I pick up Bill Gross where I left him on Friday.  He said in his monthly newsletter that the Fed is going to keep interest rates at zero percent through 2010. But, he is not willing to stick his neck out in a liquidity seeking return kind of way even though this is what reflation is all about. He advises lower risk assets over higher risk ones cognizant that this could mean under-performance.

What I found interesting is that Gross highlighted only two bits in his piece. That should lead you to believe these are the most important points he makes.  The first bit is the rationale behind why he thinks the Fed is on hold through 2010:

The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until.

This is what’s called an asset-based recovery and is exactly the same model we followed in 1992 and 2002. the Federal reserve lowers rates so much that the cash in your pocket burns a hole in it. Grandma may be stuffing her dollars in a mattress, but investors judged against an investment benchmark get fired if they don’t seek returns.  how did Chuck Prince put it: When the music’s playing…

If you are an insurance company, you have a ton of money invested expecting 6-7% nominal returns.  But, in a deflationary environment you have to be smoking something if you think you’ll get that return in low risk assets. So everyone is running the liquidity-seeking-return play. 

The Wall Street Journal mentioned this today:

Though insurers continue to buy bonds, the rally does "make it challenging in terms of getting yield," Steven Kandarian, chief investment officer at MetLife Inc., told analysts in an Oct. 30 earnings call.

Life insurers have long been one of the nation’s biggest bond buyers, currently holding about $1.78 trillion in corporate debt, or 16% of the total outstanding, according to industry group American Council of Life Insurers.

Their frustrations in finding investment opportunities signal how far and fast the bond market has recovered from the dark days when markets were frozen and insurers were diverting almost all incoming premiums and investment income into cash accounts.

But, it sounds like Gross is having none of this.  He asks a rhetorical question about overpriced assets in nearly every asset class:

Do you buy the investment grade bond market with its average yield of 3.75% (less than 3% after upfront fees and annual expenses at most run-of-the-mill bond funds)? Do you buy high yield bonds at 8% and assume the risk of default bullets whizzing at you? Or 2% yielding stocks that have already appreciated 65% from the recent bottom, which according to some estimates are now well above their long-term PE average on a cyclically adjusted basis?

Answering his own question is the only other part he highlights in his essay – one doubting the elevated price of risk assets. He says:

In a low growth environment, it seems to me that a company’s stock should yield more than its less risky debt, and many utilities provide just that opportunity.

Gross goes on to recommend high dividend safe stocks like utilities.  But, I did get the sense he was talking out of both sides of his mouth.  For months now, Gross has been advocating reflation as an economic policy. He has advocated massive deficit spending too.  Back in June of 2008, he was the first one I knew who was talking about deficits in the trillions. Yet, here he is cautioning us about inflated asset prices.  Well, zero rates and inflated asset prices go hand in hand. And I’m sure Bill Gross knows this.

Source

Anything but .01% – Bill Gross, Pimco

Related posts:

• Bill Gross: Sell equities and buy Treasuries
• Bill Gross: the new normal means investors should shun risk
• High yield is back in business in Europe
• Another take on the treasuries bubble
• Bill Gross: “almost all assets appear to be overvalued on a long-term basis”

Marc Faber is in a bullish mindset, particularly on gold. In a wide-ranging interview with CNBC TV-18 in India, Faber talked about where he sees markets headed and why he thinks gold will never drop below $1,000 an ounce.

Private sector contracting while public sector expanding

This is the frame that Marc Faber puts on recent events post 2008 panic, namely that we are likely to see an era of increased government intervention. This is an echo of comments Bill Gross has been making for some time. We are seeing this stimulus on both the fiscal and monetary sides through fiscal stimulus programmes and quantitative easing worldwide.

The economy has not responded robustly given the size of stimulus, Faber says. Asset markets, on the other hand have. This sets up a clear dichotomy between ordinary citizens and those who benefit most from asset price appreciation on Wall Street and elsewhere in the financial sector. Moreover, the spill-over of asset price appreciation into commodity prices further constrains purchasing power for ordinary citizens.

Less certain about carry trade

Faber is less certain about the U.S. dollar carry trade. He sees a dollar overhang due to the enormous U.S. current account deficit and $7.7 trillion in U.S. dollar reserves as more the issue. Many are looking to sell these dollars and hedge their exposure in precious metals and other currencies.

Treasury bearish

The one area where Faber is bearish is U.S. treasuries. He says:

There is a risk that at some stage in 2010, the government bond markets (would) weaken considerably because I don’t understand why anyone who would now buy a 10-year US treasury at a yield of less than 3.5%. It’s a losing proposition. I also don’t understand why anyone could buy a 30-year US treasury at a yield of 4.4%. So I think that eventually yields will go up and this could disturb the stock market.

