Thoughts on Cyprus

The shenanigans with Cyprus have a passing similarity to Lehman in its last days, though many differences remain.  Lehman was shopped.  South Korea comes to mind.  Cyprus is being shopped.  Somehow I doubt that the West will let it "fall" to Russia.  Cyprus is too near to Syria, where the West and its Arab allies appear to slowly be squeezing the Assad regime, and with it Russia's naval base in the Mediterranean.  If so, though, will Russian interests still help to force a disorderly event in Cyprus?

Two articles in the Greek e-paper Kathemerini discuss the latest, with insights into dissension in Europe.  LINK, LINK.

The second of these is interesting.  It shows substantial criticism within the European Parliament of how this situation was handled.

It strikes an American who knows nothing special about Cyprus as quite odd that an insured depositor or a safe and sound bank in Cyprus would have to be assessed a "tax" on deposit to bail out a shareholder or bondholder of an unsound bank.  Why not force the uninsured, and if necessary, insured depositors of the insolvent banks, plus their senior or co-equal stakeholders, to take the losses?

Or else, why not place the burden on society at large, including citizens/residents would own other assets, such as real estate, stocks and bonds?

There may be unintended consequences of this situation.

In a stock market that per Value Line is "frothy" and per Jeremy Grantham is poised to underperform even moderate inflation on a 7-year basis, there's a lot to preserve by increasing cash and decreasing exposure to the continued Goldilocks scenario.

Greenspan Bullish: Uh Oh

This could be really, really bad.  The man who warned against stocks with nearly four unbelievable full years of bull bull BULL lying ahead has perhaps rung the bell at the top (LINK).

Greenspan: No 'Irrational Exuberance' in Stocks Now

That's a bad enough headline to stop here.  But let's not...

Greenspan said in a " Squawk Box " interview that stocks by historical standards are "significantly undervalued" even considering the recent moves higher. He added that the payroll tax increase didn't dent spending because of rising asset prices.

OK.  Meanwhile, at end-January prices, Jeremy Grantham's model had as its central tendency that US stocks were priced to slightly lag anticipated 2.2% annual price inflation every year (on average) for the next seven years.  But that was at lower prices.  

Grantham has a better track record than the Maestro.  But of course prior success doesn't guarantee future results, etc.  So we shall see.

We are finally seeing the VIX and VXO break decisively above 25.  Finally.  Boy, has this been an exhausting wait.  FB buyers and the like are capitulating.  Finally.

We only had 12 weeks in a row of the NAZ being up this year-- a record, it was said, a longer streak than even in 1999.  Reality can bite, n'est ce pas?

Note I'm not a short-seller.  I simply have owned Treasuries (and high grade munis) as a natural hedge against the stocks-down/interest rates-down trend we've seen the last few years.  Plus I own AAPL, and some OTC income stocks.  I've simply been blogging "forever" that stocks have fundamentally been overpriced based on historical norms, and relative to the risks.  I presume there are very good reasons why the Fed has been doing what it has been doing and why investors are finally focusing on return of principal.

The DoctoRx rule of thumb is that high-quality stocks can be bought when the above fear indices are above 25, though the timing may be terrible for a while.  Typicall, these moves above 25 carry to or above 30.  I would look for a BTD scenario around there. 

Support for the NAZ is around 2200.

The dividend-paying top-tier NAZ tech stocks are my long-term faves for growth and income.  I would look to scale into them on weakness in the bubble tech stocks (plus I own a fair amount of AAPL as a "permanent" holding).

More to say in a later post, perhaps Sunday night.  A busy weekend looms on more than one front.

ISM Comment Leads to an 'Aha' Moment

Sometimes little things make the difference.  For example, early in 2009, I saw a comment on a blog that was arguing with the blogger and most of the commenters.  This comment went as follows:  forget about the injustices you perceive about the bailouts of the banks and bankers.  They have won.  It shows in Jamie Dimon's swagger.  Get over it.

This commenter was right, and thinking about the real-world wisdom it embodied it helped me switch from the bearish posture I had had ever since the summer of 2007-- and uber-bearish after a recession (mild, at the time) was confirmed by the spring of 2008.

In any case, a similar comment from the Chicago PMI report released this morning struck me as also bringing me to a clearer understanding of the markets, this time in a negative way.  Here is part of the intro to this report:

The short term trend of the Chicago Business Barometer, and all seven Business Activity indexes, declined in May.  The Production index fell to neutral while, inexplicably, measures of Business Policy advanced.

This was an 'aha' read for me (note emphasis was added above).

Inexplicably, the purchasing managers' companies were bullish.

