Wednesday, December 31, 2008

Forecasts for 2009

From yesterday's Wall Street Journal "MarketBeat" blog.

Tuesday, December 30, 2008

Valuation Parameters For 2009

It is looking increasingly like a mid $60 operating earnings number will be the full year result for the S&P 500 for 2008. With the index trading in the upper 800 range, the current P/E is settling in around 13 times (874/$65 = 13.45).

Since P/E ranges are dependent upon the economic scenario, the accompanying table (click image to enlarge) of P/Es and possible 2009 operating earnings provide a framework for where fair value might reside in the year ahead.

You will note that I have excluded certain projected price levels as the economic scenario does not apply to the corresponding operating earnings. (For example, one cannot assume a “great times” P/E of 20 if operating earnings plunge to $52. Conversely, neither can one assume a deflationary scenario with operating earnings rising significantly to $82.)

Investment Strategy Implications

While a highly unpredictable climate awaits investors in the year ahead, the accompanying valuation table provides some guidance as to where fair value resides. From where I sit, driven largely by a more resilient global economy and the “surprise” write-ups of “toxic assets” held on bank balance sheets, the fair value level for 2009 is 1050 (14 x $74 = 1050). That’s a 20% return from current levels.

Wishful thinking? Perhaps. Given all the risks that remain (including the threat of protectionism and other geopolitical tensions as well as further forced liquidations due to further hedge fund redemptions (estimated by Mary Ann Bartels (Merrill Lynch) at an additional $100 billion), a cautionary approach is understandable. However, I suspect that governments acting in their collective economic self interest will result in a global cooperation that will produce better economic results than many currently believe. Moreover, it is hard to envision the $3.5 trillion of money market assets sitting idling by at near zero rates of return indefinitely, thereby alleviating the capital pressures on the economy and markets.

Wishing you a very happy and successful New Year.

Tuesday, December 23, 2008

The Technicals Say Buy Oil

Investors can debate the fundamentals of the price of oil, but several key technical analysis indicators point strongly toward a buy recommendation.

To begin, let’s be clear with the fact that, from a technical analysis perspective, the mega trend for oil (and the entire energy complex as well as nearly all equity categories, for that matter) is solidly in the bearish category. This is evident in the first chart (click image to enlarge) as price is below its moving averages (50 and 200 day), moving averages have crossed to the downside (50 below 200 day), and both moving averages point downward*. This signifies that any rebound in the price of oil must be viewed as a bear market rally. That said, the technicals that support buying into oil at these price levels are the near and short term indicators tracked – Momentum, MACD, and Slow Stochastics.

The near-term indicators, Momentum and MACD, are the first two sections below the price and moving average data in the first chart. What they show is that the price of oil is producing a bullish non-confirmation low, as neither Momentum nor MACD are confirming with a lower low. It should be noted, however, that it would be better if the MACD lines were not so close to converging as it is necessary for both Momentum and MACD to in the bullish non-confirmation category. Nevertheless, since Momentum is producing such a strong non-confirmation signal and the slope of the MACD lines are upward, any upward movement in price will generate a reaffirmation of the upward trend in MACD and both lines should turn up.

The short-term indicator, Slow Stochastics, provides added support to the buy call as it has entered oversold territory (a below 20 reading), an area which produces many short-term trend reversal calls.

The second chart is interesting as it provides some backdrop to the price of oil and the energy stocks. You will note that as the price of oil was racing ahead in this past summer, the energy stocks did not follow suit. This was a clear warning sign that the commodity traders, heavily influenced by speculators, were behind much of the inflated price levels, prompting those with a less skeptical mind to predict $200 a barrel. Today, we have the mirror image of a few months ago with the price of crude making new lows while the energy stocks hold up quite well. This suggests that the current rationale of demand destruction ignores the very influential fact of speculative liquidations as the asset class advocates of earlier this year head for the hills and dump what they loved just months ago.

There is one additional dynamic that bears noting. The relative strength data you see in the second chart can also be seen in the third chart, which compares the energy group with the S&P 500. The third chart highlights why relative strength analysis involving assets that are heavily influenced by the price an underlying commodity (in this case, oil) can produce a misleading reading of relative strength. In other words, it is a mistake to ignore the underlying commodity in evaluating the relative strength of an equity index (like XLE) vis-à-vis a broad market index like the S&P 500.

Investment Strategy Implications

Oil is so out of favor that the contrarian (not to mention the longer-term investor) in me says maybe it’s time to go against the crowd, especially when the crowd in so consumed in fear and irrational behavior.

As I said at the top, investors can debate the fundamentals of the price of oil. Investors are free to buy into the depression/deflation scenario if they wish. And along with that thinking, investors are free to join the $20 a barrel club, just as they were free to join the $200 a barrel club. However, when groupthink gets so entrenched AFTER a significant price fall AND when the product in question is central to the functioning of the world economy (green dreams notwithstanding) AND when global growth will slow but not plunge into a black hole of never-ending pessimism, good contrarian investors look for signals that say maybe, just maybe, the crowd is wrong once again.

Disclosure: Accounts managed by Blue Marble Research have positions in XLE, IEZ, and USO.

*This is the Moving Averages Principles that has been referenced on numerous occasions in the past and applies to both bullish and bearish directions.

Friday, December 19, 2008

Quotable Quotes: Imelda Marcos

President Bush should be thankful that the shoe thrower wasn't someone with an endless supply of footwear, say... Imelda Marcos! A few twisted logic quotes from the shoe queen herself. (While we're talking shoes, check out Obama's impersonation of Adlai Stevenson.)

“It's the rich you can terrorize. The poor have nothing to lose.”

“God is love. I have loved. Therefore, I will go to heaven.”

“Doesn't the fight for survival also justify swindle and theft? In self defense, anything goes.”

“Filipinos want beauty. I have to look beautiful so that the poor Filipinos will have a star to look at from their slums.”

“Win or lose, we go shopping after the election.”

Have a good weekend.

Thursday, December 18, 2008

Minyanville posting: Your Portfolio Style - Concentrated or Diversified?

This week's Minyanville posting looks into the two primary portfolio construction styles - concentrated versus diversified.

"Back on August 21st, I authored an article entitled What’s Your Core Investment Style?, in which I compared the market-timing aspects of various investing styles. I now want to take the portfolio-strategy discussion to the next level, by talking about portfolio composition.

Successful investors follow one of two portfolio construction styles. They either concentrate their holdings into a handful of issues, or they diversify, tilting the positions from an economic sector and/or style perspective. Let’s look at the pros and cons of each..."

To read the full current Minyanville commentary as well as prior postings, click here

Wednesday, December 17, 2008

The US is not Japan

ZIRP (Zero Interest Rate Policy) has arrived in the US. And with it comes the inevitable comparisons with the last major country to employ the policy – Japan.

The low hanging intellectual fruit is to conclude that what happened in Japan will happen in the US. Japan employed ZIRP for years with little affect ergo the US will have the same experience. Japan struggled unsuccessfully to fend off deflation so the US will struggle unsuccessfully to fend deflation. But if we go beyond the sound bite and dig a little deeper we just might see that the US is not Japan therefore to assume an identical outcome is just too, well, sound-bitey.

For example, from a central bank perspective consider what Martin Wolf points out in his commentary today re deflation, Japan, and the US: “At this point, one might wonder why Japan has struggled with deflation for so long. I have little idea. But the explanation seems to be that the Bank of Japan did not wish to take such drastic measures (as the Fed has done) and the Ministry of Finance did not dare to force the point. Such self-restraint will not deter the US authorities.”

No doubt that the US consumer will need to drift closer to his/her Japanese counterpart as the deleveraging process continues to push Americans toward a more frugal future. But old habits are hard to shake, and with so much money being pumped into all facets of the US economy one should assume that the cutbacks in US consumer spending will never approach the levels in Japan.

