Wednesday, March 31, 2010

The Depression Continues

ADP's hiring numbers are out. February was revised down by 4000 jobs to -24,000. March was listed as -23,000. Census hiring was irrelevant as the Gov't does not outsource its bookkeeping/payroll to ADP! And ADP says the storms in Feb. did not affect its numbers. shows that hiring/not hiring shrank to -1 as of today, a number it first hit Nov. 2008. It also showed that elective spending was down to $61/day, a number first hit in Feb. 2009. Even at much better #s such as +10 (% seeing hiring - % seeing negative hiring), unemployment was increasing in 2008.

In the real world, there has been no economic recovery. There has simply been looting of the public's money to pay off Big Finance's bondholders and enrich its stockholders, along with various other shenanigans such as stealing through ZIRP from savers. Though the Govt might counter that absent FDIC, savers in many banks wouldn't have received 100 cents on the dollar from their savings. Given that in the Great D, almost all the money center banks were money good and only a very small % of all bank savings were lost to bank failures, the current crash has been far worse than that of the early 1930s. Nothing like modern life support methods. It used to be that a massive heart attack could not be survived. Dr. Ben: committed malpractice but the patient is sort of alive, suspended like Hamlet between heaven and earth.

Remember that the non-farm payrolls # in 2 days will be revised. It cannot be profitably traded off of unless one is a true pro.

Stock prices cannot go down: bad data means easy money forever; good data means that Larry Kudlow and other permabulls such as Brian Wesbury are right that America has one damn great economy.

At some point presumably ECRI and Conf Board will be correct. There will be hiring. But at about 200,000 jobs added monthly for 12 months needed to bring the unemployment rate down a mere 1%, even a nice job gain number needs to be greeted with restraint. Plus, normalization of Fed policy may accompanying greater economic activity and therefore may be further associated with another conundrum on interest rates and sluggish stock price reaction.

Copyright (C) Long Lake LLC 2010

Tuesday, March 30, 2010

Cases Study in Hype: U. S. Steel and Laszlo Birinyi

Before getting to the specific case study, I recall that Bill Fleckenstein warned months ago that a sign of the impending market top he was expecting was when "strategists" started pointing to the "resilience" of the market. Well, it's here, and from a well-known figure. Laszlo Birinyi was quite bullish at the end of 2007. He is quite bullish again and uses the "R" word:

“Given our trading background and approaches, we are impressed with the resilience of the market which, in effect, is what trading desks mean when they say the market ‘acts well,’” according to the report Birinyi sent to clients today. “Large stocks are now likely to be contributors rather than detractors.”

This "R" word is accompanied by the dubious statement that large stocks are not contributors to this move.

Are you impressed that the "market" is acting well? Do you believe that acting is reality? Does a body in motion stay in motion? Why is it that people with vested interests in rising prices talk their book? Well, duh, think for yourself. Do you buy more or less of something when its price rises?

One of the larger contributors is United States Steel ("X"). Its 2-year chart shows it to have been a laggard on that time frame but it has soared over 1 year. David Pauly of Bloomberg is bullish, citing the price rise:

Favorable news continues. Shares of U.S. Steel Corp., a backbone-industry company, have climbed almost 50 percent since Feb. 4. Apple Inc., maker of iPods and iPads, may hit $300 from its current price of about $232, Credit Suisse Group AG said Friday.

I searched Yahoo's finance section re news on U. S. Steel.

Basically there are a bunch of references to rising prices. What is lacking is that 2010 and 2011 earnings estimates are down from 60 days ago, while the stock is up. The first substantive news I found was from a couple of weeks ago, which was that a larger competitor, ArcelorMittal, had downbeat earnings news.

U. S. Steel sells at 3 1/2 times tangible book value in an industry that frequently sells under book. It has a dividend yield of 0.3% in a highly cyclical mature industry that in younger mature times such as the 1950s had high dividend yields.

I wish X well. One thing is certain. Past stock performance is no guide to future performance. All shareholders get from the big moves up and down is, at the end of the day, either the dividend, any spin-offs, or whatever another company wishes to pay you for your stock. The idea that you should be an owner of this company because you expect to outsmart a future buyer is, for most people, a difficult one for me to accept.

Has X been a resilient stock and a resilient company that makes non-resilient products?

Who cares?

Copyright (C) Long Lake LLC 2010

Monday, March 29, 2010


Conspiratorially, all this relentless rise in the price of the average stock is designed to suck John Q. Public in at prices which soon enough will crash--thing subprime housing and the like. Sluggish real economic activity representing leads to a longer and longer period of Fed ease, with more and more leverage being used. Thus the real economy's weakness in a period of alleged recovery paradoxically leads to higher stock prices, as future earnings don't change much but the short-to-mid term discounting rate stays low.

In August 2007, I said to an investing friend that I believed that the domestic, non-export-oriented part of the economy was in a recession. After all, housing was already in a depression and autos were in a severe recession. The Fed had undertaken emergency action following several months of bad news out of Bear Stearns, housing securitized stuff, and early credit crunch action.

What is amazing is watching Gallup's polling almost daily. Real people still are near cycle lows in observing companies not hiring and in spending on discretionary goods.

When you read about Best Buy's results signaling strength, remember how much competition no longer exists to siphon large amounts of sales away. Nothing at all against this company or stock-- I have traded it successfully a number of times the past year, all from the long side. And one can praise the chart here as setting up for a saucer-shaped breakout.

But BBY sells for 7 times tangible book value and has a dividend yield of about 1.3%.

So it's at 12X current year estimated earnings, but if it were truly cheap, it would have been LBO'ed or acquired by some giant company.

So this is one of many high quality companies that could take a much higher stock price, and the set-up (conspiratorially again) just might be that the public finally gets interested in stocks at $50. Who knows, this could be an $80 stock in a year or two. Or margins could get crunched, earnings estimates could decline, and the stock could easily head to 2X book, which would be an utter disaster.

When stocks were valued based on tangible assets, there was a large margin of safety that does not exist now. One to look at is Everest Re ("Re") and other insurers/reinsurers. The stock has been weak on the heels of a projected Q1 loss due primarily to the Chilean earthquake. But it trades well below current tangible book and could lose money this year and the stock could rise a great deal. Plus you are paid over 2% to wait. To me this beats a 5-year Treasury. No retail clamor exists for RE.

With the absence of public participation, the institutions and Big Finance are playing the high school game of chicken with each other, this time with other people's money instead of real lives and cars. If the public doesn't get suckered in, then they to eat the overpriced sardines they bought to trade.

Ordinarily one would think that these guys are too smart to get stuck holding the bag.

Not so. Think the recent CDO mess etc.

All the incentives continue to favor gambling. Traders are getting it while they can.

There will be more growth this spring. And it will continue. What someone else's company is worth after the orgy of money-printing is the stock buyer's/stock owner's question. Stocks are so far above their historical replacement ratio and so far above their normal cyclically-adjusted price-earnings ratio that fund managers etc. rationalize these valuations by using circular reasoning that the weak economy has caused low interest rates and therefore high valuations are OK.

Yours truly has taken some quick 15-20% profits in DLTR, TJX and ROST and added RE and Chubb (CB) late last week. Too many stocks have gone up too far, too fast. Very few have strong asset-based underpinnings. The market has to discover these relative gems one day. If not, the worst is that one is trapped in value stocks as occurred from 1998-2000-- one was early, but they led the up-move and in fact many bottomed at the overall NASDAQ peak in March 2000. Money just decided to sell the momentum stuff and buy the value stuff. It just sort of happened.

Playing chicken is for kids.

Copyright (C) Long Lake LLC 2010

'Goldilocks' Was a Fairy Tale is reporting Junk Bonds in 'Goldilocks' Market Reach Record:

Companies worldwide issued $38.3 billion of junk bonds in March, passing the previous high of $36 billion in November 2006, according to data compiled by Bloomberg. Yields fell 0.95 percentage point to within 5.96 percentage points of government debt, the narrowest gap since January 2008, Bank of America Merrill Lynch index data show.

In other signs of giddiness, The Technical Tape reports as of March 27:

The sentiment indicators would suggest that this is not investing nirvana. While prices can certainly go higher, the lack of buying power should be obvious. Who is left to buy if everyone is all in? But judging by the emails I receive, most market participants believe that this is a new paradigm, where the Fed is engineering a new prosperity founded on gains in the market. Investing nirvana? I think not. This market environment is more like a high wire act. A new paradigm? Every era is new, but fear and greed never go away. I have yet to convince myself that "this time will be different".

Shorter term Rydex measures continue to suggest excessive bullishness. . .
(See nearby pic and click on it to enlarge.)

Finally, goes for circular reasoning that supports The Technical Tape's contrarianism in S&P 500 Cheapest to Junk Bonds Since ‘07 Signals Gain:

The Standard & Poor’s 500 Index is trading at the lowest valuation compared with junk bonds in two years, a sign the stock-market rally will continue, if two decades of history are any guide.

The lowest-rated debt pays 3.22 percentage points more than the earnings yield on the S&P 500, the smallest gap since 2007 and a discount to the average 5.93 points of the past 22 years, data compiled by Bloomberg show. The measure of profits compared with share prices shows stocks may be undervalued next to the fixed-income investments most closely correlated with equities.

