Monday, October 20, 2008
Cold Water on Today's Bull
http://seekingalpha.com/article/100771-throwing-cold-water-on-today-s-rally-mark-faber?source=article_lb_articles
Saturday, October 18, 2008
Hedge Fund Not Fun Anymore
Investors pulled at least $43bn from US hedge funds in September as market turmoil led to unprecedented withdrawals, an analysis by a leading research house shows.
The data from TrimTabs Investment Research – which was to be sent to clients late on Wednesday – come as hedge funds are working to prevent far bigger redemptions by the end of the year, when many funds give investors a chance to take out money.
Withdrawals can lead to a vicious circle in the markets, as funds sell holdings to return money to clients, depressing prices and prompting further redemptions. ...
The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.
Conrad Gunn, chief operating officer of TrimTabs, said the $43bn in September withdrawals would mark “the beginning of what we expect to be a series of outflows for the remainder of the year. We expect October outflows to be larger”.
The industry, which manages close to $2,000bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year.
If you ask me what makes me most bearish, what makes me think that the S&P 500 could go to 600, it is not the recession. We have gone through recessions before, even credit-induced ones.
No, what makes me very worried and why I am not deploying capital just yet, even though the market is getting cheap, is the tsunami of hedge fund sales that may be on the horizon.
Recessions we have seen before. Highly leveraged fund liquidation by over-compensated money managers in an industry that gets paid not to take losses whose time horizon is next quarter and whose clients thought they would earn money in any market environment we have not seen before.
That is what worries me.
The data from TrimTabs Investment Research – which was to be sent to clients late on Wednesday – come as hedge funds are working to prevent far bigger redemptions by the end of the year, when many funds give investors a chance to take out money.
Withdrawals can lead to a vicious circle in the markets, as funds sell holdings to return money to clients, depressing prices and prompting further redemptions. ...
The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.
Conrad Gunn, chief operating officer of TrimTabs, said the $43bn in September withdrawals would mark “the beginning of what we expect to be a series of outflows for the remainder of the year. We expect October outflows to be larger”.
The industry, which manages close to $2,000bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year.
If you ask me what makes me most bearish, what makes me think that the S&P 500 could go to 600, it is not the recession. We have gone through recessions before, even credit-induced ones.
No, what makes me very worried and why I am not deploying capital just yet, even though the market is getting cheap, is the tsunami of hedge fund sales that may be on the horizon.
Recessions we have seen before. Highly leveraged fund liquidation by over-compensated money managers in an industry that gets paid not to take losses whose time horizon is next quarter and whose clients thought they would earn money in any market environment we have not seen before.
That is what worries me.
Thursday, October 16, 2008
Time will tell
Seth Glickenhaus, who in 1929 had just become a Wall Street Broker says that we are on the verge of a new bull market, within a week mind you, and there is no question the U.S. did the right thing.
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I suppose in this video, when Mr. Glickenhaus states that the U.S. "did the right thing" he is referring to this rapacious Wall Street bailout Bill?
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I suppose in this video, when Mr. Glickenhaus states that the U.S. "did the right thing" he is referring to this rapacious Wall Street bailout Bill?
Monday, October 13, 2008
A pure financial crisis?
chincook,
Though I never posted at mitbbs, I have been reading there a lot and like your posts the most. Glad to see you here. As for your view, I was thinking the same and still think it could be the best scenario if everything turns out the way as we hoped: a pure financial crisis. That's why I was quite bullish in the beginning of the year and shouted bottom around 1250, and worst 1150. Boy was I wrong, I would be chopped to thousand pieces if I posted that in MITBBS.
Not till the July crash, I came to realize how severe the situation is, we are talking about a 12 trillion Real Estate bubble, compare with 5 trillion Nasdaq 2000 melt down, it’s 2.5 time worse, in addition to that, We are living in a globalized era, globalization makes life better in many ways, but when it fail it could be quite ugly. As for how bad it can be, it is up to anyone’s guess.
On the bright side, the world will be much better after the wash off, there will be many prosper years ahead of us, so let’s get prepared for this to end, and end it will, that I can assure you.
chinook wrote:
头次开贴，上周四晚上和朋友们说的几句话：
“I have been thinking about this sell off with the 1929 one, and I still believe this will be a much short event, it might only have a quick dent for the economy, just like a flu. The quick response, coordinated actions across the globe and the real needs from emerging market will prevent a deep recession from happening. ”
基本的想法就是so far，实际上还是金融危机，如果政府开动印钞机器，很多程度上代理financial inst的功能，或让金融机构再次运转起来，那么经济主体当不会受太大影响。
向各位老大请教下，这个看法哪里不对？
Though I never posted at mitbbs, I have been reading there a lot and like your posts the most. Glad to see you here. As for your view, I was thinking the same and still think it could be the best scenario if everything turns out the way as we hoped: a pure financial crisis. That's why I was quite bullish in the beginning of the year and shouted bottom around 1250, and worst 1150. Boy was I wrong, I would be chopped to thousand pieces if I posted that in MITBBS.
Not till the July crash, I came to realize how severe the situation is, we are talking about a 12 trillion Real Estate bubble, compare with 5 trillion Nasdaq 2000 melt down, it’s 2.5 time worse, in addition to that, We are living in a globalized era, globalization makes life better in many ways, but when it fail it could be quite ugly. As for how bad it can be, it is up to anyone’s guess.
On the bright side, the world will be much better after the wash off, there will be many prosper years ahead of us, so let’s get prepared for this to end, and end it will, that I can assure you.
chinook wrote:
头次开贴，上周四晚上和朋友们说的几句话：
“I have been thinking about this sell off with the 1929 one, and I still believe this will be a much short event, it might only have a quick dent for the economy, just like a flu. The quick response, coordinated actions across the globe and the real needs from emerging market will prevent a deep recession from happening. ”
基本的想法就是so far，实际上还是金融危机，如果政府开动印钞机器，很多程度上代理financial inst的功能，或让金融机构再次运转起来，那么经济主体当不会受太大影响。
向各位老大请教下，这个看法哪里不对？
Sunday, October 12, 2008
Closer to the bottom
FOR THE TENS OF MILLIONS OF INVESTORS WHO HAVE been nervously watching the U.S. stock market's 40% decline in the past 12 months, and it's 18% drop in the past week alone, history holds some solace: There is a case to be made that the averages will hit bottom sometime in the next few months, even if the economy is in the middle of a recession.
Indeed, stocks showed some signs of finding a bottom late Friday, with the Dow Jones industrial average closing down just 128 points on the day, after having plummeted about 700 points earlier in the session. The Nasdaq Composite even managed a small gain on the day. Investors will be watching for a possible market bounce that could occur early this week, especially if any new measures to ease the global economic crisis emerge from the weekend's meeting in Washington of the finance ministers of the so-called G-7 industrial nations.
Scott Pollack for Barron's
The lesson of history is this: The average U.S. recession since the late 1940s has lasted 10 months, and stocks typically hit their low point about three months before the recession ends. So, if the U.S. entered a recession on July 1, as many economists now suggest, and the recession was to last until April 2009, a typical bottom for stocks would occur some time in the next few months.
Granted, much depends on the ability of the Federal Reserve and the U.S. Treasury to put rescue measures in place that will unlock today's frozen capital markets. And there are nagging concerns that the next disaster may lurk in the unregulated $60 trillion market for credit-default swaps. But the fear that sent the market down so sharply last week may have driven stocks close to their ultimate lows.
"I don't think this is the end of America as we know it," says Byron Wien, chief investment strategist at Pequot Capital Management. "I think it's conceivable that the markets will bottom before year end."
Wien cites a number of positive events in recent weeks. The Treasury now has the ability, through the $700 billion Troubled Asset Relief Program (TARP), to start buying distressed assets from banks. There is speculation the federal government will come up with yet another program to help the housing market. Oil prices have fallen below $80 a barrel from levels above $140, a slide that on its own should boost economic growth. And smart investors have started buying at what they hope are good prices. Barclays (ticker: BCS) purchased Lehman Brothers' investment-banking operations in the U.S. Warren Buffett took stakes in General Electric (GE) and Goldman Sachs (GS). Citigroup (C) and Wells Fargo (WFC) actually fought over the right to buy Wachovia (WB).
Recessions certainly have been both shorter and longer than the 10-month average. On a positive note, five recent recessions were shorter. The 1980 recession lasted a mere six months, and there were four recessions that lasted only eight months, according to data from Bespoke Investment Group.
But a mild recession wasn't what the market feared last week. Investors were worried the current economic slump will be "different" from those in the past. American consumers are carrying more debt this time around, and the banking system is in much more fragile shape.
THOUGH A TYPICAL RECESSION would end by next spring, economists are paying increasing attention to longer downturns, specifically the two recessions since 1940 that each lasted 16 months. The November 1973 to August 1975 downdraft was sparked by the Arab oil embargo, while the July 1981 to November 1982 recession was triggered by the Federal Reserve hiking interest rates dramatically to curtail runaway inflation. In each case stocks bottomed about three months before the recession ended.
The good news today is that stocks appear to have gotten out ahead of any recession, falling so sharply that they might already have priced in pretty horrible times ahead. The Dow is down almost as much in the past year as the 45% it fell in the 1973-1975 recession, and its 12-month decline far exceeds the 24% it lost in the period leading up to and during the 1981-1982 recession, according to Birinyi Associates.
Today's 40% drop also far surpasses the average bear-market slide of 30% since 1940. Markets that decline for more than a year average a loss of 42%, says Paul Desmond, President of Lowry Research Corp. The Dow has fallen by more than 40% 10 other times, with all but one such drop occurring between 1900 and 1930. It slid by more than 50% only once, between 1929 and 1932, when it shed 89%. That bear was bracketed by the Great Depression, which lasted for 44 months.
A recession is labeled a depression when economic activity shrinks by 10% or more. From August 1929 to March 1933 U.S. economic output contracted by more than 30%. That's what made it "Great."
Table: Stocks and Recessions: What History Tells UsBut back in the 'Thirties, the financial markets lacked many of today's safety nets, like deposit insurance, and the Federal Reserve didn't loosen the purse strings quickly, as the Fed lately has done. Also, the stock-market rally leading up to the Depression was much more frenzied. From 1921 to 1929, the market rose almost 500%. In the rally from 1987 to 2000, stocks jumped 574%, but did so over a much longer period. From 2002 to the market's peak in October 2007, the Dow rose 94%.
Given stocks' swoon in the past 12 months, prices look much more reasonable today. The companies in the Standard & Poor's 500 trade for an average of 11.6 times the profits that analysts expect them to earn next year. And the index trades at 17.1 times the companies' most recent earnings. That's only slightly below the market's 60-year average price/earnings multiple of 17.8, according to Birinyi Associates.
The current P/E is still high compared to the low P/Es of previous major recessions. During the '74, '80 and '82 recessions, the S&P's trailing P/E dropped to between 6.8 and 7.2. But in the '70, '90 and '01 economic downturns, the P/E ranged from 12.9 to 23.5.
The Bottom Line
Though dangers aplenty still lurk for the economy and the market, studies of stock-market performance through recessions suggest the Dow could see its low shortly.One person who fears further market declines is Wayne Nordberg, chairman of Hollow Brook Associates. "This is the end of the great credit supercycle," he says. "It takes a very long time to unwind."
Or, as Doug Cliggott, manager of the Dover Management Long-Short Sector Fund, put it with regard to the TARP, "we're fighting a forest fire with a garden hose."
But such gloomy sentiments aren't a reason to get out of the stock market. It could be quite the opposite, in fact. Consider that $1 invested in stocks from February 1966 through May 2007 would have grown to $16.58 in that period. That's a 7% annual return. By contrast, investors who were out of the market in the five best days each year during that span were left with only 11 cents.
That's a pretty good case for the buy and hold philosophy, or, if you're out of the market, for getting back in soon.
Indeed, stocks showed some signs of finding a bottom late Friday, with the Dow Jones industrial average closing down just 128 points on the day, after having plummeted about 700 points earlier in the session. The Nasdaq Composite even managed a small gain on the day. Investors will be watching for a possible market bounce that could occur early this week, especially if any new measures to ease the global economic crisis emerge from the weekend's meeting in Washington of the finance ministers of the so-called G-7 industrial nations.
Scott Pollack for Barron's
The lesson of history is this: The average U.S. recession since the late 1940s has lasted 10 months, and stocks typically hit their low point about three months before the recession ends. So, if the U.S. entered a recession on July 1, as many economists now suggest, and the recession was to last until April 2009, a typical bottom for stocks would occur some time in the next few months.
Granted, much depends on the ability of the Federal Reserve and the U.S. Treasury to put rescue measures in place that will unlock today's frozen capital markets. And there are nagging concerns that the next disaster may lurk in the unregulated $60 trillion market for credit-default swaps. But the fear that sent the market down so sharply last week may have driven stocks close to their ultimate lows.
"I don't think this is the end of America as we know it," says Byron Wien, chief investment strategist at Pequot Capital Management. "I think it's conceivable that the markets will bottom before year end."
Wien cites a number of positive events in recent weeks. The Treasury now has the ability, through the $700 billion Troubled Asset Relief Program (TARP), to start buying distressed assets from banks. There is speculation the federal government will come up with yet another program to help the housing market. Oil prices have fallen below $80 a barrel from levels above $140, a slide that on its own should boost economic growth. And smart investors have started buying at what they hope are good prices. Barclays (ticker: BCS) purchased Lehman Brothers' investment-banking operations in the U.S. Warren Buffett took stakes in General Electric (GE) and Goldman Sachs (GS). Citigroup (C) and Wells Fargo (WFC) actually fought over the right to buy Wachovia (WB).
Recessions certainly have been both shorter and longer than the 10-month average. On a positive note, five recent recessions were shorter. The 1980 recession lasted a mere six months, and there were four recessions that lasted only eight months, according to data from Bespoke Investment Group.
But a mild recession wasn't what the market feared last week. Investors were worried the current economic slump will be "different" from those in the past. American consumers are carrying more debt this time around, and the banking system is in much more fragile shape.
THOUGH A TYPICAL RECESSION would end by next spring, economists are paying increasing attention to longer downturns, specifically the two recessions since 1940 that each lasted 16 months. The November 1973 to August 1975 downdraft was sparked by the Arab oil embargo, while the July 1981 to November 1982 recession was triggered by the Federal Reserve hiking interest rates dramatically to curtail runaway inflation. In each case stocks bottomed about three months before the recession ended.
The good news today is that stocks appear to have gotten out ahead of any recession, falling so sharply that they might already have priced in pretty horrible times ahead. The Dow is down almost as much in the past year as the 45% it fell in the 1973-1975 recession, and its 12-month decline far exceeds the 24% it lost in the period leading up to and during the 1981-1982 recession, according to Birinyi Associates.