A problem that has vexed me a great deal has now been answered.  That problem is that the futures markets show that commercial hedgers have gotten much less bearish as prices have declined.  This is seen in general summary data available on the Web, and please note I'm an amateur at this and don't look at detailed COT reports and the like.  But publicly available data indicate that the commercials in important markets such as copper and less important ones such as palladium are acting as they have during routine price corrections.  However, in 2008, we saw similar activity from the commercials, and it merely presaged a much deeper depression.  In other words, so far as they knew in 2008, the U.S. was undergoing a mild recession, the world was reacting in sympathy to temporarily decreased demand, and normal inventory policies were appropriate.  And indeed, eventually, prices were higher than where they went bullish, but it took a major downtrend and many, many months for them to rise enough off of a much lower bottom for that to occur.

So we have it:  if the fringe views of the ECRI and a few economists such as John Hussman and Gary Shilling (and Econophile Jeff Harding at The Daily Capitalist) are correct, then the U.S. is in or is soon to be in a recession.  In that situation, China will lose even more demand for its exports, and we can expect more economic turmoil globally. 

This fits together an additional way.  A few weeks ago, Dr. Achuthan of ECRI went on TV and said his own 'aha'- he said that what had been going against his forecast of recession (which he had held to steadily since he first made that call around Sept. 20 of last year) was employment.  He pointed to the nascent uptrend in new unemployment claims as evidence that finally, all the diagnostic evidence was in his favor. 

So what did we see today?  Another set of bad numbers on the employment front, both in new claims and in the ADP flash employment number.  The ECRI case for recession not only remains on track, but just this week it put out a report for paying subscribers with the ominous title "More Signs of Global Economic Stress".

So, while the consensus on the Street has to be treating the current stock sell-off as a response to European turmoil, ECRI is doubling down- and it does have a strong track record. 

A mild U.S. recession can be expected to have disproportionate effects on business behavior, and if so, currently "cheap" stocks may get a lot cheaper.

I am not an economist or a professional forecaster, but I do have a knowledge of advanced statistics.  Thus I understand the message of simple statistics well.  In this case, it is that for many years, there has been a strong correlation between recessions in the U.K. and other important European countries and recessions in the U.S.  While correlation is not causation, I do respect it.  Thus, putting all the above points together, my "central tendency" is for greater caution on risk assets than I think the markets are pricing in.  So, again, in murky times when legitimately major events are occurring in the world's largest economic zone, the EU, I like a lot of cash.  Buying into an established uptrend at higher prices only has an opportunity cost, not a real economic cost.

We are, indeed, skating on thin investment ice.

Knowing and saying all this, I now feel I should add that none of this is of any value for short-term market action.  This is intermediate-term stuff.

(P.S. Due to the above, I took advantage of the late-day surge in AAPL to reverse most of my purchases yesterday.  Still long, still love the fundos there, and look for it to get to its now-declining 50 day sma, but I like to prepare for intermediate-term stuff in advance.)

Thoughts on the Failure of Yesterday's Turnaround Tuesday Rally

As I write this at 2:10 PM Eastern time, yesterday’s “turnaround Tuesday” rally has been reversed. We are finally seeing the beginnings of capitulation in stock traders, as the volatility index with the symbol VIX finally break above 20. Last year, it surged above 45, and I use 25 and above as a rule of thumb of when to trade stocks from the long side if I am liking the bullish case.

We are seeing the deflationary market events occur that I recently suggested were most likely. One of several recent posts on this topic was titled Goldman Wrong on Rates, Zero Hedge Wrong on Oil As Deflationary Side of Biflation Begins Its Ascendancy. Next-month oil prices on the futures market have dropped to a multi-month low around $95/bbl. Gold, Treasurys and the US dollar are safe havens for the moment, and I suspect will be so for a while yet.

Short-term interest rates up to the 6-month range remain lower in the US than in Japan. If you, along with the great majority of investors, think that interest rates here have nowhere to go but up, you might be interested in perusing a multi-year chart of Japanese interest rates in the 5-30 year range. This is linked to from freely available data from the consultancy www.KShitij.com, which specializes in Forex.

To summarize, the Japanese have been locked since the 1990s into a near-zero interest rate policy. It is clear that investors did not want to believe that there could be such a persistence of this policy. Investors in the 10 year bond, and in the 30 year bond that was introduced during the time frame of the chart, apparently “knew” that rates had to rise. But they did not.

