Posts Tagged ‘Barron’

The ‘Beautiful’ Deleveraging

Saturday, August 18th, 2012

Submitted by Alex Gloy of Lighthouse Investment Management,

Some of my clients like to challenge my (admittedly gloomy) views, forcing me to think – which isn’t such a bad thing to do.

It started off with Cam Hui’s “A Dalio explanation of Evans-Pritchard’s dilemma“. After laying down his strategy on winning the game of Monopoly, Dalio goes on to model the economy onto the board game. So far so good.

Then, Dalio is quoted in a Barron’s interview, describing the current phase of the U.S. deleveraging experience as “beautiful”. He goes on to explain the three options for reducing debt: austerity, restructuring and printing money.

“A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.”

That sounds pretty good and makes sense. Or does it?

  • I think Mr. Dalio would not be too upset if we labeled him a “Keynesian” (believing the government has to step in where private sector spending falls short).
  • You could respond that it was Keynesian policies which brought us to the current situation in the first place (to which Keynesians will respond that their policies did not work out because there was not enough spending. Which is like saying “the kid is not behaving because you didn’t hit it hard enough“).
  • Furthermore, how is the government sector on a different “planet” than the household sector? In the end, isn’t government debt (and hence fiscal deficits) supported and borne by taxpayers (read: household sector)? No sovereign entity in the world would be able to issue debt unless backed by taxpayers (or, for that matter, gold).
  • As governments incur additional debt it is actually taxpayers’ future income that is on the block (as tax rates will have to go up to pay for additional debt service burden). Leverage is simply being shifted around. Oh, and for that time-shift argument (“tax receipts will have increased by the time the debt comes due”) – I believe it when I see it. There has been not a single country which has paid back its debt incurred under the fiat money system.
  • If the future rate of inflation is below the interest rate paid on additional government debt, the net present value of deficit spending is negative (we are neglecting the argument over whether government can spend efficiently or not).
  • Interest rates at issuance are fixed (exception: floaters). The decision whether to run fiscal deficits boils down to the following question: will future inflation exceed the interest paid (in order to devalue debt faster than accrued interest)?
  • This makes the success of Keynesian policies dependent on elevated inflation. Governments are motivated, in a perverse way, to work towards reducing the value of money.
  • This is in contradiction of central bankers’ (presumed) goal of preserving the function of money as a store of value, setting them up for a clash with governments (assuming they are not in cahoots anyways).
  • However, there is no known case of a government successfully printing its way out of excessive debt (while there are plenty of examples for the opposite).
  • It’s a lose-lose-situation: Should the government succeed in creating inflation, (1) financially prudent savers are punished, (2) low-income families are hurt (as they have no means to invest in assets benefiting from inflation) and (3) debt service costs are likely to increase as existing debt matures and needs to be rolled over.
  • Should the government not succeed in creating inflation, future consumption will be burdened by additional taxes, lowering future growth and making excessive debt unsustainable.
  • Will printing money “compensate” for money destroyed by debt write-offs? Turned the other way ’round, was money ever “un-printed” to compensate for money created from fractional banking and/or increased levels of debt?
  • Cullen Roche of Pragmatic Capitalism states “QE [quantitative easing] doesn’t do much – it’s the great monetary non-event” (“Why QE is not working”).
  • In the comments section of above article Cullen points out that

“It is flawed economic thinking to target nominal wealth. Stock prices are not real wealth until realized gains are taken. More importantly, stocks are based on the underlying value of the assets they represent. Pushing stock prices up does not make the companies more profitable. So hoping that people will spend more of their current income because of a false price appreciation in the market is a misguided policy.”

  • So let’s take a look at Mr. Dalio’s “beautiful deleveraging”. Here’s US debt by sector:


Observations:

  • Households are de-leveraging; so are financial corporations.
  • This happens at the expense of the government sector, which continues to lever up.
  • Total debt (government + households + corporations) is actually higher (by $800bn) than when the “beautiful deleveraging” began.

Let’s look at the numbers in percent of GDP:

  • Peak debt-to-GDP has been reached in Q1 2009 for households, financial and non-financial corporations.
  • Since then (latest data Q1 2012), households have de-levered by 11%-points of GDP (or $654bn).
  • Non-financial corporations reduced debt by 3%-points (or $406bn).
  • Financial corporations, however, de-levered by a stunning 33%-points (or $3,375bn).
  • The flip-side of this: Federal debt-to-GDP increased by 27%-points (or $4,030bn).
  • While the household sector has done “it’s thing” it usually does during recessions (de-lever), it become clear who the main beneficiary of additional government debt is: the financial sector.

Looking at quarterly changes in sector debt visualizes it nicely:

  • Mr. Dalio and his firm (Bridgewater Associates, the world’s biggest hedge fund) are part of this financial sector. No wonder he describes this kind of deleveraging as “beautiful”.
  • Mr. Dalio, who, according to a recent Bloomberg story (Connecticut offers millions to aid Bridgewater expansion), “was paid $3.9bn in 2011? is taking all kinds of tax breaks / “forgivable loans” to be lured to move from Connecticut to… Connecticut (at least UBS and RBS moved to the state when receiving tax breaks).
  • I have walked through the waterfront area of Stamford. A lot of low-income families, often minorities, living in simple homes. The city is building new, expensive apartments for the new, well-paid arrivals, gentrifying the area.
  • From Bloomberg:

“If the region [Fairfield county] were a country, it would be the world’s 12th-most unequal in terms of income, ranking just below Guatemala.”

