Saturday, October 31, 2009

Gold Continues to Outperform Stocks and Bonds

As suggested here earlier this month, the volatility index VIX was indeed at a turning point as suggested by a chart with a positive "second derivative" (slowing rate of descent), soaring on limited news during the week to levels of much earlier this year, when the stock averages were much lower. I have reviewed prior post-recession periods (assuming the "banana" has ended) where the VIX has turned up suddenly. The best info I can find is that it has been unwise to buy the dips on the theory that the bottoming process in the VIX will be orderly. Certainly, nimble traders will look at short-term "oversold" numbers and step in to buy the steep drops such as we saw Friday. If over coming weeks truly awful news appears, I'd be careful. If the news is merely disappointing, such as occurred in 2003 with some weakish establishment employment numbers, while stocks succumb to profit-taking, that would be a different matter.

Meanwhile, the DoctoRx approach is to be out of almost all common stocks except those that are income plays or ETFs in precious metals. This decision occurred last week when the VIX started confirming the pattern described 2 weeks ago.

The gold chart is orderly and structurally is much stronger than the stock averages. Gold has begun to go mainstream, but for now the articles I have seen are as much about sellers as about buyers. If there is a sell-off of more major proportions in the stock market, the prior pattern during th bear market is for gold to fall only when there is panic selling/liquidation. The all-gold ETF GTU has a strong chart that is just now breaking out. It trades at a lower premium to net asset value than the much better-known CEF (Central Fund of Canada). CEF is basically Silver Bullion Trust, which trades near NAV, plus GTU in a certain ratio. In other words, there is no speculation in a physically-backed gold ETF located in Canada. If and when gold embarks on a wild bull market, rest assured that GTU will trade well over NAV, and CEF will trade more than its current 9% or so over NAV.

Meanwhile,'s hiring/not hiring numbers have shown a minimal bump up lately, but today fell back to zero -- workers seeing the same number of firms that are hiring vs. those that are laying off. Of course, it is possible that layoffs per "not hiring" firms is smaller and hires per "hiring" firms is greater than before. However, the current 1:1 ratio is horrible.

Historically, major surges off an oversold bear market-recession bottom such as has occurred this year pause and trend down for some months. In 1975, the downturn was sharp and severe, but the rally into 1976 was to new nominal highs in the stock averages, but inflation was so high that the inflation-adjusted Dow did not come close to its 1965 high; and, 1977-8 were very poor ones even for nominal stock prices.

So far, nothing has occurred to change the central case that expectations are low, which is somewhat bullish, but asset bulls have gotten too jiggy too soon. Again, historical precedent suggests a strong possibility of all sorts of whipsawing and trend reversals. The failure of stocks with improving fundamentals, reasonable valuations, good dividend yields and the like to make any progress suggests that stocks continue in a secular bear market. Long-term holdings should provide dividends and be financially very strong. Under those circumstances, returns better than Treasuries appear likely, but that may not be apparent for many years.

There are no easy places to hide. GTU and SIVR may be amongst the safest.

Copyright (C) Long Lake LLC 2009

Friday, October 30, 2009

Trick, not Treat for Stocks as the VIX Soars

The stock market is way down, the VIX has for now had at least a short-term bearish trend reversal, and gold continues its pattern of accumulation. Once again, it is going down less than stocks on down days, while rising about as much on up days for stocks. Furthermore, the weak rebound in the dollar today has affected the price of gold as follows, per Kitco:

Gold price down $7.40;

$2.10 of that decline was calculated to be due to intrinsic selling; the other $5.30 decline was directly due to their calculation of the amount the dollar declined against a basket of major foreign currencies.

In other words, the major stock indices are, as I write, down 2+% (intrinsic selling), but intrinsic selling in gold is only 0.2% of its price, and total percent price decline is about 0.7%.

Stocks are farther above their 200 day moving average than gold and are also percentagewise farther from their 12-month lows than gold; and are vastly farther above their year-to-date lows than gold.

In other words, the current message of the markets is that owners of gold are less motivated to sell than are owners of stock, as there is less selling pressure on down days; but when there is buying pressure on stocks, there is about as much buying urgency toward gold.

Gold can rise in nominal terms even if the economy is going down (think the past 2 years). Silver is much less likely to do so. If silver (or the more-difficult-t0-buy platinum) drops a lot and you believe that cyclical and other factors will make the real global economy grow, then silver will have more upside.

As an aside, one of my friends is a commodities trader who, let us say, retired young and lives and breathes markets so much that he keeps more than one TV on during the trading day in his house. He was bullish on silver from the first time we met about 7 years ago. Silver was then well under $5. He told me that his long-term chart analysis suggested an ultimate target of $100/ounce. Since then we have seen the first 5X move to over $20 with consolidation for many months. If we have a major pullback in silver without a major economic downturn, then investors/speculators interested in tangible assets may want to consider it, but only with pure risk capital.

Given my greater optimism for real global economic growth than for real rise in U. S. financial asset prices (stocks and bonds), my risk capital is increasingly oriented to real things than financial assets that I believe in my heart of hearts are at best fairly valued (think McDonald's).

Back to the VIX. Short-term, I believe it's too late to sell. Look for a snapback rally unless Citi goes under or something else fundamental makes the headlines.

Copyright (C) Long Lake LLC

JFK Adviser Compares Afghanistan to Viet Nam

This financially-oriented blog has focused on the Pak-ghanistan war(s) because of my belief that escalation there could lead to as much inflation at home as the guns-and-butter strategy of LBJ led to with his escalation in Viet Nam. An informative, interesting and brief post has appeared by John F. Kennedy's closest adviser, Theodore Sorenson, titled America's Next Unwinnable War. I recommend it is a good read from a variety of standpoints.

Mr. Sorenson makes the case that Afghanistan is close to being Barack Obama's equivalent of Lyndon Johnson's Viet Nam.

The U. S. historically has only had significant inflation during major wars or in the aftermath of the few losing ones, such as Viet Nam.

With the entire force of government and its creation the Fed committed to steadily destroying the real purchasing power of the dollar you have in your wallet, gold cannot lose nominal value in the very long run unless they fail miserably in that goal; but gold can be a poor investment nonetheless.

If the U. S. ramps up much further in Afghanistan, and continues to bribe/coerce Pakistan to do the same internally, look for domestic price increases to exceed expectations.

Copyright (C) Long Lake LLC 2009

Thursday, October 29, 2009

Market Comment

Once again, gold is performing at least as well as the Standard and Poor's 500 index. It's rather incredible that 9+ years into that outperformance, not only has it been continuing almost daily, but that the ratio of the gold price vs the S&P index is about at a "normal" 1:1.

Given that the administration is simply supporting the FIRE economy with debt-based gimmicks such as "Clunkers" and nothing-down FHA loans, plus considering Carter-era gimmicks such as paying firms to create "jobs", this cycle is looking more as though there has been a 1974 major stock market bottom with a strong rebound, but with the likelihood of new lower stock market values adjusted for the general price level.

Except for the few income stocks that offer international diversification and adequate income and where management is outperforming the economy and its competition, such as McDonald's, it's getting harder to justify stock markets investments when you can invest in your home that you get to use, and alternatives to overvalued financial instruments that might pull an AIG over permanent assets such as gold or its riskier "precious" colleagues, platinum and silver.

Copyright (C) Long Lake LLC 2009

U. S. Pushing Pakistan Toward Chaos as Dollar Traders See Policy Incoherence in Washington

The U. S. has been forcing an essentially bankrupt Pakistan to accept money to stay afloat on the condition that it fight our war for us by attacking their internal Taliban in South Waziristan. These Taliban are somewhat like our rural Appalachian citizens. The feeling I get from Pakistan's press is that it is a sophisticated country far more worried about India than what they regard as their hillbillies. Now there is carnage in town, all in retaliation for the civil war U. S. forced Pakistan to wage. A civil conflict is brewing there. Mrs. Clinton has just arrived. The trajectory is that of Viet Nam. Advisers, etc. The U. S. is widely unpopular in Pakistan.

For a view on the subject from der Spiegel in Germany, click HERE.

The French Government thought it had pulled off a big win when it went heavily into debt to help the fledgling United States gain independence from the British. What of course actually happened is that soon enough, language, historical and cultural ties won out and the special relationship between the U. S. and England was formed. As for the French, a financially-strained country soon turned to internal terror. A system of government that had been stable for centuries--which is how they got so many Louis's--was torn apart, leading to decades of turmoil.

It can't happen here . . . can it?

In its current time of economic difficulty, when Citigroup may be entering receivership one way or another, the U. S., as with any country, needs to be certain that it can afford to wage and win a war in a remote part of the world, even if that war is justified (no comment on that part). I am skeptical that both of those conditions are true, much as I disapprove and more than disapprove of the Taliban and of course al Qaeda. And I am disappointed that Barack Obama--who should in good conscience refuse the Nobel Peace Prize given that he has ramped up wars in two countries only months into his first year as President--has pursued policies in Pakistan that have already led to the deaths of hundreds of innocents, probably with many more to come.

Al Qaeda is gone from Pakistan, but we remain despite being greatly disliked. U. S. strategy is to rebuild Afghanistan on China's dime while we have more and more homelessness in this country. It's not a coherent strategy-just like Cash for Clunkers and homebuyer's tax credits. Any wonder why the dollar is sinking against trade partners that are not wasting money on foreign wars?

