“Truth or Consequences?” (Saut)

Monday, April 30th, 2012

by Jeffrey Saut, Chief Investment Strategist, Raymond James

April 30, 2012

“I have opted for more conservative ideas and not aggressive ones.”

After 28 years at this post, and 22 years before this in money management, I can sum up whatever wisdom I have accumulated this way: The trick is not to be the hottest stock-picker, the winning forecaster, or the developer of the neatest model; such victories are transient. The trick is to survive. Performing that trick requires a strong stomach for being wrong, because we are all going to be wrong more often than we expect. The future is not ours to know. But it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances. Being wrong comes with the franchise of an activity whose outcome depends on an unknown future (maybe the real trick is persuading clients of that inexorable truth). Look around at the long-term survivors at this business and think of the much larger number of colorful characters who were once in the headlines, but who have since disappeared from the scene.

The aforementioned quote, from the brilliant Peter Bernstein (author, historian, economist, and investor), hangs on the wall of my office, for in this business one is often wrong. But, as Bernstein notes, “Being wrong comes with the franchise of an activity whose outcome depends on an unknown future.” My redeeming feature is that when I am wrong, I tend to be wrong quickly. Or as stated by William O’Neil, “The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable. They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and [that] costs them dearly.”

Indeed, we are always trying to manage the “risks&rdquo inherent with investing (or trading), for as Benjamin Graham wrote, “The essence of investment management is the management of risks, not the management of returns.” And that, ladies and gentlemen, is why we often “wait” on an investment until its share price is at a point where if we are wrong, we will be wrong quickly, and hopefully the incidence of “loss” will be small and manageable. To be sure, we always consider the consequences of being wrong. This is when risk management lives up to its real meaning. Again as Peter Bernstein wrote in a New York Times article:

The key word is ‘consequences.’ I learned this lesson many years ago from studying Blaise Pascal, a French mathematical genius in the 17th century who spelled out the laws of probability more clearly than anyone before him. This was a thunderclap of an insight that, for the first time, gave humanity a systematic way of thinking about the future. Pascal was both a gambler and a religious zealot. One day he asked himself how he would handle a bet on whether ‘God is or God is not.’ Reason could not answer. But, he said, we can choose between acting as though God is or acting as though God is not. Suppose we bet that God is, and we lead a life of virtue and abstinence, and then the day of reckoning comes and we discover that there is no God. Well, life was still tolerable even if less fun than we might have liked. Here, the consequences of being wrong would be acceptable to most people. Suppose, however, we bet that God is not, and lead a life of lust and sin, and then it turns out that God is. Now being wrong has put us into big trouble.

RISK management, then, should be a process of dealing with the consequences of being wrong. Sometimes, these consequences are minimal – encountering rain after leaving home without an umbrella, for example. But betting the ranch on the assumption that home prices can only go up should tell you the consequences would be much more than minimal if home prices started to fall.

To this “truth or consequences” point, after being wildly bullish at the October 4, 2011 “undercut low” I turned cautious on the equity markets in late January when the “buying stampede” ended. Since then I have been waiting for a price decline that would produce another good risk-adjusted “buy point” like the ones identified on August 8th and 9th of last year, as well as the aforementioned “undercut low.” That does not mean I have not been featuring certain investments when the risk/reward metrics were deemed as being tipped decidedly in our favor. Rather, I have opted for more conservative ideas and not aggressive ones. Case in point, in last week’s verbal strategy comments 3.5%-yielding Rayonier (RYN/$45.51/Strong Buy) was again featured with these comments from our fundamental analyst:

We are upgrading REIT Priority List member Rayonier to Strong Buy (from Outperform) as we believe RYN shares currently offer one of the most compelling risk/reward profiles in our REIT coverage universe. In our view, the underperformance of RYN shares year-to date (RYN shares are down 1%, while the RMZ and S&P 500 are both up 10%) present an attractive entry-point for investors ahead of the company’s highly accretive cellulose specialties expansion project, which is on track to come online in mid-2013.

Another name featured was 7%-yielding LINN Energy (LINE/$39.86/Strong Buy). As stated by our fundamental analyst:

The partnership delivered another strong quarter beating our EBITDA and distribution coverage forecast, proving that not only does it know how to buy assets but it does a good job of operating them too. Speaking of operations, lightning has now struck twice in the Granite Wash with the partnership’s horizontal Hogshooter play having the potential to be one of the highest rate of return oil plays in the country. Based on our continued bullish outlook for the acquisition market, our forecasted distribution growth (5%+), and its solid hedge book, we reiterate our Strong Buy rating.

