“1-800-GET-ME-OUT?!” (Saut)

Monday, June 4th, 2012

“1-800-GET-ME-OUT?!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 4, 2012

The “S” word makes most investors uneasy. They find the “B” word, “buying,” much more pleasant. Why is perhaps best explained in a book written by Justin and Robert Mamis titled “When to Sell.” Following are several poignant excerpts from that book:

“Stocks are bought not in fear but in hope. No matter what the stock did in the past it assumes a new life once a purchaser owns it, and he looks forward to a rosy future – after all, that’s why he singled it out in the first place. But these simple expectations become complicated by what actually happens. The stock acquires a new past, beginning from the moment of purchase, and with that past comes new doubts, new concerns, and conflicts. The purchaser’s stock portfolio quickly becomes a portfolio of psychic dilemmas, with ego, id, superego, and reality in a state of constant battle.”

“The public is most comfortable when they are sitting with losses. Because if their stocks are down from where they bought them, they don’t have to worry about them. Once he’s got a loss, the typical investor is sure he isn’t going to sell. He bears the lower price because in his mind it is temporary and ridiculous; it’ll eventually go away if he doesn’t worry about it. So selling at a loss becomes absolutely out of the question. And since it is out of the question, and his mind is made up for him, the struggle of any potential decision vanishes and he is able to sit comfortably with the loss.”

“To the public mind, selling is never sound. It always conveys the possibility of being wrong twice: first, admitting that they’ve made a buying error; second, admitting that they might be wrong in selling out. And if the stock has actually gone up, they are tormented; should they take a profit or hold for a bigger one? That creates anxiety, and anxiety breeds mistakes. But as long as they’ve got losses, and never have to decide, they can sit back comfortably and dream instead.”

“Through the entire market cycle lurks the fear of finalizing the deed, of taking it from dream to reality by selling. By not selling, by tightly holding on to his stocks, the investor never has to face reality.”

Yet, “selling” seemed to be on the market’s mind late last week punctuated by Friday’s Dow Dive of ~275 points. Said decline left the senior index down 8.74% from its May 1st closing high (13279.32) into Friday’s close (12118.57). While not all that big of a decline, it brought back memories of the past two years’ May – July corrections of 17% and 20%, respectively. Yet, investors should keep in mind that since 1928 there have been 294 pullbacks of 5% or more. Ninety four of them have been moderate (>10%), 43 have been severe (>15%) and 25 have been bear markets (>20%). What is interesting to me is that since last October 4th’s “undercut low” the chant from most investors has been, “We want a pullback to become more fully invested.” Now that we have the pullback everyone is in panic mode (again). To borrow a line from George Bernard Shaw – There are two tragedies in life; one is not to get your heart’s desire, the other is to get it! The “heart’s desire” for the bulls since last October has been the fact the markets have ignored all of the bad news. Verily, the senior index has turned a deaf ear to the worsening Euroquake situation, Iran, softening economic trends, deflationary dives in commodities, etc. Of course that “deaf ear” stance has changed over the past four weeks.

Indeed, the Dow’s decline is now 22 sessions long. Such “selling stampedes” typically last 17 – 25 sessions before they exhaust themselves; it just seems to be the rhythm of the thing. This has been my observation over the years in that it takes this long to get participants bearish enough to finally panic and throw in the towel by selling their stocks. While it is true some stampedes have lasted more than 25 sessions, it is rare to have one run more than 30 sessions. Today is session 23 on the downside. Obviously Friday’s Fade took out my failsafe point of 1290 on the S&P 500 (SPX/1278.04), leaving the DJIA (INDU/12118.57), the S&P 500, and the NASDAQ Composite (COMP/2747.48) all below their respective 200-day moving averages (DMAs). The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. Also worth noting is the decline has left most of the oversold indicators I rely on pretty oversold. Nevertheless, I told “callers” on Friday that when markets get into one of these selling squalls they rarely bottom on a Friday. What tends to happen is participants go home and brood about their losses over the weekend and “show up” on Monday in selling mode, which often leads to “turning Tuesday” (read: recoil rebound). Accordingly, the SPX needs to quickly recapture 1290, and stay above that level, if a rally is to commence. On the other hand, if the SPX merely bounces back up to 1290, and then falls sharply back, I would view that as a bearish sign requiring more downside hedging and/or the raising of some more cash. Fortunately, we recommended raising cash in February – April. Unfortunately, we recommended judiciously putting some of the cash back to work (but not much of it) into somewhat more defensive names like 3.8%-yielding Rayonier (RYN/$42.18), which has a Strong Buy rating from our fundamental analyst.