I didn't bother reading the rest of the article. Who knows if two decades of history are any guide? Who knows if two millenia are any guide? The future exists to surprise us. Who would have thought 3 years ago that 2008 would occur, and then who would have guessed we would be reading about shortages of ships to bring containers to the U. S. and Europe as inventories are replenished?

All we can say is that more and more sentiment indicators are meshing with fundamental, multi-decade tested measures of fundamental valuations of stocks that suggest that stock prices have gotten ahead of themselves.

In the first article in this post, a later section mentions that the world's largest commodity trader, Glencore, is looking to raise multi-billions of dollar from banks in Asia. What's that about? Sounds like leverage ramping up to me. Meanwhile if we are in another cycle similar to the last one, with the Fed likely to stay too easy too long, we note that gold went through periods in the aughties where it lagged stocks, but ultimately did better.
Given a higher relative gold price now than then, my sense is that at least the two asset classes will track each other. Separate from a long-term core position, it makes sense now to tack toward gold on that basis if only on a trader's time frame.

Copyright (C) Long Lake LLC 2010

Sunday, March 28, 2010

Where To Now?

Approximately now, the Fed has definitively embarked upon the next tightening cycle. Looked at from a long term nominal or inflation-adjusted perspective, the U. S. economy has not performed well for some time. Measures of consumption, such as cars sold, do not reflect wealth accumulation. Thus when the economy was so weak that to sustain the appearance of strength coming out of the 2001 recession, houses were routinely sold for almost nothing down and with ridiculously low lending standards, and autos were almost always bought on credit, the signs of economic malaise were clear.

The "escape" from the abyss in fall 2008 was unsurprising. Be not impressed by the "heroism" or "brilliance" of the economic doctors in that time. All they did was socialize the losses onto you and me and reward the insiders. Plus they printed money. In other words, they took the Japan solution to a banking crisis rather than the 1990s Swedish solution.

There is no telling if consumer prices are going to go into a period of stability or even decline a la Japan. What makes more sense is that the U. S. is a decade out of phase from Japan. Increasingly we are already seeing that the funding of new Federal debt is domestic rather than foreign. If that continues, America will be following the Japan scenario in that regard as well.

The headlines are going in the MS tout resumption of job growth in March. Whether all of that is from Census hiring we won't even be sure of till revisions occur. What is certain is that small business is not hiring, though it has largely stopped firing. With housing activity not on a clear upward path if not on a downward path, despite all the support, we are left with the prospect of a post-credit crunch economy.

This in turn is one in which frugality continues, and Gallup continues to show consumers just not spending on elective things and workers just not seeing any net hiring at their firms.

The biggest mistake investors can make is to key their stock and bond valuations off of unnatural zero interest rate policies. This failed them in the last cycle and will fail them again. Last time around, Fed funds only got to 5.25%, at most equal to inflation if not below it-- and things collapsed. This is a sign of severe instability, in that the economy could not even survive imposition of a positive real rate of interest on Fed funds. So far, it looks like a replay of that. The Fed is behind the curve on inflation again and will keep that stance longer than inflation hawks want, until real progress is made on the employment front, and there is a huge hiring boom to go for the rate of unemployment to drop. That rate, of course, lags hiring as people re-enter the labor force after giving up and thus not being counted as unemployed for a period of time.

Given a weaker foundation this time and the certainty-- not the unfounded worry-- of financial instability in various spots across the globe -- investors are well advised not to take the Soma of comfort in low interest rates and keep much invested in assets which they would sell at a lower price were another bear market to start tomorrow from such matters as a bursting bubble in China or a bank failure or sovereign default in Europe, or a major rise in Treasury borrowing rates in America.

The feeling here is that the political zeal in the Obama administration suggests that the gold and bond markets will need to react, and more robust political opposition in Congress needs to materialize, before fiscal prudence becomes government policy.

This argues for gold as a core permanent (for now) holding of all investors. If the economy starts shooting up, as may happen one of these quarters based on ECRI and the Conference Board numbers, then silver and platinum may go to new highs for the cycle (new all-time highs for platinum) and outperform gold. If we have economic slowness (no double dip required) first even though the Fed is still "loose", just less loose than recently, though, then gold is the only precious metal than can continue up in price due to its status as an alternative, globally accepted store of value.

In two hundred years, which is more likely to remain a store of value: the Federal Reserve Note, or gold?

Copyright (C) Long Lake LLC 2010

Saturday, March 27, 2010

The New Bubble: Feds May Need a Stock Crash to Keep Deficit Spending Affordable

We are moving into government bailout bubble territory in the U. S. The state of California had to (could) increase the size of its bond offering. What's up with that? The Feds are helping.

A potentially vast new FHA rejiggering of mortgages to help bail out borrowers and lenders alike with taxpayer funds has just been announced. The money is said to be coming from some prior bailout funds.

The surprising thing is that with the flood of issuance, the 10-year is not back above its peak of last year in yield. Certainly sentiment on the Treasury bond is as bad as can be imagined. Meanwhile "liquidity" is running wild. The "smart money" "knows" that the party will continue until the Fed tightens, thus stocks and junk bonds are buys.

When I look at my Value Line charts, I can find almost no stocks below their "value lines". Some such as Oracle and Mickey D are at their lines, but one is left with TJX and DLTR, Chubb and Everest Re (insurers highlighted by Barron's today), and scattered others. Mostly the chart patterns look long-term weak, short term overbought. You never know with bubbles and can't try to pick the top.

Holding this bubble together is a rickety edifice.

If Treasury yields surge, look out. Since Obamanomics requires low borrowing rates, watch out for the opposite happening. Obamanomics requires Treasuries to have low rates more than companies to have high stock prices. The more people and businesses suffer, the more the Feds can step in and save them. The question is whether the government can keep long rates low or even for them to move much lower. The Japan scenario, in other words. 1-2% inflation would be fine to allow 3% 10-yar treasury yields. Remember that long rates were much lower than today's all through the 1940s and well into the 1950s even as some years of war and post-war high inflation came and went. In other words, sometimes rates can be well below inflation. It just depends on psychology and on relative opportunities. And right now cash is trash and stocks are fundamentally overpriced.

There is no good general investing solution right now other than trading profits, which most people living normal sane lives cannot hope to achieve. I still think that one of these months, we are likely to see a recrudescence of a Treasury buying surge/panic. No idea when, though. But unlike with stocks as a whole, the 10-year pays you to wait.

Gold continues to act as suggested here. It is frustrating traders, short sellers and long-term investors. The more the financial markets inflate in price and gold does not, the more it is likely that gold prices are set to surge.

Copyright (C) Long Lake LLC 2010

Thursday, March 25, 2010

Quote of the Week on Greece's Financial Future; And Thoughts on the Euro and USD is carrying a quote that I believe provides a cogent prediction of Greece's future in Merkel Sets Greek Aid Terms, Sees IMF-EU Tandem as Last Resort. To wit:

“The German strategy for the next couple of months is very simple: provide just enough positive rhetoric that investors continue to purchase Greek bonds,” said Peter Zeihan, an analyst at Stratfor, a geopolitical risk consultancy in Austin, Texas. “On the flip side, they want to make sure via rhetoric that there’s just enough doubt that the markets demand a much higher spread than the Greeks are hoping for. The Germans want to make very sure that the Greeks are punished.”

Sound a bit like World War II at the end. Yawohl?

David Kotok's Cumberland Advisors has been predicting for a few months that the Euro will hold but would show further weakness but would then become a "buy" vs. the U. S. dollar. So far that prediction has been looking - well- prescient.

The idea that the USD would strengthen because little Portugal is downgraded with a governmental deficit of about 9% of GDP, when U. S. deficits are worse, is odd.

The "DXY" tide may be with the USD, but that is a narrow index. The more relevant, broader index of the value of the dollar in the real world is the Trade Weighted Exchange Index. This chart shows essentially a stable dollar lately. The rally in the DXY that may have persuaded some to reprice gold downward is a fake-out. The current financial crisis began in America. The idea that the extend and pretend solution here in the financial community ends with triumph because some small countries in Europe tried to play our game of massive deficit finance without access to their own national printing press strikes me as naive.

The Bushbama policy of socializing the financial losses cannot be good for the USD. Right now sentiment is being whipped up against the Eurozone countries. Sitting here, we are being tipped off by various media statements that the U. K. is next up to be attacked by speculators. I am not so sure. The next attackee, should there be one, could be right here. Just as the Germans thought that the attack onto the mainland was coming elsewhere, this talk could be misdirection. A good buying opportunity in the Euro may be coming relatively soon. If so, one would suspecct that gold prices would move up in USD terms as well.

Copyright (C) Long Lake LLC 2010

Wednesday, March 24, 2010

Market Tone Changing?

Amidst widespread blogosphere revulsion against all sorts of sovereign debt, for whatever reasons the markets decided to sell Treasuries, which tied in with a stronger dollar against even weaker currencies, and gold acted like a weak currency but was the strongest of the precious metals complex.

Got that?

In stocks, what does smell a bit "correctional" is how many individual issues I follow that have developed positive movements over the 50,150 and 200 day moving averages. And meanwhile Gallup still shows hiring and spending becalmed in depression-range lows. Bill Gross of PIMCO may be selling stocks, as he touted them over bonds. Who knows?

