet.
HERSHEY - YUP, THAT HERSHEY - BEATS EXPECTATIONS
Either we’ve slipped into some sugar-induced state of a separate consciousness, or what would generally appear to be unthinkable has transpired. We’re talking right up there with alien incursions, a Chicago Cubs world championship, a business journalist passing up free food. That’s right: Hershey (HSY) had a good quarter. Call it the ultimate triumph of reduced expectations, if you must, but the chocolate maker - battling rising raw materials prices, steep market share losses, and a long tradition of dunderheaded management and ownership - actually beat forecasts for the quarter it reported Wednesday. Granted, it talked down some expectations just a month ago. But, still, a win is a win. And by indications, the company showed some progress in margins, despite cranking up the spending on marketing. Whatever the reason, it appeared to have succeeded: market share losses showed signs of flattening out. Its high-end Bliss bar debuted as the best-selling new product in the chocolate category. And new management’s ambitions would seem to be realized, though all management would admit to on the conference call was that it was off to a good start. Of course, there were a few lumps in the confection. And, no, those weren’t almonds. Its cash position declined 65% from a year ago. And the fundamentals aren’t going to completely silence the contingent that would like to see Hershey partner up to better compete globally in the battle for consumers’ sweet tooth. Shares rose 5% Wednesday.
Tuesday, July 22, 2008
I often say you can't appreciate one market without taking into consideration the backdrop of impacts and effects of other markets. No better illustration of that than last week's action. Here are some indicia:
Thus, Tel Aviv 25 broke 1000 and VIX broke 30, both for the first times since Mar 16, a nice four month anniversary.
Oil had its greatest one week drop in history, down $16 from from $145 to $129. Its previous record decline was $9.60 in the week ending Nov 30, 2007.
The S&P had its first up week of the previous seven, after spending the longest time in the last 25 years without a reasonable X day maximum.
Bunds, down 1.27 points on Friday 7/18, had their second greatest decline in history, exceeded only in Dec 2001. Corn dropped 20%, and most other grains and metals fell at least 10% on the week.
In short, there was a complete changing of the guard, and fulfillment of long frustrated dreams across the board. What other highlights did I miss?
Vince Fulco looks at the foreign policy scene:
Speaking qualitatively, if we change the term "frustrated dreams" to "frustrated pursuits", the extreme hardening of Iranian and Western positions the last few weeks with the then bolt from the blue US actions to meet in Geneva over the weekend and establish some base level of diplomatic representation within the country constitute a promising, albeit fragile reversal of trend.
Saturday, July 19, 2008
Techs Fails to Endorse the Financials-Led Rally
A SPIRITED RALLY SNAPPED the stock market's six-week losing streak and lifted shares off their two-year lows. But just how decisive -- and lasting -- is this latest turn?
Quite unusually, the climax was spread over three days, with Monday's plunge followed by a tussle on Tuesday before the eventual lift-off on Wednesday. Trading was heavy -- New York Stock Exchange composite volume topped seven billion on two separate days -- and the bounce, when it did come, was unequivocal. The afterglow even lasted until the weekend, with the market clinging to most of its hard-won gains.
The Dow Jones Industrial Average ended the week up 396, or 3.6%, at 11,497; its 4.9% rise after Tuesday was its biggest three-day gain since March 2003. The Standard & Poor's 500 index rose 21, or 1.7%, to 1261 and is 19.5% off its October peak. The Nasdaq Composite Index added 44, or 2%, to 2283, while the Russell 2000 climbed 18, or 2.7%, to 693.
Judges scoring last week's action awarded bonus points to how financial stocks -- the rot at this bear market's core -- had led this advance. Wells Fargo (ticker: WFC) managed to raise dividends, JPMorgan Chase (JPM) managed to top estimates, and the $2.5 billion Citigroup (C) lost last quarter manages to be more meager than feared. As a result, there was little that was ambiguous about the Financial Select SPDR 's (XLF) 23% bounce off its mid-week low.
The scramble to cover shorts played a big part, after a too-convenient rule change promised to make it costlier for traders to bet aggressively against some financial stocks. The 150 stocks within the S&P 1500 with the heftiest short interest jumped 15% over two days, while those with the least short betting struggled to scratch out a 2% gain. Still, an uptick in interest rates added some ballast to bank stocks, and to the extent rates might rise enough to thwart commodities, could even spell further upside for the broad market.
Can financials survive the summer without wilting? It helps that investor expectations were almost nonexistent. Among companies that have reported earnings so far, only 49% of financial stocks have beaten estimates -- the worst among S&P sectors, says Bespoke Investment Group. But those beating estimates saw shares jump 10.1% in the ensuing sigh of relief, and even those missing their marks shimmied up an average 3%. Contrast that with the crowded shelter of consumer staples, where 71% of companies have so far beaten estimates only to see their shares pull back 4.7%.
The resounding rally might have reduced the likelihood of another immediate, nerve-fraying slide to fresh stock-market hell, but a retest of the 2008 low before Thanksgiving cannot be ruled out. "The market is still in a state of flux," says Peter Green, publisher of the GreenScreen markets overview. Last week's rally might have been more convincing, for instance, if financials' advance was corroborated by technology. Instead, Microsoft 's (MSFT) muted outlook and concerns over Google 's (GOOG) advertising growth added to investors' many qualms and suggested "the market may not be ready yet for a sustained move up," Green says.
Just as important: Stocks' rise was lubricated by oil's slide, as crude fell $16.20 or 11.2% to $129 a barrel -- its biggest weekly drop in dollar terms ever. The last time oil fell by 2% or more on three consecutive days from its year's highs was in September 2000, which marked the start of a rocky patch and a year-long decline. Says Jason Goepfert of sentimentrader.com: "I suspect a further drop in the commodity would help stocks more than hurt."
Materials is the only S&P sector besides energy to manage a first-half gain (although just barely). So what are the odds of a second-half encore?
Prices for raw industrial materials and metals have pulled back sharply as the global economy falters. But materials stocks have continued to outpace the S&P 500, chiefly as momentum traders cling to what had worked in this bewildering market.
Among the warning signs: reduced estimates from the likes of Alcoa (AA) and Dow Chemical (DOW). Profit margins in the sector have slid, falling almost 20% from their 2007 peak, according to Merrill Lynch. Cash as a percentage of total assets also has declined, from just above 7% to below 5%.
Materials stocks have historically been risk-averse, so their stubborn run may have "to do more with momentum trading strategies than underlying fundamentals," suggests Merrill sector strategist Brian Belski. Besides the peaking commodity cycle, Belski sees a daunting backdrop of "deteriorating pricing power" and "a U.S. dollar that has found its footing against other major currencies."
The expectations bar also is set high, with profits still projected to jump 12% in the third quarter and 36% over the fourth -- chiefly on easier comparisons, according to Thomson Reuters.
With global manufacturing slowing and construction growth halved from recent peaks, materials stocks aren't exactly cheap either. The group traditionally traded at a discount of 5% to 10%, but now commands a premium on profits that recently were 24% higher than mid-cycle levels, notes Morgan Stanley global equity strategist Abhijit Chakrabortti. "While materials may not appear mispriced on current earnings estimates, these earnings are significantly above trend, leaving little cushion for potential disappointment."
WHEN AN OIL STRONGHOLD LIKE TEXAS plans to invest $4.9 billion in wind-generated electricity, you know wind power is more than just hot air.
Last week's nod from the Texas Utility Commission is good news for Trinity Industries (TRN), which has a small unit making wind towers. Trinity also makes everything from railcars to barges, and fading railcar demand had sent shares down 27% over the past year.
Dow but Not Out: Buoyant bank stocks and lower oil helped the Dow to a 4.9% rise after Tuesday, its best three-day percentage gain since March 2003.
When the Dallas company reports earnings July 30, expect to hear about how surging raw materials and economic deceleration have affected margins. After all, the CEO of a rival company recently bemoaned how everything railcar-related -- from pricing to demand -- "stinks."
But Trinity's cyclical rail business is moderated by a growing leasing and management-services unit, and downside risk is offset by the wind boom. Trinity's wind-energy backlog had surged 128% to nearly $1.6 billion in the first quarter, and its valuation should continue to expand with that backlog.
At 35, shares trade at 10.8 times 2008 earnings and 1.6 times book value, compared with 12.1 times earnings and 4.1 times book for other machinery stocks -- chiefly as investors fret about slowing railcars. "We believe investors should focus on Trinity's diversification and wind-energy catalysts," notes KeyBanc analyst Steve Barger, who has a 48 price target on the stock.
Among the warning signs: reduced estimates from the likes of Alcoa (AA) and Dow Chemical (DOW). Profit margins in the sector have slid, falling almost 20% from their 2007 peak, according to Merrill Lynch. Cash as a percentage of total assets also has declined, from just above 7% to below 5%.
Materials stocks have historically been risk-averse, so their stubborn run may have "to do more with momentum trading strategies than underlying fundamentals," suggests Merrill sector strategist Brian Belski. Besides the peaking commodity cycle, Belski sees a daunting backdrop of "deteriorating pricing power" and "a U.S. dollar that has found its footing against other major currencies."
The expectations bar also is set high, with profits still projected to jump 12% in the third quarter and 36% over the fourth -- chiefly on easier comparisons, according to Thomson Reuters.
With global manufacturing slowing and construction growth halved from recent peaks, materials stocks aren't exactly cheap either. The group traditionally traded at a discount of 5% to 10%, but now commands a premium on profits that recently were 24% higher than mid-cycle levels, notes Morgan Stanley global equity strategist Abhijit Chakrabortti. "While materials may not appear mispriced on current earnings estimates, these earnings are significantly above trend, leaving little cushion for potential disappointment."
WHEN AN OIL STRONGHOLD LIKE TEXAS plans to invest $4.9 billion in wind-generated electricity, you know wind power is more than just hot air.
Last week's nod from the Texas Utility Commission is good news for Trinity Industries (TRN), which has a small unit making wind towers. Trinity also makes everything from railcars to barges, and fading railcar demand had sent shares down 27% over the past year.
Dow but Not Out: Buoyant bank stocks and lower oil helped the Dow to a 4.9% rise after Tuesday, its best three-day percentage gain since March 2003.
When the Dallas company reports earnings July 30, expect to hear about how surging raw materials and economic deceleration have affected margins. After all, the CEO of a rival company recently bemoaned how everything railcar-related -- from pricing to demand -- "stinks."
But Trinity's cyclical rail business is moderated by a growing leasing and management-services unit, and downside risk is offset by the wind boom. Trinity's wind-energy backlog had surged 128% to nearly $1.6 billion in the first quarter, and its valuation should continue to expand with that backlog.
At 35, shares trade at 10.8 times 2008 earnings and 1.6 times book value, compared with 12.1 times earnings and 4.1 times book for other machinery stocks -- chiefly as investors fret about slowing railcars. "We believe investors should focus on Trinity's diversification and wind-energy catalysts," notes KeyBanc analyst Steve Barger, who has a 48 price target on the stock.
Quite unusually, the climax was spread over three days, with Monday's plunge followed by a tussle on Tuesday before the eventual lift-off on Wednesday. Trading was heavy -- New York Stock Exchange composite volume topped seven billion on two separate days -- and the bounce, when it did come, was unequivocal. The afterglow even lasted until the weekend, with the market clinging to most of its hard-won gains.
The Dow Jones Industrial Average ended the week up 396, or 3.6%, at 11,497; its 4.9% rise after Tuesday was its biggest three-day gain since March 2003. The Standard & Poor's 500 index rose 21, or 1.7%, to 1261 and is 19.5% off its October peak. The Nasdaq Composite Index added 44, or 2%, to 2283, while the Russell 2000 climbed 18, or 2.7%, to 693.
Judges scoring last week's action awarded bonus points to how financial stocks -- the rot at this bear market's core -- had led this advance. Wells Fargo (ticker: WFC) managed to raise dividends, JPMorgan Chase (JPM) managed to top estimates, and the $2.5 billion Citigroup (C) lost last quarter manages to be more meager than feared. As a result, there was little that was ambiguous about the Financial Select SPDR 's (XLF) 23% bounce off its mid-week low.