Copyright (C) Long Lake 2009

The VIX in Relation to the Stock Market

Empirically, it is observed that volatility of stock price movements correlates positively with declining prices and negatively with rising prices. The mathematics do not make it necessarily so, but the relationship keeps on holding cycle after cycle. A common measure of the volatility of stocks is the volatility index, symbol VIX. In typical bull markets following bear markets, volatility declines below 20 and if the bull is sustained, may reach or drop below 10. In the turbulence of the late 1990s through 2003, the VIX was however range-bound between 20 and 40. Last year, the VIX went to an ultra-high level above 60. The peak of the recent rally took it almost to 20. I noted recently on this blog that the famed second derivative of the VIX had turned positive, meaning that the rate of decline was continuing to slow. Above are one-year and long-term views of the VIX.

What my eye sees from the one-year chart is unfavorable for the stock market, except that short-term, the rapid move up on the VIX the past 2 days is "too far, too fast" and "deserves" a pullback, implying a rally in stocks. The long-term chart is also worrying. Correlating with geopolitics and the economy, the volatility at the end of the 1980s (not shown) and into the recession of 1990 and Iraq War of 1991 was followed by a decade of peace and prosperity. The average stock peaked in 1997-8 concomitant with the then-current global financial crisis. The Fake Recovery that began after the 2001 recession ended also had a massive drop in the VIX, followed by an even more massive record sustained rise in it.

The VIX over the past few months is making the same sort of bottom that many stocks and markets have made this year. Of course, one never knows, I respect evolving trends, especially ones that the media do not discuss. As a guidepost, I have noted the past 2 years that for some reason, 25 is a VIX number to respect. Under 25, stocks do poorly. Over 25, look for a bounce.

Because I believe that the charts suggest that stocks are in a structural bear market, I am inclined toward the hypothesis that the VIX has entered another multi-year period similar to 1998-2003. There were two single-best investment strategies in that time period. One was to buy Treasuries when yields rose. The other was to go with the hot sector that appeared to have good fundamentals. That meant buying not value but the breakout to new highs, whether it was the tech sector in early 1999 or the Russell 2000 in 2002. The safer and simpler approach was to avoid stocks and stick with gold, bonds and cash. I am still mostly doing that now, though that was a time of governmental fiscal restraint following the Perot movement.

People who own more stocks than they would be comfortable owning if the stock market dropped another 10-15% from here may want to lower their exposure the next time the VIX drops under 25.

Copyright (C) Long Lake LLC 2009

Tuesday, October 27, 2009

More on Bonds, with Insights from Bill Gross

In Midnight Candles, PIMCO's Bill Gross says what EBR has been saying all year, which is that virtually all conventional financial instruments are overpriced in aggregate: stocks, bonds, and cash. PIMCO presents an interesting analysis that comes to the conclusion that all paper "wealth" in the U. S. is in aggregate overvalued by 100% vs. 50 years ago. Without getting quantitative, I agree. That's the underlying why gold has made sense to me all year. The authorities are making heroic efforts to keep the paper ship afloat. His brief missive is worth a read, philosophizing about getting old notwithstanding, especially when one looks at his photo on the Web page and realize that it took some serious plastic surgery for a 65-year old to look like that.

Specifically because all classes of paper "wealth" appear overvalued, it continues to make sense to yours truly to run with the hypothesis that a Japanese solution could be in our future: very low inflation for long enough to allow Treasury rates to drop further or at least to stay where they are, thus allowing banks to make money on their "carry trade" and allow the Fed to dispose of all its Treasuries and mortgage-backed at no worse than breakeven. The Fed is notoriously stingy and does not like to lose.

In the prior post, we discussed some rationale for Treasuries: if the underlying principal is no good, then we have bigger troubles, and one could at least own gold (and canned goods?).

For retirement accounts, owning a no-current income Treasury can make a lot of sense. This "zero coupon" or "stripped" par bond is purchased at a discount to the ultimate payback price of 100. The rate is computed by a simple compound interest program. A price of 50 for the zero coupon bond will give a higher rate of return the sooner it is paid off at 100. There are three benefits of the zero coupon bond. Here are the advantages:

1. No reinvestment decision with small amounts of interest (at today's rates). If you spend $10,000 to purchase a 4.5% 30-year standard bond at par, every six months you will receive $225 dollars. Try reinvesting that!

2. If rates drop, the mathematics of the bond mean that the price moves up faster than a standard bond that provides current income. So, a "zero" can be bought with the possibility of speculation in mind.

3. Stated yields are about 10% or more higher for zero coupon Treasuries than for par bonds; i.e., a 3.5% standard Treasury bond rate (which is what the media report) is often correlated with a 3.85-4.0% rate for a zero. Why is that? One reason is that it just is that way; the other is the following disadvantage of zeros:
The built-in appreciation is taxable even though one receives no current income. So more people only buy them in tax-deferred accounts.

This can be avoided by finding zero coupon municipal bonds. Another way to avoid this is to find a mutual fund that owns zeros on behalf of fund owners; but yield to maturity is notably lower with these vehicles than with bonds you directly own. American Century is the fund I use; one security of theirs to look at has the symbol BTTRX.

Strangely, the standard bonds that pay interest every 6 months are much safer should interest rates soar than are zeros. Let us say that you buy a 10-year Treasury and rates soar from 3.5% to 20% in one year. Yes, the market price of both bonds will plummet. If you invested $10,000 in a standard bond, you will receive $350 per year. If interest rates go to 20%, you at least can earn $70 per year off of that $350 (excluding taxes). It's not a lot, but that extra $70 can compound at very high interest rates for the life of the bond. With a zero, the value can go near zero.

Zeros are also less liquid than standard par bonds.

Overall, the less well-known zero coupon bonds are the simpler, higher-yielding bonds that also offer better profit potential should rates drop a lot. The path less taken in this case is the better one for people who do not need current income and are confident that they can afford to hold the bond till maturity.

Zeros are one way that yours truly is dealing with the highly abnormal financial environment.

Copyright (C) Long Lake LLC 2009

Monday, October 26, 2009

On Longer-Dated Treasuries as an Investment Choice: Part 1

Probably the most detested asset class is Treasury bonds. That is why they are worth a look. That, and the chart. Click HERE and HERE for 1-year and long term views of the 10-year T-note. After every recession, people have tried to pick the low in rates. Of course, in the 1950s and perhaps even into the 1970 recession and beyond, people were thinking that rates could go lower, remembering the Depression.

Historically, rates are volatile coming out of a recession; less so coming out of a depression. Since the peak in rates in the early 1980s, there have been new cycle lows in rates during every downturn and lower highs in the upturns.

While there are great arguments about why Treasury yields should now head upward, perhaps fast and high, one generally not-discussed argument for why they may stay low and even head lower is that a slow-growth, moderate inflation scenario could allow the Fed and the banks to make money on their current troubled assets. Perhaps the free market will take mortgage rates to 4.5% on their own, and the 10-year Treasury to 2% if the prevailing inflation rate is 1.4%. So I continue to respect the downtrend that is in force.

As stated above, Treasuries are detested by individual investors, who tend to believe that the world owes them a higher yield. Thus, Treasuries are bought and held by "smart money": governments, banks, insurance companies.

What might have happened last year was the beginning of an end to the secular trend toward low interest rates in non-governmental debt. It might be that Treasuries will experience a rally spurred by public buying that could have a blow-off top similar to that which occurred in the tech sector in the late 1990s into 2000, lunatic though we now see it to have been.

In addition, Louise Yamada has demonstrated that over the history of the U. S., creating a bottom in rates has been a longer process than coming off a peak. So, even if we have seen a long-term bottom in rates, they might meander in the 3-4% range for longer than one might think.

Leaving inflation-linked bonds aside, there are two different basic types of debt, zero coupon (the purer type) and conventional par bonds.

Tomorrow, I intend to go into some basic and unexpected considerations regarding the risks and benefits of zero coupon vs. par Treasuries.

Copyright (C) Long Lake LLC 2009

Saturday, October 24, 2009

Hex and the Citi Revisited

On Jan. 10, 2009 I wrote Hex and the Citi, focusing on Robert Rubin and the mismanaged, probably insolvent Citigroup (C). I warned that the then-ongoing Obama stock rally was in great danger of failing, which it did by dropping about 23% in the next 8 weeks. It took exactly 6 months for the averages to rise above their Jan. 9 level, by which time green shoots had truly been spotted. Then on Oct. 20 I pointed out that Citi was the only one of the major banking companies I could find with a downsloping 200 day moving average. Citi is the only one of the mega banks to have a down chart in 2009, joining some large troubled regionals such as SunTrust (STI).

There is now more concern that recent actions on Citi's part presage serious problems. Mish has a post on this with interesting links titled Citigroup's "Hail Mary Pass": How To Know Citigroup Is In Serious Trouble. I recommend it.

Citi remains a sort of hairball. The stock chart had an obligatory jump likely due to short covering plus a rise in commercial real estate securitization pricing off of very depressed lows. These prices have sunk 20% this month and are far off their highs; the A-rated tranches have dropped percentagewise a bit more than the AA or AAA tranches. Click here for Markit's web page on this data. A continuing drop in CMBS pricing and other issues, details of which are nonpublic, could force Citi into full receivership.

On Friday the ECRI announced a drop in a key measure of the rate of growth of the economy. In the past, peaks and troughs in the growth rate cycle have marked good sell and buy points. Most of the good news may be out and all of it may be priced into stocks and low-quality bonds for months of good headlines ahead.
A catastrophe with Citigroup could easily tip off another bear market, though perhaps just a pause that refreshes.