The roiling currency markets are sure reminiscent of 1997-8. That actually marked the end of the great broad bull market of the 1990s, with the Value Line Index peaking then and the rally narrowing through 2000 to the best-known large caps and the flashiest tech-type stocks. In a secular bear market, is the past year's rally enough to lead to a similar scenario? Here we had AAPL up today in a down tape, ORCL down just a bit but with a strong chart, and the breakout candidate WPI (Watson Pharma) up a bit as well. Except for bottom fishing in RE, which is trading way below tangible book value, I am avoiding relatively weak stocks such as FPL (which can't get out of its own way) and have taken some significant percentage profits on some of the discount retailers.

One of my working hypotheses has been a sudden collapse in Treasury yields if even a mini-version of late 2008 strikes. There is precedent for this. The sharp 1987 October bear market was followed 2 years later by a lesser but significant bear move in part related to something or other with United Airlines.

As said many times and not profoundly, all days are new days, but we are in exceptionally unprecedented times. Just because so many aspects to the economy look like typical bottoming processes followed by significant upturns does not prove that this well happen again. The obvious reason to be different is that the Fed is out of interest rate reduction bullets and has monetized amazing amounts of debt.

Yours truly is unpersuaded that the dollar is sound, and the traditional thing against which its soundness is measured is gold. Who knows if gold got too popular, but it certainly didn't move to a 3 standard deviation outlier position vs. anything else, which is the standard definition of a bubble. The other metals are a different story, however.

If we get a sharp sell-off in stocks, the betting here (but not with much money or with any leverage) is that money will flow into Treasuries. If not, then Bill Fleckenstein and Nassim Taleb's disaster scenario may be here, and look out below. Then it would be bills, gold and meals ready to eat if you can find any.

Copyright (C) Long Lake LLC 2010

Obamacare: Petty and Arbitrary Tax Rules Bad for Capitalist Principles, and Other Complaints has a summary of some of the tax implications of the law the President has just signed into law, in New Health-Care Taxes Help Obama 'Spread the Wealth'.

What is the logic of the refusal to allow insurance companies to not be able to deduct executive salaries above $500,000? A CEO can make millions a year elsewhere. Why insurance companies? Why not financial companies, auto companies, oil companies, medical product companies, steel companies, exporting companies, importing companies, computer companies, etc?

More to the ideological point, why not state that no organization can have non-profit status if it pays anyone more than $500,000 per year?

Moving on, did someone from Nevada or Florida decide to impose a special tax on tanning salons? What's special about them to single them out?

The law plans to impose a 3.8% tax on rental income as well as dividends. But working as a landlord is hardly the same as buying stock in a REIT. Why tax this occupation?

More broadly, the government gets the media to buy into the fiction of a "Medicare tax". There is no Medicare tax. There is only a tax.

Taxing something yields less of it. With the growing number of taxes aimed not at the truly high earners but only at a couple earning $250,000-- which could include two very hard-working people simply living a middle-class life in San Francisco-- it must be assumed that fewer professionals will do the marginal extra work, that more people will opt to aim below that number who might otherwise be more productive, and that more people will do less investing and more spending for the moment.

Moving on from incentives, why is there a tax on medical devices?

And what is the humanitarian intent of imposing a 2.3% tax on wheelchairs? Huh??? Wheelchairs?

Consistency and fairness matter in capitalism. Level playing field and let the better or luckier competitor win. Not in Obamacare. And not in economic policy, where Mr. Obama continued the Bush policy of bailouts of financial companies and their bondholders but destroyed bondholders of certain auto companies.

Keeping promises also matters. The President campaigned vociferously opposing Mrs. Clinton's preference for an individual mandate. Whoops! Once in power, position forgotten.

This blog stated over a year ago that there was a depression but it was not the Great Depression and never was going to be so, that all the conditions were present for a smoother functioning of the economy, and that in fact in some ways the economy was better balanced than when Big Finance was riding high.

Unfortunately, the typical post-bubble, post-credit crunch scenario is playing out. This involves financial asset prices rising faster than hiring.

Remember that what has happened has been a financial shell game. The government has used the Fannie/Freddie unlimited bailouts to work with the Fed to socialize the losses and sort of start the game again.
Thus the big banks may "surprise", but these surprises will be solely due to the public's assumption of their bad lending practices along with the Fed's massive money-printing.

The next thing you will see is stagflation, if the script is followed. There will be reports of growth but off of a horribly depressed base, but those reports will serve to embolden the mass of "investors" who sell stocks near the bottom of a recession/depression and who buy them only when prices are high and "confidence" has returned.

There will be growth in the spring, but all this money-printing has caused a huge inflation in stock prices and prices for short-term Treasuries and the like (causing unnaturally low yields on short term money). As the money gradually creeps back into the real economy and out of the financial system where too much "money" is overwhelming the supply of securities, then assuming the Fed stays easy, there is every reason to expect a rerun of the prior cycle, where eventually the inflation will cease being in financial assets. It is unlikely to move disproportionately to housing, but house prices will do OK if the government continues to support it heavily. We do not know yet what will be the favored asset class as people see the inflation and see their standard of living declining due in part to the arbitrary and unfair government policies in favor of Big Finance and the increasing control of the economy according to political dictates from a redistributionist President, Speaker of the House and Majority Leader of the Senate.

Mostly, the real standard of living is declining or in good times holding steady and the above pols are in power because America has lost its mojo. It has become too dependent on debt and not equity (savings or true wealth creation). There are too many people with no savings who then use the ballot box to improve their lot rather than the old-fashioned way of thrift and hard work. There is too little government support for the nuclear family. America recently was ranked 30th out of 30 countries in reading skills. This ranking follows decades of new thinking in education and large increases in spending on education. Unemployment among people in their 20s is at post-war records, yet Obamacare taxes them with an individual mandate to support medical care for the older folks, even if these youngsters do not smoke, exercise regularly, and otherwise maintain good health habits. There is no surer way to prevent a 20-something year old from becoming an entrepreneur than forcing him/her to pay through the nose for individual health insurance while trying to become a success by providing a new good or service to society. In the future, why not just do government work or relatively secure big-company work, get government-subsidized health coverage, and forget about the adventurous, risky course?

Just as with Fannie and Freddie, we can predict that the Democratic Party will move heaven and earth to make the new entitlement a success and that eventually it also will prove to be a financial house of cards. The first card to topple will probably be the lie that the CBO was forced to accept, namely that the Medicare "doc fix" will not once again be repealed for another year.

Many other nations simply set up a one-payer system paid for out of general revenues and leave it at that with variations on that theme.

This has the virtue of simplicity, especially if unlike Medicare and Medicaid, billing fraud is prevented.

What Obamacare instead has done is begin to build a large, complicated structure build on a deteriorating, irregular foundation. If you want a clean new stable house, you have to get a permit to demolish the old one. The President never applied to the people for that permit and thus got in bed with the Big Pharma guys. Now he can walk down the street with Big Finance on one side of him and Big Pharma on the other side.

And if the Repubs get in, the insurance companies they love now remain alive and with more customers than even coming, and they will get more goodies. The people will remain the losers.

What's coming promises to be a mess run largely by people who have run nothing other than political campaigns and professorial offices in academia. All sold to the American people on untrue statements including that the low-margin insurance companies are the villains in our current mess and that physicians take out tonsils rather than prescribe antibiotics because they are greedy and that surgeons make tens of thousands of dollars to take off a limb rather than prescribe diabetes medicine.

And on the half-lie that taxing for a few years before spending really begins counts as deficit reduction. Just wait for the spending to start in earnest.

"Bush lied" is old hat and literally not true re Iraq ("Cheney lied" is less false if such an epistemological statement can be made).

Candidate Obama misled us, and President Obama did the same.

How can transforming the health system this way end well?

Copyright (C) Long Lake LLC 2010

Monday, March 22, 2010

All-Time Highs in Off-Price Retailers

Consistent with the themes of an impoverished nation and redistribution, today we saw new all-time highs in the price of McDonald's and several discount retailers, most notably Dollar Tree (DLTR), which surged over 5% on the news of an accelerated stock buy-back that will retire about 5% of its market cap with no offsetting stock issuance. TJX and Ross Stores also moved up to all-time highs. DLTR, which now trades around $60, would have to reach about $72 by summer simply to trade at its "value line" per the eponymous publication. From that price, it could easily be a strong long-term performer.

In other words, the "right" stocks may have a long way to run.

The stock market as a whole is, however, an entirely different kettle of fish.

Of some interest today is the decline in Treasury yields concomitant with the rise is stock prices. That has not happened much lately, and Treasuries rallied Friday morning when stocks opened down. In other words, the crisis feared and predicted by Bill Fleckenstein and many others, that of declining stock and Treasury bond prices, is not a happening thing.

The Chicago Fed National Activity Index was out today and showed some weakness in February, some of which might in fact legitimately be weather-related. This index also has an inflation predictor in it, perhaps related to the Phillips curve. In any case, every can see that all sorts of economic indicators look identical to multiple other post-recession charts, and sooner or later they all have given way to growth or outright boom conditions. Will past be prologue?
Probably, but from a market standpoint, methinks much of that is priced into all markets except perhaps gold.

In the meantime, I prefer Dollar Tree at under 15X predicted current year earnings to Tiffany's at 20X. And a vegetarian Big Mac.

Plus the long bond (TLT) for a trade.

