Friday, August 31, 2007

Quotable Quotes: Principles

As investors wait to hear whether Bernanke caves in, a few words on principles.

“'Tis the business of little minds to shrink; but he whose heart is firm, and whose conscience approves his conduct, will pursue his principles unto death.”
Thomas Paine

"Compromise is usually a sign of weakness, or an admission of defeat. Strong men don't compromise, it is said, and principles should never be compromised."
Andrew Carnegie

"Once at a social gathering, Gladstone said to Disraeli, "I predict, Sir, that you will die either by hanging or of some vile disease". Disraeli replied, "That all depends, sir, upon whether I embrace your principles or your mistress."
Benjamin Disraeli

“I am a man of fixed and unbending principles, the first of which is to be flexible at all times.”
Senator Everett Dirksen

“Those are my principles, and if you don't like them... well, I have others.”
Groucho Marx

Have a good weekend.

Thursday, August 30, 2007

Technical Thursdays: Style Investing – Momentum versus Contrarian

"Bernanke says nothing new, stocks soar!"

That easily could have been the headline explaining yesterday’s lemming-like, momentum driven stampede back into stocks. Which raises the issue just what is the investment style of most professional investors?

I don’t know if anyone has the data on this, but the past two days of market action – plunge then surge – sure looks like most professional investors, particularly the very short term hedge fund variety, are little more than momentum players. And while this may have always been the case, perhaps it has gone to another level: Momentum players on steroids. (Note to Barry Bonds: I see a hedge fund manager position in your future.)

Now, it is a fact that correlations between, among, and within asset classes are at their highest levels ever. And knowing this fact is helpful in planning and executing exploitative investment strategies and tactics (which is what I and other good contrarian investors try to do). But what struck me about Tuesday’s plunge and Wednesday’s surge is how stocks ended each day at their respective lows and highs (see chart above).

And this leads me to speculate that the vast majority of hot money traders (at least those who are active right now) must not only be momentum oriented speculators (maybe gamblers is a more apt word to use), but that have become so desperate for relative performance that they cannot afford to risk missing any move that has appears to pick up steam. If this is the case, when the rest of the gang returns from East Hampton volatility should rise even further to levels not seen in nearly a decade.

Investment Strategy Implications

For true investors, the noise factor from this whipsaw action is deafening. So, my advice is to put on your Bose noise cancellation headphones (earmuffs, if you prefer), tune out the noise, and pick your spots where prices get out of alignment with value. The momentum lemmings may be desperate for relative performance (their third yacht depends on it) and that presents opportunities for the rest of us.

In times like these, it takes conviction and commitment both by an investor and his/her clients to be a contrarian. But isn't that what buy low, sell high is all about?

Note: To view a larger version of the chart, simply click on the image.

Wednesday, August 29, 2007

The Dark Side of Globalization: The Next Big Shoe to Drop?

While investors rightly fret over the unfolding risks of the credit squeeze, perhaps it’s time to consider the real economy side of the equation – the dark side of globalization.

Just as liquidity and financial innovation has worked their mutually reinforcing wonders for oh so many years, so too has globalization enjoyed the free ride of risk-less thinking. The benefits produced by globalization are as abundant as the free flow of capital. Platform companies deliver low cost goods to developed country consumers. Developing countries experience growth rates in the double-digit range and, in the process both raised the standard of living for their citizens as well as helped fill their governmental coffers as never before. In fact, assets have accrued so significantly to many developing countries that current account surpluses abound giving rise in some cases to sovereign wealth funds.

These examples are just a few of many that could be cited. And the good that they produced in reducing global poverty while enriching both corporate and governmental entities cannot be overstated.

There is another benefit to globalization that is particularly relevant to the current credit squeeze – the ability of emerging countries to (a) withstand any global growth slowdown emanating out of the US and (b) to act as a source of demand helping to limit the damage of a US consumer-led global slowdown. It is this second point, also known as decoupling, which when combined with inherent quality of globalization - interconnectivity - that is the potential dark side of globalization.