Last week this conservative strategy looked somewhat foolish (again) with the D-J Industrials (INDU/13228.31) up 1.53% and the S&P SmallCap 600 Index (SML/462.02) better by 2.58%. The real weekly winner, however, was Natural Gas’ 9.67% sprint. The best performing macro sectors were: Financials (+2.21%); Technology (+2.56%); Energy (+2.67%); and Consumer Discretionary (+2.76%). The Consumer Discretionary performance is interesting because last week’s economic reports continue to soften as of the 15 reports released only six were above estimates. Also disappointing were earnings reports with 65.6% of reporting companies beating earnings estimates and 65.1% bettering revenue estimates. This was a pretty big drop from the previous week’s ratio. Even more troubling is that forward earnings guidance turned negative, which was a decided negative swing week over week. The two sectors that have telegraphed the best forward earnings guidance are Healthcare and Industrials. Meanwhile, many of the indices I follow are breaking down from what a technical analyst would term a rising wedge chart pattern (read: negatively), the D-J Transportation Average (TRAN/5267.39) continues to struggle with its double-top often referenced in these comments (that would be negated by a move above ~5390), the NYSE McClellan Oscillator is back in overbought territory (see the chart on page 3), the Buying Power/ Selling Pressure Indicator suggests the rally from the April 10th low has been more about reduced selling pressure rather than increased demand, the Operating Company Only Advance/Decline has never confirmed the upside, and my weekly internal energy indicator still does not have enough energy to support a new leg to the upside. Regrettably, all of this continues to leave me in cautious mode.

The call for this week: In this business when you’re wrong you say you’re wrong; at least that’s what the pros do. Clearly, I have been somewhat wrong by being conservative, but not wrong by much because the INDU is actually 70 points lower than where it was at the April 2, 2012 intraday high. Given the aforementioned litany of cautionary indicators, my sense remains the S&P 500 (SPX/1403.36) will spend some more time below 1425 while the short-term overbought condition is alleviated and the stock market’s internal energy is rebuilt. Friday’s market action only reinforced that belief with the indices gapping higher and then closing well below those highs on lower volume.

Click here to enlarge

Tags: 22 Years, 28 Years, Bad Luck, Benjamin Graham, Chief Investment Strategist, Colorful Characters, Conservative Ideas, Economist, Forecaster, Franchise, Historian, Instances, jeffrey saut, Money Management, O Neil, Peter Bernstein, Raymond James, Saut, Stock Picker, Term Survivors, Truth Or Consequences
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Canada Market Radar (April 30, 2012)

Monday, April 30th, 2012

Performance of Key TMX Sub Indices  – One Year (May 4, 2011 – April 30, 2012)

Source: StockCharts.com

Performance of Key TMX Sub Indices  – Year to Date (January 3, 2012 – April 30, 2012)

Source: StockCharts.com

Performance of Key TMX Sub Indices  – One Month (March 29, 2012 – April 30, 2012)

Strengths

Home prices move higher in March – The Globe and Mail

Home prices crept higher in March as a slowing Vancouver market was offset by an acceleration in prices in Calgary, Toronto and Montreal, according to a report by the Canadian Real Estate Association.  The MLS home price index was up 1.3 per cent in March on an month-over-month basis and up 5.1 per cent per cent compared with a year ago.

Canada March Industrial Product and Raw Materials Prices (Text) – Bloomberg

The Industrial Product Price Index (IPPI) edged up 0.2% in March, led by higher prices for petroleum and coal products. However, the advance of IPPI was moderated by primary metal products (-1.0%). The Raw Materials Price Index (RMPI) declined 1.6%, largely because of mineral fuels.

Weaknesses

Economy posts surprise decline in February – The Globe and Mail

Canada’s economy shrank unexpectedly in February, by 0.2 per cent, as factories posted their first drop in output in six months, and mining activity plunged.

Canada Feb. Gross Domestic Product Report (Text) – Bloomberg

Real gross domestic product declined 0.2% in February. Temporary closures in mining and other goods-producing industries contributed to the decline. Decreases in mining and oil and gas extraction, manufacturing, utilities as well as forestry and logging outpaced advances in construction. In service-producing industries, gains in wholesale trade and in the finance and insurance sector outweighed declines in retail trade and in the transportation and warehousing sector.

Canada’s auto parts sector falling behind – The Globe and Mail

Despite a recent rebound in the auto industry, Canada’s auto parts manufacturers have fallen from the ranks of global top 10 exporters because they failed to diversify their markets.  Canada’s auto parts sector is losing global market share because it has not found a way to tap into the rapid growth in low-cost locations, Bank of Nova Scotia economist Carlos Gomes said in a report on Wednesday.

Bank of Canada Won’t Increase Rates, Stretch Says: Video – Bloomberg

April 30 (Bloomberg) — Jeremy Stretch, head of currency strategy at Canadian Imperial Bank of Commerce, talks about the outlook for foreign-exchange markets and Bank of Canada interest rates. He speaks with Guy Johnson on Bloomberg Television’s "The Pulse." (Source: Bloomberg)

Opportunities

Energy Transfer to buy Sunoco for $5.3-billion – The Globe and Mail

Pipeline operator Energy Transfer Partners LP (ETP-N48.320.400.83%) said it will buy Sunoco Inc. (SUN-N49.188.2720.22%) for $5.3-billion in stock and cash as part of its plan to focus on transporting more crude oil and refined products amid falling natural gas prices.  Oil and gas production from shale formations in the United States has surged over the past two years creating a scramble to build infrastructure to get supplies to refining hubs.