Copyright (C) Long Lake LLC 2010

Financial Markets and Health Care "Reform"

Whether an investor considers the just-passed reshaping of the health insurance system in the U. S. as beneficial reform or "deform", your thoughts quickly turn to that which you can control: your money.

I confess that I have not kept up on the amount of tax increases that are now scheduled to take effect over the next few years before the real costs (benefits to recipients) are felt by taxpayers. For now, this legislation withdraws spending power from the public and taxes interest income and capital gains, I believe with a new 3.8% "Medicare tax" (a misnomer, as revenues go to the general fund).

This is occurring while two fundamental measures of stock market valuation each show at least 50% overvaluation: cyclically-adjusted price-earnings ratio (CAPE) and "q" (valuation of non-financial stocks based on replacement cost). Please click HERE for a link to Smithers & Co.'s chart and commentary on this.

Can the anti-stimulus measures of upcoming revenue enhancements and the real and psychological effects of increasing taxes on income derived from savings (which savings derive from income that has already been taxed) provide the impetus for declining stock prices and rising prices of Federal debt?

In other words, the Japan scenario, in which imposition of a national sales tax was associated with the above results in the 1990s?


Copyright (C) Long Lake LLC 2010

Saturday, March 20, 2010

Bernanke Must Be Joking

Bernanke Says Bailouts of Banks ‘Unconscionable’ .

I say "Ha!"

Per the article:

Federal Reserve Chairman Ben S. Bernanke said government bailouts of large financial firms are “unconscionable” and must be ended as part of a regulatory overhaul following the worst financial crisis since the 1930s.

“It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms,” Bernanke said today in a speech in Orlando, Florida. “If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.”

It was really Paul Volcker who started the bailout tradition at the Fed, most famously in the Continental Illinois mess back in 1984 (though something came earlier, the details of which I forget). The Fed exists as a public-private enterprise, dedicated to the big banking companies it allegedly regulates. Dr. Bernanke was about the head cheerleader for the Fed and Federal government bailouts rather than the clearly fairer strategy of requiring shareholders and bondholders to take the losses, and for any governmental or Fed bailers-outers to make unconsionable profits on said largesse.

The Fed is a destructive organism, based on Gentle Ben's testimony to the House on Feb. 10, 2010 (point 9):

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

Huh? No minimum reserves? Is that the same as zero reserves? In other words, depositors put $100,000 into a bank, which loans out that $100,000? When some of the depositors want their money back, does the bank call in a loan? Is the bank equivalent to the Fed, and just creates the cash if that's what the depositor wants? Does it keep a printing press on site? How does bank capital figure in this? How does it distort anything for a depository institution to hold onto some of its deposits and not loan them all out?

The regulators must be desperate when something as liberal as small, mandatory reserve requirements may get junked in order to allow the system to perform yet more frenetically.

Got gold?

Copyright (C) Long Lake LLC 2010

Friday, March 19, 2010

Incomprehensible Health Care "Reform"

From FireDogLake, just one example of how not to pass legislation of any sort, especially this momentous bill:

“Unless they put that back in, I can’t support it,” Defazio (an Oregon Democrat Representative) said, referring to the medicare disparity fix. “This is under active discussion. They just decided yesterday morning they’re stripping this out. The senate budget committee staff deliberated for 20 minutes and it was out and our leadership was going to accept that. But a number of us involved in the quality health care coalition said that’s unacceptable and we’re not going to support the bill unless you fix this.”

I have no idea what this detail is. If it truly is enough to affect the vote of a progressive-type Democrat, then the whole process sounds like a mess.

However this legislation comes out, what should have been a broad-based, well-thought out coherent change that most Americans would be awaiting positively is likely to look like a thrown-together omelette.

Not a good reflection on the way the United States functions these days. But entirely consistent with a government whose auditor- the GAO - cannot give an unqualified report to.

Copyright (C) Long Lake LLC 2010

Thursday, March 18, 2010

Stocks for the Long Run? And a Gold Update . . .

FedEx reported earnings today which apparently missed a whisper number and/or the company said insufficiently upbeat things about the global economy. The stock is down a few points pre-open to about $86/share, having run up massively from its low point in the mid $30's one year ago.

Long-term FedEx holders have been well-rewarded. The stock traded in a range in 1980 with the midpoint around $5.50/share. Since its dividend yield has been near zero all this time, I compared the total return from FedEx since election day 1980 to that of a zero-coupon Treasury with today's maturity date, about 29 1/2 years.

At that time, Treasuries of that maturity yielded 12.5%. would have given about double the total return of FedEx stock, with lower volatility and less need to follow corporate events.

And FedEx has been one of the big winners over the past several decades.

Kind of makes one think.

Another big winner that by now yields over 1% dividend rate is Teva. It was announced today that Teva is acquiring a German-based generic drugs firm, Ratiopharm, in a competition with Pfizer among other bidders.

Teva is a roll-up. It keeps acquiring large generic firms at premium valuations. It has $2.5 B in tangible net worth against a market cap of $53 B. It is getting too big to acquire. Its stock has gone up for decades. Its market cap to tangible net worth ratio is more than double Merck's. Its dividend yield is one-quarter of Merck's off an estimated P/E on 2011 earnings that is higher than Merck's. It has much less proprietary technology than the brand companies.

It may well be that one of these days, the generic drugs industry will have a major price war. Or, Teva will let its costs get out of control. Or something. I am not loving the risk-reward longer-term for Teva anymore. In the same space, Watson Pharmaceuticals is the one stock I own. Even though there's no dividend, the chart is quite promising and there are numerous potential buyers for this company that now has a global footprint.

The bigger picture is that the "fear index" -- the VIX on the S&P 500, is well into bull market range at 16.77. General market timers historically are on thin ice at this level, but this is NOT a sell signal. The pattern of this recent stock market suggests that a reaction to a VIX at least at 20 will follow sooner rather than later, and if it is not overly delayed, the averages will likely be at least somewhat below today's even if the trend is up over the intermediate term.

Meanwhile, somehow simple chart measurements and comparisons to prior up-cycles in gold in the "aughties" going back to 2001 led me to blog in early December that I was selling almost all my gold ETFs and was looking for an equilibrium point of GLD at $110 +/- $3. Well, here we are at GLD $110 once again. There was a brief stock market-related dip below $107, but my suspicion is that similar factors that pushed gold up the prior decade remain in force, namely excessive money (credit) creation.

The new ETF "PHYS" has a more modest premium to net asset value than does
"GTU". It also offers large holders the guarantee that they can actually withdraw bullion. People who don't want to hold, or don't want to exclusively hold, physical ETF gold via "GLD" may want to consider PHYS.

Copyright (C) Long Lake LLC 2010

Wednesday, March 17, 2010

The Fed and the Stock Market: Weak Economy Continues to Propel Stock Price Inflation

Every pro and many amateurs are aware of the correlation with the Fed funds rate and low volatility, and between that of low volatility and rising stock prices. Thus it is no surprise that the Fed's unsurprising reiteration of its prior policy track was followed by yet another late afternoon increase in stock prices. Gold was up all day, up a bit more later in the day, and is up a bit more overnight. The joys of cheap money!

Meanwhile, probably the best portent for job growth is yesterday's downbeat job projections out of the White House. They won't be caught on the overoptimistic side of predicting the economy if they can help it ever again.

Unfortunately, the health care "reform" fiasco is looking the end of Terminator. You can't kill it, but it keeps getting uglier. This plus the recent Nancy Pelosi pledge that Federalization of health care is just the start is definitely not helping the mood amongst small businessmen. One wonders if by some chance the majority party can't beg/borrow/steal just a few more votes from its own party members in the House to pass this bill the stock market will give a big cheer, just as it did when Bill Clinton lost control of the house in the 1994 elections. And one wonders if passing the bill would give a sense of finality (finally) and allow business to focus on business rather than the irritant of health insurance, which would also be good for the public mood. On the other hand, this bill imposes tax increases before the spending kicks in. So that might make it bad for the public mood and anti-Keynesian. So I'm ignoring this bill in discussing investment options.

Let us step back and with apologies to Barry Ritholtz and his blog, look at the big picture.

Money printing and various forms of credit extension into such things as the black hole of Fannie/Freddie and the new black hole of Ginnie Mae (FHA), plus population growth plus cyclical factors have "strengthened" the real economy-- whatever that really means. There will be growth in the spring. But much is rotten in the state of this country. The Federal government is not close to a true AAA credit any more. Multiple states are fiscally mismanaged. Many financial institutions that remain too big to fail would be insolvent today on a mark to market basis. Thus your money in the bank is not there. Gold is roughly trading at an historical average price relative to the (long-suffering) S&P 500 index.

Doubling back to the Fed-- if the economy remains so weak that cash must be trash and even the alleged security of 10-year Federal debt only pays $3.65 per $100, how are stock buyers so sure that the future is so bright as to pay such a large premium over tangible book value as they are today and to accept such a historically low rate of return on BBB-rated corporate debt?