Decoupling, which heretofore has not been put to the test, assumes that markets and economies outside the US have grown sufficiently robust that even a recession in the US will not push the global economy into a recession. Given the interconnected nature of the world economy and markets, however, it cannot be assumed that there will not be a ripple effect (a contagion) from a slowing demand from the engine of global growth, the US consumer. Nor can it be assumed that the still immature developing countries’ economies and markets are sufficiently developed that they are capable of picking up the slack.

Investment Strategy Implications

The big risk in the current credit crisis is the vast unknown. What investors don’t know is wreaking havoc with confidence, a key element of asset management, credit decisions, and general investing. Until there is clarity as to what exactly we are dealing with, discretion should be taken when making investment decisions.

The big risk with globalization centers on the interconnected nature of world markets and economies. Decoupling has been bandied about as the savior of a US consumer-led slowdown/recession. But, as with the knowledge black hole of credit derivatives, no one knows if decoupling will work. Nor does anyone know just how a highly interconnected world will function in an economic and/or financial crisis.

These are the primary risks that were dismissed for far too long by far too many Goldilocks-entranced Pollyannas. These are the risks that must not be allowed to get out of control.

Tuesday, August 28, 2007

Bulls Gone Wild

You can always tell when the beginning of the end is close at hand when stories come at you fast and furious. Such is the case as one shoe (broker-dealer downgrades) drops after another (asset-backed commercial paper conduits). Another day, another bad news story.

Added to this is what can only be described as “bulls gone wild”. Seemingly losing all sense of proportion, more than a handful of former economic and investment bulls have ramped up their angst and are now even invoking the R word, some with odds as high as 70%!

This switch from complacency and certainty that was so palpable at the beginning of the year to what now looks a lot like outright fear is remarkable. In fact, the exodus from the bull camp resembles the exodus from the Bush White House. Is the fear warranted? From an investment strategy perspective, I believe the answer is no.

Now, this may surprise some who know that I have been sounding the warning bell for two plus years re complacency and credit-related pressures. But it is one thing to acknowledge and accept a world in need of better structural balance, greater transparency, and sustainable monetary policies. It’s quite another matter to make the leap that we now stand at the edge of an economic and investment precipice. And as noted in yesterday’s weekly report, there are many reasons why a Fed Funds rate cut is not warranted. The same can be said for elevating a credit squeeze into a recession.

Investment Strategy Implications

There are lots of reasons to be very concerned, not the least of which is just how deep does the credit derivatives’ rabbit hole go? However, in all market corrections, opportunities emerge when fear is at its highest. Blood may be in the streets and the former bulls may have gone wild but a cool head, an opportunistic attitude, and some clear thinking will reward such inclined investors.

Monday, August 27, 2007

Glad You Agree

excerpts from this week's report:

"It is with some satisfaction to note that an increasing number of my investment strategist brethren have been coming around to the views expressed in this report and my blog for the better part of the past two years. Specifically, the credit derivatives problem has spawned such phrases as “black holes” and “we don’t know what we don’t know” (heard here first, I might add) that are now showing up with regularity elsewhere.

And, although too much of the talk centers on a subset (sub prime mortgages) of the infinitely larger ($400 trillion plus) credit derivatives’ universe, at least many are now getting what readers of this report and blog have heard for quite some time.

Better late than never? Perhaps, but so what? Being right is yesterday’s news. And that’s not what any good investment strategist is paid for.

The real value in being right in this area is (hopefully) clear-headed thinking re what to take from yesterday’s credit derivatives’ news and what is the next area of consensus thinking that may be off the mark? In this regard, I think it is the debate re cutting the Fed Funds rate.

Here are a few reasons to consider:..."

"Blasting the US economy with a broad based liquidity approach (which is what a Fed Funds rate cut amounts to) is ill advised, untimely, and sends a very bad moral hazard-drenched message..."

"To support my views, please read the following 8 factors and see if you can identify any reason why a Fed Funds rate cut at this time makes sense:..."

also in this week's report

• Valuation Model
• 2Q07 Earnings Update
• ETF Model Growth Portfolio
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Services link to your left for info.

Friday, August 24, 2007

Quotable Quotes: High Strung

With more than a few investors on edge of late, a few thoughts on stress, tension, and emotionalism.