Not as bullish on equities

Given the huge uptick in share prices globally, Faber believes there is now limited upside going forward.  He says the risk/reward in equity markets at present is not favourable. Moreover, profit margins are cyclically high due to cost-cutting. Faber anticipates weakness in profits in 2010, causing earnings to disappoint and precipitating a correction.

Bullish on commodities and precious metals

His logic is as follows: cash is now trash with zero interest rates. So holding cash means underperforming.  Bonds present an unfavourable risk/reward.  Therefore, commodities and precious metals look attractive. One must also have equities exposure.

Interestingly, he makes a fairly explicit statement in favour of peak oil from about 1:40 in the second video below. The world is adding less in oil reserves than it consumes. That necessarily means a tighter supply/demand dynamic, especially given the demand in emerging economies for oil.

He uses a technical argument to make his money quote (in bold):

I believe that whereas in the past the USD 1000 per ounce level was kind of a resistance level, now it becomes a support level. I don’t think that you’ll see gold below a USD 1000 per ounce probably ever again.

So I’m actually quite positive. Maybe gold at this level is a better buy than it was at USD 300 per ounce in 2001.

Much, much more below.

(videos embedded below)

Marc Faber Interview: Part 1 (6:19)

Marc Faber Interview: Part 2 (5:42)

Sources

Gold will never fall below $1,000 an ounce: Faber – Live Mint

Gold won’t fall below $1000/oz level ever again: Marc Faber – Money Control

Related posts:

• Marc Faber says avoid financials and buy gold
• Marc Faber: I advise every American to hold his gold outside of the United States
• Marc Faber makes bullish comments on Bloomberg
• Marc Faber: “Monetary policy in the United States will stay expansionary”
• Marc Faber: “I am 100% sure that the U.S. will go into hyperinflation”

Christopher Wood, the well-noted market strategist at CLSA and writer of the classic Japan crash warning book “The Bubble Economy,” is now warning of a market correction in the West.  According to CNBC India, Wood believes that the markets’ extreme upward move is increasing the chances of a major correction.

Wood is still cautious. He says there is some initial indication of a technical breakdown in the US. "The US market will be vulnerable early next year the US market. If it becomes clear, after this inventory cycle, that consumption, employment is not really recovering, then the market will go down. You will then get renewed stimulus in the US and measures trying to generate growth. The key variable in the West is government policy." CLSA’s best case scenario is 1,200 on the S&P 500 by year-end, he added.

I agree with Wood that underlying economic demand may indeed be weak and all we may be seeing is an inventory and stimulus induced cyclical upturn (see my July post “ISM: Is this the mother of all inventory corrections?”). Of course, the worry is about the employment cycle not turning up before these measures’ positive effect wears off.  This is the question for 2010. If this happens, we get  a double dip and a huge market-sell off. Even if the employment situation starts to improve slowly while stimulus and the inventory cycle recede, this will lead to a muddle-through scenario, again inducing a correction. This is the heart of Van Hoisington and Lacy Hunt’s call about partial recoveries and stock market weakness.

For those of you who want to believe and want to load up on junk, there’s a clap for that too, via bear turned bull Richard Bernstein:

Richard Bernstein of Richard Bernstein Capital Management is a lot more bullish. "Right now, there is a blurring between the secular issues and the cyclical ones. There are people, including me, who are concerned about the secular issues, but we can’t ignore the fact that the economy is getting better, employment is improving. When that happens you will see a cyclical rebound."

Just in September, Bernstein was saying America “practically invites another catastrophe.” What happened to that guy? He better be right on his bullish turn or he is going to have a lot of egg all over his face.

Source

Chances of a deeper correction are rising: Chris Wood – CNBC TV18 India

Related posts:

• Whitney Tilson: "A pullback of some sort is likely"
• Richard Bernstein: Once a huge market bear, now a bull
• Bill Gross: Sell equities and buy Treasuries
• Marc Faber: “Monetary policy in the United States will stay expansionary”
• Partial recovery will mean new lows for stocks

Yesterday, Moody’s cut the outlook for the sovereign debt of Portugal and put Greece on negative watch for a downgrade, signaling growing concern over spiraling debts. Just as with Spain and Ireland which I discussed yesterday, Portugal and Greece are smaller countries within the Eurozone with large fiscal problems due to the recession. For example, the Wall Street Journal says that Greece expects a budget deficit of 12.5% of GDP this year – that’s more than 4 times larger than the limit set by the Maastricht treaty.