Yet even more than the bond market to my eyes, the stock market has pockets of relative attraction. Discount retailers have surging stock prices but TJX and DLTR remain at quite ordinary P/E's. Everest Re is a totally boring reinsurer that trades far under tangible book value yet has a top-notch quality rating by S&P's stock advisory service. Chubb, a cream of the crop sort of insurer, trades marginally above tangible book, has a 3% dividend yield, has a very high free cash flow yield (as do the other names mentioned above), and could be a mega-company's takeover meal to boot. McDonald's is operationally outperforming its peers and has a stock chart that has already broken to new alltime highs in its 50 and 200 day moving averages. It yields almost that of the 10 year Treasury but in 10 years, if dividends rise 7% per year, it will be paying investors twice what the T-bond will pay out in year 10. What will the "stub" of the MCD equity be worth then? I dunno, but as a conservative income and inflation hedge, plus the strong chart pattern, I find it a worthwhile part of a diversified portfolio.

Every name mentioned above is "defensive". With ECRI sounding the tocsins about more frequent recessions ahead, but with many stocks pricing in a strong and/or prolonged economic expansion, yours truly finds this a stock market that only a pro should short but that most people should be leery of. As it should be of most of modern, debt-infested finance.

Copyright (C) Long Lake LLC 2010

Tuesday, March 16, 2010

Gold Market Update

The accompanying 8-year chart of gold's price looks steeper than it should because it is not log-adjusted but is arithmetic. The same price move from a $1000/ounce price gets the same vertical space in this layout as from a $500 base. With that said, let's look at the trends.

The continuous green line represents the 200 day moving average. In the other sharp ascents, there were frequent basing periods or testing periods in which the 200 day moving average was reached or breached to the downside. (Of course, late 2008 was extraordinary for almost all markets.)

Gold has recently hit all-time highs measured in euros and pounds sterling. Given the enhanced government leverage employed the past 18 months, I expect the same here; but when?

My guess is that gold has lagged the stock averages a bit and is playing catchup and thus has more short-term upside. However, indicators of small investor/speculator enthusiasm such as the premium that GTU has over NAV indicate some complacency (though not froth). A trading range with an upside bias following a potential continued upmove makes sense to me.

Selling puts or owning GLD and selling covered calls both are strategies that may appeal to income-oriented investors.

Copyright (C) Long Lake LLC 2010

Monday, March 15, 2010

America's Brain Drain Underway?

In Why MBAs are Going East, Business Week scares the reader with another version of Japan, Inc. taking over the world, updated 20 years, and now including such powerhouses as Vietnam. The issues it raises are important; the tone strikes me as a bit overblown.

The subtitle is Unprecedented growth, good salaries, and the ability to make an impact faster make Asia the new promised land for B-school grads.

No real argument with that here, though calling Asia's growth "unprecedented" is incorrect. Asia ia maturing. If you want super-rapid growth, you will need to take risks. Think parts of Africa, for example, or North Korea. China has the second largest economy in the world. It took the quasi-capitalist route in the 1980s. South Korea has been growing for decades. And so on.

Here's the take-home message, which this brief article ends with:

"The best and the brightest are leaving," says the Rotman School's Florida. "As a country, the U.S. has never confronted this before."

Now, Dr. Florida is a professor at the University of Toronto's business school. Why has Business Week gone to a foreign country for quotes in two parts of a brief article? Schadenfreude?

Will the U. S. suffer the equivalent of Britain's brain drain after WW II?

Without being overly dramatic, it is not difficult to predict that international arbitrage will occur, because it has been occurring for centuries. The more the U. S. raises taxes on the rich while sparing the non-rich, the more attractive lower-tax venues appear, both in after-tax dollars and psychologically.

Copyright (C) Long Lake LLC 2010

Sunday, March 14, 2010

Gold for the Long Run

In another example of the MSM/Big Finance trying to tell you that up is down, Credit Suisse wants you to believe that if the price of gold drops below $1000/ounce, demand will decrease. "Business Insider" reports in Credit Suisse: The Upcoming ETF Unwind Will Pummel Gold, that:

Davis (the Credit Suisse analyst) believes if the gold price remains above $1,000/oz investment demand will remain muted but if the price drops below that level annual demand for the product could fall to between 300 and 350 tonnes. In the three years before 2009, an annual average 280 tonnes of gold was absorbed by ETFs.

For something as non-speculative as gold, and one for which the fundamentals hardly change (unlike that of an industrial company), investors are value investors. India will buy more as the price (in rupees) drops. The same is true for China. Has some hot money gone into gold ETFs? Probably. But it's a drop in the bucket compared to what the NASDAQ did in the later 1990s, forgetting the complete lunacy of 1999.

Earlier in the article, more silly stuff is cited:

If investors start turning away from gold ETFs because of improving economic data from the United States, a strengthening of the trade-weighted dollar and increases in real interest rates this could lead to an oversupply of gold in the market.

In fact, the U. S. had economic growth in 2002, 2003, 2004, 2005, 2006 and 2007. Guess what the gold price did each year? It went up, generally more than the stock averages. The non-silly part of that sentence relates to real interest rates. It is no surprise that the gold bull market ended 30 years ago when Paul Volcker jacked rates up well above inflation.

If and when gentle Ben starts practicing that sort of tough love, it may very well make sense to exit gold and start truly believing in stocks and bonds for the long run rather to be rented. I'm not holding my breath for that to occur, though.

The article does point out at its conclusion that:

The over-supplied position should begin easing as mine supply drops off, with global exploration unable to yield enough replacement ounces for those being mined. The deficit in gold supply should start widening from 2014.

Of course, the gold market knows the above. It also knows that "analysts" such as Mr. Davis are as likely as not part of an elaborate scam in which Credit Suisse is planning to buy gold after it and other firms help engineer a decline.

There will be growth in the spring.

The Fed will be behind the curve.

All that points to negative real short-term interest rates. All this is fundamentally bullish for precious metals.

Is that enough to deter more profit-taking?

That's why they play the game.

But in the scheme of things, it doesn't matter what gold does next month or next year if one is holding it as a long-term store of wealth. For traders, gold is indeed acting a little "heavy" here and there are indeed too many TV ads for it. But a lower price is a buy signal, and Mr. Davis and Credit Suisse are devils for suggesting otherwise.

Copyright (C) Long Lake LLC 2010

China Banking Crisis Coming? is reporting that China May Face ‘Massive’ Bank Bailouts After Stimulus Program.

One year ago the L. A. Times reported on a raft of empty, "see-through" office buildings in Beijing, built for political reasons. This article suggests that just as the academic and Big Finance economists who warned that the U. S. housing market had levitated into a bubble were proven correct, foreigners who have no first-hand knowledge of what's going on in China are wise to be cautious about its real prospects. From the article:

China may be forced to bail out banks that made loans for local-government projects under the unprecedented stimulus program unleashed in 2008, according to Citigroup Inc. and Northwestern University’s Victor Shih.

In a “worst-case scenario,” the non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan ($350 billion) by 2011, Shen Minggao, Citigroup’s Hong Kong-based chief economist for greater China, said yesterday.

“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said Shih, a professor who spent months researching borrowing by about 8,000 local government entities. . .

Shih was more pessimistic than Shen in an interview on Bloomberg Television in Hong Kong yesterday. He said that if the central government stops lending to the entities now, the cost of a bailout may already be “in the neighborhood” of 3 trillion yuan. . .

The article more briefly presents some other viewpoints and is worth reading by many investors, given China's role in the commodities market. If China cools off, all commodities price will tend to follow. If China actually experiences a bursting bubble, it's a look-out-below scenario at least for a while for a great many markets with the possible exception of gold, which one of these days may stop tracking the stock market.

The larger context of the above issues is that it is a fact that China went on a credit binge in the aftermath of the fall 2008 global financial crisis. The U. S. government has done the same with the collaboration of the Washington-based Federal Reserve Board (which for all practical purposes is a public-private entity with the emphasis on public and thus is currently best thought of as an arm of the Federal government and the privately-owned New York Federal Reserve Bank). Certainly Britain has moved almost in policy lockstep with America. The countries with better banking regulations such as Canada and Australia actually may have their own housing bubbles or at least significant booms. Japan has continued to print money.

In other words, major governments all over the world have responded to a crisis caused by too much debt by socializing the losses at the cost of new government borrowings. This means that the return of corporate profits is largely due to money-printing rather than corporate brilliance, the sudden implementation of major cost-saving measures (other than such examples as IBM slashing R&D expense), or organic growth.'s near-real time polling data show that hiring/not hiring remains mired where it was 16 months ago. The same % of people think the economy is poor as thought so 20 months ago.

The stock market has bounced and hiring has lagged, just as predicted by Reinhard and Rogoff's research into banking crises ("This Time Is Different" is their ironically-titled book on the subject).

Almost every economist, investor and day trader "knows" that we are in a sweet spot of the investing cycle, with the economy due to turn up while the Fed remains easy, valuations are (allegedly) cheap to reasonable, and that happy days will be here again so that there will be gullible investors to sell overpriced stock to. Even hard-headed Andrew Smithers has sounded a softer tone, despite his own research showing that historically, this is a miserable time to be in the general stock market.

While Bloomberg is reporting that only now has American investor optimism replaced pessimism, my own review of Value Line's stock charts shows no bargains. Whether or not they have been optimistic, stock prices are "too high" or at least too high for current profits, asset value and dividends in my view for most individual issues, with the "junk" the worst buys.

MCD is my current favorite of the quality stuff, based on various chart patterns, recent operational news, and other criteria. Of greatest importance is that while it has not quite traded above its all-time high of mid-2008, its 50-day and 200-day moving averages are both at all-time highs. So this recent move to $65 and above is well-supported. This thinking worked out well for gold last summer. Even if MCD doesn't go up in price, its yield beats cash and is close to that of a 10-year Treasury and is likely to rise steadiliy in the future.

