Monday, June 30, 2008

Sectors and Styles Strategy Report: June 30, 2008

excerpts from this week’s report:

Model Growth Portfolio (MGP)
"A moderately rough week with a negative 28 basis points of relative performance resulting in a dropping of the year to date outperformance to just under 3% at 299 basis points. All in all, a very good relative performance for the first half of the year…”

Model Growth Portfolio (MGP) Re-balancing
“No position changes are being recommended at this time...”

ETF Market Monitor
Econ. Sectors & Industries: Energy did well but so did Heathcare. Networking and Aerospace and Defense were to weakest.
Size & Styles: Given the carnage, the Smids hung in there, particularly Mid Cap. Growth continued to best value across all size categories.
Global: India continues its terrible absolute and relative performance.
Other: Blackstone had a surprisingly strong week.

Expected Return Valuation Model
“Fearful expectations (thanks to lower equity prices this past month) have driven the ERVM back into attractive return territory. That is if one believes that global recession is not just around the corner. According to the most recent bottom-up analyst expectations at S&P, such a dire scenario is not foreseen even if one were adjust for the still overly optimistic, which are very much in the process of decline to sanity…”

Moving Averages Scorecard
“Another big down week has turned the data decidedly to the downside and reaffirmed the negative meag trends that appeared to be in process of some repair. All that is gone for the time being with a 33.33% aggregate reading. And the need for more time to repair before any upside can be reliably forecast…”

*To gain access to this week's report (and all reports), click on the newsletter subscription information link to your left.

Friday, June 27, 2008

Quotable Quotes: Oil Vey!

As the price of oil bubbles ahead, a few words on the crude stuff.

“The stars, that nature hung in heaven, and filled their lamps with everlasting oil, give due light to the misled and lonely traveler.”
John Milton

“The use of solar energy has not been opened up because the oil industry does not own the sun.”
Ralph Nadar

“It is clear our nation is reliant upon big foreign oil. More and more of our imports come from overseas.”
George W. Bush

“Let me tell you something that we Israelis have against Moses. He took us 40 years through the desert in order to bring us to the one spot in the Middle East that has no oil!”
Golda Meir

Have a good weekend.

Thursday, June 26, 2008

It's All About the Price of Oil

Does Oil Price Speculation = Manipulation?

The US stock market could not have sent a clearer signal these past two days as to what it is obsessing on – the price of oil. For as important as the Fed’s actions are (with the same opinion being applied to the Financials and their prospective economically destructive write-downs and write-offs), the price of oil is numero uno in the mind of Mr. Market.

And in this regard, the debate rages over just what explains the high price of oil. For example, today Libya , in contemplating cutting production, joined Saudi Arabia in declaring that the physical demand for oil is being more than met by existing supply. Yet, free market ideologues continue to rant that it’s all about the physical supply/demand equation with references to the oil output crisis du jour be it Nigeria or questions re the true reserves in Saudi Arabia or impending hurricane season in the US or failure to build and update adequate refinery capacity or….well you get the picture.

The center of the oil price storm appears to rest with the battle between the US politicians and the free market ideologues. In this regard, it seems that both the politicians and the free market ideologues have got it partly right, but wrong in key aspects.

The politicians are right to focus on the speculators as they have tilted the supply/demand equation via speculative positions. Moreover, in a world where positions established cannot be determined (dark markets, OTC index and derivative related trading), it is anybody’s guess as to just how strong the demand is and to what end such demand is being established.

Where the US politicians have gotten wrong, however, is their implied (and often stated) conclusion that speculation = manipulation. In this regard, it is hard to support the view that speculation = manipulation if large asset managers (e.g. pension plans) move large sums of their investment capital into what they have come to accept as an attractive asset class – commodities. Moreover, it is hard to support the speculation = manipulation thesis when true speculators (versus large asset managers) piggyback on the speculative (not physical) supply/demand imbalance pushing prices higher. That is, of course, assuming that collusion is not occurring.

As for the free market ideologues, they are right to argue that markets tend to function best when regulation is minimized. Moreover, free market activities by speculators provide desirable liquidity, which reduces the cost of investing via smaller price spreads.

Where free market ideologues get wrong, however, is to argue that free markets are efficient markets. If anything behavioral finance has proven wrong is the unfettered markets = efficient markets thesis. In this regard, it is advisable to remember that not all speculators are price efficiency arbitrage operators. Many are momentum players joining the parade for the ride and tending to exacerbate an existing trend. Therefore, unfettered free markets influenced by large shifts of capital from major asset managers enhanced by momentum speculators allowed to establish undisclosed positions is rife for price exploitation.