Just as it would have been hard to imagine that the stock market would jump 60% in 7 months, who could have imagined that Rasmussen Reports would find that:

For the first time in recent years, voters trust Republicans more than Democrats on all 10 key electoral issues regularly tracked by Rasmussen Reports. The GOP holds double-digit advantages on five of them.

Is anything making sense any more?

Well, maybe something. Here is what I wrote about gold on Jan. 6, 2009:

It makes sense to own gold as a hedge. This should be a bullion equivalent such as a Krugerrand.I own gold and root against its "success".

Gold was around $852 then and is about 25% higher in price as "quantitative easing" e.g. debt monetization has been introduced by the inflationists at the Fed and the Bank of England, and as no serious financial reforms have been introduced by the Obama administration. This move in the price of gold would be more dangerous if it had not already exceed $1000 per ounce early in 2008.

Watch Citi. If its stock price moves sharply down, the general stock market, which is looking toppy on technical grounds, could be ready for a sharp move down as well.

Copyright (C) Long Lake LLC 2009

Friday, October 23, 2009

If the Peak in the First Derivative of Economic Growth is Here, Will Investor Sentiment Cool?

The fine forecasters at the Economic Cycle Research Institute more or less rang the bell at the bottom of the market when their publicly-disclosed growth index cycled to a new low. Has it peaked, and is it the start of a "correction"?

US Recovery to Gain Strength Through New Year

October 23, 2009

Slower housing activity pulled a weekly index of future U.S. economic growth lower in the latest week after it touched a record high the week earlier, a research group said on Friday.

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index slipped to 127.9 in the week to October 16 from 128.1 in the the previous week.

"Despite a dip, WLI growth remains close to the previous week's record high, suggesting that the U.S. economic recovery will continue to gain strength through the New Year," said ECRI Managing Director Lakshman Achuthan.

The index's yearly growth rate fell to 27.2 percent from the previous week's revised 27.8 percent, which was originally reported at 27.9 percent.

The index has shown annualized economic growth at record highs since September. That's a turnaround from earlier this year, when the growth rate was sharply negative.

As suggested here, mathematically the mature U. S. economy may well have seen the first derivative of growth prospects peak. The stock market may follow in a typical post-end of recession rally correction.

Meanwhile, the often-correct, often-early Nouriel Roubini has resurfaced singing the same song, warning of irrational exuberance with an interview subtly titled Nouriel Roubini: Big Crash Coming (not that he writes the title of the report). A sense of cyclicality suggests that since "no one" pays attention to him because of asset price inflation in the stock market, perhaps it's time to listen.

He dislikes gold and has been wrong on this asset class throughout the past two years, whereas he has been prescient on the more important economic matters.

While NBER will officially date the end of the economic banana a long time from now, it is likely that absent government incentives, it wouldn't be so clear that it has ended (if it has). Witness the U. K.'s third quarter economic report in U.K. Economy Unexpectedly Shrinks in Longest Slump:

“This is desperately disappointing news, especially given that it was hoped that a modest recovery had begun,” said John Philpott, chief economist at the Chartered Institute of Personnel and Development. “The U.K. economy is continuing to shrink, with six quarters of contraction in output making this recession look more like a depression.”

A few bloggers, such as Ed Harrison of Credit Writedowns and I have used the "d" word to describe the U. S. downturn. The higher-profile Paul Volcker has used the euphemism "Great Recession", which means the same thing but is more politic. It is good to see the reality of what has happened and is still happening be acknowledged, gradually, in the MSM. It's a start to the healing process. But only a start.

Copyright (C) Long Lake LLC 2009

Thursday, October 22, 2009

Stocks for the Long Run

The financial markets had an interesting day yesterday that were consistent with the hypothesis that a correction is underway. The late-day sinking spell in stocks was unexpected and had no real obvious cause, though a report from the "why does any care what he thinks" personality and "analyst" Richard Bove is said to have sparked selling in the financials. EBR however has been noting early signs of weakness in the financials and has been more than hinting about a change of leadership. The late-day price drops are just the opposite of what started happening in the winter when stocks were ready to be taken upward.

It is routine to have a correction in a strong end-of-recession (depression) rally. The deeper the recession low from the high, the more likely the post-rally recession is to undergo a more severe drop. 1975 saw such a downturn, and adjusted for the inflation of the time, the rally to the 1975 high was about as good as it got until the markets blasted off in 1982 when Mr. Volcker eased up on Mr. Reagan, having achieved both the crushing of inflation expectations and the securing of a strong midterm election for the Democrats less than three months later.

Nonetheless, there are always investment opportunities on the long side in today's markets, where one can go long a "short" fund or short a "long" fund. Within stocks, here are three that were mentioned months ago as having strong fundamentals, recession-resistant qualities, and, importantly, strong long-term charts.

One way to look at these charts is to open a second window and click for the charts in that window, keeping this one open throughout.

Click for the 2-year and max charts for Ross Stores (ROST; discount clothing), with the 2-year showing the 50 and 200 day moving averages. The long-term chart hardly shows the depression. The stock went to an all-time high this year. It is now correcting. Fundamentally, it may have problems getting enough cheap inventory, as general clothing stores are ordering very conservatively. This is one that I would not buy yet unless it were for a multi-year period.

The 2-year and max charts on Teva (TEVA; generic drugs) are similar but the stock looks different than ROST to me. The brand drug-makers have been regaining pricing power, which helps Teva. Teva had much less of a run off the bottom than Ross, which more than doubled. Teva is almost immune to the inventory cycle. If it meets consensus 2010 estimates, it is trading at about 10.5 X earnings. This stock could easily trade at 16-18 X earnings. I own Teva but not Ross.

Finally, I admire the business discipline of the little-known stock National Presto (NPK; diversified), and mentioned it this spring. Click for the 2-year and max charts. The max chart is difficult to interpret casually because the company is cash-rich in an old-fashioned way and pays huge dividends once a year. Thus, the total return is far greater than the chart suggests. The stock simply looks ahead of itself, but it has strong support at 80. Not shown is NPK's fundamental problem, which is that traditionally it sells down every now and then to book value, which is far below the current price. I am out of NPK for now.

The working hypothesis here is that the well-publicized penalizing of Citi and BofA is not quite a death sentence but could easily put the kibosh on their over-hyped, over-traded, over-priced stocks. Every bubble ends up frustrating the bulls in the field of the prior bubble. This cycle and these stocks are expected to follow the script.

Junk may well have had its day for a while. The stocks highlighted above, and the pharmaceutical sector in particular, may be relatively immune if all we are facing is a correction within a cyclical bull move; granted that in the style of Churchill's comment about Russia, this is probably all happening within a secular bear market that may be just passing the halfway mark.

Copyright (C) Long Lake LLC 2009

Wednesday, October 21, 2009

American Cancer Society Now Going My Way: "Overdiagnosis is pure, unadulterated harm"

The NYT is reporting on an impending important change, one with which I am quite sympathetic: see In Shift, Cancer Society Has Concerns on Screenings. It is worth a read. The single most interesting part to me is the finale:

“The issue here is, as we look at cancer medicine over the last 35 or 40 years, we have always worked to treat cancer or to find cancer early,” Dr. Brawley said. “And we never sat back and actually thought, ‘Are we treating the cancers that need to be treated?’ ” (Ed: She also obviously means, "Are we finding the cancers that we need to find?")

The very idea that some cancers are not dangerous and some might actually go away on their own can be hard to swallow, researchers say.

“It is so counterintuitive that it raises debate every time it comes up and every time it has been observed,” said Dr. Barnett Kramer, associate director for disease prevention at the National Institutes of Health.
It was first raised as a theoretical possibility in the 1970s, Dr. Kramer said. Then it was documented in a rare pediatric cancer, but was dismissed as something peculiar to that cancer. Then it was discovered in common cancers as well, but it is still not always accepted or appreciated, he said.

But finding those insignificant cancers is the reason the breast and prostate cancer rates soared when screening was introduced, Dr. Kramer said. And those cancers, he said, are the reason screening has the problem called overdiagnosis — labeling innocuous tumors cancer and treating them as though they could be lethal when in fact they are not dangerous.

“Overdiagnosis is pure, unadulterated harm,” he said.

I had a patient in the 1990s who was competing for the Nobel Prize with his research into breast cancer and other topics. His publications filled a number of large books. He refused to be tested for prostate cancer for the above reasons. He felt that cancers are always forming and being killed by the body's natural defences.

On behalf of "doing healthcare", the President has argued that more preventative medicine would save money. In this blog, I pointed out that the medical data did not support this claim. Presidents can talk all they want, but talking can't make it so.

Here's a true, tragic example that from a doctor's standpoint tells the inside story of much of cancer screening.

A young man saw multiple family members die young of colon cancer. He became a gastroenterologist in response. At a very young age, he began to have yearly colonoscopies performed on himself. All were normal. One day, he woke up and noticed that his liver was enlarged. He had cancer that had spread to the liver. A biopsy showed it was colon cancer. How could that be? Well, his number had been called. He had a primary tumor in the only part of the colon that cannot be screened by colonoscopy. He had primary cancer of the appendix--invisible to the colonoscope--which silently spread to the liver and killed him soon after.