Today's 40% drop also far surpasses the average bear-market slide of 30% since 1940. Markets that decline for more than a year average a loss of 42%, says Paul Desmond, President of Lowry Research Corp. The Dow has fallen by more than 40% 10 other times, with all but one such drop occurring between 1900 and 1930. It slid by more than 50% only once, between 1929 and 1932, when it shed 89%. That bear was bracketed by the Great Depression, which lasted for 44 months.
A recession is labeled a depression when economic activity shrinks by 10% or more. From August 1929 to March 1933 U.S. economic output contracted by more than 30%. That's what made it "Great."
Table: Stocks and Recessions: What History Tells UsBut back in the 'Thirties, the financial markets lacked many of today's safety nets, like deposit insurance, and the Federal Reserve didn't loosen the purse strings quickly, as the Fed lately has done. Also, the stock-market rally leading up to the Depression was much more frenzied. From 1921 to 1929, the market rose almost 500%. In the rally from 1987 to 2000, stocks jumped 574%, but did so over a much longer period. From 2002 to the market's peak in October 2007, the Dow rose 94%.
Given stocks' swoon in the past 12 months, prices look much more reasonable today. The companies in the Standard & Poor's 500 trade for an average of 11.6 times the profits that analysts expect them to earn next year. And the index trades at 17.1 times the companies' most recent earnings. That's only slightly below the market's 60-year average price/earnings multiple of 17.8, according to Birinyi Associates.
The current P/E is still high compared to the low P/Es of previous major recessions. During the '74, '80 and '82 recessions, the S&P's trailing P/E dropped to between 6.8 and 7.2. But in the '70, '90 and '01 economic downturns, the P/E ranged from 12.9 to 23.5.
The Bottom Line
Though dangers aplenty still lurk for the economy and the market, studies of stock-market performance through recessions suggest the Dow could see its low shortly.One person who fears further market declines is Wayne Nordberg, chairman of Hollow Brook Associates. "This is the end of the great credit supercycle," he says. "It takes a very long time to unwind."
Or, as Doug Cliggott, manager of the Dover Management Long-Short Sector Fund, put it with regard to the TARP, "we're fighting a forest fire with a garden hose."
But such gloomy sentiments aren't a reason to get out of the stock market. It could be quite the opposite, in fact. Consider that $1 invested in stocks from February 1966 through May 2007 would have grown to $16.58 in that period. That's a 7% annual return. By contrast, investors who were out of the market in the five best days each year during that span were left with only 11 cents.
That's a pretty good case for the buy and hold philosophy, or, if you're out of the market, for getting back in soon.
Still Holding Back
FOR THREE YEARS, HE'S CAUTIONED INVESTORS TO AVOID RISK. Jeremy Grantham, chairman of institutional money manager GMO in Boston, was early, but eventually right.
Grantham told Barron's in February of 2006 that "housing is a classic bubble" and that "this feels like the end of a cycle." Known for his insights on global investing, Grantham, 70, co-founded GMO, which has a value framework combining quantitative and fundamental analysis. It oversees assets of about $120 billion.
For Grantham's latest views on the fallout from the financial crisis and what investment opportunities he sees, please read on.
Shawn Henry
"I can't say we are going to be in a great hurry, but our next move…will be back to emerging-market equities and small-cap international value." – Jeremy Grantham
Barron's: How much will the recent $700 billion bailout plan approved by Congress help stabilize the economy and the financial markets?
Grantham: It certainly doesn't hurt. It is an amazingly complicated situation. But I do believe we have passed the point where we have to worry about moral hazard. When Bear Stearns was in trouble, I used to worry about moral hazard.
What is your sense of how this crisis has been handled by those in charge?
It's been a haphazard response, and the next time something happens, you can't be sure what will happen. In one deal they protect the bonds, while in the next deal the bonds go. Then in the next deal they protect the foreign bonds but not the domestic bonds. My guess is that people will be nervous that they will be at the bad end of one of the tough deals, rather than one of the more gentle deals.
Everyone is shaking in their boots. The awareness of risk has come back with a terrifying surge, and it is not going to go away too quickly.
With the Fed and other central banks lowering rates last week, are you worried about inflation?
My view is, "Forget inflation, guys." This is serious, the real McCoy, and you don't have to worry about little things like inflation. Global growth will slow down, commodities will be weaker for a while, and inflation is a thing of the past. Now we are talking about getting the financial machinery to work and just keeping [gross domestic product] grinding along.
What was at the core of what got the financial system into this crisis?
It was the belief by a lot of people who counted that financial bubbles did not have to addressed. The thinking was that...you could step in and, by scattering a bit of money around, ease the downside consequences. Therefore, you could let the tech bubble run amok and wait for it to burst and step in. And you could let the housing bubble run amok and step in.
At the center of this crisis was a bubble in risk-taking. The risk premiums dropped off the cosmic scale, the lowest ever recorded. On our seven-year forecast data, we reckoned that between June of '06 and June of '07, people were actually paying for the privilege of taking risk. Our constant theme for the last three years was avoid risk, avoid risk, avoid risk.
How much further do we have to go to get through this downturn?
Great bubbles like the one in 2000 take a long time to wash through the system, and you shouldn't really expect a low much before 2010. The fair value on the [Standard & Poor's 500 index] is about 1025 [versus 910 late last week].
This was not only a monetary event, but it coincided with the first truly global bubble in all assets. You had inflated housing in almost every country in the world, except for Japan and Germany. You had overpriced stocks in every country in the world. And you had too much money and too-low interest rates. I was confident about very little, but I was confident that this would be different from anything we had seen before, and potentially more dangerous. It should have been treated with more care.
Is this crisis playing out the way you thought it would?
No. I threw in the towel three months ago, and wrote a quarterly letter saying I thought I was the bear around this joint.
But this is much worse than I thought. All the fundamentals are turning out worse than I thought they would. All the competencies of the senior people at the Fed, Treasury and [firms like Merrill Lynch and Lehman Brothers] have turned out to be much less than I had expected; that's very disappointing.
And, therefore, how could one's confidence that the senior people would get us through the storm be very high? Prior to three months ago, we were investing in emerging-market equities. Then we battened down the hatches, and I changed my view from avoid all risk except emerging markets to avoid all risk, period.
The terrible thing -- after all this pain -- is that the U.S. equity market is not even cheap. You would imagine that, given the amount of panic, that it would be. But it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.
What about equities outside the U.S.?
Things are getting cheaper. We score the EAFE [the Europe, Australasia and Far East Index] as absolutely cheap, and it's offering a 7% real annual return over seven years. Emerging-market equities are a bit cheaper, and we see a 9.5% annual real return over the same period.
The problem, though, is that we have so much downside momentum, so many financial problems and so many interlocking relationships, that it is hard to imagine this crisis subsiding because stock prices are digging in their heels and approaching fair value.
What happens to hedge funds in the wake of this crisis?
A year ago, I said that half of all hedge funds would go out of business in five years, and I would certainly stand by that today. Unfortunately, like a lot of my dire projections, that may turn out to be conservative.
I also said that at least one major bank will fail. I got a lot of grief for that, and now it looks like I could have said at least a dozen major banks will fail.
As for the broad, typical opinion that we would muddle through this crisis, it just shows you what a dangerous optimistic bias the advisory business has built into it.
Do you think we will learn anything from all of this turmoil?
We will learn an enormous amount in a very short time, quite a bit in the medium term and absolutely nothing in the long term. That would be the historical precedent.
Let's talk about your asset allocations.
In a nutshell, we are as conservative as we can possibly get. One bet that has been very successful for us, touch wood, has been long high-quality, blue-chip stocks, particularly in the U.S., and short risky companies. We have been screaming against risk-taking for a long time, and in recent weeks, it has paid off enormously.
What about looking ahead in terms of asset allocation?
Going forward, you can think about slowly moving back into the cheapest pockets of global equities. So the next move that we make will be back to moderate neutral in emerging-market equities and small-cap international value. I can't say we are going to be in a great hurry, but that will be our next move. We had finished selling almost everything except emerging markets two years ago. We finished selling emerging-market equities three months ago.
But the next move will be buying, and we are encouraged that there are a few pockets that are cheap on an absolute basis. We are not encouraged that they will rally immediately. But we will be looking to buy the cheap pockets of global equities as our next move some time in the next several months.
Why emerging markets and small-cap international value?
Just value and because they have been hit the most. Emerging equities are down almost 50% since late last year, and some of small-cap international is down more than 40%. That big a drop has this wonderful effect of making these categories look cheap pretty fast. You can buy, but it doesn't mean it is their low, and I strongly suspect it is not.
The great trap is to buy too soon and, in the big move, to sell too soon. I've been saying since '98-'99 that my next major-league error will be buying too soon -- but we will not buy quite yet. But when we do, I suspect it will be too soon again.
What do you see ahead for commodities?
Commodities have a great long-term future, now that the long-term trend has shifted from falling commodity prices to rising commodity prices. Having said that, the next couple of years will be quite different. We are in a global slowdown, which I think will be worse than expected even today, and it will be longer than expected -- so this is not a healthy environment for commodities. Over a shorter horizon, I would be getting out of the way of commodities or I would be short commodities. I'm personally short oil; the firm is short copper.
What about some other trades?
I'm speaking for the asset-allocation unit at the firm. We have been substantially long the safe-haven currencies. We have been very long the yen and somewhat long the Swiss franc and short sterling, which is one of our favorite bets. We have been short the euro for three months, and slightly long the U.S. dollar. One of the paradoxes is, if the world is worse than people expect, the U.S. dollar will outperform.
Why are you shorting the euro?
It just ran too far. It went from 85 cents on the U.S. dollar to $1.60; it more or less doubled, which I don't think reflects reality. But the biggest lay-up of any idea over the last three or six months was shorting the pound.
The U.K. housing market was dreadfully overpriced. I felt nearly certain that the U.K. housing market would come back to a more normal multiple of family income, which is a very big decline of 40% if you did it in a hurry -- or you can sit back for many years and wait for income to catch up. But you should really count on that market coming down over a couple of years painfully.
Do you have any closing thoughts about how we got into this financial state?
I ask myself, "Why is it that several dozen people saw this crisis coming for years?" I described it as being like watching a train wreck in very slow motion. It seemed so inevitable and so merciless, and yet the bosses of Merrill Lynch and Citi and even [U.S. Treasury Secretary] Hank Paulson and [Fed Chairman Ben] Bernanke -- none of them seemed to see it coming.
I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained -- but we end up with an army of left-brained immediate doers.
So it's more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored.
If you look at the people who have been screaming about impending doom, and you added all of those several dozen people together, I don't suppose that collectively they could run a single firm without dragging it into bankruptcy in two weeks. They are just a different kind of person.
So we kept putting organization people -- people who can influence and persuade and cajole -- into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don't have those skills.
Where do you see all of this going?
I want to emphasize how little I understand all of the intricate workings of the global financial system. I hope that someone else gets it, because I don't. And I have no idea, really, how this will work out. I certainly wish it hadn't happened. It is just so intricate that all I can conclude, by instinct and by reading the history books, is that it will be longer, harder and more complicated than we expect.
Grantham told Barron's in February of 2006 that "housing is a classic bubble" and that "this feels like the end of a cycle." Known for his insights on global investing, Grantham, 70, co-founded GMO, which has a value framework combining quantitative and fundamental analysis. It oversees assets of about $120 billion.
For Grantham's latest views on the fallout from the financial crisis and what investment opportunities he sees, please read on.
Shawn Henry
"I can't say we are going to be in a great hurry, but our next move…will be back to emerging-market equities and small-cap international value." – Jeremy Grantham
Barron's: How much will the recent $700 billion bailout plan approved by Congress help stabilize the economy and the financial markets?
Grantham: It certainly doesn't hurt. It is an amazingly complicated situation. But I do believe we have passed the point where we have to worry about moral hazard. When Bear Stearns was in trouble, I used to worry about moral hazard.
What is your sense of how this crisis has been handled by those in charge?
It's been a haphazard response, and the next time something happens, you can't be sure what will happen. In one deal they protect the bonds, while in the next deal the bonds go. Then in the next deal they protect the foreign bonds but not the domestic bonds. My guess is that people will be nervous that they will be at the bad end of one of the tough deals, rather than one of the more gentle deals.
Everyone is shaking in their boots. The awareness of risk has come back with a terrifying surge, and it is not going to go away too quickly.
With the Fed and other central banks lowering rates last week, are you worried about inflation?
My view is, "Forget inflation, guys." This is serious, the real McCoy, and you don't have to worry about little things like inflation. Global growth will slow down, commodities will be weaker for a while, and inflation is a thing of the past. Now we are talking about getting the financial machinery to work and just keeping [gross domestic product] grinding along.
What was at the core of what got the financial system into this crisis?
It was the belief by a lot of people who counted that financial bubbles did not have to addressed. The thinking was that...you could step in and, by scattering a bit of money around, ease the downside consequences. Therefore, you could let the tech bubble run amok and wait for it to burst and step in. And you could let the housing bubble run amok and step in.
At the center of this crisis was a bubble in risk-taking. The risk premiums dropped off the cosmic scale, the lowest ever recorded. On our seven-year forecast data, we reckoned that between June of '06 and June of '07, people were actually paying for the privilege of taking risk. Our constant theme for the last three years was avoid risk, avoid risk, avoid risk.
How much further do we have to go to get through this downturn?
Great bubbles like the one in 2000 take a long time to wash through the system, and you shouldn't really expect a low much before 2010. The fair value on the [Standard & Poor's 500 index] is about 1025 [versus 910 late last week].
This was not only a monetary event, but it coincided with the first truly global bubble in all assets. You had inflated housing in almost every country in the world, except for Japan and Germany. You had overpriced stocks in every country in the world. And you had too much money and too-low interest rates. I was confident about very little, but I was confident that this would be different from anything we had seen before, and potentially more dangerous. It should have been treated with more care.
Is this crisis playing out the way you thought it would?
No. I threw in the towel three months ago, and wrote a quarterly letter saying I thought I was the bear around this joint.
But this is much worse than I thought. All the fundamentals are turning out worse than I thought they would. All the competencies of the senior people at the Fed, Treasury and [firms like Merrill Lynch and Lehman Brothers] have turned out to be much less than I had expected; that's very disappointing.
And, therefore, how could one's confidence that the senior people would get us through the storm be very high? Prior to three months ago, we were investing in emerging-market equities. Then we battened down the hatches, and I changed my view from avoid all risk except emerging markets to avoid all risk, period.
The terrible thing -- after all this pain -- is that the U.S. equity market is not even cheap. You would imagine that, given the amount of panic, that it would be. But it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.
What about equities outside the U.S.?