Threats

Carney’s debt warnings at odds with monetary policy – The Globe and Mail

Canadians have never been as indebted as they are now. The Bank of Canada expects debt levels to eventually reach near 160 per cent of disposable income – the same level reached by Americans just prior to the crash.  These debt warnings have been a constant in Mr. Carney’s public pronouncements over the past few years – just not in his actions.  And nothing speaks louder than easy money. Low mortgage rates make larger and pricier homes accessible to more people, pushing home prices higher in a vicious cycle that may not end well.

Moody’s debt-rating downgrade sour news for Ontario – The Globe and Mail

Just two days after the McGuinty Liberals’ first minority government budget passed a crucial vote, one of the world’s major credit rating agencies downgraded Ontario, citing the province’s swollen debt burden and tough economic times ahead.  Moody’s Investors Service’s decision Thursday to downgrade Ontario followed a stern warning and dimmer outlook issued one day earlier from Standard & Poor, another influential credit rating agency.

Loonie 6-Month Lead at Risk as First G-7 Rate Gain Looms – Bloomberg

The Canadian dollar’s reign as the best-performing major currency over the past six months is in jeopardy as rising consumer debt loads collide with plans by Bank of Canada Governor Mark Carney to increase interest rates.

Tags: Auto Industry, Auto Parts Manufacturers, Canada March, Coal Products, energy, Gas Extraction, Globe And Mail, Globe Mail, Goods Producing Industries, Gross Domestic Product, Home Price Index, Industry Canada, Insurance Sector, Mail Canada, Market Radar, Mineral Fuels, Mls Home, Raw Materials, Retail Trade, Vancouver Market, Wholesale Trade
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“Release the Kraken” (Hussman)

Monday, April 30th, 2012

by John P. Hussman, Ph.D., Hussman Funds

Over the past 13 years, and including the recent market advance, the S&P 500 has underperformed even the minuscule return on risk-free Treasury bills, while experiencing two market plunges in excess of 50%. I am concerned that we are about to continue this journey. At present, we estimate that the S&P 500 will likely underperform Treasury bills (essentially achieving zero total returns) over the coming 5 year period, with a probable intervening loss in the range of 30-40% peak-to-trough.

Why? First, with respect to 5-year prospective returns, it’s important to recognize that returns at that horizon are primarily driven by valuations – not the “Fed Model” kind, but the normalized earnings and discounted cash flow kind. Stocks remain strenuously overvalued here, and only appear “fairly priced” relative to recent and near-term earnings estimates because corporate profit margins are more than 50% above their long-term norm. Meanwhile, corporate profits as a share of GDP are about 70% above the long-term average. As I detailed in Too Little To Lock In, these abnormally high margins are tightly related (via accounting identity) to massive fiscal deficits and depressed household savings rates, neither which are sustainable.

Our projection for 10-year S&P 500 total returns – nominal – is about 4.4% annually, which is far better than the 2000 peak, far inferior to the 2009 trough, and save for the period before the 1929 crash, worse than any prospective return observed prior to the late-1990′s bubble – even in periods having similarly depressed interest rates.

Of course, rich valuations can persist for some time – predictably resulting in poor long-term returns, but often doing little to prevent short-run speculation and temporary gains. The issue is then to identify the point at which overvalued conditions are joined by sufficiently overextended conditions, and a sufficient loss of speculative drivers, to make rich valuations “bite” even in the shorter-term. This is where additional criteria come in, such as overbought technical conditions and extreme optimism in the form of low bearish sentiment, depressed mutual fund cash levels, and heavy insider selling. Presently, it doesn’t help that T-bill yields and long-term bond yields remain higher than 6 months ago, and we have signs of oncoming recession. This is particularly evidenced by collapsing economic measures in Europe, softening economic performance in developing economies including China and India, and jointly weak year-over-year growth in key U.S. economic measures such as real personal income, real personal consumption, real final sales, and reliable leading indicators from the OECD and ECRI, as well as our own measures.

The combination of rich valuations, overbought conditions, overbullish sentiment, and deteriorating leading economic evidence can still unfortunately persist for months before being resolved. But once the hostile syndromes we’ve seen recently have emerged in the data, attempts at continued speculation have amounted to playing with fire. Similar conditions have repeatedly resulted in disastrous outcomes for investors. It would be nice to be able to “time” these outcomes better. We haven’t found a reliable way to do so, and would still be concerned about robustness – sensitivity to small errors – even if we did. Yet even when unfortunate outcomes are not immediate, the fact that the S&P 500 has underperformed T-bills for 13 years is not very sympathetic to arguments that stock market risk has been worth taking overall, except in confined doses.

Tags: Corporate Profit, Corporate Profits, Discounted Cash Flow, Earnings Estimates, Fed Model, Fiscal Deficits, GDP, Household Savings, Hussman Funds, Kraken, Market Advance, Market Plunges, Model Kind, Profit Margins, Speculation, Term Earnings, Treasury Bills, Trough, Valuations
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Kathleen Gaffney: Bond Investor says Dividends Best Source of Income

Monday, April 30th, 2012

A bond investor who says stocks are the next best thing! Great Investor Kathleen Gaffney, co-manager of the legendary Loomis Sayles Bond Fund explains why the great generational bull market in bonds is coming to a close and why dividends are becoming the best source of income.