While some fret over deflation, others worry that the flood of money will inevitably produce inflation. This is a justifiable concern. But that is a problem for another day. For today’s problem, the analogy that best fits is the one describing the firefighter and a house on fire – you don’t worry about water damage when the house is ablaze. Besides, once the credit crisis/deflation blaze is extinguished the Fed has ample policy options to address the more familiar risks of inflation.

The last point to make re the Fed and its announcement yesterday is their intention to purchase longer-dated assets to force rates lower, specifically in the mortgage arena. In this regard, it is worth noting that such action may have a powerful side effect – the pricing of illiquid, hard to value assets tied to mortgages. This aspect was part of the original TARP proposal (price discovery) and may result in write-ups of assets held on the banks' books written down to 20 cents on the dollar.

Investment Strategy Implications

With the TED spread sitting at 1.57% this morning, all due to LIBOR, the flood of money from the Fed coupled with anything resembling $70 or better in operating earnings for the S&P 500 in 2009 (current bottom up estimates sit at over $80) may be more than enough to draw investment funds out from under the mattress (3 month Treasury rates at 0.01% today) and into financial assets.

The past is prologue. The US is not Japan.

Tuesday, December 16, 2008

Keep Your Eye on the Credit Markets' Ball - Revisited

Back on October 7th, I referenced the TED spread and its importance in measuring the twin forces pressuring the financial markets - banks capacity and willingness to lend and the degree of investor fear. Both are captured in the TED spread (3 month LIBOR - 3 month US Treasury rate) and together they serve as an excellent metric for measuring the progress toward alleviating the credit crisis.

As the first chart shows, since the October 7 posting substantial progress has been made as the TED spread has declined significantly. However, as the accompanying second chart and the table shows, the decline has been centered exclusively in a decline in LIBOR (second chart) while the 3 month US Treasury rate has hit under the mattress yield levels.

Investment Strategy Implications

One aspect of a return to normalcy has begun with the descent in LIBOR. However, the much anticipated "mother of all bear market rallies" still waits in the wings as the fear factor (in the form of effectively zero percent interest rates) remains elevated.

Over the past few weeks, brave investors have bid up stocks in anticipation of a partial stampede from $3.5 trillion sitting in money markets with the tipping point being reflected in a rise in the 3 month Treasury rate. Keeping our investment eye on the credit markets' ball remains the watchword for financial assets.

Friday, December 12, 2008

Advice to Obama Administration – Less Pro-cyclicality, More Contrarian Behavior

Contrarians are a lonely lot. They sell when others buy and buy when others sell. They are not the run with the herd type.

In the world of investing, herd-like behavior is the dominant form of action and can be seen in many forms – high correlations and animal spirits, for example. A pro-cyclical force that leads to bubbles and busts, in the extreme. And a high degree of mediocre investment performance (often via closet indexing).

Yet, pro-cyclical forces are not limited to the animal spirits of Wall Street. Main Street has its own version, one being played out in the form of layoffs and capex cutbacks as the business cycle runs roughshod over the longer-term secular trends. Understandable but very short sighted. Kind of like the preoccupation with quarterly earnings results.

Even in banking, pro-cyclicality is the way business is usually conducted. Consider the accompanying chart from the Economist re lending standards. Easy money when times are good, tight money when times are tough. More often than not, exactly the opposite of what the economy needs.

Now, easy money during good times is a good thing in the early to mid stages of an economic recovery, however it becomes highly destructive in the latter stages of an economic expansion as dubious projects get funded when a more appropriate approach would be toward prudence. The music is playing and everyone has to dance.

Sadly, as we are all learning with great pain, in the extreme, in all facets of the real and financial economy, privatizing gains and socializing losses becomes the end result.

Investment Strategy Implications

President-elect Obama wants to bring change to Washington. Being forced upon his administration and the global economy as a whole is change across all facets of the financial and economic spectrum. A new financial model needs to be constructed as does a new economic order.

One hoped for addition to the change mantra would be finding ways to encourage less pro-cyclical and more contrarian behavior. Perhaps, then the bubbles and busts will be less pronounced and the socialization of losses less costly.

Thursday, December 11, 2008

Minyanville Posting: Slow Stochastics - When Timing is Everything

This week's Minyanville posting describes the usefulness of the technical analysis tool - Slow Stochastics.

"Investors frequently look for a timing tool to help determine entry and exit points for their longer-term positions; traders are obviously interested in one to determine the same for their short-term interests..."

To read the Minyanville articles including this week's posting, click here

Wednesday, December 10, 2008

Breaking the Cycle of Lower Highs

Two add on points re yesterday's commentary.

First, it is always constructive when a market rallies in the face of bad news. This point was most recently noted by Barton Biggs (formerly of Morgan Stanley fame). Such action suggests that a psychology corner has turned as investors have begun to look passed the valley of FUD (fear, uncertainty, and doubt).

Second, an important dynamic to the bottoming process is the helpful price pattern of breaking the downward cycle of lower highs and lower lows - that corrosive process of a ball bouncing down the stairs: each drop to a new low, each bounce below the previous one. A careful look at yesterday's chart shows (see chart below) that this pattern was finally broken with the move above 900. However, it must noted that the 900 level is not as significant as the 1000 level, not because it is a nicer, more round number but due to the fact that during the decline the lower high of 1000 was set on two occasions - Oct. 13 and Nov. 4, versus the one time at the 900 level. Therefore, breaching the 1000 lower high would be more significant.

Investment Strategy Implications

I am not so sure that yesterday's market decline is the short-term breather the blog title refers to as the shorter time frame of Slow Stochastics has touched the 80 zone but has not crossed over its longer time frame cousin. Given the very positive strength in near term indicators - Momentum and MACD - plus the two points noted above, I would watch for a Slow Stochastics move more strongly into the >80 zone and then the crossover. It appears likely that this would occur right around the 50 day moving average, giving the false impression that it and not the short=term momentum aspects of the market was responsible for the subsequent breather.

Should all go as described, an assault on 1000 would be in the cards.

Tuesday, December 9, 2008

A Short-term Breather

A number of market technicians have pointed to the S&P 500 and its approach to its 50 day moving average (see accompanying chart*). While such levels have a spotty predictive track record, it does seem likely that stocks are poised to take a breather from their 20%+ climb off the floor (752.44, which some are calling a major market bottom).

The more predictive element in this bear market rally breather view is the just barely short-term overbought reading (third indicator on the chart, Slow Stochastics >80), providing the trading justification for a pause. That said, it must be noted that the near-term indicators tracked – Momentum and MACD – have rarely been more bullish (first and second indicators on chart).

Investment Strategy Implications

The bottom-forming debate now centers on whether we are experiencing a 1974 style process (September/December 1974) or the 2002/03 variety (October 2002/March 2003). Its resolution remains to be seen as the longer-term mega trend reading across all markets and styles is decidedly bearish and will take many more months to resolve**. For the near term, however, the strength in current rally run has solid technical legs underneath, a near-term breather notwithstanding.

*click image to enlarge.
**To learn more about how the mega trend works, click here

Friday, December 5, 2008

Quotable Quotes: Dr. Doom (Nouriel Roubini) is 100% in Equities?!!

"I am not in the Armageddon camp". So states the one economist who got the current economic climate right for (more importantly) the right reasons. Given that fact, however, why is his personal money 100% in equities?

To hear Dr. Roubini's comments from this morning Yahoo! Finance "Tech Ticker", click here

Have a good weekend.

Wednesday, December 3, 2008

Beyond the Sound Bite: An Interview with Dr. Rob Atkinson

I was able to catch the the president of the Information Technology and Innovation Foundation ( between his meetings with the Obama transition team for a most informative discussion that included his views on the importance of productivity enhancing public policy, the intricate blend of old fashioned consumer demand, industrial style infrastructure spending, and technological tax policy, and the key role innovation economics can play in producing sustainable growth for the US economy.