The scramble to cover shorts played a big part, after a too-convenient rule change promised to make it costlier for traders to bet aggressively against some financial stocks. The 150 stocks within the S&P 1500 with the heftiest short interest jumped 15% over two days, while those with the least short betting struggled to scratch out a 2% gain. Still, an uptick in interest rates added some ballast to bank stocks, and to the extent rates might rise enough to thwart commodities, could even spell further upside for the broad market.
Can financials survive the summer without wilting? It helps that investor expectations were almost nonexistent. Among companies that have reported earnings so far, only 49% of financial stocks have beaten estimates -- the worst among S&P sectors, says Bespoke Investment Group. But those beating estimates saw shares jump 10.1% in the ensuing sigh of relief, and even those missing their marks shimmied up an average 3%. Contrast that with the crowded shelter of consumer staples, where 71% of companies have so far beaten estimates only to see their shares pull back 4.7%.
The resounding rally might have reduced the likelihood of another immediate, nerve-fraying slide to fresh stock-market hell, but a retest of the 2008 low before Thanksgiving cannot be ruled out. "The market is still in a state of flux," says Peter Green, publisher of the GreenScreen markets overview. Last week's rally might have been more convincing, for instance, if financials' advance was corroborated by technology. Instead, Microsoft 's (MSFT) muted outlook and concerns over Google 's (GOOG) advertising growth added to investors' many qualms and suggested "the market may not be ready yet for a sustained move up," Green says.
Just as important: Stocks' rise was lubricated by oil's slide, as crude fell $16.20 or 11.2% to $129 a barrel -- its biggest weekly drop in dollar terms ever. The last time oil fell by 2% or more on three consecutive days from its year's highs was in September 2000, which marked the start of a rocky patch and a year-long decline. Says Jason Goepfert of sentimentrader.com: "I suspect a further drop in the commodity would help stocks more than hurt."
Materials is the only S&P sector besides energy to manage a first-half gain (although just barely). So what are the odds of a second-half encore?
Prices for raw industrial materials and metals have pulled back sharply as the global economy falters. But materials stocks have continued to outpace the S&P 500, chiefly as momentum traders cling to what had worked in this bewildering market.
Among the warning signs: reduced estimates from the likes of Alcoa (AA) and Dow Chemical (DOW). Profit margins in the sector have slid, falling almost 20% from their 2007 peak, according to Merrill Lynch. Cash as a percentage of total assets also has declined, from just above 7% to below 5%.
Materials stocks have historically been risk-averse, so their stubborn run may have "to do more with momentum trading strategies than underlying fundamentals," suggests Merrill sector strategist Brian Belski. Besides the peaking commodity cycle, Belski sees a daunting backdrop of "deteriorating pricing power" and "a U.S. dollar that has found its footing against other major currencies."
The expectations bar also is set high, with profits still projected to jump 12% in the third quarter and 36% over the fourth -- chiefly on easier comparisons, according to Thomson Reuters.
With global manufacturing slowing and construction growth halved from recent peaks, materials stocks aren't exactly cheap either. The group traditionally traded at a discount of 5% to 10%, but now commands a premium on profits that recently were 24% higher than mid-cycle levels, notes Morgan Stanley global equity strategist Abhijit Chakrabortti. "While materials may not appear mispriced on current earnings estimates, these earnings are significantly above trend, leaving little cushion for potential disappointment."
WHEN AN OIL STRONGHOLD LIKE TEXAS plans to invest $4.9 billion in wind-generated electricity, you know wind power is more than just hot air.
Last week's nod from the Texas Utility Commission is good news for Trinity Industries (TRN), which has a small unit making wind towers. Trinity also makes everything from railcars to barges, and fading railcar demand had sent shares down 27% over the past year.
Dow but Not Out: Buoyant bank stocks and lower oil helped the Dow to a 4.9% rise after Tuesday, its best three-day percentage gain since March 2003.
When the Dallas company reports earnings July 30, expect to hear about how surging raw materials and economic deceleration have affected margins. After all, the CEO of a rival company recently bemoaned how everything railcar-related -- from pricing to demand -- "stinks."
But Trinity's cyclical rail business is moderated by a growing leasing and management-services unit, and downside risk is offset by the wind boom. Trinity's wind-energy backlog had surged 128% to nearly $1.6 billion in the first quarter, and its valuation should continue to expand with that backlog.
At 35, shares trade at 10.8 times 2008 earnings and 1.6 times book value, compared with 12.1 times earnings and 4.1 times book for other machinery stocks -- chiefly as investors fret about slowing railcars. "We believe investors should focus on Trinity's diversification and wind-energy catalysts," notes KeyBanc analyst Steve Barger, who has a 48 price target on the stock.
Among the warning signs: reduced estimates from the likes of Alcoa (AA) and Dow Chemical (DOW). Profit margins in the sector have slid, falling almost 20% from their 2007 peak, according to Merrill Lynch. Cash as a percentage of total assets also has declined, from just above 7% to below 5%.
Materials stocks have historically been risk-averse, so their stubborn run may have "to do more with momentum trading strategies than underlying fundamentals," suggests Merrill sector strategist Brian Belski. Besides the peaking commodity cycle, Belski sees a daunting backdrop of "deteriorating pricing power" and "a U.S. dollar that has found its footing against other major currencies."
The expectations bar also is set high, with profits still projected to jump 12% in the third quarter and 36% over the fourth -- chiefly on easier comparisons, according to Thomson Reuters.
With global manufacturing slowing and construction growth halved from recent peaks, materials stocks aren't exactly cheap either. The group traditionally traded at a discount of 5% to 10%, but now commands a premium on profits that recently were 24% higher than mid-cycle levels, notes Morgan Stanley global equity strategist Abhijit Chakrabortti. "While materials may not appear mispriced on current earnings estimates, these earnings are significantly above trend, leaving little cushion for potential disappointment."
WHEN AN OIL STRONGHOLD LIKE TEXAS plans to invest $4.9 billion in wind-generated electricity, you know wind power is more than just hot air.
Last week's nod from the Texas Utility Commission is good news for Trinity Industries (TRN), which has a small unit making wind towers. Trinity also makes everything from railcars to barges, and fading railcar demand had sent shares down 27% over the past year.
Dow but Not Out: Buoyant bank stocks and lower oil helped the Dow to a 4.9% rise after Tuesday, its best three-day percentage gain since March 2003.
When the Dallas company reports earnings July 30, expect to hear about how surging raw materials and economic deceleration have affected margins. After all, the CEO of a rival company recently bemoaned how everything railcar-related -- from pricing to demand -- "stinks."
But Trinity's cyclical rail business is moderated by a growing leasing and management-services unit, and downside risk is offset by the wind boom. Trinity's wind-energy backlog had surged 128% to nearly $1.6 billion in the first quarter, and its valuation should continue to expand with that backlog.
At 35, shares trade at 10.8 times 2008 earnings and 1.6 times book value, compared with 12.1 times earnings and 4.1 times book for other machinery stocks -- chiefly as investors fret about slowing railcars. "We believe investors should focus on Trinity's diversification and wind-energy catalysts," notes KeyBanc analyst Steve Barger, who has a 48 price target on the stock.
Wednesday, July 16, 2008
Caveat Emptor or misadventures in the art world
No market is immune from potential fraud, criminal activity, or outright fakery. Whether it be in the equities, commodities, currencies, financial, or art markets, one should remain skeptical about what is offered for sale, and know your market. I consider myself to be rather knowledgeable about several different markets, including the art market. Although I don't claim great expertise in the art market, I do know how to avoid paying retail in most cases, and have a good eye for art. Since I'm not an insider in the art market, I have to rely on the expertise of others, trust the provenance being offered, and trust the dealer's due diligence. Sometimes, even those safeguards fail. I recently had my entire collection checked out and verified for insurance purposes, and one of the pieces was determined to be a fake, a forgery. This opinion was confirmed by a third and fourth party, and the insurance company dropped the coverage on the piece. The rest of my mid-sized collection passed with flying colors, and the company only raised my premium by 30%. The dealer I bought the work from went out of business in the 90's, so I'm out of luck getting any restitution. Although I can get tax treatment on the loss, I'm feeling the sting, and am just glad the fake was only a minor piece in my collection. Whereas losing trades are a cost of doing business, and don't rile me much, I was always of the opinion that beautiful art would never be a losing proposition. The fake that was hanging on my wall is beautiful, but it's still a fake, and therefore a losing proposition. The mistress of the market can offer objects that appear to be very enticing and beautiful on the surface, but scratch that surface, and the ugliness of deceit, dishonesty, and criminality will be evident. Whether it be the art market, used cars, the grains, stocks, bonds, or anything… one can be assured that there are participants that are less than honest, that have absolutely no conscience when they rip you off. Frankly, I'd prefer to be mugged in a back alley than be swindled in the purchase of fake art. Since my art is so beautiful and completely moves my heart, there's something very tawdry about the idea of that a fake invaded my personal space.
Monday, July 14, 2008
The Fannie / Freddie Bailout: Necessary, But Don't Expect a Happy Ending
It’s the end of the "American Dream." It’s the story of how the inevitable bailout of insolvent housing giants Fannie Mae (FNM) and Freddie Mac (FRE) - with the Federal Housing Administration soon to follow - will ultimately lead to such sorrowful sequels as "TheDeath of the Dollar," "The Downgrading of U.S. Government Debt" and, yes, "The Depression."
Let’s be very clear on one point, however: There’s no question about it - Freddie and Fannie have to be supported. If the doctrine of "too big to fail" didn’t already exist, it would have to be invented - immediately. Although many are arguing against a "bailout," those "experts" never seem to address the fallout that would emanate from such a strategy. Nor do they ever discuss the sad series of events that brought us to this financial brink. On that latter point, the truth is so ugly and the failure of governance and its resulting greed so disgusting that to not understand it will guarantee the loss of the American Dream for generations.
Fannie Mae and Freddie: From Dream to Drama
Because it was designed to foster capital creation - and directly promote the American Dream of home ownership, as well as a vibrant economy - the creation of Fannie Mae and Freddie Mac involved some of the best and brightest legislation ever enacted.
That brings us to the most obvious question of all: What went wrong?
First and foremost, both Fannie and Freddie should long ago have been phased out as "government sponsored enterprises," or GSEs. The implicit (now explicit) guarantee of U.S. government backing allowed the firms to borrow cheaply in the capital markets. If fixed-income (debt) investors - and equity investors as well, for that matter - believe their investments are guaranteed, they will likely invest more and with greater comfort.
The result: These enterprises are able to borrow more cheaply than their rivals - namely banks, investment banks, mortgage companies and other non-bank lenders.
Since Fannie and Freddie were able to borrow more for less, they were also able to post fatter profit margins and dwarfed all potential competitors. The federal government should have gradually unshackled itself from this implicit backing by simply declaring a timetable over which future debt issuance would be explicitly exempt from any government guarantees. This graduated phaseout would have resulted in existing debt being guaranteed up to its maturity, while any new debt would have to be raised competitively, and not at preferential rates. This would have fostered competition, reduced the swelling balance sheets of both enterprises, and kept U.S taxpayers from having to be on the hook for both institutions.
How simple that would have been.
Secondly, and manifestly because of their ability to cheaply fund their balance sheets, both enterprises diverged from their mandates and began to buy and hold the securities they were supposed to create and sell to investors. They bought their own products. The more they created, the more they bought. Ultimately, both enterprises were making more on an operating basis - by fattening their own balance sheets with trillions of dollars of their own securities - than they were making in fees from originating, guaranteeing and selling mortgage debt.
Both enterprises began to borrow aggressively and fund their purchases by borrowing shorter. Their "protected" status enabled them to tap the market whenever they wished.
After recognizing they were creating the classic dilemma of borrowing short and lending long, Fannie and Freddie decided to mitigate their interest rate exposure by hedging with swaps and derivatives. They also bought insurance from the monoline insurers, expecting that their investments would be further protected by these insurers whose own capital was so inadequate that they could never pay 1/100th of their contingent liability exposure.
So, just how big did the balance sheets of Fannie Mae and Freddie Mac actually get? Together, the two housing giants currently guarantee or hold approximately $6 trillion of mortgage-related securities.