Things are getting cheaper. We score the EAFE [the Europe, Australasia and Far East Index] as absolutely cheap, and it's offering a 7% real annual return over seven years. Emerging-market equities are a bit cheaper, and we see a 9.5% annual real return over the same period.
The problem, though, is that we have so much downside momentum, so many financial problems and so many interlocking relationships, that it is hard to imagine this crisis subsiding because stock prices are digging in their heels and approaching fair value.
What happens to hedge funds in the wake of this crisis?
A year ago, I said that half of all hedge funds would go out of business in five years, and I would certainly stand by that today. Unfortunately, like a lot of my dire projections, that may turn out to be conservative.
I also said that at least one major bank will fail. I got a lot of grief for that, and now it looks like I could have said at least a dozen major banks will fail.
As for the broad, typical opinion that we would muddle through this crisis, it just shows you what a dangerous optimistic bias the advisory business has built into it.
Do you think we will learn anything from all of this turmoil?
We will learn an enormous amount in a very short time, quite a bit in the medium term and absolutely nothing in the long term. That would be the historical precedent.
Let's talk about your asset allocations.
In a nutshell, we are as conservative as we can possibly get. One bet that has been very successful for us, touch wood, has been long high-quality, blue-chip stocks, particularly in the U.S., and short risky companies. We have been screaming against risk-taking for a long time, and in recent weeks, it has paid off enormously.
What about looking ahead in terms of asset allocation?
Going forward, you can think about slowly moving back into the cheapest pockets of global equities. So the next move that we make will be back to moderate neutral in emerging-market equities and small-cap international value. I can't say we are going to be in a great hurry, but that will be our next move. We had finished selling almost everything except emerging markets two years ago. We finished selling emerging-market equities three months ago.
But the next move will be buying, and we are encouraged that there are a few pockets that are cheap on an absolute basis. We are not encouraged that they will rally immediately. But we will be looking to buy the cheap pockets of global equities as our next move some time in the next several months.
Why emerging markets and small-cap international value?
Just value and because they have been hit the most. Emerging equities are down almost 50% since late last year, and some of small-cap international is down more than 40%. That big a drop has this wonderful effect of making these categories look cheap pretty fast. You can buy, but it doesn't mean it is their low, and I strongly suspect it is not.
The great trap is to buy too soon and, in the big move, to sell too soon. I've been saying since '98-'99 that my next major-league error will be buying too soon -- but we will not buy quite yet. But when we do, I suspect it will be too soon again.
What do you see ahead for commodities?
Commodities have a great long-term future, now that the long-term trend has shifted from falling commodity prices to rising commodity prices. Having said that, the next couple of years will be quite different. We are in a global slowdown, which I think will be worse than expected even today, and it will be longer than expected -- so this is not a healthy environment for commodities. Over a shorter horizon, I would be getting out of the way of commodities or I would be short commodities. I'm personally short oil; the firm is short copper.
What about some other trades?
I'm speaking for the asset-allocation unit at the firm. We have been substantially long the safe-haven currencies. We have been very long the yen and somewhat long the Swiss franc and short sterling, which is one of our favorite bets. We have been short the euro for three months, and slightly long the U.S. dollar. One of the paradoxes is, if the world is worse than people expect, the U.S. dollar will outperform.
Why are you shorting the euro?
It just ran too far. It went from 85 cents on the U.S. dollar to $1.60; it more or less doubled, which I don't think reflects reality. But the biggest lay-up of any idea over the last three or six months was shorting the pound.
The U.K. housing market was dreadfully overpriced. I felt nearly certain that the U.K. housing market would come back to a more normal multiple of family income, which is a very big decline of 40% if you did it in a hurry -- or you can sit back for many years and wait for income to catch up. But you should really count on that market coming down over a couple of years painfully.
Do you have any closing thoughts about how we got into this financial state?
I ask myself, "Why is it that several dozen people saw this crisis coming for years?" I described it as being like watching a train wreck in very slow motion. It seemed so inevitable and so merciless, and yet the bosses of Merrill Lynch and Citi and even [U.S. Treasury Secretary] Hank Paulson and [Fed Chairman Ben] Bernanke -- none of them seemed to see it coming.
I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained -- but we end up with an army of left-brained immediate doers.
So it's more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored.
If you look at the people who have been screaming about impending doom, and you added all of those several dozen people together, I don't suppose that collectively they could run a single firm without dragging it into bankruptcy in two weeks. They are just a different kind of person.
So we kept putting organization people -- people who can influence and persuade and cajole -- into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don't have those skills.
Where do you see all of this going?
I want to emphasize how little I understand all of the intricate workings of the global financial system. I hope that someone else gets it, because I don't. And I have no idea, really, how this will work out. I certainly wish it hadn't happened. It is just so intricate that all I can conclude, by instinct and by reading the history books, is that it will be longer, harder and more complicated than we expect.
A little perspective, please
How did this crisis happen? Could it get worse? When will the pain end ? If you were looking for answers to those questions - and you should be - you'd seek out someone with knowledge of the past and a record for being right about the future.
Allow us, then, to introduce you to three people rich in both. Diane Swonk, the chief economist of Chicago's Mesirow Financial, has been named one of the country's top forecasters and is an adviser to the Federal Reserve Board.
Jeremy Grantham, co-founder of the investment firm GMO, was one of the first investors to foresee that the financial system was headed for a breakdown.
And market historian John Steele Gordon, whose grandfathers held seats on the New York Stock Exchange, has chronicled America's long history of booms and busts in An Empire of Wealth.
Reporter Joe Light and senior writer Janice Revell spoke with them in mid-September.
In retrospect, there were plenty of signs pointing to the serious and growing problems in the financial system before everything seemed to fall apart at once. Why didn't anyone, on Wall Street or in Washington, take action sooner?
Jeremy Grantham: We got so good at denial. The Fed was in denial, the Treasury was in denial, the bosses of Merrill Lynch and Lehman were in denial. And yet this crisis was the most widely heralded "surprise" in the history of finance - there were plenty of people warning that it was going to happen long before it did.
You were one of them. What did you see that bothered you?
Grantham: All you had to do was open a history book and see what happens when you have a bubble. In this case, there was a bubble in housing and there was a magnificent bubble in risk taking. People were just shoveling their money into risk on the pathetic idea that risk is always rewarded.
That is completely misguided. You don't get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.
You can lay the evidence in front of everybody, but they will yawn and ignore it. It's that denial that's impressive. It's what happens in bubbles.
How did individual homeowners contribute to the current meltdown?
Diane Swonk: The housing bubble is certainly the root of the problem in the financial markets. If you were a home buyer, you didn't have to have any skin in the game, you didn't have to put any equity down to get a mortgage.
Another problem is the ease with which people can walk away from their homes in this country. A home buyer can say to a bank, "Here are the keys; the house is your problem now. But I'm going to keep my car, my 401(k) and everything else."
No other major industrialized country in the world allows that. And it encouraged homeowners here to take more risk, to put zero money down.
How much at risk were the financial institutions involved? That is, was this degree of intervention really necessary?
Grantham: Leverage is the ultimate demonstration of risk, and we never had system-wide leverage like this before. Ever. We had several firms that were leveraged 30 to 1. [For every $30 of assets on their books, they put up $1 of equity and borrowed the other $29.] At leverage of 30 to 1, you have to lose only about 3% on your $30 worth of assets and your dollar of equity gets wiped out. You're bankrupt.
Why would those financial firms take on such extreme risk?
Grantham: They believed their risk models, which said they had a diversified portfolio, so their investments couldn't all go down together. And the potential rewards were out of whack with the risk.
Say you're in the hedge fund division of some investment bank and you have a billion dollars to invest. You hit the ball out of the park, make 120% on that billion and probably walk away with a $45 million bonus. If you lose the billion dollars, you're fired. Hey, that's not bad! If I thought the odds of success were fifty-fifty, I'd be a fool not to try.
How bad is our current situation compared with previous financial crises?
John Steele Gordon: It feels bad but not like a panic. In a classic panic, as in 1987 or 1929, everyone was selling and prices went through the floor. The market lost 22% on Oct. 19, 1987, compared with 4% on the day Lehman filed for bankruptcy. We were getting close to a breakdown in the whole financial system, but now that decisive government actions are being taken, we're stepping back from the brink.
By comparison, after the 1929 stock market crash, the government didn't do much of anything - and what they did do just made the situation worse. For instance, the Fed kept interest rates high and the government implemented the largest tariff in American history, which was effectively a big tax increase in a declining economy. These things converted a perfectly ordinary recession and market crash into the greatest economic calamity in American history.
In 1987, on the other hand, it was the Federal Reserve that ended the panic. The Fed basically called up Wall Street and said, "Listen, you guys need liquidity. Bring your wheelbarrows and we'll fill them up." We've seen a similar use of the Fed in the current crisis.
How have other countries responded to the deteriorating situation here?
Swonk: This is one aspect of the crisis that most people aren't talking about. The financial liquidity that has been infused into the market to provide stability has come not only from the Federal Reserve but from international sources as well. The European Central Bank and the Bank of Japan have been very involved.
The reality is setting in that globalization has made us all intrinsically linked, and coordination of policy across borders is critical. That is not the place America was in during the Great Depression. Then the rest of the world was still hurting financially from World War I and there was nowhere to go outside the U.S. to raise money. Today there are a lot of places to go.
Is a massive government rescue program really necessary?
Swonk: The piecemeal approach to creating some sort of backstop to the financial system - Bear Stearns, AIG and so on - appeared to add more panic than confidence to the markets. We needed a more holistic approach to stop the bloodletting, especially once it started to affect short-term credit.
What about the cost to taxpayers?
Gordon: People thought the cost associated with the S&L crisis would be two or three times larger than the $150 billion it turned out to be. At the time the S&L's problem assets - real estate - would have overwhelmed the market if sold at once. The government later sold them for much more than people originally thought they could. That may also be the case today.
We've now seen huge banks acquire other huge banks. Are these massive financial institutions dangerous?
Gordon: It's good because it makes the banks more stable. A lot of the banking problems we had earlier in our history occurred because the banks were so small. In 1920 we had 30,000 banks in this country; each small town had its own bank. If the economy of that small town went into the toilet - a factory closed or there was a long drought - the bank went broke because there was such a small base supporting it.
The more widespread a bank is, the more stable it is. If something goes wrong in one area, there are other places where things are going well to offset that.
What can the past tell us about where the stock market is going next?
Grantham: Historically, when a market bubble has popped, it has almost always overcorrected. But after the tech bubble burst in 2000, the stock market didn't hit the lows it should have.
Before it could, the housing bubble and tax cuts that followed 9/11 kicked off the biggest sucker rally in history, from 2002 to 2006. So I think the market isn't cheap yet. There is more pain coming. I don't think we'll hit the low until 2010.
Swonk: But even though the market is turbulent and scary today, we're still looking at a pretty favorable environment over the longer term for stocks. Productivity growth is accelerating - we all know this, of course, because we're working harder for less money. Rising productivity leads to rising corporate profits. That, historically, has been highly correlated with a bull market.
What's your advice to investors now?
Grantham: Understand that the market may recover for a while and then go to a new low. One of the lessons I have learned over the years is that things can get a whole lot more extreme, both up and down, than you ever dreamed of. So we may drop another 30% before we hit bottom.
Keep telling yourself every night that you're a long-term investor and don't look at daily stock prices. And it's not too late to shift some of your money to high-quality blue chips. Emerging markets are probably no longer too expensive either. If you had 80% of your stockholdings in blue chips and 20% in emerging markets, you'd have a pretty reasonable portfolio to ride out the bad times.
Gordon: Psychology is central in these kinds of markets. Don't panic, that's the No. 1 rule, and think long term.
What's ahead for the economy now?
Swonk: We can't really avoid the economy getting worse before it gets better. We don't have the tax rebates helping us out anymore. Labor markets have deteriorated further, and people who are working are in many cases earning less. So I don't think we'll recover before 2010. It won't be until then that housing prices stabilize, and that's the key issue.
I'm confident that they will by 2010 because we are still creating a million new households a year and those people have to live somewhere. We've got some fundamentals working for us, but it will take a while to get there.
What needs to change to prevent another crisis from happening?
Gordon: We need a thorough housecleaning of the financial regulation system. Right now it isn't even really a system. It just sort of grew over the years and doesn't make a whole lot of sense.
You have the Federal Reserve, the Comptroller of the Currency, the FDIC, the SEC, state banking authorities and state insurance authorities - and all of them working at cross-purposes. It doesn't make any sense at all anymore.
Is there a silver lining to all of this ?
Grantham: People lost the knack of thinking that cheaper assets are better. We're going to return to that way of thinking, and that's incredibly good news.
Allow us, then, to introduce you to three people rich in both. Diane Swonk, the chief economist of Chicago's Mesirow Financial, has been named one of the country's top forecasters and is an adviser to the Federal Reserve Board.
Jeremy Grantham, co-founder of the investment firm GMO, was one of the first investors to foresee that the financial system was headed for a breakdown.
And market historian John Steele Gordon, whose grandfathers held seats on the New York Stock Exchange, has chronicled America's long history of booms and busts in An Empire of Wealth.
Reporter Joe Light and senior writer Janice Revell spoke with them in mid-September.
In retrospect, there were plenty of signs pointing to the serious and growing problems in the financial system before everything seemed to fall apart at once. Why didn't anyone, on Wall Street or in Washington, take action sooner?
Jeremy Grantham: We got so good at denial. The Fed was in denial, the Treasury was in denial, the bosses of Merrill Lynch and Lehman were in denial. And yet this crisis was the most widely heralded "surprise" in the history of finance - there were plenty of people warning that it was going to happen long before it did.
You were one of them. What did you see that bothered you?
Grantham: All you had to do was open a history book and see what happens when you have a bubble. In this case, there was a bubble in housing and there was a magnificent bubble in risk taking. People were just shoveling their money into risk on the pathetic idea that risk is always rewarded.
That is completely misguided. You don't get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.
You can lay the evidence in front of everybody, but they will yawn and ignore it. It's that denial that's impressive. It's what happens in bubbles.
How did individual homeowners contribute to the current meltdown?
Diane Swonk: The housing bubble is certainly the root of the problem in the financial markets. If you were a home buyer, you didn't have to have any skin in the game, you didn't have to put any equity down to get a mortgage.
Another problem is the ease with which people can walk away from their homes in this country. A home buyer can say to a bank, "Here are the keys; the house is your problem now. But I'm going to keep my car, my 401(k) and everything else."
No other major industrialized country in the world allows that. And it encouraged homeowners here to take more risk, to put zero money down.
How much at risk were the financial institutions involved? That is, was this degree of intervention really necessary?