Don't smoke, get enough sleep, exercise, eat a balanced diet free of the bad stuff, don't be fat, have good genes, have a happy committed relationship, and be lucky. Those are the sorts of things that doctors know are the secrets to having the best shot at a long healthy life. And laugh a lot.

Regarding screening, nothing here is a recommendation for therapeutic nihilism. But low-risk, asymptomatic people should discuss the risks and benefits of screenings with a medical professional and do that screening, if any, with which they are comfortable. People should be aware that there truly is a huge industry making a huge income from screening low-risk people for cancer, sometimes with little or no evidence of benefit.

For example, women under age 50 should ask their doctors for any evidence that routine mammograms are of any known health value in the absence of risk factors such as fibrocystic disease, family history etc. Click HERE for a reference on this topic.

In my prior practice of clinical cardiology, in my later years I almost completely stopped giving people screening stress tests. I knew without a computer-generated risk profile if they needed a statin, other medication, or testing if asymptomatic. When I retired, I heard from patient after patient who felt well that they had been shot up with some radioactive scanning agent to find out if they had a problem. Invariably, this test was a highly reimbursed one that the doctor did in his private office. Cancer screening is too often analogous, in my view.

It's about time that the ACS calmed down. We need more data before we create or perpetuate large medical-industrial complexes and scare people unnecessarily about something as terrifying as cancer.

Copyright (C) Long Lake LLC 2009

Tuesday, October 20, 2009

Surveys of Real People Rather than of Economists Unfortunately Paints an Ugly Picture

The news from real people about the economy just refuses to turn upward in any consistent fashion, despite massive government spending that has to goose up the economic numbers. Apparently larger companies have such high profit margins and those that are international see growth prospects out of the U. S. as more exciting than here that they are currently unwilling to invest for growth; and smaller companies have difficult access to financing and even the ones that carry health insurance are confused about the future cost.

Today (Oct. 20) we had a sudden relapse in two of the poll numbers that I watch daily. The 3-day average index of job creation (hiring/letting go), collapsed after looking stronger the past week, to a dismal -2. This is the number which represents the % of employees seeing their company adding other employees minus the % seeing them shrinking the workforce. Thus, a negative number sees more shrinkage than adding. Zero is not anywhere close to labor force equilibrium, though. When the number was strongly positive--such +20, unemployment was increasing. After all, the workforce is increasing. No matter what massaging of the data the people at the Bureau of Labor Statistics do, the employment situation is miserable. Very likely it will get better, but you know that objectively, the economy is a lot stronger early on in recessions than it is early in significant recoveries.

The other Gallup data with movement in the wrong direction is the U. S. Economic Outlook. Improvement in this number correlated very closely with the stock market up-move in March. The % seeing the economy as worsening has jumped to 60% from a recent low of 50%. The amount seeing it as improving has fallen to 34% from a recent high of 43%.

Separately, the ABC News weekly report of a poll the Consumer Comfort Index came out today and was subtitled "Back in the Dead Zone". Also, click HERE to go straight to the charts.

Last week, I noted that the S&P 500 had finally filled the gap on the chart at 1100 from the major collapse early last October. This theme was picked up by at least one analyst who has had a superb track record the past two years. Given the failure of average people to see any real improvement in the economy essentially two years out from the peak of the economy (most people thought the U. S. was in recession or worse more than 2 years ago), and given the floundering of the recent leading stocks, we are now in a classic time for what is politely called consolidation of gains.

If you click HERE on the two-year chart of GE, you will see that the panic bottom notwithstanding, an obvious downtrend is in force. The rule is that trends continue until they do not. Click HERE, HERE and HERE for similar charts of BofA, Nokia and a 5-year chart) Ford. These are charts that accurately reflect the changing business fortunes of the companies.

Click HERE for the 2-year chart of the S&P 500 (or its ETF = SPY as you prefer). This is the best of the bunch but the 2, 5 and 10 year charts taken together show no trend. Given a dividend yield of 2%, who needs it?

On all of these, the eye can see the downtrend. For all of these, business prospects simply appear to be worse than they were perceived to be in the past. The naked eye can easily see the loss of inventor support revealed by the downtrends.

If you adjust either for gold or for two or ten-year Treasuries, the downtrends are steeper (though in fairness, Nokia pays a good dividend).

Marty Zweig popularized the term, "Don't fight the tape". He was correct.

Yes, I will bravely predict that the above surveys will show rampant optimism in the future. But for now, business conditions are compatible with stock averages much lower than they are now. Federal finances are compatible with interest rates ranging from Japan-style on the low end to much higher. That Team Obama is apparently now planning yet another stimulus package makes me withdraw any optimism for lower rates in the near-term. Things are far too fluid to guess, even forgetting market manipulation.

In the days ahead, we will discuss technical patterns and some fundamental thinking about different asset classes, including individual stocks that may be poised to outperform if past is prologue.

Copyright (C) Long Lake 2009

None Dare Call It Stimulus

Time is out with the news that a second stimulus package is going to be passed soon, but for some reason or other it will be the stimulus that dare not speak its name. Also, the article alleges that the President does support another round of homebuyer tax credits; whether the very recent revelation that this program has been riddled with fraud would affect his views is not discussed.

Here is the link to The White House Readies a Stealth Stimulus.

They are making it hard to be long the T-bond!

Copyright (C) Long Lake LLC 2009

As Negative Publicity Mounts, the Big Finance Stocks Have Begun to Underperform

The markets continue to sizzle, but once again, the price increases were revealed to be nothing more than speculation due to "liquidity", whatever that really is. Stocks started out strongly Monday even in relation to gold, which was down in price adjusted for dollar weakness, but by the day's end, gold and Treasury bond prices--that queer couple--had shown buying interest. Once again, adjusted for the price of gold, stocks went nowhere (this decade, they usually go down in gold terms). Since 9/11/2001, after which the money-printing began to go into hyperdrive, the Dow Jones is roughly even, adjusted upward for dividend payouts and downward for consumer price inflation, whereas gold has at least tripled despite having no yield.

The returns from boring, much-hated Treasuries have beaten stocks this decade and over longer time frames.

Yet it is stocks that get the publicity.

Think different. (Unrelated to finance, click on the link for an entertaining example of how a genius thought differently when asked to solve a simple science problem.)

As suggested a few days ago on this site, there is strong evidence of trend changes in the stock market that may correlate with economic changes. The charts are very interesting in that regard. Over the next several days, we will discuss fundamental and technical considerations in a variety of asset classes.

One quick comment on today's action. Within the asset price inflation that cannot produce prosperity, the large financial companies have started to underperform. Of the big guys, the only one I can find that still has a declining 200 day moving average is Citigroup ("C")*. GE is close in that regard. Citi was down 1% today on a 1% up day for the averages and GE was down 1 1/2%. JPM, GS, BAC and WFC were all roughly flat. If you think these modest degrees of underperformance for the stocks with the worst charts vs. those with stronger charts are random occurrences, well, you are entitled to your opinion. I think the pros care about movements like these, though of course one day's relative strength may reverse soon enough. The trend is your friend--until it isn't.

Also, AIG was down big time and Fannie and Freddie suffered small strokes.

Meanwhile, GSK, Merck (MRK), MCD, FPL, Du Pont and the like: large boring stocks that all yield more than the 10-year T-note, have been very strong today and very recently.

We may thus be seeing an important rotation with broader implications.

More in upcoming days.

* Full disclosure: 1. Not investment advice. 2. I went short Citigroup last week and am long several of the stocks mentioned 2 paragraphs above. Positions may change without notice.

Copyright (C) Long Lake LLC 2009

Monday, October 19, 2009

Fiscal Position of the States Shows Record Decline

The Nelson A. Rockefeller Institute of Government has issued its latest quarterly report about state and local finances in State Tax Revenues Show Record Drop, For Second Consecutive Quarter. It is worth reading in its entirety. It covers the second quarter of this year, not the third quarter. Here are some excerpts.

We have compiled historical data from the Census Bureau
Web site going back to 1962. Both nominal and inflation
adjusted figures indicate that the second quarter of 2009 marked
the largest decline in state tax collections at least since 1963. The
same is true for combined state and local tax collections, which
declined by 12.2 percent in nominal terms. . .

The year-over-year change in state taxes, adjusted
for inflation, has averaged negative 9.2 percent over the last
four quarters, down from the 1.2 percent average growth of a year
ago and 2.0 percent of two years ago. Real, year-over-year growth
in local taxes has slowed to an average of 0.7 percent over the last
four quarters, from 1.6 percent for the preceding year. . .

The local tax slowdown is less severe than the state tax slowdown.
In the second quarter of 2009, local tax collections declined
by 2.8 percent, mostly due to declines in local income tax and
sales tax collections. Most local governments rely heavily on property
taxes, which tend to be relatively stable and rose a surprising
3.1 percent during the quarter. . .

Second quarter
revenues fell by
amounts unseen in at
least five decades. Total
state tax revenue in
the second quarter of
2009 declined by 16.6
percent relative to a
year ago, before adjustments.
The income
tax was down by 27.5
percent, the sales tax
was down by 9.5 percent, and the corporate income tax increased
by 2.9 percent. . .

DoctoRx here. California in essence legislated accelerated income tax payments; absent that, the report elsewhere makes clear that excluding California, corporate income tax collections declined 16.4%.

State finances lagged the economic cycle after the 2001 recession. I suspect that this will be the case this time as well.