While Euroquake has been on center stage for weeks, Friday’s shockingly weak employment report brought the focus back to the economy and jobs. The 69,000 private sector payroll growth figure was well below the estimate of 150,000 and just to add pain to injury the unemployment rate ticked up to 8.2% from 8.1%. Still, investors should remember unadjusted private-sector payrolls have risen by 1.983 million over the trailing 12 months for roughly a 165,000 monthly average jobs gain. As our economist, Dr. Scott Brown, notes, “That’s not bad, but it is far short of what’s needed to make up ground lost during the economic downturn.” Now for weeks I have been discussing the weakening economic reports. That string of weakness continued last week given that of the 21 economic releases, 18 were weaker than expected, two were in line, and only one exceeded the estimate (that would be Continuing Claims). This softening trend could still just be a weather-related issue combined with skewed seasonal adjustments; the next few months will decide.

The call for this week: Friday was the first day of hurricane season here in Florida, yet the storm didn’t hit our beaches but rather blew onto the Street of Dreams with a 275-point “storm surge.” The media attributed Friday’s Flop entirely to the disappointing employment numbers, but the truth was the market was already headed down before the release of those numbers. And when the SPX’s 1290 level was breached, the rout was on. The result left all of the indexes we monitor near their lows of the day and the three major market indices (INDU, SPX, COMP) below their respective 200-DMAs for the first time in about five months. The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. And despite the break below my 1290 pivot point I can’t shake the feeling that all of this is just part of the bottoming process.

P.S. – I am on the road again this week seeing accounts and speaking at conferences.

Copyright © Raymond James

Tags: Anxiety, Book Stocks, Chief Investment Strategist, Conflicts, Doubts, Ego Id Superego, Excerpts, Fear, Investors, jeffrey saut, Losses, Purchaser, Raymond James, Saut, Stock Portfolio, Struggle, Typical Investor
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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: Barron, Collapse, Decision Making Process, ECB, Euro Zone, Excerpts, Federal Reserve, Fiscal Policy, Growth Trend, Hedge Fund Manager, Monetary Decisions, Nbsp, Quantitative Easing, Ray Dalio, Redistribution Of Wealth, Refinancing, Social Tension, Taxation, Treasury, Unemployment
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Greg Smith’s Parting Confession on Goldman’s “Toxic and Destructive” Culture

Wednesday, March 14th, 2012

Greg Smith’s confession, a now former executive director and head of the Goldman’s United States equity derivatives business in Europe, the Middle East and Africa.

Excerpts from the NYT:

Why I Am Leaving Goldman Sachs

Today is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.

To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

…

I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.

When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.

…

How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

Tags: Belief, Confession, Conscience, Derivatives, Excerpts, Executive Director, Global Finance, Goldman Sachs, Greg Smith, History Books, Humility, Investment Banks, Matt Taibbi, Nyt, Pride, Skeptical Public, Squid, Stanford, Summer Intern, Teamwork, Trajectory, Vampire Squid
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Jeremy Grantham: Investment Outlook (Q3 Letter)

Tuesday, December 6th, 2011

Here is the latest quarterly letter (Q3) from GMO’s Jeremy Grantham: The Shortest Quarterly Letter Ever.  One of Grantham’s shorter letters, indeed, and as a usual, a must.

Some excerpts pulled out courtesy of ZeroHedge (without the alarming headline) ;)

• Avoid lower quality U.S. stocks but otherwise have a near normal weight in global equities.
• Tilt, where possible, to safety.
• Try to avoid duration risk in bonds. For the long term they are desperately unattractive. Don’t be too proud (or short-term greedy) to have substantial cash reserves. Admittedly, this is the point where we at GMO try to be clever and do a little better than the minus 1% real from real cash – and, so far, with decent success.
• I like (personally) resources in the ground on a 10-year horizon, but I am nibbling in very slowly because, as per my Quarterly Letter on resources in April 2011, I fear a major short-term decline in commodities based on a combination of less bad weather – which has been bad, but indeed less bad – and economic weakness, especially in China. Prices have declined, often quite substantially, since that letter. However, I believe chances for further price declines in resources are still better than 50/50 as China and the world slow down for a while, and the weather becomes a bit more stable.