“The world is all gates, all opportunities, strings of tension waiting to be struck.”
Ralph Waldo Emerson

“Sex alleviates tension. Love causes it.”
Woody Allen

“The computer can't tell you the emotional story. It can give you the exact mathematical design, but what's missing is the eyebrows.”
Frank Zappa

“I’ve tried yoga, but I find stress less boring.”

Have a good weekend.

Thursday, August 23, 2007

Technical Thursdays: Size Matters

To help gain further market strategy insight, the time frame an investor uses will influence his/her conclusions. Take, for example, large cap versus the Smids.

If an investor takes the arbitrary and artificial time frames of year to date or one year perspective, there is no shift from the Smids and Micro cap to large cap. However, if an investor starts with the far more meaningful May/June 2006 correction, a very different picture emerges, as the first chart clearly shows.

Over this time frame, large and mega cap outperform the Smids and the Micro cap sectors. In fact, the performance order is mega (OEF) over large (SPX) over Smids (MDY and IJR) over Micro (IWC).

Why use May/June 2006 as the starting point? Primarily because that is when the market’s behavior changed. That correction was the first of three (and counting) sharp corrective shocks to the equity markets, which just happened to coincide with the beginning of the end of monetary ease that is now being manifested in a credit squeeze. Moreover, it is also the start of the rise in volatility (see second chart).

Investment Strategy Implications

The investment climate changed in the spring of ‘06. And, while it may have taken investors a good year to truly appreciate that change (old habits die hard), the investment strategy implications are fairly clear: a lower portfolio risk profile is warranted.

If size equates to quality (which it does), then mega and large cap are the preferred investment styles to employ.

Note: To view a larger version of the above charts, simply click on the image.

Wednesday, August 22, 2007

Cold Turkey

Enough with all the moaning and groaning over a normal stock market correction. Volatility returns and the game changes but apparently, like an addict, certain market participants insist on their liquidity fix.

The Fed does not need to cut anything beyond what it has done thus far. Frankly, the one thing that should be cut is the crap from the East Hampton crowd. “Oh, look at the poor homeowner. He/she needs help”, wails the hedge fund/private equity manager, crocodile tears streaming down his face as he contemplates his next plea for a government bailout (that’s what a rate cut amounts to) from the veranda of his mansion overlooking the Atlantic. ("Jeeves, get me another martini.")

What is needed is more clarity as to who owes what to whom. Considering the $400 trillion in OTC credit derivatives (that’s 8 times the world GDP), getting to know what we don’t know would certainly help. Hopefully, the Fed can achieve some of this through its discount window initiative.

What is not needed is to listen to the cries for what is in effect a government bailout for those who created the mess in the first place. Looks like free market ideology applies only when times are good.

Keep serving the cold turkey, Ben.

Tuesday, August 21, 2007

Citibank Becomes Deputy Dawg

If I've got this right, the Fed’s innovative discount window action taken last week will have the effect of “deputizing” the commercial banks that come to its discount window with collateral from sources that are unable to tap the Fed for emergency funds. The key point of the discount window deal that has not been discussed in the media is what happens when the 30-day loan is due?

Unless I am mistaken (and if someone knows otherwise, please feel free to comment), as far as the Fed is concerned it is the commercial bank, and not the institution requesting the loan through the commercial bank, that is on the hook for the money when the 30-day loan is up. Therefore, since in the eyes of the Fed the loan is owed by the bank (and not the hedge fund or mortgage banker or investment bank, etc.) one can assume that the bank accepting the collateral for the loan will be very diligent in assessing the quality of the paper it will present to the Fed as collateral. It is logical to then assume that the commercial bank will insist on strong assurances that the paper they accept and will present to the Fed for the discount window loan is good. Two things should occur from this arrangement:

• Temporary liquidity is provided where needed
• Transparency is improved

By deputizing the banks, the Fed may help further clarify the real credit risks in the system without compromising its market discipline philosophy.

Monday, August 20, 2007

Piercing the Veil

excerpts from this week's report:

"To help understand the consequences of the current credit squeeze, it is worthwhile to distinguish between what can be measured and what cannot.