What is being called a “credit collapse” is a reasonable title for the dissipation of real capital in the booms, first of the late ’90s and then in the aughties, but it is a bit too gentle. The amazing leverage of companies’ capital bases led to insolvency when that limited real capital vanished. Until the stock market gets real with its valuation of operating companies, I remain unconvinced that a Japanese-type fate does not await, meaning a multi-decade stagnation/decline of prices of these pre-owned equities. There simply is a fundamental difference between stocks and bonds. Low rates on the latter is historically consistent in the US as well as Japan with low valuations on the former. To the extent that stocks are an inflation hedge, got gold? To the (more important) extent that stocks reflect the current value of the assets of the companies plus the (unknowable) present value of future profits, it just might be that today’s low interest rates are forecasting below-trend and below-expectations growth of said profits.

Today’s outside reversal (so far) of yesterday’s rally in stocks and oil is, as stated, finally beginning to get some bulls to throw in the towel. With no (public) interest in suggesting what tomorrow or the next day will bring, I think the most likely course is for more disappointing economic news in the months ahead, and that gold and only gold is the optimal hedge against a new round of money creation by the Fed.

COpyright (C) Long Lake LLC 2011

New Post on the Stock Market at The Daily Capitalist

A new post has gone up on The Daily Capitalist on the stock market, click on the link or cut and past the link below. Due to formatting problems, work of this nature is not transferrable to the Blogger format.

http://dailycapitalist.com/2011/06/12/why-bill-russell-would-be-a-bear-on-the-stock-market-now/

How I Learned to Stop Worrying and Lote the Stock Market

There's no typo in the title. "Lote" is a combination of love and hate. Here's a precis of why that's my current attitude toward the stock market.

By the 'stock market', I mean operating companies as opposed to funds of various sorts, preferred stocks, and other securities that would not qualify for consideration for entry into a stock index such as the S&P 500 or the Russell 2000.

From my start in the financial markets in 1979, I was always oriented toward the stock market, taking a brief timeout only in 1981-2, when bonds were very high-yielding and a severe recession raged and triple-tax exempt New York City bonds made sense for a professional couple earning the munificent combined income of $40,000 yearly.

That pro-stock posture continued until the tech-growth stock/"Nifty Fifty" stock bubble peaked in 2000, and the revelation of widespread corporate fraud at such companies as Worldcom and Enron, plus my own experience with some high-flying local companies, led me to swear that never again would I go all in with common stocks.

I did go half in in spring 2003 and then all out in the summer of 2007.

At this point, with money rates still at or below the price inflation rate in most countries, my posture toward stocks is that I would want to see what would happen if governments simply taxed as much as they spent. What would the effect on economic activity and corporate profits be? I suspect there would be a severe shrinkage of the percentage of reported corporate profits to GDP.

For example, about one out of every six dollars in the U. S. goes to the health care "industry". What would that ratio be without government support? Much less, I suppose.

In fact, the tech sector receives little in the way governmental subsidies. It has to prove its worth to businesses and its attractiveness to consumers every day. Perhaps that is why it has rebounded strongly.

So you can sense the hate part.

Now for the love.

Companies have proven to be decent stores of wealth in high-inflation states, though not as good as gold, silver, or oil. If one is in the (amazingly still small) minority that "gets" what the central authorities are up to, and especially if one is in the yet smaller minority that "gets" that central banks generally do as they are told by their political masters, one will be able to direct one's stock investments more appropriately than people who continue with traditional balanced portfolios or people who make the mistake of looking at dividend yields as indicating value.

When governments are directing their central banks to create money at below-market interest rates, that is usually the time when yield plays start to not work. Think the 1940s and the mid-1960s through January 1980.

Bulls on the stock market will tell you that historically nothing beats the stock market.

As a reliable predictor of the future, of course that statement is irrelevant. Perhaps the historical outperformance of the stock market has used up its future outperformance. Perhaps it's all a random walk. What will tomorrow bring, and tomorrow, and tomorrow? That is the question.

The government of the U. S. has changed. When the Fed was being formed, the issue of issuing currency tied to the issuance of debt was criticized. The Federal government had, after, almost no outstanding debt. Would there not be insufficient debt issuance to allow enough currency to be created?

We all know the answer to that question.

So I would paraphrase Edgar from King Lear (Act V, Scene II), to continue the Shakespearean theme. When I look at the financial markets on a tomorrow-tomorrow-and-tomorrow basis, I think that money-printing is all. Everything else is secondary.

Companies can raise prices over time to adjust for changes in the general price level, and with good fortune an investor may do OK even with companies that see shrinking margins, such as price-takers in the inflation rather than producers of the products (such as precious metals, usually) that see strong price increases.

Thus I lote the stock market.

Copyright (C) Long Lake LLC 2011

Stocks Increasingly Frothy

Gallup's continuous polling is showing a continuing stagnation with a downward trend in discretionary consumer spending.