Those Missed Opportunities
The capital base underlying their bloated balance sheets was never adequate.
Never.
But again - because of their importance in the grand scheme of capital formation and the implicit government guarantee - investors didn’t focus on their equity or capital base. Just like what happened with technology stocks in the late 1990s, housing prices just kept moving higher.
Both companies saw their share prices escalate as the investments they held made money. Everyone’s eyes were diverted. People were getting rich - debt and equity investors, and especially management.
All hell should have broken loose when, in 2003 and 2004, Fannie Mae suffered from massive accounting scandals. Its top three executives pocketed over $115 million. They were cooking the books. After billions of dollars of the company’s money was spent to "fix" the accounting problems and $400 million of fines were paid by the company, no one went to jail.
Yes, you heard that correctly.
Where were the regulators? Where was the congressional outrage? Where were the analysts and ratings agencies?
There are myriad technical aspects to the workings and investments of both Fannie and Freddie. And there are many questions as to how they were allowed to grow and expose taxpayers to their massive liabilities, and how they are able to manipulate and coddle regulators when it comes to their accounting and specifically their capital adequacy.
The day of reckoning has finally arrived.
The Painful Payoff of the Fannie/Freddie Debacle
Because of the precipitous drop in both companies’ share prices, the resulting erasure of their capital, and the fact that Freddie Mac was yesterday (Monday) scheduled to auction off $3 billion worth of 3-month and 6-month notes (they reportedly sold), the rescue was inevitable.
In a classic attempt to calm the markets Sunday, U.S. Treasury Secretary Henry Paulson said the Treasury Department and the Federal Reserve will provide a "liquidity backstop" by offering a line of credit that is "to be determined." Furthermore, "if needed," it will supply "temporary authority to purchase equity" in the enterprises. [For a more detailed story on Treasury Secretary Paulson’s bailout plan - including some harsh criticism’s from investing guru Jim Rogers - check out our news story on the Fannie Mae/Freddie Mac bailout plan published in today’s edition of Money Morning.]
The Treasury Department and the Fed also will strengthen regulatory measures.
Now, I’m relieved!
The bailout has begun. The $6 trillion burden will be shouldered by U.S. taxpayers. U.S. debt will double to the equivalent of our gross domestic product [GDP]. Borrowing costs will rise for homebuyers, further depressing the housing market and leading to hundreds of billions of additional bank write-offs, hedge-fund losses and failures of financial institutions and enterprises ranging from banks to hedge funds.
The Fed has no concern about inflation relative to the demise of the economy, and will have to keep interest rates low for critical liquidity demands and to stave off a deep recession. The building inflationary pressures in the face of the Fed’s efforts to provide liquidity and keep interest rates low will crush the dollar.
We are facing the prospect of a depression and the end of the American Dream. What can be done? Will the housing legislation on the table be the rescue plan we desperately need?
Absolutely not.
This crisis can’t wait. I’ll address the legislation, why it will fail and what should be done, later this week.
Don’t be fooled by any bounce in the markets. Every bounce is an opportunity to sell and add to shorts. This is no time to be picking bottoms. The trend is your friend - and that trend is clearly down
Let’s be very clear on one point, however: There’s no question about it - Freddie and Fannie have to be supported. If the doctrine of "too big to fail" didn’t already exist, it would have to be invented - immediately. Although many are arguing against a "bailout," those "experts" never seem to address the fallout that would emanate from such a strategy. Nor do they ever discuss the sad series of events that brought us to this financial brink. On that latter point, the truth is so ugly and the failure of governance and its resulting greed so disgusting that to not understand it will guarantee the loss of the American Dream for generations.
Fannie Mae and Freddie: From Dream to Drama
Because it was designed to foster capital creation - and directly promote the American Dream of home ownership, as well as a vibrant economy - the creation of Fannie Mae and Freddie Mac involved some of the best and brightest legislation ever enacted.
That brings us to the most obvious question of all: What went wrong?
First and foremost, both Fannie and Freddie should long ago have been phased out as "government sponsored enterprises," or GSEs. The implicit (now explicit) guarantee of U.S. government backing allowed the firms to borrow cheaply in the capital markets. If fixed-income (debt) investors - and equity investors as well, for that matter - believe their investments are guaranteed, they will likely invest more and with greater comfort.
The result: These enterprises are able to borrow more cheaply than their rivals - namely banks, investment banks, mortgage companies and other non-bank lenders.
Since Fannie and Freddie were able to borrow more for less, they were also able to post fatter profit margins and dwarfed all potential competitors. The federal government should have gradually unshackled itself from this implicit backing by simply declaring a timetable over which future debt issuance would be explicitly exempt from any government guarantees. This graduated phaseout would have resulted in existing debt being guaranteed up to its maturity, while any new debt would have to be raised competitively, and not at preferential rates. This would have fostered competition, reduced the swelling balance sheets of both enterprises, and kept U.S taxpayers from having to be on the hook for both institutions.
How simple that would have been.
Secondly, and manifestly because of their ability to cheaply fund their balance sheets, both enterprises diverged from their mandates and began to buy and hold the securities they were supposed to create and sell to investors. They bought their own products. The more they created, the more they bought. Ultimately, both enterprises were making more on an operating basis - by fattening their own balance sheets with trillions of dollars of their own securities - than they were making in fees from originating, guaranteeing and selling mortgage debt.
Both enterprises began to borrow aggressively and fund their purchases by borrowing shorter. Their "protected" status enabled them to tap the market whenever they wished.
After recognizing they were creating the classic dilemma of borrowing short and lending long, Fannie and Freddie decided to mitigate their interest rate exposure by hedging with swaps and derivatives. They also bought insurance from the monoline insurers, expecting that their investments would be further protected by these insurers whose own capital was so inadequate that they could never pay 1/100th of their contingent liability exposure.
So, just how big did the balance sheets of Fannie Mae and Freddie Mac actually get? Together, the two housing giants currently guarantee or hold approximately $6 trillion of mortgage-related securities.
Those Missed Opportunities
The capital base underlying their bloated balance sheets was never adequate.
Never.
But again - because of their importance in the grand scheme of capital formation and the implicit government guarantee - investors didn’t focus on their equity or capital base. Just like what happened with technology stocks in the late 1990s, housing prices just kept moving higher.
Both companies saw their share prices escalate as the investments they held made money. Everyone’s eyes were diverted. People were getting rich - debt and equity investors, and especially management.
All hell should have broken loose when, in 2003 and 2004, Fannie Mae suffered from massive accounting scandals. Its top three executives pocketed over $115 million. They were cooking the books. After billions of dollars of the company’s money was spent to "fix" the accounting problems and $400 million of fines were paid by the company, no one went to jail.
Yes, you heard that correctly.
Where were the regulators? Where was the congressional outrage? Where were the analysts and ratings agencies?
There are myriad technical aspects to the workings and investments of both Fannie and Freddie. And there are many questions as to how they were allowed to grow and expose taxpayers to their massive liabilities, and how they are able to manipulate and coddle regulators when it comes to their accounting and specifically their capital adequacy.
The day of reckoning has finally arrived.
The Painful Payoff of the Fannie/Freddie Debacle
Because of the precipitous drop in both companies’ share prices, the resulting erasure of their capital, and the fact that Freddie Mac was yesterday (Monday) scheduled to auction off $3 billion worth of 3-month and 6-month notes (they reportedly sold), the rescue was inevitable.
In a classic attempt to calm the markets Sunday, U.S. Treasury Secretary Henry Paulson said the Treasury Department and the Federal Reserve will provide a "liquidity backstop" by offering a line of credit that is "to be determined." Furthermore, "if needed," it will supply "temporary authority to purchase equity" in the enterprises. [For a more detailed story on Treasury Secretary Paulson’s bailout plan - including some harsh criticism’s from investing guru Jim Rogers - check out our news story on the Fannie Mae/Freddie Mac bailout plan published in today’s edition of Money Morning.]
The Treasury Department and the Fed also will strengthen regulatory measures.
Now, I’m relieved!
The bailout has begun. The $6 trillion burden will be shouldered by U.S. taxpayers. U.S. debt will double to the equivalent of our gross domestic product [GDP]. Borrowing costs will rise for homebuyers, further depressing the housing market and leading to hundreds of billions of additional bank write-offs, hedge-fund losses and failures of financial institutions and enterprises ranging from banks to hedge funds.
The Fed has no concern about inflation relative to the demise of the economy, and will have to keep interest rates low for critical liquidity demands and to stave off a deep recession. The building inflationary pressures in the face of the Fed’s efforts to provide liquidity and keep interest rates low will crush the dollar.
We are facing the prospect of a depression and the end of the American Dream. What can be done? Will the housing legislation on the table be the rescue plan we desperately need?
Absolutely not.
This crisis can’t wait. I’ll address the legislation, why it will fail and what should be done, later this week.
Don’t be fooled by any bounce in the markets. Every bounce is an opportunity to sell and add to shorts. This is no time to be picking bottoms. The trend is your friend - and that trend is clearly down
Saturday, July 12, 2008
Where Do Stocks Go From Here?
YOU DON'T NEED ME to tell you, but it was an awful June, quarter, and first half of the year.
The 10.2% loss turned in by the Dow Jones Industrial Average during June was the third worst for that month in this index's history, eclipsed only by 1930 and 1896.
The Dow's loss during the second quarter is not ranked quite as close to the bottom as June's, but still low: Only 15 other years out of the last 112 have had second quarters with worse returns.
So where do we go from here? Is the stock market destined for much bigger losses, now that some of the major market averages are in official bear market territory?
For insight, I decided to turn to the top-performing stock-market-timing newsletters. I defined this group to be the 10 services with the best risk-adjusted market-timing returns over the last 15 years, according to the Hulbert Financial Digest.
As I often advise my subscribers to do when they engage in such an exercise themselves, it's important to define the group of top performers by focusing on performance over a long enough period to include both a bull and a bear market. That way you eliminate newsletters that are either bullish or bearish stopped clocks.
For example, we would not satisfy this requirement if we were to focus on market-timing performance over just the last 10 years. As measured by the Dow Jones Wilshire 5000 total-return index, the market has gained just 3.6% annualized over the last 10 years, far lower than the long-term average. Focusing on top timers over this 10-year period therefore runs the risk of having a bearish stopped clock appear at the top of the rankings.
That's why for this column I chose to focus on 15-year performance. Over that longer period, the Dow Jones Wilshire 5000 index produced a 9.3% annualized return, which is within shouting distance of the stock market's historical average.
I eliminated one of the 10 top performers because it is a purely mechanical model based on the calendar. Its good performance notwithstanding, its current posture tells us little about the market's prospects.
That leaves nine newsletters in this group of top timers. What follows is a brief synopsis of what each of them is currently saying about the stock market. (The newsletters are listed alphabetically.)
• Blue Chip Investor: Bullish. Editor Steven Check's valuation model, based on a comparison of the earnings yield of the stock market and the yield on corporate bonds, shows stocks currently to be in the "Very Undervalued." In his July issue, Check cautioned subscribers against giving too much credence to those who, in effect, say "this time is different." "Of course every decline has its own set of problems and concerns," Check writes. "Think back, however: We had strikingly similar problems in 1990. That was just before the first Iraq war. Oil prices were rising. The savings-and-loan crisis was in full swing and the real-estate market was struggling. The economy was officially in a recession, and the market fell 20% from July 16 to October 11. What happened next? Stocks gained 30% in 1991." Check's model portfolio is close to being fully invested in stocks.
• Bob Brinker's Marketimer: Bullish. In his most recent issue, which was published in early July, Editor Bob Brinker reported that his stock-market timing model remains in favorable territory. However, he cautioned that oil's price constitutes a "wild card." "In the event oil prices continue to rise, consumers and the stock market will be held hostage to the cost of energy. This would provide a strong headwind against the economic recovery process. If oil prices stabilize or decline from current levels, we believe stock prices can make progress into 2009." Brinker is recommending that subscribers' stock portfolios be fully invested.
