Some Contrarian Signs in the Treasury Market

First, a note.  I put up a "long-term bullish" article on CVS on Seeking Alpha (LINK).

Next, while I continue to be more bemused than anything else, I am noting the bubbly valuations on the Russell 2000 (25X trailing P/E) and even higher on the Russell "growth stock" indices, and wondering if and when it is 1998-9.  If so, Treasuries will come into fashion again.  But overvaluation along does not kill a bull market.  In those pre-QE days when money was acknowledged not to be free, the market top only occurred after the Fed tightened.  Will it be the same now, or as with Japan, stock corrections and recessions will occur with ZIRP going on?

ZH updated a chart I saw some months ago that show a strange correlation between very low volatility in the T-bond and future market corrections or worse, associated with sharp drops in interest rates (LINKhttp://www.zerohedge.com/news/2013-02-13/how-bad-could-it-get-bonds).

There are few data points, and both were followed by dramatic events:  the LTCM/Russian bankruptcy fiasco, and the 2006-7 period.  Note for those looking at the right-side numbers, the numbers have a zero cut off.  The top right number is 200, not 20, the next down is 180, not 18, etc.

Also, I was emailed the most recent copy of the McClellan Report, which has turned bullish on bonds.  It presents data from the Rydex Funds showing the following:  A) that money market fund balances are at multi-year lows; everyone is "in", and B) the market timer(s) in the long Treasury and short Treasury trading funds, who have been consistently wrong, is(are) heavily short them again.

Next, futures market positioning on the 30 year Treasury is at speculative short levels that have been associated with major peaks in yield the past two years, though the 10-year shows less negative sentiment, and negativity in both assets was even greater leading up to and during the Great Recession.

Last, I have observed that as a moderator of the Apple-oriented Braeburn Forum and as a contributor to SA, bullishness is rampant.  There are some skeptics, but few people even try to adjust P/E's for the fact that the U.S. is engaging in monetary financing of state deficits.  This would be sustainable only if there is still a crisis as in 2008-9, in which case P/E's should be low; or it will stop soon, and all this free money from Washington will no longer be free, in which case P/E's will tend to drop (though earnings of the "right" companies may continue to grow.

I continue to believe that if the Rogoff-Reinhart paradigm continues to follow historical precedent, more low-interest rate stagflation lies ahead for the United States.  The investing public, including fund managers, is not thinking this way.

Thus, there is an increased chance of a discontinuous market event within the next year or two.

Thoughts On the Long Bond, and Other Comments

A post went up on Seeking Alpha suggesting that even equity-oriented investors should consider diversifying their portfolios with Treasury bonds, such as with the widely-traded ETF TLT.
This is the LINK.

The theme is familiar; there is updated information here and there, so it may be of interest.

The US markets continue to follow the Reinhart-Rogoff pattern.  Economic data is coming in OK, but adjusted for Federal deficits paid for by Fed money rather than by borrowing out of real savings, it would, I think, probably still be seen to be recessionary or at best troughing.

Bill McBride of Calculated Risk is looking at yoy sales data in depressed markets such as Sacramento and noting that aggregate "used" home sales are sharply down in volume yoy.  Now that Obama has been re-elected, there is less need to cheerlead the economy.  In fairness to him, a year ago he was more cautious on housing for the next couple of years than he got more recently.  (I use him because he links almost exclusively to Paul Krugman and his ilk on his featured blogs and columns.)  Also,  Robert Shiller came on CNBC and expressed a distinct lack of enthusiasm about housing prices for the next several years.

Meanwhile, over-bullish signs regarding not just sentiment but also bullish behavior by the "dumb money" are being documented not just by the short-seller's favored blog (ZH), but by the unbiased subscription-only publication SentimenTrader (behind a firewall).  One can never know how long this condition persists, and it can taper off with little damage to stock prices.  However, the Russell 2000 (R2K) is trading around 25X trailing earnings, and that P/E excludes the contribution from companies such as biotechs that have negative earnings.  This index is wildly overvalued.  The trailing 5-year growth rate
from the R2K is 5%.  Meanwhile you can buy CVS at about an 8% free cash flow yield (12.5X projected free cash flow for the next 12 months), with a 20% growth rate the past 5 years and unending projected growth ahead as it begins to expand internationally.  Thus I see this as an overvalued stock market but also, as it was in the 1998-2002 period, one in which some sectors are too cheap but the average stock is too expensive.