Tags: Bonds, Dividends, Investor, Kathleen Gaffney, Loomis Sayles Bond, Loomis Sayles Bond Fund, Stocks
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Energy’s Pain is Consumer Discretionary’s Gain

Monday, April 30th, 2012

Each week in our Sector Snapshots report, one of the topics we cover is the performance of individual sectors relative to the S&P 500.  Looking at relative strength helps to show which sectors are outperforming and leading the market, which sectors are underperforming and lagging the market, as well as other relationships between sectors.  One notable trend in this week’s relative strength charts was the divergence between the Consumer Discretionary and Energy sectors.  As shown in the chart below, just as the relative strength of Energy began to fall off a cliff, Consumer Discretionary stocks took off.

Looking at the above chart, it seems completely reasonable to think that what would be bad for the Energy sector (lower energy prices) would be good for the consumer.  Looking at a longer term chart, however, shows that this has not always been the case.  Taking a longer term look at the relative strength charts of both sectors shows that from April 2010 through the end of 2010, both sectors were outperforming the S&P 500.  In early 2011, however, the Energy sector’s performance relative to the S&P 500 peaked while the Consumer Discretionary sector kept outperforming.

Tags: Amp, Bad Sector, Consumer Discretionary Sector, Consumer Discretionary Stocks, Consumer Energy, Divergence, Energy Prices, energy sector, Energy Sectors, Relationships, Relative Strength, Snapshots
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Hugh Hendry: Investment Outlook (April 2012)

Monday, April 30th, 2012

Hugh Hendry is back with a bang after a two year hiatus with what so many have been clamoring for, for so long – another must read letter from one of the true (if completely unsung) visionary investors of our time: “I have not written to you at any great length since the winter of 2010. This is largely because not much has happened to change our views. We still see the global economy as grotesquely distorted by the presence of fixed exchange rates, the unraveling of which is creating financial anarchy, just as it did in the 1920s and 1930s. Back then the relevant fixes were around the gold standard. Today it is the dual fixed pricing regimes of the euro countries and of the dollar/renminbi peg.”

In the letter the most surprising insight from the perpetual contrarian is his almost predictable contrary view of the dominant investing meme at the moment. To wit: “We are, as a result, long the debt saddled west and short the vastly over vaunted and over owned BRICs.“ More on this: “There is a near consensus that China will supplant America this decade. We do not believe this. We are more bullish on US growth than most. The momentous nature of recent advances in shale oil and gas extraction and America’s acceptance of the unpleasantness of debt and labour price restructuring looks to us as if it is creating yet another historic turning point. By embracing his inadequacies and leaping on his luck, the strong man may have finally broken the binds that had previously held him back. We are also more pessimistic on Chinese growth than ever. This makes us bearish on most Asian stocks, bearish on industrial commodity prices, interested in some US stocks, a seller of high variance equities and deeply concerned that Japan could become the focal point of the next global leg down. On the plus side we also believe that we are much closer than before to the beginning of a bull market of perhaps 1982, if not 1932, proportions. We just need the last shoe to drop.”

We will let readers combs through the narrative that shapes Hendry’s most recent outlook, although one chart worth pointing out is The Eclectica boss’ visual summary of the “New Economic Order” which presents precisely the tenuous relationship between the Fed and the PBOC we have been decrying for so long, and which so many commentators (ooh, ooh, the PBOC is easing any minute now… oh wait, it isn’t) fail to grasp:

Yet one thing we do want to point out is how different compared to your run off the mill 2 and 20 rent collector is the Eclectica M.O. when it comes to generating Alpha (as opposed to everyone else’s levered beta):

As you know, I have a proclivity to make money in a bear market. The Fund’s ten-year NAV progression demonstrates this survivorship bias; when bad things have happened, we have made money. We are very robust. Last year was no exception. Despite the challenges confronting speculators, I am much relieved that we succeeded in making 12% in a rather disciplined manner, and the Fund has now posted a CAGR of almost 10% for the last nine years.

Maybe that was the easy bit. The question now is just how we can make money in the tough business of global macro investing this year. As I am sure you by now know, I am nothing but a worrier. I have, I think, a soul mate in the prolific but often misunderstood Italian soccer player Pippo Inzaghi, the second highest scorer in all European club competitions. He has 70 goals behind him but he recently noted that, “the tension is always the same…I hoped to become less agitated with time, but this is also my strength”. I suspect he would have made a fine macro manager.

I meet a lot of inquisitive and extremely intelligent people in this business and I have come to think that maybe this is something of a problem. Perhaps they are just too smart. Perhaps they just try too hard. Rightly or wrongly, the highest return on intellectual capital of any endeavour in the world today comes from the management of other people’s money. So it is entirely rational (especially if you have never met a hedge fund manager) to assume the industry attracts the brightest, smartest minds. The beautiful mind, if you will. But I am not aiming to outsmart George, Stan, Julian, Bruce or the others. I do not think it is logical to try and outsmart the smartest people. Instead, my weapons are irony and paradox. The joy of life is partly in the strange and unexpected. It is in the constant exclamation “Who would have thought it?”