Full read here – hit fullscreen for easy reading:

Tags: Bad Weather, Bonds, Cash Reserves, China, Commodities, Decent Success, Decline, Duration, Economic Weakness, Excerpts, Fullscreen, Global Equities, Horizon, Investment Outlook, Jeremy Grantham, Price Declines, Q3, Quarterly Letter, Stocks, Substantial Cash
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Daniel Kahneman: Would You Be Happy If You Were Richer?

Friday, October 28th, 2011

“When people consider the impact of any single factor on their well-being — not only income — they are prone to exaggerate its importance; we refer to this tendency as the focusing illusion”

Click Here To Read: Daniel Kahneman ” Would You Be Happier If You were Richer? A Focusing Illusion”

Introduction (Via Princeton)

Most people believe that they would be happier if they were richer, but survey evidence on subjective well-being is largely inconsistent with that belief. Subjective well-being is most commonly measured by questions that ask people, “All things considered, how satisfied are you with your life as a whole these days?” or “Taken all together, would you say that you are very happy, pretty happy, or not too happy?” Such questions elicit a global evaluation of one’s life. An alternative method asks people to report their feelings in real time, which yields a measure of experienced happiness. Surveys in many countries conducted over decades indicate that, on average, reported global judgments of life satisfaction or happiness have not changed much over the last four decades, in spite of large increases in real income per capita. While reported life satisfaction and household income are positively correlated in a cross-section of people at a given time, increases in income have been found to have mainly a transitory effect on individuals’ reported life satisfaction. (1-3) Moreover, the correlation between income and subjective well-being is weaker when a measure of experienced happiness is used instead of a global measure. This article reviews recent evidence that helps interpret these observations.

Additional Excerpts (Via Princeton)

When people consider the impact of any single factor on their well-being — not only income — they are prone to exaggerate its importance; we refer to this tendency as the focusing illusion. Income has even less effect on people’s moment-to-moment hedonic experiences than on the judgment they make when asked to report their satisfaction with their life or overall happiness. These findings suggest that the standard survey questions by which subjective wellbeing is measured (mainly by asking respondents for a global judgment about their satisfaction or happiness with their life as a whole) may induce a form of focusing illusion, by drawing people’s attention to their relative standing in the distribution of material well-being. More importantly, the focusing illusion may be a source of error in significant decisions that people make.

Despite the weak relationship between income and global life satisfaction or experienced happiness, many people are highly motivated to increase their income. In some cases, this focusing illusion may lead to a misallocation of time, from accepting lengthy commutes (which are among the worst moments of the day) to sacrificing time spent socializing (which are among the best moments of the day). (28) An emphasis on the role of attention helps to explain both why many people seek high income – because they over predict the increase in happiness due to the focusing illusion and because changes in relative income are associated with strong emotional responses – and why the long-term effects of these changes are relatively small — because attention eventually shifts to less novel aspects of daily life.

Copyright © Daniel Kahneman, Princeton University

h/t: Simoleon Sense

Tags: Correlation, Cross Section, Daniel Kahneman, Excerpts, Global Evaluation, Happiness, Household Income, Illusion, Income Per Capita, Judgments, Last Four Decades, Life Satisfaction, Moment To Moment, Princeton, Spite, Subjective Well Being, Survey Evidence, Tendency, Time Increases, Transitory Effect
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Fed Most Likely to Announce QE2 on November 3

Wednesday, October 13th, 2010

by Asha Bangalore, Northern Trust

The Fed is most likely to announce the second phase of quantitative easing (QE) in the policy statement after the conclusion of the November 2-3 FOMC meeting.  The minutes of the September 21 meeting indicate an extensive discussion about the unsatisfactory pace of economic recovery.  The utmost importance of taking action to promote economic growth was visible in the repetitive mention of the need for additional monetary accommodation.  The following excerpts from the minutes support expectations of further Fed action at the close of the November 2-3 meeting.

“Participants discussed the medium-term outlook for monetary policy and issues related to monetary policy implementation. Many participants noted that if economic growth remained too slow to make satisfactory progress toward reducing the unemployment rate or if inflation continued to come in below levels consistent with the FOMC’s dual mandate, it would be appropriate to provide additional monetary policy accommodation.”

“Several members noted that unless the pace of economic recovery strengthened or underlying inflation moved back toward a level consistent with the Committee’s mandate, they would consider it appropriate to take action soon.”

“Members generally thought that the statement should note that the Committee was prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. Such an indication accorded with the members’ sense that such accommodation may be appropriate before long, but also made clear that any decisions would depend upon future information about the economic situation and outlook.”