CONCLUSION:

While Mr. Dalio’s narrative reads well, it doesn’t stand up to common sense. Unfortunately there is lingering suspicion his views on government spending are a mere ploy to advocate for transferring even more debt from “his” sector onto taxpayers, while at the same time transferring taxpayers’ money to his firm via tax breaks.

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Gold Miners are Finally Starting to Outperform Bullion

Tuesday, August 14th, 2012

by Michael Kahn, Barron’s

Although it has been quiet on the gold front in recent months, gold-mining stocks are finally making some technical noise. They are not yet fully in bullish mode, but several changes on the charts bode well for miners and, by extension, for the metal too.

The first chart of consequence is the performance comparison between gold shares and gold itself. By plotting a ratio of the Market Vectors Gold Miners exchange-traded fund (ticker: GDX) to the SPDR Gold Trust ETF (GLD), we can easily see changes in their relationship (see Chart 1).

The chart headed south for most of this …

Read the complete article below:

Gold Miners Starting to Pan Out

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Barron’s Interviews Ray Dalio

Tuesday, May 22nd, 2012

 

While hedge fund manager Ray Dalio generally stays under the radar, it is always interesting to read the thought’s of the man who runs the world’s largest hedge fund shop.  This weekend Barron’s did an extensive interview with the man, and it is worth the full read.  He does a very interesting comparison of Europe now with “America” post revolution in terms of structure.  Some excerpts below:

We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

We will also need fiscal stimulation by the government, which of course, is very classic. Governments have to spend more when sales and tax revenue go down and as unemployment and other social benefits kick in and there is a redistribution of wealth. That’s why there is going to be more taxation on the wealthy and more social tension. A deleveraging is not an easy time. But when you are approaching balance again, that’s a good thing.

How do you expect Europe to fare?

Europe is probably the most interesting case of a deleveraging in recorded history. Normally, a country will find out what’s best for itself. In other words, a central bank will make monetary decisions for the country and a treasury will set fiscal policy for the country. They might make mistakes along the way, but they can be adjusted, and eventually there is a policy for the country. There is a very big problem in Europe because there isn’t a good agreement about who should bear what kind of risks, and there isn’t a decision-making process to produce that kind of an agreement.

We were very close to a debt collapse in Europe, and then the European Central Bank began the LTROs [long-term refinancing operations]. The ECB said it would lend euro-zone banks as much money as they wanted at a 1% interest rate for three years. The banks then could buy government bonds with significantly higher yields, which would also produce a lot more demand for those assets and ease the pressure in countries like Spain and Italy. Essentially, the ECB and the individual banks took on a whole lot of credit exposure. The banks have something like 20 trillion euros ($25.38 trillion) worth of assets and less than one trillion euros of capital. They are very leveraged.

Also, the countries themselves have debt problems and they need to roll over existing debts and borrow more. The banks are now overleveraged and can’t expand their balance sheets. And the governments don’t have enough buyers of their debt. Demand has fallen not just because of bad expectations, although everybody should have bad expectations, but because the buyers themselves have less money to spend on that debt. So the ECB action created a temporary surge in buying of those bonds and it relieved the crisis for the moment, but that’s still not good enough. They can keep doing that, but each central bank in each country wants to know what happens if the debtors can’t pay, who is going to bear what part of the burden?

What’s your outlook for the U.S.?

The economy will be slowing into the end of the year, and then it will become more risky in 2013. Then, in 2013, we have the so-called fiscal cliff and the prospect of significantly higher taxes, as well as worsening conditions in Europe to contend with. This is coming immediately after the U.S. presidential election, which makes it more difficult. This can be successfully dealt with, but it won’t necessarily be successfully dealt with. We have the equipment and the policy makers, and as long as policy is well managed, we’ll be okay.

What of China and the emerging economies at this point?

They are doing much better in the following way: They were in a bubble, and when I say a bubble, I mean a debt explosion. Their debts were growing at a fast rate. Their debts were rising relative to income and they were growing at rates that were too fast. Those growth rates have slowed up significantly and probably will remain at a moderate pace. They are in pretty good shape but will be subject to the deleveraging of European banks.

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Technical Take: This Should Make You Wonder

Tuesday, April 24th, 2012

 

by Guy Lerner, The Technical Take

I think his person has it right when he writes: “You Won’t BELIEVE How Bearish Investors Are On Treasuries”.

Barron’s conducted a poll of portfolio managers asking them about their outlook on the markets and economy.  As we can see from the table below, only 2% are bullish on Treasuries and 81% are bearish.

Table 1. Barron’s Poll of Portfolio Managers

The author sums this tidbit of information very nicely when he asks: “can you imagine any other asset that was in the midst of a 30-year bull market, that had just 2% of the investing population saying they were bullish? Frankly, it’s unfathomable.  People have long said Treasuries were in a bubble, but it’s hard to believe any bubble has burst with just 2% being long.”

 

Copyright © The Technical Take

Tags: , , , , , , , , , , , ,
Posted in Markets | Comments Off

Rosenberg Roasts Roundtable of Groupthink

Monday, April 23rd, 2012

 

 

It appears that when it comes to mocking consensus groupthink emanating from lazy career ‘financiers’ who seek protection from their lack of imagination and original thought, ‘creation’ of negative alpha and general underperformance (not to mention reliance on rating agencies, only to jump at the first opportunity to demonize the clueless raters), in the sheer herds of other D-grade asset “managers” (for much more read Jeremy Grantham explaining this and much more here), David Rosenberg enjoys even more linguistic flexibility than even us. Case in point, his just released trashing of the latest Barron’s permabull groupthink effort titled “Outlook: Mostly Sunny.” And just as it so often happens, no sooner did those words hit the cover of that particular rag, that it started raining, generously providing material for the latest “Roasting with Rosie.”