A few working days ago, I spoke favorably of long Treasuries for a trade (TLT). I closed that trade out with a small profit Friday. TLT went up a little more after I sold it. Any government as powerful as the U. S. government can keep supplying enough bonds to the market to overwhelm the possibility of meaningful price appreciation. It appears as though this administration, with the support of Congress, means to do just that. Perhaps by November, China will be seen to have a bursting bubble, a Perot-like zeal to shrink our Federal deficit will have gained real power in the elections, and Treasuries can surge up in price (down in yield) as David Rosenberg has been forecasting for some time.

Thus a core holding in Treasuries is reasonable, but it should be in direct ownership of bonds, not in a perpetual fund that in theory could provide zero nominal return indefinitely. The Japan scenario remains a realistic possibility for the U. S., which would surprise almost everyone, perhaps even the Japanese.

Copyright (C) Long Lake LLC 2010

Saturday, March 13, 2010

Overpromising and Underdelivering

The New York Times recently ran a piece demonstrating the extent of the looming retirement problems across much of the Western world, using the Greek financial crisis as the kick-off, in Patchwork Pension Plan Adds to Greek Debt Woes.

Here is the key excerpt:

According to research by Jagadeesh Gokhale, an economist at the Cato Institute in Washington, bringing Greece’s pension obligations onto its balance sheet would show that the government’s debt is in reality equal to 875 percent of its gross domestic product, which is the broadest measure of a nation’s economic output. That would be the highest debt level among the 16 nations that use the euro, and far above Greece’s official debt level of 113 percent.

Other countries have obscured their total obligations as well. In France, where the official debt level is 76 percent of economic output, total debt rises to 549 percent once all of its current pension promises are taken into account. And in Germany, the current debt level of 69 percent would soar to 418 percent.

Mr. Gokhale, like many other economists, says he believes that this is a more appropriate way to assess a country’s debt level because it underscores the extent to which the cost of providing for rapidly aging populations, if left unchanged, will add to already troubling debt burdens.

“You have to look ahead and see how pension expenditures are rising in comparison to the revenues needed to finance them,” he said. “It’s not just Greece; all major European countries are facing pension shortfalls. It is a very difficult challenge because it involves selling pain to current voters.”

He estimates that to fully finance future pension obligations, the average European country would need to set aside 8 percent of its economic output each year, a practical impossibility given that raising already high taxes so much would impose a crushing economic burden.

Mr. Gokhale has done a similar calculation for the United States and estimates that the truest measure of federal government debt, incorporating Medicare, Medicaid, Social Security and other obligations, is $79 trillion, or about 500 percent of the nation’s output. Currently, its public debt is equal to about 60 percent of its domestic output.

I would question whether an additional 8% tax burden is "crushing", but it might be difficult to collect. If something like that were instituted across many countries, where are people going to go? More likely, something would be worked out so that parents don't harm their children's living standards.

The bigger issue is demographic. Greece has been reported to produce 1.3 children for every 2 adults now living. Recent data I have seen show that only France (Catholic and Muslim) and the U. S. are above replacement rate. China and Japan are aging societies as well.

There are no easy answers. Because of the strains on resources as more people in India and Brazil enjoy air conditioning and the comforts of the oil age, as well as the electricity hog called the Internet, either major changes in productivity need to come, global population needs to stop growing nearly as fast, and/or standards of living need to stop rising globally.

If we add demographic facts of more retirees to be supported (unless we all become greeters at stores in our old age), the reasons to become more and more optimistic about an improving economy (hope vs. facts) appear vagues. Yet reports:

Record Advance in S&P 500 Futures Shows Confidence in Economy, saying:

The longest-ever gain in futures linked to the Standard & Poor’s 500 Index shows growing investor confidence in the U.S. economy.

“It’s a bullish indication,” said Stephen Lieber, chief investment officer of Alpine Woods Capital Investors LLC, which manages more than $7 billion in Purchase, New York. “There’s greater confidence in the equity market. Earnings have been relatively positive.” . . .

“People are looking to buy stocks,” said Mark Bronzo, an Irvington, New York-based money manager at Security Global Investors, which oversees $21 billion. “Risk appetite seems to be growing as people become more comfortable with the sustainability of the economic recovery.”

BBB-rated corporate yields are at cyclical lows even as nominal retail sales are still well below their peak, not to mention inflation-adjusted and per capita-adjusted retail sails. Most stock charts look "healthy", with very few stocks below both their 50-day and 200-day moving averages.

All that has really happened is that all the money-printing has made its way into the financial markets. We can expect it to eventually trickle down into the real economy. As it does that, the inflation will transition from financial assets to consumer and capital goods. Until organic population growth replaces population growth largely due to adding retirees, technical increases in productivity will tend to be offset by an increasingly unproductive populace.

The real economy in the Western world is suffering from too many cans being kicked down too many roads.

The effects of massive money-printing must wear off, just as a lost weekend of drinking must give way to reality or else a descent into a personal hell. Investors should be careful about euphoria when all that has happened is frantic leak-plugging in an old ship. Just as today's Greece is nothing like that of Homer's time, today's America and its phony manipulated markets are nothing like those of 100 years ago that gave rise to the alleged stellar long term stock market results.

Buy and hold?


Think different.

Copyright (C) Long Lake LLC 2010

Friday, March 12, 2010

VIX Showing a Lot of Optimism but Is not Necessarily Signaling a Market Top

The S&P 500 volatility index, VIX, more or less hit new lows for this move, closing at 17.66. What the VIX actually measures is more complex than the common interpretation, which is that is acts as a fear index. At the peak of what now looks to have been a credit bubble, the VIX briefly went under 10, which was perhaps as extreme a sign of optimism as the post-Lehman panic highs in the VIX were signs of fear.

A 5-year snapshot of the VIX is shown; click on it to enlarge.
Also shown is a Yahoo/Finance chart of the VIX since 1988.

The prior pattern has been for a post-recession multi-year drop in the VIX, followed by a turn upward before the next recession.
The VIX has correlated very well with the Fed funds rate with a substantial lag, perhaps up to 2 years.

This correlation is well known and emboldens the bulls.
My sense is that this trend is your friend till it is not. Numerous stocks look rich on various measures; others look OK such as those mentioned here recently (TJX, for example).
Overall, though, my sense is that this labor market is much less V-shaped than is GDP. For whatever reason(s), I suspect that uncertainty over the Obama agenda is contributing to a freezing of hiring in small business, which has plenty of business reasons to be cautious anyway.
With the S&P 500 having a dividend yield about 2%, I have this nagging sense that people who are not good stockpickers will ultimately do as well purchasing 3-5 year secure debt obligations and buying in when the VIX finally moves up. It won't matter, unless dividends soar, if the indices soar on speculative buying. There is a lot of drop that can happen again, either in absolute numbers or adjusted for whatever inflation is coming.
Now that the VIX is finally reported on the CNBC ticker, it is guaranteed to be less useful as a tool in understanding the stock market than previously. It is not, however, anywhere close to a household index, so it still makes sense to time one's stock portfolio by using surges up in the VIX to buy and big drops to sell. If in March or April the VIX drops to 15, selling in or before May and going away till it at least moves up to 20 may be a smart strategy for non-core positions.
In other words, we of course may be at a market top, but the VIX is merely in a zone which has allowed multi-year advances in stock prices and should not be used as more than a timing tool.
Copyright (C) Long Lake LLC 2010

Inaccurate Happy Talk on U. S. Fiscal Problems

The MSM continues to misinform its followers. One new example is a column in Forbes by Bruce Bartlett, a former Treasury economist. He says in the conclusion of America's Foreign-Owned National Debt that:

As long as the U.S. national debt is entirely denominated in dollars, there is no risk that we will run into the sort of financial crisis that small countries often run into. What gets them into trouble isn't the debt per se, but an inability to acquire sufficient foreign exchange with their own currency to service it. While the U.S. Treasury has never issued bonds denominated in foreign currencies, it is conceivable that it could be forced to do so if the dollar falls sharply and foreign demand for U.S. bonds wanes. That will be the point at which our debt problem becomes more than theoretical and we are really on the road to national bankruptcy.

This is erroneous on several levels.

Factually, America has in fact issued foreign-denominated debt:

"The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold "Carter bonds", denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries."

More substantively, innumerable countries have issued debt in U. S. dollars and did not declare national bankruptcy.

Even more important, simply being able to issue debt in one's own currency does not guarantee that there are buyers for that debt. Too much principal and too much interest are quite possible even if the Treasury follows a dollar-only financing policy. No one cares if the U. S. cannot run into the same sort of problem as small countries, as Dr. Bartlett asserts correctly. The U. S. is not a small country!

The point is that the U. S. has become an increasingly irresponsible custodian of the world's reserve currency.

The idea that the Government can safely run large deficits so that the private sector can show large profits or income is the idea that shell games are sound and honest. Either Fannie/Freddie obligations are obligations of the Federal Government or they are not. Based on securities pricing, the market believes they are permanent obligations. Based on that sort of consideration and the possibility of an FDIC bailout, then Federal debt is understated, and an improving economy that pushes up interest rates will limit the cyclical decline in debt repayment costs, since the Feds have chosen to go short-term in issuing debt.