• Chartist. Bearish. Editor Dan Sullivan turned bearish on the stock market in mid-January. Earlier this week, Sullivan wrote to his subscribers: "The economic news continues to paint a bleak picture with unemployment creeping higher, the housing market still weakening and inflation around the globe skyrocketing… [A] positive note is that when things look the bleakest the future returns are the brightest. At some point we are going to have another excellent buying opportunity. But for now we continue to recommend 100% money market funds."
• Growth Fund Guide. Bearish. Editor Walter Rouleau believes that the investment markets over the next several years will be dominated by a trend away from financial assets such as stocks and toward inflation hedges such as gold and other hard assets. "While we, nor anyone else, can tell you exactly where the gold market or the S&P 500 are in their super bull and super bear markets, our analysis suggests these trends could last for years. One possible target date we have repeated several times…is 2012 for a low in the S&P 500." Rouleau's model portfolios currently have an average equity allocation that is 14% short.
• Investor's Guide to Closed-End Funds: Bullish. Editor Thomas Herzfeld's "U.S. Equity Funds" model portfolio is around 92% invested.
• No-Load Fund Investor: Neutral to moderately bullish. Editor Mark Salzinger's so-called "Wealth Builder" portfolio, his letter's most aggressive, currently allocates 70% to U.S. equities and another 15% to international stocks.
• Timer Digest: Neutral to moderately bearish. Editor Jim Schmidt bases this newsletter's market-timing model on a consensus of the top market timers. His consensus of the top 10 based on performance over the last 52 weeks is neutral, with four bulls, four bears, and two neutral. His consensus of the top 10 for performance over the last two years is bearish, with two bulls, seven bears, and one neutral. The newsletter's model portfolios currently are about 64% invested in stocks, on average.
• Vantage Point: Bearish. Editor John Harris writes that "Until the price of energy levels off, inflation will be a threat and the Fed will have some tough monetary policy challenges to weigh. The long-term moving averages, which define the long-term trend, are bearish for the major averages. Risk levels are such that a defensive 50% to 67% cash."
• Vickers Weekly Insider Report. Bullish. The ratio of insider sales to insider purchases remains well below historical norms, which is a bullish omen, according to this newsletter. The services' two model portfolio are, on average, about 87% invested in U.S. stocks.
The picture is mixed, to be sure. Just four of these nine top timers are bullish, while four more are bearish and the ninth classified as neutral to moderately bullish. The average equity allocation among all nine is 60%.
The moral of the story, if it were to end here, it would be to be only moderately bullish at best.
But the story doesn't end here. Contrast the 60% average recommended equity allocation among the top timers with the comparable average among the 10 market-timing newsletters with the very worst records over the last 15 years. Those worst timers currently are 2% short the market, on average, or 62 percentage points less than the average of the top timers.
That is a bullish contrast. It means that to bet that the stock market will decline from here, you have to bet that the timers with the worst records over the last 15 years will be more right than those with the best records.
Anything can happen, of course. And, indeed, throughout the decline that began last fall, the best performers have been more bullish than their poorer-performing brethren. So, at least in recent months, the profitable bet has been the one that has gone against the top performers.
Still, successful investing requires a disciplined paying attention to the odds. And the odds favor the past's winners when, as I have in this column, measured performance over a long-enough period that winning and losing is unlikely to have been caused by mere luck alone.
The bottom line? The average top-performing market-timing letter has pulled a few chips off the table. But he remains far more bullish than the timers with the worst records.
The 10.2% loss turned in by the Dow Jones Industrial Average during June was the third worst for that month in this index's history, eclipsed only by 1930 and 1896.
The Dow's loss during the second quarter is not ranked quite as close to the bottom as June's, but still low: Only 15 other years out of the last 112 have had second quarters with worse returns.
So where do we go from here? Is the stock market destined for much bigger losses, now that some of the major market averages are in official bear market territory?
For insight, I decided to turn to the top-performing stock-market-timing newsletters. I defined this group to be the 10 services with the best risk-adjusted market-timing returns over the last 15 years, according to the Hulbert Financial Digest.
As I often advise my subscribers to do when they engage in such an exercise themselves, it's important to define the group of top performers by focusing on performance over a long enough period to include both a bull and a bear market. That way you eliminate newsletters that are either bullish or bearish stopped clocks.
For example, we would not satisfy this requirement if we were to focus on market-timing performance over just the last 10 years. As measured by the Dow Jones Wilshire 5000 total-return index, the market has gained just 3.6% annualized over the last 10 years, far lower than the long-term average. Focusing on top timers over this 10-year period therefore runs the risk of having a bearish stopped clock appear at the top of the rankings.
That's why for this column I chose to focus on 15-year performance. Over that longer period, the Dow Jones Wilshire 5000 index produced a 9.3% annualized return, which is within shouting distance of the stock market's historical average.
I eliminated one of the 10 top performers because it is a purely mechanical model based on the calendar. Its good performance notwithstanding, its current posture tells us little about the market's prospects.
That leaves nine newsletters in this group of top timers. What follows is a brief synopsis of what each of them is currently saying about the stock market. (The newsletters are listed alphabetically.)
• Blue Chip Investor: Bullish. Editor Steven Check's valuation model, based on a comparison of the earnings yield of the stock market and the yield on corporate bonds, shows stocks currently to be in the "Very Undervalued." In his July issue, Check cautioned subscribers against giving too much credence to those who, in effect, say "this time is different." "Of course every decline has its own set of problems and concerns," Check writes. "Think back, however: We had strikingly similar problems in 1990. That was just before the first Iraq war. Oil prices were rising. The savings-and-loan crisis was in full swing and the real-estate market was struggling. The economy was officially in a recession, and the market fell 20% from July 16 to October 11. What happened next? Stocks gained 30% in 1991." Check's model portfolio is close to being fully invested in stocks.
• Bob Brinker's Marketimer: Bullish. In his most recent issue, which was published in early July, Editor Bob Brinker reported that his stock-market timing model remains in favorable territory. However, he cautioned that oil's price constitutes a "wild card." "In the event oil prices continue to rise, consumers and the stock market will be held hostage to the cost of energy. This would provide a strong headwind against the economic recovery process. If oil prices stabilize or decline from current levels, we believe stock prices can make progress into 2009." Brinker is recommending that subscribers' stock portfolios be fully invested.
• Chartist. Bearish. Editor Dan Sullivan turned bearish on the stock market in mid-January. Earlier this week, Sullivan wrote to his subscribers: "The economic news continues to paint a bleak picture with unemployment creeping higher, the housing market still weakening and inflation around the globe skyrocketing… [A] positive note is that when things look the bleakest the future returns are the brightest. At some point we are going to have another excellent buying opportunity. But for now we continue to recommend 100% money market funds."
• Growth Fund Guide. Bearish. Editor Walter Rouleau believes that the investment markets over the next several years will be dominated by a trend away from financial assets such as stocks and toward inflation hedges such as gold and other hard assets. "While we, nor anyone else, can tell you exactly where the gold market or the S&P 500 are in their super bull and super bear markets, our analysis suggests these trends could last for years. One possible target date we have repeated several times…is 2012 for a low in the S&P 500." Rouleau's model portfolios currently have an average equity allocation that is 14% short.
• Investor's Guide to Closed-End Funds: Bullish. Editor Thomas Herzfeld's "U.S. Equity Funds" model portfolio is around 92% invested.
• No-Load Fund Investor: Neutral to moderately bullish. Editor Mark Salzinger's so-called "Wealth Builder" portfolio, his letter's most aggressive, currently allocates 70% to U.S. equities and another 15% to international stocks.
• Timer Digest: Neutral to moderately bearish. Editor Jim Schmidt bases this newsletter's market-timing model on a consensus of the top market timers. His consensus of the top 10 based on performance over the last 52 weeks is neutral, with four bulls, four bears, and two neutral. His consensus of the top 10 for performance over the last two years is bearish, with two bulls, seven bears, and one neutral. The newsletter's model portfolios currently are about 64% invested in stocks, on average.
• Vantage Point: Bearish. Editor John Harris writes that "Until the price of energy levels off, inflation will be a threat and the Fed will have some tough monetary policy challenges to weigh. The long-term moving averages, which define the long-term trend, are bearish for the major averages. Risk levels are such that a defensive 50% to 67% cash."
• Vickers Weekly Insider Report. Bullish. The ratio of insider sales to insider purchases remains well below historical norms, which is a bullish omen, according to this newsletter. The services' two model portfolio are, on average, about 87% invested in U.S. stocks.
The picture is mixed, to be sure. Just four of these nine top timers are bullish, while four more are bearish and the ninth classified as neutral to moderately bullish. The average equity allocation among all nine is 60%.
The moral of the story, if it were to end here, it would be to be only moderately bullish at best.
But the story doesn't end here. Contrast the 60% average recommended equity allocation among the top timers with the comparable average among the 10 market-timing newsletters with the very worst records over the last 15 years. Those worst timers currently are 2% short the market, on average, or 62 percentage points less than the average of the top timers.
That is a bullish contrast. It means that to bet that the stock market will decline from here, you have to bet that the timers with the worst records over the last 15 years will be more right than those with the best records.
Anything can happen, of course. And, indeed, throughout the decline that began last fall, the best performers have been more bullish than their poorer-performing brethren. So, at least in recent months, the profitable bet has been the one that has gone against the top performers.
Still, successful investing requires a disciplined paying attention to the odds. And the odds favor the past's winners when, as I have in this column, measured performance over a long-enough period that winning and losing is unlikely to have been caused by mere luck alone.
The bottom line? The average top-performing market-timing letter has pulled a few chips off the table. But he remains far more bullish than the timers with the worst records.
Some Relief Possible Following Painful Week
PLUCKY BOUNCE late Friday lifted the Dow Jones Industrial Average back above 11,000 after it had plummeted below that threshold for the first time in two years. But is it a sign the fever gripping the stock market has finally broken?
Investors are praying that the thermometer measuring the market's misery surely must have peaked: The Standard & Poor's 500 fell into bear-market territory last week and had skidded almost 22% from its peak. It has gone 36 days without as much as a reflexive 2% bounce. The discomfort also has spread, with the bear mauling nearly 60% of 84 stock markets around the globe (and sparing only the oil-rich states), according to Bespoke Investment Group. The 6.67 billion shares of New York Stock Exchange stocks that traded Friday was the third highest ever.
If that doesn't say anguish, consider this: Each time the stock market eked out an advance, it tumbled by a bigger margin the next day, and this particularly blood-curdling species of "Bounce Interruptus" was spotted 16 times over the past 50-day period -- the most in 70 years. "If the market were a book, its title would probably be The Little Engine That Couldn't," says Bespoke analyst Justin Walters. He adds that the deepening slide has led him to anticipate a short-term rally of 5% to 10% within the longer-term decline.
The S&P 500 and the Nasdaq Composite Index both fell for the sixth straight week, while the Dow's losing streak stretched to four. The Dow ended the week down 188, or 1.7%, to 11,101, after falling as low as 10,978 Friday. The S&P 500 lost 23, or 1.9%, to 1239, its lowest finish since July 18, 2006. The Nasdaq gave up six, or 0.3%, to 2239. Only the Russell 2000 snapped its five-week losing streak and gained nine, or 1.4%, to 675.
The stock market increasingly is oversold, with traders now flinching even before the connected blow of bad news. Stocks careened up and down with the fluctuating prospects for mortgage giants Fannie Mae (ticker: FNM) and Freddie Mac (FRE) -- see "Fannie and Freddie" -- while muted forecasts from Alcoa (AA) and Marriott (MAR) drove home the grim reality.
By Friday, the casualty list was staggering: More than 85% of S&P 500 stocks have slumped below their 50-day averages -- compared with 96% in the consumer discretionary sector, 97% in financials, 87% in technology and even 79% in the energy group. These take the market closer to at least a temporary rally.
What might provide the cue? "The market wants clarity from financials, and it wants to see first that financials have bottomed," says Peter Green, publisher of GreenScreen, which takes a broad overview of the equity markets. A decisive 8% to 10% rally by the Financial Select SPDR (XLF), especially in the face of bad news, would constitute a clear sign the group has bottomed. In fact, the covering of short bets on Friday -- before bellwethers like JPMorgan Chase (JPM) and Citigroup (C) report earnings this week -- showed some traders bracing for this possibility.