Beyond the Sound Bite postings can be found at
To listen to this week's podcast interview, click here

Tuesday, December 2, 2008

Patience, The Lost Virtue

As the alternate universe of derivatives continues their great detoxification unwind, financial assets struggle to comprehend a world in transition to a new financial and economic order. In the process, fixed income markets remain frozen while equity markets lurch from one end of the prospective economic spectrum to the other in near 1.0 correlation.

Investment Strategy Implications

The derivatives tail continues to wag the cash market dog. For traditional investors (those who still believe in things like earnings, P/E ratios, and Discounted Cash Flow models), the only path through this chaotic, cold-turkey transition from an economically juiced, over leveraged, structurally imbalanced world to a less leveraged, more balanced one (e.g., global growth being less dependent on the US consumer) is patience. The alternative is to sell everything and hope that one is smart and quick enough to time their re-entry point.

Investors (in the true sense of the word) will follow the former while traders will choose the latter.

Wednesday, November 26, 2008

Beyond the Sound Bite: An Interview with Phil Roth, CMT

My interview with the Chief Market Technical Analyst for Miller + Tabak includes the conditions necessary for a successful stock market bottom, the positive secular story for commodities (especially agriculture), attractive market action in water related companies, and a dismal longer term outlook for financials and info tech and telecom.

Beyond the Sound Bite postings can be found at
To listen to this week's podcast interview, click here

⇐ 4 days left to vote.

Tuesday, November 25, 2008

The Not-So-Smart Smart Money

It should be fairly evident by now that heavy redemptions at hedge funds over the past two months contributed significantly to the recent pounding in the one area where markets are liquid – stocks. Moreover, the deleveraging process continues to impact many hedgies as available capital (for leveraged strategies) has dried up*.

Accordingly and in anticipation of continuing redemption demands (many of which remain unsatisfied due to gating), many hedge funds have sold more than has been requested thus far. Lastly, there is some talk that private equity commitments of institutional investors are also forcing redemptions in their hedge fund holdings.

Investment Strategy Implications

With the market cap of the S&P 500 sitting at $7.4 trillion and money funds (institutional and retail) amounting to more that $3.3 trillion, the momentum nature of hedge funds and their high cash positions would only need a less bad environment (see Barton Biggs’ comments in yesterday’s Financial Times) to trigger a stampede back into equities.

With valuation currently at deep recession (bordering on depression/deflation) levels, any earnings surprises into 2009 (as in something north of $70) would be the justification for buying what was just sold.

*One wonders what has transpired behind closed doors between financial institutions and government re lending to the masters of the universe.

⇐ Only 5 days left to vote.

Friday, November 21, 2008

Quotable Quotes: Exhaustion

A near state of exhaustion exists be it the investor trying to make sense of the current climate or the avenues being pursued by government in dealing with the credit and economic crisis or the negative feedback loop that is producing lower lows. Therefore, a few words on the topic.

“When you’ve exhausted all possibilities, remember this—you haven’t.”
Robert Shuller

“The man who says he has exhausted life generally means that life has exhausted him.”
Oscar Wilde

“Men and nations behave wisely once they have exhausted all the other alternatives.”
Abba Eban

“An era can be said to end when its basic illusions are exhausted”
Arthur Miller

“Living in a constant chase after gain compels people to expend their spirit to the point of exhaustion”
Friedrich Nietzsche

“I have witnessed and greatly enjoyed the first act of everything which Wagner created, but the effect on me has always been so powerful that one act was quite sufficient; whenever I have witnessed two acts I have gone away physically exhausted; and whenever I have ventured an entire opera the result has been the next thing to suicide.”
Mark Twain

“Tom Cruise's attorney said he is going to sue anyone who claims he is gay. In a related story, Ricky Martin's attorney has been hospitalized for exhaustion.”
Conan O’Brien

Have a good weekend.

Thursday, November 20, 2008

Minyanville posting: Resisting Market-Psychology Extremes

This week's Minyanville posting picks up where last week's left off.

"18 months ago in my last appearance on what was then called “Kudlow & Co.”, I expressed serious concerns re the level of enthusiasm for the markets and in particular the Goldilocks economy. The Great Moderation was the anchor for the economic nirvana that supported ever-higher equity prices. Then the credit crisis erupted and the rest is all too well known.

But emotional extremes, the animal spirits had not fully run their course, as the enthusiastic residue had not gasped its last breadth. Commodity prices soared in the summer of 2008 led by predictions of $200 a barrel of oil. Then came the second wave of the credit crisis and with it fears of a global slowdown and demand destruction.

Now, when we flash forward to today’s environment, we see..."

To read my Minyanville articles including this week's posting, click here

⇐ Vote for US Treasury Secretary and the market.

Wednesday, November 19, 2008

Krugman and El-Erian in the Valley of FUD

In his excellent book, “When Markets Collide”, PIMCO chief Mohammed El-Erian writes about the journey and the destination that the global economy and markets are undergoing and puts in context and helps clarifies much of the current economic and financial chaos. Mr. El-Erian describes a world that will be but is clear to note that the process of getting there may be “bumpy”.

Nobel laureate Paul Krugman points to the same concept in his blog posting yesterday (“After the Stimulus”) in which he lists the components of the US economy for 2007 and their averages from 1979 to 2007. As the accompanying table from his blog shows, the economic mix of the US economy got to be quite imbalanced primarily due to credit inspired high consumption levels by the US consumer. In the process, net exports became the counterbalancing force*.

As El-Erian declares in his book, a transformational world (economic and financial) is inevitable and has been underway for some time (long before the current credit and now economic crisis). And Krugman states, “Consumption probably isn’t going back to a 2007 share of GDP — savings are back. So what will fill the gap, once the stimulus is gone? Housing? Not for a long time. Business investment? Hard to see why. The natural thing would be to trade lower consumption for a smaller trade deficit.”

It is logical to assume that the US economy will experience two mega trends in the coming years:

• US consumer spending will fall while US consumer savings rise (aided by the baby boomers’ need to provide for their retirement years now that the wealth effect has gone kaput)
• Net exports will improve as global growth, particularly in emerging markets, continues to expand (certainly relative to developed economies)

It is also likely that non-residential investments (capex) will move closer to their average as corporations retool to meet the global export opportunities while government spending will increase as the US government seeks to stabilize the US economy (large fiscal deficits and other government programs like TARP).

Investment Strategy Implications

The bottom line for those investors willing to look beyond the valley of FUD (fear, uncertainty, and doubt) that we are currently wallowing in is to position their portfolios (what’s left of them) to exploit these mega trends. To follow this direction, however, requires context, perspective, and perseverance – something sorely lacking in a panic stricken financial climate.

*table contents
C = Consumer
N = Non residential investment (capex)
R = Residential investment (housing)
G = Government expenditures
NX = Net exports (exports minus imports)

Tuesday, November 18, 2008

Just How Bad Are Corporate Profits?

Today's earnings report from Hewlett-Packard raises the question posed in this blog postings' title. To help shed some light on the subject, consider the corporate results produced thus far re 3Q08.

Compiled each week from data published in the Wall Street Journal (and produced for subscribers in each weekly report along with more than a dozen other charts and tables), the accompanying table* shows that when you exclude Financials & Energy, the earnings results are less than great but nowhere near as dire as the headlines and sound bites would led investors to believe. Moreover, the quarter over quarter results ex Financials show a net gain.

That said, several items warrant comment:

* Autos (Consumer Goods) had the largest swing from horrendous (-$42.6B) to just plain bad (-$2.5B)
* Broadcasting and Airlines hit the Consumer Services sector with negative swings of $17.5B and $3.5B, respectively
* Conventional Electricity (Utilities) were hit hard due to higher energy costs to the tune of $-5.3B

Going Forward

Needless to say, investing is a forward looking game. Guidance has ranged from cautious to the ever dangerous "challenging". Despite this fact, however, most bottom up analyst projections remain in what could only be classified as the enthusiastic category, as evidenced by 2009 S&P 500 operating earnings estimated in $90 range.