Bartlett ignores the possibility that all lenders to the Feds could in the future be domestic, so that relative values of the dollar vs. other fiat currencies may not be the key to a funding crisis. The key is income vs. expenditures, including debt servicing costs. The risk of getting into a situation where the government has to borrow simply to service its debt has increased. Focusing on Chinese and other foreign holdings of the debt is a misplaced focus. The situation can be remedied but the facts are stubborn things. A government can default on its debt even if all debt is domestically held.

Copyright (C) Long Lake LLC 2010

Stocks Are not Cheap, No Matter how a Chart Is Drawn

As markets float upward following the path of least monetary resistance, the argument is made that the "market" is "cheap".

Today's Chart of the Day implies that P/E (price to earnings) ratios are comparable across the decades.

Unfortunately, that is not so. The greatest reason this is not so is the recent introduction of "non-recurring" earnings that are not presented according to Generally Accepted Accounting principles. In other words, today's earnings are often overstated relative to prior periods' earnings, thus falsely depressing the P/E.

This is one reason why dividend yields are so much lower than historical yields, despite alleged payout ratios that are much less different than before. (Another reason is the weaker financial strength of dividend-payers; decades ago there were numerous AAA-rated companies, now even though the economy can support more companies and they are bigger, there are hardly any.)

This blog recently pointed to Teva Pharmaceuticals, which is a litigious primarily generic products company, as a high-quality large-cap company that arbitrarily has decided that when it pays out hundreds of millions of dollars to brand companies for patent infringement or other patent-related costs such as out-of-court settlements, those dollars are not costs for purposes of earnings presentation.

It was not long ago that GAAP was the standard and only way earnings were presented. It was up to analysts to make the case that perhaps the stock price was too low due to GAAP peculiarities.

The problem now is that the financial community hardly ever goes beyond "earnings" in valuing stocks, unless it wants to highlight potential future earnings or earnings growth rate. Dividend yield and especially book value or asset value are forgotten. But the problem with pointing to non-GAAP "earnings" and excluding patent costs or the infamous "restructuring" costs (which pretend that closing obsolete factories is not a normal, recurring cost of doing business) is that the money is still not there.

A person can pretend that a sudden business or investment loss, or adverse IRS ruling is non-recurring. But a lender does care about income but also should care about net worth.

According to both the cyclically adjusted P/E and "q" (or Tobin's "q" ratio), stocks are about 50% overvalued. These two are favored by Andrew Smithers, a noted economist whose research has shown that these two measures are the two valid methods of measuring fair value in the stock market.

Because of the nature of those two measures, they cannot change quickly. A good year for earnings or real corporate wealth accumulation only changes them somewhat. Thus a 50% stock market fundamental overvaluation means that investors should be extra wary when a free chart purports to suggest that the "market" is historically "cheap".

Virtually all financial assets are expensive.

Choose your flavor. My flavors include financially strong companies that do not routinely present non-GAAP "earnings" with any prominence that have strong charts and strong real earnings trends, preferably with dividends, and with historically average or better than average fundamental valuations; gold for long-term safety; cash because everything appears too rich; and Treasuries because of the Japan scenario.

Copyright (C) Long Lake LLC 2010

Wednesday, March 10, 2010

Health Care Reform Now?

I woke up this morning thinking that the odds have to favor the President here. No matter that he and his party just have not made the case to the American people. Raw party politics can trump that. Then I saw his worst numbers yet coming from Rasmussen Reports, which while a nominally Republican-oriented firm, has a very good track record of accuracy no matter which way the political winds blow.

From polling posted today, Rasmussen Daily Presidential Tracking Poll, here are highlights:

The Rasmussen Reports daily Presidential Tracking Poll for Wednesday shows that 22% of the nation's voters Strongly Approve of the way that Barack Obama is performing his role as President. Forty-three percent (43%) Strongly Disapprove giving Obama a Presidential Approval Index rating of -21. That matches the lowest Approval Index rating yet recorded for this President.

Forty-two percent (42%) of Democrats Strongly Approve while 72% of Republicans Strongly Disapprove. Among those not affiliated with either major political party, 17% Strongly Approve and 45% Strongly Disapprove. . .

Overall, 43% of voters say they at least somewhat approve of the President's performance. That, too matches the lowest level yet recorded for this President. Fifty-six percent (56%) disapprove.

Rasmussen has noted that the President's popularity has bottomed several times after he has made a big push on health care, including last summer and then after his health care speech to Congress.

Is this worsening polling data enough to prevent party discipline and all the goodies that come with going with leadership enough to prevent the House from approving the Senate bill?

Much would appear to ride on the outcome both for America and for the economy.

Copyright (C) Long Lake LLC 2010

Financial Establishment Disinformation Campaign Reaches Yahoo

You now have to beware of "facts" on Yahoo's Finance site. Not merely a link, the blaring headline on "Yahoo! Finance" is misleading: Curbing derivatives might hurt, not help, Greece; Curbing derivatives could make it harder for Greece to dig itself out of debt, experts say.

Of course, parsing the title shows the statement is qualified with "might" and "could", but the message is clear. Here is the argument:

Hold on, many experts say: Credit default swaps -- contracts that insure debt --have actually prevented Greece's debacle from worsening. Without them, they say, investors would be less willing to buy Greece's debt. It would likely need a bailout to run its government and service its huge debt. That could threaten Europe's economic rebound.

Without defending Greece's fiscal (mis)management, Greece is correct on the following:

Greece favors banning "naked" credit default swaps on a country's debt. In naked trades, the buyers of the swaps don't actually hold the underlying debt. Yet they can still profit or lose money on the bet.

Papandreou likened this practice to buying insurance on a neighbor's house and then burning it down to collect. Without naming names, he said some U.S. banks that were bailed out during the financial crisis are using naked swaps to make "a fortune out of Greece's misfortune."

Such speculation, he warned, could trigger a "domino effect" of higher borrowing costs for indebted countries around the world.

And how traders love those domino effects.

If an owner of a bond doesn't like the bond, he/she/it can simply sell the bond. If an underwriter of a bond thinks the bond is overpriced (yielding too little), the underwriter can simply not be involved in the deal.
There is no need for "insurance" on defaults, especially when the "default" can be technical in nature (declining rating by rating agencies, as sank AIG). If there is to be this type of bond insurance, common sense dictates that it should be regulated as other insurance products are and must have reserves.

Credit default swaps (CDS) exist to generate fees for Big Finance. The more destabilizing they are, the more trading profits and transactional fees.

It is a sad thing to see Yahoo join ranks with the banksters. Yahoo has lost its mojo. While it never had an especially countercultural orientation, it did cultivate a hip image in its gogo days. Those days are long gone.

In any case, back to the technical CDS argument in the article:

Analysts acknowledge that heavy buying of swaps can temporarily drive up a country's borrowing costs. Greece on Thursday raised $6.83 billion through a 10-year bond issue. It paid a hefty premium to buyers willing to take the risk.

Yet without credit default swaps, the country's borrowing costs "would be even higher," said Brian Yelvington, head of fixed-income strategy at Knight Libertas.

Unable to hedge their bets on Greece's debt, lenders would demand punishing premiums from Greece, and would themselves have to pay more to offset the risk of such loans, said Mikhail Foux, a credit strategist at Citigroup in New York.

"It would be destabilizing for everybody," Foux said. "As soon as you restrict the credit default swap market in even a small way, it will be more expensive to borrow and more expensive to hedge."

Beware anybody from Citigroup opens his mouth. What emanates from it is likely to be stated only to benefit his or her employer, not you.

All this is manifestly false. If the seller of CDS protection actually intends the sale to ultimately be a profitable deal rather than a one-off means of generating a fee (think AIGFP), it will require an extra profit margin from the debt sale. That profit margin can only come by charging the borrower more, meaning a higher interest rate. Out of that excess interest cost comes the cost of the CDS transaction.

The basic rule of economics is that there is no free traded good or service. This applies to adding a CDS wrapper so that an institution can both purchase a debt offering and "insure" against default.

Come on Mr. Foux and all the shills for Big Finance. The world got along fine without CDS. In fact, it may have gotten along better without them than with them.

Either the sale of CDS should simply be banned or they need to be regulated insurance products. If the latter, they should only be allowed to be purchased by the owner of the debt product.

Copyright Long Lake LLC 2010

Lithuania: "We Can't Live Endlessly on Debt" is reporting Greece Should Copy Baltic Adjustment, Sarkinas Says.
In it, the governor of little Lithuania's central bank compares his country's adjustment to the Global Financial Crisis to the options open to Greece and says:

Lithuania’s central bank governor said Greece should avoid seeking international aid to solve its fiscal crisis and follow the example of the Baltic nation, which suffered the European Union’s second-deepest recession last year without a bailout.

“Greece must show determination that it is willing to solve its problems,” Reinoldijus Sarkinas, 63, said in an interview in Vilnius. The EU will probably assist Greece “with loans to tackle the most acute problems. But only Greeks can solve their problems, nobody else will do that for them.”
. .

“We must save because we can’t live endlessly on debt and by simply consuming borrowed money,” the central banker said.

Good for Sarkinas. Not that anyone is listening in Washington.

Copyright (C) Long Lake LLC 2010

  • Unlike Greece, Lithuania is an EU member but not a Euro currency member. It wants "in" enough to do the right things.

