Monday, August 30, 2010

Stock Post on The Daily Capitalist; and Treasury Bonds Have Begun to Bubble

The Daily Capitalist has posted an article I wrote with the very kind assistance of Econophile, the proprietor of said website.

While I discuss in that article why I have begun buying some stocks with the goal of holding them for the long term,the stock market as a whole may well be overpriced and may well prove to be, in the aggregate, poor investments. But such is the nature of investing. Stocks are far from their bubble phase. Perhaps they will enter a sustained period of historical undervaluation. In contrast . . .

The evidence is now that Treasury bonds have entered a bubble and left a standard, mature bull market behind. The economist David Rosenberg is calling for a 2% 30-year Treasury bond. He recently shrugged off the fiscal problems that the U. S. Gov't has, saying that Canada had similar problems in the 1990s. I don't know about Canada's problems, but I would assume, having lived through the 1990s, that no investors were rewarding the federal government of Canada with ultra-low and falling borrowing costs. What is happening in the U. S. is characteristic of bubbles. Those who are short the asset (i. e. have bet against it) are forced, as the price rises enough, to buy it to cover their bets against it, and momentum players jump in who have no interest in the investment merits of the asset. These momentum players are especially dangerous when they leverage their capital many times and thus purchase many more Treasuries than they can truly afford. The combination of short covering and leveraged Treasury purchases are key parts of the development of a bubble in Treasuries.

Another aspect of bubbles is the creation of misguided public enthusiasm late in the game.

In a piece running today, continues the pattern of promoting Treasuries. This piece is given a political wrapper but serves the bubble story well. It is titled Deficit Cost Drop Gives Obama Stimulus Clinton Missed. Here are some quotes from it:

While the government has increased the amount of marketable Treasuries by 70 percent to $8.18 trillion the past two years, rising demand has driven yields so low that interest to service the debt has fallen 17 percent so far in fiscal 2010 ending Sept. 30 from all of 2008.

Instead of punishing the Obama administration for running up a budget deficit the Congressional Budget Office said will total $1.34 trillion this year, bond investors are pouring money into fixed-income assets as inflation slows and equity markets stumble. . .

“The deficit concerns are on the back burner,” said Andy Richman, who oversees $10 billion as a strategist in Palm Beach, Florida for SunTrust Bank’s private wealth management division. “The bigger concerns are on the deflationary mode and seeing growth slowing in the second half of the year.”

Deficit concerns are on the back burner? Really? Perhaps in a parallel universe. Not among anyone I know.

Suddenly, people see the merits of Treasuries at these yields? I doubt it. More likely in my view is that the authorities are trying to scare people enough about the economy that they buy bonds to keep the statist, deficit-finance game going. Will the U. S. actually go Japanese, interest rate-wise? I don't know, but I wouldn't bet big money on it happening.

Here is one example of just how risky long Treasuries are at this level. In July 2007, the 30-year bond traded above 5.25%. Now let's say it is at 3.7% (up from as low as about 3.50% last week). To eliminate reinvestment considerations, I am going to give you the purest type of bond, known as a zero-coupon bond. All the interest accrues to the price of the security rather than coming back to the owner regularly (twice-yearly for Treasuries).

If one purchased a 30-year zero coupon bond at a 3.7% annual yield, the price would be $33.62. This excludes commission. Assume that five years from the now the yield finally gets back to 5.25%. What would this security then be worth? Well, one would now own a 5-year bond yielding 5.25% annually. The price calculates to $27.83 for a bond that will mature at $100 thirty years later.

Even if it took 8 1/2 years for yields to get back to 5.25%, the price of the hypothetical zero coupon bond would still not be back to its starting value of $33.62.

A bond that pays interest semi-annually, which most people are more familiar with, is mathematically similar, though the nature of its pricing and periodic payouts makes it less volatile. Nonetheless, a calculation of this sort of "par" bond would also show how risky a simple reversion to a "normal" yield of 5.25% would be at any time within the next 5 years.

I have begun to tack against the wind. Just as I sold out of stocks almost completely in 2000 and again in 2007, which both times was against the prevailing zeitgeist of growth forever, I am now seeing cash and Treasuries (not stocks) as unduly likely to provide negative returns after accounting for consumer price changes (which I unhappily anticipate to move up and to have more upside than downside risk). I am hearing more stories of people who can welll afford the risk of stocks but who want nothing to do with them, and of brokers who are responding by pushing bonds rather than stocks.

People fleeing into Treasuries because they held stocks too long should know that bonds can disappoint simultaneously with stocks. The idea that people are tying up capital for long periods of time at historically very low interest rates lending to a borrower with no coherent plan to repay its obligations simply because the stock market was vastly overpriced a decade ago strikes me as strange. What a brilliant investment strategy: own a hugely overpriced asset (stocks) in 2000, or simply be afraid of it now when their valuation is much more reasonable, and instead avoid that asset to instead buy another one after it has had an amazing three decade run of outperformance (Treasuries, of course).

The Japan scenario of even lower Treasury rates is a possibility, but not likely here in my view. Time will tell; is there a rush to make that call? One example in a different country proves nothing about the future in America. When it is in government's interest to sell massive amounts of bonds for little more than routine operating expenses (wars in Asia and the Mideast and economic stagnation both having become routine), and the media starts telling you about "rising demand" for bonds at the same time that the Federal Reserve has been a huge part of that demand, caveat emptor.

I now view 7-30 year Treasuries as trading vehicles only, just as I treated Internet stocks back in their bubble heyday. Once again, I am suspicious of situations in which the mainstream media push a story after valuations already are at historical extremes, trying to make the public believe that there is legitimate demand despite the extreme valuations. That to me is part and parcel of the pre-popping phase of a bubble. We are not seeing mainstream media hype for either stocks or precious metals. We saw it in tech stocks in the late '90s and homes 3-5 years ago, and it has begun in Treasury notes and bonds today.

Copyright (C) Long Lake LLC 2010

Saturday, August 28, 2010

Chubb and McDonald's Suggest Leadership for Next Bull Move in Stocks

On a week in which both gold and silver had strong price move, one might think that stock leadership might come from miners. Not so. While intermediate to long term Treasuries continued their price surge (lower yields) the first four trading days of the week, one of the only two Dow 30 stocks to rise in price during 2008 set yet another all-time price high today. That is McDonald's. It is the only Dow 30 stock to have hit an all-time high since the bear market officially began early in 2008. If one believes as I do that central banks and governments will pull out all the anti-deflation stops and err in policy to be soft on inflation, just as the Bank of England is currently doing (0.5% policy rate with 3+% inflation rates) and Ben Bernanke did in 2006-8 (and I believe is doing again), then one wants exposure to nominal growth as well as organic growth.

Well, Mickey D can benefit from price decreases and it is gaining market share globally. Business is good for MCD.

While I have not done a formal statistical analysis, I have been watching MCD for well over a year in relation to the 10-year Treasury yield. The two have tended to track each other. Thus when stocks were rally sharply in 2009 and Treasury yields were surging upwards, MCD dropped or at best stagnated in price when the whole market was rallying. So here are my thoughts on this stock at its current price around the all-time high set yesterday of $74.

Dividends are expected to be $2.45/share in 2011. (The board may announce a dividend increase soon.) At today's price, that would give shareholders about a 3.3% yield. The 10-year is around 2.60. Let us say that the 10-year yield backs up to 3.0% on average for all of 2011. If MCD trades at a yield equal to the 10 year as has been the case a number of times in 2009 and 2010, that would allow about a 9% price appreciation in addition to the dividend. If at any time in 2011 MCD trades at a 2.6% yield, one is looking at about a 30% total return.

What is the downside?

Of course, it is unlimited. But on a 15-year basis, I think it is reasonable to expect that MCD raises its dividend at least 5% annually. This would mean a doubling of dividends from 3% to a terminal dividend of 6% if the stock price is unchanged. Let us say that the average dividend yield would then be 4.5% at year 7/8 of this 15-year horizon. One can go out 7 years on the Treasury yield curve and get 2% back on one's money yearly.

Between the two choices, I'll take McDonald's for long-term capital I can afford to lose. And given operational trends and price increases that are galloping along in fast-growing countries such as Brazil, where MCD is doing very well; India; and China. McDonald's is financially flexible in a way Uncle Sam isn't, having just received some accolades for a yuan-denominated bond issue.

Now, I am not a professional stock analyst. I haven't eaten at a McDonald's in decades. I tried their espresso drinks last year and hated them (as did two other people who taste-tested them with me). I'm a vegetarian cardiologist who thinks America would have been better off from a public health standpoint without than with McDonald's. But I also think America would be better off without trillion-plus dollar federal deficits or Americans and "allies" chasing Afghans around their own country. But I have to live in the real world, and at least MCD has added some sops to health, and the head of McDonald's India is also a vegetarian.

But I have digressed. I am going with technical chart strength, strong operational results, steady dividend growth, global presence, and the like. If the 10-year returns to 4%, I expect MCD stock price to drop, but that would likely be in association with price increases/economic growth, so faster dividend growth and stronger earnings may await.