Grantham: Leverage is the ultimate demonstration of risk, and we never had system-wide leverage like this before. Ever. We had several firms that were leveraged 30 to 1. [For every $30 of assets on their books, they put up $1 of equity and borrowed the other $29.] At leverage of 30 to 1, you have to lose only about 3% on your $30 worth of assets and your dollar of equity gets wiped out. You're bankrupt.
Why would those financial firms take on such extreme risk?
Grantham: They believed their risk models, which said they had a diversified portfolio, so their investments couldn't all go down together. And the potential rewards were out of whack with the risk.
Say you're in the hedge fund division of some investment bank and you have a billion dollars to invest. You hit the ball out of the park, make 120% on that billion and probably walk away with a $45 million bonus. If you lose the billion dollars, you're fired. Hey, that's not bad! If I thought the odds of success were fifty-fifty, I'd be a fool not to try.
How bad is our current situation compared with previous financial crises?
John Steele Gordon: It feels bad but not like a panic. In a classic panic, as in 1987 or 1929, everyone was selling and prices went through the floor. The market lost 22% on Oct. 19, 1987, compared with 4% on the day Lehman filed for bankruptcy. We were getting close to a breakdown in the whole financial system, but now that decisive government actions are being taken, we're stepping back from the brink.
By comparison, after the 1929 stock market crash, the government didn't do much of anything - and what they did do just made the situation worse. For instance, the Fed kept interest rates high and the government implemented the largest tariff in American history, which was effectively a big tax increase in a declining economy. These things converted a perfectly ordinary recession and market crash into the greatest economic calamity in American history.
In 1987, on the other hand, it was the Federal Reserve that ended the panic. The Fed basically called up Wall Street and said, "Listen, you guys need liquidity. Bring your wheelbarrows and we'll fill them up." We've seen a similar use of the Fed in the current crisis.
How have other countries responded to the deteriorating situation here?
Swonk: This is one aspect of the crisis that most people aren't talking about. The financial liquidity that has been infused into the market to provide stability has come not only from the Federal Reserve but from international sources as well. The European Central Bank and the Bank of Japan have been very involved.
The reality is setting in that globalization has made us all intrinsically linked, and coordination of policy across borders is critical. That is not the place America was in during the Great Depression. Then the rest of the world was still hurting financially from World War I and there was nowhere to go outside the U.S. to raise money. Today there are a lot of places to go.
Is a massive government rescue program really necessary?
Swonk: The piecemeal approach to creating some sort of backstop to the financial system - Bear Stearns, AIG and so on - appeared to add more panic than confidence to the markets. We needed a more holistic approach to stop the bloodletting, especially once it started to affect short-term credit.
What about the cost to taxpayers?
Gordon: People thought the cost associated with the S&L crisis would be two or three times larger than the $150 billion it turned out to be. At the time the S&L's problem assets - real estate - would have overwhelmed the market if sold at once. The government later sold them for much more than people originally thought they could. That may also be the case today.
We've now seen huge banks acquire other huge banks. Are these massive financial institutions dangerous?
Gordon: It's good because it makes the banks more stable. A lot of the banking problems we had earlier in our history occurred because the banks were so small. In 1920 we had 30,000 banks in this country; each small town had its own bank. If the economy of that small town went into the toilet - a factory closed or there was a long drought - the bank went broke because there was such a small base supporting it.
The more widespread a bank is, the more stable it is. If something goes wrong in one area, there are other places where things are going well to offset that.
What can the past tell us about where the stock market is going next?
Grantham: Historically, when a market bubble has popped, it has almost always overcorrected. But after the tech bubble burst in 2000, the stock market didn't hit the lows it should have.
Before it could, the housing bubble and tax cuts that followed 9/11 kicked off the biggest sucker rally in history, from 2002 to 2006. So I think the market isn't cheap yet. There is more pain coming. I don't think we'll hit the low until 2010.
Swonk: But even though the market is turbulent and scary today, we're still looking at a pretty favorable environment over the longer term for stocks. Productivity growth is accelerating - we all know this, of course, because we're working harder for less money. Rising productivity leads to rising corporate profits. That, historically, has been highly correlated with a bull market.
What's your advice to investors now?
Grantham: Understand that the market may recover for a while and then go to a new low. One of the lessons I have learned over the years is that things can get a whole lot more extreme, both up and down, than you ever dreamed of. So we may drop another 30% before we hit bottom.
Keep telling yourself every night that you're a long-term investor and don't look at daily stock prices. And it's not too late to shift some of your money to high-quality blue chips. Emerging markets are probably no longer too expensive either. If you had 80% of your stockholdings in blue chips and 20% in emerging markets, you'd have a pretty reasonable portfolio to ride out the bad times.
Gordon: Psychology is central in these kinds of markets. Don't panic, that's the No. 1 rule, and think long term.
What's ahead for the economy now?
Swonk: We can't really avoid the economy getting worse before it gets better. We don't have the tax rebates helping us out anymore. Labor markets have deteriorated further, and people who are working are in many cases earning less. So I don't think we'll recover before 2010. It won't be until then that housing prices stabilize, and that's the key issue.
I'm confident that they will by 2010 because we are still creating a million new households a year and those people have to live somewhere. We've got some fundamentals working for us, but it will take a while to get there.
What needs to change to prevent another crisis from happening?
Gordon: We need a thorough housecleaning of the financial regulation system. Right now it isn't even really a system. It just sort of grew over the years and doesn't make a whole lot of sense.
You have the Federal Reserve, the Comptroller of the Currency, the FDIC, the SEC, state banking authorities and state insurance authorities - and all of them working at cross-purposes. It doesn't make any sense at all anymore.
Is there a silver lining to all of this ?
Grantham: People lost the knack of thinking that cheaper assets are better. We're going to return to that way of thinking, and that's incredibly good news.
Thursday, October 9, 2008
Marc Faber Gives Investors Some Hope
Investor Marc Faber said a series of coordinated interest-rate cuts by central banks including the Federal Reserve to ease the economic effects of the global financial crisis won’t halt a worldwide slide in equities…
“The slashing of interest rates will not help very much,” Faber, who manages $300 million, said in an interview in Manila. “They may cushion somewhat the decline but make matters worse.”
The Swiss-born investor added:
Had central banks around the world kept interest rates that encourage saving we wouldn’t have these problems today.
However, Dr. Faber believes there still remains a glimmer of hope for investors in equities. From the CNBC website yesterday:
The stock market is as oversold as it has been since the crash of 1987 and the broader market could start to rebound until early next year, Marc Faber, editor and publisher of the Gloom Boom and Doom Report, said Tuesday.
The market is possibly in “the most oversold condition” since perhaps Oct. 19, 1987, Faber told CNBC’s “Squawk Box.”
“Usually there is some seasonal strength between October and March” so it is possible the S&P 500 index will create a low between now and the end of the month, he said.
He talked about some areas investors should be looking at:
Longer-term investors will have to position themselves in emerging country stock markets to play the global recovery, Faber advised.
Faber, who recommended buying gold at the start of its six-year rally, also pointed out:
For now, gold is still attractive, with central banks readying more rate cuts and printing money, he said.
“The slashing of interest rates will not help very much,” Faber, who manages $300 million, said in an interview in Manila. “They may cushion somewhat the decline but make matters worse.”
The Swiss-born investor added:
Had central banks around the world kept interest rates that encourage saving we wouldn’t have these problems today.
However, Dr. Faber believes there still remains a glimmer of hope for investors in equities. From the CNBC website yesterday:
The stock market is as oversold as it has been since the crash of 1987 and the broader market could start to rebound until early next year, Marc Faber, editor and publisher of the Gloom Boom and Doom Report, said Tuesday.
The market is possibly in “the most oversold condition” since perhaps Oct. 19, 1987, Faber told CNBC’s “Squawk Box.”
“Usually there is some seasonal strength between October and March” so it is possible the S&P 500 index will create a low between now and the end of the month, he said.
He talked about some areas investors should be looking at:
Longer-term investors will have to position themselves in emerging country stock markets to play the global recovery, Faber advised.
Faber, who recommended buying gold at the start of its six-year rally, also pointed out:
For now, gold is still attractive, with central banks readying more rate cuts and printing money, he said.
Wednesday, October 8, 2008
Rolling 7 Day DJIA Returns <-15%
9 of the 39 cases since 1928 were not during the Depression:
Date 7D
09/21/01 -0.163
09/20/01 -0.165
10/27/87 -0.178
10/26/87 -0.238
10/23/87 -0.191
10/22/87 -0.222
10/21/87 -0.179
10/20/87 -0.258
10/19/87 -0.309
05/22/40 -0.166
05/21/40 -0.212
05/20/40 -0.174
05/17/40 -0.161
03/31/38 -0.155
03/30/38 -0.161
10/19/33 -0.154
07/21/33 -0.152
10/13/32 -0.161
10/10/32 -0.183
09/19/32 -0.160
09/16/32 -0.161
06/01/32 -0.157
05/31/32 -0.158
04/11/32 -0.153
04/08/32 -0.185
12/16/31 -0.151
10/05/31 -0.198
10/02/31 -0.165
06/24/30 -0.152
11/14/29 -0.157
11/13/29 -0.274
11/12/29 -0.189
11/07/29 -0.209
11/06/29 -0.225
11/04/29 -0.157
10/31/29 -0.162
10/30/29 -0.195
10/29/29 -0.310
10/28/29 -0.238
Date 7D
09/21/01 -0.163
09/20/01 -0.165
10/27/87 -0.178
10/26/87 -0.238
10/23/87 -0.191
10/22/87 -0.222
10/21/87 -0.179
10/20/87 -0.258
10/19/87 -0.309
05/22/40 -0.166
05/21/40 -0.212
05/20/40 -0.174
05/17/40 -0.161
03/31/38 -0.155
03/30/38 -0.161
10/19/33 -0.154
07/21/33 -0.152
10/13/32 -0.161
10/10/32 -0.183
09/19/32 -0.160
09/16/32 -0.161
06/01/32 -0.157
05/31/32 -0.158
04/11/32 -0.153
04/08/32 -0.185
12/16/31 -0.151
10/05/31 -0.198
10/02/31 -0.165
06/24/30 -0.152
11/14/29 -0.157
11/13/29 -0.274
11/12/29 -0.189
11/07/29 -0.209
11/06/29 -0.225
11/04/29 -0.157
10/31/29 -0.162
10/30/29 -0.195
10/29/29 -0.310
10/28/29 -0.238
Monday, October 6, 2008
Time To Go Long, At Least For A Short Time?
The violent sell-off in stock markets Monday morning, along with the stream of bad economic news of last week, is bound to provoke substantial cuts in short-term interest rates by the Federal Reserve and other central banks. Stock markets should thus be near a good rebound, especially given near-term oversold conditions.
If you went into those double-short ETFs last week, take the 10% to 25% gains so far and shift into the double-long ETFs. There is a list at Stock-Encyclopedia.com. I myself bought the Horizons BetaPro S&P/TSX 60 Bull Plus ETF (HXU) and the ProShares Ultra S&P500 ETF (SSO) – or should the symbol be SOS now?). It could be early and the double-long ETFs could come down fast, but they can come back fast too.
If and when the rally comes, it may be short-lived as attention shifts back to the worsening economic indicators parading through the headlines. So one could don their trader’s hat … or consider buying and holding since it’s hard to imagine stocks staying below this level over the next year to three years. Moreover, the Fed and politicians will likely have a number of other counterpunches lined up after the first rate cut.
If you went into those double-short ETFs last week, take the 10% to 25% gains so far and shift into the double-long ETFs. There is a list at Stock-Encyclopedia.com. I myself bought the Horizons BetaPro S&P/TSX 60 Bull Plus ETF (HXU) and the ProShares Ultra S&P500 ETF (SSO) – or should the symbol be SOS now?). It could be early and the double-long ETFs could come down fast, but they can come back fast too.
If and when the rally comes, it may be short-lived as attention shifts back to the worsening economic indicators parading through the headlines. So one could don their trader’s hat … or consider buying and holding since it’s hard to imagine stocks staying below this level over the next year to three years. Moreover, the Fed and politicians will likely have a number of other counterpunches lined up after the first rate cut.
Wednesday, October 1, 2008
Reflection on the Crash
1. It was symmetric with the previous week where it opened limit up on the news. They had reached a compromise, and then it went limit down, indeed 100 down when they didn't reach an agreement. Amazing that the time horizon is so short. As soon as they voted the agreement down, it was clear that they'd come up with an agreement shortly. The stock market took care of that. "It's amazing how a 900 point drop in Dow can get their attention" with all the lobbyists involved, and the power increases, but yet the leverage of traders is so great that they automatically get exited from their positions on bad news even if it's going to be reversed the next day at the open.
2. This crash and the Oct 19, 1987 both were symmetric in that the Secretary of the Treasury caused it. In the first one, Jim Baker said, "The Europeans have to strengthen the currencies." In this case, there was revulsion against a political plan to feather the nest of both parties. The bonds in both cases had their biggest up moves in history, but in 1987 they stayed up for the next week, and in this case they reversed the next day. Commodities had one of their worst days in history showing that all markets are interrelated and when wealth goes down, all spending is reduced.
3. This crash brought all markets to many year lows, and was the final revulsion, the final throwing the frog into hot water that cleared the decks as the move the next day, one of biggest in history, showed. The discount rate is always ready to be lowered when the market goes down by more than 4% in a day as it did on Jan 21, and in Aug 2007.
4. The European markets were down a few percent more than the US at the open, as were Japan and Israel, foretelling what was going to happen.
2. This crash and the Oct 19, 1987 both were symmetric in that the Secretary of the Treasury caused it. In the first one, Jim Baker said, "The Europeans have to strengthen the currencies." In this case, there was revulsion against a political plan to feather the nest of both parties. The bonds in both cases had their biggest up moves in history, but in 1987 they stayed up for the next week, and in this case they reversed the next day. Commodities had one of their worst days in history showing that all markets are interrelated and when wealth goes down, all spending is reduced.
3. This crash brought all markets to many year lows, and was the final revulsion, the final throwing the frog into hot water that cleared the decks as the move the next day, one of biggest in history, showed. The discount rate is always ready to be lowered when the market goes down by more than 4% in a day as it did on Jan 21, and in Aug 2007.
4. The European markets were down a few percent more than the US at the open, as were Japan and Israel, foretelling what was going to happen.
Tuesday, September 30, 2008
SP500 to 1000 as bottom
After experiencing the worst one day loss on Monday since the market crash on October 19, 1987, markets rallied hard, with the Dow closing up nearly 500 points. There were several reasons for the gain.
1. The market was oversold
When only one stock in the S&P 500 goes up and the downside volume to upside volume is 26.5:1, as it was on Monday, a snapback rally is no surprise.