Investment Strategy Implications

When it comes to today's stock market, it’s all about the price of oil. The economic havoc due to soaring energy costs has many parallels to the destruction of the credit creation process and broken business models of financial services firms and their effect on economic growth. If the US politicians and various experts are correct, the price of oil will decline once both regulatory (CFTC) and legislative action (closing the Enron and London Loopholes) take effect.

On the other hand, if the free market ideologues are correct, then demand destruction is the sole path to end of the current oil price crisis. However, that path will produce broad economic pain (how does a global recession sound?) and, therefore, significant and more onerous regulatory and legislative action, made more likely in a US election year.

On this last point: Investors operating under the assumption that the Democrats in charge of the US Congress will operate in manner similar to the way the Republicans have acted for a dozen years are sorely mistaken. Should the free market ideologues prove correct, investors will learn the real meaning of the slogan “change”.

Wednesday, June 25, 2008

Beyond the Sound Bite: An Interview with Jason DeSena Trennert

My interview with the Chief Investment Strategist of Strategas Research Partners includes his short term bullish/long term bearish outlook for equities, the economic growth versus valuation conundrum facing various emerging markets, and the limited political wiggle room a new US President will have.

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

Tuesday, June 24, 2008

The Death of Market Fundamentalism

commentary from this week’s “Sectors and Styles Strategy Report”*:

The US Congress was never been known for getting things done speedily. And for many years, under Republican rule, neither was it known for aggressive supervisory action. However, a decidedly more activist tone and tempo have emerged from the Democrats in charge. And the ramifications are likely to be quite significant.

The opening battleground centers on the speed and aggressiveness of the congressional Democrats (Senate and House) versus Wall Street, the futures industry, and the energy industry. Activist Democrats are on the move calling before congressional committees a steady stream of experts to testify on oil price speculation. Pressure has been brought to bear on regulatory bodies such as the CFTC. And laws are being submitted to pressure groups such as the energy companies to start drilling on the nearly 4,900 leases already granted of which less than 1,900 are in production (“Use It or Lose It”).

And it isn’t just the volume of action taken, but also the speed and a certain sense of media savvy that seems to be a part of the activist Democrats agenda. With Internet distribution of their message via organizations such as Move On and People for the American Way as well as mainstream media channels such as the “Countdown” program on MSNBC, mobilization of public opinion is moving with greater speed and power than ever before. And in the process the agenda for discussion is being set.

Republicans, in the meantime, reduced to a limited number of talk radio advocates operate in reactionary mode. The consequences of a decade of squandered opportunity.

Investment Strategy Implications

The investment implications of political matters fall into two categories: regulatory and legislative change, and public opinion. Both are being impacted by the activist Democrats. As noted above, the initial battleground centers on the price of oil. If the price of oil declines, the activist Democrats will feel emboldened as their first foray into a new era of power (speed, knowledge, informed spokespersons, and media savvy) will likely emerge. One near certain outcome will be a more aggressive regulatory regime. For free market fundamentalists, this will produce a fate worse than death.

The multi-decade era of market fundamentalism** is on the verge of ending. A more activist government appears almost certain to emerge. Bye bye laissez-faire, hello Mr. Regulator. After many years of detached government management, the pendulum appears to have swung. However, this may not be all that bad, as the detached government management style of the Bush Administration has produced poor administrative execution (e.g. Katrina) and more extreme developments in the markets (e.g. subprime). Of course, such a regulatory shift may be taken to an extreme. But that is not likely to occur for several years as political corruption takes time.

That said, it does seem probable that the death of market fundamentalism has arrived.

*subscription required
**A belief that markets are best suited to handle the trading and value of assets with as little regulatory intervention as possible.

Monday, June 23, 2008

Sectors and Styles Strategy Report: June 23, 2008

excerpts from this week’s report:

Model Growth Portfolio (MGP)
“An excellent relative performance week as the MGP beat the S&P 500 by a solid 53 basis points pushing the year to date results to their highest level at 327 basis points over the S&P 500…”

Model Growth Portfolio (MGP) Re-balancing
“Many of the position changes noted are designed to move some of the portfolio’s assets toward a growth tilt. Also, given the valuation numbers noted in the ERVM along with certain technical indicators (Smids strong, Dow Transports not confirming Dow Industrials weakness), it seems prudent to increase the overall equity exposure to...”

ETF Market Monitor
Econ. Sectors & Industries: A bit of mixed bag with Energy (all subsets) doing relatively well but so did Biotech and Steel. Consumer Discretionary was hit hard but so was Healthcare Providers.
Size & Styles: The Smids and even Micro Cap put in a solid relative performance week. Transports were up in absolute terms.
Global: Other than India (down big) only the energy resource countries (Russia, Canada) moved.
Other: Gold had a strong recovery week.