If you doubt that it is a market of stocks vs. a stock market, look at the charts of MCD vs. JPM (strong bank) and BAC or C (weak banks). Rising earnings/rising dividends and all-time high stock prices for MCD. Sliced dividends and variable earnings of uncertain quality for the financials = failing stock charts.

However, not all financials are created equal. The boring insurer Chubb (CB) also set a 12-month high yesterday. Its stock chart over the past 2 years is gently upsloping. It retires substantial amounts of stock, sells only slightly above tangible book value (which may be understated due to the bull market in its assets, which are almost entirely bonds), raises the dividend regularly, and has rising earnings estimates, and has stellar financial strength ratings from S&P. The stock is near its May 2007 high (I ignore the bizarre up-move into the $60s during the meltdown in fall 2008 as it might have been due to takeover speculation) and the various moving averages show that it is picking up strength on an accelerated basis.

Thus, even someone such as myself who believes that the general stock market remains overpriced, I am able to find specific boring companies such as the two listed above that meet my criteria for sleep-well-at-night on price declines plus reasonable valuation, strong chart action, no hype by the Street, and rising dividends.

If things break properly, these two stocks could provide 10% total returns year after year even if the general stock averages fail to keep up with consumer price increases (0r less likely decreases).

Lest one think I am bubbling over with enthusiasm for these assets, there is a more mature and safer asset that has no operational issues, cannot disappoint the Street with insufficient earnings gains or a smaller-than-expected dividend increase, and that remains out-of-favor with the mainstream media yet has a picture-perfect bull market chart that looks like a bull market that just might turn into a bubble that could expand for a while before it bursts. That asset is gold. Its compound annual return over long periods of time proves that compared to other financial assets, it is in no bubble. It remains my favorite asset on risk-reward considerations, but it is good to see that as discussed above, stock buyers are quietly rewarding well-run diverse companies.

If only the authorities in Washington were paying heed.

Copyright (C) Long Lake LLC 2010

Thursday, August 26, 2010

Statism on the March Gives Bears the Fundamental Upper Hand

Let's start with an ominous longer-term signal that is occurring in the stock market. The simple moving averages (sma) are the main topic. These have the advantage of smoothing out very short term moves. This discussion relates to the Standard & Poor's 500 index; the DJIA is similar.

The 50 day and 150 day sma have been downsloping with the current average below both, the the 50 day in the "proper" bear market configuration of being below the 150 and 200 day sma.

Reflecting prior strength, the 150 day sma has been above (higher than) the 200 day. This is about to change, absent an amazing move upward in the spot index. Assuming that this happens, the S&P 500 will be in the same configuration is was in throughout the big bear market of 2008-9. The 50, 150 and 200 day sma will then all be downsloping, the spot average will be below all of them (any bounces during the bear were contained by the 200 day sma until spring 2009 (green shoots rally), and the shorter-term the average, the lower it is. In other words, 50 below 150 below 200.

The last time this began: around or about Jan. 14, 2008. That was also a time of great uncertainty about the economy. Mainstream economists had not called even a mild recession, Bear Stearns stock was healthy, and so on.

Meanwhile, the Consumer Metrics Institute is showing some measures of growth as being in the bottom 2nd percentile of all quarters in the last 63 years.

From a stock market standpoint, it may not matter much if there is a new recession, assuming the recent one actually ended. The mild 2001 recession was followed by a new bear market low in 2002, though the economy was growing. The strong recovery after the 1973-5 recession was followed by a bear market in 1977, though the economy had no recession till 1980.

On the other hand, the major 1958 global recession was followed by a double dip recession in 1960 (which undoubtedly elected John Kennedy), but the stock market hardly noticed. The DJIA hit a record in 1955 and yearly through 1959, and by winter 1961 was setting new records again.

From a sentiment standpoint, the media has been confusing people. The White House began with the pre-election spin just a couple of months ago, touting the summer of recovery. The Veep allowed as to how the economy might just show 250-500,000 monthly job gains. What happened? A near-record rally in Treasuries and a surfeit of gloom.

Sentiment measures suggest that even if lower lows await, a stock market bounce would be no surprise even to the bears.

But Washington, meaning the Fed and the Feds, continue to assert their power in statist, unimaginative ways. They are like the 1962 Mets, of whom Casey Stengel said, "Can't anybody here play this game?". The only obvious reason the dollar hasn't collapsed again is that hardly any other major country is doing better. The money-printing is widespread globally, and the foolish borrowing and lending paradigm as a way to create a wealthier society is becoming more easy for the public to see has been little but a way to transfer wealth to financial types. These financial types now own a record amount of real estate in the U. S., having offered too-good-to-be-true deals to too many borrowers.

Regardless of the arguments of the redoubtable David Rosenberg and Gary Shilling, the history of the U. S. with the conditions of sub-3% 10-year T-notes and Fed debt monetization suggests that price increases lie ahead and may well exceed the paltry coupon of the bonds. The modern example of Japan as to why U. S. bonds are still on the bargain counter must take note that the average Japanese female is only producing a little over 1 child on average, whereas demographers say that 2.1 children per woman is needed just to keep the population stable. Plus, Japan is not spending a ton of money fighting "terrorists" all over the world.

I don't know the future of interest rates especially given the interest of the authorities to keep them artificially low for an extended period, but by definition the U. S. is not Japan. Yes, if our population is slated to decline massively and the U. S. stops chasing Afghans around their own country, I can certainly see price stability ahead despite a massive money-printing program by the Fed, but I am thoroughly unpersuaded that the Japan analogy is valid here.

With the U. S. in an all war, all the time (now it's Yemen!) posture draining lots and lots of money; with the Fed printing excessively; with a President who one poll showed was viewed by a majority of the public as being a socialist (he's certainly a statist); and with an economy that lacks a new New Thing to bring new efficiencies and new excitement to the plate; we now have a trifecta. Stocks as a whole remain seriously overvalued on both an asset and a smoothed earnings basis, cash is hugely undercompensated; and Treasuries have marvelous momentum but no one seriously expects them ever to be paid back rather than rolled over ad infinitum.

Maybe munis, certain high quality stock, gold, and perhaps oil given loose monetary and fiscal policies in the U. S., are not overvalued. The same goes for the currencies of the few true AAA-rated sovereigns, which according to independent experts do not include the U. S. but do include some Scandinavian countries, Switzerland, Australia and New Zealand, and perhaps Canada. (None of these are fighting any wars, though I forget if Australia or Canada still has any troops in Afghanistan.)

I am sticking with a very conservative strategy, owning only the highest quality assets and avoiding "bargains" such as any stock with a failing chart.

This blog has always called the stimulus bill a "stimulus" bill. Even Christina Romer's own research showed that tax cuts provide a positive return on foregone governmental income, whereas government spending has a multiplier effect of at most one and probably less than one.

We are simply seeing the typical results of a credit collapse. Central banks pump money into the financial system, leading stock markets to rise and now we are seeing the bond market rise as well (meaning rates are falling). The real economy can't use much of this credit money, though, which is why I said above that it is not all that important exactly when the next recession occurs (again, assuming the prior one actually ended).

Business has government's and the central bank's boot on its throat due to misguided policies that have never worked. Meanwhile the GAO has this to say about the U. S. Government last month:

During its audit of the fiscal year 2009 CFS, GAO identified continuing and new control deficiencies in the federal government’s processes used to prepare the CFS. The control deficiencies GAO identified involved

enhancing policies and procedures for identifying and analyzing federal entities’ reported restatements and changes in accounting principles;

establishing and documenting policies and procedures for disclosing significant accounting policies and related party transactions;

establishing and documenting procedures to assure the accuracy of Treasury staff’s work in three areas: (1) social insurance, (2) legal contingencies, and (3) analytical procedures; and

various other control deficiencies identified in previous years’ audits (see
app. I for related recommendations).

These control deficiencies contribute to material weaknesses in internal control over the federal government’s ability to (1) adequately account for and reconcile intragovernmental activity and balances between federal entities; (2) ensure that the accrual-based consolidated financial statements were consistent with the underlying audited entities’ financial statements, properly balanced, and in conformity with U.S. generally accepted accounting principles; and (3) identify and either resolve or explain material differences between components of the budget deficit reported in Treasury’s records, which are used to prepare the Reconciliation of Net Operating Cost and Unified Budget Deficit and Statement of Changes in Cash Balance from Unified Budget and Other Activities, and related amounts reported in federal entities’ financial statements and underlying financial information and records. As a result of these and other material weaknesses, the federal government did not have effective internal control over financial reporting.

Of the 44 open recommendations GAO reported in April 2009, 2 were closed and 42 remained open as of February 19, 2010, the date of GAO’s report on its audit of the fiscal year 2009 CFS. GAO will continue to monitor the status of corrective actions taken to address the 10 new recommendations as well as the 42 open recommendations from prior years (see app. I).

A government that can't get its own financial house in order has no moral right or practical ability to try to control anything as complicated as the American economy.

Meanwhile an unreformed Republican party is likely to share the mismanagement of Washington in January.