From Gluskin Sheff:

Consensus Creates A Contrary Call

When the experts and forecasts agree, something else is going to happen.”
~ Bob Farrell’s investment rule #9.

Did the folks at Barron’s intentionally lob a ball right into my wheelhouse? The front cover says it all — Outlook: Mostly Sunny. Check it out. Any perma-bull out there right now should be trembling by the front cover effect. This is no different than the fabled Death of Equities in the 1979 Businessweek, the Economist front cover calling for oil prices to basically head towards zero circa 1998, and the front cover of Barron’s a decade ago saying That’s All, Folks when it came to interest rates supposedly bottoming out. Come to think of it, Barron’s ran with Dow 15,000 on its front cover back on February 13, 2012, and last we saw, at the nearby peak in early April, the blue-chip index closed 1,700 points below that threshold (and has been roughly flat since the date of that article).

What Barron’s is referring to here is the latest Big Money poll that it conducts semi-annually. The actual title of the article (on page 25) is Reason to Cheer. Reason to cheer? About what? Margins being squeezed? Profit growth practically evaporating? Earnings downgrades still significantly outpacing upgrades? The recovery so excruciatingly slow that senior members of the Fed are contemplating QE3? Insolvency of Spanish banks? Hard landing risks in China? The 2013 fiscal cliff? The fact that over 60% of the data in the past two months have surprised to the downside?

The results of the Big Money Poll were startling:

- 55% of the portfolio managers are either bullish or very bullish. Only 14% are bearish or very bearish.
- Financials and technology are the favourites, with 31% citing both as being the top performers in the next six to 12 months.
- Favourite stock … Apple (surprised?).
- Utilities are seen as the worst performer — by 30% of those polled.
- With respect to Treasuries, 81% are bears, just 2% are bulls. How can yields rise in such a lopsided environment? I mean, who is there left to sell? This is a classic bullish contrary signpost.
- Bonds of all types are detested — 33% bearish on corporates while 14% are bullish; 35% are bearish on munis while only 12% are bullish.
- But … 41% are bulls on real estate; only 10% bears are left.
- For gold, 39% bears and 30% are bulls. That is great— the one asset class that has been in a secular bear market for 12 years is adored (equities), and the two that have actually made you money over this time span (the bond- bullion barbell) is to be avoided. Go figure!

The latest market positioning by non-commercial accounts (proxy for what the hedge funds are doing) from the weekly Commitment of Traders report is also rather instructive (futures and options contracts combined):

- 10-year T-note: Net speculative short position of 130,045 contracts on the CBOT. As I said above, who is left to sell?
- DJIA index: Net long 13,285 contracts on the CBOT.
- EAFE stocks: Net short 440 contracts on the CME but this number has been coming down.
- EM stocks: Net short 4,787 contracts on the CME, also coming down of late as the shorts cover.
- Nikkei index: Net short 4,894 contracts and also on the descent.
- Copper: Net long 1,229 contracts.
- Energy: Net short 124,941 natural gas contracts on the NYMEX: net long 288,393 WTI oil contracts. Patient investors know what to do.

- Gold: Net long position has been cut in half since last summer to 146,833 contracts. The latest corrective action has been healthy as the earlier froth is gone.
- Silver: Ditto — the net speculative long position has been sliced 40% to 21,309 contracts.
- Euro: Net short 117,062 contracts on the CME (likely why the currency won’t go down … the bears are already all in that trade!).
- Sterling: Net short 13,456 contracts (and is enjoying a humdinger of a short- covering rally of late).
- Yen: Net short 57,984 contracts (if the Japanese government is telling you they want the currency to depreciate, we should probably take heed).
- Canadian dollar: Still has a net speculative long position of 37,873 contracts on the CME, which could hold back the gains.

It is viewed as a global darling. But the Aussie dollar still commands a net speculative long position of 48,902 contracts and the Reserve Bank of Australia is about to cut rates while the Bank of Canada seems itchy to raise them as they did in 2010 — so there could be an opportunity on the ‘cross rate’ here.

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Volatility is Not Risk (Carnevale)

Friday, April 13th, 2012

 

by Chuck Carnevale, FAST Graphs

This article was inspired by Roger Nusbaum’s post on his Random Roger blog – Sunday Morning Coffee on Sunday, April 8, 2012.  Roger is a highly respected financial blogger that I believe is genuinely interested in providing his readers meaningful and prudent investment advice and guidance.  Therefore, I have a great deal of respect for his work and intentions. On the other hand, Roger and I often disagree on certain investing principles, especially those that deal with asset allocation, proper diversification and the definition of risk.  However, I would hope that he respects my differing views as being offered with the same best of intentions, as I see his offerings.

The Greater Risk is People’s Reaction to Volatility

Roger’s blog dealt with his feelings about a recurring theme in Barron’s over the weekend referencing people’s complacency for risk. The first part of his writing dealt with the risks associated with the utilization of puts.  On this subject, Roger and I are in agreement.  However, the second part of his blog talked about what he obviously felt was the great risk of using dividend paying equities as an alternative investment choice.  The following excerpt introduces his views, which frankly, up to this point, I take little exception to:

“The other point from Barron’s (this was repeated in a couple of places) was a repeat of the idea that the Fed’s interest rate policy (and the other attempts to stimulate the economy) are forcing investors into other instruments to seek a “reasonable return.”