Bonds sold off on the news. The Wall Street Journal reports:

The news spooked investors in government bond markets. The yield spread between 10-year Greek government bonds and comparable German government bonds, or bunds, widened to 1.42 percentage points from 1.36 points. The impact was milder on Portuguese yield spreads, which widened to 0.56 point from 0.54 point against German bunds, because a possible downgrade appeared less imminent.

Moody’s said it hoped to complete the review process promptly, and within three months in the case of Greece. It added that it might keep Greece on a negative outlook even if it decides upon a downgrade.

Standard & Poor’s downgraded both Portugal and Greece in January, while Fitch downgraded Greece last week and revised its outlook on Portugal to negative in September.

And we should certainly expect these downgrades to continue. Back in January, when Portugal was downgraded, the spread to German Bunds moved out to a 12-year high of 146 bps. We are now only 4 beeps lower than that. So, that sounds bearish for their bonds. However, their is a silver lining as Peter Schaffrik of Commerzbank explains in the video below.  Bond investors are incredibly starved for yield and that means there is a good bid for these sovereign issues as they offer relatively more yield pickup than German Bunds.

On the other hand, Chris Wyllie of Iveagh says he is zero weight in bonds now because even these bonds and corporate issues simply do not have enough yield to make them attractive.

You should see this as further evidence that stocks are being artificially buoyed by an increased risk appetite driven by low interest rates.

Related posts:

• Spain can’t sell its bonds
• More trouble in the Baltics as S&P downgrades
• Treasury yields go below zero
• Baltics: Fitch downgrade and more downgrades to come
• Corporate defaults mean more hedge fund blow-ups

This is a guest post from our newest contributor, Charles D. Bull.

Greetings Writedowners,

Ed has gone to bed already. This is Charles D. Bull speaking.

You know, my wife told me yesterday that the local shopping area already has the Christmas tree up and is all geared up to drum up holiday season sales.  Shoppers were out, the sun was shining and the place was really looking pretty, she said. It warmed my heart. I was so excited for the holidays. I couldn’t wait.

Then, I wake up this morning and along comes this guy, what’s his name, David Rosenberg — with his tales of doom and gloom like the Grinch who stole Christmas. Forget about Nouriel Roubini, this guy makes him look like Mary Poppins.

Check this out:

BULL RUN MAY BE REVERSING
The S&P 500 is riding a four-day losing streak. And while we have seen these corrections turn around before during this massive bear market rally that started last March, the difference this time is that the uptrend line from the lows has been violated across a fairly broad front, including the S&P 500, Nasdaq and the Russell 2000. When trend lines get violated, and when this happens on high volume, it usually, though not always, signals something big.
So many people are deluding themselves that we have some sort of durable recovery on our hands and yet consumer confidence, at 47.7 in October, is unbelievable — the lowest this every got in the 2001 recession, which included the 9-11 terrorist attacks, was 84.9. Think about that for a second. If the equity market is catching on to the view that we could be in for some slowing in the data, then a significant correction after a 60% surge is very likely. This is a time to be raising cash if you haven’t done so already — valuation, technicals, fund flows and fundamentals at this juncture are all near-term obstacles.

In terms of valuation, we said yesterday that the P/E ratio on the S&P 500 on a normalized 10-year basis is 20x and the long-turn norm is 16x. Just to go back to the norm, let alone compress to a level commensurate with an unusually high level of economic and financial uncertainty, would suggest that we would see the S&P correct down towards 875.

ONLY ECONOMISTS SEE THE RECESSION AS BEING OVER
The man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go — and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

Only 29% of those polled believe the economy has hit bottom — imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally — not the onset of a new bull market) has not swayed their view (or ours for that matter). There is going to be some very tough slogging ahead as far as the economy is concerned.

OK. Enough already. I think Dave needs to take a few happy pills.  Dave, did you see that rally today? Dow up 200. S&P up 23. Now, that’s what a bull market rally looks like, my friends: stocks way up, bonds way down, lower dollar, lower gold prices.  That’s what I’m talking about!

As for you shorts out there, you’re probably grabbing your ankles, crying “thank you, sir. May I have another?” Serves you right. In the ‘real’ America, we’re doing just fine, thank you.

Stop listening to those clowns Ed Harrison and Marshall Auerback, writing here about depressions and pulling the rug from under our trusted banks. Earth to Ed: we are going into a V-shaped r-e-c-o-v-e-r-y, not depression. Our banks need to be bigger, not smaller. And, um, Eddie, take off the blinders. I don’t know if you noticed it, but we just printed 3.5% on GDP. So, me, I AM popping the cork on the Moet. In fact, I’m sipping it right now.

I don’t know what Ed and Marshall are smoking, but don’t pass it around.

See, I’m an optimist. I knew we would pull out of this one. My motto? Remember, there’s always a bull market somewhere. You just need to know where to look.