Expected Return Valuation Model
“As noted above, valuation levels improved to the point where an increase in equity exposure is warranted with a potential total return from current levels of approximately 18% (dark blue zone).

FYI - While bottom-up analyst operating earnings forecasts remain overly optimistic (see table below), the expected return estimate noted above is based on the much more conservative full year operating earnings for the S&P 500 of $82. Therefore, ample room is left for any earnings disappointment or…”

Moving Averages Scorecard
The big down week in the US produced a number of downward ticks in the Scorecard. Most notable were several US sectors that had begun to form potential trends only to slide back to neutral even deteriorating near term direction. The net effect was to push the cumulative mega trend number down to nearly 40%. Most notable re the Global markets is the sharp decline in the two Asian giants – China and India. Both are solidly in negative…”

*To gain access to this week's report (and all reports), click on the newsletter subscription information link to your left.

Friday, June 20, 2008

Quotable Quotes: Ideas

Be it bull or bear market, good investment ideas are rare occurrences. Therefore, a few words on ideas.

“Catastrophes come when some dominant institution, swollen like a soap-bubble and still standing without foundations, suddenly crumbles at the touch of what may seem a word or an idea, but is really some stronger material force.”
George Santayana

“Great ideas often receive violent opposition from mediocre minds.”
Albert Einstein

“A man is not idle because he is absorbed in thought. There is a visible labor and there is an invisible labor.”
Victor Hugo

“It is not once nor twice but times without number that the same ideas make their appearance in the world.” 


“I can't understand why people are frightened of new ideas. I'm frightened of the old ones.”
John Cage

“Man's mind, once stretched by a new idea, never regains its original dimensions.”
Oliver Wendell Holmes

“You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.”
Warren Buffett

Have a good weekend.

Thursday, June 19, 2008

Slamming the Door on the Enron Loophole

The US Congress is on a rampage. And the oil speculators (who have inflated the price of oil by anywhere between 30 to $50 a barrel) are on the run. Perhaps the most extreme proposal by a legislator or regulator to reign in energy speculation comes from Senator Joe Lieberman. Consider his comments of yesterday:

"We are not, as some continue to argue, witnessing the ebb and flow of natural market forces at work. We are instead seeing excessive market speculation at work and that is why our government must step in with new laws to protect our economy and our consumers,"

With yesterday’s override of President Bush’s veto of the Farm Bill, the first of many steps taken and to be taken to put a serious crimp in energy speculation are well underway. And with each new effort to tamp down on unlimited and undisclosed oil futures’ positions, be it closing key aspects of the Enron Loophole as in the Farm Bill* or the proposals to close the “London Loophole”, or the Lieberman effort to “prohibit private and public pension funds with more than $500 million in assets from investing in agricultural and energy commodities traded on a U.S. futures exchange, foreign exchange or over the counter”, the debate over whether the high price of oil is due strictly to supply and demand in the real economy versus supply and demand of speculators will soon be resolved.

Investment Strategy Implications

I believe the catalyst for higher stock prices this summer will be a sustained and possibly sharp drop in the price of oil for all the reasons (and then some) noted above. With valuation at reasonable levels and professional investor pessimism as high as the recent Merrill Lynch survey states, room for higher equity prices appears more than justified.

Moreover, from both a fundamental and technical analysis perspective, it is hard to understand how stocks will head lower when Mid Cap and Small Cap Growth issues (IJK and IJT, respectively)** are outperforming the broad market and, in the process, signaling that 2Q08 earnings (which are not so inflated as 4Q08 numbers are) are likely to be more than acceptable. Strength in second and third tier issues is usually not the precondition for lower prices.

Beta bets plus a tilt toward growth appears to be advisable. For the truly adventuresome, Consumer Discretionary (XLY), Double Long Financials (UYG), and the Broker/Dealers (IAI) should react positively to any summer rally.

*However, not enough according to Michael Greenberger (see blog posting below re The Enron Loophole), as the process by which the CFTC can act requires too many steps.
**See above chart. Click on image to enlarge.

Wednesday, June 18, 2008

Beyond the Sound Bite: An Interview with Marty Fridson, CFA

My interview with the CEO and CIO of Fridson Investment Advisors explored the fault line in credit instruments - high yield bonds. Related to this we discussed credit default swaps, the potential for rising corporate default rates, and the changing investor environment for high yield instruments, among others.

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

Tuesday, June 17, 2008

Summer Breeze

commentary from this week’s “Sectors and Styles Strategy Report”*:

The past several weeks have witnessed the equity markets filled with many crosscurrents. As noted in the various portions of this week’s report, strength has emerged side by side with new and renewed weakness. And it isn’t just the US. Take, for example, certain global markets.