While obviously overly optimistic, the bottom up boys and girls' forecast may not be too terribly off the mark as lower energy costs and a more robust global growth scenario turn out to be two of the surprise events of the new year. Then there is the very serious prospect of write-ups in Financials as assets held get mark to market upward should any return to normalcy in debt and credit related assets pricing occur.

Investment Strategy Implications

Doomsday scenarios abound. The headlines are awful. And while the credit markets show some progress, the TED spread remains elevated as the improvement in LIBOR is offset by the deflation/depression fear driven levels in the 3 month US Treasury rate.

Thankfully, the equity markets are now past the November 15th notification date for hedge fund redemptions, which should alleviate some of the forced liquidations that have roiled stocks over the past six weeks. However, unmet hedge fund redemptions linger as something of an overhang remains (gradual liquidations replaced hurried forced liquidations) as does tax related selling by individual investors.

Lots of conflicting factors at play. Then again, what would you expect during the bottoming process of one of the worst financial and economic episodes in history?

*click image to enlarge

Friday, November 14, 2008

Quotable Quotes: Hogwash!

One of my favorite podcast services is Bloomberg On the Economy. Last week, they posted a very provocative interview with the author of "The Black Swan", Nassim Taleb. In the interview, Mr. Taleb launches several broadsides against conventional investment thinking including "all of quantitative risk management is bogus", equating modern portfolio theories with "astrology", the uselessness of value at risk, and why buying credit default swaps these days is like "buying insurance on the Titanic from someone on the Titanic".

Here is the 17 minute 42 second interview.

Have a good weekend.

⇐ Only 16 days left to vote.

Thursday, November 13, 2008

Minyanville posting: Bottoms No Place for Fundamentals Alone

This week's Minyanville posting refers to a recent interview Paul Tudor Jones gave re market behavior at and around market tops and bottoms.

"Every now and then I come across sayings or comments that capture the essence of the current economic and/or market environment. This morning, in my email inbox comes the following words from Paul Tudor Jones II that I strongly recommend all investors take a moment to consider in the current environment.

Here are three excerpts from his recent comments:

"When it comes to trading macro, you cannot rely solely on fundamentals; you have to..."

To read my Minyanville articles including this week's posting, click here

⇐ Only 17 days left to vote.

Wednesday, November 12, 2008

For Whom the Deep Oversold Bell Tolls (again)

Whatever the fundamental rationale may be – November 15th and hedge fund redemptions; capital gains sales in anticipation of tax increases next year; fears of a global recession; concerns re FAS 140 and QSPEs (more on this one in a future posting); S&P 500 earnings closer to $50 with a 10 or less P/E – the technicals of the market are once again on the verge of signaling another strong non-confirmation low.

As the accompanying chart* shows, the deep oversold in Slow Stochastics (below 20) combined with a vastly improved Momentum and MACD readings point to a bell ringing non-confirmation low. In my experience, when combined in this fashion these indicators have a > 80% probability of success. And when they fail, the worst-case result is breakeven.

Investment Strategy Implications

Will this time be different? Perhaps, but only the nightmare scenario of plunging earnings and deflationary level P/Es justify lower prices.

*click image to enlarge

Tuesday, November 11, 2008

Out With The Old, In With The New

On the surface China’s actions re stimulating their economy may look to some as a modestly positive development. However, such thinking misses the larger point.

Emerging economies are beginning to show a willingness to take the global growth lead. By seeking to generate domestic demand (which is what their stimulus package is designed to target), China is showing the way for other well capitalized emerging economies to take control of their own economic destiny: Depend less on exports to the developed countries and their overburdened consumers and more on their own emergent middle class for growth and stability. In the process, emerging economies will be a central part to a world economic transformation that will usher in a new, more sustained era of global growth that is difficult to impossible for many to see through the current haze of the credit crisis.

It is, of course, reasonable to be skeptical that such a transformation will succeed, certainly to the extent that it replaces in large part what has been the engine of global growth – the US consumer. Moreover, the process of transformation will not be smooth. The disruptions to the world economy and financial markets have been profound. And the policy responses have been both disjointed and evolutionary. But progress is being made as evidenced by the TED spread.

Of course, in a world dominated by conventional thinking and simplifying assumptions re trends, it is not hard to find many doubters that the progression to a new multi-polar world order underway will result in growth and stability that far exceeds the credit juiced era just ended. Moreover, it is equally hard for many to believe that such a world will include better managed financial instruments to satisfy the emergent global appetite for financial innovation. But that is precisely where the surprise may lie.

Investment Strategy Implications

While it won’t happen overnight, the global growth handoff is underway. Coupled with a rebalanced developed economies, global growth driven by emerging economies appears to be poised to lead the way for a more sustainable and balanced era. More work needs to be done and things must go right on a whole range of levels (economic and financial). However, yesterday’s news re China is a big step in the right direction.

Monday, November 10, 2008

Where will the S&P 500 end the year?

⇐ 20 days remain. Cast your vote.

Thursday, November 6, 2008

Quotable Quotes: Inspiration

A fitting end to a most momentous week. A few of the lesser known but no less profound words of a living inspiration. And a cautionary word from another place and time.

“Human salvation lies in the hands of the creatively maladjusted.”

“Our scientific power has outrun our spiritual power. We have guided missiles and misguided men.”

“A man can't ride your back unless it's bent.”

“Success, recognition, and conformity are the bywords of the modern world where everyone seems to crave the anesthetizing
security of being identified with the majority.”

“Lord, we ain’t what we want to be; we ain’t what we ought to be; we ain’t what we gonna be, but, thank God, we ain’t what we was.”
Dr. Martin Luther King, Jr.

"You may not be interested in war, but war is interested in you."
Leon Trotsky

Have a good weekend.

Minyanville posting: Actionable Ideas, Emerging Markets

This week's Minyanville posting leverages upon yesterday's Beyond the Sound Bite interview by pointing out certain facts related to politics and the markets.

"Sometimes having the facts about the market environment in which investors operate can be very beneficial. In my podcast interview, conducted yesterday..."

To read my Minyanville articles including this week's posting, click here

⇐ Don't forget to vote.

Wednesday, November 5, 2008

Beyond the Sound Bite: An Interview with Sam Stovall

My conversation with Standard and Poors' Equity Research Chief Investment Strategist includes how stocks tend to perform when one party controls government, fourth quarter of an election year stock performance, first year of a new administration and stock performance, and the earnings estimate split between bottom up analyst forecasts versus top down driven estimates.

The length of the interview is 13 minutes 30 seconds.

Beyond the Sound Bite interviews can be found at
To listen to this week's podcast interview, click here

Tuesday, November 4, 2008

An Overbought Pause

As delightful as the rally has been, a key super short-term technical indicator, Slow Stochastics, is registering an overbought reading (above 80) and a cause for a pause.

As the accompanying chart* shows, while the near-term indicators, Momentum and MACD, are in fine shape (especially MACD) and supportive of further market strength, Slow Stochastics suggest that the market may have reached a near-term peak.

As was the case with the recent oversold levels and near unanimous non-confirmation readings, overbought readings are abundant (most indicators registering the same readings) and give further evidence of a peaking out in the rally.

*click image to enlarge

Monday, November 3, 2008

Time to Vote!

What's your opinion on where the S&P 500 will end the year?

Vote now (nav bar to your left).

Friday, October 31, 2008

Quotable Quotes: Spooky Times

Scared to view your upcoming portfolio statement? Well, here’s a few thoughts to lighten the mood.

“One need not be a chamber to be haunted;

One need not be a house;

The brain has corridors surpassing

Material place.”
Emily Dickinson

“He may not enter anywhere at the first, unless there be some one of the household who bid him to come, though afterwards he can come as he please.”
“Dracula” (Bram Stoker)

“Fear has many eyes and can see things underground.”

“This Halloween the most popular mask is the Arnold Schwarzenegger mask. And the best part? With a mouth full of candy you will sound just like him.”
Conan O'Brien

Have a ghoulishly good weekend.

