Friday, December 31, 2010

Hussman - Best December Read Award

I thought the piece below was the best thing I read this month. It isn't based on technicals or speculation. Just long term valuation standards and facts. One thing that should have become apparent in 2010 is that there may be absolute truth, but at least in the financial world in the short term, truth is relative.

I encourage you read the entire Hussman piece.

Hope every has a great New Year!!

Why are Treasury yields rising despite hundreds of billions of Treasury purchases by the Federal Reserve? There are two possibilities in the current debate. One is that the Fed's policy of purchasing Treasuries has scared the willies out of the bond market on fears of higher inflation, and that the policy is a failure. The other is that the policy has been such a success at boosting the prospects for economic growth that interest rates are rising on anticipation of a better economy.

From our standpoint, neither of these explanations hold much water. On the inflation front, the recent bond selloff has hit TIPS prices as well as straight Treasuries, which isn't something you'd expect to see if inflation expectations were being destabilized. And although precious metals and other commodity prices have been pressed higher, the commodity run can be more accurately traced to negative real interest rates at the short-end of the maturity curve, coupled with a downward trend in long-term yields that has now reversed dramatically (more on that below). I've long argued that unproductive government spending and profligate fiscal policy are ultimately inflationary (regardless of how the spending is financed, and particularly if it is monetized), but I continue to view persistent inflation as a long-term, not near-term concern. A rise in T-bill yields of more than 15-25 basis points would change that assessment. Until then, velocity can be expected to collapse in direct proportion to changes in the monetary base, with little impact on prices.

As for the notion that the Fed's targeted Treasury purchases have directly aided the economy, the argument requires bizarre logical gymnastics. It demands one to believe that although the purchases were intended to stimulate the economy by lowering rates, they have been successful without lowering them, and in fact by raising them, because the expectation of lower rates was so stimulative that it caused rates to rise, so that the higher rates can be taken as evidence that lowering rates without lowering them was a success. Oh, brother.

And this is the hard part - basically if you have managed money avoiding the ugly you have gotten killed. You needed to to own trash.
The performance of these 133 factor portfolios over the past 13 weeks offers tremendous insight into the extent to which the Federal Reserve has encouraged speculative risk. Investors are chasing stocks with the greatest exposure to market fluctuations, commodities, credit risk, small-cap risk and volatility. Conversely, securities demonstrating reasonable valuation, stability, quality, or payout have been virtually abandoned by investors. Here is a sampling:


Market Beta

Raw Materials Beta
Commodity Sensitivity

Credit Spread Beta
Macro Economic Sensitivity

Small vs. Large Beta
Style Sensitivity

Silver Beta
Commodity Sensitivity

Sigma Risk (Volatility)

Operating Cash Flow Yield

EPS Stability

Value vs. Growth Beta
Style Sensitivity

Return on Invested Capital

Dividend Yield

10-Year T-Note Beta
Macro Economic Sensitivity

High vs. Low Quality Beta
Style Sensitivity

He writes at length on valuation of the market.

Even if we assume a future dividend growth rate of 6.7%, which is the fastest growth rate observed over any 25-year span during the past century (and again, includes the impact of share repurchases), the S&P 500 would currently have to stand at 748 in order to be priced to achieve long-term total returns of 10% annually. Of course, with the S&P 500 at about 1256 despite a contraction in dividends over the past few years, this analysis would imply that fair value is again about 40% below present levels. It would be nice to be able to rule that conclusion out.

Wednesday, December 15, 2010

United Kingdom Prepares for Massive Job Cuts

As riots and protests were occurring across Europe today (incredible the lack of coverage by the U.S. media) the Guardian is reporting that Brits are preparing for massive job cuts.

From the Guardian:

At least 100,000 public servants will receive grim news over the Christmas holidays or soon after as councils, police forces and other public services race to meet a deadline of 1 January to formally announce job cuts.

An analysis of local authority documents reveals that the number of council redundancies directly resulting from the coalition's austerity measures is expected to break the 100,000 mark by early in the new year, fuelled by the swingeing cuts announced this week to councils' budgets and the pressure to start cutting before the new financial year in April.

This comes on top of the 33,000 drop in public sector jobs over the three months to October that was detailed yesterday in official unemployment data and is likely to lead to a torrent of "at risk" warning letters hitting doormats across the country in the next few weeks.