With the unexpected rise in the ECB’s rate coupled with Ireland’s rejection of the EU’s Lisbon treaty, pressure on the EU’s ability to compete, despite many advantages, has emerged. And the equity markets of the EU have taken notice, as evidenced by poor relative and absolute performance of the Europe 350 (IEV).

Then you have various emerging markets, particularly the Asian variety, that have pushed strongly to the downside of late, which requires an investor to decide if a bubble has burst or is it a healthy bull market correction? Sensitivity to the US consumer and inflationary induced riots are two of several areas of concern for investors.

On the more positive side is a likely modest US economic rebound (or at least not falling off the cliff) driven by the stimulus efforts (fiscal and monetary) of the US government. GDP reports and corporate profits for 2Q08 will likely be a touch better than consensus enabling equity investors to benefit from any upside surprises. That said, however, it cannot be assumed that the US consumer will be able to continue his/her profligate ways indefinitely. No matter, for as noted by Phil Roth in a recent Beyond the Sound Bite interview (June 4, 2008), the equity markets are dominated by short term momentum hedge fund players as never before. And the very short term momentum action is about all that will be the primary focus for equities in the US this summer.

Investment Strategy Implications

Given so many crosscurrents, where would one find the drivers for higher equity prices? Let me offer the closing of the Enron and “London” Loopholes as the potential catalysts for much lower oil prices and, therefore, a justification for a summer stock market rally. If so, then the likely bigger winners should be US consumer sensitive sectors and the higher volatility regions that are also highly sensitive to US consumer spending, such as the recently beaten down equity markets in China (FXI).

The legislative action re the loopholes this summer coupled with better than expected 2Q08 US economic activity and corporate profitability should provide enough fuel for a reasonable summer rally. However, from a longer term perspective, it will be the quality of that summer rally that determines whether the fall of this year will be the opening act for the second wave of credit related problems and the associated second leg of the bear.

*subscription required

*To download this month's free sample "Sectors and Styles Strategy Report, click here
*To learn more about "Sectors and Styles Strategy Report" and other subscriber benefits, click here

Monday, June 16, 2008

Sectors and Styles Strategy Report: June 16, 2008

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“The adage, “all good things must come to an end” applied to last week’s Model Growth Portfolio’s (MGP) performance as poor global markets’ performance stopped the MGP’s winning streak at seven weeks.…”

Model Growth Portfolio (MGP) Re-balancing

“No portfolio changes are being made at this time...”

ETF Market Monitor

Econ. Sectors & Industries: Selective areas had an extraordinarily rough week with Steel (SLX), Regional Banks (IAT), Semiconductors (IGW), and Telecom (IYZ) experiencing sharp declines.
Size & Styles: Growth continues to outperform value while large cap weathered the week better than the Smids.
Global: Strong declines everywhere save Russia.
Other: Commodities and Ag were the winners. All other indicators tracked had a strong down week.

Expected Return Valuation Model

“For the past two months, I have resisted lowering the risk adjustment factor despite the recent rise in the 10 US Treasury rate (see chart below) along with the modest narrowing of the credit spreads mainly due to the belief that credit crisis has a second wave waiting in the wings. However, it is more probable that the second wave will not occur until after the current US economic recovery driven by the fiscal and monetary stimulus has run its course. Moreover, the VIX has finally moved…”

Moving Averages Scorecard

“Last week’s late Friday rally in the US was too little and too late to offset the sharp deterioration in several global markets. Flipping to the downside were the EAFE (EFA), Europe 350 (IEV), and China (FXI). One would have to assume that the weakness in European issues was…”

Friday, June 13, 2008

Quotable Quotes: Lucky Day

What else on Friday the 13th?

“I think we consider too much the good luck of the early bird and not enough the bad luck of the early worm.”
Franklin D. Roosevelt

“I'm a lucky guy and I'm happy to be with the Yankees. And I want to thank everyone for making this night necessary.”
Yogi Berra

“America's health care system is second only to Japan... Canada, Sweden, Great Britain, ... well all of Europe. But you can thank your lucky stars we don't live in Paraguay!”
Homer Simpson

“I know what you're thinking. "Did he fire six shots or only five?" Well, to tell you the truth, in all this excitement I kind of lost track myself. But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: Do I feel lucky? Well, do ya, punk?”
Dirty Harry

Have a good weekend.