Thursday, October 30, 2008

Minyanville Posting: PE Scenarios for a Volatile Time

This week's Minyanville posting provides an update to one of the valuation models that I use - the P/E Scenario Model

"Back on August 28th, I provided a table that listed various economic outcomes using simple, yet direct terms, such as “average times”, “great times” and “terrible times.” Accompanying each economic outcome was a P/E ratio and earnings outlook that, when multiplied with each other, produced a valuation level for..."

To read my Minyanville articles including this week's posting, click here

Wednesday, October 29, 2008

Look Out Above

Yesterday’s big stock market surge has some serious near term technical analysis legs under it. And the prospect of an attempt to rise to the S&P 500’s 50 moving average (just under 1100) looks achievable. Yet, there are also three non technical analysis reasons supporting a sustained near term advance – calendar related events, market factors, and valuation considerations. Here are a few thoughts on each.

Calendar related events

1 - While all eyes will be justifiably fixed on the election results of November 4th, another November date, the 15th, contains its own stock market importance, for it is on that day that the global economic summit takes place, which should provide a reasonable psychological boost to investors as the image of coordination and cooperation between and among the major developed country players provides its desired impression. Then there is the other aspect of November 15th that should benefit the markets.

2 - November 15th is the mid zone date (between 60 and 30 days before the end of the year) for hedge fund investors seeking to redeem their interests for this year. Alleviation of redemption induced forced liquidations (a major factor in this month's indiscriminate selling) will help all financial assets.

3 - Finally, November is the month when all the government programs agreed to (TARP and the commercial paper program, for example) begin to kick in. It is when the US Treasury and other governmental bodies worldwide begin to walk the talk.

Market factors

1 - According to several sources, there is more than $3 trillion in cash sitting on the sidelines. As of the end of August, this number represented 30% of the total S&P 500 market cap, a percentage that equaled the bottom of the last bear market (October 2002), and a percentage that is no doubt substantially higher today (conservatively estimated at just around 40%). That’s a lot of capital waiting for the right catalyst.

2 - When measured on a one year basis, the drop in the US equity markets is now a record percentage decline over the same time period for the last ten bear markets. At greater than 40% down, the one year decline rivals the worst of all previous such declines. This was further noted by former Merrill Lynch Chief Market Analyst Bob Farrell when he recently wrote, “The current bear market decline is already as extreme or more extreme than other major downtrends in history. Here in October it has included other asset classes as well, such as commodity markets, emerging markets and the currency markets. Deleveraging has essentially caused asset implosions in all markets globally despite the attempts by governments to provide support and liquidity. We have to go back to the 1930s or even the beginning of the twentieth century to find examples of volatility and market extremes comparable to today.”

Valuation considerations

1 - You don’t need me to tell you that many stocks are at outrageously attractive valuation levels. None other than Warren Buffett has taken care of that viewpoint. What may be of broader investment strategy interest is the fact that only a depression style deflation scenario justifies equity values below current price levels. As noted in this week’s Sectors and Styles Strategy Report (published before the jump this week), “Even under a strong recessionary scenario of 12.5 times $72 (= 900), the current S&P 500 price produces a positive return. Only a deflationary scenario puts the current market level at overvalued." And a deflationary scenario means 8 times $60, or an S&P 500 at 480. Although in this climate anything seems possible, given the massive sums of capital being pumped into the system, it is hard to envision deflation taking hold beyond the asset class destruction that has already taken place.

2 - Last point to make is the fact that while global growth is slowing, a global recession is not the base case. All the data suggests that emerging economies will weather this storm in fairly good shape and they will emerge as the demand engine of growth. One could argue that they will be the one area where many investors will gravitate to as growth in developed economies remains below trend and potential.

Investment Strategy Implications

For all the reasons noted above, stocks seem poised to make a run at their downtrend moving averages, which in the case of the S&P 500 is just under 1100, or another 15% up from current levels.

Tuesday, October 28, 2008

Toward A New Valuation Model

Approximately five years ago at a meeting with many of the leading behavioral finance thinkers, I asked the following question: "When will behavioral finance produce the successor to the centerpiece of the rational investor efficient markets theory - the capital asset pricing model?" The answer from one of the leading lights in attendance was ten years. If true, we are only half way toward a key component of finance, a component that is sorely needed as the valuation model used by nearly every traditionally-trained investor is broken.

For most investors bound to a methodology that hasn't made much sense for decades, the path ahead is a highly uncertain one. Company analyses and portfolio management tools and processes are anchored in the ancient art of the efficient market hypothesis and its central equity valuation tool, the capital asset pricing model. To retool established, well entrenched ways of doing business will not be easy for those locked in the ways of the past.

In a recent CFA Institute meeting, PIMCO Co-CEO and CIO, Mohammed El-Erian, brings to light many of the issues that all investors need to think through, especially those whose livelihoods depend on managing other people's money. Mr. El-Erian's speech renders advice that investors should "think the unthinkable" and brings the credit crisis into full valuation and financial modeling view as he places the recent crisis in context.

To listen to his insightful and unnerving views, click here.

Investment Strategy Implications

The behavioral finance clock is ticking and its arrival cannot come too soon for a new world economic order that cannot effectively proceed without the necessary evolution in valuation modeling. And as it does occur, investors who position themselves to take advantage of our brave new economic and financial world to be will reap the benefits.

Monday, October 27, 2008

Sectors and Styles Strategy Report: October 27, 2008

excerpt from this week's report*:
"The traditional method of fundamental analysis implies a market that is substantially undervalued. Even under a strong recessionary scenario of 12.5 times $72 (= 900), the current S&P 500 price produces a positive return. Only a deflationary scenario puts the current market level at overvalued."

*To learn about the report, subscriber features, and other benefits, click here

Saturday, October 25, 2008

Beyond the Sound Bite: Vinny on NPR

My latest National Public Radio interview (conducted Friday, October 24) included the investor migration from credit crisis to economic crisis, circuit breakers, and the implications on stocks due to mutual fund redemptions and lines of credit.

To listen to the 8 minute 45 second NPR interview, click here

Friday, October 24, 2008

Quotable Quotes: Luna-cy

Blame it on the moon.

If you are looking for a reason why the markets are in freefall, then the 1998 Charles Dow award winning paper has the answer. With the 28th day of the 7th lunar month occurring on Saturday, October 25th, a major selling climax is likely either today or Monday, October 27th.

To read the Charles Dow award paper, click here

Have a good weekend.

Thursday, October 23, 2008

Minyanville posting: Resist the Urge to Overshoot

This week's Minyanville posting looks at the issue of markets overshooting, including an important point learned at last evening's hedge fund seminar that I conducted in Boca Raton, FL re mutual funds, the inability to access credit, and forced liquidations.

"Markets can remain irrational longer than you can remain solvent."
- John Maynard Keynes

Remember the prediction of $200 a barrel of oil? Peak oil overrode any rational thinking regarding demand destruction as speculative positions via the Enron (and London) loophole played their supportive role. Then the bubble burst thanks to the credit crisis with demand destruction and the exiting from speculative positions by financial investors bringing prices down..."

To read my Minyanville articles including this week's posting, click here

Wednesday, October 22, 2008

Beyond the Sound Bite: An Interview with Liz Ann Sonders

My conversation with Charles Schwab's Chief Investment Strategist includes a recession call, thoughts on the lasting consequences of the credit crisis (most notably deleveraging), and sector weightings.

The length of the interview is 12 minutes 45 seconds.

Beyond the Sound Bite interviews can be found at
To listen to this week's podcast interview, click here

Tuesday, October 21, 2008


In his award-wining book, “When Markets Collide”, incoming PIMCO CEO, Mohammed El-Erian makes the following statement: “…in contrast to past episodes of US economic slowdowns, emerging economies have two distinct secular forces going for them; and these should prove sufficient to partially offset what is likely to be a relatively prolonged period of lower import demand on the part of the Untied States. First, the internal components of aggregate demand are coming online in a gradual and robust manner, thereby offsetting the prospect of reduced exports to the Unties States. Second, these economies – and in particular the commodity exporters – are looking to a period of relatively high export unit values.”