For investors and increasingly for small businesspeople and much of the general working population, this is a nowhere to run, nowhere to hide economy. Caveat everyone and everything right now.

Copyright (C) Long Lake LLC 2010

Wednesday, August 25, 2010

Too Much Bubble Babble; Focus on Treasuries and Gold

Might there be a bubble in talk about the same?

This weekend, Randall Forsyth filled in for Alan Abelson with the lead article in this week's Barron's, titled Vacuous Bond-Bubble Talk. He begins as follows:

THERE'S A REAL BUBBLE TAKING PLACE in the markets and you can scarcely miss it, so blatant and omnipresent has it become. It is, of course, the bubble in talk about a bond bubble.

Maybe not. CNN Money and Fortune have the following article running, 5 Investing Bubbles, which asserts:

U.S. Treasury Bonds . . .
Verdict: Not a Bubble


Gold . . .
Verdict: A Major Bubble

Michael Pento is out with an article titled The Fed's Biggest Bubble. He states that:

While Wall Street and Washington are petrified of the deflation boogieman, the real menace lurking in the shadows is the Fed's bond bubble . . .

A decade or more ago, you heard little or now talk of bubbles. It was understand in general terms that bubbles were rare and undefined. Just as with Justice Stewart's definition of pornography, you knew one when you saw it. So, when gold spiked to over $800/ounce in January 1980, then trended down for two decades, it looked like a bubble at the time and acted in the long term as if it had been one. Similarly concepts apply to U. S. stocks in 1929. Now that NASDAQ stocks went into a bubble phase in 1999-2000, and housing more recently, a search for bubbles appears de rigeur.

As with all investment memes and media themes, it's helpful to avoid undefined labels such as "bubble" and look at the facts. In investments, there are both fundamental and technical factors. Most people think they understand what a fundamental of a security or commodity is, at least in concept. A technical factor attempts to look at supply-demand forces to help guide one's thinking about where the price of the asset in question may move to. One important characteristic of technical analysis is whether an asset is moving from strong to weak hands or vice versa.

In this write-up, I am going to discuss fundamental and technical factors relating to the topics described above, namely Treasury securities and gold.


It is of concern that a media that has not been advising the public to jump into the wonderful asset class of Treasury bonds for the last 30 years is pushing it hard now that yields are at historically low to unprecedentedly low levels.

Here is another quote from CNN/Fortune piece as to the author's reasons why Treasuries are not in a bubble:

The national debt is still a manageable 40% of GDP. Economists warn that growth will slow when it reaches 90% of GDP. The Congressional Budget Office projects it will take nine years to get to that level, and that's if Washington, which is debating the deficit, does nothing.

Let's do a fact check. Here's what OMB has to say. In Table S-14 (page 55) of its mid-year report to Congress, total gross Federal debt for the fiscal year that is drawing to a close was estimated as $13.779 trillion. For upcoming FY 2011, they are projecting $15.265 T. Sorry, CNN/Fortune, your numbers are incorrect. These numbers are excluding the ongoing and massive Fannie/Freddie bailouts, prospective FDIC and FHA (Ginnie Mae) losses, guarantees pursuant to emergency measures adopted in 20089, and implied but unfunded Medicare obligations. Debt has reached 90% of GDP under the most conservative assumptions and guess what, growth has slowed. And so far as Washington may do something about the deficit, it naturally is debating continuing some or even all of the 2001 and 2003 tax cuts that are due to expire at the end of this year, and the expiration of which is assumed by OMB's analysis of the projected (very large) deficit for FY 2011.

Beyond the above facts, there is common sense. Which would you rather own, an FDIC-insured bank deposit available on demand yielding 1.30-1.50% with the bank arm of profitable, highly-rated credit card issuers that advertise these deals all over the Net, or relatively illiquid 2-year Treasury notes yielding 1/2 of one per cent per year? (They are in practice relatively illiquid because of the bid-asked spread retail has to pay.)

Re the 10-year note now yielding 2 1/2%, consider that the same debt instrument yielded 3% and above between 1929 continuously into 1933.

That period involved obvious massive decline in prices across the board, and the U. S. was almost debt-free with massive gold reserves. A financially much weaker federal government, with banks that were/are arguably insolvent in the good times of 2007 (as revealed by securities pricing that became known in 2008), now is selling debt at higher prices (lower yields) than it did during the Great Depression!

This may or may not be a bubble, but is this fair value?

In another way of looking at things, my quick analysis is that in the 20th century, every time that Treasury bond yields have gone well under 3%, stocks have provided much better returns in the 10 years following.

One of the characteristics of bubbles in a see-it-you-know-it mode is media cheerleading.

Well, the L. A. Times is out with the bond equivalent of Internet hype a decade later. It is throwing out for all to laugh at the idea that there is a shortage of federal debt, in its article titled As economy fears deepen, everybody wants what the Treasury sells . It begins:

Good thing Uncle Sam is floating another $102 billion of debt this week. From the looks of the Treasury market on Tuesday, there aren’t enough government securities to go around.

Yes, John and Jane Q. are camping out the night before those hot Treasuries go on sale to get their share of the national debt, aren't they? What? They aren't?

No, they aren't. Here's the proof, from the same LAT article:

In this environment, whatever debt Uncle Sam has to sell, there are plenty of buyers -- including the Federal Reserve . . .

Austrian economists however teach to be wary of central banks buying Treasury debt. These anti-central bank libertarians have led the charge against the evils of central bank debt monetization. The central bank wouldn't buy the debt directly unless the free market would not (at current interest rates).

Maybe the public can still be misled by "Keynesians" run wild (though I am not sure whether in his later years even Keynes was as "Keynesian" as Ben Bernanke) is something I can't answer, but I smell the same rat I smelled in 1999-2000, when the media made sure the great unwashed were the repository of the greatest distribution of junk stocks in American history, pushing Yahoo! at 100X sales and Cisco at 150X earnings.

Now, 150X earnings is actually less undervalued in theory than 2-year federal debt at 200X earnings (the reciprocal of 0.5% interest).

On a chart basis, the 10-year note's yield has collapsed from 4% to 2.5% since April 5 of this year. This yield is lower than the note's 200 day moving average hit at any point at least as far back as my continuous chart goes back (to 1962), even including the period in 2008-9 post Lehman/AIG when the financial world had its equivalent of a stroke or heart attack.

So on a variety of fundamental, media and technical standpoints, my view is that short-term and intermediate Treasury issues have at the very least dropped too far, too fast to be attractive to me at this time.


Gold has no fundamentals per se, so here are some of the ways I look at it.

First, the cost of prospecting for gold, developing a permitted mine, getting gold out of the mine in refined form, etc., is substantial. In the colloquial, it is not a gold mine of a business. And this is not 1979-80. Investors are not throwing scads of money at start-up gold ventures. So from that standpoint, gold is not in a bubble.

Another fundamental about gold is whether it has returned "too much" to its owners relative to competing monetary choices.

I went to a site that lists historical gold prices (, which is a commercial site that I have no business relationship with, and found gold prices from various years. I then used a standard calculator to determine compound annual rates of return (CAGR) from then to now, using $1230/ounce for today's gold price. This is what I came up with.

Gold in 1840 = $20.73/ounce. CAGR: 2.43% over 170 years.
Gold in 1860 = $20.67/ounce. CAGR: 2.76% over 150 years.
Gold in 1910 = $20.67/ounce. CAGR: 4.17% over 100 years.
Gold in 1977 = $161/ounce. CAGR: 6.36% over 43 years.

Highlighting the 100-year return, Norfolk Southern just sold a 100-year bond at 5.95% return per year. Given that NS is not a AAA-rated company, does a 4.17% 100 year return on gold seem as though its price is in a bubble in comparison?

Re the 1977 comparison, economic statistics from WikiAnswers from 1977 include:

Yearly Inflation Rate USA 6.5%
Year End Close Dow Jones Industrial Average 831
Interest Rates Year End Federal Reserve 7.75%

Separately, I have looked at 10-year Treasury note rates from 1977. It appears that they averaged about 7.4%. That would imply that had there been a 30-year Treasury bond out then, it would have yielded about 8%. And the Dow Industrials are up 12X since then, which even without dividends included beats gold's return.

What has been presented above indicates to me that gold, which after all is intended to be a permanent, indestructible store of wealth, shows no bubble valuation characteristics in comparison to many other financial alternatives.

From a media standpoint, to review, the CNN/Fortune article lists 5 asset classes; of those 5, it deems only Treasuries as not being in a bubble. It classes Chinese stocks as being in a bubble. It classifies pure-play shale stocks (natural gas) as being in a bubble. It waffles on cotton, calling it as being in a "minor bubble".

Its verdict on gold, as mentioned at the beginning of this article: "major bubble".

My view is, unsurprisingly, different. That the mainstream media would tar gold, which has been a mediocre investment over long periods of time, as being more bubbly than a Communist country's stock market says to me that gold has yet to become truly mainstream and thus it would be hard to be in a bubble (though it could simply be overpriced). And I identify the zero to negative real interest rate policy of the Federal Reserve since the events of 9/11/2001, the associated recession, and then the creation of and bursting of the resultant debt bubble as the core reason why gold has gone up reasonably steadily for 9 years.