Thursday, June 12, 2008

Buy the Dips? Sell the Rallies? An "Inflection Day" Rally Update

There is little doubt that many counterbalancing forces are at work in today’s equity markets. The bulls argue that March 17 (“Inflection Day” – see prior blog postings) was the turning point for the longer-term bull market correction that began in earnest last October. The worst is behind us and whatever market action investors are currently experiencing presents a buying opportunity (consolidation range), as the US economy (and, therefore, the world economy) will weather the current economic slowdown. For a testament to this view one need only look at the bottom up earnings numbers generated for confirmation that late 2008 will usher in a return to growth.

The bears would counter that the decline from October 2007 to March 17, 2008 was the first leg of a bear market and the current market action is little more than a distribution range that will end sometime late summer/early fall when the second leg of the bear emerges.

There are many arguments that support both views. Let’s look at a few of them from both a fundamental and technical analysis point of view.

From a fundamental perspective, we have the following items on the plus side of the equation:

• 2Q08 earnings (ex Financials) are likely to be decent (especially in light of today’s retail sales numbers, a point mentioned on this blog weeks ago).
• Valuation is okay with the BMR proprietary Expected Return Valuation Model* at the ever so slightly overvalued point of -2.32% (S&P 500 at 1351, 10 year US Treasury at 4.17%).

From a technical analysis perspective, the following indicators are positive:

• SMIDS, specifically Small and Mid Cap Growth have outperformed the broad market since inflection day (see chart above).
• Shorter-term Momentum has not confirmed the recent lower lows of the market and Slow Stochastics have entered oversold territory.

The major negatives, from a fundamental perspective, are twofold:

• The US economy may experience a rebound this summer as the stimulus package helps the US consumer. However, once the stimulus fades, various forces will drive the US economy into a more meaningful decline beginning 2009.
• The credit crisis is far from over as much toxic paper remains on the banking books and once generous covenants in the high yield arena are lifted (largely beginning in 2009) the odds are that the subprime meltdown will look like a dress rehearsal.

From a technical analysis perspective, the major negatives are:

• Most sectors, styles, regions, and countries have flipped into mega trend declines (Moving Averages Scorecard*)
• MACD, a short-tem indicator, is solidly negative.

Investment Strategy Implications

There are obviously many other factors one can put into the investment strategy mix*. The conclusion I come to is the following:

• The US equity markets are in a range-bound distribution phase.
• Investors can capitalize on both selling the rallies and buying the dips for as long as the range-bound distribution phase is in effect, which should end sometime late summer/early fall as 2009 comes into view.
• 2009 will likely experience a confluence of very negative forces (new administration in the US, economic hangover effects of the stimulus package, and the second, and much larger, wave of the credit crisis into numerous other areas such as credit default swaps on corporate debt).
• Financial institutions will remain at the epicenter of the credit crisis and the direct effects of deleveraging coupled with the negative wealth effects from housing and equities will produce a real economy recession, possibly far greater than only the most pessimistic economists are calling for.
• Stagflation will be a contributing factor to economic difficulties, with the increasing probabilities of significant social unrest throughout the world (something has already begun in various emerging economies)

If one believes, as I do, that equities are in the eighth year of 14+ year secular bear market, then the current environment is an opportunity to trade the range-bound rallies and declines and a time to consider rebalancing one’s portfolio for the much rougher times ahead.

*subscription required

*To download this month's free sample "Sectors and Styles Strategy Report, click here
*To learn more about "Sectors and Styles Strategy Report" and other subscriber benefits, click here

Wednesday, June 11, 2008

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

In light of the emerging economic debate between the Senators McCain and Obama, my interview with the president of the Washington think tank, "Information Technology and Innovation Foundation", is a most timely one. Included in the discussion is the issue of traditional economic policy doctrines – supply-side and Keynesian/demand – versus innovation/growth economics.

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

Tuesday, June 10, 2008

The Enron Loophole

commentary from this week’s “Sectors and Styles Strategy Report”:

Prior to listening to the weekend replay of the congressional testimony of George Soros and others from last Tuesday, I must admit I had never heard of the “Enron Loophole”. But it didn’t take too long to realize that this multi dimensional topic is economic and political dynamite.

Let me start with what I understand the key aspects of the “Enron Loophole” to be.

Back in December 2000, Congress passed and President Clinton signed into law the “Commodities Futures Modernization Act of 2000 (CFMA)”. While the CFMA attempted to resolve the dispute over jurisdiction between the SEC and the CFTC, two elements of the bill appear to have a direct impact on the markets and the financial services industry, specifically investment banks and hedge funds.

I will save the second point for a later report, as it requires further research before I feel comfortable commenting on the derivatives portion of the bill. What I do want to get to is what has come to be known as the “Enron Loophole”, a provision that was slipped into the bill literally in the dead of night by then Senator Phil Gramm (R – TX).