Mr. El-Erian goes on to point out that “There is also a third factor that is more cyclical in nature. The robust nature of many of these countries’ balance sheets – historically unusual – gives them the ability to stimulate internal consumption and investment.”

Investment Strategy Implications

In the aftermath of the credit crisis, three patterns re the equity markets and economy appear to be underway:

• Sector rotation (within a bottoming process, range-bound market) producing the likely winners and losers of the emerging economic environment
• Secular trend of a slowing US (and other developed countries) growth (driven in large part by deleveraging)
• Secular trend of higher emerging economies' growth rates (an evolutionary form of decoupling)

Should the second two patterns become a reality, the first will likely show some manifestation of them, although the full effect of an emerging markets global growth driver may take some time to register with investors. What appears to be very intriguing is the prospect that US domestic growth-oriented investors will find themselves disadvantaged (from an investment performance perspective) if the global macro secular trends Mr. El-Erian and others describe do in fact occur. The logical result will be an investment situation similar to the end of the dot-com bubble phase when many value investors were forced into owning growth issues just to maintain some semblance of relative performance.

Clearly, the longer-term investment winners in the above described scenarios will be those who recognize the secular trends and act on them sooner rather than later.

Note: For those interested in learning more about one such emerging economy, Brazil, you might want to consider a program that I am affiliated with that will take place one week from today (October 28) at the Bloomberg headquarters in New York City. For more information and to register for Brazil Day 2008, click here

To register, use the following login and password:
login: vinny
password: vcatabd08

Friday, October 17, 2008

Quotable Quotes: Joe the Plumber

As the credit freeze continues its slow, steady thaw (see today's TED spread), Joe provides advice to Hank Paulson on how to unclog the credit crisis hairball. It's the blockage, stupid.

Have a good weekend.

Thursday, October 16, 2008

Minyanville Posting: Market Timing Doesn't Work

This week's Minyanville posting looks at the questionable logic behind market timing.

"Recently, some in the financial media have advocated selling off all of one's stocks. Any investor following that advice did save some capital as the market went considerably lower. However, investors following this "advice" have now joined a high-stress fraternity whose track record is consistently erratic over the short term and consistently wrong over the long term. Here are factors to consider:..."

To read my Minyanville articles including this week's posting, click here

Wednesday, October 15, 2008

A Thawny Issue

As noted previously, stocks, having partially recovered from their deep oversold condition, are not the epicenter of the real economy impact of the credit crisis. The credit markets are. And in this regard, as lovely as the big oversold bounce in equities may have been and as astute as any investor might have been identifying the baby thrown out with the bathwater (oil services and global infrastructure, for example), investor focus needs remain firmly on the credit markets.

As of this morning, the TED spread* (LIBOR minus 3 month US Treasury rate) has narrowed some. LIBOR declined but so did the 3 month US Treasury rate. This is not what investors (and central banks) want to see – some improvement in inter-bank lending (lower LIBOR rate) offset by greater fear (lower 3 month US Treasury rate).

Investment Strategy Implications

Equities appear to be in that twilight world of leadership transition where the winners and losers of the next sustainable rally phase (and the inevitable bull market) will emerge. However, as confident as equity investors might and should be re the central banks and governments' actions, it does seem advisable to restrain any large amounts of enthusiasm until more visible signs of the freeze is thawing. In this regards, the credit crisis remains a thawny issue.

*To track the TED spread, click here

Tuesday, October 14, 2008

Finally On The Right Track But...

...not out of the woods.

The way out of the credit crisis has been paved. Coordinated actions taken by European countries following the lead of the UK now points toward a recapitalization of the banks (injecting money into the banks in return for an equity stake) as the first right step, according to most economists and informed market strategists. Additionally, a shift in the US toward a similar plan is underway.

With a plan of action that appears to address most of the problem head on, investor attention can and should begin to turn to the aftermath of the crisis. In that regard, there appears to be two dimensions to our brave new world:

1. What will be the global financial model?
2. What will be the global economic model?

While this will become the primary area of analysis going forward, there is one conclusion that can be reached immediately – the US consumer is on the long deleveraging path toward more savings and less spending. The consequences to the global economy and where growth oriented investors should place their bets will be part of the investment equation of the future. But that is then and this is now.

For the moment, with the TED spread still at elevated levels and the technicals only supporting an oversold rally, all market advances should be viewed as just that – oversold rallies. For while the equity markets may be at an internal low, a sustainable advance is most certainly months away.

Investment Strategy Implications

While it is debatable whether yesterday's record stock market advance is a product of the belief that the light at the end of the credit crisis tunnel is not a train headed our way but the daylight out of the darkness, the path toward a resolution of the financial crisis appears to have its best hope yet. To get there, however, it must be forgotten that equities are not the thermometer of the credit freeze - the TED spread is.

So when bond traders return today and bankers have another day to digest the European and American government actions, we will all get a better read on where things stand.

Friday, October 10, 2008

Lehman's Credit Default Swaps Settlement

If you are looking for a reason why stocks are plunging, here's one major reason.

Today, at 10:30 AM and then again at 2 PM (both eastern time) announcements re settlement of the massive Lehman Bros. credit default swaps will occur. According to one trading desk source of mine, the equity markets are far more concerned on this point than are the debt markets. Earlier this week, the settlement of Fannie and Freddie CDS' were announced.

While the settlement of the Fannie and Freddie loans was enormous, the CDS settlement prices were more than 90 cents on the dollar making the CDS losses far more manageable (less than 10 cents on the dollar). However, as the Financial Times noted last week, "In the Lehman case, numerous banks and investors have already made losses due to exposure to Lehman as a counterparty on numerous derivatives trades. The auctions next week are for credit derivatives which have Lehman as a reference entity. There are likely to be fewer contracts outstanding than for Fannie Mae and Freddie Mac because Lehman was not included in many of the benchmark credit derivatives. However, exposure remains unclear,..."

Expectations for Lehman CDS' settlements are in the 10 to 20 cents on the dollar range.

Investment Strategy Implications

The equity markets are pressured on multiple levels. One of them is the forced liquidations due to client redemptions, including mutual funds and hedge funds. In the case of hedge funds, it is unknowable at the moment but can be reasonably assumed that despite having an estimated 1/3 of their assets ($600B) in cash, many have exposure to credit default swaps and may incur huge losses as a result. Hence, forced equity liquidations.

By the end of day investors should have a far better idea just how extensive the counterparty damage is. Additionally, knowledge of the credit crisis process and the methods by which it will work its way toward resolution along with the interconnected dynamics of and impact to the real economy will advance. However, the psychological damage to confused equity investors may be far more long lasting.

Fear is feeding upon itself. And the greatest aspect of this fear is ignorance. Tragically, a leadership vacuum is evident with the failure to explain to the American public (and the world audience) what is happening and why. And in the process, panic in all its ugly forms is running rampant. Yet, time will almost certainly show that many equity values being posted today do not reflect their true intrinsic value. In other words, we are clearly at the point where, just as with many credit instruments, mark-to-market in many equities do not reflect their fundamental value.

To view the Lehman auction results, click here

To learn more about the credit default swaps settlement process, click here

Thursday, October 9, 2008

Minyanville posting: A New Regulatory America

This week's Minyanville posting focuses on regulation and oversight, two certain outcomes as a result of the credit crisis.

“There is nothing involved in federal regulation per se which makes it superior to market regulation.”
Alan Greenspan

Nothing captures the blind allegiance to laissez-faire economics and the dubious claims that the markets are always efficient than the above quote from the former Fed chairman. As a result, the credit crisis combined with the near certain increase in Democratic power after next month’s election will produce an increase in regulation and oversight..."

To read my Minyanville articles including this week's posting, click here

Wednesday, October 8, 2008

Beyond the Sound Bite: Vinny on NPR

The folks over at National Public Radio noticed my blog posting of yesterday re the credit markets, Treasury yields, LIBOR, and the TED spread and did an interview with me on the topic, which you can listen to by clicking on the following link.