In this context, the buoyancy of many consumer stocks makes little sense. There's a difference between optimism and investing based on hope against the facts. When even a semi-free market has essentially no value placed on money for as long as two years, with Treasuries paying less than one dollar in total interest per $100 invested for two full years, then the profit outlook for reinvested profits, which is what helps drive the stock market, is poor.

Ultimately what matters in investing is value. Two standard ways to decide on the value of companies ties to their earnings and to the value of their assets. The accountant and investments expert Andrew Smithers, who loudly and contemporaneously called the stock market a bubble in 2000, has just provided another quarterly update of his estimate of the fair value of the S&P 500.

Please look carefully at the linked chart he provides on his website. His earnings-based (CAPE) estimate of fair value and his asset-based estimate (q) are in close agreement that the stock market is massively overvalued. Averaging fair value provided by CAPE with that provided by q gives a fair value of about 725. This in turn means that based on Friday's closing prices, the stock market can be estimated to be about 57% overvalued.

People point to ultra-low interest rates to justify high valuations. Unfortunately, that's circular reasoning. A dead economy is required to justify near-zero short-to-intermediate interest rates. If one carefully studies the Smithers chart, one can look at the 1930s and 1940s, as well as the early 1920s, to find times when there were low to very low interest rates and very low stock prices in relation both to earnings power and assets.

Not only are American common stocks very risky, their prices are increasingly disconnected from the experience of everyone I know and every poll or survey I see. No one I know sees business doing especially well or about to do well. The idea that stock traders know better is a dubious one. It's far more likely that ultra-cheap money is fueling the bull moves in all sorts of assets. The investor's task is to separate wheat from chaff, AIG from Chubb, Honda from GM, stocks vs. Treasuries circa 2000 and circa 2007.

The situation re stocks is reminiscent of the old punch line, "Who are you going to believe, me or your lying eyes?"

Another analogy is Wile E. Coyote suspended in midair.

Yet another analogy is a chart of the Japanese stock market since 1989. It looks like ours, about a decade out of phase. It shows several massive bull moves in a 21 year structural bear market.

This blog has argued for a long time that the best places for investment money were the trend-following ones of being long Treasuries (and implicitly other high quality bonds) and gold. Both of their structural bull markets remain intact. The gold bull is mildly extended short-term and is up about 30% year over year, which is a red flag. The 30 year Treasury is also extended, but the longer duration bonds represent the only part of the Treasury curve which I believe is not yet in bubble valuation.

The chronic weakness of consumer spending continues to support the Treasury bull, and the Fed's response is to print money, which then supports the gold bull. In that context, stocks (other than precious metals stocks) are an afterthought.

Someday the trends will change. Are they changing here and now?

I doubt it.

Copyright (C) Long Lake LLC 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, Bloomberg.com 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

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

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?


Perhaps.


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 RealClearMarkets.com 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, TheStreet.com
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 . . .

Economy
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

Rising Earnings Estimates a Bad Sign for Stocks

Bloomberg.com is reporting what I believe to generally be bad news for stocks, namely rapidly rising earnings estimates:

Analysts are raising earnings estimates for U.S. companies at the fastest rate since at least 2004 just as stocks post the biggest losses in 16 months on concern that the economy will sink back into a recession.

Profit for Standard & Poor’s 500 Index companies will jump 34 percent in 2010, compared with a projected gain of 27 percent on March 29, according to more than 8,000 estimates compiled by Bloomberg. The revision, the most during any quarter in at least six years . . .

Analysts such as Smith Barney's Tobias Lefkovich use peak earnings estimate revisions as signs of market tops, and massive earnings estimate cuts as signs of bottoms (think March 2009).

Whether prices have been cut enough to mark an intermediate bottom I have no idea, but I don't like the set-up here new recession or not. There was no recession in 1977 or 1978, but stocks stank both years.

Copyright (C) Long Lake LLC 2010

Wishing the Times Were NOT So Interesting

The non-permabears I follow who were bearish in 2008 and perhaps 2007 and bullish for most or all of the up-move in stocks, are growling again. This blog has been growling as well for at least 2 weeks and has pointed out for months that stocks are fundamentally overvalued at almost record levels by two different measures, "q" and cyclically-adjusted P/E. Now that systemic contagion occurred with the famous meltdown last week, yours truly simply does not want to be in the U. S. equity markets. ETFs that own gold and foreign currencies are OK still, though some of them hit air pockets in the sell-off as well.

Charts tell the tale. The move up from the 2009 low was lengthy but the angle of the ascent was much weaker than the angle of the descent. If stocks were undervalued, they would laugh at Greek debt problems.

Given our wildly over-financialized economy, falling stocks will have an adverse feedback effect on the real economy. This is what happens when the powers that be try to revive "animal spirits" by printing money.