Why did ten year treasuries yield 14% under the vice like grip of iron-man Volker but yield just 1.8% under the bookish and most definitely Weimar-like Bernanke? Why does France in 2012 flirt with the notion of electing a socialist president intent on reducing the retirement age, imposing a top rate of tax of 75% and increasing the size of the public sector? Why do we hang on the every word of elected politicians when Luxembourg’s prime minister Jean Claude Junker openly admits, “When it becomes serious, you have to lie”?

You cannot make stuff like this up. It is simply too absurd.

That is perhaps a long way of saying that existentialism is alive and well in the 21st century. For, if the last ten years have taught me anything, it must be that the French philosopher Albert Camus, in his search for an understanding of the principals of ethics that can shape and form our behaviour, may have surreptitiously provided us with three basic principles for macro investing. I am perhaps doing him a gross injustice, but I would summarise as follows: God is dead, life is absurd and there are no rules. In other words, you are on your own and you must take ownership of your own destiny.

For me this has always meant being detached from the sell-side community. It is not a question of respect, it is just that I prefer not to engage in their perpetual dialogue of determining where the “flow” is. I cannot be reached by telephone. I suspect that I am one of the few CIOs who does not maintain daily correspondence with investment bankers and their specialist hedge fund sales teams. Not one buddy, not one phone call, not one instant message. I am not seeking that kind of “edge.” Eclectica occupies an area outside the accepted belief system.

I attempt to cultivate my own insights and to recognise the precarious uncertainty of global macro trends. I attempt to observe such things first hand through my extensive travel (I promise no more YouTube videos), and seek to understand their significance by investigating how previous societies coped under similar circumstances. But first and foremost, I am always preoccupied with the notion that I just do not have the answer. I am not blessed with the notion of certainty. Someone once said we should think of the world as a sentence with no grammar. If we do I see my job as putting in the punctuation. But above all, my job is to make money.

In keeping with this theme, I want define the three ingredients that I believe make for an outstanding macro hedge fund manager. These are, in no stringent order:

1. Successful but contentious macro risk posturing.

2. The need to choose the asset class offering the highest probability of payout should the conviction hold true whilst offering an asymmetric loss profile should the original premise prove unfounded

3. A best in class risk technique that stop losses the narrative and responds early with loss mitigation procedures (i.e. a method of staying solvent, rational and disciplined under pressure).

I have always figured that the first is the real key. That success was simply a matter of contentious macro posturing. In other words, going long very rich risk premium or buying cheap stuff. It is my assertion that what makes a great fund manager first and foremost is the ability to establish a contentious premise outside the existing belief system and have it go on to become adopted by the broader financial community. Bruce Kovner expressed the idea more eloquently when he said, “I have the ability to imagine configurations of the world different from today and really believe it can happen. I can imagine…that the dollar can fall to 100 yen”. I am sure you are nodding in agreement, except Bruce was saying this when the USDJPY was well over 200, not today’s rate of 80!

That is the kind of guy I want to be when I grow up. Recall that I have the kind of imagination that can conceive of the yen trading closer to 60. Similarly, if we look back and reminisce about previous years, the Fund’s 50% return in 2003 was derived from a legitimate but certainly contentious view that China’s WTO entry was set to boost the cyclical “old” economy of the West and that fiat hyper-management of the financial economy could propel gold into a super bull market. To think these views were once contentious; plus ça change!

Who would’a thunk it: one just needs some imagination and creativity, the ability to visualize that which most of the other ones cant or are too lazy to do it, and just wait as the bizarro market takes over and makes the impossible not only probable, but conventionally accepted by the herd.

…

And a segment that all the Whitney Tilsons of the world should read:

I fear that our no longer small community has been compromised. Funds are neglecting their hard portfolio stop limits. Last year was generally very tough for long/short strategies and I commiserate with all concerned. But last year witnessed too many world class funds lose over 15% in the space of just two months. Of course today they are celebrated once again for making double digit returns in the quarter just ended yet they still languish below high water marks and their Sharpe ratios are busted.

You could probably live with that if you are a pension scheme or a large, sophisticated fund-of-fund because you have a global macro sub-sector that is typically long gamma (just look at our credit tail fund’s 46% gain last year). The unfortunate thing is this group exercised its stop losses somewhere between 2009 and 2010. That is to say, they honoured the pact they had with clients. They adhered to the terms of their risk budget. I fear that owing to this nasty experience, today no one in macro is running much risk. I suspect daily VaR budgets are anchored at 50 bps or less. That is to say, I fear the financial world is in danger of harvesting a monoculture of fund returns that could prove less than robust should the global economy suffer another deflationary reversal…

Read the full letter below:

April 2012 TEF Commentary

Tags: 1920s, 1930s, Asian Stocks, Chinese Growth, Commodity Prices, Contrary View, Euro Countries, Fixed Exchange Rates, Focal Point, Gas Extraction, Global Economy, Hiatus, Hugh Hendry, Inadequacies, Industrial Commodity, Investment Outlook, Shale Oil, Strong Man, Variance, Visionary Investors
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PIMCO’s Bill Gross – No QE3 Right Away, but a Few Weak Employment Reports Brings It

Monday, April 30th, 2012

PIMCO’s Bill Gross has a wide ranging interview on Bloomberg discussing all sorts of topics from more QE, the Fed following the Bank of England’s plan to ignore any inflation as ‘temporary’ so they can continue ultra easy policies, the dysfunction in Europe, the potential for recession, among other topics.