To listen to the 12 minute NPR interview, click here

Note: To track the all-important TED spread, click here

Tuesday, October 7, 2008

Keep Your Eye on the Credit Markets’ Ball

Despite what you may hear in the media, the equity markets are the sideshow. It is the credit markets that hold center stage.

The table and chart below show the yields on various instruments and the TED spread (3 month LIBOR less 3 month US Treasury). When (not if) short term yields begin to rise in US Treasuries and decline elsewhere (specifically LIBOR), then an unfreezing of the credit markets will signal the beginning of the end of the credit panic.

While being mindful of the real economy and the risks of a deep recession, right now it is the credit markets where the focus needs to be placed.

sources: Yahoo! Finance,

Friday, October 3, 2008

Quotable Quotes: Expectations

As someone who has conducted hundreds of interviews, when I ask a question I typically expect an answer to the question asked. Obviously, things don’t work that way in Alaska. So much for the straight talk express. But, maybe I expect too much. Therefore, a few words on expectations.

“It is great to be a blonde. With low expectations it's very easy to surprise people.”
Pamela Anderson

“Those who will play with cats must expect to be scratched.”

“Climate is what we expect, weather is what we get.”
Mark Twain

“You got to be careful if you don't know where you're going, because you might not get there.”
Yogi Berra

“One of the common denominators I have found is that expectations rise above that which is expected.”
George W. Bush

“The only man who behaved sensibly was my tailor; he took my measurement anew every time he saw me, while all the rest went on with their old measurements and expected them to fit me.”
George Bernard Shaw

Have a good weekend.

Thursday, October 2, 2008

Minyanville posting: "The Mega Trend is Your Friend"

This week's Minyanville posting references and updates a commentary on my blog from several months ago re a technical analysis tool that subscribers are well aware of.

"As the equity markets set up for what I believe will be a short-term non-confirmation (see Making Divergences Work For You), it's advisable not to lose sight of the fact that the longer-term technical picture is decidedly less positive. To help understand how to view the longer-term market picture, a technical analysis tool..."

To read my Minyanville articles including this week's posting, click here

Wednesday, October 1, 2008

Looking Beyond the Panic

Warren Buffett may have been way too premature when he declared in May of this year that the panic phase of the credit crisis was over. Recent developments suggest, however, that there are good reasons to conclude that Mr. Buffett's prediction is close at hand. Evidence for this thinking can be found in two items posted in today’s media.

The first is the Financial Times commentary by George Soros (“Recapitalise the banking system”*), which is a must read for all investors interested in understanding key aspects of the next steps in the credit crisis. The second is the simply awful results of the latest ISM manufacturing report.

With the near certain passage of the sweetened Senate bill, the Soros commentary may strike some as moot, for the Soros prescription will never go beyond the eyeballs of its readers. Such thinking, however, would miss the nuggets of insight embedded in his views. Of special note is how mark-to-market for illiquid assets will die its deserved death. For example, Soros’ recommendation “could require the Treasury to provide cheap financing for mortgage securities whose terms have been renegotiated based on the Treasury’s cost of borrowing. Mortgage service companies…could expect the owners of the securities to provide incentives for renegotiation as Fannie Mae and Freddie Mac are already doing.” In other words, valuation will be (and in fact is being) determined not on the capital requirements of impaired banks but on the US government. This is, in effect, the same valuation result that will occur under the Paulson plan (see section 132 of the House bill) and the announcement of the SEC and FASB made yesterday re fair value and FAS 157. Bye bye, fair value. Hello, common sense.

On the assumption of passage of the Senate bill by the adults in Congress, the pressure on the House will be enormous, made all the more difficult to resist considering the extension of the business tax breaks (in the Senate bill) and today’s dire ISM manufacturing report. The business oriented realists in the House will hopefully make the connection.

Investment Strategy Implications

The financial markets are not out of the woods. But with the full faith and credit (and the attention) of the US government now fully engaged, it does seem fair to conclude that Warren Buffett’s premature prediction will now come to pass. If so, then it’s time to look past the panic and examine the economic debris that the unnecessarily disorderly deleveraging process has wrought. In that regard, it can be assumed that overall operating earnings will decline moderately thanks to improving financial earnings (write ups!) offset by a substantial decline in the more cyclical sensitive sectors (consumer balance sheet repair via deleveraging). In the process, P/E ratios will likely continue their descent below their long-term average of 15x, but not into the deep recession zone of 8 to 12x. The near term effect should be a sense of relief for investors as the panic triggered by the credit crisis slowly recedes.

(Oh, did I mention the fact that the fourth quarter tends to be a very good one for stocks?)

*To read the Soros commentary (subscription required), click here

Tuesday, September 30, 2008

What’s In A Name?

A bailout by any other name would smell just a foul. Or would it?

The Bard may have captured the essence (pun intended) of the smell test, but then again he didn’t run for elected office. Nor did he live in a media saturated, image drenched world as we do. Therefore, when Bush left it up to the political tone deaf Treasury Secretary and Fed Chairman to be the messengers of the plan to rescue the US and world economy, he violated the primary rule of any political action – control the message. And controlling the message means framing the issue properly with a title that captures the essence of the desired action and one that will help win the hearts and minds of voters and their representatives. After all, who is in favor of a bailout of any sort? Least of all one for the “New York City fatcats (who) expect Joe Sixpack to buck up and pay for all of this nonsense*”?

To some, what you call something may appear to be trivial. However, behavioral scientists (and common sense) will tell you that many decisions made in life (including investing matters) are not done in a dispassionate, rational manner but by using mental shorthand tools (heuristics). And part and parcel of that process is how you frame the issue (framing). Therefore, if you let something get framed as a “bailout”, that’s what it will be perceived as.

So, as many members of the House rethink their profiles in cowardice by putting re-election before country, perhaps the administration and congressional leaders might consider a better process of explaining more clearly to the American public and their highly re-election conscious representatives what it is at stake.

The “Rescue America from a Depression” bill may not be the best smelling sausage to come out of Washington, but the stench of a deep recession will smell a heck of lot worse.

*Rep. Ted Poe (R), Texas

Monday, September 29, 2008

Cutting Off Your Nose to Spite Your Face

As of this moment (2:50 PM eastern) the House of Representatives has dealt a huge blow toward stabilizing the financial markets and avoiding a world economic crisis. The less than perfect Paulson bill would have accomplished that goal in numerous ways. One of them, which has been least understood and grossly underappreciated by most other than those who read this blog, is the method by which the Treasury and the Fed would have finessed the rules and stopped the gasoline that turned a house fire into an inferno – FAS 157.

The Paulson plan’s tourniquet that would have stopped the writedown bleeding is mark-to-maturity, the plan’s component that would have enabled Treasury and the Fed to finesse the insanity of FAS 157’s mark-to-market and ceased the graveyard spiral of lower values, more capital, forced sales, lower value, etc.

What Now?

There is still time for the House to come to its senses and immediately pass a bill that would be far better than the alternative of no bill. On the assumption that such an action did not occur, however, then financial assets and therefrom the world economy will suffer the consequences the likes of which are extreme in the best case.

Yet, there is an alternative, an action that could help alleviate the carnage, one that comes from the source of the carnage – FASB. A repeal or more likely a suspension of FAS 157 would go miles toward accomplishing what the Paulson plan would have achieved – stopping the graveyard spiral in asset values.

As for the odds of that happening, the answer is simply “who knows?” However, the consequences of no action by either the House or FASB are frankly unthinkable. Let’s pray for less principled outrage and more adult, common sense decision-making.

Friday, September 26, 2008

Quotable Quotes: Picture This

Here are three pictures that seem to capture the events and mood out of Washington.

The number of people who actually listened to President Bush's 12 minute speech.

The behind the scenes "discussion" at yesterday's White House meeting with congressional leaders, McCain and Obama, and Bush.