In other words, so long as the Fed keeps printing money and monetizing the debt, the MSM sneers at gold while propounding misinformation about the quantity of federal debt, and gold's chart shows no clear signs of distribution from strong (well-informed) to weak (poorly-informed) hands, I am confident that gold is not in a bubble.

I suspect that gold remains a good investment apart from a bubble-no bubble discussion, but that's a topic to be discussed in the near future in more detail.

Copyright (C) Long Lake LLC 2010

Tuesday, August 24, 2010

Short-Term Market Comments: Tear Down These Policies

Recently I have posted some strategic thoughts about changing relative investment merits given the huge move down recently in bond rates.

On a more tactical basis, I have been commenting for many months about the technical deterioration in the financials. This continues and is worsening. In addition, the general stock market as judged by the SPY looks terrible based on moving averages, with the SPY now below a down-sloping 50-day simple moving average (SMA) and a down-sloping 150 day sma about to drop below a flat 200 day sma. Ugly, to the point of being fugly.

One of my favorite relatively unknown financials, UMBF, has moved below its 2009 low despite rising earnings estimates. NTRS (banker to young Barack Obama back in Chicago when a crook named Rezko helped enlarge Mr. Obama's backyard) also is one of the non-Big 5 (or whatever the number is) financial firms I have followed to see what the real world is doing, and its chart is definitely fugly. And NTRS's earnings estimates have been declining, and it still sells for over 13X projected 2011 earnings; and who knows what they will really be?

The bigger bellwethers of JPM and WFC have ugly and fugly charts, respectively. Uh-oh.

In the meantime, though, if the American consumer is so badly off, why is DLTR going to new highs and Tractor Supply (TSCO) holding up so well?

Other stocks holding up well so far in this decline are CB and RE, which are an insurer and a reinsurer; and McDonald's, which has a picture-perfect chart.

So there are lots of cross-currents now.

Meanwhile, gold has an even more picture-perfect chart than MCD or CB, and silver looks OK as well.

The dean of stock analysts in America is probably Richard Russell, and he is uber-bearish on stocks. His view deserves respect; I do not look at him as someone to be contrary against.

Putting matters together with seasonality, matters are setting up as I projected in May when I stated that stock rallies should be sold. I am concerned about the tw0-year pattern in stocks.

Two years after the 1987 stock collapse, a mini-collapse occurred in fall 1989; that did not take the averages to the 1987 lows, as in retrospect the stock market was only partly through its structural multi-year bull market. Stocks are certainly acting as if they could reprise 2008, just as 1989 reprised 1987. Now, however, stocks are mired in what I believe to be a structural bear market. Any collapse, I believe, carries with it real risk of new lows, given that the 2008 low fell below the 2002 low in nominal terms (worse in inflation-adjusted terms).

The U. S. and the world are in more unusually uncertain times than usual. Regular readers of my blog know that I have excoriated Ben Bernanke as amongst the worst Fed chairmen of all time, and perhaps the single worst. For all the blame Sir Alan deserves, he left when the leaving was good, and who knows whether what he would have done when the rubber was hitting the road in 2007-8? This is Helicopter Ben's Fed and Barack Obama's government, and IMVHO they are and have been stinking up the joint with ineffective and harmful policies.

Just as I believed at the time that Paul Volcker (a Dem) and Ronald Reagan (a former Dem) were the right men for the problems facing the country, and invested accordingly, I want them back! I think that we have just the wrong men for today's problems in these key offices. If Mr. Obama were to give Tall Paul real authority, wouldn't that make a statement that the President is willing to face up to our very solvable financial and economic problems and overcome them? But he didn't do so, and he won't. So we have a tax fiddler running Treasury (and IRS) and a Wall Street hanger-on sitting by the President advising him to make Big Finance happy as a way to help Main Street (assuming LS really cares about Main Street).

Historically the stock market has gone up more under Dems than Repubs, but the ineffective inflationist with two inflationist Fed chairmen named Jimmy Carter was an exception. Mr. Obama may be following in Mr. Carter's footsteps.

The path of least resistance for the stock averages is down. Fundamentally the S&P 500 can be considered to be a massive 40+% above fair value. The experience of the 1930s and 1940s prove that low Treasury rates can easily coexist with depressed stock market values. Japan for the last many years proves that as well.

America is blessed with a hard-working population and a lot of smart businesspeople who want to make money the old-fashioned way, which unfortunately is neither the Chicago way nor the modern Big Finance way. What the old-fashioned types need is for government and the Fed to be old-fashioned as well. No matter how pure the motives, statism in very large, complicated economies is very different from statism in small Scandinavian countries where "everyone" is related to each other.

Money should be treated with respect, not with zero interest rates. And the standard financial principles that failure should not be rewarded with bailouts should be restored post-haste. If Citigroup is still insolvent after all that has been done (unfairly, IMO) to assist it, so be it.

There is no surprise in this observer that the stock market is acting badly. An economy that creates neither jobs nor optimism amongst small businessmen is a very troubled one. "Don't fight the Fed" worked when the Fed could engineer lower rates and the real world extended more and more (imaginary, to be sure) credit.

In this era of all-time record low interest rates, the Japan scenario shows that the next shoe to drop after a credit collapse is equity valuations if prices don't rise. While longer term I vote for stagflation, in the very short term a rerun of 2008 with collapsing commodity prices could occur. There's no way to even guess. And to be sure, I agree once in a while with Keynes: as he said, if the facts change, I do adjust my thinking.

The stock market is voting lately against the policies of appeasing the titans of Wall Street. Where it goes nobody knows, of course; at least I don't know; but I do know what I think about freedom-friendly and economy-friendly governmental and Fed policies.

What ails the economy is not all that complicated. The money-printing has stayed almost hermetically sealed within the Street. The statist and Big Finance-friendly policies of the Bushbama Continuity just aren't allowing the inherent dynamism of the American worker and business community to do what comes naturally.

Money should be treated with respect, not zero return (while lenders charge crazy high rates on credit card debt even to credit-worthy borrowers).

Mr. Bernanke and Mr. Obama, tear down these policies. You have nothing to lose but your failures.

Copyright (C) Long Lake LLC 2010

Monday, August 23, 2010

Stocks to Consider for the Long Run; Fed and Boom-Bust Considerations

Are stocks finally a "buy"?

This is written by someone who sold virtually 100% out of stocks at Dow 13,000 in August-September 2007 with such confidence that even when the market went up 7-8% in the fall, had no indecision and argued with friends and relatives to get out when the getting was good. Except for tactical forays, yours truly has stayed out of stocks ever since.

Nonetheless, sentiment and fundamental factors are changing rapidly, and every type of investment has its time and place. Central banks across the world have led the creation of so much credit money that too much money has chased too few real assets, and thus too much of this credit money has stayed within the financial system, bidding up prices across the board. Bill Gross of PIMCO did a fascinating piece on this topic last year based on PIMCO research. Here is the money quote from this November 2009 piece:

Let me start out by summarising a long-standing PIMCO thesis: The US and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades.

In this regard, matters appear to have made a full half-circle from the 1970s and early 1980s, when credit money finally became so expensive (relatively scarce) that there was not enough money to support all the real assets (and related debt obligations) and so that the price of said assets, such as stocks fell far below fair value; see relevant time period in this chart from Andrew Smithers, which values the U. S. stock market both on an asset basis and on a 10-year earnings basis. By this measure, fair value on the S&P 500 is not much over 700.

Caveat emptor.

However, the stock market has been overvalued by these measures for quite some time, and I was lucky enough to have had substantial net appreciation of my stocks in that time. Is there a way to invest in stocks given their historical overvaluation?


Even in 2000, at the overvaluation peak, it turns out that there were numerous types of stocks that bottomed as the averages were topping. These tended to be boring companies that investors started dumping when the average stock topped in 1997-8 as measured by the Value Line averages, which weight all stocks equally rather than by market capitalization. Such industry groups as homebuilders, basic industrial companies, and HMOs (hated at that time) hit what remain their decade-plus lows just as the glamor stocks peaked. It was as if investors were running to the left side of the ship, leaving those on the (safer) right side lonely and the ship tilting; then they gradually rebalanced the ship.

I used to joke in 1999-2000 that if the stock market were so all-knowing, what it was saying with Yahoo! at 100 times sales (not 100X earnings) and Cisco at well over 100X earnings (forget about the Internet companies that were not real companies), but with homebuilders at book value and very low P/E's, the future of America was that everyone would live in a little shack but have all the electronics known to man.