What can be measured might be considered the low hanging fruit. It is the scenario that progresses from the mortgage mess to its impact on US consumer spending, which then takes the US economy to below growth expectations for the remainder of this year and next possibly resulting in a recession. The larger manifestation of this scenario is a real test of the decoupling thesis – should the US consumer contract, will there..."

"The good news is that the above is measurable and knowable. All items noted are visible. And the investment strategy consequences can be prepared and acted upon.

The bad news is what is not measurable in the current credit squeeze. And that is the big risk factor that should not be ignored..."

" would hope that by putting the banks on the hook for the discount window loans they present (which presumably will come from that very same hedge fund/credit derivative black hole world), some light will be shed into the nether world of hedge funds and private equity..."

also in this week's report

• Valuation Model
• 2Q07 Earnings Update
• ETF Model Growth Portfolio
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Services link to your left for info.

Friday, August 17, 2007

Quotable Quotes: The Panic of 1907 and FUD

Once again, the Bernanke Fed chooses the right course of action and thereby helps take some of the pressure off the core of the banking system without compromising its commitment to the market discipline. It is therefore worth reflecting on an event that happened one hundred years ago – the Panic of 1907 – and a few quotes re FUD (fear, uncertainty, and doubt).

“The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis in the United States. The stock market fell nearly 50% from its peak in 1906, the economy was in recession, and there were numerous runs on banks and trust companies. Its primary cause was a retraction of loans by some banks that began in New York and soon spread across the nation, leading to the closings of banks and businesses.”

“To him who is in fear, everything rustles.”

“Knowledge is an unending adventure at the edge of uncertainty.”
Jacob Bronowski

Doubt is uncomfortable, certainty is ridiculous.”

Have a good weekend.

Thursday, August 16, 2007

Technical Thursdays: Any Port in a Storm

"There is nothing, in my judgment, that we should be doing in terms of guaranteeing market participants against losses or in terms of restraining risk taking."

Henry Paulson
article by David Wessell, Wall Street Journal, August 16, 2007

In its darkest hours as the market discipline exacts its pound of flesh from non-bank lenders and other high risk, leveraged players, certain technical indicators are flashing an interesting short term buying opportunity.

The above chart of the S&P 500 shows that the price decline in this second down wave of the current correction is not being matched by Momentum*. And with MACD right around oversold, a bounce in certain market segments is now highly probable. Among those market segments is none other than the beleaguered Financials (second chart), which is exhibiting the same such technical conditions as the S&P 500 yet with a surprising better MACD reading.

While this potential bounce will likely not resolve the current correction, it should help provide some relief to portfolios taking a beating and afford traders and speculators so inclined with an opportunity to scalp a trade or two. Any port in a storm.

*Note: this is an important non-confirmation which could be swamped in very short order should selling pressure intensify dramatically in the next few days producing a lower low in Momentum thereby confirming the decline, Nevertheless, given the rapidly rising fear factor plus the fact that the longer term moving averages have not turned bearish (see blog entry August 2, 2007), the odds favor the signal holding up. It should be noted, however, that while the Financials may be signalling a bounce, their moving average indicator has turned decidedly negative as price is below both moving averages, the 50 day crossed the 200 day, and both moving averages are pointing south. Beyond its bounce potential, definitely not a pretty picture.

To view a larger version of the above charts, simply click on the image.

Wednesday, August 15, 2007

Neither Alfred E. Neuman nor Chicken Little Be

As what-me-worry battles the sky-is-falling, a visit to the land between greed and fear might be useful.

For far too long, members of the Alfred E. Neuman club dominated investment thinking as risk was ignored and Goldilocks was crowned an immortal goddess. The Great Moderation lent support to this view and productivity/globalization juiced double-digit earnings gains were promoted as the norm. While some did puzzle over conundrums, the rah-rah crowd proclaimed the death of the business cycle and equity valuations found a new metric to replace the P/E (price to earnings) ratio – the PE (private equity) ratio. Then, along came realty reality.