But why not a more lasting rally? For all the pain, one wonders if the market has seen the kind of unconditional surrender that marks an enduring turn. For instance, anxiety as measured by the VIX volatility index flirted Friday with 29, almost but not quite near peaks above 30 seen in January and in March. Also, VIX futures suggest traders expect this fear gauge to quickly relax to about 25 by August -- and for stocks to stabilize soon. Meanwhile, the fundamental picture remains bleak, with nearly every yardstick of consumer wealth -- jobs, real estate, stock portfolio, access to credit -- heading in the wrong direction, with no turn in sight.
Investors are praying that the thermometer measuring the market's misery surely must have peaked: The Standard & Poor's 500 fell into bear-market territory last week and had skidded almost 22% from its peak. It has gone 36 days without as much as a reflexive 2% bounce. The discomfort also has spread, with the bear mauling nearly 60% of 84 stock markets around the globe (and sparing only the oil-rich states), according to Bespoke Investment Group. The 6.67 billion shares of New York Stock Exchange stocks that traded Friday was the third highest ever.
If that doesn't say anguish, consider this: Each time the stock market eked out an advance, it tumbled by a bigger margin the next day, and this particularly blood-curdling species of "Bounce Interruptus" was spotted 16 times over the past 50-day period -- the most in 70 years. "If the market were a book, its title would probably be The Little Engine That Couldn't," says Bespoke analyst Justin Walters. He adds that the deepening slide has led him to anticipate a short-term rally of 5% to 10% within the longer-term decline.
The S&P 500 and the Nasdaq Composite Index both fell for the sixth straight week, while the Dow's losing streak stretched to four. The Dow ended the week down 188, or 1.7%, to 11,101, after falling as low as 10,978 Friday. The S&P 500 lost 23, or 1.9%, to 1239, its lowest finish since July 18, 2006. The Nasdaq gave up six, or 0.3%, to 2239. Only the Russell 2000 snapped its five-week losing streak and gained nine, or 1.4%, to 675.
The stock market increasingly is oversold, with traders now flinching even before the connected blow of bad news. Stocks careened up and down with the fluctuating prospects for mortgage giants Fannie Mae (ticker: FNM) and Freddie Mac (FRE) -- see "Fannie and Freddie" -- while muted forecasts from Alcoa (AA) and Marriott (MAR) drove home the grim reality.
By Friday, the casualty list was staggering: More than 85% of S&P 500 stocks have slumped below their 50-day averages -- compared with 96% in the consumer discretionary sector, 97% in financials, 87% in technology and even 79% in the energy group. These take the market closer to at least a temporary rally.
What might provide the cue? "The market wants clarity from financials, and it wants to see first that financials have bottomed," says Peter Green, publisher of GreenScreen, which takes a broad overview of the equity markets. A decisive 8% to 10% rally by the Financial Select SPDR (XLF), especially in the face of bad news, would constitute a clear sign the group has bottomed. In fact, the covering of short bets on Friday -- before bellwethers like JPMorgan Chase (JPM) and Citigroup (C) report earnings this week -- showed some traders bracing for this possibility.
But why not a more lasting rally? For all the pain, one wonders if the market has seen the kind of unconditional surrender that marks an enduring turn. For instance, anxiety as measured by the VIX volatility index flirted Friday with 29, almost but not quite near peaks above 30 seen in January and in March. Also, VIX futures suggest traders expect this fear gauge to quickly relax to about 25 by August -- and for stocks to stabilize soon. Meanwhile, the fundamental picture remains bleak, with nearly every yardstick of consumer wealth -- jobs, real estate, stock portfolio, access to credit -- heading in the wrong direction, with no turn in sight.
Friday, July 11, 2008
Is America in a permanent decline?
Forbes magazine's annual list of the world's richest people is eagerly anticipated as a barometer of wealth and power. And each year the mighty U.S., whose economy is often described as the envy of the world, has dominated the rankings.
Until now, that is.
In its most recent survey, the Forbes billionaire list changed dramatically: The United States made only four appearances in the top 20, compared with 10 names two years ago. India, by contrast, posted an astonishing four in the top 10, twice as many as the U.S. While America still leads the overall list, Russia, the new nation of raging capitalism, ranked second. Its 87 billionaires pushed aside Germany, the former runner-up. Is Wall Street's dominance over?
Many Americans are still rich, of course; many more are comfortably middle class. And the economy, though weak, is nowhere near collapse. But the shift in the billionaire allotment reflects broader trends. While globalization is indeed producing fabulous wealth in countries that were once considered basket cases, many are asking whether the U.S. is losing its competitive edge and surrendering its long-held leadership positions in business, finance and innovation to foreign competitors.
"The U.S. was always No. 1 and assumed it would be No. 1 and acted accordingly," says Doug Rediker, a former investment banker and a co-director of the Global Strategic Finance Initiative at the New America Foundation, a Washington, D.C., think tank. "Now other nations are catching up. There are competitors fighting for market share in every industry. The U.S. is under pressure."
Consider the sinking value of the dollar: The greenback is still the world's reserve currency, but its continuing erosion carries a symbolic value, telling the world that the U.S. doesn't have its financial house in order. At home, that means higher prices for food and fuel; it also means more-expensive vacations for Americans traveling abroad.
Talk Back: Do you think America is locked into decline?
The incredible shrinking dollar has also made America a great place for Europeans -- wielding their strong euros and pounds -- to go on cheap shopping sprees, swamping our department stores and designer boutiques to pick up bargains. The U.S., once an elite shopping destination, is becoming their giant outlet mall. Foreign tourists on shopping sprees
And what about Detroit's once-vaunted role as an auto industry leader? That has been diminished by more-nimble global competitors. Companies such as Japan's Toyota are threatening the once-indomitable General Motors with more-stylish design and advanced engineering. While GM was turning out gas-guzzling SUVs and Hummers, Toyota got on the green bandwagon early with hybrids and other fuel-efficient cars, and is now reaping the rewards as gas prices soar. Meanwhile, Wall Street faces rivals in cities such as London, which is attracting so many international banks and companies to its booming stock and capital markets that it now claims to be the new center for global business and finance -- a title disputed, of course, by New York City boosters.
Still, argues Michael Charlton, the chief executive of Think London, the city's official foreign-direct-investment agency, "It is a valid claim that London is the world financial capital because its status is based on its international credentials and because we trade so successfully internationally." Is London the next global capital?
Even New York's pre-eminent position as the center of the booming global art market is being challenged -- again by London, a city that once shunned contemporary art. Nowadays, London's galleries and auction houses are crowded with new collectors, including many newly rich Russians, clamoring for the work of blue-chip artists.
Taken together, some say, the evidence suggests the U.S. might be heading into a twilight phase -- one in which it is ceding to other nations its usual claim to superlatives and leadership as well as its adventurous, cutting-edge spirit. A spate of recent books has explored this development, including Newsweek editor Fareed Zakaria's "The Post-American World." Among the examples he cites: The world's tallest building is in Taipei, Taiwan; the largest publicly traded company is in China; India will soon have the world's biggest oil refinery; and Macau has overtaken Las Vegas in gambling revenue. Map: Global markets on the rise
The reality is a bit more complex, but we do now live in a multipolar world, and we had better get used to it. Forget the superpower rivalry between the U.S. and the former Soviet Union, as well as the brief time in which the U.S. was the only superpower. Forget the time when there was no Airbus, only Boeing and Lockheed and McDonnell Douglas.
Today the centers of power, finance and trade have realigned into three heavyweight blocks: the U.S., the European Union and Asia, with the last dominated by China and India, boasting massive populations and rapidly developing economies. Each group is looking out for its own interests and using its might to influence economic policy and world affairs.
So where does that leave the U.S.?
Rediker, of the New America Foundation, says the U.S. is still a major player in the global economy and isn't likely to become a second-tier nation anytime soon. But, he adds, it's time to recognize that "it's also not the only player, and as such, can't dictate terms to the rest of the world."
In the short term, that shift in thinking might not cut prices at the pump or in grocery stores, or restore strength in the dollar. But it could become part of a wider strategy on how the U.S. can deal with the world's evolving economic structure and encourage business leaders to adopt a broader, bolder outlook to remain competitive in the global marketplace.
Despite the challenges and gloomy outlook fostered by the credit crunch and subprime mortgage mess, many believe the U.S. economy remains both formidable and resilient, with deep reserves of talent, entrepreneurship and continuing investment in research and development.
Even General Motors is trying to change: It has vowed to design an electric car and have it on the road by 2010.
"We should not underestimate the ability of the U.S. economy to transform itself," says Mauro Guillen, a professor of international management at The Wharton School in Philadelphia. "It has one of the most flexible economies and continues to be a magnet for the best and the brightest." Although the nation is at a crossroads in many respects, Guillen adds, "The U.S. will weather the storm."
Until now, that is.
In its most recent survey, the Forbes billionaire list changed dramatically: The United States made only four appearances in the top 20, compared with 10 names two years ago. India, by contrast, posted an astonishing four in the top 10, twice as many as the U.S. While America still leads the overall list, Russia, the new nation of raging capitalism, ranked second. Its 87 billionaires pushed aside Germany, the former runner-up. Is Wall Street's dominance over?
Many Americans are still rich, of course; many more are comfortably middle class. And the economy, though weak, is nowhere near collapse. But the shift in the billionaire allotment reflects broader trends. While globalization is indeed producing fabulous wealth in countries that were once considered basket cases, many are asking whether the U.S. is losing its competitive edge and surrendering its long-held leadership positions in business, finance and innovation to foreign competitors.
"The U.S. was always No. 1 and assumed it would be No. 1 and acted accordingly," says Doug Rediker, a former investment banker and a co-director of the Global Strategic Finance Initiative at the New America Foundation, a Washington, D.C., think tank. "Now other nations are catching up. There are competitors fighting for market share in every industry. The U.S. is under pressure."
Consider the sinking value of the dollar: The greenback is still the world's reserve currency, but its continuing erosion carries a symbolic value, telling the world that the U.S. doesn't have its financial house in order. At home, that means higher prices for food and fuel; it also means more-expensive vacations for Americans traveling abroad.
Talk Back: Do you think America is locked into decline?
The incredible shrinking dollar has also made America a great place for Europeans -- wielding their strong euros and pounds -- to go on cheap shopping sprees, swamping our department stores and designer boutiques to pick up bargains. The U.S., once an elite shopping destination, is becoming their giant outlet mall. Foreign tourists on shopping sprees
And what about Detroit's once-vaunted role as an auto industry leader? That has been diminished by more-nimble global competitors. Companies such as Japan's Toyota are threatening the once-indomitable General Motors with more-stylish design and advanced engineering. While GM was turning out gas-guzzling SUVs and Hummers, Toyota got on the green bandwagon early with hybrids and other fuel-efficient cars, and is now reaping the rewards as gas prices soar. Meanwhile, Wall Street faces rivals in cities such as London, which is attracting so many international banks and companies to its booming stock and capital markets that it now claims to be the new center for global business and finance -- a title disputed, of course, by New York City boosters.
Still, argues Michael Charlton, the chief executive of Think London, the city's official foreign-direct-investment agency, "It is a valid claim that London is the world financial capital because its status is based on its international credentials and because we trade so successfully internationally." Is London the next global capital?
Even New York's pre-eminent position as the center of the booming global art market is being challenged -- again by London, a city that once shunned contemporary art. Nowadays, London's galleries and auction houses are crowded with new collectors, including many newly rich Russians, clamoring for the work of blue-chip artists.
Taken together, some say, the evidence suggests the U.S. might be heading into a twilight phase -- one in which it is ceding to other nations its usual claim to superlatives and leadership as well as its adventurous, cutting-edge spirit. A spate of recent books has explored this development, including Newsweek editor Fareed Zakaria's "The Post-American World." Among the examples he cites: The world's tallest building is in Taipei, Taiwan; the largest publicly traded company is in China; India will soon have the world's biggest oil refinery; and Macau has overtaken Las Vegas in gambling revenue. Map: Global markets on the rise
The reality is a bit more complex, but we do now live in a multipolar world, and we had better get used to it. Forget the superpower rivalry between the U.S. and the former Soviet Union, as well as the brief time in which the U.S. was the only superpower. Forget the time when there was no Airbus, only Boeing and Lockheed and McDonnell Douglas.