The discussion of suitable strategies to provide monetary accommodation appears to have concluded with the focus on “further purchases of longer-term Treasury securities and possible steps to affect inflation expectations.”  Inflation expectations, as measured by the difference the 5-year Treasury note yield and the 5-year yield on inflation protected securities (see chart 1) has risen from a recent low of 1.19% on August 19 to 1.41% as of October 8.  An increase of inflation expectations lowers real short-term interest rates and stimulates economic activity.  With nominal short-term interest rates constrained by the zero bound, an increase in inflation expectations is important to lift economic activity.

As noted in prior commentaries, the precise terms of QE2 are unclear and the Fed is unlikely to announce the magnitude of accommodation as this is the path already taken when it engaged in QE1.  The policy statement will probably reflect the Fed’s full employment and price stability mandate as guidance for the extent of support it plans to provide.  For QE2 to work, banks need to move away from accumulating excess reserves.  Excess reserves have been trending down from a peak of $1.192 trillion of February 24, 2010 to $964 billion as of October 6 (see chart 2).

Tags: Bangalore, Dual Mandate, Economic Growth, Economic Recovery, Economic Situation, Excerpts, Fomc, Inflation Expectations, Medium Term Outlook, Monetary Policy, Northern Trust, Policy Implementation, Qe, Qe2, Satisfactory Progress, Second Phase, Suitable Strategies, Treasury Securities, Unemployment Rate, Utmost Importance
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Jeremy Grantham: “Fair value on the S&P is 860″

Tuesday, October 27th, 2009

Jeremy Grantham has become a familiar and very popular face on this site. For those treasuring his insight, wisdom and prescient calls, the co-founder and chief investment strategist of Boston-based GMO has just published the October edition of his quarterly newsletter entitled “Just desserts and markets being silly again”.

Before quoting from the report, Grantham recently put matters into perspective in a Kiplinger article, saying: “The recent rally has been very speculative, favoring risky assets over the past few months. I’m sorry if you missed investing at the market’s March lows, but don’t compound the damage to your portfolio by chasing gains in risky assets. We’re at the beginning of a seven-year period of lean returns. You should only be buying the highest-quality blue-chip com­panies, where valuations are most attractive.”

Here are a few excerpts from the Grantham’s newsletter.

“Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year. Doesn’t it seem odd that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal?

“Price … does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors. First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away. Second, the slow gravitational pull of value as US stocks reach +30-35% overpricing in the face of an extended difficult environment.

“It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1,100. It can certainly happen. Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again. I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. ‘Painfully’ is arbitrarily deemed by me to start at -15%. My guess, though, is that the US market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1,098 on October 19).

“Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.”

Click here for the full report on Grantham’s reasoning for his cautious stance.

Source: Jeremy Grantham, GMO, October 2009.

Tags: Chief Investment Strategist, Co Founder, Desserts, Excerpts, Gmo, Guess, Horizon, Jeremy Grantham, Lean Years, Lows, October 19, Panies, Price Earnings Ratios, Profit Margins, Quarterly Newsletter, Rally, Risky Assets, S Market, Valuations, Wreckage
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How to interpret the Dow Theory bull signal, according to Richard Russell

Tuesday, July 28th, 2009

There was a great deal of interest in my recent post “Dow Theory calls a bull market“. Readers had many questions on what brought about the Dow Theory bull signal, and specifically whether Richard Russell, “Mr Dow Theory” and author of the Dow Theory Letters, was the last bear standing when he replaced the bear on the first page of his daily newsletter with a long-horned Texas bull.

Who better to ask for more background on his thinking than the R man himself? The paragraphs below are excerpts from his latest newsletter.

“For four frustrating months or ever since the March lows, this writer [Russell] has been in a state of perplexity, better known as confusion. Now, at last the picture has clarified. I would like my subscribers to study the following explanation carefully. I’m going to explain why the trend of the stock market has turned clearly bullish under Dow Theory. The fooler was that this pattern did not occur immediately off the March lows – but it took place part-way up the rally and four months after the March lows.

“Please, refer to the charts of the Industrial and Transportation Averages below.

(1) The Industrials (top chart) recorded a low in May at 8230.

(2) The Transports also established a low in May at 2971.

(3) Next, both Averages rallied to June peaks, the Dow to 8877 and the Transports to 3434.

(4) Both Averages then turned down, with the Dow breaking support and declining to 8087. But important – note that the Transports held support and did not confirm the Dow weakness.