However, I do take exception to his next paragraph as I felt that it is overstating the risk associated with the utilization of dividend paying stocks for two primary reasons.  First of all, his assumption that a bear market will provide a tragic outcome because dismayed investors will panic is more assumption than fact. Second, his last sentence insinuates, at least in my opinion, that dividend paying stocks are not safe investments.

“I hate this line of thinking. It would be great to get a “reasonable” rate of return from cash and treasuries but for now that is not the case. That people put what should be their low risk dollars into higher risk instruments to get a return they used to get from cash has tragic outcome written all over it. If there is another bear market before interest rates normalize there will be an avalanche of dismayed investors panic selling their dividend stocks because they thought the stocks were “safe.”

But it was with the last couple of sentences of his blog post that I took the greatest exception.  More precisely, I found that his example of Phillip Morris International (PM) to be misleading.  However, not because of what Roger included, but rather because of what he left out. I will elaborate more right after the following excerpt where he closed out his blog post:

“All stocks have strong and weak holders and I promise you that the weak holders will sell into the face of something bad–this is normal market behavior and has nothing to do with the merits of a stock or a strategy. I believe a client holding Philip Morris Intl (PM) is favorably viewed by the dividend crowd yet it went down 32% from when it spun off in March 2008 into the March 2009 low–weak hands not bad stock.”

It is certainly possible, and perhaps even probable that Roger is correct in assuming that so-called “weak holders” may in truth do as he suggests and panic sell. However, I believe a lot of that “normal market behavior” can greatly be attributed to the preponderance of negatively biased information that is promogulated upon the general public, especially regarding equities and how risky they are.  In other words, if people were offered a more reasoned perspective, then perhaps much of the irrational and catastrophic panic selling that Roger alludes to could be avoided.

The following analysis utilizing the F.A.S.T. Graphs™ earnings and price correlated research tool on Philip Morris International illuminates the important parts that I feel Roger’s comment left out. Roger is correct regarding how far that Philip Morris International’s stock price dropped, as can be seen by reviewing the black monthly closing stock price line marked by the flags on the graph.  Phillip Morris International’s stock price did, in fact, fall by the 32% plus number that Roger presented, and as he also stated, can most likely be attributed to “weak hands.”  However, what his comment left out was the fact that the company’s operating earnings were stable and continued to grow.  More simply stated, the stock price fell even though the company’s operating results remained strong and solid.

Therefore, investors armed with that information could have seen that this low point in Philip Morris International’s stock price represented an incredible opportunity not a high risk. The smart money (strong hands) would have added to their positions in this high-quality company that was continuing to post good results and raised its dividend every year, rather than sell out.  However, even if no one added money and simply held on they would have been given a substantial increase in their dividend each year and had their stock price rise from the original $50 a share to the more than $80 a share that it currently trades at (see flags on graph). The risk was not in the volatility itself, true risk would have been irrationally reacting to the volatility.

My point is that price volatility in itself is not risk, in my opinion, true risk is how people react to volatility when it occurs. Moreover, I believe that the reason there are so many “weak hands” is because of the weak information that investors are inundated with.  Knowledge is power, and I believe that if people were provided with greater knowledge on how equities, especially dividend paying equities, truly work, then we would be cultivating a lot more strong hands.  At the end of the day, this could also reduce the level of volatility by reducing the level of panic that would result from a better informed public.

Risk, Diversification and Prudent Behavior

In an attempt to summarize my views on diversification and how they differ from Roger’s I offer the following.  The principles of proper diversification are both important and sound, and therefore should never be neglected when developing an asset allocation strategy.  Moreover, the principles of proper diversification are valid and necessary when dealing with uncertain markets, but especially during times when markets are functioning (plus or minus) in a normal manner. Therefore, I am comfortable with and embrace a strategy of diversifying across numerous asset classes as long as each asset class makes sound and prudent economic sense at the time. However, when, and if, an asset class sits at an extreme level, then I feel it is imprudent to utilize it for the sole sake of so-called diversification.

I believe bonds of all types are currently sitting at such an extreme.  Traditionally thought of as safe investments, I believe that over the next four or five years bond prices could show more downside volatility than equities did even during the great recession of 2008.  Under normal times, bonds would offer yields that were several percentage points higher than quality dividend paying stocks.  Consequently, bonds were attractive due to the higher level of income they offered and were relatively stable as long as interest rates remained within historical normal ranges. Today that is not true.

As a result, I currently eschew the asset class bonds in favor of high-quality blue-chip dividend paying stocks. To be clear, when bond yields move back to more normal levels I would once again be happy to embrace including them in a properly diversified asset allocation plan.  But at today’s low rates, I believe that the traditionally safe bond has become one of the riskier asset classes, especially if you consider the potential for high volatility with their prices as risk. My point is, my aversion to bonds is a temporary one that would change if and when interest rates normalize and stabilize.

Therefore, to mindlessly invest in an obviously dangerous asset class for the sole sake of diversification does not make sense to me. We believe that investors should always think their way through the process of allocating their assets when building their portfolios. On the other hand, I don’t believe that money should be forced into an asset class when it doesn’t make economic sense just because you hold the notion of diversification as sacred.

Diversification when properly applied is a great way to control risk.  But investing in an asset class that is upside down solely for the purpose of diversification when it can be obviously avoided makes no sense to me.  Technology stocks during the 1999 bubble were a case in point. All you had to do was run the numbers and you could have quickly determined that there was no economic value in technology stocks at that time.