Today the centers of power, finance and trade have realigned into three heavyweight blocks: the U.S., the European Union and Asia, with the last dominated by China and India, boasting massive populations and rapidly developing economies. Each group is looking out for its own interests and using its might to influence economic policy and world affairs.
So where does that leave the U.S.?
Rediker, of the New America Foundation, says the U.S. is still a major player in the global economy and isn't likely to become a second-tier nation anytime soon. But, he adds, it's time to recognize that "it's also not the only player, and as such, can't dictate terms to the rest of the world."
In the short term, that shift in thinking might not cut prices at the pump or in grocery stores, or restore strength in the dollar. But it could become part of a wider strategy on how the U.S. can deal with the world's evolving economic structure and encourage business leaders to adopt a broader, bolder outlook to remain competitive in the global marketplace.
Despite the challenges and gloomy outlook fostered by the credit crunch and subprime mortgage mess, many believe the U.S. economy remains both formidable and resilient, with deep reserves of talent, entrepreneurship and continuing investment in research and development.
Even General Motors is trying to change: It has vowed to design an electric car and have it on the road by 2010.
"We should not underestimate the ability of the U.S. economy to transform itself," says Mauro Guillen, a professor of international management at The Wharton School in Philadelphia. "It has one of the most flexible economies and continues to be a magnet for the best and the brightest." Although the nation is at a crossroads in many respects, Guillen adds, "The U.S. will weather the storm."
Thursday, July 10, 2008
Chart of SPX
The S. & P. 500 "officially" entered bear market territory yesterday, meaning it's dropped 20 percent the October 9, 2007 peak. The index has seen similar declines six previous times since 1950, and while previous performance won't help us predict the future, it can at least be a guide.
The above chart shows the number of trading days it took the S. & P. 500 to hit bear market territory after reaching a peak, how long it took to go from the start of the bear market to a low, how long before it retraced its way back to the previous peak, as well as the percentage drop from peak to low:
As is evident from the chart, there appear to be two kinds of bear markets:
1) relatively short ones like those which followed peaks in '61, '66, '68, and '87
2) or extended ones like those following the '73 and '00 peaks
Some think that we're in for something resembling type 2, but let's be generous and instead take the average of all six. Then we might expect the S. & P. to hit its cycle low at the end of next summer, and rebound back to its October peak somewhere around 2011-12.
Jeremy Siegel, Wharton professor and author of Stocks for the Long Run, thinks the way to avoid scenario 2 is for oil to drop to $100.
...if I were to say "What is bedeviling the market right now, worldwide?" I would say that the energy question is more important now than the credit question.
While I'm on the subject, it's worth pointing out that we've actually come out of another type of bear market recently.
Wednesday, July 9, 2008
Three Themes I'm Tracking for Signs of a Reversal
Is the stock market likely to take out its previous day's highs? Are we likely to test or break the prior day's lows? These are the questions I typically ask during the opening minutes of trading. As the day unfolds, I watch short-term sentiment (NYSE TICK, Market Delta) and the behavior of various market sectors to handicap the odds of making various moves during the day.
Lately, much of the odds have boiled down to whether the market is trading in what I call "recession mode" or "recovery mode". In recession mode, there is risk-aversion among stocks; in recovery mode we see bargain hunting among the hardest hit sectors. The three themes I've found most helpful in tracking these modes are:
Performance of the Financial Sector Relative to the Broad Market - I look at the banking sector ($BKX), the S&P 500 financial sector (XLF), and individual stocks that have been vulnerable [(LEH), (MER), (C), (FNM)]. When the financial stocks are weak, the market is in its risk-averse, recession mode and I anticipate selling in the broad market;
Performance of the Housing Sector Relative to the Broad Market - I look at the homebuilders ($HGX), but also regional banks (KRE), as those have exposure to loans to struggling housing developers. When the housing sector is weak, the market is risk-averse and anticipating further recession.
Performance of Consumer Staples Sector Relative to the Consumer Discretionary Sector - When the market is anticipating recession and in its risk-averse mode, we see money going into the more recession-resistant staples stocks (XLP) and away from the discretionaries (XLY).
Monday all three themes kicked into their risk-averse, recessionary modes. That was a great tell for the day's direction. I suspect these themes will also help us identify any eventual turnaround in this weak market. As long as traders and investors anticipate further bad news and losses from banking and housing, however, they will stay defensive--and that poses pressure for the rest of the stock market.
Lately, much of the odds have boiled down to whether the market is trading in what I call "recession mode" or "recovery mode". In recession mode, there is risk-aversion among stocks; in recovery mode we see bargain hunting among the hardest hit sectors. The three themes I've found most helpful in tracking these modes are:
Performance of the Financial Sector Relative to the Broad Market - I look at the banking sector ($BKX), the S&P 500 financial sector (XLF), and individual stocks that have been vulnerable [(LEH), (MER), (C), (FNM)]. When the financial stocks are weak, the market is in its risk-averse, recession mode and I anticipate selling in the broad market;
Performance of the Housing Sector Relative to the Broad Market - I look at the homebuilders ($HGX), but also regional banks (KRE), as those have exposure to loans to struggling housing developers. When the housing sector is weak, the market is risk-averse and anticipating further recession.
Performance of Consumer Staples Sector Relative to the Consumer Discretionary Sector - When the market is anticipating recession and in its risk-averse mode, we see money going into the more recession-resistant staples stocks (XLP) and away from the discretionaries (XLY).
Monday all three themes kicked into their risk-averse, recessionary modes. That was a great tell for the day's direction. I suspect these themes will also help us identify any eventual turnaround in this weak market. As long as traders and investors anticipate further bad news and losses from banking and housing, however, they will stay defensive--and that poses pressure for the rest of the stock market.
Tuesday, July 8, 2008
In All Seriousness
In all seriousness, does anyone note a similarity in art and life here vis a vis the Nadal / Federer match and S&P today, 7-07-2008? It was a most unusual day in SPU: neutral in morning, then a terrible fall starting at noon, then a dramatic rally, then a horrible fall after 15:38. Okay. Vis a vis Federer, considering him a bull. He loses the first two sets (the terrible fall). He wins the next two sets (a dramatic rally) to unchanged at two sets each. Then he loses the fifth set (a horrible fall) in darkness. Most readers will think I'm overreaching. I say the evil hand of the Mistress was at work copying the Wimbledon finals.
Monday, July 7, 2008
Tyler Cowen Speaks
Tyler Cowen gave an interesting talk at the NY Junto about the economics of worry, what you should worry about and what you shouldn't. He touched on his bearish views for the stock market, and felt Dow 8000 was a good goal because of the conjunction of the real estate and commodity crises, and various psychological anomalies.
1) He attributed part of the origin of the subprime problem to a calculation error where the perceived default rate could have been 1% in securities when the true probability of default was 4%. (Somewhat relatedly, Richard Clarida wrote in an October PIMCO commentary, "The proximate cause of this 'hard day's Knight' was the more or less simultaneous realization by millions of global investors that their underlying assumption about the distribution of returns on a wide "variety of asset-backed securities" was fundamentally flawed.")
I also think a rational bubble was a source. The Keynesian beauty pageant as an asset pricing model could be consistent with buying and selling of assets at values that adhere to an overall market convention that is inconsistent with how each market participant would appraise the asset if unable to flip it to another participant. (There was that ill-timed dance metaphor that then-former Citigroup CEO Chuck Prince used last July, "As long as the music is playing, you've got to get up and dance.") In my view the bursting rational bubble would just be a breakdown in the pricing convention.
If a bond fund manager gets evaluated by Morningstar ratings and receives capital inflows on the basis of a narrow trailing 2 or 3 year performance, then the incentives to harbor blowup risk in a portfolio is such that the manager marginally setting prices in the market could be apathetic about whether he privately believes that default rate is 1% or 4%.
It conjures up an interesting thought experiment: Can credit risk be underpriced and yet everyone in the market thinks bonds are overvalued? Or the parallel inquiry from a rational bubble section of my senior thesis in college: Can eToys be worth $10 billion when mutual fund managers collectively think it is worth $1-$2 billion? (I surveyed fund managers, many of whom owned the stock, and the average response was the latter figure at a time when the market cap was multiples higher.)
2) I liked how Cowen's view of the macroeconomy was nuanced instead of a one dimensional scapegoating of an overly accomodative Fed, over (or under) regulation, etc. that is so popular. I find scary the compulsion towards narrative fallacies, attribution errors, and cramming world events into a preexisting ideological view.
3) His metaphor comparing subprime securities to poisoned water seemed apt. Bill Gross chose a "Where's Waldo" metaphor to eloquently make the same point in some of his commentaries during the financial crisis– ("…While market analysts can guesstimate how many Waldos might actually show their face over the next few years - 100 to 200 billion dollars worth is a reasonable estimate - no one really knows where they are hidden…"). In analyzing earlier crises Mohamed El-Erian has also related the lemons problem to EM debt pricing.
4) Cowen spoke about how the inequality of happiness in Denmark is similar to the U.S. despite a lower income inequality there. My takeaway from Daniel Gilbert's book was happiness set points and the power of habituation. Couldn't the inequality of happiness just converge upon some distribution regardless of the level of income inequality if there haven't been recent changes?
Also, I think in Gilbert's book there is an assertion about how the most realistic people (i.e. least susceptible to cognitive biases) are ones that are classified as mildly clinically depressed. Similarly, if people generally worry too much (which seemed to be your contention even if there are certain things people worry insufficiently about), then maybe some self delusion would be useful to avoid excess sensitivity to perceived threats.
5) In general comments on income inequality he mentioned how the rate of inflation varied by income right now. This is a bit of a non sequitur, but it's a topic I've been thinking about in the context of the Fed's fervent interest in inflation expectations. Surveys show how expectations differ by region and even gender in normal conditions. People's expectations have a consistent upward bias and overweight more frequent purchases. If the Fed is so obsessed with controlling these expectations than perhaps we need separate monetary policies by region, gender, and income so that we can reset an expectations-augmented Phillips curve to a price stability point. Since we of course don't, then maybe the Fed and market participants shouldn't look at these surveys to the second decimal place and pretend that the fate of the economy depends on 1.8% vs 2.2% inflation.
6) He made a point on health care about how people are blindly deferential to not properly incentivized doctors reminded me of this good column that David Leonhardt wrote in November– ("… Economists sometimes refer to this situation as an "expert service problem," because the same expert who is diagnosing the flaw is the one who will be paid to fix it. In most of these cases, consumers aren't sophisticated enough to make an independent judgment. That's why they went to the expert. The problem, of course, extends well beyond the car business. Anytime you call a plumber or roofer to your home or anytime you visit a doctor or dentist, you're at risk of having an expert service problem…If anything, Professor Hubbard argues that the expert service problem is more serious in medicine than in auto repair, because most people are less willing to question a doctor than to question a mechanic. Any effort to reform American medicine has to grapple with these conflicts of interest…").
7) Cowen commented that a catastrophe isn't more likely because markets don't price the prospect more aggressively now than in the past. However, in an article he linked to on his blog, Peter Thiel said the pricing is distorted because no one would be around to collect the insurance payout in the event of the catastrophe– ("…The catastrophe is so large that no functioning market or government remains: This is the only case where one would incur catastrophic "losses," although nobody might be left to collect them…" ) Similarly, there was recent speculation that a market on a Large Hadron Collider-motivated catastrophe would break down because of the inability to collect a payout in an apocalyptic event. ("…Unfortunately this is one kind of question where an Idea Futures market would not work too well, because people who correctly bet that the reactor will destroy the earth may not be able to collect their winnings. This would cause the market to under-estimate the risks…")
1) He attributed part of the origin of the subprime problem to a calculation error where the perceived default rate could have been 1% in securities when the true probability of default was 4%. (Somewhat relatedly, Richard Clarida wrote in an October PIMCO commentary, "The proximate cause of this 'hard day's Knight' was the more or less simultaneous realization by millions of global investors that their underlying assumption about the distribution of returns on a wide "variety of asset-backed securities" was fundamentally flawed.")