The problems we have with financial and monetary policy are worse than the excessive debt loads carried at all levels of society. They include lies such as those to Social Security recipients that it's your money, you paid in, you earned it, etc., disguising the pay-as-you-go nature of the scheme. We now have another lie in Obamacare, which passed due to almost certainly fraudulent assumptions such as that the Congressionally-mandated major cuts in Medicare physician reimbursement will finally occur and the pseudo-fraudulent tactic of providing years of tax increases before the costs really kick in.

Most of the country sees through the charade but can do nothing The time for real financial reform was a year ago, when Big Finance was on its knees. Instead Obama focused on remaking the U. S. health care system years from now. What a genius! Let the fire smolder while getting architectural plans for a major extension to the house. Helping Big Finance get on its feet was an essential part of the strategy that guaranteed that real reform would not occur.

The current Greek tragedy is small beer compared to what could come in the New World. Short-term, though, stocks are oversold. But they are too high. Treasuries may be over-bought. But there is no reported net inflation. Thus yields may arguable be too high. Interesting times, to say the least.

Copyright (C) Long Lake LLC 2010

Bloomberg Having no Trouble Finding Bulls. What a Difference a Year Makes!

In a piece of financial pornography masquerading as news rather than opinion, Bloomberg.com "reports" U.S. Stocks Cheapest Since 1990 on Analyst Estimates. It begins:

Even after the biggest rally since the 1930s, U.S. stocks remain the cheapest in two decades as the economy improves.

It ends:

“The earnings story is very supportive of the market even after the rally over the last year,” said Liz Ann Sonders, chief investment strategist at Charles Schwab Corp., which oversees $1.4 trillion in client assets from San Francisco. “The recovery is real, it’s V-shaped and it’s got legs.”

(But what happens when the record combined monetary/fiscal stimuli end or merely diminish?)

In between one gets amazing sections as follows:

Concerns Are Past

“We’re in a time period where the concerns we had in 2007 and 2008 have been taken care of or are past,” Kenneth Fisher, who oversees about $40 billion as chairman of Fisher Investments in Woodside, California, said in a April 20 Bloomberg Television interview. “If you’re waiting for a market pullback or individual stock pullbacks, you could be waiting a long time.”

Or you get this straw man argument:

“The stock market is incredibly inexpensive,” said Kevin Rendino, who manages $11 billion in Plainsboro, New Jersey, for BlackRock, the world’s largest asset manager. “I don’t know how the bears can argue against how well corporations are doing.”

Obviously if Mr. Rendino manages the same assets and their market price simply rises 20%, his pay will rise even though the main driver is the traditional one - - price inflation.

There is a brief nod or two to what the reader is supposed to recognize as a blind bear, with no quote nearly as bearish as the rip-snortingly bullish comments scattered throughout. A reductio ad absurdum of the bullish tone is that it implies that anyone who is decreasing allocation stocks who does not need cash is obviously misquided.

I may have missed it in the article, which is not worth many rereads, but it emphasizes rapid earning gains. The fact that accounting changes for Big Finance plus multi-trillion dollar Fed and governmental support for said banks is responsible for most of said profit change is not mentioned. That Dr. Bernanke and a number of other Fed officials are less bullish than "V" advocate Ms. Sonders may be worth considering. Also not mentioned are the repeated findings from otherwise upbeat reports such as are emanating from the Empire State Manufacturing Survey that businesses are seeing input costs rise a good deal more noticeably than are selling prices; thus profit margins are being squeezed as oil and the like rise in price.

In another piece cut from the same cloth, Bloomberg announces the obvious in Big Banks Are Back as JPMorgan, Citigroup Turn Corner on Crisis. An example of the cheerleading and general idiocy of the piece comes in the third paragraph:

“This quarter is confirmation that credit has turned a corner,” said Charles Peabody, an analyst at New York-based Portales Partners LLC who assigns “buy” ratings to Bank of America and JPMorgan, and a “hold” to Citigroup. Peabody doesn’t cover Wells Fargo. “You’ve heard every CEO say credit has turned, and there is nothing to be gained for them by being overly optimistic.”

Well, no. There is much to be gained by CEOs gaming the system. What about rising stock prices as something to be gained? What about the strategy to have tapped-out consumers draw down savings once again? Etc.

The very title is laughable. There is a survivorship bias here. The banks that are "back" are not "back". They never left. They have been the recipients of unbelievable gifts from the authorities at the expense of massive money-printing, unfairly low rates paid to savers (who have issued no stocks to be pumped up by the Street), immense governmental deficits, etc.