2. Belief that the government will still bail out the market.
This was the main reason why the market was up. Frankly, I am in disbelief of the market's credulity on this one. Yesterday, I wrote that Washington has no credibility on Wall Street, given that the House sandbagged the market, voting down TARP. I was wrong. Apparently Washington has a great deal of credibility on Wall Street, despite getting blindsided yesterday. I want Washington to do something, but there is a part of me that would like to see this fail just to wring the gullibility out of Wall Street. If the legislators fail and a bill does not pass and the market falls another 1000 points, then Wall Street will have no one to blame but themselves.
3. Suspension of mark-to-market accounting
Investors were under the impression that mark-to-market accounting, FASB 157, would be suspended. The SEC released a statement clarifying the interpretation of mark-to-market but did not say it would be suspended. The idea is that banks would not have to mark down their assets to recent market transactions if FASB 157 were suspended. The proponents argue that current market transactions represent distressed sales and not the true value of the underlying assets, but companies have to mark their assets to those unrealistic levels. Suspending the accounting rule will stop the death spiral of financial companies.
I think this is a canard. It would be yet another gimmick akin to suspending short selling. Financial companies are not collapsing because of mark-to-market accounting. They are collapsing because they did really dumb things and took on too much debt. Investors aren't stupid. Increasing opacity in the financial statements does not help investors understand the risks of the company in which they are investing. Compare the likes of AIG, Freddie Mac, Fannie Mae, Bear Stearns, IndyMac, and Lehman with the likes of US Bancorp and Wells Fargo. The former collapsed because they made bad business decisions whereas the latter are near 52 week highs because they didn't over-lever their balance sheets and make stupid investments.
Also, there are pools of capital out there waiting to invest in distressed assets. However, few transactions have occurred. Many of these pools of capital have long-term lock-ups of three or more years. They can handle the volatility of mark-to-market accounting if distressed sales are below intrinsic value because their investors cannot call their capital. Yet, few transactions are being done. Why? Could it be that the funds do not believe that the assets for sale are ridiculously cheap?
4. Stocks did not collapse so traders bought.
This is perhaps the most discouraging reason for the market's gain today. The willingness to buy in front of news after a hard down day does not seem to me to be behaviour one sees at the bottom. I would have preferred that investors puked out stocks rather than believe Washington will come to their rescue and buy the dips hopefully.
5. The possibility of an increase in FDIC insurance.
Today, the government of Ireland guaranteed bank deposits. There was chatter that the FDIC may increase insurance from $100,000 to $250,000. Some were saying that deposit insurance may become unlimited. Never mind that the FDIC might not be capitalized enough to handle all the bank failures to come, the government stepping up to guarantee all deposits was probably the single most bullish news today as it would make bank runs less likely. It could tank the dollar, but there are so many factors that could also tank the dollar, what's another one, eh?
6. ECB rate cut
Rumours had it that the ECB would cut rates soon. This very well may be true. The bank will start cutting rates shortly. Given the incredible stresses on the financial system, the rate cut may come sooner rather than later.
7. Money market pressures ease.
Slightly. The TED spread was over 3.5% today before easing to 3.15%, still very high but not as high as earlier in the day. The 3-month Treasury bill oscillated between 0.5% and 1% while swap spreads, though still high, were lower than yesterday. The Fed has pushed in an enormous amount of liquidity over the past few weeks to meet the insatiable demand for dollars. You could see the tremendous volatility in the Fed funds market, with rates as high as 7% this morning and falling to 0.125% this afternoon. Such volatility has been the norm as of late. This is why I'm not sure rate cuts by the Fed would be helpful in the near term.
8. Better than expected economic news
Forgotten by many was that the Chicago PMI and the Conference Board's consumer confidence index came in better than expected this morning.
9. Month and quarter end.
Month and quarter ends often bring unusual activity.
Volume was lighter than yesterday. Upside volume was 9.1:1 to downside volume, good but was dwarfed by Monday's 26.5:1 volume to the downside. It appears that the rally merely brings the indices back to within range where one would expect the market to start selling off again.
I keep hearing investors claim the market is cheap. I do not think so. I use $75 as my normalized earnings estimate, assuming a 7.5% margin, which is well above the long-term average of 6%. At $75, the market is trading at 15.5x earnings. That is not cheap. It is not expensive but it is not where bear markets have historically bottomed.
The average bear market since World War II has generated losses of 28%. To the lows yesterday, the market was down 30%, top to bottom. I contend that the worst credit crisis since the Depression will not lead to an average bear market in stocks.
The two worst bear markets during this time were 1973-74 and 2000-02, both of which saw declines of 50%. I do not think the decline in this bear market will be 50%, but instead will be somewhere between 30% and 50%. I'll pick 40% because it is a nice round number, which would take us to around 1000 on the S&P 500.
I do not know if the near-term bottom is in but I highly doubt the ultimate bottom is in. Thus, rallies remain to be sold.
1. The market was oversold
When only one stock in the S&P 500 goes up and the downside volume to upside volume is 26.5:1, as it was on Monday, a snapback rally is no surprise.
2. Belief that the government will still bail out the market.
This was the main reason why the market was up. Frankly, I am in disbelief of the market's credulity on this one. Yesterday, I wrote that Washington has no credibility on Wall Street, given that the House sandbagged the market, voting down TARP. I was wrong. Apparently Washington has a great deal of credibility on Wall Street, despite getting blindsided yesterday. I want Washington to do something, but there is a part of me that would like to see this fail just to wring the gullibility out of Wall Street. If the legislators fail and a bill does not pass and the market falls another 1000 points, then Wall Street will have no one to blame but themselves.
3. Suspension of mark-to-market accounting
Investors were under the impression that mark-to-market accounting, FASB 157, would be suspended. The SEC released a statement clarifying the interpretation of mark-to-market but did not say it would be suspended. The idea is that banks would not have to mark down their assets to recent market transactions if FASB 157 were suspended. The proponents argue that current market transactions represent distressed sales and not the true value of the underlying assets, but companies have to mark their assets to those unrealistic levels. Suspending the accounting rule will stop the death spiral of financial companies.
I think this is a canard. It would be yet another gimmick akin to suspending short selling. Financial companies are not collapsing because of mark-to-market accounting. They are collapsing because they did really dumb things and took on too much debt. Investors aren't stupid. Increasing opacity in the financial statements does not help investors understand the risks of the company in which they are investing. Compare the likes of AIG, Freddie Mac, Fannie Mae, Bear Stearns, IndyMac, and Lehman with the likes of US Bancorp and Wells Fargo. The former collapsed because they made bad business decisions whereas the latter are near 52 week highs because they didn't over-lever their balance sheets and make stupid investments.
Also, there are pools of capital out there waiting to invest in distressed assets. However, few transactions have occurred. Many of these pools of capital have long-term lock-ups of three or more years. They can handle the volatility of mark-to-market accounting if distressed sales are below intrinsic value because their investors cannot call their capital. Yet, few transactions are being done. Why? Could it be that the funds do not believe that the assets for sale are ridiculously cheap?
4. Stocks did not collapse so traders bought.
This is perhaps the most discouraging reason for the market's gain today. The willingness to buy in front of news after a hard down day does not seem to me to be behaviour one sees at the bottom. I would have preferred that investors puked out stocks rather than believe Washington will come to their rescue and buy the dips hopefully.
5. The possibility of an increase in FDIC insurance.
Today, the government of Ireland guaranteed bank deposits. There was chatter that the FDIC may increase insurance from $100,000 to $250,000. Some were saying that deposit insurance may become unlimited. Never mind that the FDIC might not be capitalized enough to handle all the bank failures to come, the government stepping up to guarantee all deposits was probably the single most bullish news today as it would make bank runs less likely. It could tank the dollar, but there are so many factors that could also tank the dollar, what's another one, eh?
6. ECB rate cut
Rumours had it that the ECB would cut rates soon. This very well may be true. The bank will start cutting rates shortly. Given the incredible stresses on the financial system, the rate cut may come sooner rather than later.
7. Money market pressures ease.
Slightly. The TED spread was over 3.5% today before easing to 3.15%, still very high but not as high as earlier in the day. The 3-month Treasury bill oscillated between 0.5% and 1% while swap spreads, though still high, were lower than yesterday. The Fed has pushed in an enormous amount of liquidity over the past few weeks to meet the insatiable demand for dollars. You could see the tremendous volatility in the Fed funds market, with rates as high as 7% this morning and falling to 0.125% this afternoon. Such volatility has been the norm as of late. This is why I'm not sure rate cuts by the Fed would be helpful in the near term.
8. Better than expected economic news
Forgotten by many was that the Chicago PMI and the Conference Board's consumer confidence index came in better than expected this morning.
9. Month and quarter end.
Month and quarter ends often bring unusual activity.
Volume was lighter than yesterday. Upside volume was 9.1:1 to downside volume, good but was dwarfed by Monday's 26.5:1 volume to the downside. It appears that the rally merely brings the indices back to within range where one would expect the market to start selling off again.
I keep hearing investors claim the market is cheap. I do not think so. I use $75 as my normalized earnings estimate, assuming a 7.5% margin, which is well above the long-term average of 6%. At $75, the market is trading at 15.5x earnings. That is not cheap. It is not expensive but it is not where bear markets have historically bottomed.
The average bear market since World War II has generated losses of 28%. To the lows yesterday, the market was down 30%, top to bottom. I contend that the worst credit crisis since the Depression will not lead to an average bear market in stocks.
The two worst bear markets during this time were 1973-74 and 2000-02, both of which saw declines of 50%. I do not think the decline in this bear market will be 50%, but instead will be somewhere between 30% and 50%. I'll pick 40% because it is a nice round number, which would take us to around 1000 on the S&P 500.
I do not know if the near-term bottom is in but I highly doubt the ultimate bottom is in. Thus, rallies remain to be sold.
SP500 to 1000 as bottom
After experiencing the worst one day loss on Monday since the market crash on October 19, 1987, markets rallied hard, with the Dow closing up nearly 500 points. There were several reasons for the gain.
1. The market was oversold
When only one stock in the S&P 500 goes up and the downside volume to upside volume is 26.5:1, as it was on Monday, a snapback rally is no surprise.
2. Belief that the government will still bail out the market.
This was the main reason why the market was up. Frankly, I am in disbelief of the market's credulity on this one. Yesterday, I wrote that Washington has no credibility on Wall Street, given that the House sandbagged the market, voting down TARP. I was wrong. Apparently Washington has a great deal of credibility on Wall Street, despite getting blindsided yesterday. I want Washington to do something, but there is a part of me that would like to see this fail just to wring the gullibility out of Wall Street. If the legislators fail and a bill does not pass and the market falls another 1000 points, then Wall Street will have no one to blame but themselves.
3. Suspension of mark-to-market accounting
Investors were under the impression that mark-to-market accounting, FASB 157, would be suspended. The SEC released a statement clarifying the interpretation of mark-to-market but did not say it would be suspended. The idea is that banks would not have to mark down their assets to recent market transactions if FASB 157 were suspended. The proponents argue that current market transactions represent distressed sales and not the true value of the underlying assets, but companies have to mark their assets to those unrealistic levels. Suspending the accounting rule will stop the death spiral of financial companies.
I think this is a canard. It would be yet another gimmick akin to suspending short selling. Financial companies are not collapsing because of mark-to-market accounting. They are collapsing because they did really dumb things and took on too much debt. Investors aren't stupid. Increasing opacity in the financial statements does not help investors understand the risks of the company in which they are investing. Compare the likes of AIG, Freddie Mac, Fannie Mae, Bear Stearns, IndyMac, and Lehman with the likes of US Bancorp and Wells Fargo. The former collapsed because they made bad business decisions whereas the latter are near 52 week highs because they didn't over-lever their balance sheets and make stupid investments.
Also, there are pools of capital out there waiting to invest in distressed assets. However, few transactions have occurred. Many of these pools of capital have long-term lock-ups of three or more years. They can handle the volatility of mark-to-market accounting if distressed sales are below intrinsic value because their investors cannot call their capital. Yet, few transactions are being done. Why? Could it be that the funds do not believe that the assets for sale are ridiculously cheap?
4. Stocks did not collapse so traders bought.
This is perhaps the most discouraging reason for the market's gain today. The willingness to buy in front of news after a hard down day does not seem to me to be behaviour one sees at the bottom. I would have preferred that investors puked out stocks rather than believe Washington will come to their rescue and buy the dips hopefully.
5. The possibility of an increase in FDIC insurance.
Today, the government of Ireland guaranteed bank deposits. There was chatter that the FDIC may increase insurance from $100,000 to $250,000. Some were saying that deposit insurance may become unlimited. Never mind that the FDIC might not be capitalized enough to handle all the bank failures to come, the government stepping up to guarantee all deposits was probably the single most bullish news today as it would make bank runs less likely. It could tank the dollar, but there are so many factors that could also tank the dollar, what's another one, eh?
6. ECB rate cut
Rumours had it that the ECB would cut rates soon. This very well may be true. The bank will start cutting rates shortly. Given the incredible stresses on the financial system, the rate cut may come sooner rather than later.
7. Money market pressures ease.
Slightly. The TED spread was over 3.5% today before easing to 3.15%, still very high but not as high as earlier in the day. The 3-month Treasury bill oscillated between 0.5% and 1% while swap spreads, though still high, were lower than yesterday. The Fed has pushed in an enormous amount of liquidity over the past few weeks to meet the insatiable demand for dollars. You could see the tremendous volatility in the Fed funds market, with rates as high as 7% this morning and falling to 0.125% this afternoon. Such volatility has been the norm as of late. This is why I'm not sure rate cuts by the Fed would be helpful in the near term.
8. Better than expected economic news
Forgotten by many was that the Chicago PMI and the Conference Board's consumer confidence index came in better than expected this morning.
9. Month and quarter end.
Month and quarter ends often bring unusual activity.
Volume was lighter than yesterday. Upside volume was 9.1:1 to downside volume, good but was dwarfed by Monday's 26.5:1 volume to the downside. It appears that the rally merely brings the indices back to within range where one would expect the market to start selling off again.
I keep hearing investors claim the market is cheap. I do not think so. I use $75 as my normalized earnings estimate, assuming a 7.5% margin, which is well above the long-term average of 6%. At $75, the market is trading at 15.5x earnings. That is not cheap. It is not expensive but it is not where bear markets have historically bottomed.
The average bear market since World War II has generated losses of 28%. To the lows yesterday, the market was down 30%, top to bottom. I contend that the worst credit crisis since the Depression will not lead to an average bear market in stocks.
The two worst bear markets during this time were 1973-74 and 2000-02, both of which saw declines of 50%. I do not think the decline in this bear market will be 50%, but instead will be somewhere between 30% and 50%. I'll pick 40% because it is a nice round number, which would take us to around 1000 on the S&P 500.
I do not know if the near-term bottom is in but I highly doubt the ultimate bottom is in. Thus, rallies remain to be sold.