Futures positioning in the R2K is at its most bullish as far as I can find data easily (LINK).  The speculators are heavily long in copper as well.  The last time they went quickly from moderately bearish to heavily long was coming out of the Great Recession.  Copper was $3.50 a pound when they bulled the price up.  As of December 2012, the price was $.350.  Copper went nowhere for 3 years.
Should this pattern recur, Treasury yields are getting near or have already seen their peak.

With the Fed loose and the Federal government loose but less lose than in 2009, I do not foresee a collapse in stocks.  The lack of good competing alternatives leads me to cover the bases with recession-resistant securities that pay dividends.  Stocks in that category generally are shrinking or holding steady the share count.  This includes Blackrock (BLK) and IBM (IBM).  Stocks are risky; bonds with any "decent" yield are risky.  Pick your risk.  I choose some from column A and some from column B.

Finally, per the name of this blog, there are two posts up recently worth reading and thinking about:
LINK and LINK.  Please check them out.  The second one is a Seeking Alpha article that improves part-way into the body.  I have not even finished it.  Both linked articles are interesting.

Futures are, not unusually, bright green again.  The inflationary 'boom" that the Fed and the Feds are engineering is going on apace.  This could be 2011 again.  Please don't chase hot stuff unless it's with a well-defined profit goal.

Good-Bye to The Daily Capitalist, and Why the Stock Market Is Not Close to a New Real High

Now that The Daily Capitalist has unfortunately closed, I welcome any regular readers of that blog.  We will see what evolves here.  Jeff Harding set a high standard.  Perhaps it will make sense for some of his contributors to post here.  We shall see what technical or other consideration will be required.
"Working" at TDC made me a better writer and allowed me to learn more about economics and finance, and more important things as well.

Meanwhile, naturally the MSM is cheering the achievement of the major stock market averages equaling or exceeding their pre-crisis highs.

So, ever the realist, I wondered what deflator to put on today's averages.  The S&P 500 and DJIA are roughly where they were in mid-July, 2007.  So I went back and looked at what the two most "core" forms of wealth/money for the long run in America and the world are.  One is gold.  The other, with a shorter duration than gold but still long, is the 30-year Treasury bond.  In order to be comparable to gold and to eliminate the reinvestment problem, this should be a zero-coupon bond.

It turns out that, without fine-tuning the compound interest numbers, gold has returned roughly 18% per year since then, and the T-bond has returned about 16% per year.  Meanwhile, stocks have returned only their dividends.  This explains, at least teleologically, why the Russell 2000 has gone to a new high-- it has lower dividend payouts than the more mature Dow.

In other words, the stock market has dropped by about half relative to gold and T-bonds since July 2007, even including dividends.  Hold the applause.

The above said, I look at the stock-bond cycle as follows.  In Y2K, bonds yielded about 6.5%, with a flat yield curve.  Stock dividends were well under 2%.  Bonds were the overwhelmingly better choice.  Buy 2007, bonds were still better, yielding 5.25% at their high, also with a flat yield curve.  Stocks were less overvalued than in 2000, though.  Now, after the second stock crash, bonds and stocks finally have about equal yields/dividend payouts.  There is finally a level playing field.  Thus I am going to go back to my roots and focus more on stocks, believing that more than 30 years of generally successful individual stock-picking can provide insights that will allow a patient investor to actually beat the market.  I will have more to say on this.  Of course, all stock-pickers say they can beat the market, but then they/we become the market, LOL, and beating the market becomes impossible.  That said, until I left stocks between 2007 and 2009, and then went back only grudgingly, I regularly beat the market by 15% yearly, year after year, never with a down year.  That includes 2001 and 2002.  So we shall see.

I am going to submit articles on various matters to Seeking Alpha (SA).  Some have been published there.  I am going to comment periodically on matters I have been researching.

I mentioned RyanAir (RYAAY) in the last post.  In researching it, I see that it trades 15-20% higher in price in the U.S. ADR's than in Europe.  That's a red flag.  It's a great company but if bought, a correction would be the time.

The other company I have looked into and know from my combined experiences as a physician, pharmaceutical industry executive and entrepreneur, and consumer is CVS Caremark (CVS).  This stock is a clear long-term buy and hold.  They are really good- a free cash flow machine, almost all of which goes straight back to shareholders.  That's a much fairer strategy than Apple's cash-hoarding habit.  I will get a piece up on that company within the week, personal events permitting-- either here or on SA.

Over and out for now.

Seeking Alpha Update

Readers have commented on how to find my Seeking Alpha posts.

It looks easy.  On signing in at seekingalpha.com, you should see a horizontal box on the right-hand side, near the top, that allows you to type in a keyword such as an author.  Typing in doctorx should bring up a list of my posts.  I'm able to do that; please let me know if you are not able to.