Instead the article ascribes the business cycle to this success and minimizes the ongoing crisis in banks that didn't receive this sort of help and in fact were penalized by FDIC assessments:

While smaller U.S. lenders keep failing, pushing the Federal Deposit Insurance Corp.’s list of “problem” banks to a 17-year high, the largest are getting a lift from economic growth that’s helping consumers and businesses stay current on loan payments.

Whoop-de-doo! They are staying current. Well, sort of. Actually the numbers defaulting have stopped growing. Defaults are still plentiful. But you already see companies such as Wells and Goldman Sachs trading well above book value despite having unknown amounts of dodgy assets on their books as Level 3 assets.

The article ends with the same rah-rah quote with which the other article ends:

“A year ago we were in the middle of a financial panic, but these banks are looking forward,” said Gary Townsend, president of Hill-Townsend Capital, a Chevy Chase, Maryland- based investment firm with $50 million of holdings in financial companies. “The improvement is becoming quite pronounced.”

The powers that be should be discussing openly how the epidemic of mortgage and other fraud in the 1980s that brought down the S&L's worsened after a healing phase in the 1990s. By 2001 the FBI was already investigating this epidemic, but its priorities changed after 9/11. It probably was much more the alt-A ("liar's loans) modality that fueled the real estate boom, which became self-sustaining after a while and then needed the explosion of subprime lending to push the boom into the bubble phase.

As small investors see theis sort of headlines, it will be time for the smart money that has been accumulating or holding stocks while the individual investor has been gobbling up bond funds to start the distribution process.

Right now all financial instruments are expensive.

I continue to believe that a winning contrarian view is a healthy skepticism about the cheerleading while being in alignment with the Fed or the tape.

Two asset classes that remain in unbroken well-defined uptrends over the intermediate term are gold (and almost silver and platinum) and Treasuries. The latter looks extended and has massive supply; but as per Japan, who knows?

Gold's chart remains impeccable, and the more the Establishment flogs stocks and how wonderful and resilient the U. S. economy is even though there was a stock "panic", the more we are farther from all the Depression-era food line pictures of late 2008 and into a go-go time.

Caveat (and holder) emptor. They are feeding the quacking ducks with thin gruel. As the business cycle moves along toward the next peak, companies and industries with real assets and real staying power that have not been the recipients of extraordinary aid may be the best. Chubb (CB) is on the verge of a technical breakout, has 20% or so upside per conservative valuators of stocks, and yields almost 3% while retiring lots of stock and reporting rising book value; other insurers and reinsurers suffered no more than collateral damage during the downturn and represent some of the little reamaining fundamentally inexpensive stock groups remaining in this market that according to Andrew Smithers' version of q trades at a near-record high valuation.

Copyright (C) Long Lake LLC 2010

Pedal to the Metal in the Merry Merry Land of US

Per Zero Hedge, economists Robert Shiller and Mark Zandi believe that perhaps up to $100 B yearly is spent by consumers who have stopped paying their mortgages, or who pay much less than they owe due to modification programs. That may be 1% of consumer spending ultimately paid for by the taxpayer due to such programs as the Fannie/Freddie/Fed MBS two-step. Basically it's monetization.

Meanwhile the stock market remembers Marty Zweig's admonition and is not fighting the Fed or the tape.

Not only is this an extend and pretend rally and then some, but based on antiquated measures such as the Greenspan Fed model, the stock market can be said to be grievously undervalued. But . . . but . . . the rationalist splutters-- it's a contrivance. Treasury rates are low because the economy is so weak, not strong, and thus price-earnings ratios must account for normalized Treasury or corporate bond rates.

And the rationalist is right--someday.

Living in the immaterial world, as the (former?) Kabbala-ist known as Madonna has done, stocks are just numbers on a computer screen.

Probably the worst thing heard today was that a talking head on CNBC asserted that GOOG stock is undervalued because Baidu trades at 100 times earnings. 1999, anyone?

But as in 1999, babies were thrown out while bathwater was being promoted as perfume (or something like that!). On its own merits, the reinsurer Everest Re ("RE") trades at a big discount to tangible book value. In the early 2000s, it did so and then went wild, quickly trading at a big premium to (rising) tangible book. This sort of stuff happened like mad in 1999 and 2000. So there are both trading and buy-and-hold opportunities in the stock market, with a lot of fluff.

Re cash, a poll of economists in early 1982 showed an overwhelming preference for cash. Looking out over the next year or two, by far the worst investment class was cash, as rates plummeted. Stocks and bonds, disliked by those experts, did far better. By analogy, cash is hated and disdained, but one of these days if the economy in fact is/becomes strong, rates on cash will rise. Stocks and bonds may both fall in price and cash will then be the appreciating asset. Watch for it. Not today or tomorrow, but investors should watch for that situation.