Copyright (C) Long Lake LLC 2009

Civil War in Pakistan Continues

There are two divergent reports on the Government move on the Pakistani Taliban with the invasion of South Waziristan. On, we have Pakistan Kills 60 Taliban in Push Against Waziristan Home Base, wherein the title makes matters look good for the government. It is clear that the U. S. is financing this effort and that Pakistan would rather leave well enough along. The article also says:

The Taliban will “split into small groups and harass the strangers in a terrain which the Mehsuds know well,” said Bahukutumbi Raman at the Chennai, India-based Institute for Topical Studies. Pakistan is likely to face a new round of terrorist attacks in cities far from the fighting, he said.

The Pakistan-based reports on this action as well and suggests that the Taliban may melt away in Troops make steady gains in South Waziristan:

Security forces claimed on Sunday to have made steady gains in their assaults on militants’ strongholds in South Waziristan and army officials said they were surprised by low level of resistance.

'The area has been heavily mined. There are a lot of improvised explosive devices and mines. But the level of resistance from the militants is not very high,' one of them said.

As in Afghanistan, Iraq and Viet Nam, the U. S. or its proxy is fighting a body count war against an ideological foe. One just has to wonder what the cost in money, revenge, and other factors is going to be.

The advice from this former Viet Nam War protester but non-pacifist is to be skeptical of reports of success in Pak-ghanistan. We can hope for the best but "spin" will be everywhere.

Copyright (C) Long Lake LLC

Friday, October 16, 2009

Is ECRI's Optimism Sign of an Impending Market Top?

The top-notch economic forecasters at the Economic Cycle Research Institute are human, as was discussed recently by Mish; to read his extensive and often-incisive comments, click HERE. ECRI's caution about the economy all through 2008, and their increasing concern beginning on or about early September, was useful to my investing. However, how useful is ECRI at extremes?

Here are some comments from ECRI in late February 2009 in WLI Remains Near Cyclical Low, as the bear market was within days of ending (though not at its bottom):

The annualized growth rate inched up to negative 24.0 percent from negative 24.5 percent. "While the WLI rose for the first time in six weeks, it still remains near its cyclical low," said Melinda Hubman, research associate at ECRI. "An economic recovery is not at hand," Hubman added. The weekly index rose due to lower interest rates and stronger housing activity, with the gauge partly offset by a decline in stock prices, Hubman said.

OK. "An economic recovery is not at hand." Implicit message to investors: don't buy. And, of course, said recovery was not "at hand". No criticism from yours truly. But if you bought then and help the SPY, you'd be up about 50% as of today. Similarly, if you bought in mid-late October and November 2008 based on plunging WLI and WLI growth rate and held till today, you would be up. You would have been down a lot temporarily, and all this is with perfect hindsight.

And, ECRI has pounded the table on the economy, and you can actually chart the upmove in its WLI growth rate and correlate it with the stock averages.

Where are we today?

ECRI says: US Recovery Poised to Trounce Any Obstacle
October 16, 2009
Reuters) - A weekly index of future U.S.economic growth edged down in the latest week, but its yearly growth rate rose to a new record high that further suggests signs of a tapering recession, a research group said on Friday.
The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index slipped to 128.1 in the week to Oct. 9 from an upwardly revised 129.1 the previous week, which was originally reported as 128.3.

But the index's yearly growth rate climbed to a fresh all-time high of 27.9 percent from 27.4 percent the prior week, which was revised higher from an original 26.1 percent.

The group's data has posted annualized economic growth at record high rates since September. Earlier this year, the growth rate was struggling to dig itself out of deeply negative territory.

"Such a pronounced, pervasive and persistent upswing in the WLI and its components assures that this economic recovery can overcome any obstacles in the months ahead," said ECRI Managing Director Lakshman Achuthan.

The report's yearly growth gains are in step with U.S. industrial production figures released earlier on Friday that suggest the third quarter closed out with surprisingly strong economic growth.

"IP numbers are very much in line with our April forecast that recession would end over the summer," said Achuthan, who has said chances of a double-dip recession are highly unlikely.

Meanwhile, the VIX collapsed under 21 today briefly, closing down 1.34% while the SPY closed down nearly 1%. As these indices normally move together, this is another negative divergence; another finger on the scale on the bear side.

Given that the certainty that the U. S. economy is mature, then exactly what the economy does for a quarter or two has little meaning in the context of stocks being valued at (say) 20 times their yearly earnings and 50 times their dividends, or 10-30 year bonds.

The public has shown extremes of optimism on standard measures for months, and this is a common phenomenon early in bull markets; and it is also standard for insiders to avoid buying. After all, they get nervous in depressions and bear markets, and they may not be rich with cash after the bear market. These facts are why certain seers have been short the market and wrong for months.

Meanwhile, stores are closing in the wealthy area in which I am renting a cottage, and the mid-range housing market is above the Fannie/Freddie conforming loan limit and remains weak. In the real world, I know almost no one who really cares about the stock market anymore as anything but a game, and the general feeling is "God Bless Bernanke" for saving the financial system.

The collapse in the VIX this month suggests that at the least, matters have moved beyond the successful speculative rally stage into the complacency stage. There are lots of profits to be taken in stocks that have gone up 3-7 times in 7 months.

The good news is that value stocks such as WMT, MCD, GSK and others are seeing rising prices.

The averages may or may not move much, but watch for rotation into the quality names that have seen little or no bull market since March. And

Copyright (C) Long Lake LLC 2009

Is Pakistan Closer to the Brink than Afghanistan?

This blog has emphasized that if America escalates in the Pak-ghanistan ("Af-Pak") region, it needs to be honest and pay for it. No guns and butter, please. This will not be easy. See the latest from the WSJ, Pakistan Faces New Wave of Attacks. Here is some of the news:

A series of well-planned and audacious attacks on police and government installations that left at least 40 people dead across Pakistan Thursday exposed major weaknesses in the nation's security apparatus and appeared to show Taliban insurgents gaining the upper hand. . .

The day marked an escalation of violence even in a period marred by massive terror strikes and brazen attacks, including last weekend's assault on the Pakistani military's headquarters in Rawalpindi outside Islamabad. In the past 10 days, insurgent attacks have left more than 150 people dead.

Pakistani Interior Minister Rehman Malik said the Pakistan Taliban, an offshoot of the Afghan movement, had "started a guerrilla war." He urged Pakistanis to unite behind the government.

His tone was a marked shift from last month, when officials were boasting they had "broken the back" of the Taliban after a successful spring offensive in the Swat Valley northwest of the Islamabad and the death of the Pakistan Taliban's leader, Baitullah Mehsud, in a U.S. missile strike in August.

The 2009 winner of the Nobel Peace Prize began his Presidency with ramped-up drone attacks from the air into sovereign Pakistani territory and then sent more troops into Afghanistan to chase the elusive Taliban around hill and dale while carrying heavy packs and body equipment in the cloudless heat of the Afghan summer. He has not convinced the American people why a dispute that is largely between the traditionally independent hill people of Pakistan and their nominal government is any of our business.

In a related article on one of the attacks, the Pakistani newspaper reported:

Taliban spokesman Usman Ali told this correspondent on phone that the attack was revenge for the killing of their two activists.

Back and forth revenge killings in a remote land we do not understand are hardly what America needs to focus on now. How about a Pecora-type Commission to investigate the financial shenanigans of recent years?

A month ago, the article demonstrates that things were looking better for the government; this may have been just a transient victory. Somehow I am skeptical that a bunch of tribesmen for Waziristan are going to successfully fight their way to control of nukes. I suspect that if America stops reimbursing Pakistan for fighting them, peace will reign again. But then Big Finance would lack one more rationale to sell bonds, wouldn't it?

At least when LBJ escalated in Viet Nam in 1965, the economy was looking strong. Yes, America is definitely rich enough that it can afford any size war it wants, even a truly large one. But based on LBJ/Nixon and G W Bush's precedents, any enhanced war in Pak-ghanistan is likely to be fought with printed or borrowed money.

Stay tuned.

Thursday, October 15, 2009

The '500' Fills the Gap

While many individual stocks look reasonably valued on a price-earnings basis, the market as a whole is looking more and more tired and more and more like a "sell" rather than a venue for gamblers.
The chart nearby (click on to enlarge) shows the S&P 500 for the past two years. It has now filled the gap around 100 created when things began to implode late in September.