(5) After the Transport non-confirmation, both Averages rallied, and both Averages broke out above their June peaks.

“This was a classic Dow Theory bull market signal! To review – we saw the two Averages decline with one Average (Industrial) breaking to a new low while the other Average (Transports) refused to confirm. Next, we witnessed a rally with both Averages breaking out to new highs.

“Note – Both Averages are now overbought, based on the level of the RSI.”

Source: StockCharts.com

Source: StockCharts.com

“The trend of the stock market is now bullish. But this is where interpretation is critical.

“Nowhere during 2008 or 2009 did we see anything typical or characteristic of a major bear market bottom. However, recently we witnessed a Dow Theory bull market signal. My interpretation? We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.

“There is no way of knowing how high this bear market rally might carry. The question – is it worth playing this cyclical bull market? My answer is yes, but play it very conservatively and carefully.”

And that is the word according to a long-timer that has spent more than half a century following the ticks on the tape.

As an aside, I have been subscribing to the Dow Theory Letters for more than 26 years and highly recommend them for the stimulative nature of the content.

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Tags: Confirmation, Confusion, Daily Newsletter, Decline, Dow Theory Letters, Excerpts, Four Months, Industrials, Lows, Market Signal, New Highs, Paragraphs, Perplexity, Rally, Richard Russell, Stock Market, Subscribers, Trend
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Why Jeremy Grantham Changed His Mind

Thursday, May 28th, 2009

The opinions of Jeremy Grantham, veteran investor and founder of Boston-based money-management firm GMO, have been featured regularly in posts on the Investment Postcards blog. Against the background of his general disregard for conventional wisdom, his turnaround in early March from a perma-bearish stance to a more bullish demeanour was particularly closely followed.

“… be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle less black than the day before,” he said in March in a newsletter entitled “Reinvesting when terrified“. He also cautioned investors not to fall prey to “terminal paralysis” that often sets in after a financial crisis.

A recent interview by SmartMoney with Grantham provides insight on why he has changed his mind and his prognosis for the future. A few excerpts from the interview are shared below.

SmartMoney: In 2007 you were worried the global financial market could fall apart, and you said a market downturn was probably coming. Okay, say it: “I told you so.”

Jeremy Grantham: That seems so long ago. I felt like saying that a few months ago, but now onward and upward, and wait for the next unexpected twist.

SM: Why were you so certain things were going to get so ugly?

G: There wasn’t a whole lot of doubt where I was coming from. I thought the fair value of the S&P was 925; the S&P went to 1500. And by 2006 the housing bubble was at a 100-year peak. This was the 32nd asset bubble that we’ve tracked, and all but the U.K. housing bubble have popped.

SM: … for the first time in years, you like US stocks.

JG: We think a fair price for the S&P 500 index is 900. By sheer divine intervention we bought into the market on Mar. 6, the day it hit the recent low of 666. It’s likely, but far from certain, that we’ll go back and make a new low. You aren’t going to get to buy at the absolute low unless you have a time machine.

SM: Anything else besides US stocks?

JG: US stocks were nicely cheap, and frankly, the rest of the world was even cheaper. In early March, when we bought, we invested only in stocks we thought would have a 10 to 14 percent average annual return after inflation. That’s magnificent. We haven’t seen anything like that in 20 years. It was somewhat disappointing that prices moved up so fast in just a couple of weeks. The odds are a bit more than 50-50 that we will go back and test that low.

SM: So you’ve made a quick buck. Now what?

JG: You have a set of possibilities. First, if the market nosedives, it’s easy: You buy. The second is confusing, when the market just goes sideways, between 700 and 800. The market is irritatingly cheap then, but not super cheap. The longer that goes on, the less probability we will set a new low, so we’ll ultimately put money each month into the market.

SM: What if stocks keep rallying?

JG: If the market goes higher, above 950, and then starts moving sideways, between 950 and 1050, we probably do very little. Then the market is moderately overpriced.

SM: Over the long haul, is there any particular industry or sector you like?

JG: The people who move quickly in this market can make money. The people who invest in energy alternatives will make more. Alternative energies and combating climate change are the single most important economic initiatives over the next 10 years-really over the next 50 years. It will be a very exciting next 50 years.

SM: Will we get out of this mess?

JG: The stimulus is so great in the United States, China and the United Kingdom, it will kick the economy up. GDP will go back positive for two to three quarters. They’ll assume everything is settled, that throwing money at it has worked. But the long-term imbalance between overproducers [like China] and overspenders [like the US] will continue. It’ll be a multiyear drag on growth.

