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