100,000 may not sound like a huge number (or maybe it does) when you first hear it but lets compare apples to applies. The population of the United Kingdom is 61.8 million. The population of the United States is 307 million or 4.96x bigger. So that is the equivalent to the United States government announcing 496,000 job losses in basically one day. Throw in the 33,000 government jobs already lost in the last couple of months which is the equivalent of 164,000 U.S. jobs and the United Kingdom is announcing the equivalent of 660,000 United States jobs losses in just a couple of months. That is a massive number and is akin to the United States losing 600k jobs a month at the depth of the Great Recession.

No wonder there were riots all over Europe today. If you did not see this video it is worth the watch. It is from Greece today.

This is the beginning, not the end. Why? Simply nothing at the foundational level has yet to be fixed in the United States or in Europe.

Guest Post From Llano Llama

Was posted in the comments by Llano Llama and I agree so much with it that I thought I would make it its own post. Thanks

There are so many angles on this.

I think Prechter is making the better case because he is taking into consideration more of reality. Unfortunately, to explain things clearly, laying out the arguments and counter-arguments requires multiple book length treatise that few would ever read. Our ability to process complexity is limited so we prefer simple answers and simple models. But alas, the economic world is not a simple linear predictable beast. It is a non-linear, non-equilibrium, path dependent, complex interaction of systems and sub-systems.

If anyone asks, I push the path dependent idea first. People seem to understand that we will get a different result if we raise taxes in 2011 rather than leave them at current rates. If they are more economically inclined, they will understand that Europe moving to a tighter monetary union and sharing the pain is very different than breaking up the EU/EMU.

If they are still listening, I try to lay out some cases where the expected simplistic story didn't occur. For example, in 2008 we heard that oil going over $140/bbl was a sign of runaway inflation or Peak Oil. And yet a few months later oil traded to the $30s. Similarly, you will hear that "A central bank in a country with debt denominated in their own currency can force as much inflation as they want." And yet Japan has gone about 20 years in some form of economic stagnation. Apparently, there are more forces at work than mentioned in the simplistic story.

At that point the discussion is either about human nature, the limits of Capitalism, or "should I buy gold?"

Monday, December 13, 2010

The Must Watch Videos of the Year - Peter Schiff and Bob Prechter

There has been no bigger debate over the last two years than that over deflation and inflation. Perhaps the biggest deflationist Bob Prechter debates one of the biggest hyperinflationist Peter Schiff in the two videos below. They both believe the same thing, a complete collapse is coming in the next few years. They couldn't be more different in how that collapse will occur. Schiff believes we are heading towards a hyperinflation and Prechter believes deflation will come with a vengence and that banks will fail and people will lose deposits etc. (hyperinflation comes on the back end)

Unfortunately they both are just throwing out scenarios. There is little to go off of to conduct fundamental analysis. Collapse is coming, that can be fundamentally analyzed, how it occurs can't because it is based on social mood and political decisions. For my two cents, I think Prechter will be proven right but not to the extent that he is predicting. Deflation will lead to inflation. Dow will never get to 1,000 like Prechter is predicting. Hyperinflation is a political event and Dow well above 1,000 will cause collapse to jump start massive inflation.

I really think one of the more important things to listen to in 2010.

Part 1

Part 2

Wednesday, December 8, 2010

Money Printing?? - Hasn't Happened

Maybe I am being naive but I think I figured out the technical way the Fed worked before almost anyone on Wall St. (Hoisington had it figured out) The knowledge and my efforts have cost me dearly as the perceived truth is much more powerful than actual truth. (i.e. David Teppers comments become gospel though completely 100% wrong in how the whole thing actually works) In other words it is a puzzle I wish I never would have solved. Sunday on 60 minutes Bernanke said the Fed wasn't printing money after saying in 2009 and 2002 he could. Now all of a sudden several Wall St firms analysts are echoing him. No one thinks!!! If the Fed says it must be gospel so when Bernank said he was printing money everyone assumed he was without actually looking. I have about determined Wall St. never thinks. It is 100% about gaming others, not fundamentals.

Below are a few excerpts by Morgan Stanleys David Greenlaw. (who also had it figured out earlier than most) The entire thing I can be found here. It is the best description I have read explaining a very complicated topic.