I also think a rational bubble was a source. The Keynesian beauty pageant as an asset pricing model could be consistent with buying and selling of assets at values that adhere to an overall market convention that is inconsistent with how each market participant would appraise the asset if unable to flip it to another participant. (There was that ill-timed dance metaphor that then-former Citigroup CEO Chuck Prince used last July, "As long as the music is playing, you've got to get up and dance.") In my view the bursting rational bubble would just be a breakdown in the pricing convention.
If a bond fund manager gets evaluated by Morningstar ratings and receives capital inflows on the basis of a narrow trailing 2 or 3 year performance, then the incentives to harbor blowup risk in a portfolio is such that the manager marginally setting prices in the market could be apathetic about whether he privately believes that default rate is 1% or 4%.
It conjures up an interesting thought experiment: Can credit risk be underpriced and yet everyone in the market thinks bonds are overvalued? Or the parallel inquiry from a rational bubble section of my senior thesis in college: Can eToys be worth $10 billion when mutual fund managers collectively think it is worth $1-$2 billion? (I surveyed fund managers, many of whom owned the stock, and the average response was the latter figure at a time when the market cap was multiples higher.)
2) I liked how Cowen's view of the macroeconomy was nuanced instead of a one dimensional scapegoating of an overly accomodative Fed, over (or under) regulation, etc. that is so popular. I find scary the compulsion towards narrative fallacies, attribution errors, and cramming world events into a preexisting ideological view.
3) His metaphor comparing subprime securities to poisoned water seemed apt. Bill Gross chose a "Where's Waldo" metaphor to eloquently make the same point in some of his commentaries during the financial crisis– ("…While market analysts can guesstimate how many Waldos might actually show their face over the next few years - 100 to 200 billion dollars worth is a reasonable estimate - no one really knows where they are hidden…"). In analyzing earlier crises Mohamed El-Erian has also related the lemons problem to EM debt pricing.
4) Cowen spoke about how the inequality of happiness in Denmark is similar to the U.S. despite a lower income inequality there. My takeaway from Daniel Gilbert's book was happiness set points and the power of habituation. Couldn't the inequality of happiness just converge upon some distribution regardless of the level of income inequality if there haven't been recent changes?
Also, I think in Gilbert's book there is an assertion about how the most realistic people (i.e. least susceptible to cognitive biases) are ones that are classified as mildly clinically depressed. Similarly, if people generally worry too much (which seemed to be your contention even if there are certain things people worry insufficiently about), then maybe some self delusion would be useful to avoid excess sensitivity to perceived threats.
5) In general comments on income inequality he mentioned how the rate of inflation varied by income right now. This is a bit of a non sequitur, but it's a topic I've been thinking about in the context of the Fed's fervent interest in inflation expectations. Surveys show how expectations differ by region and even gender in normal conditions. People's expectations have a consistent upward bias and overweight more frequent purchases. If the Fed is so obsessed with controlling these expectations than perhaps we need separate monetary policies by region, gender, and income so that we can reset an expectations-augmented Phillips curve to a price stability point. Since we of course don't, then maybe the Fed and market participants shouldn't look at these surveys to the second decimal place and pretend that the fate of the economy depends on 1.8% vs 2.2% inflation.
6) He made a point on health care about how people are blindly deferential to not properly incentivized doctors reminded me of this good column that David Leonhardt wrote in November– ("… Economists sometimes refer to this situation as an "expert service problem," because the same expert who is diagnosing the flaw is the one who will be paid to fix it. In most of these cases, consumers aren't sophisticated enough to make an independent judgment. That's why they went to the expert. The problem, of course, extends well beyond the car business. Anytime you call a plumber or roofer to your home or anytime you visit a doctor or dentist, you're at risk of having an expert service problem…If anything, Professor Hubbard argues that the expert service problem is more serious in medicine than in auto repair, because most people are less willing to question a doctor than to question a mechanic. Any effort to reform American medicine has to grapple with these conflicts of interest…").
7) Cowen commented that a catastrophe isn't more likely because markets don't price the prospect more aggressively now than in the past. However, in an article he linked to on his blog, Peter Thiel said the pricing is distorted because no one would be around to collect the insurance payout in the event of the catastrophe– ("…The catastrophe is so large that no functioning market or government remains: This is the only case where one would incur catastrophic "losses," although nobody might be left to collect them…" ) Similarly, there was recent speculation that a market on a Large Hadron Collider-motivated catastrophe would break down because of the inability to collect a payout in an apocalyptic event. ("…Unfortunately this is one kind of question where an Idea Futures market would not work too well, because people who correctly bet that the reactor will destroy the earth may not be able to collect their winnings. This would cause the market to under-estimate the risks…")
Sunday, July 6, 2008
Sunday Briefing
One notes the Tel Aviv 25 index perilously close to the round number of 1000 but down a relatively subdued 1% from its Thursday close. The role of round numbers like this should be considered, as well as the attraction of round % declines like 20%. One notes that almost all European markets are down 20 to 24% this year, Germany -22%, France -24% , Spain -22%, Switzerland -20%, Italy -24%, Ireland -29%, Netherlands -22% , Belgium -27%… Only England and Denmark are down in the teens.
In this context one speculates that it would be worthwhile to look at holidays as being inordinately associated with turning points, especially when they try to throw you off the first day following.
In this context one speculates that it would be worthwhile to look at holidays as being inordinately associated with turning points, especially when they try to throw you off the first day following.
Saturday, July 5, 2008
The Bear is back
IT'S OFFICIAL: THE BEAR HAS ARRIVED. The Dow Jones Industrial Average last week qualified for the widely accepted definition of a bear market of a 20% drop from the highs. The good news is that once the decline reaches that arbitrary 20% mark, based on history, the market has suffered most of its losses. The bad news is that the decline typically drags on for some time, and time may be the worst enemy. Investors may initially try to grab erstwhile highfliers that have crashed and burned but rarely regain their former status. And as the decline wears down investors' psyches, they tend to bail out at the market's nadir, when things look bleakest -- and when the greatest opportunities present themselves.
The post-1940 average bear market (as defined by the Standard & Poor's 500 index) produced a decline of 30.4% from a peak that took 386 days to reach its trough, according to data compiled by Bespoke Investment Group. By the time the market was down the requisite 20%, the average bear market was 74% completed. Based on those averages, the bear market would have another 118 days to run and would face losses of another 14% from current levels.
Rarely does the market get a short, sharp shock, as in 1987, when the bear market lasted just 101 days -- with most of the total damage of 22.51% done on Black Monday, Oct. 19. The longest march downward was the 1973-74 decline, which took 630 days and sliced 48.2% off the S&P.
BUT BESPOKE DEFINES two separate bear markets following the bursting of the technology bubble -- an initial 36.77% drop from March 2000 to September 2001, punctuated by a brief, post-9/11 recovery until the next decline of January-July 2002 of 31.97%. In the minds of most investors who suffered through that period, it was three long years of false starts and frustration until the recovery really got under way, in March 2003.
Signs of bear-market fatigue already are becoming evident. Investors have yanked more than $80.4 billion from domestic equity funds in the past 12 months, according to Investment Company Institute data parsed by Bianco Research. Overseas funds drew $75.7 billion from American mutual-fund investors, leaving a net equity fund outflow of $4.7 billion.
What's more, there have been few hiding places other than commodities, observes Jack A. Ablin, chief investment officer at Harris Private Bank. Even Warren Buffett isn't immune, with Berkshire Hathaway (ticker: BRKA) off 21% from its peak.
The foreign stocks Americans have been flocking to lost nearly as much as U.S. equities, despite help from the falling dollar. The MSCI EAFE, the benchmark for developed markets outside the U.S., suffered a negative 10.58% total return in the first half, according to Bianco Research, compared with a negative 11.91% for the S&P. Emerging markets were slightly worse than the EAFE, with a negative 11.64% return, according to MSCI's measure. Even the once hotter-than-hot China market has gone into a deep-freeze; the iShares FTSE/Xinhua exchange-traded fund (FXI), a popular way for Americans to play that market, is down 43% from its high last October. Bonds other than Treasuries lost money in the first half, especially corporates, junk bonds and municipals. Meanwhile, the Dow Jones-AIG Commodity Index returned 27.23% in the first six months of 2008.
Yet there's little prospect for relief in the near term, especially as the second-quarter earnings reporting season is about to kick off. Despite its near 20% retreat, the S&P 500 remains too high relative to prospective earnings, says Ablin. Even though analysts have slashed their 2008 earnings forecasts to just 5.8% gains from 15% at the beginning of the year, he thinks they're still too optimistic. Based on his estimated profit gains this year of 3%, and an earnings yield (the inverse of the price-earnings multiple) equal to triple-B corporate bonds' 6.8%, Ablin's model indicates the S&P should shed another 5%.
But others see the current decline as another phase in a longer-term secular bear market. "We are still in the super bear of 2000," asserts Jeremy Grantham, chairman of money manager GMO. In a bear market, stocks fall back to, or below, their long-term trend line. But after the great bull market from 1982 to 2000, equities never flushed out their excesses "because of the Greenspan-inspired chain of bubbles, from growth stocks to real estate to commodities," referring to former Federal Reserve Chairman Alan Greenspan.
"Great bear markets always take their time, and the most likely end is 2010," Grantham continues. If the S&P 500 were to fall to 1100 in 2010, that would be about a 13% decline from here, about 1263, and would put the index back on its long-term trend line. He adds: "Chances are we will overshoot on the downside. We always do. We will be lucky if it is 1100."
Like Tolstoy's unhappy families, every bear market is different, observes John De-Gulis, a portfolio manager at the Sound Shore Fund. Citing data from Ned Davis Research, he notes that the S&P has been down an average of 4.83% six months after the start of a recession and up 3.15% 12 months on. "Of course, we haven't entered the recession officially yet," he adds, which may happen late this year or early 2009. But, he adds, "the two recessions where the market was down big time 12 months after the recession started were '73, minus 27%, and '81, down 18% -- both periods when oil prices spiked."
What seems consistent among bear markets is the tendency of investors to despair in their later stages, dumping everything indiscriminately. For instance, Bespoke Investment found that in the early stages of a decline, from the peak to the down-20% bear print, the traditional defensive redoubts -- consumer staples and health care -- hold up relatively well, shedding about 4% each. But after the bear market becomes "official" at minus 20%, the two actually do slightly worse through the rest of the decline -- down 11.6% for consumer staples and down 13.9% for health care, versus minus 10% for the S&P at that stage, as investors tend to dump anything and everything.
There's no surprise about what did best during past bear markets tracked by Bespoke. During the first phase on the way to the minus-20% mark, gold prices were virtually unchanged while oil was up 18.7%. Bond yields, as measured by the 10-year Treasury, actually were up by about 7% in the early phase, which would result in negative returns. But after the S&P was down 20%, gold gained an average of 6.6%, oil was up 19%, and bond yields were down 0.5% for a positive return.
WHAT'S LESS CLEAR IS what will be the signal leader when a new bull phase starts. Rarely, however, is it the group that led the previous advance. Energy stocks, for instance, did not return to the lead position until the recent bull run, about a quarter century after their last heyday. After the dot-com bust, technology stocks did not take the lead in the subsequent bull market; indeed, the Nasdaq recovered only a bit more than half its decline from its bubble peak of 5048.
The late bull market was, of course, led by financial stocks -- on the way up as well as down. Critics charge that was because the Fed slashed rates too far, to 1% at their low, and kept them too low for too long. This effectively free money fueled the subprime mortgage bubble and bust, which reverberated throughout the credit markets and eventually led to the emergency rescue of Bear Stearns in March.
But after numerous declarations that the worst of the credit crisis is over, and with the latest round of "kitchen sink" write-downs of bad assets by banks and brokers, few pros at this point want to bottom-pick in financials. "I know what I don't want to own," says David Sowerby, portfolio manager of Loomis Sayles -- "toxic subprimes," which one day will be "great trades," but not yet.