In contrast, today when looking at quality blue-chip dividend paying stocks that are trading at historically low valuations thereby offering above-average and growing yields, makes a lot of sense to me. I would argue that because of historically low valuations, they have never been a safer investment choice than they are today. And, the only reason to consider a Dividend Aristocrat or a Dividend Champion, at least to my way of thinking, is because you intend to own it for a very, very long time. Therefore, you cannot avoid short to intermediate term volatility, nor should you try.  Instead you should accept it as an unavoidable fact of the market. Otherwise, a record of increasing the dividends every year for 25 straight years or more doesn’t really seem relevant, unless you were going to hold for many years.

Not All Price Drops are the Same

A final point I would like to introduce is the idea that not all price drops are the same.  Sometimes the drop in a company’s stock price is justified and the harbinger of real systemic issues. At other times, a drop in the price of a stock can represent an incredible opportunity to buy an excellent business that has unjustifiably gone on sale.  Making these distinctions regarding volatility is a critical differentiation that should be made.

Furthermore, it’s also valuable to be able to identify and determine whether an interruption of a company’s business is a temporary one or a more permanent phenomenon.  Because, there are times when the drop in price of a stock is a sell signal, and there are times when it represents an attractive buying opportunity. The following discussion is offered to illustrate examples of the many faces of stock price volatility to include the good, the bad and the ugly.  These are just a few select examples, and there are many others that I could have used.

Bank of America an Ugly Price Drop

Our first example looks at Bank of America (BAC), and represents a quintessential example of an operating meltdown due to the now infamous financial crisis. Bank of America’s stock price fell from a high of over $55 to a low of $2.53, which followed an earnings collapse from $4.65 in calendar year 2006 to a loss by calendar year 2009 (see red highlight at bottom of graph).  Therefore, since both earnings and price collapsed, not only was the price drop justified, but the recovery may be years away, if ever.  This is why I consider this an ugly price drop.

General Electric – a Bad Price Drop and an Ugly Price Drop

In the case of General Electric (GE), there are actually multiple variations of different kinds of price drops.  First, we can see that in calendar year 2000 General Electric’s stock price had become massively overvalued.  Consequently, even though earnings continued to look good for several years, the falling prices in 2001 and 2002 were justified due to excessive valuation. Then, of course, we see a price drop where prices followed earnings down during the financial debacle in 2008 and 2009.  In this case, recovery should be sooner than what we saw with Bank of America, although it still looks like it’s still going to be many years away. 

Wells Fargo – a Bad Price Drop Getting Better

Wells Fargo & Co. (WFC) represents a financial that had a bad price drop that followed a similar drop in earnings.  However, earnings have subsequently recovered and stock price recovery has already been good to the extent that it may soon eclipse historical highs.

Cognizant Technology Solutions – A Good Price Drop

My last example looks at a company that had its stock price drop significantly during the great recession, while operating earnings continued to increase at a very strong rate.  Consequently, this represents an example of a good price drop that created an extraordinary bargain.  Therefore, price recovery has already dramatically exceeded historical highs (see price flags on graph).

The point with this exercise was simply to illustrate that a drop in a company’s stock price is not always a bad thing. Sometimes it is, as we saw with the Bank of America example, and sometimes it represents a great opportunity as illustrated by the Cognizant Technology Solutions’ example.  I believe that investors need to make these types of distinctions in order to truly be able to make sound and proper buy,sell or hold decisions. In other words, sometimes the price drop is justified and sometimes it’s not.

Summary and Conclusions

As I mentioned in the opening of this article, it was inspired by comments that were made by a financial blogger that I respect.  On the other hand, there was much about what he wrote that I disagreed with,and therefore, I felt compelled to offer my opposing views.  On the other hand, I cannot argue with his position regarding weak or strong hands.  It is true, that many investors, because they are ignorant of the facts, can and will panic during periods of market turbulence.  However, what I disagreed with most was the fatalistic attitude surrounding the notion that equities were bad because investors would panic.

I once read a quote attributed to Bob Veres, a respected columnist for the financial planning community that at its essence summarizes my view. I offer it as a pseudo-quote because I maybe interjecting a little paraphrasing:

“the definition of an excellent investment advisor is one who possesses the courage and integrity to insist that his clients do what they should do, rather than what they want to do.”

In my way of thinking, I believe it is our responsibility as professional financial advisors and bloggers to educate our clients and readers to factual and valid principles of sound investing practices.  To suggest that it’s a bad idea for investors to own equities only because you believe they will panic because their hands are weak, is not a valid recommendation, in my humble opinion.  Instead, I believe it’s incumbent upon us to offer the correct information and education that will prevent investors from behaving in irrational ways that could hurt their long-term investment results.

Furthermore, the bottom line is that I believe that equities, especially blue-chip dividend paying equities are being given a bad rap from this attitude by suggesting they are riskier than, in fact, they truly are.  The truth is that blue-chip companies such as Procter & Gamble (PG), Johnson & Johnson (JNJ) and many others too numerous to mention, have long legacies spanning decades of operating excellence and increasing dividends.  To classify them as risky investments based on simply the idea that pricing can be volatile, is in my way of thinking, an injustice.

If these blue-chip companies are purchased at reasonable valuations based on fundamentals, then the prudent investor can and should be capable of owning them over long periods of time. On the best ways to do this is to make the distinction between emotionally-driven price volatility versus permanent deterioration of the company’s long-term fundamentals.  As I stated before, both competent mountain climbers and Dividend Growth Investors recognize that the only way to get to the highest peak is to be willing to traverse the occasional valley along the way. We should not be telling investors that they are too dumb or weak-minded to own stocks, instead, we should be educating them on the true benefits and risks that come with owning them. Knowledge is power.