QE2 departs from the textbook. The issue is confusing because all of us who took a basic undergraduate Money & Banking class learned that a central bank's open market purchase of securities was effectively the same thing as printing money.[My comment - no one actually challenges the textbook. No one challenges perceived truth!!!] But the experience of the last few years has taught us that this logic is not always correct. In fact, Fed officials have been reluctant to adopt the QE terminology because the impact of asset purchases is all about rates - not quantities.


Fed will respond to inflation as needed. Interestingly, the market moves that we are seeing in currencies, commodities, inflation expectations, etc., appear to reflect a belief that the Fed has been printing money - or will do so at some point down the road as the money multiplier normalizes. Bernanke tried to address this point in the 60 Minutes interview. He indicated that the Fed could raise rates in "15 minutes" if necessary and that he is "100%" certain of the Fed's ability to respond to an inflation threat. Of course, it remains to be seen whether the Fed will follow through on this pledge - and it remains to be seen what the FOMC will consider to be a legitimate inflation threat. But the market moves that appeared to coincide with the reintroduction of Fed asset purchases reflect speculation - as opposed to a fundamental supply/demand shift - because there hasn't been any money creation to date. Ultimately, the success or failure of the Fed's asset purchase policy will depend on an interest rate transmission mechanism, not a quantity channel.

Tuesday, December 7, 2010

A Day to Take Note Of

Very very interesting day today. I thought so during the day today and was reading some commentators tonight who thought so as well. The first prints of the day I covered some shorts and towards the end of the day I put half of it back on. Yes, that was a bad short term trade but the reversal today was amazing in ALMOST ALL asset classes. In technical terms hammers in the NASDAQ, S&P, gold, silver, copper, VIX etc.

Tomorrow will tell you alot. If we don't follow through to the downside it is ignorable but if we start selling off confirming today's price action it could get really interesting.

Today's news of course was the president became Republican showing there really isn't much difference between two parties. Republicans won today, Democrats won today, and America got screwed. You have to cut spending on the other side of it and the bond market noticed that didn't happen. Maybe that is when this all finally blows to bits, when the bond market sells off hard causing interest rates to spike. Typically bonds and stocks move inversely. That hasn't really happened this year. Bonds went way down looking like the economy was going to crunch while stocks continued to climb. However, when the game is up, both can go down. Look at Spain. Bonds go way down and stocks go down with it. There is some differences since Spain can't print its own money.

Anyway, today was a day to take notice of. Very interesting and tomorrow will tell you alot.

Wednesday, December 1, 2010

More of the Same

Strong day on Wall St. I wasn't surprised that we were up (was expecting it yesterday with the start of a new month and Europe being sold hard the last few days), but as usual I was surprised how fercious the up move was. Because it was so strong it puts the odds that the market has higher to go. First watch 1227ish and than 1250. That is if the market doesn't reverse tomorrow, which could still happen. The reason we were up so strong is very suspect. Many are credited the "strong" China number last night which doesn't make alot of sense because the futures yawned at the number and the Chinese markets finshed flat. It started with Europe and unlike when Europe sells off hard and the U.S. markets shrug it off, when Europe surges it gives an excuse for the U.S. to surge. So up up and away we went. ADP employment numbers were strong but annouced layoffs were the highest they have been in 8 months. There was also a rumor that the U.S. would bail out Europe which was quickly denied.

I think the market continues to rest on Europe first and China second. If the problem spreads to where Spain has to be bailed out - game is up. The question is which game. Will Germany buckle and allow the ECB to start its own version of QE or will haircuts be taken on debt, losses taken, and we revert back to some sort of capitalism? More and more thoughts on some sort of QE in Europe.

Tomorrow the ECB meets and it is likely the bears only hope for the remaining of this year. The market seems to be indicating that it is expecting some form of signal that the ECB will loosen up buy more government debt. It is entirely unclear that will indeed happen. If it doesnt and the Euro starts heading down again, than todays rally should reverse tomorrow somewhat. Not really expecting it will but we will see. Someone was out there today buying European debt today and it almost had to be the ECB.

Gotten a few comments that I havent been blogging as much lately, and I haven't. I have been really busy but it is getting really old talking about the same thing over and over again. This is bad but it doesn't matter because the government will print more money. The last couple of weeks the market should have been down really strong with Europe falling apart but it wasn't. Probably bullish in the near term. The market won't start going down strong until something happens outside of Bernankes control. That will come from politicias, the populace, or an oustide nation (i.e. China). Like I said - if tomorrow the market doesn't reverse, the odds are strong that the market heads higher between now and year end.