 I do not know if it is possible to obtain an RSS feed of my SA posts.

Thanks for following.

Seeking Alpha Follow-Up; Jim Rogers Shorts Treasuries

A second article, on gold/GLD, has been published on SA:

I picked GLD for a general readership.  My preference is either for physical or for a true physical fund, basically PHYS, the Sprott fund that allows Americans to get capital gains treatment; no other fund has this capability.  Thus gains in GLD etc. get treated as commodity gains.  In any case, the longer-term bull case on gold looks better to me than it has since mid-2011, though as restated below, times are unusually uncertain.  Gold has no short-term momentum behind it, so this is not a "wild bull" piece, more of a statement of a bullish bias toward the asset versus the USD and other USD-based investment choices.

I am in the process of getting links or notifications in place between SA and this site.  My daughter who lives down the street from us just had a C-section and a healthy baby, and I've been busy with other mission-critical things, so -- everything in its time.  It's gratifying to start that relationship.  I think that SA has potential and that it might be attracting a better class of writers; likely that's their goal.

I published a thematic article in which the message was "gold on hold, buy munis" piece at The Daily Capitalist in September, 2011 around the current gold price but at much higher muni bond yields.  This was a good call.  Gold has gone nowhere even though stocks have caught up and QE is now underway in a huge way.

I now reverse that muni call and think munis are at best a hold, or a sell-- the fear factor is finally gone from munis.  Though some California zero-coupon low-investment grade tax-exempt munis-- a very special niche, to be sure, yield much more than Treasuries and may still see some nice price appreciation faster than the yield implies.  And given how I feel about stocks "for the long run", I also took some spare cash and purchased a small odd lot of Illinois GO's maturing in 2016 at a pretty decent yield for the times we're in.  The reasoning was the the President is not, not, not going to let his home state default.  I think that Illinois GO's are money-good for a while.  It's sad that investors are reduced to scrounging for 100 basis points of yield, but as Charlie Munger said, we have to suck it up.

And actually, per today's topic, Treasuries are beginning to finally be looking like the tail end of a bear move, though perhaps they have some more upside potential in yield even if lower yields await (though the structural bull market may or may not be over).

One reason I say this is the following headline in BBG (LINK):

Jim Rogers Joins Bill Gross Warning on Treasuries

Much as I have enjoyed reading Jim Rogers' travel books and have followed him into investing in Russian ETFs (a modest exposure, to be sure), he has been the single best contrarian indicator on the movement of Treasuries I have seen over the past three years.  It seems to me that the time to short Tbonds is when stocks have been pummeled and the VIX is high.  Even Jim Rogers has to pay the broker its call money to short a security, and he is out the coupon.  So on an annualized basis, perhaps he's out 6% or more just to short the long bond.  Who needs it?  Why not just go long silver if he's so confident that price inflation is going to accelerate?

The other reason I'm sniffing at least a rally is that, finally, the speculators are shorting them on the futures board.  Now we will just have to see how the politicians handle things in DC, and how the real economy appears to perform, and whether Europe actually finally suffers an extreme event or actually starts healing for real.  These are unusually uncertain times, and thus I'm not trading much or initiating new positions.  Is the long-term secular bear market in stocks actually ending, or resting?  Could be, you never know.  Or are we due for a third crash?  Could be, you never know.

Bill Gross, OTOH, has not been much of an indicator either way.  Sometimes he's right on interest rates, sometimes he's wrong-- at least in his public pronouncements.  But sometimes he's talking his book, and sometimes perhaps he's trying to move markets a bit so he can trade against the market.

For want of a better valuation metric in today's very strange markets, I'm happy to use Value Line's time-tested and self-adjusting algorithm.  Based on that, and based on a mediocre Q4 earnings season and higher interest rates than at year-end (a negative for stock prices in their equation), stocks are ahead of themselves at best. (Their average projection for the Dow for 2013 was 13,440; that would be lower now given higher yields.  Thus a correction to 13,000 would make sense to their computer even in a non-recessionary situation.)

I am also researching RyanAir (RYAAY in the US), the Irish airline, which is the European version of LUV (Southwest Airlines).  Here is a LINK to the max timeframe chart.  To a nerd like me, this chart is a thing of beauty, not necessarily for a short-term trade, but on a longer-term basis.  The agreement with SA is that the articles are unique, so I won't say more now.  If any readers have personal experience with the airline or if you have thoughts on it as an investment, please comment.  I have not solidified my thinking on it.  It just announced a bang-up quarter and analysts raised out-year earnings estimates a lot, so it appears to be achieving strong operational results.

Over and out for now.