Unlike then, sentiment is far from ebullient; there is little irrationality about stock prices. This is not summer 1987 or all of 1999 re over-enthusiasm over a raging, overvalued bull market. Investors get it. If you have any doubt about whether investors are reading upbeat or downbeat headlines, here are the titles of the first several articles headlined at Monday (afternoon edition):

We Are On the Road to 70's-Style Stagflation - Jeff Harding, Minyanville
It's Really, Really Ugly Out There - Jim Cramer,
How We Get Through This Terrible Mess - John Mauldin, InvestorsInsight
Hedge Fund Managers Feeling the Heat - Charles Wallace, Daily Finance
Will Housing Slide Drag Economy Down? - Gittelsohn & Willis, Bloomberg
The Housing Gold Rush May Be Gone for Good - David Streitfeld, NY Times

Cheery, yes? Do these make you want to buy stocks or sell them?

Things are hardly less downbeat on the sidebar at RCM, with the following capsule headlines seen there:

Stock Market
Slowdown Fears Hit Street
U.S. Stocks Retreat as Economic Concerns Overshadow M&A . . .

U.S. Mortgage Fraud On the Rise
Jobless Claims Unexpectedly Rise to 500K; Highest Since November
Leading Indicators Show Slowdown
CBO: Hard Economic Times Ahead
Numbers Point to Darker Outlook

Contrast the above with the headlines from 1999-2000, or 2005-7.

I am in the stagflation camp; I am not a deflationist though I believe there is a good chance that within the next couple of years we see yet lower yields on long Treasuries.

On that topic but on a global scale, the economist Andy Xie came out with the following article, with excerpts:

Inflation, not deflation, Mr. Bernanke
Commentary: World divides into ice-cold and red-hot economies

When the Fed or the European Central Bank tries to stimulate, they are actually stimulating the global economy as a whole. Water, no matter where it comes from, flows downwards. Stimulus, similarly, flows to where costs are low and banking systems are healthy. If you believe this logic, the actions of the Fed and the ECB fuel inflation and asset bubbles in emerging economies rather than stimulate growth at home. . .

Despite trillions of dollars in stimulus and a sharp one-year rebound in the global economy from the middle of 2009, the developed economies have virtually seen no employment growth. . .

We are seeing overheating in emerging economies. The stimulus is just working somewhere else. . .

There is a bright spot for developed economies from globalization. While their economic data tend to surprise on the downside, the corporate profits will surprise on the upside.

There is much more in the Xie article, which inter alia addresses Japan and gold/commodities. I want to focus on the final comment I have excerpted, about corporate profits. It is a good read.

In accord with Xie, I believe that increasingly it is looking as though the West has been outsourcing its price increases. Multinational companies are doing better than individuals in the West, as global wage arbitrage and healthier banking systems in the East combine to revert wealth to the mean between countries. Before the Industrial Revolution, China and India had a share of global wealth proportional to their populations.

Investors need resolution of an apparent paradox: in the face of such low bond yields, how can many of the biggest and best multinationals sell at 10X earnings, pay dividends higher than a 7-year Treasury note, and retire stock through net buybacks (i. e. exceeding options dilution) despite strong balance sheets and technological and other economies of scale that appear to make them far distant from GM's and AIG's fate?

What difference does it make to their "correct" prices if other stocks are overvalued, perhaps those of companies that are highly leveraged financially and dependent on cheap imports to sell to over-leveraged, financially stretched Americans? Or those such as homebuilders that are dependent on massive governmental subsidies to make money nowadays?

A partial answer takes into account the gloom that informed individual investors are at least now and then assaulted with. To sum up my point about the possibility that stocks are finally competitive with bonds, here is the title of a New York Times current article: In Striking Shift, Small Investors Flee Stock Market (to enter the bond market about 29 years into a record bull market).

Personally, overwhelmingly my portfolio is comprised of high quality muni bonds, shortish duration individually owned Ginnie Mae securities (full faith and credit debt obligations of the U. S. government), cash and gold (ETFs, primarily, owning only allocated gold). I have a very, very small amount of my capital in stocks, and every one of those is a very strong company. The stock market's overall chart looks dangerous to me and the current and upcoming hurricane season is the classic time for stock market collapses. So the following is not a day-to-day timing matter but rather part of a strategic discussion I am having with myself about where the best relative values in the public markets lie, to then tie in with technical timing factors if I see the greatest relative value in stocks despite all their negatives.

After the rebound following the early May "Flash Crash", I blogged that I thought that stock rallies should be sold. I am now thinking that certain types of stocks could now be bought at the current price, and that if the market takes a significant further tumble, more could be bought.

Here is some of my reasoning.

After each credit-induced boom for the last several decades, that which was overproduced and over-invested in helped fuel the next economic cycle. Thus the investment in energy, plus conservation efforts, helped fuel growth from the peak of the energy cycle in 1980 for the next two decades; and if one did not invest in energy or gold in 1979-81, one did great in the stock market thereafter for the next 20 years. Similarly, the boom in tech in the '90s fueled the current disinflationary economy and the resultant gains in productivity have been perhaps the one major force for the "good" sort of price decreases(as opposed to price decreases due to overproduction of homes due to the artificial boom). This overinvestment in houses and over-provision of credit may fuel restraint in housing price increases or further price drops as, just as in the 1980s with energy, too many dwellings face continued price resistance and may well drop in real terms, thus (I hope) freeing up real resources to be spent on more productive endeavors than a larger house filled with more large-screen TV's. Similarly, ongoing weakness of lenders should provide a real business advantage to financially strong companies, whatever their size.

My stock thesis incorporates the above points. Asia is the creditor to the world (plus oil exporters), leaving aside a possible China real estate bubble. (This status is where the U. S. was after its sound money-based amazing growth after the Civil War.) U. S. multinationals can both source from and sell to Asia and their stocks nonetheless sell in many cases for much better values than U. S. government bonds or the bonds of those companies themselves. The strong multinationals need no financing from weak banks, whereas start-ups or small fry will be constrained from challenging them, at least in the U. S. relative to prior eras. And these strong companies have pricing power in inflationary emerging countries, per the Xie thesis, and may use the U. S. consumer as a cash cow while continuing to reinvest the profits where returns are greatest (typically ex-U. S. these days).

Added to the above, I expect the Fed to continue to interfere with the free market and keep interest rates extremely low and below the rate of price increases. So every year one gets a (say) 3% dividend yield from a multinational rather than a 1% (say) return from a high-interest rate bank deposit (!), one is ahead of the game by 2%; and one has inflation protection and international diversification with stocks. At some point, assuming the economic world does not end, should not the market price of the stock move at least back to where it is today (or where it may drop to as the current structural stock bear market moves along), thus providing bond- and cash-beating returns to the buy-and-hold investor?

No guarantees, but the stock odds are looking better and better to me as bond yields continue to collapse (this is written Tuesday morning, Aug. 24) and stock prices also continue to descend.

Unlike so many high-tech IPOs in the 1990s that made vaporware or wanted to be the fifth online pet supplies company, and financial companies in the more recent boom that made bad loans and put bad assets on their books, the companies I am thinking about actually have strong or super-strong market positions attained by decades or even a century or more of competition; tend to both be raising their dividends while shrinking their shares outstanding and ideally also be increasing their tangible book value; and they actually make products that meet the real needs of real people or other companies. Now that the 7-year Treasury note yields 2%, the fact that it is non-callable no longer interests me.

Superb economists such as David Rosenberg point out that after the credit collapse of 1929-32, the long govvie bond fell to 2.5% in 1940. What I have not seen him point out, though, is that the CPI averaged 5.6% annually in the 1940s, and this was not just a WW II phenomenon. The CPI averaged 7.1% in 1947-9.

So with Fed and federal policies oriented to growth, bond yields were far too low to have been good investments. Even if one bought stocks at the beginning of 1940 and then endured a serious bear market, by the end of the decade, their dividend yields alone beat bonds, and the Dow moved up several percent a year on average in price as well.

"Don't fight the Fed" was Marty Zweig's dictum from the way-back. When both the Fed and the federal government, the two most powerful financial forces on the planet, agree that they want growth and consumer prices to rise, and are willing to do all they have done for that, why does one want to overweight 20-30 year bonds at near-record high valuations? Why not go with the flow? Sometimes, resistance to governmental desires is futile.

A 10X price-earnings ratio equates to a 10% earnings yield. A 14X P/E equates to a 7% earnings yield. Even a 20X P/E equates to a 5% earnings yield. So relative to ultra-low bond yields, stocks have fundamental support. Earlier, I provided ample evidence that at the very least, ebullience is lacking from the market.

So putting the above points together, I believe a case increasingly can be made for stocks that meet some or all of the following characteristics:

1. Financially very strong; net creditors/cash-flow positive;
2. Make products that enhance productivity/meet real needs of "unstimulated" consumers/are timeless;
3. Ideally be multi-national rather than U. S.-only;
4. Be as far as possible from the financial bubble-type industries (banks, homebuilders etc.);
5. Very strong free cash-flow generation;
6. Very strong market position;
7. Either be technically oversold or have a chart showing outperformance;
8. Own gold in the ground at a cheap valuation per ounce and not depend on investors to stay afloat.