The provision, allegedly at the behest of Ken Lay of Enron, exempted from regulation energy trading on electronic platforms. This provision is believed to be the primary reason for the spike in electricity costs in California in 2001 and is at the heart of the debate re the speculation in oil prices today.

The most vociferous of the expert witnesses at last Tuesday's congressional event was I. Michael Greenberger, professor of law at Maryland University and former CFTC Director of the Division of Trading & Markets (1997 – 1999). Professor Greenberger argued that the “Enron Loophole” provision in the CFMA produced a change in the supervision of certain commodities (energy, for example) that had been in place since 1922 thereby enabling Enron to engage in their trading practices (with led to the electricity crisis in California in 2001) and the development of “dark markets” (Intercontinental Commodities Exchange in Atlanta, for example) enabling unlimited positions and limited transparency to be established by speculators. All outside the purview of the US regulatory bodies such as the CFTC.

Currently, an attempt to eliminate the “Enron Loophole” has been attached to the massive farm bill (amendment by Sen. Carl Levin) that was passed with a veto proof majority and has been threatened with a veto by President Bush for stated reasons that are suspect, at best.

There are several dimensions to this dynamic issue and they will be explored in the coming days. But let me leave you with a few initial observations:

1 - There is a real probablity that investment banks will be at risk as last week’s testimony makes abundantly clear. One point illustrates the danger – Professor Greenberger noted that the largest holder of heating oil for New England residents is Morgan Stanley. Related to this, George Soros and other panelists noted that hoarding is taking place, as the incentive to convert a rising and controllable asset such as heating oil to US dollars (which is in a structural decline in value and not controllable) is not in the investment banks' interest.

2 – The obvious direct economic impact cannot be overstated. From consumers to industries (airlines, for example) are being effected by the speculation of indexers and hedgies. With consumers stressed and industries on the verge of bankruptcy, the uproar in an election year will not go unnoticed. To that end, consider the following point re the upcoming presidential election.

3 – Former Senator Phil Gramm is acknowledged as the key economic advisor to Senator John McCain. Senator McCain has joined President Bush in opposing the current farm bill for the same apparent reasons. However, in Senator McCain’s case the reason may be more ignorance by relying on his economic advisor, Sen. Gramm, than the more nefarious supporting of the Enron Loophole. The bottom line is there is real risk that McCain will look more than a touch clueless on the key economic matter of the price of energy.

Investment Strategy Implications

At last week’s congressional hearing, several experts testified to what the fair value of oil might be – a subject that I wrote about last week, without knowledge of the actual testimony. It was interesting to hear that my rather simplistic calculation of where the fair value of oil might be (approx. $80) matched very closely to several expert witnesses’ estimates, as well as the more sophisticated analysis conducted by Exxon Mobil and Shell Oil.

The coming weeks will be telling as the farm bill works its way into law. And then we shall see if $130 oil is really only about real economy supply and demand and not the supply and demand of the speculators.

Monday, June 9, 2008

Sectors and Styles Strategy Report: June 9, 2008

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“Last week’s results of +22 basis points extends the best relative performance weekly winning streak for the MGP: 10 out of the last 11, 16 out of the last 18, and 18 out of 23 for the year. The MGP’s year to date alpha now sits at 316 basis points…”

Model Growth Portfolio (MGP) Re-balancing

“A net modest increase of 1% in the MGP is being recommended as valuation levels improve. Moreover, individual adjustments appear to be warranted for the reasons noted below...”

ETF Market Monitor

Econ. Sectors & Industries: Energy may have had held the media spotlight, but Telecomm was a surprise weekly good performer.
Size & Styles: Mid and Small cap Growth (MGP holdings) did exceptionally well.
Global: Developed Europe survived but emerging markets everywhere were pounded, especially India and China.
Other: Reversal of prior week (again) with exceptional strength across the commodity board led by (what else?) Oil.

Expected Return Valuation Model

“Keeping the BMR estimated fair value range unchanged (at 120 to 140 basis points over the 10 year US Treasury) may have been a close call over these past weeks but now appears to be the right call as the uncertainty in the energy markets and the recent bad economic news (Friday’s unemployment data) has pushed the VIX back into the 20’s range. With that, the fair value zones are converging around the fair value range in the higher probability $82 to 84 operating earnings levels. And yet despite last week’s sharp decline in equities and in the 10 year rate, the S&P 500 has moved only modestly undervalued to 1.22%. Now that fundamentals have moved…”

Moving Averages Scorecard

“The most notable item this week is the near term directional downgrading of EEM (emerging markets) to deteriorating. Where it not for Brazil and Russia, the slide in India, China, and other emerging markets, EEM might be in bearish territory. The following chart shows its precarious position…”

*To gain access to this week's report (and all reports), click on the newsletter subscription information link to your left.