Disclosure:  Long CTSH, PG at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Do I Feel Lucky? (Hussman)

Monday, March 12th, 2012

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

As of last week, the market continued to reflect a set of conditions that have characterized a wicked subset of historical instances, comprising a Who’s Who of Awful Times to Invest . Over the weekend, Randall Forsyth of Barron’s ran a nice piece that reviewed our case (the chart in Barrons has a problem with the date axis, but the original chart is in last week’s comment Warning: A New Who’s Who of Awful Times to Invest). It’s interesting to me that among the predictable objections to that piece by bullish readers (mostly related to our flat post-2009 performance, but overlooking the 2000-2009 record), none addressed the simple fact that the prior instances of this syndrome invariably turned out badly. It seems to me that before entirely disregarding evidence that is as rare as it is ominous, you have to ask yourself one question. Do I feel lucky?

From our perspective, accepting stock market risk is not presently a venture that is priced to achieve reasonable investment returns (we estimate a likely 4.3% annual total return for the S&P 500 over the coming decade, and a great deal of volatility in achieving that return). Nor is market risk attractive on a speculative basis, given present overbought conditions, overbullish sentiment, and growing set of hostile syndromes (what we call Aunt Minnies) that have historically been associated with negative return/risk tradeoffs. Then again, what keeps slot machines spinning all around the world is the hope – despite the predictably and reliably negative average return/risk tradeoff – that this time will be different, and this spin will work out. So you have to ask yourself one question. Do I feel lucky?

Investors Intelligence notes that corporate insiders are now selling shares at levels associated with “near panic action.” Since corporate insiders typically receive stock as part of their compensation, it is normal for insiders to sell about 2 shares on the open market for every share they purchase outright. Recently, however, insider sales have been running at a pace of more than 8-to-1. Indeed, some of the weekly spikes have been to levels that are associated almost exclusively with intermediate market peaks, the most recent being the run-up to the 2007 market peak, the early 2010 peak, and the 2011 peak, all of which resulted in significant intermediate corrections or worse. Of course, it’s sometimes the case that insiders are early, and therefore miss part of the tail of a market advance. So it might be worth ignoring the heavy pace of insider selling for a little while. But you have to ask yourself one question. Do I feel lucky?

As disciplined investors who align ourselves with the average return/risk profile that is associated with prevailing market conditions, we don’t believe that this is a good time to take significant market risk in hopes of getting lucky. On an objective basis, we identify present conditions among the lowest 1.5% of historical periods in terms of overall return/risk profile. Maybe investors will get lucky, but the odds are still unfavorable.

It’s likely that for some investors, our defensiveness since 2009 bleeds into a general inclination to take our concerns about risk with a grain of salt. On that subject, it’s important to recognize that our defensiveness in 2009 did not result from unfavorable valuations or hostile indicator syndromes, but from the inability to distinguish prevailing conditions at the time from much of what was observed during the Depression-era. In response to the credit crisis, and what I continue to view as a misguided “kick-the-can” policy response, I insisted that our methods should perform well with reasonable drawdowns not only in post-war data, but also in Depression-era data (when for example, stocks lost two thirds of their value even after they were priced to achieve 10-year total returns in excess of 10% annually).

The resulting ensemble methods allow us to make distinctions that we were not able to make in 2009, but that period of stress-testing also left us with a “miss” (2009-early 2010) when the same indicators and methods that are so hostile today would have been much more favorable toward investment risk. One could ignore that fact, and use our miss in 2009 as a reason to ignore demonstrably hostile evidence today. But one would also have to overlook the fact that the narrow syndrome of conditions we observe today mirrors what we observed at the 2000 peak and the 2007 peak, and very few times in-between (including the 2010 peak and the runup to the 2011 peak – see last week’s comment for a chart). Notably, whatever market returns we missed by being defensive too early in those instances were wiped out in short order anyway during the subsequent declines. Yes, stocks might move even higher before the present bull-bear cycle moves to completion. But you have to ask yourself one question. Do I feel lucky?

A note on extracting economic signals

While investors and the economic consensus has largely abandoned any concern about a fresh economic downturn, we remain uncomfortable with the divergence between reliable leading measures – which are still actually deteriorating – and more upbeat coincident/lagging measures on which public optimism appears to be based.

Much of our research effort in recent weeks has been focused on developing a deeper understanding of this divergence. The historical evidence clearly indicates that such divergences are settled in favor of the leading indicators (see last week’s economic discussion in Warning: A New Who’s Who of Awful Times to Invest ), but since our views are so out of sync with the broad consensus, the issue demands as much additional investigation and research as we can amass. It bears repeating we neither desire a recession, nor have any interest in “pounding the table” about it. We would rather have the data convincingly shift to a condition that eases our recession concerns. But if we’re likely to have a recession, we don’t want to be surprised or lulled into complacency by improvement in what are largely lagging indicators.

Probably the best, if slightly technical, way to understand our reluctance to discard recession concerns is to think about observed economic data as being driven by a series of unobserved “true” states of the economy. For example, suppose that the true underlying state of the economy can be summarized by a single positive or negative number each month, call it X(t), and that each economic indicator we can actually observe is driven by a series of those current and past monthly economic states. So for example, some variable that we can observe might be written as a series of unobserved economic states:

Y(t) = a0*X(t) + a1*X(t-1) + a2*X(t-2) + …. + a “shock” from truly new developments and random noise.