Copyright (C) Long Lake LLC 2010

"They" Are Still Spinning

Asset inflation continued apace last week in the financial markets, most notably on Friday, when prices of stocks, government bonds and precious metals all went up. Huh?

One of the theoretical underpinnings of the rise in stocks is that prices to earnings are reasonable to cheap, and hey all other yields stink anyway, so who needs dividends?

The problem that is summarized in Investorsfriend.com, an almost infinite number of P/E ratios exist.

In a more specific mode, Oracle "earned" 38 cents in the February quarter just reported. But wait! Under
generally accepted accounting principles, ORCL earned only 23 cents the same quarter. What's up with that?

From Oracle's press release:

GAAP operating income was down 5% to $1.8 billion, and GAAP operating margin was 29%. Non-GAAP operating income was up 13% to $2.9 billion, and non-GAAP operating margin was 45%. GAAP net income was down 10% to $1.2 billion, while non-GAAP net income was up 9% to $1.9 billion. GAAP earnings per share were $0.23, down 11% compared to last year while non-GAAP earnings per share were up 9% to $0.38.

Double huh. Try to make sense of that! No further explanation was given by the company. Basically, Oracle "earned" a fictitious number but its accountants said it actually earned about 2/3 of what it wanted to tell you it "earned". It returned a nickel a share in dividends, for an annualized yield of less than 1%.

In the old days, such as 1929, investors would have walked away from a mature, large company that disdained sharing the wealth with shareholders. Now, in financial Fantasyland, earnings mean whatever the company wants them to mean, and the SEC cares not a whit.

It is reasons such as the macro example given first and the micro example of ORCL (which also applies to other darlings such as TEVA) that it is important to also consider asset values such as tangible book value or the Tobin "q" value, such as the Smithers version of such referred to many times herein.

On that score, stocks are richly valued, and only the low level of interest rates (due to economic weakness) makes the whole olio acceptable.

Assuming that the economic optimists are correct, much higher interest rates are coming and along with that one day will come much lower stock valuations, if the past is any guide at all.

Meanwhile, while not transactional money, gold continues to boringly just sit there, and unlike the stock averages even with dividends reinvested, gold almost uniquely among major US asset classes has broken out to all-time highs and continues to act well.

When GLD got to $119 in early December, this site "called" a top and suggested a $110 +/- $3 trading range would follow. This happened with one break below that level. The price is now challenging/breaking out from the top of that range. Based on patterns of other financial asset such as TJX and ROST, sooner rather than it makes sense that with debt piled upon debt, those with paper wealth in stocks will continue to transfer it to precious metals, gold shorts will cover, and the same melt-up that has occurred in stocks will occur with no overhead supply in the gold market. Gold has had a strong surge very recently, but given all the chicanery in stocks and, increasingly, the proof that short-term money rates are below any reasonable estimate of consumer inflation, we are back to the 1970s as well as 2007-8 where the Fed is just simply behind the curve.

For now, the DoctoRx approach is: marry gold (with no-fault divorce available), rent the best stocks including asset-backed ETFs, flee cash.

Copyright (C) Long Lake LLC 2010

Stocks for the Long Yawn

From the beginning of 1994, when the economic recovery from the 1990 recession was more or less complete and the Fed began hiking rates, till now, the stock market as judged by the S&P 500 has risen from 446 to 1187.

Value Line maintains a different index, in which all stocks are weighted equally, so that a small company counts the same as IBM. This reflects the fact that for a small investor, $1000 or $10,000 can just as well go into a small cap as a mega-cap. Institutions of course lack that freedom.

In the same time period, the overall Value Line Index ("Geometric") is unchanged. I also suspect that dividend payouts were higher from the '500', given the greater maturity of those companies.

The Value Line Industrials are actually down a bit, as are the Utilities (though with much higher yields); only the Rails are up (6 times!).

In these past 16 years, the country has been out of recession all but about 2 1/2 years. Thus overall the climate for small companies and their stocks could have been good. It is difficult to explain this observation. Large-cap stocks had been moving up substantially since the 1982 bottom, so they were not "depressed". Did smaller companies' stocks suffer from chronic overpricing?

I suspect that was and remains so. This flies in the face of the standard line that research shows that since 1927, small caps have noticeably outperformed large caps.

Most investors who choose their own individual stocks are best off ignoring market cap and focus on financial strength, track record of the company and the stock, presence or absence of dividends or dividend-paying ability, and other fundamental and also technical factors. When in doubt, financial strength and the absence of a stretched valuation vis-a-vis the underlying assets of the company take away much of the downside risk to a stock.