9 minute video – email readers will need to come to site to view

Tags: All Sorts, Bank Of England, Bill Gross, Bloomberg, Employment Reports, Europe, inflation, PIMCO, Qe, Qe3, Recession, Video Email
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Does Quantitative Easing Benefit the 99% or the 1%?

Sunday, April 29th, 2012

Forget Competing Theories … What Do the Facts Say about Quantitative Easing?

Paul Krugman says that QE, expansive monetary policy and inflation help the little guy (the 99%) and hurt the big banks (the 1%).

Of course, followers of the Austrian school of economics dispute this argument – and say that it is only the big boys who benefit from easy money.

As hedge fund manager Mark Spitznagel argues in the Wall Street Journal, in an article entitled “How the Fed Favors The 1%”:

The relentless expansion of credit by the Fed creates artificial disparities based on political privilege and economic power. [We have repeatedly pointed out that Fed policy increases inequality.]David Hume, the 18th-century Scottish philosopher, pointed out that when money is inserted into the economy (from a government printing press or, as in Hume’s time, the importation of gold and silver), it is not distributed evenly but “confined to the coffers of a few persons, who immediately seek to employ it to advantage.”

In the 20th century, the economists of the Austrian school built upon this fact as their central monetary tenet. Ludwig von Mises and his students demonstrated how an increase in money supply is beneficial to those who get it first and is detrimental to those who get it last. Monetary inflation is a process, not a static effect. To think of it only in terms of aggregate price levels (which is all Fed Chairman Ben Bernanke seems capable of) is to ignore this pernicious process and the imbalance and economic dislocation that it creates.

As Mises protégé Murray Rothbard explained, monetary inflation is akin to counterfeiting, which necessitates that some benefit and others don’t. After all, if everyone counterfeited in proportion to their wealth, there would be no real economic benefit to anyone. [Remember, even Keynes himself - and Ben Bernanake - said that inflation is a stealth tax.] Similarly, the expansion of credit is uneven in the economy, which results in wealth redistribution. To borrow a visual from another Mises student, Friedrich von Hayek, the Fed’s money creation does not flow evenly like water into a tank, but rather oozes like honey into a saucer, dolloping one area first and only then very slowly dribbling to the rest.

The Fed doesn’t expand the money supply by uniformly dropping cash from helicopters over the hapless masses. Rather, it directs capital transfers to the largest banks (whether by overpaying them for their financial assets or by lending to them on the cheap), minimizes their borrowing costs, and lowers their reserve requirements. All of these actions result in immediate handouts to the financial elite first, with the hope that they will subsequently unleash this fresh capital onto the unsuspecting markets, raising demand and prices wherever they do.”

***

The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged. This coercive redistribution has been a far more egregious source of disparity than the president’s presumption of tax unfairness ….

***

Before we start down the path of arguing about the merits of redistributing wealth to benefit the many, why not first stop redistributing it to the most privileged?”

And Ben Bernanke himself said in 1988 that quantitative easing doesn’t work. As Ed Yardley notes:

Two economists, Seth B. Carpenter and Selva Demiralp, recently posted a discussion paper on the Federal Reserve Board’s website, titled “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?” [Here's the link.]

[The study states:] “In the absence of a multiplier, open market operations, which simply change reserve balances, do not directly affect lending behavior at the aggregate level. Put differently, if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found. The argument against the textbook money multiplier is not new. For example, Bernanke and Blinder (1988) and Kashyap and Stein (1995) note that the bank lending channel is not operative if banks have access to external sources of funding. The appendix illustrates these relationships with a simple model. This paper provides institutional and empirical evidence that the money multiplier and the associated narrow bank lending channel are not relevant for analyzing the United States.”

Did you catch that? Bernanke knew back in 1988 that quantitative easing doesn’t work. Yet, in recent years, he has been one of the biggest proponents of the notion that if all else fails to revive economic growth and avert deflation, QE will work.

Indeed, Fed policy itself has killed the money multiplier by paying interest on excess reserves. And a large percentage of the bailout money went to foreign banks (and see this). And so did most of money from the second round of quantitative easing.

Forget Theory … What Do the Facts Show?

But let’s forget ivory the tower theories of either neo-Keynesians like Krugman or Austrians … and look at the evidence.

Initially:

[The] Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry.

Similarly, former Secretary of Labor Robert Reich points out that quantitative easing won’t help the economy, but will simply fuel a new round of mergers and acquisitions:

A debate is being played out in the Fed about whether it should return to so-called “quantitative easing” — buying more mortgage-backed securities, Treasury bills, and other bonds — in order to lower the cost of capital still further.