[Geek's note - this is a version of an unobserved components model, of the kind used in nearly every modern signal-processing application. For example, when you go to the hospital to get a CT scan, the picture you see is not actually "taken" directly. Instead, the machine shoots X-rays at you from every possible angle, and then uses all of that sensor data to compute an image that could never have been obtained directly. That's why it's called computed tomography (CT). If signal processing methods weren't applied, every image of an internal organ would be obstructed by artifacts from bone, cartilage and other organs. Similar signal processing methods are used to combine data from multiple sensors in order to navigate anti-ballistic missiles and other objects that can't be directly observed (and of course, to identify meaningful genetic signals in autism data)].

Leading indicators essentially place weight on the unobserved true state a few months into the future (allowing that state to be estimated today based on those observed indicators), while coincident and lagging indicators load on previous components. To see what this looks like, the following chart presents the load factors we estimate for dozens of widely followed economic variables, including one-month, 6-month and year-over-year employment gains, new unemployment claims, real consumption growth, ISM data, consumer confidence, quarterly and year-over-year GDP growth, stock returns, credit spreads, OECD leading indices, and a score of other measures. Notice that most of the variables load not on the first (most leading) economic state variable, but instead on the fourth or fifth component. That’s another way of saying that most observed economic variables actually lag the best leading indicators by several months. A good example is year-over-year growth in payroll employment, which trails year-over-year growth in real consumption with a consistent lag of about 5 months.

So what do the unobserved components look like today? In the chart below, the green line shows the average standardized value (mean zero, unit variance) of dozens of economic variables, and provides a very good summary of what can be observed directly. Note that this observable data has enjoyed a clear bounce in recent months. The blue line presents estimates of the unobserved economic states that drive the observable data. Importantly, the extracted signals lead the observed economic composite by several months. This is really simply a reflection of the underlying structure of the data – leading indicators lead, and lagging indicators lag (the full analysis uses data since 1950, but the lead of a few months is hard to distinguish visually on a long-term chart).

The most recent estimates we obtain for the extracted economic signal (most recent first) are as follows:

Feb: -0.647
Jan: -0.603
Dec: -0.435
Nov: -0.189
Oct: -0.041
Sep: 0.075
Aug: -0.507
Jul: -0.603

What strikes me about these estimates is short-lived spike in the implied economic signal between September and November. My thinking on the recent improvement in economic data was that it was primarily driven by the large intervention by the ECB near the end of last year. But even when we estimate the parameters of the model using half the data set, and then run true out-of-sample estimates of the economic signal through the present, we still get that burst of improvement in the September through November period. What’s interesting about that improvement was that it was not driven by any obvious shift in the observable data. Rather, the spike was driven by the failure of the data to deteriorate during that period to an extent that would have been expected, given the trajectory of the economic state (this is similar to shifting your expectation for a bird’s flight path not because it turned, but because it failed to turn as much as expected).

In that context, we can see that the improvement in the observable data in recent months has faithfully followed the improvement in that underlying state, which actually happened months ago. Since then, however, the estimated state has deteriorated to a point that is now worse than it was last July.

This is important, because given the deterioration in the inferred economic condition between October and December, it follows that we would expect to see a clear deterioration in observable economic variables over the next 8-12 weeks. If the trajectory holds, the weakness is likely to emerge slowly and then accelerate. For example, the preliminary expectation would be for continued positive payroll growth in March (roughly 50,000-70,000 jobs) and a shift to net job losses in April.

Equally important, to the extent that we observe economic variables coming in better than expected, the inferred underlying state of the economy is likely to improve sharply, as it did last September. This will take a few months of data, but it’s not going to require quarters and quarters of it. At present, we have to view the economic situation negatively, but on the optimistic side, we should also be able to abandon our own recession concerns if the observable data move off of the trajectory that we’ve imputed to-date. On this, leading measures such as consumption growth and OECD leading indices will be most important in driving our estimates of future prospects, while the employment data over the next few months will be useful in confirming the downturn we’ve seen in the inferred state estimates since November.

Market Climate

As noted above, the Market Climate for stocks remains among the most negative 1.5% of historical instances. This time may be different. We see no reason to expect so other than the hope of being lucky. Still, one thing is certain, and that is that present conditions will be impermanent. With certainty, market conditions will shift in a way that removes the present syndrome of overvalued, overbought, overbullish conditions. We don’t know whether that shift will involve a moderate retreat that removes the overbought and overbullish aspects, or a major decline that removes the overvaluation, or just maybe with a further advance that then corrects enough to clear this syndrome at a higher level than the market is today. Conditions might improve without a major breakdown in market internals, or they may improve by a firming of market internals following an extended period of weakness. But with certainty, market conditions will shift in a way that provides us an opportunity to accept market risk at a positive and favorable expected return/risk tradeoff.

Also, with certainty, the present divergence between leading economic measures and coincident/lagging measures will also be resolved. While the historical likelihood is that the coincident and lagging measures will follow the leading measures, we also know that our estimates of the underlying state of the economy could shift quickly in the coming months simply in response to an economy that achieves moderate positive growth, and thereby deviates from what is now an unfavorable projected trajectory.

For now, Strategic Growth and Strategic International remain tightly hedged. Strategic Dividend Value is hedged in an amount equal to 50% of its equity holdings (which is the largest hedge the Fund can establish, but which also leaves the Fund more exposed to general market fluctuations in both directions). Strategic Total Return also remains relatively conservative here, with a duration of about 3.5 years in Treasury securities, and a very small percentage of assets in precious metals shares, utility shares and foreign currencies.