1. The market was oversold
When only one stock in the S&P 500 goes up and the downside volume to upside volume is 26.5:1, as it was on Monday, a snapback rally is no surprise.
2. Belief that the government will still bail out the market.
This was the main reason why the market was up. Frankly, I am in disbelief of the market's credulity on this one. Yesterday, I wrote that Washington has no credibility on Wall Street, given that the House sandbagged the market, voting down TARP. I was wrong. Apparently Washington has a great deal of credibility on Wall Street, despite getting blindsided yesterday. I want Washington to do something, but there is a part of me that would like to see this fail just to wring the gullibility out of Wall Street. If the legislators fail and a bill does not pass and the market falls another 1000 points, then Wall Street will have no one to blame but themselves.
3. Suspension of mark-to-market accounting
Investors were under the impression that mark-to-market accounting, FASB 157, would be suspended. The SEC released a statement clarifying the interpretation of mark-to-market but did not say it would be suspended. The idea is that banks would not have to mark down their assets to recent market transactions if FASB 157 were suspended. The proponents argue that current market transactions represent distressed sales and not the true value of the underlying assets, but companies have to mark their assets to those unrealistic levels. Suspending the accounting rule will stop the death spiral of financial companies.
I think this is a canard. It would be yet another gimmick akin to suspending short selling. Financial companies are not collapsing because of mark-to-market accounting. They are collapsing because they did really dumb things and took on too much debt. Investors aren't stupid. Increasing opacity in the financial statements does not help investors understand the risks of the company in which they are investing. Compare the likes of AIG, Freddie Mac, Fannie Mae, Bear Stearns, IndyMac, and Lehman with the likes of US Bancorp and Wells Fargo. The former collapsed because they made bad business decisions whereas the latter are near 52 week highs because they didn't over-lever their balance sheets and make stupid investments.
Also, there are pools of capital out there waiting to invest in distressed assets. However, few transactions have occurred. Many of these pools of capital have long-term lock-ups of three or more years. They can handle the volatility of mark-to-market accounting if distressed sales are below intrinsic value because their investors cannot call their capital. Yet, few transactions are being done. Why? Could it be that the funds do not believe that the assets for sale are ridiculously cheap?
4. Stocks did not collapse so traders bought.
This is perhaps the most discouraging reason for the market's gain today. The willingness to buy in front of news after a hard down day does not seem to me to be behaviour one sees at the bottom. I would have preferred that investors puked out stocks rather than believe Washington will come to their rescue and buy the dips hopefully.
5. The possibility of an increase in FDIC insurance.
Today, the government of Ireland guaranteed bank deposits. There was chatter that the FDIC may increase insurance from $100,000 to $250,000. Some were saying that deposit insurance may become unlimited. Never mind that the FDIC might not be capitalized enough to handle all the bank failures to come, the government stepping up to guarantee all deposits was probably the single most bullish news today as it would make bank runs less likely. It could tank the dollar, but there are so many factors that could also tank the dollar, what's another one, eh?
6. ECB rate cut
Rumours had it that the ECB would cut rates soon. This very well may be true. The bank will start cutting rates shortly. Given the incredible stresses on the financial system, the rate cut may come sooner rather than later.
7. Money market pressures ease.
Slightly. The TED spread was over 3.5% today before easing to 3.15%, still very high but not as high as earlier in the day. The 3-month Treasury bill oscillated between 0.5% and 1% while swap spreads, though still high, were lower than yesterday. The Fed has pushed in an enormous amount of liquidity over the past few weeks to meet the insatiable demand for dollars. You could see the tremendous volatility in the Fed funds market, with rates as high as 7% this morning and falling to 0.125% this afternoon. Such volatility has been the norm as of late. This is why I'm not sure rate cuts by the Fed would be helpful in the near term.
8. Better than expected economic news
Forgotten by many was that the Chicago PMI and the Conference Board's consumer confidence index came in better than expected this morning.
9. Month and quarter end.
Month and quarter ends often bring unusual activity.
Volume was lighter than yesterday. Upside volume was 9.1:1 to downside volume, good but was dwarfed by Monday's 26.5:1 volume to the downside. It appears that the rally merely brings the indices back to within range where one would expect the market to start selling off again.
I keep hearing investors claim the market is cheap. I do not think so. I use $75 as my normalized earnings estimate, assuming a 7.5% margin, which is well above the long-term average of 6%. At $75, the market is trading at 15.5x earnings. That is not cheap. It is not expensive but it is not where bear markets have historically bottomed.
The average bear market since World War II has generated losses of 28%. To the lows yesterday, the market was down 30%, top to bottom. I contend that the worst credit crisis since the Depression will not lead to an average bear market in stocks.
The two worst bear markets during this time were 1973-74 and 2000-02, both of which saw declines of 50%. I do not think the decline in this bear market will be 50%, but instead will be somewhere between 30% and 50%. I'll pick 40% because it is a nice round number, which would take us to around 1000 on the S&P 500.
I do not know if the near-term bottom is in but I highly doubt the ultimate bottom is in. Thus, rallies remain to be sold.
Monday, September 29, 2008
-777.7 Shorters all hit a big lottery
Today was an amazing day.
I truly did not expect the house to kill the bailout bill.
Neither did the market, as the Dow dropped 777.7 points, the worst one day decline since the 1987 crash.
The leaders of the country played a stunning game of political brinkmanship, with the majority of Republicans voting against the bill, in part due to a stridently partisan speech given by Nancy Pelosi.
Blame is to be had on all sides. The Democrats tried to attach amendments to the bill having nothing to do with the crisis which would instead satisfy their backers, such as passing laws forcing boards to have union representation.
The Republicans were no better. Tonight on CNBC's Fast Money, a Texas GOP Congressman who voted against the bill offered several so-called free market solutions to the credit crisis, one of which was cutting capital gains taxes, a mind-boggling display of economic cluelessness and/or craven ideological and political pandering.
The White House also deserves more than its fair share of blame. For so long, the mantra from Bush and Co. was that the economy was fundamentally strong. The Bush administration's disdain and contempt for others who were not onside bred suspicion and hostility, such that the White House no longer has the moral suasion to lead when leadership is most required. Given the administration's lack of credibility, it is not surprising Congress would be highly skeptical of the White House, especially when the original proposal appeared to abrogate the constitution.
However, the reason why the House failed to pass the bill was that constituents were overwhelmingly against it. Representatives in swing states voted against the bill, fearing they would lose their seats in November.
Well, democracy is messy, but The People may have sealed their own fate. C'est la vie. That is their right. But whatever one might have thought about the bill, the markets - both stocks and credit - certainly hated that it failed to pass.
Perhaps over the long run, the bill's failure is a good thing. It may be that a purging of the markets will clean out the excesses so rampant in the financial system today.
Or, it may induce a terrible crash and reductions in credit, with tremendous ramifications throughout the broad economy.
There has been talk in certain quarters of another 1930s-style Depression. That will not happen. There are too many structural stabilizers in the system to prevent such a catastrophe. But we could experience a sharp recession.
If we do have a significant economic contraction, this is the recession we should have had after the collapse of the Tech Bubble. At the time, the authorities made a conscious decision to implement policies to avoid a severe recession, particularly Alan Greenspan's decision to lower the Fed funds target to 1% and keep it there. However, fiscal policy and the decision to give Americans a massive tax cut without any reductions in spending also contributed to this mess.
The primary effects of these policies were to push the pain further into the future, and to create even bigger problems in the housing and debt markets. Now, the chickens have come home to roost, and the problems are far worse than if we had just taken our medicine during the early part of the decade.
So what to do now?
First, the market usually does not bottom the day after it closes on its lows. Thus, it is highly unlikely today was the bottom. Expect the market to fall further.
Second, it is my guess - and I strongly emphasize the word "guess" - that a near-term bottom is approaching in terms of time. In terms of return, I have no idea. I have no clue if the near-term bottom is 200 or 2000 points away. My intuition tells me that we are going to hit a bottom sometime within the next two weeks. But that does not mean there will not be acute pain before then.
Next, we are working without a net. Washington has no credibility on Wall Street. Despite the platitudes on television from the politicians tonight about getting a bill done, there is no reason to believe them, nor is there any reason to believe any new bill would be effective.
Now, I do not think that Paulson's plan would have stopped the rot in the system. But I do believe the bill would have cushioned the fall.
The effect of Paulson's bill, however, may have been to prolong the adjustment process, spreading the pain out over time. We may go through a traumatic period, but a shorter period compared to the Paulson plan, where the excesses are purged quicker. If so, this will ultimately be good for the market and the economy over the long-term.
Finally, in a bear market, the most important thing is to protect your capital. If you are long and cannot take the pain, get out. There will always be opportunities in the future.
The lower we go, though, the higher the future returns become. Every drop in the market decreases the values of stocks and increases the potential returns over time.
You have to decide where you are on this risk/return spectrum.
I am very, very short at the moment. I covered a small portion this afternoon and will be looking to cover more into further weakness.
I also intend to start adding to long-term positions. I believe that some stocks are getting to levels where historically, they have been doubles or triples a few years out.
But in the meantime, we are in unchartered waters.
I truly did not expect the house to kill the bailout bill.
Neither did the market, as the Dow dropped 777.7 points, the worst one day decline since the 1987 crash.
The leaders of the country played a stunning game of political brinkmanship, with the majority of Republicans voting against the bill, in part due to a stridently partisan speech given by Nancy Pelosi.
Blame is to be had on all sides. The Democrats tried to attach amendments to the bill having nothing to do with the crisis which would instead satisfy their backers, such as passing laws forcing boards to have union representation.
The Republicans were no better. Tonight on CNBC's Fast Money, a Texas GOP Congressman who voted against the bill offered several so-called free market solutions to the credit crisis, one of which was cutting capital gains taxes, a mind-boggling display of economic cluelessness and/or craven ideological and political pandering.
The White House also deserves more than its fair share of blame. For so long, the mantra from Bush and Co. was that the economy was fundamentally strong. The Bush administration's disdain and contempt for others who were not onside bred suspicion and hostility, such that the White House no longer has the moral suasion to lead when leadership is most required. Given the administration's lack of credibility, it is not surprising Congress would be highly skeptical of the White House, especially when the original proposal appeared to abrogate the constitution.
However, the reason why the House failed to pass the bill was that constituents were overwhelmingly against it. Representatives in swing states voted against the bill, fearing they would lose their seats in November.
Well, democracy is messy, but The People may have sealed their own fate. C'est la vie. That is their right. But whatever one might have thought about the bill, the markets - both stocks and credit - certainly hated that it failed to pass.
Perhaps over the long run, the bill's failure is a good thing. It may be that a purging of the markets will clean out the excesses so rampant in the financial system today.
Or, it may induce a terrible crash and reductions in credit, with tremendous ramifications throughout the broad economy.
There has been talk in certain quarters of another 1930s-style Depression. That will not happen. There are too many structural stabilizers in the system to prevent such a catastrophe. But we could experience a sharp recession.
If we do have a significant economic contraction, this is the recession we should have had after the collapse of the Tech Bubble. At the time, the authorities made a conscious decision to implement policies to avoid a severe recession, particularly Alan Greenspan's decision to lower the Fed funds target to 1% and keep it there. However, fiscal policy and the decision to give Americans a massive tax cut without any reductions in spending also contributed to this mess.
The primary effects of these policies were to push the pain further into the future, and to create even bigger problems in the housing and debt markets. Now, the chickens have come home to roost, and the problems are far worse than if we had just taken our medicine during the early part of the decade.
So what to do now?
First, the market usually does not bottom the day after it closes on its lows. Thus, it is highly unlikely today was the bottom. Expect the market to fall further.
Second, it is my guess - and I strongly emphasize the word "guess" - that a near-term bottom is approaching in terms of time. In terms of return, I have no idea. I have no clue if the near-term bottom is 200 or 2000 points away. My intuition tells me that we are going to hit a bottom sometime within the next two weeks. But that does not mean there will not be acute pain before then.
Next, we are working without a net. Washington has no credibility on Wall Street. Despite the platitudes on television from the politicians tonight about getting a bill done, there is no reason to believe them, nor is there any reason to believe any new bill would be effective.
Now, I do not think that Paulson's plan would have stopped the rot in the system. But I do believe the bill would have cushioned the fall.
The effect of Paulson's bill, however, may have been to prolong the adjustment process, spreading the pain out over time. We may go through a traumatic period, but a shorter period compared to the Paulson plan, where the excesses are purged quicker. If so, this will ultimately be good for the market and the economy over the long-term.
Finally, in a bear market, the most important thing is to protect your capital. If you are long and cannot take the pain, get out. There will always be opportunities in the future.
The lower we go, though, the higher the future returns become. Every drop in the market decreases the values of stocks and increases the potential returns over time.
You have to decide where you are on this risk/return spectrum.
I am very, very short at the moment. I covered a small portion this afternoon and will be looking to cover more into further weakness.
I also intend to start adding to long-term positions. I believe that some stocks are getting to levels where historically, they have been doubles or triples a few years out.
But in the meantime, we are in unchartered waters.
Saturday, September 27, 2008
Marc Faber Report Card
Let's talk about interest rates. Marc, you've been uncharacteristically quiet. Aren't you feeling well?
Faber: I am well and happy because I talked about many of these issues a year ago and recommended shorting the brokers. Subprime is a symptom of a much wider problem: the huge credit bubble built over the past 25 years. It is just the appetizer to something bigger, which will lead to relative illiquidity in the world. I travel around the world regularly, and every place I've gone has had a boom. The U.S. already would be in recession if government statistics were correct. The rest of the world will see a meaningful slowdown because global financial connectivity is greater than ever before.
The Fed brought about the latest boom by cutting the federal-funds rate from 6.5% in January 2001 to 1%. It kept fed funds at 1% until June 2004, even though the recovery in the U.S. began in November 2001. In other words, almost three years into a recovery [then-Fed Chairman] Alan Greenspan still had the fed-funds rate at 1%. This led to huge liquidity in the system -- asset bubbles, debt growth and growth in the trade and current-account deficits. Now those deficits are shrinking. This is an unfriendly environment for economic growth, financial markets and even industrial commodities. But it is friendly for the U.S. dollar.
Faber: I took a taxi from Times Square to lower Manhattan this morning and paid $14. In Europe the ride would have cost me three times as much. Prices in the U.S. are relatively inexpensive, as Abby learned at breakfast in Paris. This reminds me of other economies in which prices became low and inflation picked up. The taxi driver will increase his price massively sooner or later. Let me stress that weak currencies don't produce inflation. Inflation in the system produces a weak currency.
Faber: U.S. exports have gone up a bit, especially because of price increases in agricultural commodities and some capital goods. But the number of inbound and arriving containers at U.S. ports is down year on year, as are rail-car loadings. The trucking index is down. These statistics point to a recession in the U.S.