Bank stocks are nowhere near as cheap as in the early '90s, contends Frederic Marks, president of Cheviot Value Management, which manages $236 million in separate accounts. For instance, Wells Fargo (WFC) had been cut in half by the fall of 1990 to just 75% of its book value. Today, Wells' shares trade for closer to 1.75 times book, and book values are less than certain, given the potential for write-downs. Wells traded in 1990 at about six to seven times its long-term earnings power (not that year's published earnings), compared with 12 times long-term earnings today.
Barron's Online Editor Randall W. Forsyth warns investors about the bear wear. Keep cash ready, he suggests. (July 5)
Despite the ongoing housing woes and credit strains, inflation has moved to the top of the Fed's worry list. So, too, with the stock market. "The critical variable lies with the [consumer-price index]. It's the biggest driver of the market multiple for the S&P 500," says Francois Trahan, strategist with ISI Group.
He adds that if gains in the CPI slacken in the second half, "then multiples start to expand. Some 80% looks great, like rents and wages, but 20% -- oil and food and import prices -- looks horrible. If commodities just level off, then the CPI will come down." On that score, the Economic Cycle Research Institute's Future Inflation Gauge, a leading indicator for the CPI, fell to a four-year low in June.
WITH CRUDE SOARING past $145 a barrel and prices at the gas pump well past $4 a gallon, investor and consumer psychology is the glummest in decades. So much so, in fact, that the market might be setting itself up for a short-term trading bounce, says Woody Dorsey, proprietor of Market Semiotics. It would be akin to the short-lived rebound from the March lows following the passing of the Bear Stearns phase of the credit crisis.
Marks of Cheviot, who says his composite portfolio of client accounts is up 4% in the past 12 months' 13% slide in the S&P, has had one-third in precious metals and other vehicles that benefit when the dollar or the market declines, one-third in cash, and one-third in strong U.S. companies not tied to the domestic economy. Two exceptions are Wal-Mart Stores (WMT), "which is one of our largest holdings a couple of years running because of our thesis that buyers will be more price conscious and will be more attracted than ever to this store." Another retailer Cheviot has been buying recently is Walgreen (WAG), says Marks, because "two-thirds of its revenues are from pharmacy sales, the company is enormously profitable with zero debt, and its shares are as cheap as they've been in well over a decade."
Down, but Not There Yet: Despite being down 8.2% in June and nearly 20% from its peak, the S&P 500 remains overvalued by 5% reckons Jack Ablin of Harris Private Bank, given 2008 earnings estimates that are "unrealistically" high.
BCA Research's Global Investment Strategy Weekly Bulletin advises subscribers to batten down the hatches to ride out the "perfect storm" resulting from spiking oil prices by reducing equities and boosting bonds, especially European securities. (The SPDR Lehman International Treasury Bond ETF [BWX] provides exposure to foreign government bonds.) "This latest oil surge is canceling out the impact of the Federal Reserve's policy easing, crippling economic growth and causing share prices to relapse," writes Chen Zhao, BCA's managing editor. It is no time for heroics, he adds.
The key to surviving bear markets is capital preservation, concludes GMO's Grantham. You want to "live to fight another day. You may see amazingly cheap asset opportunities in the next couple of years as distressed pricing might become more commonplace. It would be nice to have the money to take advantage."
The post-1940 average bear market (as defined by the Standard & Poor's 500 index) produced a decline of 30.4% from a peak that took 386 days to reach its trough, according to data compiled by Bespoke Investment Group. By the time the market was down the requisite 20%, the average bear market was 74% completed. Based on those averages, the bear market would have another 118 days to run and would face losses of another 14% from current levels.
Rarely does the market get a short, sharp shock, as in 1987, when the bear market lasted just 101 days -- with most of the total damage of 22.51% done on Black Monday, Oct. 19. The longest march downward was the 1973-74 decline, which took 630 days and sliced 48.2% off the S&P.
BUT BESPOKE DEFINES two separate bear markets following the bursting of the technology bubble -- an initial 36.77% drop from March 2000 to September 2001, punctuated by a brief, post-9/11 recovery until the next decline of January-July 2002 of 31.97%. In the minds of most investors who suffered through that period, it was three long years of false starts and frustration until the recovery really got under way, in March 2003.
Signs of bear-market fatigue already are becoming evident. Investors have yanked more than $80.4 billion from domestic equity funds in the past 12 months, according to Investment Company Institute data parsed by Bianco Research. Overseas funds drew $75.7 billion from American mutual-fund investors, leaving a net equity fund outflow of $4.7 billion.
What's more, there have been few hiding places other than commodities, observes Jack A. Ablin, chief investment officer at Harris Private Bank. Even Warren Buffett isn't immune, with Berkshire Hathaway (ticker: BRKA) off 21% from its peak.
The foreign stocks Americans have been flocking to lost nearly as much as U.S. equities, despite help from the falling dollar. The MSCI EAFE, the benchmark for developed markets outside the U.S., suffered a negative 10.58% total return in the first half, according to Bianco Research, compared with a negative 11.91% for the S&P. Emerging markets were slightly worse than the EAFE, with a negative 11.64% return, according to MSCI's measure. Even the once hotter-than-hot China market has gone into a deep-freeze; the iShares FTSE/Xinhua exchange-traded fund (FXI), a popular way for Americans to play that market, is down 43% from its high last October. Bonds other than Treasuries lost money in the first half, especially corporates, junk bonds and municipals. Meanwhile, the Dow Jones-AIG Commodity Index returned 27.23% in the first six months of 2008.
Yet there's little prospect for relief in the near term, especially as the second-quarter earnings reporting season is about to kick off. Despite its near 20% retreat, the S&P 500 remains too high relative to prospective earnings, says Ablin. Even though analysts have slashed their 2008 earnings forecasts to just 5.8% gains from 15% at the beginning of the year, he thinks they're still too optimistic. Based on his estimated profit gains this year of 3%, and an earnings yield (the inverse of the price-earnings multiple) equal to triple-B corporate bonds' 6.8%, Ablin's model indicates the S&P should shed another 5%.
But others see the current decline as another phase in a longer-term secular bear market. "We are still in the super bear of 2000," asserts Jeremy Grantham, chairman of money manager GMO. In a bear market, stocks fall back to, or below, their long-term trend line. But after the great bull market from 1982 to 2000, equities never flushed out their excesses "because of the Greenspan-inspired chain of bubbles, from growth stocks to real estate to commodities," referring to former Federal Reserve Chairman Alan Greenspan.
"Great bear markets always take their time, and the most likely end is 2010," Grantham continues. If the S&P 500 were to fall to 1100 in 2010, that would be about a 13% decline from here, about 1263, and would put the index back on its long-term trend line. He adds: "Chances are we will overshoot on the downside. We always do. We will be lucky if it is 1100."
Like Tolstoy's unhappy families, every bear market is different, observes John De-Gulis, a portfolio manager at the Sound Shore Fund. Citing data from Ned Davis Research, he notes that the S&P has been down an average of 4.83% six months after the start of a recession and up 3.15% 12 months on. "Of course, we haven't entered the recession officially yet," he adds, which may happen late this year or early 2009. But, he adds, "the two recessions where the market was down big time 12 months after the recession started were '73, minus 27%, and '81, down 18% -- both periods when oil prices spiked."
What seems consistent among bear markets is the tendency of investors to despair in their later stages, dumping everything indiscriminately. For instance, Bespoke Investment found that in the early stages of a decline, from the peak to the down-20% bear print, the traditional defensive redoubts -- consumer staples and health care -- hold up relatively well, shedding about 4% each. But after the bear market becomes "official" at minus 20%, the two actually do slightly worse through the rest of the decline -- down 11.6% for consumer staples and down 13.9% for health care, versus minus 10% for the S&P at that stage, as investors tend to dump anything and everything.
There's no surprise about what did best during past bear markets tracked by Bespoke. During the first phase on the way to the minus-20% mark, gold prices were virtually unchanged while oil was up 18.7%. Bond yields, as measured by the 10-year Treasury, actually were up by about 7% in the early phase, which would result in negative returns. But after the S&P was down 20%, gold gained an average of 6.6%, oil was up 19%, and bond yields were down 0.5% for a positive return.
WHAT'S LESS CLEAR IS what will be the signal leader when a new bull phase starts. Rarely, however, is it the group that led the previous advance. Energy stocks, for instance, did not return to the lead position until the recent bull run, about a quarter century after their last heyday. After the dot-com bust, technology stocks did not take the lead in the subsequent bull market; indeed, the Nasdaq recovered only a bit more than half its decline from its bubble peak of 5048.
The late bull market was, of course, led by financial stocks -- on the way up as well as down. Critics charge that was because the Fed slashed rates too far, to 1% at their low, and kept them too low for too long. This effectively free money fueled the subprime mortgage bubble and bust, which reverberated throughout the credit markets and eventually led to the emergency rescue of Bear Stearns in March.
But after numerous declarations that the worst of the credit crisis is over, and with the latest round of "kitchen sink" write-downs of bad assets by banks and brokers, few pros at this point want to bottom-pick in financials. "I know what I don't want to own," says David Sowerby, portfolio manager of Loomis Sayles -- "toxic subprimes," which one day will be "great trades," but not yet.
Bank stocks are nowhere near as cheap as in the early '90s, contends Frederic Marks, president of Cheviot Value Management, which manages $236 million in separate accounts. For instance, Wells Fargo (WFC) had been cut in half by the fall of 1990 to just 75% of its book value. Today, Wells' shares trade for closer to 1.75 times book, and book values are less than certain, given the potential for write-downs. Wells traded in 1990 at about six to seven times its long-term earnings power (not that year's published earnings), compared with 12 times long-term earnings today.
Barron's Online Editor Randall W. Forsyth warns investors about the bear wear. Keep cash ready, he suggests. (July 5)
Despite the ongoing housing woes and credit strains, inflation has moved to the top of the Fed's worry list. So, too, with the stock market. "The critical variable lies with the [consumer-price index]. It's the biggest driver of the market multiple for the S&P 500," says Francois Trahan, strategist with ISI Group.
He adds that if gains in the CPI slacken in the second half, "then multiples start to expand. Some 80% looks great, like rents and wages, but 20% -- oil and food and import prices -- looks horrible. If commodities just level off, then the CPI will come down." On that score, the Economic Cycle Research Institute's Future Inflation Gauge, a leading indicator for the CPI, fell to a four-year low in June.
WITH CRUDE SOARING past $145 a barrel and prices at the gas pump well past $4 a gallon, investor and consumer psychology is the glummest in decades. So much so, in fact, that the market might be setting itself up for a short-term trading bounce, says Woody Dorsey, proprietor of Market Semiotics. It would be akin to the short-lived rebound from the March lows following the passing of the Bear Stearns phase of the credit crisis.
Marks of Cheviot, who says his composite portfolio of client accounts is up 4% in the past 12 months' 13% slide in the S&P, has had one-third in precious metals and other vehicles that benefit when the dollar or the market declines, one-third in cash, and one-third in strong U.S. companies not tied to the domestic economy. Two exceptions are Wal-Mart Stores (WMT), "which is one of our largest holdings a couple of years running because of our thesis that buyers will be more price conscious and will be more attracted than ever to this store." Another retailer Cheviot has been buying recently is Walgreen (WAG), says Marks, because "two-thirds of its revenues are from pharmacy sales, the company is enormously profitable with zero debt, and its shares are as cheap as they've been in well over a decade."
Down, but Not There Yet: Despite being down 8.2% in June and nearly 20% from its peak, the S&P 500 remains overvalued by 5% reckons Jack Ablin of Harris Private Bank, given 2008 earnings estimates that are "unrealistically" high.
BCA Research's Global Investment Strategy Weekly Bulletin advises subscribers to batten down the hatches to ride out the "perfect storm" resulting from spiking oil prices by reducing equities and boosting bonds, especially European securities. (The SPDR Lehman International Treasury Bond ETF [BWX] provides exposure to foreign government bonds.) "This latest oil surge is canceling out the impact of the Federal Reserve's policy easing, crippling economic growth and causing share prices to relapse," writes Chen Zhao, BCA's managing editor. It is no time for heroics, he adds.
The key to surviving bear markets is capital preservation, concludes GMO's Grantham. You want to "live to fight another day. You may see amazingly cheap asset opportunities in the next couple of years as distressed pricing might become more commonplace. It would be nice to have the money to take advantage."
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