The housing bubble began to deflate. And nasty surprises sprang out of the credit derivatives black hole as assets that were valued at par on Monday were declared worthless on Wednesday. Volatility returned with a vengeance, spreads widened, and sanity crept back into asset pricing. For their part, equities did what equities are supposed to do in a bull market – they corrected. In the process, valuations began to return to some semblance of normalcy. Except, of course, to the Chicken Little crowd, as they seek vindication for years of being on the wrong side of insanity.

At the moment, the market momentum is clearly on the side of Chicken as literally no one can predict what other shoe is going to drop. Reason, therefore, dictates that caution is the better part of valor. But Chicken, like Neuman, does not subscribe to cautious thinking. Rather, Chicken, like Neuman, sees things as black or white, which is another way of saying that they are both colorblind to the nuances of economic and financial reality.

In the Land Between Greed and Fear

As long as central bankers can prevent a credit squeeze from becoming a credit crunch, exorcising the Greenspan put through the exercising of the market discipline will help wring out much of the excesses that have built up over these past five years. As long as solid global growth continues to serve as a counterbalance to anything short of an economic implosion in the US, sustainable earnings growth can be expected. And as long as no mega shoes drop out of the credit derivatives black hole, risk re-pricing can proceed and equity valuations can continue their march to normalcy.


To Neuman I say – you have ignored risk for far too long and the chickens of bad decision-making are coming home to roost.
To Chicken I say – don’t count yourself before you hatch.
And to equity investors I say – I think this is what a correction is supposed to look like.

Tuesday, August 14, 2007

Justifiable Concerns re the US Consumer

“It is unwise bordering on imprudent to assume that terrible will not follow bad,” Catalano said.

MarketWatch/Smart Money (Greg Robb), quote of the day (Tanta)
August 10, 2007

The US consumer is in the spotlight today as the outlook from several key retailers is not encouraging. There is good reason for investors to have concern not just for consumer related issues but in a much larger context, as the above chart shows a serious shift in US consumer borrowing preferences.

To maintain current lifestyles, the chart highlights the obvious future purchasing power risk that results due to a shift from deductible, low interest mortgage debt to non-deductible, higher interest credit card debt. This will only pressure the US consumer further and, in the process, will not only impact consumer related businesses but increase the risk of defaults to both mortgage lenders (remember the $1 trillion mortgage resets due over the next 12 months) and credit card lending institutions.

A key indicator to watch, therefore, is the Fed’s “Household Debt Service and Financial Obligations Ratios”. According to this data*, the US consumer shows little to no signs of major stress. The risk in relying on this data is that it is both slow to update and backward looking. It is logical to assume, however, that things are pointed to more difficult times ahead. Moreover, the speed with which a US consumer spending slowdown might occur could catch the Fed behind the curve on this issue, if Bernanke & Co. are not careful.

There is a larger macro story here and it deals with a potential real test of the decoupling thesis the bulls have repeatedly noted over the past year. The argument made is that consumer demand outside the US plus capex driven spending will help the world economy achieve the IMF’s projected global growth rates of approx. 5% and enable the US consumer time to repair any damage to his/her personal financial balance sheet.

If so, then global growth opportunities should help mitigate the credit risks underway. If not, then terrible could follow bad very quickly. Either way, change is in the air, and just as with the $400 trillion of credit derivatives, the consequences remain to be discovered.

Chart source: Strategas
Note: To view a larger image of the chart, simply click on the image

Monday, August 13, 2007

Don’t Do It, Ben

excerpts from this week's report

"$400 trillion.

That is the estimated notational value of over-the-counter credit derivatives. It is the iceberg that lies beneath the surface of the increasingly (yet not fully) visible sub prime tip. And it represents a potential force that could precipitate a massive financial, and ultimately economic, contagion. Yet, it remains largely beneath the surface in both actuality and in investor’s consciousness. But that is sure to change.

With each passing week, it is becoming increasingly evident to many investors that there is much that lies beneath the surface – unseen and little known. Gradually, however, in drips and drabs, the risks taken during the now deceased era of the “Great Moderation” are ever so slowly revealed through corporate bailouts and hedge fund blowups. And, in the process, bit by bit, the market discipline of the Bernanke Fed does its work. Despite the howling from the mansions in East Hampton..."

also in this week's report

• Current Blue Marble Research Fed Valuation Model
• 2Q07 Earnings Update
• Blue Marble Research ETF Model Growth Portfolio
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Services link to your left for info.