Faber: Scott, your fiscal policy will be another disaster superimposed on a disastrous monetary policy.
Faber: The average citizen will be in a recession anyway, because inflation will be higher than the benefits he gets from the tax cuts you propose. I also see a stagflation scenario similar to the 1970s, with high volatility in financial markets. Corporate earnings get squeezed nicely, with S&P earnings falling
Faber: U.S. policy is misguided in targeting consumption, not investments.
Faber: Equity prices have increased in dollar terms, but in euros the S&P 500 is down about 45% from its peak in 2000 and the Nasdaq is down 60%. Measured in gold, the markets have done horribly and the economy has been in a recession for a long time. I'm not bullish about U.S. stocks, but everything is so bad on a global basis that they might do better on a relative basis. That doesn't mean they go up, but the U.S. market might go down less than China, India, Vietnam and some of the other markets that are in cuckoo land. These markets have gone up because people believe in decoupling. Economically we could see a decoupling, whereby the U.S. is in a recession and China still grows by 5% or 10%. The financial markets won't decouple. Unless, Mario, they reintroduce that uptick rule.
Five years ago I visited family offices and financial institutions that had practically no exposure to international stocks. Today the same people have 50% of their money in emerging markets. Valuations in these markets aren't compelling any more, except for real estate in emerging economies.
Marc, what do you think of gold?
Faber: There are times when stocks do fantastically well and there are times when commodities do well. On a relative basis, gold became unbelievably inexpensive in the years 1999 to 2001. Now, prices have gone up. We had a bubble in Japan in 1989. Then we had the Nasdaq bubble, and bubbles in countries like China, and in the credit markets. The last big bubble to burst will be gold.
Black: If gold rallies at least 15%, to $1,000 an ounce, wouldn't it be better to buy an exploration and production company that could rally more?
Faber: Not necessarily. You want to own gold because you think something will go wrong, leading to deflation or hyperinflation. Mines can be expropriated. Also, exploration companies are like biotechnology and nanotechnology companies. One in a hundred will succeed.
Faber: A company like this is likely to be bought by a major miner, because the majors, like big pharmaceutical companies, don't spend much on research. They would rather buy
Marc, man of the world and proprietor of Marc Faber Ltd. in Hong Kong, says all asset markets are oversold "in the very short term" and due to rebound strongly, although he doubts they'll go to new highs. Equity investors, he grouses, still are focused on buying the dips, not selling the bounces, and sentiment is negative not because they have liquidated their shares, but because they're sitting on large losses. Emerging markets, he adds, have "considerable downside risk," but recoveries of 10% to 15% are common in bear markets. Marc's picks this year are mostly pans -- of several currencies and emerging-market shares.
2008 Barron's Roundtable Members
Marc Faber, Managing director, Marc Faber Ltd., Hong Kong
Thanks, Abby. Marc, what have you got for us?
Faber: We aren't dealing purely with market forces today, but with an economy that is largely manipulated by central banks, which create excess liquidity by cutting interest rates dramatically and letting credit growth accelerate dramatically. I'd like to read a quote from a German newspaper published in 1923, when Germany was dealing with hyperinflation: 'There have been extraordinary rises in the quotations for all shares, the chief cause being the catastrophic change in the economic situation.' In other words, you could have a slump in the economy, yet share markets could go up simply because of excessive liquidity and interest rates being cut, theoretically, to zero.
Since 2002, all asset prices have risen substantially. Against this backdrop, I'll focus on pair trades -- assets that will perform better in the next three to six months relative to others. The U.S. is in a bear market, and earnings will disappoint here and worldwide. Cost pressures will diminish profit margins. The stock market doesn't have a bubble valuation, though the Standard & Poor's 500 is selling at a higher price-earnings multiple than is evident. Take out the energy sector and the S&P has a P/E of 20, not 15. If earnings decline -- partly because the energy sector won't have higher earnings this year than last, and also because the financial sector has diminishing earnings and the economy is in a recession -- then the S&P isn't cheap.
Cohen: If you were to sector-weight the S&P with the same sector weights as in Europe, the P/Es are identical.
Faber: I didn't say Europe is cheap. Stocks in the U.S. probably are cheaper than 10-year Treasuries. Cash has been a disastrous investment for the past 40 years because the purchasing power of money has diminished. I don't find any great values in the stock market now. If people want to buy stocks, stick to the recommendations I made last year. [You'll find them listed free of charge on Barron's Online, www.barrons.com, under the 2007 Roundtable Report Card.]
I still like gold, cotton and sugar. My new recommendation is to short the British pound against the yen. The pound, as Felix explained, is overvalued. It doesn't have a lot of upside potential compared to the dollar. It is probably less risky to short it against the yen than the dollar. [The pound has fallen 3.3% against the yen since Jan. 7. Faber remains short the pound.]
You can also short the euro against the yen. The euro is a relatively expensive currency and European economies aren't going to perform well. Europe also had a lot of excesses, and the ECB [European Central Bank] will cut rates dramatically. Central-bank monetary policies are leading to the competitive devaluation of currencies.
Zulauf: Which is good for gold.
Faber: I suppose so. Since 2001, emerging stock markets have significantly outperformed the U.S. It's not that I am bullish about the S&P 500 or the Dow Jones [industrial average], but they may go down less than emerging markets. If there's a strong rally in financial assets, it could be that the Dow outperforms emerging markets. I would short an emerging-market index via the ProShares Short MSCI Emerging Markets exchange-traded fund. You could also short the FXI, the iShares FTSE/Xinhua China 25, which mimics the 25 largest Chinese stocks listed in Hong Kong and China. And, there's an ETF, the ProShares UltraShort FTSE/Xinhua China 25, which appreciates twice as much when the Chinese market goes down.
In the long run, the U.S. dollar will go down, but because of the diminishing current-account deficit, it doesn't have huge downside risk now. Negative sentiment on the dollar reached an extreme recently, with many front-page articles noting its decline.
Sentiment on the dollar was very bearish a year ago, too. Sentiment in this case didn't count.
Faber: It has reached extremes. It also has depreciated considerably against the euro. Today, I would buy the dollar.
At the moment, there is a war: The private sector is cutting credit and the central banks are cutting interest rates because they are desperate to revitalize credit growth. In the long run, the central banks will win, but in the next six to 12 months, relative credit contraction isn't going to be good for any asset class. In a year's time, the S&P 500 will be lower than it is today.
Marc Faber's Picks 1/4/08
Investment Ticker Price Currency Pair Trades
Short the British pound/Buy the Yen £1=¥211.97
Short the Euro/Buy the Yen €1=¥160.09
Buy the U.S. Dollar /Sell the Euro €1=$1.47
Short Emerging Markets
Buy: ProShares Short MSCI Emerging Mkt.
EUM $75.40
Short: iShares FTSE/Xinhua China 25 Index
FXI 163.61
Buy: ProShares UltraSht FTSE/Xinhua China 25
FXP 82.51
Buy
iShares MSCI Japan Small Cap*
SCJ $49.94
Short
DryShips
DRYS 73.17
Future Investment Opportunities:
Cambodia
*Buy after a 10% correction.
Source: Bloomberg
My next recommendation is a shipping short. I turned bearish about home-building stocks in 2005, and felt the troubles in the housing market would hurt the subprime-lending industry and spread to other sectors of the economy -- in particular, consumption. Private consumption now accounts for more than 70% of U.S. GDP, which is why I'm negative about the U.S. economy. The problems here will also affect other economies. The Chinese stock market is closely correlated with the Baltic Dry Index, a shipping index. Tanker rates have plunged, but the Baltic Dry Index is still in the sky. If you can't short the index, short DryShips [DRYS]. The BDI has fallen 28% since Jan. 7. Faber suggests remaining short DryShips.
Any other ideas, Marc?
Faber: Two trades today are totally out of favor. One is betting on the dollar, and the other is buying Japanese shares. I go to seminars, and whereas 10, 15 years ago there were hundreds of people attending the Japanese sessions, today there are hundreds attending sessions on investing in Vietnam. Nobody goes to the Japanese sessions anymore. It's remarkable that people talk about equity valuations being low in the U.S. compared with bond yields, while valuations in Japan are very low compared to the Japanese bond yield. Buy the Japanese stock market on a correction of 10% or so.
What would you buy?
Faber: Give your money to a good money manager, or just buy the index. The small-cap index is interesting. You can buy the iShares MSCI Japan Small Cap Index, an ETF.
Faber: Many countries have opened up following the breakdowns of communism and socialism. China began opening in 1978, proceeding at different times and in different sectors. The same has occurred since the late '90s in India, and more recently, Vietnam. One country in Asia hasn't begun to attract a lot of attention, but has great potential. It is Cambodia. You can't play Cambodia now, but some Cambodia funds will be launched this year.
Eastern Europe has climbed the value scale. There isn't a big difference anymore between, say, Slovenia and Austria. Go further east, into Ukraine, and you'll find big opportunities in real estate, in particular agricultural land.
Basically, investors should avoid correlated assets such as the S&P 500 and the FTSE index, emerging markets, art prices and real estate in financial centers. I'm ultra-bearish about the financial sector, as it will contract for many years, not just one year. I wouldn't buy Citigroup [C] here, or Merrill Lynch [MER]. And as much as I like Abby, I wouldn't buy Goldman Sachs [GS]. I anticipate the day when half of Wall Street will be looking for jobs as drivers of tractors and combine machines.
Faber: I am well and happy because I talked about many of these issues a year ago and recommended shorting the brokers. Subprime is a symptom of a much wider problem: the huge credit bubble built over the past 25 years. It is just the appetizer to something bigger, which will lead to relative illiquidity in the world. I travel around the world regularly, and every place I've gone has had a boom. The U.S. already would be in recession if government statistics were correct. The rest of the world will see a meaningful slowdown because global financial connectivity is greater than ever before.
The Fed brought about the latest boom by cutting the federal-funds rate from 6.5% in January 2001 to 1%. It kept fed funds at 1% until June 2004, even though the recovery in the U.S. began in November 2001. In other words, almost three years into a recovery [then-Fed Chairman] Alan Greenspan still had the fed-funds rate at 1%. This led to huge liquidity in the system -- asset bubbles, debt growth and growth in the trade and current-account deficits. Now those deficits are shrinking. This is an unfriendly environment for economic growth, financial markets and even industrial commodities. But it is friendly for the U.S. dollar.
Faber: I took a taxi from Times Square to lower Manhattan this morning and paid $14. In Europe the ride would have cost me three times as much. Prices in the U.S. are relatively inexpensive, as Abby learned at breakfast in Paris. This reminds me of other economies in which prices became low and inflation picked up. The taxi driver will increase his price massively sooner or later. Let me stress that weak currencies don't produce inflation. Inflation in the system produces a weak currency.
Faber: U.S. exports have gone up a bit, especially because of price increases in agricultural commodities and some capital goods. But the number of inbound and arriving containers at U.S. ports is down year on year, as are rail-car loadings. The trucking index is down. These statistics point to a recession in the U.S.
Faber: Scott, your fiscal policy will be another disaster superimposed on a disastrous monetary policy.
Faber: The average citizen will be in a recession anyway, because inflation will be higher than the benefits he gets from the tax cuts you propose. I also see a stagflation scenario similar to the 1970s, with high volatility in financial markets. Corporate earnings get squeezed nicely, with S&P earnings falling
Faber: U.S. policy is misguided in targeting consumption, not investments.
Faber: Equity prices have increased in dollar terms, but in euros the S&P 500 is down about 45% from its peak in 2000 and the Nasdaq is down 60%. Measured in gold, the markets have done horribly and the economy has been in a recession for a long time. I'm not bullish about U.S. stocks, but everything is so bad on a global basis that they might do better on a relative basis. That doesn't mean they go up, but the U.S. market might go down less than China, India, Vietnam and some of the other markets that are in cuckoo land. These markets have gone up because people believe in decoupling. Economically we could see a decoupling, whereby the U.S. is in a recession and China still grows by 5% or 10%. The financial markets won't decouple. Unless, Mario, they reintroduce that uptick rule.
Five years ago I visited family offices and financial institutions that had practically no exposure to international stocks. Today the same people have 50% of their money in emerging markets. Valuations in these markets aren't compelling any more, except for real estate in emerging economies.
Marc, what do you think of gold?
Faber: There are times when stocks do fantastically well and there are times when commodities do well. On a relative basis, gold became unbelievably inexpensive in the years 1999 to 2001. Now, prices have gone up. We had a bubble in Japan in 1989. Then we had the Nasdaq bubble, and bubbles in countries like China, and in the credit markets. The last big bubble to burst will be gold.
Black: If gold rallies at least 15%, to $1,000 an ounce, wouldn't it be better to buy an exploration and production company that could rally more?
Faber: Not necessarily. You want to own gold because you think something will go wrong, leading to deflation or hyperinflation. Mines can be expropriated. Also, exploration companies are like biotechnology and nanotechnology companies. One in a hundred will succeed.
Faber: A company like this is likely to be bought by a major miner, because the majors, like big pharmaceutical companies, don't spend much on research. They would rather buy
Marc, man of the world and proprietor of Marc Faber Ltd. in Hong Kong, says all asset markets are oversold "in the very short term" and due to rebound strongly, although he doubts they'll go to new highs. Equity investors, he grouses, still are focused on buying the dips, not selling the bounces, and sentiment is negative not because they have liquidated their shares, but because they're sitting on large losses. Emerging markets, he adds, have "considerable downside risk," but recoveries of 10% to 15% are common in bear markets. Marc's picks this year are mostly pans -- of several currencies and emerging-market shares.
2008 Barron's Roundtable Members
Marc Faber, Managing director, Marc Faber Ltd., Hong Kong
Thanks, Abby. Marc, what have you got for us?
Faber: We aren't dealing purely with market forces today, but with an economy that is largely manipulated by central banks, which create excess liquidity by cutting interest rates dramatically and letting credit growth accelerate dramatically. I'd like to read a quote from a German newspaper published in 1923, when Germany was dealing with hyperinflation: 'There have been extraordinary rises in the quotations for all shares, the chief cause being the catastrophic change in the economic situation.' In other words, you could have a slump in the economy, yet share markets could go up simply because of excessive liquidity and interest rates being cut, theoretically, to zero.
Since 2002, all asset prices have risen substantially. Against this backdrop, I'll focus on pair trades -- assets that will perform better in the next three to six months relative to others. The U.S. is in a bear market, and earnings will disappoint here and worldwide. Cost pressures will diminish profit margins. The stock market doesn't have a bubble valuation, though the Standard & Poor's 500 is selling at a higher price-earnings multiple than is evident. Take out the energy sector and the S&P has a P/E of 20, not 15. If earnings decline -- partly because the energy sector won't have higher earnings this year than last, and also because the financial sector has diminishing earnings and the economy is in a recession -- then the S&P isn't cheap.
