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.