Friday, August 10, 2007

Quotable Quotes: Life on the Edge

With investors very much on edge, a few words about danger.

“Banking establishments are more dangerous than standing armies.”
Thomas Jefferson

“Beware of false knowledge; it is more dangerous than ignorance.”
George Bernard Shaw

“Nothing in the world is more dangerous than sincere ignorance and conscientious stupidity.”
Martin Luther King, Jr.

“All men dream: but not equally. Those who dream by night in the dusty recesses of their minds wake in the day to find that it was vanity: but the dreamers of the day are dangerous men, for they may act their dreams with open eyes, to make it possible.”
T. E. Lawrence (of Arabia)

Have a good weekend.

Thursday, August 9, 2007

Technical Thursdays: Stay Underweight Financials, Remain Overweight Tech & Telecom

A key argument made on this blog and in my reports is that a leadership change began months ago and a power shift away from financial engineers and a shift toward technology engineers has begun. The chart to your left* shows this rather clearly. But is this sustainable?

Re Financials: The negative developments unfolding in the that sector are reasonably well documented but there is still much that remains unknown. Today’s latest Financial bad news story (BNP Paribas) only highlights the major risk facing investors – just how many other shoes will drop? Perhaps the more important question to ask is, will the other shoes to drop make those that have dropped look like baby booties? Considering the black hole of knowledge re credit derivatives (of which the sub prime space is a modest part of the enormous $400 trillion puzzle), it is unwise bordering on imprudent to assume that terrible will not follow bad.

The tech and telecom story is a bit less developed to some but can be summed up as follows:

• Global growth, defense spending (large tech usage), and technological innovation remains in fairly good shape.
• Earnings results for 2Q07 are excellent with Tech and Telecom ranked 1 and 2 in year over year growth**.
• Valuation is more than reasonable.

Investment Strategy Implications

Needless to say, nothing is without risk***. And risk is the issue that has been underappreciated for far too long in this bull market. Thankfully, the current correction is helping to remedy this defect, a fact that appears to be most welcome by the US Fed.

Where risk is abundant is in the Financial sector. And is likely not to get better before it gets worse. Where risk is far less abundant, however, is in the Tech and Telecom space. Their story is much more clearly defined and reliant on cyclical and secular trends that are far more favorable than the unfolding calamity in the Financial sector.

*To view a larger version of the chart, simply click on the image
**S&P 500 reporting companies, market weighted results.
***Defined as uncertainty of future outcomes versus a backward looking metric such as beta.
Note: Blue Marble Research managed accounts have positions in XLK, IYW, XLF, and IAK.

Wednesday, August 8, 2007

A Cause for Celebration?

Exactly one year from today (8/8/08) the world will celebrate the start of the Olympics in Beijing. Yesterday, the equity markets celebrated….what?

Did the equity markets celebrate the reality that central bank power has diminished over the past several years thanks to globalization and financial innovation? Perhaps it celebrated the end of easy money, preemption, and the Greenspan put and a new era of market discipline and a more holistic approach to monetary policy? Or maybe it rejoiced in the fact that over the next twelve months close to $1 trillion of mortgage debt will reset to higher levels thereby further impacting US consumer spending power, not to mention the default rate of an already troubled housing market?

Investment Strategy Implications

In time, I am confident that investors will come to appreciate that we are in a new monetary regime – one that does not use preemption and easy money as its first reaction to a crisis – just as investors came to appreciate the extent and consequences of excess liquidity (or as it goes by its more commonly heard phrase “risk re-pricing”). And with that appreciation will no doubt come the recognition that the opportunities and risks in a dynamic global economy lie not in the powers that were but in the powers to be*.

It’s a brave new world. The Bernanke Fed gets it. Investors will...eventually.

*Another way of saying leadership change.

Tuesday, August 7, 2007

Will Bernanke Blink?