SM: We’re just throwing money at the problems?

JG: If the problem is that we consume too much and borrow too much, does it make sense to borrow more and spend more? It doesn’t make sense to solve alcoholism by giving an alcoholic a quart of whiskey, but everyone believes that we must stimulate. So that’s why we feel this is a temporary cure. This is like when you revive the drunk, he staggers down a few blocks, then falls down again.

SM: That does not sound promising.

JG: We’re not rich, and we’re undersaved and underpensioned. Those will be a real brake on economic growth. This will be a pretty long recovery period, longer than we’re used to, but hopefully not as long as Japan took. It will not be as long as the Depression, but it will be several years, and not just two. Lord knows we have had several fat years.

Source: Russell Pearlman and Jonathan Dahl, SmartMoney, May 21, 2009.

Tags: Conventional Wisdom, Demeanour, Disregard, Divine Intervention, Excerpts, Financial Crisis, Global Financial Market, Gmo, Housing Bubble, Jeremy Grantham, Light At The End Of The Tunnel, Market Downturn, Money Management Firm, Paralysis, Prey, Prognosis, Smartmoney, Time Machine, Turnaround, Unexpected Twist, Whole Lot
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Crispin Odey: Markets Giving Misleading Signals

Thursday, March 5th, 2009

Crispin Odey, CIO, Odey Asset Management, shares a wealth of insight in his 2008 year-end Letter to Shareholders reflecting, in the following excerpts, on the mixed signals the markets are sending about valuations, and commodities. Unlike his former protege and partner, Hugh Hendry, who is avoiding equities for the time being, and long long-term government bonds, Odey likens the current pricing climate in bank shares, “like trading options,” and believes there will be a bear market in bonds within 12 months. Read on:

“Keynes believed that economics was a polemical science. He made economics popular and powerful because he abstracted ideas that in the workaday world looked sensible and showed them to be dangerous if followed by everyone. Thus he changed the way that policy makers and people thought. Has there been a better time to renew the challenge?”

“Given that all of this is a long way away from being accepted we must reluctantly conclude that the world economy is not yet in a recovery position. The recession only started to get into its stride in September of last year. Most companies will have been guilty of over-trading as they have sought to cover falls in orders by accepting any orders. They will be finding themselves with customers going bust and inventory still rising. Profit numbers will be dire. The only good news is that at some point the survivors will be able to charge more for less, and margins will be higher on the other side of this hill”.

“Current investments come about from the outstanding opportunities being opened up by the pain from the falls in share prices that we have seen over the last year. This anguish is sorely felt by us all but it is also the time to be investing. We have become big buyers of the UK clearing banks. This reflects quite how cheap they are. The shares are trading like options. After Northern Rock and Lehman Brothers, many are now convinced that they will be nationalised. However, the government has realised that nothing is solved by nationalising them, and in the UK’s case, that there is everything to be gained from letting them live. In an election year who else has Brown got to blame?”

“Given that on the other side of this disaster these banks can earn multiples of their current share price, the risk/return is wrong. In many ways these purchases remind me of Marconi, when the share price fell to 10p but the lack of covenants on the £4 billion bank loan meant that it could not be bankrupted for four years. We made 450% on that trade. Hopefully these banks will fare better and for longer. Given time and distance they will be fine”.

“This is because the markets have been giving misleading signals for some time. Wheat is a typical example. There is barely any surplus supply over demand in wheat. Yet last year farmers found themselves with rising input costs, thanks to the oil and fertilizer price hikes, and then falling incomes with wheat prices that were some 60% off their highs. They had one of their worst years ever. As a result this year plantings are way down, farmers are distressed and in Brazil and Argentina facing droughts. The wheat price is likely to soar”.

“All in all I expect that within 12 months government bond markets will go into a bear market which may be long and protracted. The stockmarkets remain good value and would prosper after some worries if inflation came back and my portfolio should do quite well in that environment. However it remains hard work in the main”.

Hat tip: Jonathan Davis, Independent Investor

Tags: Anguish, Asset Management, Bear Market, Better Time, Brazil, Bust, Clearing Banks, Crispin Odey, Excerpts, Government Bonds, Hugh Hendry, Keynes, Lehman Brothers, Letter To Shareholders, Margins, Mixed Signals, Recession, Recovery Position, Share Prices, Valuations, Workaday World, World Economy, Year End
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