Cohen: If you were to sector-weight the S&P with the same sector weights as in Europe, the P/Es are identical.
Faber: I didn't say Europe is cheap. Stocks in the U.S. probably are cheaper than 10-year Treasuries. Cash has been a disastrous investment for the past 40 years because the purchasing power of money has diminished. I don't find any great values in the stock market now. If people want to buy stocks, stick to the recommendations I made last year. [You'll find them listed free of charge on Barron's Online, www.barrons.com, under the 2007 Roundtable Report Card.]
I still like gold, cotton and sugar. My new recommendation is to short the British pound against the yen. The pound, as Felix explained, is overvalued. It doesn't have a lot of upside potential compared to the dollar. It is probably less risky to short it against the yen than the dollar. [The pound has fallen 3.3% against the yen since Jan. 7. Faber remains short the pound.]
You can also short the euro against the yen. The euro is a relatively expensive currency and European economies aren't going to perform well. Europe also had a lot of excesses, and the ECB [European Central Bank] will cut rates dramatically. Central-bank monetary policies are leading to the competitive devaluation of currencies.
Zulauf: Which is good for gold.
Faber: I suppose so. Since 2001, emerging stock markets have significantly outperformed the U.S. It's not that I am bullish about the S&P 500 or the Dow Jones [industrial average], but they may go down less than emerging markets. If there's a strong rally in financial assets, it could be that the Dow outperforms emerging markets. I would short an emerging-market index via the ProShares Short MSCI Emerging Markets exchange-traded fund. You could also short the FXI, the iShares FTSE/Xinhua China 25, which mimics the 25 largest Chinese stocks listed in Hong Kong and China. And, there's an ETF, the ProShares UltraShort FTSE/Xinhua China 25, which appreciates twice as much when the Chinese market goes down.
In the long run, the U.S. dollar will go down, but because of the diminishing current-account deficit, it doesn't have huge downside risk now. Negative sentiment on the dollar reached an extreme recently, with many front-page articles noting its decline.
Sentiment on the dollar was very bearish a year ago, too. Sentiment in this case didn't count.
Faber: It has reached extremes. It also has depreciated considerably against the euro. Today, I would buy the dollar.
At the moment, there is a war: The private sector is cutting credit and the central banks are cutting interest rates because they are desperate to revitalize credit growth. In the long run, the central banks will win, but in the next six to 12 months, relative credit contraction isn't going to be good for any asset class. In a year's time, the S&P 500 will be lower than it is today.
Marc Faber's Picks 1/4/08
Investment Ticker Price Currency Pair Trades
Short the British pound/Buy the Yen £1=¥211.97
Short the Euro/Buy the Yen €1=¥160.09
Buy the U.S. Dollar /Sell the Euro €1=$1.47
Short Emerging Markets
Buy: ProShares Short MSCI Emerging Mkt.
EUM $75.40
Short: iShares FTSE/Xinhua China 25 Index
FXI 163.61
Buy: ProShares UltraSht FTSE/Xinhua China 25
FXP 82.51
Buy
iShares MSCI Japan Small Cap*
SCJ $49.94
Short
DryShips
DRYS 73.17
Future Investment Opportunities:
Cambodia
*Buy after a 10% correction.
Source: Bloomberg
My next recommendation is a shipping short. I turned bearish about home-building stocks in 2005, and felt the troubles in the housing market would hurt the subprime-lending industry and spread to other sectors of the economy -- in particular, consumption. Private consumption now accounts for more than 70% of U.S. GDP, which is why I'm negative about the U.S. economy. The problems here will also affect other economies. The Chinese stock market is closely correlated with the Baltic Dry Index, a shipping index. Tanker rates have plunged, but the Baltic Dry Index is still in the sky. If you can't short the index, short DryShips [DRYS]. The BDI has fallen 28% since Jan. 7. Faber suggests remaining short DryShips.
Any other ideas, Marc?
Faber: Two trades today are totally out of favor. One is betting on the dollar, and the other is buying Japanese shares. I go to seminars, and whereas 10, 15 years ago there were hundreds of people attending the Japanese sessions, today there are hundreds attending sessions on investing in Vietnam. Nobody goes to the Japanese sessions anymore. It's remarkable that people talk about equity valuations being low in the U.S. compared with bond yields, while valuations in Japan are very low compared to the Japanese bond yield. Buy the Japanese stock market on a correction of 10% or so.
What would you buy?
Faber: Give your money to a good money manager, or just buy the index. The small-cap index is interesting. You can buy the iShares MSCI Japan Small Cap Index, an ETF.
Faber: Many countries have opened up following the breakdowns of communism and socialism. China began opening in 1978, proceeding at different times and in different sectors. The same has occurred since the late '90s in India, and more recently, Vietnam. One country in Asia hasn't begun to attract a lot of attention, but has great potential. It is Cambodia. You can't play Cambodia now, but some Cambodia funds will be launched this year.
Eastern Europe has climbed the value scale. There isn't a big difference anymore between, say, Slovenia and Austria. Go further east, into Ukraine, and you'll find big opportunities in real estate, in particular agricultural land.
Basically, investors should avoid correlated assets such as the S&P 500 and the FTSE index, emerging markets, art prices and real estate in financial centers. I'm ultra-bearish about the financial sector, as it will contract for many years, not just one year. I wouldn't buy Citigroup [C] here, or Merrill Lynch [MER]. And as much as I like Abby, I wouldn't buy Goldman Sachs [GS]. I anticipate the day when half of Wall Street will be looking for jobs as drivers of tractors and combine machines.
Thursday, September 25, 2008
Banks vs Wall Street
Don't confuse speculators with the banks and Wall Street. There is an enormous gulf between the two. The fact is the banks did create loans and loan structures that encouraged excessive borrowing. Merrill used to encourage homeowners to take out home equity loans and put the money in stocks. Homeowners did not create option ARMs or understand them. Banks created then and sold them. The public did not slice, dice and engineer toxic securities from their mortgages. Wall Street did that.
Does the public have culpability for their stupidity and greed? Of course they do and they are paying for it. Look at foreclosures. That can't be a pleasant experience. However, the Street has to take its share of blame for creating the speculative fires and then pouring gas on them.
Most "speculators" had nothing to do with the creation of this mess. They do not lend money or create securities. They trade. And most of us do it with our own money.
Does the public have culpability for their stupidity and greed? Of course they do and they are paying for it. Look at foreclosures. That can't be a pleasant experience. However, the Street has to take its share of blame for creating the speculative fires and then pouring gas on them.
Most "speculators" had nothing to do with the creation of this mess. They do not lend money or create securities. They trade. And most of us do it with our own money.
Wednesday, September 24, 2008
Setting Main Street vs. Wall Street
The vilification of Wall Street is taking full force. It is the worst form of scapegoating, denial, and mistakes were made (but not by me). It is similar to the criticisms of the legal profession where the intransigence, unreasonableness, and greed of the litigants is blamed on the representatives who are doing the job set out for them in the system. The current crisis originated in the greed and failure to save by homeowners, their use of real estate borrowing for consumptive lifestyles. Their failure to save, their spendthrift ways are all being loaded on to the investment community who were doing their function within the system. Now emails are floating around fighting the bailout of billionaires on Wall Street. You are an easy scapegoat. No matter that the speculator helped provide the liquidity to create trillions in new wealth. No matter that the long held family home is valued at many multiples of it's purchase price. It is the most culpable real estate speculator and overextended consumer that now point the finger in the attempt to avoid their own errors, lack of judgment. With an election coming up, the politicians, the worst of all, are jumping on the BANDWAGON. The cycle is ending. The funny thing is that equities are barely down a 1/5 and they are throwing out the baby along with the bathwater. But it's good. We really don't need the big firms anymore with universal access and electronic execution. Truth is we really don't need big government either, but its turn comes next.
For the speculator, many new niches and many opportunity will arise. The government will be the ultimate slow mover. As they try to enter the market, as we have seen this last week, there are big waves kicked up. The least qualified populate government functions. Small and fast moving adaptors can thrive in such an environment. Seems that many big hedge funds are going down or weakening. The white shoe brokers are weak. The change will be good. It's just like evolution and climatic change. New species will arise. Many will perish unless they adapt. Even the data itself is reinventing itself with data over a year old being almost irrelevant. As Lack says, regulation will be a joke. Every rule will create a dozen loopholes to exploit that the slow moving professors never thought about. THEY can't control the markets. The big illusion is that government can cure the problems when in fact, THEY are the problem.
For the speculator, many new niches and many opportunity will arise. The government will be the ultimate slow mover. As they try to enter the market, as we have seen this last week, there are big waves kicked up. The least qualified populate government functions. Small and fast moving adaptors can thrive in such an environment. Seems that many big hedge funds are going down or weakening. The white shoe brokers are weak. The change will be good. It's just like evolution and climatic change. New species will arise. Many will perish unless they adapt. Even the data itself is reinventing itself with data over a year old being almost irrelevant. As Lack says, regulation will be a joke. Every rule will create a dozen loopholes to exploit that the slow moving professors never thought about. THEY can't control the markets. The big illusion is that government can cure the problems when in fact, THEY are the problem.
Friday, September 12, 2008
We're Still a Long Way from a Real Banking Crisis
So far this year, 11 U.S. banks have failed (FDIC data here), out of 8,451 FDIC-insured banks, matching the 11 bank failures in 2002. The last time more than 11 banks failed was 1994, when 15 banks failed on the tail end of the S&L crisis (see chart above). In total, almost 3,000 banks failed during the 15-year S&L crisis between 1980 and 1994.
The FDIC has currently identified 117 "problem banks" (through June 2008) with assets of $78 billion (data here), the highest level since 2002 when there were 136 "problem banks" following the 2001 recession (see chart below). This compares to the 1990-1992 period when there were more than 1,000 problem banks in each of those three years at the end of the S&L crisis, along with a recession in 1990-1991.
As a percent of total commercial bank assets (data here), the assets of troubled banks are currently at 0.71% (through second quarter), the highest level since 1995, but far below the 20-25 % levels in the early 1990s (see chart below).
We still have more than three months to go in the year, and there will certainly be more bank failures to come in 2008. There are also two more quarters of banking data to be reported, and there will probably be more banks added to the problem bank list. But at least back to the 1930s, there has never been a 5-year period of banking stability like 2003-2007 when only 10 banks failed, and the banking industry has probably never been in a better position to absorb a shock like the current subprime problems.
Problem banks are still a relatively small share (1.38%) of the 8,451 commercial banks, 98.62% of banks are not "problem banks," the assets of the problem banks represent less than 3/4 of 1% of total commercial bank assets, and therefore 99.29% of commercial bank assets are not in "problem banks."
The FDIC has currently identified 117 "problem banks" (through June 2008) with assets of $78 billion (data here), the highest level since 2002 when there were 136 "problem banks" following the 2001 recession (see chart below). This compares to the 1990-1992 period when there were more than 1,000 problem banks in each of those three years at the end of the S&L crisis, along with a recession in 1990-1991.
As a percent of total commercial bank assets (data here), the assets of troubled banks are currently at 0.71% (through second quarter), the highest level since 1995, but far below the 20-25 % levels in the early 1990s (see chart below).
We still have more than three months to go in the year, and there will certainly be more bank failures to come in 2008. There are also two more quarters of banking data to be reported, and there will probably be more banks added to the problem bank list. But at least back to the 1930s, there has never been a 5-year period of banking stability like 2003-2007 when only 10 banks failed, and the banking industry has probably never been in a better position to absorb a shock like the current subprime problems.
Problem banks are still a relatively small share (1.38%) of the 8,451 commercial banks, 98.62% of banks are not "problem banks," the assets of the problem banks represent less than 3/4 of 1% of total commercial bank assets, and therefore 99.29% of commercial bank assets are not in "problem banks."
Wednesday, September 10, 2008
Random Thoughts
The action on the first day of the month of September was highly unusual, and apparently at that time the employment number had leaked so the moves after that first day were much more likely to happen than before. After such bad starts the rest of the week has a standard deviation of 30 and only 50% chance of rise.
The 40 point S&P decline on Thursday was the fourth largest decline on a Thursday ever. By that time, the news was out, and the increase in unemployment was icing on the cake.
All this occured in conjunction with repeated highs in the fixed income prices around the world, and declines in the omniscient market in Israel below the round and Japan near three year lows of 12000 on the Nikkei.
To me, the key event was the raising of the Swedish discount rate during the night Thursday, causing an immediate 1% decline in all European equities. How come they weren't keyed in like the others to the forthcoming announcement?
The most hurtful piece of mass psychology was the naive notion about stocks having to go down because the P/E of 25 was the highest in 15 years, and that was bearish. Earnings are forecast next quarter to be the highest increase ever of 50% and you would think that people are taught to look at the future rather than the past for moves in markets.
There were many good economic numbers and bad economic numbers in the past week relative to expectations. What is it that caused the employment number to be the focus, other than the desire to paint the economy as weak before the election for obvious reasons of agrarianism? More important, why should a decline in employment at this stage be bearish for stock markets?
The one factor that made it seem so much like the end of the world was the the four day move down in S&P from the Thursday 8 28 close of 1298 to the Tuesday 9 04 close of 1236, a decline of 62 points was the second worst start of a week since the beginning of 2002, the only comparable being the four day move on 1 17 2008 before the French bank inside trading activity.
The 40 point S&P decline on Thursday was the fourth largest decline on a Thursday ever. By that time, the news was out, and the increase in unemployment was icing on the cake.
All this occured in conjunction with repeated highs in the fixed income prices around the world, and declines in the omniscient market in Israel below the round and Japan near three year lows of 12000 on the Nikkei.
To me, the key event was the raising of the Swedish discount rate during the night Thursday, causing an immediate 1% decline in all European equities. How come they weren't keyed in like the others to the forthcoming announcement?
The most hurtful piece of mass psychology was the naive notion about stocks having to go down because the P/E of 25 was the highest in 15 years, and that was bearish. Earnings are forecast next quarter to be the highest increase ever of 50% and you would think that people are taught to look at the future rather than the past for moves in markets.
There were many good economic numbers and bad economic numbers in the past week relative to expectations. What is it that caused the employment number to be the focus, other than the desire to paint the economy as weak before the election for obvious reasons of agrarianism? More important, why should a decline in employment at this stage be bearish for stock markets?
The one factor that made it seem so much like the end of the world was the the four day move down in S&P from the Thursday 8 28 close of 1298 to the Tuesday 9 04 close of 1236, a decline of 62 points was the second worst start of a week since the beginning of 2002, the only comparable being the four day move on 1 17 2008 before the French bank inside trading activity.
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