Tuesday, March 9, 2010

James Montier on Investing

A quick note to readers. If you want to learn a great deal about investing in a short time, please click HERE to access Part I of an interview with James Montier, now with GMO (Jeremy Grantham). Part II can be accessed from the top of the page of Part I. It's first-class stuff.

Copyright (C) Long Lake LLC 2010

Sin of Self-Praise at the New York Fed

Calculated Risk blogged yesterday as follows: Some Praise for the Fed.

This well-respected senior financial blogger previously stirred up his readership by supporting Ben Bernanke for reappointment as Fed Chairman, not overly reluctantly either.

Now he approvingly quotes EVP of the New York Fed Brian Sack as patting the Fed on the back and them some with what I view as highly inappropriate self-praise. From Sack's remarks as quoted by CR:

With the wind-down of these short-term liquidity facilities, it is a good time to look back and assess their performance. The bottom line here is simple: These programs were an unquestionable success. . .

It is impressive that the Fed was able to remove itself from such a large amount of credit extension . . .

This design worked incredibly well . . .

Where I come from, self-praise is unseemly. Brian Sack should let the independent bloggers and of course shareholders of the New York Fed, such as JPMorgan Chase, use whatever favorable language they wish to in favor of the brilliance of these guys.

So far as this blogger is concerned, the New York Fed engaged in improper activities in favor of Big Finance in 2008, Ben Bernanke was guilty of financial malpractice though the patient survived after an unnecessary stay in intensive care, and I am unsurprised and unimpressed that with the power of the printing press, massive influence in the White House under the Bushbama Continuity and effective ownership of both houses of Congress, Big Finance survived on the backs of millions of unemployed people and tens of millions of savers who have been forced to accept record low interest rates to satisfy the greed of the owners of the New York Fed.

Hitler and Mussolini may have made the trains run on time. Without meaning to compare the Fed to those dictators, the point is that we must look at the totality of the picture, not a pretty detail. The Fed did not see, or pretended not to see, the financial crisis even when it was clearly underway, it helped cause and exacerbate what Reinhard and Rogoff call the Second Great Contraction (since the Great Depression), so that printing vast amounts of money may have been a nice technical achievement, but that's small beer to the incompetence and outrageous insider dealing that the New York Fed and Ben Bernanke demonstrated.

And of course, the tax fiddler Tim Geithner who headed the New York Fed through its fateful decisions in 2008 now heads Treasury, having been succeeded as NY Fed head by the Goldman Sachs insider Steve Friedman, who was forced to resign after the news came out that he was double dipping between Goldman and the Fed.

Unlike the Washington Fed, the New York Fed is a privately owned institution. It acts on behalf of its owners, not you and me. When its EVP goes overboard to praise its brilliance, he makes it sound similar to the head of Goldman Sachs claiming to be doing God's work.

Not an attractive picture.

Copyright (C)Long Lake LLC 2010

On an Open Letter to the President Re Healthcare and Economics

An Open Letter to President Obama at Cafe Hayek is quite the witty rejoinder to a key part of the Democratic Party's core argument for healthcare reform. It's brief enough to simply copy:

Dear Mr. Obama:

CBS radio news this morning ran a clip of one of your recent speeches. In it, you criticize insurance companies because they “ration coverage … according to who can pay and who can’t.”

My first thought was “not exactly; coverage is rationed according to who pays and who doesn’t.” Ability to pay isn’t the same thing as actually paying, and what insurers care about is the latter. Many folks – especially young adults – have the ability to pay but choose not to do so. They get no coverage.

But further pondering of your point leads me to look beyond such nit-picking to see fascinating possibilities. Not only insurers, but all producers who greedily refuse to supply persons who don’t pay should be set aright. Now I’m sure that you don’t ration the supply of the books you write according to any criteria as sordid as requiring people actually to pay for them. But our society is full of people less enlightened than you.

For example, the typical worker rations his labor services according to who pays and who doesn’t. That must stop. Oh, and supermarkets! Every single one rations groceries according to who pays. Likewise with restaurants, clothing stores, home-builders, furniture makers, even lawyers! You name it, rationing is done according to who pays. Indeed, my own county government has been corrupted by this greedy attitude: if I don’t pay my taxes, the sheriff takes my house – effectively booting me out of the county merely because I didn’t pay for its services.


I look forward to your changing this selfish and unfair system of rationing that for too long now has kept Americans impoverished.

Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030

Whatever one's position is on healthcare as a right and various legislative details, the Professor has a point.

Politically, the President attacks insurance companies, suggesting they are low-life entities. Why, then, did he not fight for the "public option"? Why does he fight so hard for a law that forces all Americans to become clients of these same insurance companies?

If we're going to have socialized medicine- where the points Dr. Boudreaux would not apply just as our socialized armed forces protect all citizens regardless of whether they pay taxes or not- then why not go Canadian or British and just have government do it?

Methinks this contradiction of complaining about private companies acting as they are supposed to act--to maximize profits-- and then empowering them to take massive amounts of our money supposedly for the greater good-- is part of the President's problem on healthcare. It's a hybrid public-private non-partnership in which Washington holds all the trump cards.

Copyright (C) Long Lake LLC 2010

The Case for, and against, a Trade in Treasuries

Structurally, one can see from the accompanying 5-year chart of TLT (an ETF for the 20-30 year T-bond) closing yesterday at 89.80, it is at one level of multi-year support. Even during the commodities-fueled inflation of the first half of 2008, when oil crossed $140/barrel and gold first passed $1000/ounce, TLT traded in the 90s.

(Click on chart to enlarge.)

Please recall that TLT prices move inversely to interest rates. When bond prices rise, interest rates fall in an opposite pattern.

Not shown here is the well-known 25-30 year bull market trend in Treasuries, with the current rates roughly in the middle of a well-defined channel.

The 2-century charts of long-term U. S. interest rates you may have seen also show that the 30-year bond, trading around 4.6%, is right at its long-term rate. So if you buy TLT, you are basically getting historical yield. You are not accepting the horrible yields available in the short maturities.

Why consider a trade in Treasuries besides playing for support near 90 to hold once again?

Fundamentally, whatever resolution comes from the healthcare reform effort can be good for bonds. If the Senate bill passes, it imposes tax increases before the big spending kicks in. So that's bond-friendly. If it fails, investors can take heart that the ever-expanding Federal behemoth has been stopped in at least one of its growth paths, and thus dream on about smaller government and a longer-term reduction in the tax/spend/borrow dynamic.

Moving to economics, various indicators such as that of the Economic Cycle Research Indicator suggest that the economy is nearing its fastest rate of growth for this cycle, with ECRI's weekly leading indicator showing steadily waning near-to-intermediate term growth momentum.

In relation to stocks, the long bond has a relative valuation that has been good to bond-owners in the past.

In or about 1960, the yield on the long Treasury exceed that on the average stock for the first time in U. S. history. By 1965, it is said that anyone who bought 20-year Treasuries, held for one year, then bought a new 20-year Treasury outperformed a buy-and-hold strategy in the stock market. Certainly, since then whenever Treasuries yielded at least twice the S&P 500 dividend yield, Treasuries were the superior buy. A bit over a year ago, there was a brief time when stocks had fallen so low, with fears of much more dividend reductions, and Treasuries had fallen so low in yield, when dividend yields exceeded long T-bond yields.

Thus we can think of a fundamental range for these different financial assets. If you believe in stocks, buy when dividend yields approach Treasury yields. Be cautious on stocks at a 2:1 yield ratio. Right now, the S&P 500 yields about 2%. The 20-year T-bond yields over 4.2%.

Please remember that with stocks, all a long-term holder keeps in his/her pocket are the dividends. A dividend yield of 2% that grows at 5% per year doubles its yield to 4% in 14 years assuming the stock price stays constant. Remember that stocks historically have yielded 4% as a baseline, and in the roaring '20s, yields of 7% and above were quite common. Thus, stocks may well fall in price even as dividends are increased again.

If you want to get scared about stocks, please click HERE to find historical evidence that a 1/3 drop in the average stock would simply bring stocks back to fair value.

Some final points. If one were to speculate in TLT or its 7-10 cousin ETF "IEF" (which has a "stronger" chart), one can see danger ahead if support were to be broken. This is the near-hyperinflation scenario. Holders of gold or other inflation hedges are especially well-suited to live with that risk.

The other point is that as a continuous holder of bonds, there is no maturity of the bond to bring the price back to 100 (par). Thus there is in theory greater risk in owning a mutual bond fund or ETF than an individual bond itself. Over the short term, however, that risk is negligible, and a discount broker's commission structure plus the ultra-low overhead costs imposed on the ETF, along with minimal bid-ask spreads, make TLT and IEF superior trading vehicles for Treasuries than buying an individual issue. If one really wants to be a long term owner of Treasuries as a portion of one's portfolio, then direct ownership of individual bonds is probably superior to an ETF or mutual fund.

The case against Treasuries can be boiled down to irresponsibility in Washington as well as in the states that ultimately Washington may have to bail out. Plus, whenever Democrats have controlled both houses of Congress and the White House ever since LBJ took office, interest rates have trended upward.

Purchasing TLT and IEF would therefore be seen as a counter-trend purchase, perhaps banking on market hopes for a big midterm sweep for Republicans, in which case history would be much kinder to Treasury holders.

Copyright (C) Long Lake LLC 2010