The pressure is building as the cold turkey effect of the Fed and Treasury's mantra, the market discipline, is being felt with greater intensity with each passing week and cries of "rescue me" can be heard (see Cramer's tirade from last Friday on youtube for a good example of bellyaching at its best).

As the sub prime debacle evolves into the tipping point for the larger mortgage market mess unfolding, most importantly, the tip of the much larger credit derivatives iceberg still remains well below the surface of understanding. And therein lies the real danger to the global financial system and, ultimately, the world economy. Can the global financial system de-leverage itself without precipitating contagion? Which brings us to today’s FOMC decision.

Those expecting today’s Fed announcement to contain the easy money/Greenspan elixir are sure to be disappointed. Should the Bernanke Fed back off its market discipline philosophy however, then the financial markets will almost certainly celebrate the return of the Greenspan put. If, on the other hand, the Bernanke Fed sticks to its philosophical guns and withstands the pressure to bail out bad behavior, then the risk adjustment process will continue and the balancing act of stability and growth versus contagion will continue.

With growth (global GDP and corporate earnings) still strong, inflation becoming more of a concern, and the absence of the financial contagion reaching beyond Wall Street (broadly defined) and into the traditional banking system and the real economy, my bet is on the other guy, not Bernanke, blinking – as in blinking away their tears.

Monday, August 6, 2007

The Rip Van Winkle Correction

excerpts from this week's report

"Ever so slowly but no less dramatically, investors are coming to appreciate what readers of this newsletter and blog have known for well over a year – risk has been grossly underestimated and correlations among assets are very high. And, in the process, a very healthy, and long overdue, correction is underway.

From an investment strategy perspectives, two issues appear to be worth noting:

• The magnitude of the correction
• The meaning of the correction

Here are a few thoughts on each..."

"The magnitude of the correction depends on your perspective on the driver of the correction – risk adjustment due to credit related problems. For this, an opinion needs to be rendered as to whether we are experiencing a financial crisis comparable to the Long Term Capital debacle of nearly ten years ago? Or is the crisis more like the one-off Amaranth blow up of last year? In other words, contagion or no contagion? That is the first question..."

Investment Strategy Implications

"The world’s financial markets are going through a grand transition from Greenspan’s bubblenomics to Bernanke's professorial sensibilities. If I am correct in this view, then the risks, opportunities, and implications are both more complex and more substantial than many investors appear to realize.

It is good that the discussion has finally moved to where I have been harping about for well over a year – risk. However, it is far more productive if a better understanding of the nature of change the world economy and financial markets have been undergoing these past few years took hold.

The correction underway is both healthy and long overdue. Rip Van Winkle would be proud."

also in this week's report

• Current Blue Marble Research Fed Valuation Model
• 2Q07 Earnings Update
• Model Growth Portfolio
• Key Economic Indicators

Note: To gain access to this week's report (and all previous reports), please click on the Blue Marble Research Services link to your left for info.

Friday, August 3, 2007

Quotable Quotes: Consequences

The great unknowns re credit derivatives have finally begun to register in the minds of investors. Therefore, a few thoughts on consequences seem appropriate.

“The man that sets out to carry a cat by it's tail learns something that will always be useful and which will never grow dim or doubtful.”
Mark Twain

“Folly is often more cruel in the consequences than malice can be in the intent.”
Aldous Huxley

“Everybody, soon or late, sits down to a banquet of consequences.”
Robert Louis Stevenson

“Consequences, Schmonsequences, as long as I'm rich.”
Daffy Duck

Have a good weekend.

Thursday, August 2, 2007

Technical Thursdays: Avoiding the Noise with Moving Averages

When markets get this volatile, investors benefit greatly by keeping their eye on the longer-term investment ball. And no technical analysis tool does this better than the moving average. By smoothing out the short term wiggles and squiggles of the market, moving averages help investors avoid getting caught up in the noise of the moment. It has been my experience, however, that more than a few investors are not clear on how to best utilize this tool. Here are a few suggestions:

The most often cited value in moving averages is their current price point. For example, yesterday’s market saw the S&P 500 briefly trade at, then through, its 200-day moving average, only close well above it (see left chart above). However, as useful as a specific price point might be, I have found that the direction and slope of the 200-day moving average, along with its interaction with other moving averages and the current price level of the index to be the most productive and predictive aspect of a moving average. To illustrate, consider the second chart above, which is a longer-term picture of the S&P 500 (from Jan. 1, 1995 to the present).