Given the above stringent criteria, it may be clear that I am not especially bullish about the stock market as a whole and have a relatively short shopping list. Too many companies that simply lack many real assets and/or lack the staying power to ever provide an acceptable return on their current market valuation are hanging around. Too many institutions still are all-in on stocks, and too many companies that meet the above criteria lack sufficient underlying tangible asset value, whether said asset value be government bonds or bricks-and-mortar assets.

Even though we think of debt as "senior" in a company's capital structure, it is cooperative economic enterprise, and ownership thereof, that is the core societal "business" activity. Money-lending and credit creation are newer concepts than cooperatively engaging in productive activities. The modern corporation, and ownership of a piece of a well-run company with the characteristics listed above, may finally, once again, be beginning to make sense to investors so many years after the amazing 2000 bubble peak in the major averages given the paltry alternatives the authorities and the markets present to us today.

Copyright (C) Long Lake LLC 2010

Sunday, August 22, 2010

Weekend Update: More Stocks Finally Looking Less Bad than the Alternatives

The public continues to be in a sour mood, and continues not to engage in many elective purchases, as shown by Gallup's ongoing polling, which shows that one measure of discretionary spending by consumers remains stuck in the $65 per day range, roughly where it has been since the mild recession of 2008 turned into the nightmare of the Great/Global Financial Crisis. This level was in the $100-125 range well into 2008 per Gallup data no longer shown on the chart, if memory serves. This is a simply amazing drop. To think that this is not a form of a very great recession requires, in my opinion, one to think again.

Governmental retail sales data suggest to me that from peak in 2008 to trough in 2009, per capita inflation-adjusted spending dropped at least 15%, given that nominal sales dropped about 12.3% (Jan. 2008 through Mar. 2009).

Since then, conventional macroeconomists have simply gotten it wrong. The best advice that President Obama obtained early in 2009 indicated that at most unemployment rates would peak at 8%. Wall Street economists concurred. The stock market began anticipating a strong and sustained economic recovery, but personal income absent governmental transfer payments have yet to reach their peak. If it were not for all the millions of unanticipated dropouts from the labor force, the measured unemployment rate would be well over 10%.

Recently (finally), mainstream economists have been substantially lowering their estimates for 2010 and often for 2011 economic performance.

Are the markets are finally discounting, or over-discounting, the economic weakness that many of the Austrian persuasion (and others, such as Nouriel Roubini) have been foreseeing? Now that there is a growing understanding that the paradox of shifting a credit boom/bubble from private to governmental ownership does not induce more profitable economic activities, is there so much gloom that it's time to tack toward a form of optimism as exemplified by buying certain common stocks?

My sense is that there is still more economic pain to go but that the answer to the above question is a "Yes, but" type of answer. For guidance I refer readers to the paper by Reinhard and Rogoff (go to and then click on the first link, to "This Time Is Different"), or read the book of the same name. I also refer readers to a variety of the books on the reading list of Econophile that present an array of viewpoints and historical narratives often from the standpoint of Austrian economics.

Since securities such as stocks and bonds of at least intermediate duration, or assets such as precious metals, are long-term, investors are forced to read tea leaves and look beyond the financial storms that are so common during hurricane season in Florida.

Now that the interest rate structure has come down drastically in a short time, while at the same time the S&P 500 has dropped about 9% since interest rates peaked April 5, common stocks are far more competitive against fixed income than they were this past spring.

While many valuation measures show stocks to be overvalued, that measure assumes a desired positive rate of return, such as 7-9% annually. If, however, one is willing to invest in stocks at a 5 +/- 2% (i.e. 3-7%) annual rate, I suspect that the formulas that indicate overvaluation would no longer do so.

Further, Jeremy Grantham of GMO LLC is out with his famous 7 year predictions as of July 31, suggesting that the best asset class 7 years from now will prove to be high quality U. S. stocks (he does not define high quality, and does not equate that with large cap). He has been pretty darn accurate to date with these predictions to date, so far as I know. He does not like non-high quality small cap U. S. stocks. He gives a 6.1% return from the class of high-quality stocks in real terms, which would be about 9% per year if prices rise 3% annually.

Supporting the idea that a stock market which currently is trading with a high degree of correlation between all stocks can have an identifiable subset with superior risk-adjusted prospective returns is the lfact that when the general stock market was at its most overvalued ever, in 2000, it surprises most people to look at numerous types of stocks and find that they peaked in 1997-8 and bottomed in March 2000 just when the NASDAQ peaked. Think of everybody rushing to the left side of a boat, then some rushing to the right side.

Many of the stocks that bottomed in 2000 made things, as opposed to techs that made vaporware or proposed to be the fifth online pet supplies company, or the recent enthusiasm for financials that made bad loans or bad investments but produced little or nothing or real value. This list of relatively undervalued stocks as of 2000 includes homebuilders and numerous industrial companies. In fact, the Russell 2000 Index, which includes stocks with market cap between 1001-3000 and is thus a proxy for small cap stocks, hit a record early in 2004 when the general averages were far behind their 2000 peak. Thus there is precedent for a large class of stocks to outperform their index.

For stocks, my working hypothesis has been that the process of creative destruction/boom-bust cycles within industries remains in play as follows.

After the energy boom and overvaluation of energy and gold stocks (and gold and oil themselves) in 1980, cheap energy fueled growth for over two decades until oil started a huge price rise about a decade ago. After tech stocks went wild in the late 1990s, the stocks were just as bad buys as oil drillers were in 1980, but the technology revolution fueled growth and efficiency and continues to do so. Tech is the major force in the economy fueling lower prices in a virtuous cycle, as opposed to lower prices simply resulting from oversupply due to malinvestment during the recent boom.

The latest fad was obviously for financials. It is said that about 40% of corporate profits at the bubble peak in 2007 were from financial activities. Of course, these were in many (most?) cases "profits" rather than real, economic profits. Thus the bust.

The analogy I am drawing is that the bust in the financials has the potential to fuel growth, but that the financials and their relatives such as housing- and finance-related businesses are likely to prove as disappointing investments on a multi-year basis as techs and energy stocks were following their busts and rebounds. Trading: OK. Buy and hold; I don't think so.

The special problem now, though, is how inextricably linked with all other financial assets the financial companies are and with the State itself. Thus, teleologically, the historical record per Rogoff and Reinhart of an average of perhaps 6 years post-credit collapse for matters to right themselves. They observed that stock markets bounced back well ahead of the economy as central banks flooded the markets with cash. Thus a bust in the price of energy was viewed as good for most of the country, but a bust in financial intermediaries plays havoc with a macroeconomic world-view in which borrowing and lending, rather than accumulation of true equity, provides a crucial key to growth.

So I believe that industries with real futures, meeting real needs of real people and other real businesses globally, and that are in fields that are as far from leveraged finance as possible, should (broad brush picture here) be optimally positioned to survive and, probably grow, and could be as good investments for years to come as depressed consumer stocks were in 1981 (pre-great recession of 1981-2). At a time of constrained credit, being self-financing is a marvelous situation. As an example, Intel recently announced a deal to buy McAfee (MFE) at about 15X earnings. Zeroing out MFE's cash, that's about a 7% earnings yield; Intel is paying with cash yielding nothing. The Street booed the acquisition. Whether it's a good one or not, just think what price Intel was paying for acquisitions or what Intel's investment portfolio was receiving for IPOs a decade ago.

This buy or potential buy "list" (I have no formal list) could include energy producers and high tech companies, but it really could include almost any company. Said companies would in general be of very high quality, a la Grantham's analysis, and thus would be financially stronger than the banking system itself. If a company were a strong enough multinational, it might be stronger than almost all sovereigns financially as well as somewhat independent of any one sovereign, as well.

So my personal investing strategy is as follows. I am heavily allocated to muni bonds and short-duration Ginnie Maes (yielding as much as long-term Treasuries when bought correctly), as well as to cash. I have sold all my intermediate to long Treasuries which I bought so recently, following the amazing plunge in rates this month. I went to about a zero stock allocation at Dow 13000 in summer 2007 and except for a few months in late 2009 ending in early May this year, have hardly been in stocks at all.

While noting that the chart on all sorts of stocks stinks, the same would have been said for Treasuries at all optimal buy opportunities during this almost 30 year bull market in bonds. Seasonality and the down-pointing charts, and the rise of statism in the economy, make the future of the economy and the public's prospective mood for stocks unusually uncertain and even scary. Nonetheless, in a time of very poor investment choices, as an investor seeking both current income and long-term capital appreciation that at least stays even with inflation, I have started in with a program of purchasing stocks that yield around or over 3% and that often have P/E's in the 10 range. My thinking is that some time within the next 7 years, these companies will at the least probably not cut their dividends and will probably raise them (examples such as BP notwithstanding), and at some point their stock prices will exceed their current prices; thus their total return potential adjusted for risk probably exceeds that of the 7 year Treasury note, currently at 2.05%. Such names include Chubb (CB), McDonald's (MCD)--both of which have strong charts; and Intel (INTC) and ExxonMobil (both of which have weak charts) and/or other oils.

I am avoiding yet higher-yielding pharmaceuticals because so much of their income comes directly and indirectly from governments, which are tapped out and will have to cut somewhere, and because their profit margins are ultra-high as a direct result. But I'm watching them carefully for signs of technical strength and improvement in their R&D productivity.