In the here and now, stocks are either cheap or expensive, depending to whom one listens. Monetary and fiscal stimulus, AKA easy money, are working their magic. Overcapacity is allowing ultra-low short-term rates to persist. Small investors who have patiently held stocks but not bought more over the last few years are increasingly reaching the break-even point. As their perceptions of the overall economy remain downbeat, many will wish to get out even. I for one am sticking either with fundamentally cheap stocks that are going nowhere fast-- RE, RNR, CB; or stocks that are either already at all-time highs or multi-year highs such as TJX, DLTR, MCD and WPI. All the above have P/E's lower than the market and have substantial free cash flows.

Nonetheless, overall yours truly remains of the view that stocks are fundamentally overpriced as a whole and that the current cyclical upturn in the economy is so unbalanced that we need to fear the next cyclical downturn, when investor psychology will allow stocks to return to a valuation which offers a more attractive entry point for the market as a whole.

Copyright (C) Long Lake LLC 2010

Financial Crisis Was Predictable and Leaves Poor Investment Choices

Steve Keen's Debtdeflation.com has a post that contains a remarkable history of predictions of the housing bubble-induced economic crisis. Reading it makes it clear that the permabulls made no sense. It was in the run-up to the crisis that Dr. Keen registered the URL "debtdeflation.com". Even as a non-economist, it was obvious to me by summer 2007 that housing was in a depression, autos were in a severe recession, and therefore the domestic economy was in or going into at least a mild recession already, with only exports keeping things afloat. Given how high stocks were, it was an easy decision to sell all I could.

After being long stocks since August 1982 on, the first exit I made was throughout 2000. It was back in but only halfway in spring 2003.

Where now?

The averages: no.

Individual issues in selected asset classes: yes.

The economy will grow until it does not, but stock prices in the aggregate are too high for one year of improved earnings to affect their fundamental overvaluation. Right now, technical and sentiment factors argue for a "correction". Will "they" squeeze some remaining shorts and goose things higher?

Could be. But the S&P 500 could be halved to merely bring its dividend yield equal to the level of the 10-year Treasury. It was only about15 months ago that this equivalence occurred (briefly). The prior time was about 1960.

I anticipate this equivalence to return, but when and at what yield levels are unknowable. Right now one can find stocks with a 6-7% free cash flow "yield" that would be available for dividend payouts. DLTR, ROST, WPI, TEVA and CB are among many issues with that "value" characteristic. In overvalued times, Graham and Dodd just don't work anymore. One day their much more stringent criteria may be useful. For now, free cash flow yield or discount to tangible book value for profitable companies are the best the market offers.

Copyright (C) Long Lake LLC 2010

An Unholy Trio of News Items

When one clicks on an NYT article on wage garnishment, one is led to a resonant trio of articles. In the garnishment article, we learn that many people can fall prey to a vicious cycle of huge interest payments, so they become debt zombies, unable to pay off the loan in full given (say) 28% interest rates. We also learn that judicial review of the garnishment procedure is not the norm.

At the bottom of the page of this article, the Times asks you to click on another article. This one is about a multiyear record number of personal bankruptcies for March 2010. This is of course the worst outcome for a lender. It is obvious why a reader looking at the garnishment article would want to click on a personal bankruptcy update.

What was the next suggested article to read?

How strong the stock market was last week!

Says it all . . .

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Gold Traders Bored While Stock Investors Enthused

As yours truly has been busily moving some assets from discount retail stocks and some other stocks into Gold-Trust (GTU)this past trading week, it is good to see that Trader's Narrative reports that gold sentiment is not very good; for the full blog post from March 30, click HERE.

Here is the money quote from his piece that makes me especially comfortable with a ramped-up allocation to physical gold:

While that reduction in exuberance may appear bullish at first glance, looking at the historical pattern of gold corrections in the past few years shows us that sentiment needs to get a lot lower. For example, during the low one year ago, the HGNSI (Ed.: Hulbert Gold Newsletter Sentiment Index) fell to -17%; implying that gold timers were actually short gold.

I can't tell if the "low one year ago" is the April 2009 low or the panic lows of fall 2008. In either case, the idea that sentiment "needs" to get a lot lower is unsupported. And in any case, the idea that with financial asset inflation on the march and money market reserves yielding nothing, even if we are some months from the next bull move in gold, dead money is not so terrible.

The same blog pointed out yesterday that the estimable Ned Davis' crowd sentiment index shows extreme optimism and therefore is flashing a short-term top signal; for that post, click HERE.

Gold outperformed stocks in the U. S. from late August till early December. Since then, it has been the opposite case. Perhaps it's time for a change once again.

Copyright (C) Long Lake LLC 2010