Friday, June 6, 2008

Quotable Quotes: Traps

Yesterday’s middle of the trading range stock market surge (replete with weak momentum, MACD, and slow stochastics, as well as narrow sector leadership – Energy and Basic Materials) has the look and smell of a bull trap.

So, how about a few words on traps.

“With the monstrous weapons man already has, humanity is in danger of being trapped in this world by its moral adolescents”
Omar Bradley

“Here we are, trapped in the amber of the moment. There is no why.”
Kurt Vonnegut

“We all live in a house on fire, no fire department to call; no way out, just the upstairs window to look out of while the fire burns the house down with us trapped, locked in it.”
Tennessee Williams

“A mouse trap, placed on top on of your alarm clock will prevent you from rolling over and going back to sleep.”

“I don't want the cheese, I just want to get out of the trap”
Spanish proverb

Have a good weekend.

Thursday, June 5, 2008

What’s Wrong With This Picture?

Someone help me out with this one.

If, as the true believers in the purity of market forces say, the price of oil is a function of supply and demand AND considering the fact the US economy consumes more oil than any other country in the world, then how does one explain the accompanying chart from today’s Wall Street Journal?

Recently, before Saudi Arabia relented to political pressure, country leaders said that there is no need to increase their output as supply is meeting demand. Moreover, according to various sources, the cost of extracting oil from the ground ranges approximately from the mid teens to $60 per barrel, depending on various cost factors including the ease of access to the crude. Therefore, as I noted in my last appearance on the Business News Network, the fair value for oil seems to be somewhere in the $80 range, if one assumes an average exploration cost of $50 plus an extra $30 (60%) for all associated additional costs and reasonable profit margins.*

That said, perhaps the following excerpt from George Soros’ testimony before Congress yesterday might help shed light on the debate re a commodity bubble and help explain $120 oil:

"Madame Chairperson, distinguished members, I am honored to be invited to testify before your committee. As I understand it, you are seeking an explanation for the recent sharp rise in the oil futures market and in gasoline prices. In particular, you want to know whether this rise constitutes a bubble and, if it is a bubble, whether better regulation could mitigate the harmful consequences.

In trying to answer these questions, I must stress that I am not an expert in oil markets. I have, however, made a life-long study of bubbles. So I will briefly outline my theory of bubbles, which is at odds with the conventional wisdom and then discuss the current situation in the oil market. I shall focus on financial institutions investing in commodity indexes as an asset class because this is a relatively recent phenomenon and it has become the 'elephant in the room' in the futures market.

According to my theory, every bubble has two components: a trend based on reality and a misconception or misinterpretation of that trend. Financial markets are usually very good at correcting misconceptions. But occasionally misconceptions can lead to bubbles because they can reinforce the prevailing trend and by doing so they also reinforce the misconception until the gap between reality and the market's interpretation of reality becomes unsustainable. The misconception is recognized as a misconception, disillusionment sets in, and the trend is reversed. A decline in the value of collaterals provokes margin calls and distress selling causes an overshoot in the opposite direction. The bust tends to be shorter and sharper than the boom that preceded it.

This sequence contradicts the prevailing theory of financial markets, which is based on the belief that markets are always right and deviations from equilibrium occur in a random manner. The various synthetic financial instruments like CDOs and CLOs, which have played such an important role in turning the subprime crisis into a much larger financial crisis have been built on that belief. But the prevailing theory is wrong. Deviations can be self-reinforcing. We are currently experiencing the bursting of a housing bubble and, at the same time, a rise in oil and other commodities, which has some of the earmarks of a bubble. I believe the two phenomena are connected in what I call a super-bubble that has evolved over the last quarter of a century. The misconception in that super-bubble is that markets tend toward equilibrium and deviations are random.

So much for bubbles in general. With respect to the oil market in particular, I believe there are four major factors at play, which mutually reinforce each other.

First, the increasing cost of discovering and developing new reserves and the accelerating depletion of existing oil fields as they age. This goes under the rather misleading name of 'peak oil'.

Second, there is what may be described as a backward-sloping supply curve. As the price of oil rises, oil-producing countries have less incentive to convert their oil reserves underground, which are expected to appreciate in value, into dollar reserves above ground, which are losing their value. In addition, the high price of oil has allowed political regimes, which are inefficient and hostile to the West, to maintain themselves in power, notably Iran, Venezuela and Russia. Oil production in these countries is declining.

Third, the countries with the fastest growing demand, notably the major oil producers, and China and other Asian exporters, keep domestic energy prices artificially low by providing subsidies. Therefore rising prices do not reduce demand as they would under normal conditions.