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Tags: 18th Century Scottish Philosopher, Aggregate Price, Austrian School Of Economics, Ben Bernanke, David Hume, Economic Benefit, Economic Dislocation, Fed Chairman, Fed Policy, Government Printing Press, Hedge Fund Manager, Ludwig Von Mises, Monetary Inflation, Money Supply, Murray Rothbard, Paul Krugman, Relentless Expansion, Spitznagel, Stealth Tax, Wall Street Journal
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Eric Sprott: Investment Outlook (April 27, 2012)

Sunday, April 29th, 2012

When Fundamentals No Longer Apply, Review the Fundamentals

by Eric Sprott & David Baker

April 27, 2012

This may not come as a surprise, but we’re still not seeing it. We’re not seeing a US recovery.

Here we are, well into 2012, and the fact remains that the US housing situation is still a bust. There is simply no housing recovery happening in the United States. US New Home Sales fell for the fourth time in a row month-overmonth in March, representing a seasonally-adjusted annual rate of 328,000, down from 353,000 in February.¹ Do you know what the annual rate of New Home Sales was back in 2006? About 1.21 million.² No recovery there.

Same goes for US Existing Home Sales, which fell unexpectedly by 2.6% in March to an annual rate of 4.48 million units.³ Again – would you care to know where they were in the same month back in 2006, before the financial system fell apart? Approximately 6.92 million units.⁴ No recovery there either.

Then there’s unemployment. Judging by all the recent earnings-release cheerleading, March’s jobs numbers seem to have been forgotten, but they were plainly weak. The US Labor Department showed US hiring slowing to a mere 120,000 new jobs in March, below expectations of 200,000+.⁵ That’s not a recovery. That’s simply weak data.

Same goes for the most recent jobless claims numbers, which have been running above 380,000 for the last two weeks, above the 375,000 threshold that supposedly signals future unemployment increases.⁶ Again – this is not positive data, this is weak data. How high will it have to go before the economists admit that it’s weak? 400,000? 425,000? We’re asking – we’d like to know.

Then there are US tax receipts, which continue to point in the same direction. If the US is recovering so strongly, then why are employment tax receipts only up 2%? ($484 billion fiscal year-to-date as of March 2012 vs. $475 billion over the same period to March 2011).⁷ A 2% increase is explainable by inflation alone, which was last reported running at 2.7% according to the Bureau of Labour Stastics.⁸ Shouldn’t the tax receipts be much higher than that? Wasn’t unemployment down so far this year? As the Associated Press plainly states, “The unemployment rate has fallen to 8.2% in March [2012] from 9.1% in August [2011]. Part of the drop was because people gave up looking for work. People who are out of work but not looking for jobs aren’t counted among the unemployed.“⁹ Oh! Sorry,… now the numbers make more sense. There hasn’t been any net new employment at all. Question: if everyone “gives up” looking for work next week, will the US unemployment rate go to zero? We’re asking – we’d like to know.

Other economic indicators exhibit the same downward momentum that the pundits are loath to acknowledge. For example, the Economic Cycle Research Institute’s (ECRI) Weekly Leading Indicator index, which had been rising from its 2011 lows earlier this year, has resumed its downtrend in April.¹⁰ More recently, US Durable Goods Orders were revealed to have dropped 4.2% in March, representing the largest decline since January 2009.¹¹ To top it all off, China’s most recent Purchasing Managers Index (PMI) indicated that China’s manufacturing activity has now been in contraction for six months in a row.¹²

FIGURE 1: SPANISH BANKS – DEPOSIT AND EUROSYSTEM FUNDING (% OF TOTAL ASSETS),
1999 – FEB 2012

Note: Deposits of domestic ex credit institutions in Spanish MFIs. Eurosystem borrowing Eurosystem funding via Open Market Operations Source: Bank of Spain, ECB and Citi Investment Research and Analysis

Meanwhile, the situation in Europe continues to worsen. There’s no point in mincing words: Spain is a complete disaster. This past week, the Spanish government managed to pull off two separate bond auctions, only to have the yield on their 10-year government bond shoot right back up the moment the second auction closed. Everyone’s nervous because the Spanish banking system is up to its eyeballs in approximately €143.8 billion worth of delinquent loans, and the private sector is unwilling to lend Spanish banks the money to weather the potential write-downs.¹³ As we’ve seen before, the real culprit plaguing the Spanish banks is customer deposit withdrawals. It is estimated that €65 billion of deposits left Spanish banks this past March alone.¹⁴ People are taking their money out of the Spanish banking system, and without the help of the generous European Central Bank (ECB), the Spanish banks would likely be in a full collapse today (see Figure 1).¹⁵ As it stands, the Spanish banks have now borrowed a massive €316.3 billion from the ECB in order to meet the withdrawals and maintain the illusion of solvency.