Not shown is that the index is slightly more than 20% above its 200 day moving average. On the one hand, this reflects the dramatic turnaround in corporate profits. Teleologically, companies cut back inventory "too much", especially in view of all the government stimulative measures. Worse, companies cut back staff and are reluctant to hire; though, they will eventually hire if profits hold up.
Moving on, the VIX, an index that reflects actual or feared volatility and in practice correlates with the perceived trend of stock prices, has collapsed 25% from about 28 to about 21 in only two weeks. This is a large decline in a short time. In the rally since March, this situation has either been followed by a correction in stock prices or some stability in prices offset by a rise in the VIX (a rising VIX means rising volatility, and generally reflects bearish sentiment). Of course, past performance doesn't predict future . . . you know the rest. But it's nice to have precedent on your side.
From a technical standpoint, the financials, which led this rally, lagged today even as a bullish event happened over the past two days, which is a significant widening in the 2-10 year Treasury spread. Higher quality, boring stocks that have not participated in the rally began to participate, such as MCD and GSK. Might the fast money be "tired of" financials?
Nokia before the opening and IBM after the close each saw their stocks fall on bad news, which is what happens in an average market. Meanwhile, Intel had a legitimate beat-and-raise and the stock did not do much, even though it is depressed on a 2-year basis. And Alcoa, with a less impressive earnings beat, has also done little since an exuberant day; in fact it has trended down over the past week. So, under cover of rising averages, we are seeing lots of new 12-month highs, little but rising earnings estimates, and other bull market action, but evidence of fatigue.
What happens in a wild bull market is that you see stocks trading way above their 200 day moving averages. We are seeing this. When these stocks have the worst fundamentals, many prudent investors simply stand back. MU and AMD are two of many examples. Not counting its recent minor drop, GS is about 40% above its moving average and is quite the momentum stock these days. Meanwhile, there has been nearly zero corporate insider buying for several months. These guys are almost always right, though with a lag.
These sorts of stocks, even if the fundamentals are strong, have so much profit in them that in a normal bull market, one not fueled by short covering or hot money, that they move up more slowly.
Eventually, financial markets are weighing machines. The weights comprise return of capital or dividend payouts. A rising stock price for 2 decades did AIG shareholders no good when it went near zero, given the lack of meaningful dividend payouts along the way. With the S&P 500 once again yielding more or less exactly 2.0%, and with old Wall Street hand remembering when a normal (wide) fluctuating range of dividend yields was 3% at bull market tops and 6% at bear market bottoms, what we are seeing is levitation ahead of proven fundamentals.
Unfortunately, indicators such as's polling shows that consumer spending has not risen at all.
Based on 14-day averages of responses to smooth out weekend and other variations, Gallup found that in May 2008, consumers spent as much as $112/day above and beyond fixed costs such as mortgages (!).
Two months ago, that had rebounded from below $60/day to as high as $72 (Aug. 18). The index has dropped back to $60. Where are the money printers when we need them?
The same polling continues to detect no net hiring, which has been quite accurate in predicting the BLS monthly data. Employment is almost undoubtedly shrinking at a significant pace, and initial unemployment claims are probably understating the case due to reluctance of large and small companies to hire. And when they can hire overseas, they are doing so. There are no healthcare benefits and few if any payroll taxes in China!
The 10-year Treasury yield is back to 3.47% at a time when the CPI is negative and rents are falling for the first time in 17 years. The real yield is very high. As the peak momentum of the economic move off the bottom inevitably arrives--some week-- measured in various ways--it is likely that the media will start talking of a growth slowdown. Not only are Treasuries a buy for real return, if you ask virtually anyone which asset class will provide a better return over, say, two years or ten years, choosing between stocks, gold and Treasuries, how many people do you know who will say Treasuries? (I would also suspect that if people were asked to choose between all cash for 10 years vs. a 10-year Treasury, most people would take cash over a 3.47% annual yield.)
Gold was down on a day when oil surged. This smacks of profit-taking, given that the dollar was unchanged against a basket of other currencies.
The stock averages look vulnerable here, and many individual issues probably are more likely to drop than rise. However, the boring stocks such as MCD, GSK and WMT that have done little or nothing since March could rise even if the averages have what might be a pause that refreshes a/k/a a correction.
In a confusing world in which the financial crisis remains unresolved, yours truly remains long government securities, dividend stocks with strong long-term charts, gold and cash. Dynamic it's not. But given an outperformance over stocks by 40% last year by being in bonds and cash and out of stocks, I don't feel that aggressiveness is needed right now. Avoiding losses and investing for income and/or capital gains when they appear low risk is the DoctoRx watchword in managing money.
NOTE: Nothing said herein is investment advice for any individual. Econblog Review and DoctoRx are NOT professional money managers.
Copyright (C) Long Lake LLC 2009

Wednesday, October 14, 2009

Thinly Disguised Bribery Proposed by the President

In Obama Seeks More Payouts, the WSJ reports that the President, upset at the lack of price increases, proposes to have Congress print or borrow $13 B more for 57 million Americans, allegedly to be nice to them so that they can have a cost of living (equivalent) increase of 2%. Thus the other 250 million Americans will lose the same amount of money.

There is no economic point to this "payout". This is the equivalent of bribery to get votes, as the recipients will notice the money whereas the mass of Americans won't know the difference. There is also no fairness to this bribery, as it will presumably go to wealthy seniors but not to struggling non-seniors. Seniors are already the wealthiest Americans . . . but they vote the most.

The President is the leader of a Party that went wild when President G W Bush tried (and succeeded) to pass legislation with at least the argument that a permanent (or, semi-permanent) reduction in tax rates for all taxpayers would help the economy grow. Bill Clinton had a deficit-reduction public argument for his 1993 tax increase (and a private one, which was to fund healthcare reform in 1994). Likewise, G H W Bush and Ronald Reagan had arguments for their tax increases and tax cuts, respectively.

Just as the recent President Bush had a weak argument for his tax cut of spring 2008 and no good argument for an almost open-ended TARP and lots of other examples of him and Gentle Ben throwing other money at large complex financial institutions, the current President is just throwing money around.

I would like to be out of my gold holdings. I enjoyed being bearish on gold year after year from 1980 to 2001; rooting it down, as it were. But the politicians and Big Finance make it hard to regain my prior enthusiasm for conventional assets.

It's time to do things the old-fashioned way. Spock could have said the following.

"Work hard and prosper."

Payouts which are just handouts are symptomatic of the much larger handouts to the financial class. Favored groups get the fruits of the labor of others. Not fair. And not the way to retain world financial dominance.

Copyright (C) Long Lake LLC 2009

NFIB Uses Newspeak to Write an Upbeat Headline

Headline: NFIB SBET: Small Business Optimism Returns

Here's some of the text:

WASHINGTON, October 13, 2009 –The National Federation of Independent Business Index of Small Business Optimism gained 0.2 points in September to 88.8 (1986=100). Four of the 10 Index components posted gains, two were unchanged, and four declined.

“The good news is the Index didn’t decline. The bad news is that improvements were far less than what we hoped for,” said NFIB Chief Economist William Dunkelberg. . .

Almost 2 years from the economic peak, certainly there are some employment gains?


In September, small business owners reported a decline in average employment of 0.83 workers per firm during the prior three months, a substantial improvement from May but virtually no change from July and August and historically the sixth largest loss per firm in the 35 year survey history (the record is negative 1.26 in May, 2009). Seven percent of the owners increased employment and 23 percent reduced employment, yielding a seasonally adjusted net negative 16 percent of owners decreasing employment in the last three months, unchanged from August. The job generating machine is still in reverse. Sales are not picking up, so survival requires continuous attention to costs, and labor costs loom large.

(Unsaid in the above, and without opining on the merits of any healthcare legislation that may be passed soon, those business owners who do not carry health insurance for their employees are looking at materially higher costs from said legislation. Every single small business owner is considering this issue.)

What about capital spending? That drives growth, which since we are a full half year from green shoots language, has to occur to drive said growth?

Overall, a dismal performance, only vehicle purchases were up most likely due to the cash for clunkers program.

Are the small businesses moving the merchandise?

The net percent of all owners (seasonally adjusted) reporting higher sales in the past three months was negative 26 percent, up a point and 8 points better than the record low set in March and revisited in July.

It looks as though that answer is NO. Surely the "money-printing" from the Fed and the record gold price mean that there are pricing pressures:

The weak economy continued to put downward pressure on prices. Ten percent of the owners reported raising average selling prices, but 32 percent reported price reductions. Widespread price cutting is a major factor shaping the reports of lower nominal sales.

Unsurprisingly, earnings trends were poor:

Reports of positive profit trends were unchanged at a net negative 40 percent.

To end the press release and end the section about credit (difficult to obtain but much less a problem than sales), Dr. Dunkelberg states:

“It is no surprise that credit is more difficult to obtain since sales prospects and profit trends are very weak.”

So, where did that press release's headline come from? Perhaps even NFIB isn't so independent of the Newspeak wherein bad news is good news nowadays.

The DoctoRx summary:

Price increases for most common stocks have as little to do with the overall economy as the fall 1929 stock market correction from a hyped bubble peak had to do with the economic collapse that began later, after the passage of the Smoot-Hawley Tariff Act and all sorts of post-WW I political and financial machinations. The message of the facts and the markets appears to be: times are tough and not visibly improving. Government credit guarantees and back-t0-bubble financing of homes is doing what it is doing. "Banks" which are really not banks in the traditional sense of making well-secured loans with depositors' savings accounts but which are trading and gambling houses are thriving, but real banks are not doing well. In other words, the oligarchy is prospering. There is no money either in equity or loans for the vaunted scrappy start-up that wants to challenge an entrenched player.

I'm apathetic about the Dow crossing 10,000 again. But with U. S. banks holding hundreds of trillions of dollars of "notional" value in interest rate swaps, dwarfing the tens of trillions of dollars they may be holding in credit default swaps, the conclusion remains that the gambling that is going on is on such a grand scale that conventional financial instruments are pawns in a greater game.

For those people who avoid gold for the reason that it has quadupled in nominal price in 8 years (from an almost 22-year nominal price low), consider that BofA stock (BAC) is up more than 7 times in 7 months. Was this a panic low? Yes. But wasn't BofA paying out dividends for years and buying its stock, leaving no retained earnings, when in retrospect it had no margin of safety when a little panic occurred, as it always might? Yes.
Whereas the point with gold is that it pays nothing, so its total return comes from what some call price appreciation but others call preservation of purchasing power. The most basic reason to invest in gold is a highly conservative one: keep what one has, rather than try to grow it as with a speculative growth vehicle.