Barring major financial/economic events such as led up to the collapse in stock prices from 2007-August 2008 (i.e., pre-stock market collapse), in my humble opinion the highest-quality common stocks are finally beginning to merit a significant place in a diversified portfolio with a multi-year horizon and are finally competitive with munis for taxable accounts. I write this, though, with a distinct lack of enthusiasm given the fact that in Japan, there has hardly ever been a good time to go long stocks other than for a trade since the 1980s, and the U. S. is continuing to look Japanese. Nonetheless, analogies are imperfect, America is not Japan, etc. Most importantly, I have signed on to the stagflation rather than price deflation scenario.

Meanwhile, I do not think that stocks are safe and I believe that the rent money should not be entrusted to the stock market. I also continue to believe that gold is the single best investment for funds that will not be needed any time soon, given the apparent commitment of the ancien regime (aka the authorities) to more money printing and other financial maneuvers to "save" us rather than directly face up to the many historical and ongoing malinvestments that plague the U. S. economy. But an all-gold (or all precious metals) portfolio would be quite something else again!

Last but not least, and with the caveat that I know nothing about tech, AAPL appears to be a classic GARP (growth at a reasonable price) special situation stock with a company that is a financial and market share juggernaut. AAPL is very risky, though, and may or may not ever return cash to shareholders.

I am not an investment adviser and am proffering no investment advice in this and my other web posts. No obligation exists to disclose any changes in specific or general views discussed herein or by me elsewhere.

Copyright (C) Long Lake LLC 2010

Friday, August 20, 2010

More Headwinds for Treasury Bond Bulls: Goldman Turns Bullish

Talk about coming so late to the party even the good leftovers are gone. Zero Hedge reports that a Goldman Sachs technical analyst espies much higher prices ahead for long-term Treasuries after one of the most amazing rallies ever seen. Capitulation, anyone? Wanna short the euro at $1.20?

Sarcasm aside, I am not actually disagreeing with Goldman's Noyce. I tend to agree, but in the fashion as follows: about a year ago (timing may be off), I read somewhere, perhaps, that Goldman's London office had turned strategically bullish on 10-year Treasury yields dropping to about the 3% level. This was after a small move down in yields, not a massive one, if memory serves. Well, the forecast was correct, but was premature. Far better buying opportunities lay ahead.

The 10-year Treasury is vastly overbought. Even most of the comments on Zero Hedge about the article were positive to neutral on Treasuries; usually ZH comments are pro-gold and assume that Treasuriees are going to default in the near future. The public mood is gloomy. And all stock traders know that hurricane season is very dangerous for stocks. Plus the stock charts don't look too hot. So it's easy to see hiding in the 10-year. If you're hiding from a threatened financial storm, you don't really care if your aggregate income over 10 years from your $100 is $25 or $30 (2.5% vs. 3% yield).

But as an investor, I agree with Drs. Rosenberg and Shilling that the main point of owning long Treasuries at these low rates is for capital gains. So I've sold out of my Treasuries. I do own munis for income, as well as short duration Ginnie Maes (not Fannie or Freddie) MBS with yields similar to that of much longer duration Treasuries (and with principal paydown as well as interest). I have no interest in selling those securities at today's prices.

I remain in the stagflation camp. I don't believe in fighting the Fed. The Fed wants a low level of rise in the consumer price indices, or at least so they say. I believe that as in 2007-8, and as was the case after the Great Crash 1929-33 and until Paul Volcker came on the scene, the Fed will be behind the curve re short-term interest rates and price rises.

Got inflation hedges?

Copyright (C) Long Lake LLC 2010

Price Increases Coming

Reuters is providing advance notice that goods made in China are going to become a good deal more expensive soon; and this is expected to occur without an upward revaluation of China's currency vs. the U. S. dollar. From the article:

"Apparel prices are going to go up. It's as simple as that," said Perry Ellis Chief Executive George Feldenkreis, who said a rise of up to 10 percent will be seen next year. "The American consumer will have to accept it."

China looks to be raising its prices of manufactured good to the developed world. While this article is specific to apparel, it's hard to see that the same type of price rises will not be general from China.

The massive expansion of credit that occurred in past years in both China and the U. S. is beginning to bite, even while the American economy remains weak. The silver lining for this country is that imports represent a relatively small part of the overall consumer cost structure. Nonetheless, those economists who are predicting an actual and somewhat chronic fall in the general price level in America to justify very aggressive low yield targets on long-term federal securities have just been provided with a real-world counterexample.

Copyright (C) Long Lake LLC 2010

The Daily Capitalist and I

I have begun blogging at The Daily Capitalist as well as here. The proprietor, Jeff Harding aka Econophile (or, the Capitalist), is a friend who is a leading exponent of Austrian economics and libertarianism. I look forward to sharing my observations with his readers and am grateful for the opportunity to post on his site from time to time.

Regular readers of this blog may enjoy my initial post on his site.

You will likely enjoy perusing his posts, including his most recent major effort, a multi-part discussion of Dodd-Frank ("Finreg").

Copyright (C) Long Lake LLC 2010

Thursday, August 19, 2010

Brief Markets Update

Toward the end of his letter today, in which he makes an impassioned case for lower Treasury rates over time, David Rosenberg mentions that he has heard that bulls on Treasuries are now at the 98% level; there were said to be 99% bulls in December 2008, at the peak of that buying panic/short-covering rally in Treasuries. Of course, that was followed by a massive bear market in Treasuries, with yields nearly doubling on the 10-year and rising over 200 basis points on the 30-year.

It took over a month after the Lehman/AIG mess for yields on the 30-year bond to get unstuck from the 4-4.5% trading range. By then, it was obvious that a global credit collapse and severe economic downturn in the U. S. were underway. Now, while there is lots of anxiety, and a new recession or significant intensification of an ongoing depression are certainly possible, but it is also possible that economic activity will strengthen or at least that leading indicators will turn up.

Certainly the price of silver and platinum are treading water rather than collapsing, and gold is becalmed on a multi-month basis; and there is no general price deflation that anyone can see.

So, both on fundamental (inflation and governmental supply-demand), technical and sentiment bases, Treasuries look risky to me here on a trading basis. And, pricing of munis has followed that of Treasuries upward. I suspect that people and institutions have been capitulating from cash and ever-disappointing equities into bonds, and that this has almost all the characteristics of an intermediate top in the bond bull market. Is it the final hurrah? Time will tell; I suspect not.

More and more the financial landscape is beginning to look as though Treasuries are turning into trading vehicles, with the Japan scenario held out to justify aggressive price targets for the bonds (i.e., yet lower yields). However, in U. S. history, if one thinks back to the 1930s and 1940s, when Treasuries got to very low yields, high quality dividend-paying stocks did better on a multi-year basis, and bonds generally provided zero or negative returns after inflation. People forget how fast consumer prices rose even in a number of years after 1933 in the rest of the Great Depression years and especially in the post-Depression 1940s, which was a high-inflation decade.

While both the charts and the short-term economic trends don't look too promising for stocks, I am getting interested in financially very strong U. S.-based companies with large to very large international sales, such as McDonald's (mentioned yesterday), ExxonMobil, Intel and others, on a total return basis for portfolios with a longer-term horizon.

I also continue to believe that gold's technicals and "fundamentals" make it a very sensible approach to wealth preservation, both through direct physical ownership and through share ownership in ETFs such as GTU and PHYS that own allocated bullion in vaults in Canada.

Family commitments will limit posting over the next several days.

Wednesday, August 18, 2010

Trading Uncle Sam's Debt for Burgers and Fries

The long Treasury bond has defied the obvious tendency that when a lot more of something is produced, the price tends to drop. Instead, there has been a buying surge in Treasuries. Thus, based on such reasons as weakening forward-looking economic statistics, general disdain for the way in which the economy has been run (including disapproval that it is being "run" at all rather than functioning freely), and the technical picture just a few weeks ago, I turned tactically bullish on bond prices just a few weeks ago, as discussed in various blog posts.

The Treasury markets have moved massively in a very short time, with relatively little fundamental support for such a large repricing. The 10-year (not shown here) has collapsed from high to low in 4 1/2 months over 35% in yield (4.0% to below 2.6% briefly). The 30-year (click on image to enlarge) shown here has moved less, and I favor it over the 10-year as the yield spread between the 10 and the 30 hit over 120 basis points and compressed today to a very wide level of 110 bps.

Nonetheless, the absolute yield level of the 30 year bond at about 3.7% is at or below the lowest level its 200 day smooth moving average hit during the entire 2008-9 stock bear market and amazing Treasury bull market. Thus I'm thinking there's some combination of fundamental and technical overvaluation here in both the 10 and 30 year bonds, with greater risk in the former (and less reward).