Tags: Amp, April 27, Bust, Cheerleading, David Baker, Earnings Release, Economists, Employment Tax, Eric Sprott, Existing Home Sales, Fiscal Year, Investment Outlook, Jobless Claims, Nbsp, New Jobs, Sprott, Surprise, Tax Receipts, Threshold, Unemployment, Us Labor Department
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Sell in May and Go Away? Not this Year

Sunday, April 29th, 2012

Sell in May and Go Away? Not this Year

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

One catchy investing maxim that’s popular this time of year is “sell in May and go away,” the notion that investors should cash in their investments and take the summer off. Historically, this hasn’t been a bad strategy. You can see from this chart that June, July, August and September have been the worst four months of the year for the S&P 500 Index since 1988.

Since 2000, the June-September period for the S&P 500 is split. Half of the years saw positive returns, while the other half were negative. Historically, you have only about a fifty-fifty chance for a positive gain during those months while your odds are roughly 10 percent better during the rest of the year.

The trend is less consistent for emerging market stocks. You can see that the median monthly return for the MSCI Emerging Markets Index since 1988 is negative for June and August, but positive for July and September. The frequency of positive returns during the June-September period is roughly 6 percent lower than the rest of the year.

Last year, investors who employed the “sell in May” strategy averted an almost 17 percent drop in the S&P 500 and a nearly 25 percent drop in the MSCI Emerging Markets Index from June-September. Summer of 2010 was a similar experience.

With last year fresh on the minds of investors, should they take the summer off? We don’t think so.

We believe it’s a much better market this year. After following a similar trajectory as the previous year from October to the beginning of March, improving economic data pushed the S&P 500 over 3 percent higher in March 2012 after trending sideways during the same time period last year.

Nominal GDP in the U.S. grew 3.8 percent during the first quarter of 2012 versus 0.4 percent in 2011, and several areas of the economy are much stronger than they were a year ago. Nonfarm payrolls (up 29 percent), ISM Manufacturing (up 2 percent) and auto sales (up 8 percent) have all improved from a year ago, according to J.P. Morgan. In fact, auto sales are currently at a four-year high.

More importantly, the U.S. housing sector continues to improve. The ISI Group’s homebuilders survey is currently at 50.4, nearly 40 percent higher than a year ago.

Building permits are 35 percent higher and the number of housing starts is 3 percent higher than a year ago, according to Credit Suisse. Sales of existing homes are up 5 percent on a year-over-year basis. Credit Suisse says, “The supply of existing one-family homes has fallen from a peak of 11.5 months in July 2010 to 6.3 months in March (in line with the 20-year average).”

ISI Group says an improvement in housing is important because it lifts consumer net worth and employment, which leads to rising consumer confidence. Housing accounts for just over 2 percent of U.S. GDP, but roughly 27 percent of household wealth, according to Credit Suisse.

Earnings Season Off to a Record Start

The improving global economy is reflected in the thirteenth-straight quarter of better-than-expected corporate earnings. As of Thursday, 80 percent of S&P 500 companies have reported earnings above analyst estimates. Earnings for the 260 companies reporting so far were up 11.4 percent year-over-year and beat the consensus estimate by 6.3 percent.

This is good news for shareholders. According to a Bloomberg story this week, “companies are increasing shareholder returns in the form of dividends and buybacks after the 2008 financial crisis led them to hoard cash to a record $1 trillion by the end of 2011.” The number of S&P 500 companies paying out dividends now sits at 401, the largest number since January 2000. Corporations bought back roughly $543 billion worth of shares in 2011 and J.P. Morgan estimates companies will purchase another $679 billion worth in 2012.

U.S. companies aren’t the only ones reporting stronger results. This chart from Credit Suisse shows earnings momentum is strengthening around the world based on 12-month forward earnings per share estimates for the MSCI ACWI (All Company World Index). This is the opposite of what we experienced in 2011.

Buy in May?

May has historically been a strong one for markets. Since 1988, the median return for the S&P 500 and MSCI Emerging Markets during May has been 1.22 percent and 1.28 percent, respectively. In fact, May returns rank in the top half for both indices.

This is also a presidential election year in the U.S., which has historically produced positive returns. Since 1972, the stock market has rallied in 5 of the 8 election years, according to J.P. Morgan, with market gains of 12-26 percent. Only during recession years (2000 and 2008) did the S&P 500 provide negative returns.

Last week, Bank of America-Merrill Lynch suggested “investors position for an economic upturn” by increasing their exposure to equities. The firm’s Global Wave indicator, a compilation of seven global metrics designed to provide a comprehensive assessment of trends in global economic activity, was signaling a trough in the global cycle. According to BofA-ML’s research, the MSCI ACWI (All Country World Index) averages a 14.2 percent increase for the 12 months following a trough in the Global Wave. Historically, the index has experienced a positive return 86 percent of the time.

Instead of “selling in May and going away” for the summer in 2012, we think investors should look to global stock markets and ride the global wave.

Tags: Amp, August And September, Chief Investment Officer, Economic Data, Emerging Market Stocks, First Quarter, Four Months, Frank Holmes, GDP, Maxim, Months Of The Year, Msci Emerging Markets, Msci Emerging Markets Index, Nominal Gdp, Nonfarm Payrolls, Previous Year, Same Time Period, Time Of Year, Trajectory, U S Global Investors
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