Note how the index’s current price oscillates around the largely meaningless (on its own) short-term 50-day moving average and occasionally trades through its (far more valuable) longer-term 200-day moving average. More importantly, however, note the slope of the 200-day moving average, headed in a defined direction for years at a time. As can be seen, once a mega trend is in place, it tends to stay that way, that is until a confluence of events (fundamental or technical) shifts it to its opposite direction. Now, also note the interplay between the current price and the 50-day moving average with the 200-day.

When the 200-day’s slope is set (up or down), the current price and the 50 day tends to lead in that direction (above or below). In other words, a mega trend contains two elements: the current price and the 50-day moving average must lead the 200-day and the slope of the 200-day must point in a clearly defined direction.

A preliminary warning signal to a mega trend occurs when the current price crosses the 200-day. A slightly more significant warning signal occurs when the 50-day crosses the 200-day. BUT, it is only when both current price and 50-day cross the 200-day AND the 200-day changes direction that the existing mega trend can be considered over.

Investment Strategy Implications

Until the level of the current price and the 50-day moving average cross the 200-day AND the slope of the 200-day points downward, the current mega trend is intact. Since both of these conditions do not exist, it therefore must be assumed that what the markets are currently experiencing is a correction and not a mega trend reversal.

Note: The current three mega cycles noted above do not show the infrequent crisscrossing of price and moving averages which then tilts the slope of the 200-day in the opposite direction of its existing mega trend only to revert back to its previous direction. Such occurrences may produce a temporary John Kerry-like flip-flop effect but that is both infrequent and temporary. The mega trend to be does establish itself in relatively short order.

Also, note that to view a larger version of the above image, simply click on the image.

Wednesday, August 1, 2007

Cool Headed Opportunism

"The selling was so aggressive on Tuesday because this was another reminder of the great unknown," said Vinny Catalano, chief global strategist at Blue Marble Research. "There appears to be no clear understanding of how deep the credit-derivative problem is and how long it will take to be resolved."
Wall Street Journal, Abreast of the Market, August 1, 2007

”Markets do not always trade in line with fundamentals. All asset classes show inefficiencies, and much money is made exploiting them. But this latest spasm raises questions about the vast and unruly market for credit derivatives. How does it operate, and how to gauge fundamental value?” John Authers, FT, July 31, 2007

Perhaps the most unnerving aspects of the present financial market meltdown is the magnitude of the hits taken and fear of the great unknown. For, every bad news story seems to involve not your garden-variety decline, say, 10 – 15%. Rather, the damage is in the mega category, >50%. Moreover, today’s news that investors who want out of the latest Bear Stearns debacle can’t get their money only adds to the concern. And, if recent history is any guide, when they can get their money, it will likely be in that mega loss category. Yet, it is the ignorance re just how deep the rabbit hole goes that remains the most dangerous part of the current financial market meltdown.

Frankly, none of what is occurring is news to the readers of this blog and my weekly reports. For well over a year, the risk factors pertaining to the black hole of knowledge re credit derivatives and hedge funds has been noted. So, as the rest of investment world finally acknowledges the risks that existed all along, the appropriate current investment strategy requires a little Joe cool (see image above - the pass that became "The Catch")*.

Investment Strategy Implications

With correlations so high (and even higher in market declines – see blog entry July 26, 2007), the potential for the brake to become the accelerator is possible but not highly probable. That’s another way of saying that the contagion the markets are experiencing is likely to fall somewhere between the systemic dangers prevalent during the LTCM crisis and the isolated Amaranth blow up. If so, then a buying opportunity is unfolding with leadership change underway. As noted in this week’s Weekly Report, the investment strategy course of action is to answer the three questions posed (see Monday’s, July 30th blog below).

*It seems only fitting to use the image above as a very small tribute to Bill Walsh, a true innovative genius.