The one man who can fix the entire mess.

Have a good weekend.

Thursday, September 25, 2008

Minyanville posting:

This week's Minyanville posting provides the fundamental strategy of exploiting professional investors' tendencies.

"Professional investors dominate the market. They have access to tools and information that the non-professional investor doesn’t. This fact, however, does not preclude the average investor from taking advantage of the professional investor’s tendencies, allowing for the following opportunities:..."

To read my Minyanville articles including today's posting, click here

Tuesday, September 23, 2008


As the world listens to Messrs. Paulson and Bernanke argue for support of their three-page $700 billion manifesto, I wish to focus your attention on a central aspect of the credit crisis – the scale and scope of the credit derivatives octopus.

To illustrate, consider this: If scientists can “identify all the approximately 20,000-25,000 genes in human DNA”, and “determine the sequences of the 3 billion chemical base pairs that make up human DNA,” then why can’t the financial scientists identify the extent of the credit derivatives market?

This is a national, if not global, emergency. In such an emergency, is it acceptable to say, “We don’t know what we don’t know?” Or, “It’s too hard to figure out.” Nonsense. If this emergency were a war, would it be acceptable to say, “We can’t build that tank or missile because we don’t know where the steel is”? Of course not. So, why is it acceptable to say we don’t know the extent of the credit derivatives octopus?

Perhaps certain US government officials do know but they are just not saying so. Perhaps those certain US government officials reside in the US Treasury and Federal Reserve Bank. If so, then their actions these past anxiety-riddled months are about as inept as could be possible as a more comprehensive plan of action should have been constructed (from such knowledge) rather than the firemen Hank and Ben put out the latest financial wildfire this weekend, right now routine we have been treated to.

Investment Strategy Implications

Along with the insane decisions to implement FAS 157 and eliminate the uptick rule, the outrageous neglect on the part of those charged with oversight of the entire financial services industry, and the fundamental rationale supporting each (efficient markets and laissez-faire), you can add the unacceptable argument that it’s just too hard to figure out the credit derivatives octopus.

In the process, the world’s markets and economies are now forced to experience a disorderly unwinding of the credit bubble – a disorderly unwinding that could have been mitigated had certain action steps, and the rationales supporting them, been avoided.

Sadly, today’s testimony will almost certainly contain a lot of shoulder shrugging “we don’t know what we don’t know, it’s too hard to figure out” statements. Unacceptable.

Friday, September 19, 2008

Quotable Quotes: Lost

With all the turmoil this past week, there is little doubt that more than a few investors had a sense of feeling lost. Therefore, a few words on the topic.

“If we open a quarrel between the past and the present, we shall find that we have lost the future”
Winston Churchill

“There are only two people who can tell you the truth about yourself - an enemy who has lost his temper and a friend who loves you dearly.

“Not until we are lost do we begin to understand ourselves.”
Henry David Thoreau

“Stand still. The trees ahead and bush beside you are not lost.”
Albert Einstein

“Then indecision brings its own delays,

And days are lost lamenting o'er lost days.

Are you in earnest? Seize this very minute;

What you can do, or dream you can, begin it;

Boldness has genius, power and magic in it.”
Johann Wolfgang von Goethe

Have a good weekend.

Thursday, September 18, 2008

Minyanville: Understanding the Panic of 08

This week's Minyanville posting provides a concise review of how things got to where they are and how investors might go beyond their own fears and exploit the panic, including 2 buy recommendations in the infrastructure area.

"The Panic of '08 has nearly every investor convinced that the world is coming to an end. With the financial system shaken to its core, who can blame them? But is the world really coming to an end? Are the "evil doers" on Wall Street getting their just deserts while causing unbearable hurt for the rest of us? Is it time to repent, for the end is near?..."

To read my Minyanville articles including today's posting, click here

Wednesday, September 17, 2008

From Chaos to Sanity: The Imperative of Logic

Rules Matter.

If the NFL changes its rules of play, does that not have an effect on the game? So, why would a rule change by the FASB or the SEC or a law by Congress not have the same game changing effect?

When the FASB said that illiquid and opaque assets should be valued at their last sale (or whatever could be approximated as such), were they cognizant of the impact it would have on financial institutions with their capital requirements?

When the SEC eliminated the uptick rule and looked the other way on naked short selling, were they cognizant of the impact it would have in facilitating the bear raids from short sellers? And were they aware that such bear raids would virtually take off the table any capital raising options via an equity sale for financial stressed institutions?

When Congress let the financial innovation genie out of the bottle via various laws (mostly in the area of deregulation) and lax oversight, were they cognizant of the impact it would have on the financial engineers on Wall Street?

The answer to all of the above is apparently not.

Let me clear – the problems of excess amounts of leverage, animal spirits, and bad business decision-making are at the core of the credit crisis. There is no doubt that this is where the blame must lie. Be it no-doc, no-income mortgages, or homes purchased with the intent of flipping them in six months, or credit cards to teenagers in high school, or junk bonds with very generous covenants, the list is very, very long. However, the circumstances produced by such bad behavior are not the only culprits. For when coupled with virtually no oversight and the above noted rule, legislative, and regulatory changes, the bubbles that were blown are what the financial system is now struggling to unwind. Which brings us right to the single most important aspect of the crisis – will the unwinding of the excess amounts of leverage (the deleveraging process) be an orderly or disorderly one?

If left unchanged, the answer is what you see on your screens everyday. Firemen Hank and Ben rushing about to put out one financial wildfire after another.

But it need not be this way.

No doubt, there are many ways to achieve the same end result – a more orderly transition of the deleveraging process – but we’ve got to get beyond the reactive mode and become more proactive to begin to move from chaos to sanity. So, let me humbly offer a few immediate solutions to the credit crisis:

1 - Modify FAS 157

Change the rule from the insanely destructive and academically illogical mark-to-market to mark-to-moving average. By shifting the “fair value” reading from the last sale to the average of the past six months, you will get the closest thing to a reasonable compromise between the market fundamentalist ideologues (with their quaint notion that markets are always efficient) and the realists who know that in the short term investors can be anything but rational, especially when it involves illiquid, opaque assets.

2 – Require more transparency in illiquid assets

The FASB’s recent rule change for FAS 133 appears to be one such solid step in the right direction. More needs to be done.

3 – Begin the process of creating standards for derivatives

Financial innovation is not going away. And when conducting properly, financial innovation can be a very positive force for the real economy. However, when so much is constructed in the dark, in times of stress it becomes impossible to determine where the bodies are buried.

4 – Restore the uptick rule

Since the SEC has finally woken up and instituted sanity into the naked short selling arena, they now need to revisit their laissez-faire, market fundamentalist ideology and restore the uptick rule. By doing so, it will significantly reduce the incentive for the pre-Depression era bear raids that are wrecking such havoc.

5 – Move with a sense of urgency

I began this commentary with a reference to football, so let me return to that metaphor.

In a football game, there often comes a point where time is of the essence. And those teams that are prepared for such times act with clarity and a strong sense of urgency. They may not always succeed but the process is the correct one. The current crisis requires such a sense of urgency. If left unchecked, however, the bear forces at work will continue their bear raids (on equity and debt) until the threat to the system becomes more than it can withstand. Frankly, financial Armageddon is not too strong of a phrase.

Investment Strategy Implications

The impact on the economy has now become so significant that lives are being impacted, most dramatically within the companies that are being driven out of business or into the arms of the US Government and for why? Because rule changes have altered the game.

The laissez-faire, market fundamentalism Reagan doctrine is dead. Over. Finished. Kaput. In its place will be a return to the regulatory and oversight environment that preceded it. The danger is if the pendulum swings too far the other way and restrictions are imposed that severely limits the US’s ability to compete. Given the populist rant of the two presidential candidates, such a move to overregulation is not out of the question.

As I noted yesterday and Mr. El-Erian stated in his interview, transitions can be very messy. Let’s hope that some degree of clear thinking will produce the kind of results needed.