 

Copyright © Hussman Funds

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Lazlo Birinyi – Uber Bull Calls for S&P 1700 this Year

Tuesday, March 6th, 2012

Looks like we are going to see the market’s first significant gap down of the year this morning – no specific reason, it is just “due”. There have been any number of bears who have been turned to the bull camp in the past 2-3 weeks, but one guy consistently bullish has been well known pundit Laszlo Birinyi, who came out with a S&P 1700 call yesterday on CNBC. It would be easy to say “hey that was an obvious ‘call the top’ moment” but there have been any number of similar signals (Roubini bullish, uber bullish Barron cover, etc) over the last month which have led to only more pain for bears. Either way it’s always good to see the ‘other side’ of the argument so below is the video:

  • Well-known stock commentator Laszlo Birinyi sees more than a rising stock market. The market bull told CNBC Monday he sees signs of a U.S. economy that may be doing far better than others expect. “This year the bet is GDP of 2 percent to 2.5 percent,” he said. “When I look at the market I see stocks like Cummins and Salesforce.com, Microsoft, General Motors up 20, 30 and 40 percent. That makes me question, maybe the market’s saying something about a good economy. “I just wonder if we’re prepared for a 3 percent to 4 percent GDP? If it does [reach that level] I think we can again have a mirror of 1995 where the market surprised everybody on the upside.”
  • The head of Birinyi Associates, who has long stressed picking strong individual stocks that can resist market volatility, last week released a robust forecast for a Standard & Poor’s 500 spiking to 1,700 this year, up over 20 percent. He based the forecast on market patterns showing this year’s rally is remarkably similar to what happened in 1995, when expectations were low for both stocks and bonds.
  • “What happened was just the opposite. Interest rates went down, the market went up 35 percent” and had the best year in 50 years, Birinyi told CNBC. “As I’ve often said, the negative case is always more articulate, it’s always more rational, more reasonable because we see it,” Birinyi said. “The market is looking ahead, and I contend what stocks are telling us is a possibility, and I think a fairly good possibility, that something positive is going to develop [and] perhaps we’re underestimating the economy. Don’t disregard the possibility of something good happening.”

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Dow 15,000: Is this an Outlier Call or Consensus?

Friday, February 17th, 2012

Sources:
Feb. 13, 2012 – (Bloomberg) — Jeremy Siegel, professor of finance at the University of Pennsylvania’s Wharton School, talks about the outlook for U.S. stocks, and his call for the Dow to reach 15,000 by the end of this year, and possibly even 17,000 over at least the next two years, with Trish Regan on Bloomberg Television’s “Street Smart.”

http://www.bloomberg.com/video/86292500/

Mon 13 Feb 13 – Is it too soon to call for a Dow 15,000 based on an article in Barron’s over the weekend? Jim Paulsen, Wells Capital Management shares his thoughts. | 04:06 PM ET

http://video.cnbc.com/gallery/?video=3000073016

Feb. 13, 2012 – Bob Doll, of BlackRock, discusses the likelihood that the Dow will hit 15,000 in 2012.

http://video.cnbc.com/gallery/?video=3000072922

Doug Kass says bullish sentiment is just to prevalent period. And he points to the following:
- Surveys showing a substantial rise in bulls and decline in bears over the last couple weeks
- Hedge funds have increased net long exposure
- Individual investors are putting money into domestic equity funds
- Famed bear Nouriel Roubini is optimist on the market
All told, that would suggest the next big move should be lower.

http://www.cnbc.com/id/46342627

Tags: , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off

Doug Kass Wonders Why Anyone Listens To Jeremy Siegel

Thursday, February 16th, 2012

Lately, everybody’s been talking about Jeremy Siegel’s latest bullish call on stocks.

On Saturday, Barron’s cover story highlighted Siegel’s call for Dow 15,000 within the next two years.

Yesterday, Bloomberg’s Trish Regan had the Wharton Professor on to further explain his call.

But Seabreeze Partners’ Doug Kass isn’t having any of it.

Kass, who famously called the March 2009 stock market bottom and nailed the 2011 S&P 500 close, aims to bring down the Jeremy Siegel bulls.

He groups Siegel with the likes of Meredith Whitney and Nouriel Roubini who made names for themselves with spectacularly successful calls, only to be followed by some pretty bad calls.

“[Q]uite frankly, the streets of Wall Street are paved with geniuses who have made one great call in a row,” writes Kass.

In his latest column on Real Money Pro, he expands:

Dr. Siegel comes off as a very nice person, but he is an academic who has been bullish at some very wrong times. Importantly, his theories regarding equities for the long term have been wildly off, as bonds have outperformed stocks for one, five, 10, 30 and 40 years, which, according to his investment thesis, is impossible.

His view on the fixed-income market also has been manifestly incorrect over the last two years. Dr. Siegel’s Wall Street Journal op-ed, “The Great American Bond Bubble” was wrong in its conclusion back in August 2010.

Kass also reminds us that back in July 2009, the Wall Street Journal’s Jason Zweig poked some holes in the data Siegel used in his research.

Earlier this year, Doug Kass wrote that that S&P 500 could “eclipse the 2000 high of 1527.46 during the second half of the year.” However, he recently changed his tone when be found out that Nouriel Roubini, Dr. Doom himself, turned bullish on stocks.

Read Doug Kass’s whole column at Real Money Pro >

Copyright © Business Insider

Tags: , , , , , , , , , , , , , , , , , , , ,
Posted in Markets | Comments Off