Fourth, both trend-following speculation and institutional commodity index buying reinforce the upward pressure on prices. Commodities have become an asset class for institutional investors and they are increasing allocations to that asset class by following an index buying strategy. Recently, spot prices have risen far above the marginal cost of production and far-out, forward contracts have risen much faster than spot prices. Price charts have taken on a parabolic shape which is characteristic of bubbles in the making."

*I realize this is a rather simplistic analysis and that factors such as global growth have been strong. Nevertheless, the primary focus is on the "fair value" of oil, which is a function of overall supply and demand. And that of course includes the global growth story. The bottom line is simply this: if one can determine the fair value of any asset, then why can't one determine the fair value of a commodity? Unless, of course, one buys the bogus argument that the current market value is the fair value.

Wednesday, June 4, 2008

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

My interview with the Chief Market Technical Analyst for Miller + Tabak includes his (small) bear market call, the investment implications of the absence of the public and the dominance of hedge funds in today's market, and when the March lows of this year will be taken out.

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

Tuesday, June 3, 2008

Tapped Out

commentary from this week’s Sectors and Styles Strategy Report:

I found today’s Wall Street Journal story (“Pinched Consumers Scramble for Cash”) to warrant its most viewed story of the day status. To quote: “As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals.”

Without the aid of rising real wages and the positive wealth effects of increasing home values (thereby enabling home equity withdrawals – HEWs), the US consumer, still addicted to maintaining an unsustainable lifestyle, has turned not only to the aforementioned retirement accounts but to higher cost debt, such as revolving credit (most notably credit cards).

One would assume that this consumer behavior has only so far to go before sanity overwhelms the power of denial. This will almost certainly occur the longer weak real wage growth (along with a higher cost living) puts increasing pressure on the household pocket book.

And the longer this process takes, the closer it brings baby boomers to the painful reality that assets that have been counted on to supplement Social Security payments will need to be supplemented themselves. In other words: more savings, less spending.

Investment Strategy Implications

The longer-term investment implications of a transformation of the US economy away from domestic consumption and more toward exports (where domestic consumption will be on the rise) is a secular play that benefits those sectors and industries best positioned to compete in that space. At present, the infrastructure build in emerging markets accrues to Industrials, Tech, Basic Materials, and Energy. However, as emerging economies realize an emerging middle class, the competition for those domestic consumer markets will be hotly contested by all developed market players (US, Europe, Japan) as well as the domestic players within the emerging economies.

For now, the focus remains on the very near term economic and investment climate. In that regard, a summer rally (albeit modest) appears in the cards. However, investors would be wise to not follow the lead of the US consumer and wait until conditions are forced upon them and change occurs. Anticipation of a new global consumer market is best considered sooner rather than later.

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Monday, June 2, 2008

Sectors and Styles Strategy Report: June 2, 2008

excerpts from this week’s report:

Model Growth Portfolio (MGP)

“Last week’s results (albeit very modest) have, once again, extended one of the best relative performance weekly winning streaks for the MGP: 9 out of the last 10, 15 out of the last 17, and 17 out of 22 for the year. The MGP’s year to date alpha now sits at 295 basis points*.

Model Growth Portfolio (MGP) Re-balancing

“No portfolio adjustments are recommended at this time. However, it is likely that an increase will occur in the coming weeks...”

ETF Market Monitor

Econ. Sectors & Industries: Energy was pounded, particularly Oil & Gas exploration (IEO). Tech & Telecom was the big weekly winner with Software (IGV) and Networking (IGN) leading the way.
Size & Styles: The Smids along with Micro cap appear to be signaling a broader market upside potential than the large caps. Transports (IYT) were up huge.
Global: Europe (IEV, EWU) and Canada (EWC) were strong to the downside.
Other: Reversal of prior week with exceptional weakness across the commodity board.

Expected Return Valuation Model

“Keeping the BMR estimated fair value range unchanged was a close call this week due to the fact that operating earnings for the remainder of this year looks much improved versus earlier this year (see table below). Moreover, with the recent rise in the US Treasury 10 year (thereby narrowing credit spreads some) along with a more subdued VIX level*, the temptation to lower the risk adjustment range (to 100 – 120 basis points over the 10 year) is getting stronger.

The following table shows a modest upward adjustment to the BMR scenario forecast. The wild card in these forecasts is the US consumer (see Key US Economic Indicators commentary on page 9).”

Moving Averages Scorecard

“The most notable item is the improvement in the style grouping, specifically the Smids and Micro caps…”

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*To download this month's free sample "Sectors and Styles Strategy Report, click here