Big Finance is playing poker against everyone else and, as with Goldfinger gambling in Miami Beach, they see your cards but you don't see theirs. And the government will provide downside protection for them but not you. Nice work if you can get it. How long will going with this sort of stock continue to be a one-way bet for the public without government backstop of the stock price?

Copyright (C) Long Lake LLC 2009

Tuesday, October 13, 2009

Economic Update

The fundamentals of the U. S. economy aren't looking so hot to ordinary people or to CFOs. Duke University published last month its quarterly CFO Survey. It's an ideal survey for bond bulls. The CFOs have mild optimism but in general plan to cut jobs and capital spending next year. They also plan to outsource jobs to Asia next year, where capital spending plans are relatively robust. They do plan to increase their cash balances as profits slowly improve.

Meanwhile, continues to show dismal hiring/letting go numbers.

I have not talked to one person in the small-midsized business community who sees a pickup in business--au contraire, in general.

Amongst my several banker contacts, one thing is clear. The bankers ARE NOT LENDING except to clients who barely need to borrow, or where there is a Federal backstop. Banks are purchasing munis and Treasuries for lack of anything better to do.

Yes, every traditional cyclical indicator suggests good growth ahead. Perhaps this is the pause that refreshes. But as a physician, I treated every case as a new one. Anomalies occur. Somehow the current economic/financial/markets case just feels different. Right now, I'm taking "the under" on the economy. (Not too brave, since I'm agreeing with Dr. Hatzius of Goldman Sachs!)

Prosperity must be just around the corner . . .

Copyright (C) Long Lake LLC 2009

The Push Continues for a Value-Added Tax and Lots and Lots of Debt

Early in his Presidency, Bill Clinton was overheard to muse about the good things that the Government could do with the revenues from a Europe-styled value-added tax (VAT). This idea went away after it received a frosty reception but has been resuscitated in the Obama era.

In a refreshingly honest and allegedly fiscally responsible manner, two Brookings Institute economists have a WaPo editorial laying out the need for and virtues of a VAT. The title is: Bend the Revenue Curve; Health Reform Alone Won't End Deficits.

Only an economist could speak about "bending" the revenue curve when talking about tax increases, pure and simple. And only the Brookings Institute and their allies seriously believe that the more government becomes the payer/subsidizer etc. for Americans' health care, the more money it and we will save. No doubt the pharmaceutical industry bellied up to the health care reform bar with a $150 M ad campaign to save us money!

Medicare was supposed to be a small, easily affordable program. Now, everyone's paycheck has a 2.9% additional tax laughingly called a "Medicare tax". But it's just a tax that goes into general revenues.

The VAT proposed by Drs. Aaron and Sawhill is just another tax in addition to the crazy quilt of taxes Americans are faced with.

Unfortunately, the more one taxes something--in this case production and sales of goods and services--the less one gets of it.

In investing, one of the enduring adages is to keep it simple. Large scale unemployment in the U. S. never occurred for long until the interventionist president Herbert Hoover hoved onto the scene. What we think of as one depression from 1929-32 was at least two. The 1929 downturn appeared to end quickly in 1930, with a major decline in unemployment in the first half of 1930, but an immediate double dip occurred, perhaps related to the Smoot-Hawley Tariff Act of June 1930. The low-tax region of Hong Kong has had nothing but economic dynamism decade after decade.

The saying that the government is best that governs least is from to the anti-slavery activist Henry David Thoreau- hardly a reactionary.

Part of me applauds the point made in the above-linked editorial: pay for what the government spends, but only part of me, because I don't believe they mean it. All of me believes that the progressive agenda involves paying for all the good things that the progressives want government to do for the people with unending borrowing and where suitable with frank money printing. The commentator Marshall Auerback states this repeatedly, such as in Time for a New "New Deal":
Is President-elect Obama another Franklin Roosevelt, ready to embark on a radical remaking of the country’s political and social fabric?

We hope so. There is no shortage of places in which to invest: extended unemployment insurance, state fiscal relief, increased food stamp programs, and large scale infrastructure. No question, there will be more debt, lots and lots of it.

The American progressive agenda is a copy of what the European "Social Democrat" parties advocate. To Europe's credit, the socialists are honest about what they are. If America wants to go more and more socialist, at least it should do so with a much simpler tax system. Adding a VAT on top of all our other taxes and exemptions would be inefficient and confusing.

As stated at EBR many times, statism is on the march in the U. S. It became apparent for real a year ago with the statist/crony capitalism actions of the Bush Administration and the Fed in response to the failure of highly leveraged financial companies. It is intensifying under the Obama Administration. The most consistent financial market response has been toward higher gold prices.

The market does not always get the future right, but investors need to be aware of the major trend and separate it from the churning actions. Short term, Goldman Sachs came out last week with a call for a relatively weak economy in 2010, no Fed action to raise short term interest rates for a year or so, and a rally in the 10 year Treasury toward 3% by yearend 2009. This strikes me as realistic, and I bought TLT back after a sudden 3-4 point sudden dip, but only for a trade. When the powers that be in Washington want more debt and more spending, with more taxes to allow yet more borrowing and spending, the unending supply of debt offerings hardly makes for a compelling long term supply-demand proposition.

Copyright (C) Long Lake LLC 2009

Monday, October 12, 2009

How Difficult Asian Geopolitics Aid the Price of Gold


The Pakistani Taliban have claimed responsibility for a brazen weekend attack on the army's headquarters compound in the city of Rawalpindi.

Taliban spokesman Azam Tariq called The Associated Press on Monday and said the attack that killed 20 people was only the first in a planned series of strikes intended to avenge the killing of their leader Baitullah Mehsud in a CIA drone attack in August.

He said the raid on army headquarters was carried out by a Punjabi faction of the militant group and it had given orders to other militant branches across the country to launch similar operations.

He also warned the army that if it launched a planned offensive into Waziristan it would be its undoing.

The Nobel Peace Prize winner Barack Obama authorized, directly or indirectly, that CIA drone attack.

If he wants to be a war president, then in good conscience he should refuse the Peace Prize. He can say that he will be pleased to accept it if it is reoffered after he has fought and won the good fight and helped bring peace to a tortured region. If he wants to be a "peace now" president, then it is hard to see how he believes that an America of questionable financial solvency should be so involved in the internal affairs of a sovereign nation. Please recall that the Mehsud tribal leader that our country killed (in cold blood) has not been asserted to have been involved in fighting in Afghanistan. What did that killing have to do with the Afghan insurgency?

The game of tit for tat amongst tribes and factions in Pakistan is a difficult one for America to play now.

Here is what Pakistan is really concerned about, also from today's Massive war games showcase deepening India-US ties:

NEW DELHI: India and the United States began a massive joint military exercise on Monday, underscoring their deepening security ties they view as crucial in a troubled South Asia region.

Pakistan created the Taliban, very likely with U. S. assistance and encouragement, during the Soviet Union's occupation of Afghanistan. Months of reading tell me that Pakistan regards its Taliban as country bumpkins. Meanwhile, Pakistan has fought three wars with India and developed nukes because India had them.

Think of Pakistan as Cambodia, Afghanistan as Viet Nam, and Obama as Nixon. Nixon's expansion of the Viet Nam War to Cambodia was useless to our Viet Nam effort and may have led to the murderous Pol Pot regime coming to power in Cambodia. It would be quite an irony, and a sad one, if Mr. Obama followed the Nixon example with similar results.

The greater the U. S. military involvement in the internal affairs of faraway people, the greater the chance that via one route or another, we will get more rather than less involved. Such is the nature of positive feedback loops. Given our economic and financial problems, is President Obama willing to demand the domestic stringencies necessary to fight an expanded war in Asia if he deems it necessary without resorting to out-and-out money printing to finance it?

The above represents another argument for gold ownership as a hedge if our role in the Afghan war or the Pakistan civil conflict expands and the answer to the above question is the answer Presidents Johnson, Nixon and Bush II gave.

Copyright (C) Long Lake LLC 2009

The Message of the Markets and a Master of the Markets on How to Allocate Assets

Skeptical minds are wondering why is running Rallying S&P 500 Never Cheaper in Europe on Dollar. I don't recommend that you read all of it. That would IMO be a waste of time. Its point can be summarized as follows: The U. S. stock market has been going nowhere in international units of money. The article is dangerous because it suggests that despite the massive inflation in asset prices of stocks, the media continues to flog them. What are we to make of the prominence given to an obscure financial researcher, as follows?

“The valuation for the market is still below normal levels,” said Jason Pride, director of research at Haverford Investments, which oversees $6 billion in Radnor, Pennsylvania. “We still believe there’s a fairly good, positive bias in the direction of the market.”

What is that valuation?

The MSCI World was valued at 27.7 times the earnings of its 1,659 companies in September, exceeding the S&P 500’s ratio by 7.75 points, according to monthly data compiled by Bloomberg.

In other words, global stock markets are at bubble valuations. The U. S., the epicenter of the latest global financial crisis, is merely at fully-priced valuations that were sustained for a while in the 1950s but still has emergency zero short rates in place because . . . supposedly there's a crisis.