Who knows, but it's looking more and more to me that a base case is for the 10-year to correct upward in yield even if the longer-term picture is for a 2% yield and a 30-year yielding in the 2.5-3.5% range. Thus the long bond, which day-to-day tends to trade directionally with the 10-year, is in my view a difficult hold from a trading perspective, and I have taken some nice profits for a 1-2 week trade. A completely unscientific rule of thumb I have developed is that if I can "make" one year's worth of interest income from a quick bond trade, I strongly consider taking it. If I get two year's worth of interest income, I grab it.

Thus I've reversed most of my bond purchases put on in the last few weeks.

Meanwhile, one of the many correlations I have found useful in the post-Great/Global Financial Crisis world is that MCD (McDonald's; Mickey D) has for over a year traded in line with the 10-year. MCD recently joined gold in making a new all-time high in 2010; I believe MCD is the only Dow 30 Industrial to do so. And this is MCD's 2nd surge this year to a new high, if memory serves me well. Meanwhile, with the amazing fall in the 10-year yield to well under 2.70, MCD yields 3.00% now and thus can easily appreciate 10% in price and still be fairly valued under this relationship.

In addition, should the rest of this year not have a re-run of 2008 or worse, MCD's board will increase its dividend late this year for 2011. My guess is about a 9% increase. Thus I reason that if the 10-year yield is at 3.0% sometime next year, MCD stock could easily trade at that same 3.% dividend yield it now enjoys and thus stockholders could see a price increase of about 9% to keep the new (projected) yield at 3.0%, plus the current yield of 3.0%, and thus get a total return of 12%.

If over the next 10 years MCD's dividend rises at a compound annual rate of 7%, it will have a terminal dividend yield of 6%. Thus for every $100 invested in the stock at today's price, about $45 would come back to shareholders; this is vs. about $26 back to buyers of the 10-year bond at this week's price/yield. All other things being equal, MCD's stock price could thus drop 19% (45-26) ten years from now and be about an equally good investment as the 10 year bond.

This August 18, with so much of the public convinced that the "Great Recession" never ended and thus pinching pennies, and with MCD's sales and profits growing in the U. S. and abroad at a pretty good clip, a good part of my personal trading money has abruptly shifted to MCD on the early breakout to new highs and sold the extended Treasury move. If MCD stock price falls without a change in the fundamentals and without a massive breakdown in Treasury prices, I plan to buy more.

Less than 10 years ago, the stock market recognized McDonald's as a poorly run behemoth. It cleaned up its act. Will the U. S. government, another poorly run behemoth than unlike McDonald's is a monopolist extraordinaire, do the same?

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Monday, August 16, 2010

Bonds Triumphant, But . . .

Remember there was a slave assigned to remind the returning triumphant Roman general that success is transient?

Now think of the 10 year bond collapsing in yield from 4.0% on April 5 to 2.60% or less in mid-August, with little major news in this period to cause such an extreme change in price/yield.

In the usual course of events, profits by the buyers the past few months will be taken. Rapid extreme success (to the bond bulls) may be transient, at least temporarily.

The long (30 year) bond has rallied as well but is far less extended on the charts. I continue to mentally target the 10-year backing up in yield or at most stabilizing, while the 30 year trends lower in yield to re-establish the more traditional yield relationship of 50 or 75 basis points difference between them.

So long as the yield is higher from the long bond and the 10-30 spread is at or near historical extremes, the weight of the evidence favors being in the long bond rather than the 10 year.

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Sunday, August 15, 2010

Mainstream Mis- or Dis-Information Campaign Intensifying?

Now that Rupert Murdoch and team own the WSJ and Marketwatch, they speak for the mainstream. A "Marketwatch" bylined article from late in the week, allegedly on gold, has so much incorrect information that I suspect provides truly contrarian investors who see matters as I do with some strategies to conserve wealth and potentially increase it. The article is titled Gold rises as world spirals toward deflation.

While I am tactically bullish over the intermediate term on long bonds for a modest portion of my portfolio, I do not expect either price deflation or "Austrian" deflation to occur in a major way.

Here is some of this apparently mainstream opinion:

Most serious economists believe the real risk facing the U.S. and other Western economies is deflation, not inflation. Unless the Fed, joined by the government, really steps up to the plate to stimulate the economy, no matter which way you cut it, deflation can't be too good for gold either, especially not compared with bonds. . .

It (not well defined in the article exactly to what that word refers) will be a mere, if classic, safe-haven bet, but no doubt gold bugs of all stripes will continue to present it in many other ways.

For some reason, with soup line photos no longer in vogue in this season of a "weakening recovery", the Establishment wants us to believe that undocumented "serious" economists--as opposed to unserious ones, one must infer--suddenly agree that the "real" risk is deflation (which we are to take as price decreases rather than direct credit shrinkage). The implied message is to buy allegedly high-quality bonds.

The obvious response is to hold onto your wallets and prepare for price increases. When? It would be a bit obvious for this to occur, say, tomorrow. The long bond may well be a good trade for the next months or even years, just as the NASDAQ was in the later 1990s. But unless you are a "paper bug", the relative valuations and chart structures suggest to me that gold has a more secure intermediate term future as a wealth preserver and even enhancer.

In 100 and 200 years, which would you rather your descendants inherit from you: Federal Reserve notes, perhaps earning interest through correlated bond issues, or gold?

Everyone needs to make their own choice, which I believe is the key investment choice. For now I am playing both sides of that trade, but while my heart is with my government, my mind makes a persuasive argument otherwise.

The more the mainstream media continues to tar gold investors as "bugs" (meaning "nuts"), the more secure I feel that there is no gold bubble, just a gold bull market. The gold bull may rest or reverse, just as stock bull markets have done, but patient money can ride those out. The bubble is in cash yielding nothing while prices rise apace; at any time, as in the WW II and Korean War eras, consumer prices may soar while allegedly safe long Treasuries yield far less than the rate of price increases. If and when that happens, the one-decision asset that never changes--gold--may finally garner the respect from the media that it has had for, oh, five thousand years or more.

The fad does not (yet) involve gold; it is actually believing in "deflation" in an era of fiat money, especially when the issuing government has always been at war with Eastasia. (Or is it the Horn of Africa? See linked NYT article about the Nobel Peace Prize winner's expansion of secret wars.)

In any case, there's far too much hype about "deflation" to suit me. I am embracing it warily, as I did the tech bubble ten and more years ago; and my long bond holdings are in my mind speculative. Strange, unfortunate times, but so it goes when governments dominate markets.

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Saturday, August 14, 2010

Thinking about Treasuries

The 10 year yield has collapsed in a nearly unprecedented fashion to just under 2.70% from 4.0% on April 5. This about 1/3 drop in yields in just over 4 months with relatively little news is astounding and brings the yield to roughly the Fed's long-term inflation goal. The 200 day simple moving average is 3.46%. Even if David Rosenberg's target of a 1.5% yield is on target, then it would take a Fannie/Freddie/Lehman/AIG catastrophe to push yields much lower in the short term.

The long bond, exemplified by the on-the-run 30 year bond yield, is listed as yielding 3.87%, down from an April 5 high of 4.84%. My recollection of a 200 year chart of U. S. Government long bond yields from the year 2000 is that the long-term average was about 4.70%. Thus while the current yield is below average, it was about average only 4 months ago. There is no bubble in the long bond, and it is much less extended on the charts.

Supporting the idea that the prospective action for both traders and new money investors is in the long bond is that the spread between the 10 and 30 year is 118 basis points, a record since the long bond was instituted in 1979 except for a slightly greater spread intra-week. Dr. Rosenberg states that the average spread has been 50 bps. Looking at Japan, the spread is about 75 bps.

If the 10 year stabilizes at 2.75, which is midway between the zone of congestion the chart shows January-April last year as yields recovered from the post-Lehman panic, and if the 30 year moves toward a 75 bps spread, then the target for the 30 year is 3.5%, which is about where its zone of congestion from the same time period is. The upper part of the 30 year's congestion zone was 3.7% or so.

Thus various reversion to the mean based on chart/trading considerations, and absolute spread differentials between the 10 and 30 year bond, suggest to me that barring cataclysmic events, a very plausible scenario involves a zero to negative short term total return from the 10 year bond while the 30 year bond provides both slightly greater income and some capital gain potential.

The fundamentals of price inflation since the Fed was formed in 1913 are as follows. If it now takes a dollar to buy what a nickel bought in 1913, then the compound rate of price increases is 3.14% yearly. If the proper ratio is 3 cents to one dollar, then the rate of price increases rises to 3.68%. Meanwhile, gold has risen 4.3% yearly.

Thus numerous numbers hold together. In a chancy economic time and one of significant turbulence in the financial markets (as opposed to the real economy), the long Treasury bond and gold both appear to be fundamentally reasonably priced, and both have chart patterns that prove that they have been attracting buying support.

To those who argue for one of the above and not the other as trading/investment vehicles, please answer what is so different now as to change either trend? And please don't talk about the Federal deficit to argue against Treasuries; Japan disproves that argument.

My view is that long-term trends deserve great respect. When the 40 year old trend of rising interest rates ended in or around 1981, the actions by the Fed were obvious and followed crisis after crisis. What drastic policy change has occurred to change any of the major trends currently in force?

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