Meanwhile, as I complete this post, GLD is up 0.80% and SPY is up 0.6%. Quietly, gold continues its outperformance. Someone is accumulating it and has been doing so ever since the U. S. began a guns and butter-type economy following the 9/11 attacks. In general, the collective accumulator is to some degree the public via exchange traded funds, but the signs of a peak in public enthusiasm for gold are not very visible. Check out the small ETF with the symbol GTU to see that it is only today even beginning to emerge from a bearish chart pattern of several months duration, despite the bullish configuration from the better known ETF GLD for quite some time. If the public were fully engaged, GTU should have been flying.

Technically, gold has no overhead resistance. Think stocks, circa late 1982 or early-mid Clinton years. Fundamentally vs. other asset prices, gold is neither overvalued nor undervalued. More fundamentally, the massive Federal deficit is a gift that keeps on giving. So, it is not hard to see gold moving toward a richer valuation, and possibly an over-rich one (think NASDAQ late 1990s). IF that happens, then it would be a "don't buy" or "sell". But that has not happened yet and may not.

To conclude with a quote from John Paulson (from Your dollars are just Monopoly money by Bill Fleckenstein), the hedge fund manager who made billions in 2007-8 largely from shorting subprime at the right time:

"What I'm looking at is not where gold is going to be tomorrow, one week from now, one month from now, three months from now. What I'm looking at is where is gold going to be vis-à-vis the dollar one year from now, three years from now, five years from now. And I think, with a high probability at each of those points, gold will be higher than it is relative to the dollar today. That probability increases the further out you go. So when I look at what the risk is, the risk to me is far more staying in dollars than it is in gold at this point."

If by 2012 it is Springtime in America again and Barack Obama is headed for a 49 state electoral sweep because the economy is growing and adding lots of jobs and he has justified winning the Nobel Peace Prize, and therefore my gold holdings have underperformed inflation, I will be so happy for my children and for the majority of my assets that are not gold that I will be a happier person than if times stay unsettled and I own gold that continues to outperform cash and stocks.

In other words, one does not have to be a "gold bug" to own gold. One simply has to ignore the spin from the MSM and focus on facts and preservation of purchasing power of one's mostly electronic assets we call money.

Copyright (C) Long Lake LLC 2009

Friday, October 9, 2009

Something's Coming?

You can believe that the economy is already improving when you see the following (MarketWatch):

Washington starts cooking third stimulus
Bleak job report moves plan from back burner

The bleak September jobs report appears to have cracked the political logjam blocking progress on a third stimulus package.

Many economists have come to think that a third stimulus makes good sense. "I think the economy needs more help and they should provide it," said Mark Zandi, chief economist at Moody's

The more debt that is out there, the more business Moody's gets. A third "stimulus"? Earth to Washington: the stock market is up 60% or so. Business profits are rebounding. Layoffs are decreasing. The normal next part of the business cycle is for hiring to pick up. It's supposed to be free enterprise. Just please build more medical, nursing and other schools so that we can properly care for the Boomers when we start doddering.

Here's where the article gets toxic:

. . . analysts say that Democrats are likely to need a new initiative to show voters they are trying to create more jobs.

I'm all in favor of Democrats creating jobs. I'm also in favor of Republicans, independents, Libertarians, Naderites, etc. creating jobs. But I'm not a big fan of politicians "creating jobs". Because, you see, it's our money they are using with which to create jobs. Call politicians the parasitic job-creating class. Politicians earn their money the old-fashioned way. They extract it from others at the implicit point of a gun, or they print it. The rest of us have to earn it.

The truth is that the public "gets it". There was a housing bubble based on mortgage fraud. There was unsound financing and there was gambling going on within the very structures of Big Finance. The worst offenders, AIG and Fannie/Freddie, exist as zombie institutions with publicly traded stocks for no apparent reason other than to continue to provide jobs for financial types and to provide stock trading commissions for Merrill Lynch et al. Big Finance helped cause the aforementioned problems just as it got rich on overinvestment on tech stuff a decade ago. Big Finance is getting richer due to government fiat. That is why there are insufficient jobs. The money was looted. Why do you think the Swiss are building more storage for physical gold? How many ordinary people do you know who are keeping physical gold in Switzerland?

Rather than trading the same barrel of oil over and over again, or clearing stock trades that serve no other economic purpose than to enrich the middlemen, perhaps the financiers who know enough to have been buying physical gold should emulate the Obamas and grow organic vegetables. Actually physically cultivate and care for them. Something useful, in other words.

The same government that is keeping zombie institutions alive and that is in a real sense forcing and for certain encouraging people to speculate again in the stock market and other markets by recapitalizing the banks by forcing short-term interest rates to zero is, if the MarketWatch report is correct, once again going to pull a Herbert Hoover and intervene unnecessarily in the private economy (think Hawley and Smoot) when it should focus on helping the needy through these difficult times while letting the business cycle create jobs that actually have a point. These jobs fulfill a societal need and therefore allow a business, large or small, to create profits. Those profits can then be part of a virtuous cycle. Think Microsoft in its creative years and the numerous companies and technologies that formed around its products.

A guess: a new government "stimulus" program will be viewed by the financial markets as counter-productive unless it is really relief for the needy disguised as stimulus. In either case, the guess here is that it will be bad for T-bond prices and bullish for precious metals. The effects on stocks are murkier.

The cynic in me says that Big Finance is long gold and short T-bonds if indeed we find early next week that a third "stimulus" is going to happen. Could be, who knows.

The EBR solution: hold your bonds unless you are overweight already but buy no more Treasuries. Make sure that you have a significant weighting in gold and other precious metals with your risk capital. And watch Afghanistan.

Copyrighti (C) Long Lake LLC 2009

Time to Get Bearish on Stocks?

To answer the title question, not quite; but now that bullishness on the economy is so widespread and CEOs are at multi-year levels of optimism on the economy while not buying the stocks of their own companies, yours truly has largely exited the stock market except for bond equivalents such as MCD and FPL.

Regular EBR readers know that the view since the blog began in late December 2008 was that the general stock market was for gamblers. After the bottom was seen, some specific buy suggestions were made. These included stocks that have gone to all-time highs, such as (symbols only) NPK, ROST, and TEVA. For patient income-oriented buy and hold investors (not traders), MCD was suggested and remains in the portfolio of yours truly in increased quantities given improved fundamentals (see below).

The stock market as measured by SPY has now more or less filled the gap set when it collapsed last September and October. It has outperformed the long T-bond this year by a massive amount. Its long-term chart is churning. Bloomberg has a headline today that CEO confidence has reached a 5-year high. The ECRI growth rate of its economic indicators has reached a new record (reflecting the bungee jump moves up and down in these indicators), and in most weeks it refers to improvement in the housing market as the main mover.

Yet now we see increasing evidence that the housing market is being kept alive by FHA making loans by the bucketful with limited care being given to each loan, even though they are more or less free of a significant down-payment, with increasing default rates. Bubble financing redux. With mortgage rates rock-bottom and the dollar down, can things look better in housing land? Yes they can, but probably only in the high end, where there are no government subsidies and where it would appear that sellers are continuing to ask too much.

I wrote this winter that panic was not appropriate, the world was still turning, and the economy was continuing to fill the basic needs of the populace. What remains still lacking is transparency on our financial situation. The large financial institutions are faith-based. For publicly-traded companies to be completely opaque as to what assets they own is unfair.

Businesses are still not doing much hiring, though layoffs have decreased. Corporate profits are rebounding, which makes sense given that the Feds have to put the $1.8 T deficit to work. Call it privatizing the profits and socializing the costs. The earnings from above-normal deficit spending get a P/E of about one in my world.

Stocks are normally valued by the asset values of the companies, financial strength, dividend-paying capability, takeover value, and also by earnings. The same magical thinking that allows a new President who is a war President to date and has ended no war, solved no Middle East conflict, brought no peace to any part of Africa etc. to be deemed worthy of the Nobel Peace Prize is used to justify stock prices by talking only about P/E's, even if the earnings derive from no tangible asset base.

The sense here is that Treasuries are so hated and too many people missed the breakout in gold (if they care about gold at all) to provide a strong feeling that their bull markets have ended, though for me Treasuries are primarily trading vehicles given that we are probably in an up part of the economic cycle that has been discounted and perhaps then some by equities and given the extraordinary efforts of the government to sell debt to benefit private companies and some individuals.

Until common stocks have better valuations not only regarding P/E's but re dividends and price to tangible equity, they remain subject to large moves down. It was valuation and not earnings that broke the falls in stock prices in 1932-3 and in the early 1980s and that allowed the massive bull market from 1942-65 despite 5 recessions in that time. The stock market rally since March has now moved toward (but not to) the upper part of its long-term inflation-adjusted trading range, which uptrend itself is not guaranteed to continue. When McDonald's stock goes absolutely nowhere despite an earnings yield of about 7%, a current dividend yield of about 4%, record earnings, rising earnings estimates for 2009 and 2010, and has tremendous international diversification, but Macy's with negligible tangible book value and highly variable and uncertain earnings has tripled in only 7 months, market risk appears very high.

CIT quadrupled from its August low, and has been cut in half in only 10 days on no real fundamental news. I like the risk-reward in well-timed purchases (and sales) of Treasuries, gold and MCD much better than the kind of speculation that ownership in Macy's (M) represents, and I don't give a second's thought to the investment merits of CIT or AIG. That said, any market can go anywhere, especially a low-volume one. So, shorting this market is also quite risky.

The above is a lengthy way of saying that a pause that, should it occur, I hope refreshes has a good chance of being close at hand for the stock averages.

Copyright (C) Long Lake LLC 2009