You’ve probably been sitting there wondering, "What is The Secret?" I’ll tell you, it’s called positive thinking.

Anyway, I’m sure you pessimists are going to try to bring me down in the comments: aitrader, Lavrenti, kbob, Vangel, you know I’m talking to you – you too Wadsworth. I can take it. As my boy Nails would say, “I love it, baby… Pile it on, bro.”

Charlie has left the building.

Charles D. Bull is a pseudonym. He has been loosed on this site to post purely for your amusement… and ridicule.

Related posts:

• Rosenberg: Market rally is just multiple expansion
• Overbought?
• An amazing market rally. What’s next?
• Rosenberg thinks U.S. market may Test March lows
• Back to the future: Rosenberg says it’s like the crisis never happened

Bill Gross has a must-read piece out for his monthly Investment Outlook called “Midnight Candles.” He begins the piece with allusions to his advancing years (Gross is now 65) and the mortality he feels because of it – pretty sobering stuff. gross then abruptly segues into his investment outlook, leaving one with the distinct impression he is suggesting there is something ephemeral in the global financial system’s status quo ante.

To solve the problem, Gross suggests continuing artificially low interest rates to maintain pumped up asset prices. This is a perverse conclusion I reject categorically. But his analysis leading up to this is right on the money. And the line he takes to make the transition to his thinking is right out of Credit Writedowns’ playbook.

I’ll jump straight into a discussion of why in a New Normal economy (1) almost all assets appear to be overvalued on a long-term basis, and, therefore, (2) policymakers need to maintain artificially low interest rates and supportive easing measures in order to keep economies on the “right side of the grass.”

Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them. How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.

This, my friends, is the dreaded asset-based economy. It is the same financial model which has led us to mountains of debt and repeated bubbles and extreme financial instability.  I have said in the past that aggregate debt levels as measured by ratios like debt to nominal GDP should remain constant to the degree that the capital used to generate that growth is efficiently allocated. However, we have seen a ballooning in debt, which suggests that we need far more capital to generate a unit of growth than we did a generation ago.  Gross makes similar arguments, focusing instead on assets instead of debt (liabilities).

First of all, assets didn’t always appreciate faster than GDP. For the first several decades of this history, economic growth, not paper wealth, was king. We were getting richer by making things, not paper. Beginning in the 1980s, however, the cult of the markets, which included the development of financial derivatives and the increasing use of leverage, began to dominate. A long history marred only by negative givebacks during recessions in the early 1990s, 2001–2002, and 2008–2009, produced a persistent increase in asset prices vs. nominal GDP that led to an average overall 50-year appreciation advantage of 1.3% annually. That’s another way of saying you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce. We, in effect, were hollowing out our productive future at the expense of worthless paper such as subprimes, dotcoms, or in part, blue chip stocks and investment grade/government bonds.

Again, these themes echo something i recently posted on, namely the hollowing out of America’s middle class from downsizing and outsourcing. See my post “A conversation with Stephen Roach on Charlie Rose “ in which the juxtaposition between a Stephen Roach interview circa 1996 and one from this past week makes plain the long-term problem.

Gross comes to a very different conclusion to all of this than I come to.  He says, faced with a potential collapse in nominal GDP growth, the answer is to feed the patient more of the asset price elixir to wean him off his drugs. Cold turkey would lead to depression (i.e. death – that makes the tie to his lead in plain).

This is where it gets tricky, however, because policymakers, (The Fed, the Treasury, the FDIC) recognize the predicament, maybe not with the same model or in the same magnitude, but they recognize that asset prices must be supported in order to generate positive future nominal GDP growth somewhere close to historical norms. The virus has infected far too many parts of the economy’s body, for far too long, to go cold turkey. The Japanese example over the past 15 years is an excellent historical reference point. Their quantitative easing and near-0% short-term interest rates eventually arrested equity and property market deflation but at much greater percentage losses, which produced an economy barely above the grass as opposed to buried six feet under. The current objective of global policymakers is to do likewise – keep the capitalistic patient alive through asset price support, but at an “old normal” pace if possible, six feet or 6% in U.S. nominal GDP terms above the grass.

My conclusion is different. I have said before that I also think cold turkey would lead to disaster (see my post “Confessions of an Austrian economist), but I am under no illusion that we need to keep supporting the asset-based economy indefinitely.  Our goal should be to use government stimulus as cover to eliminate malinvestments and downsize bloated sectors of the economy like financial services. This is one reason I am in favor of introducing a comprehensive too-big-to-fail (TBTF) resolution process to allow big banks to fail and breaking up TBTF financial institutions.

Going back to Gross, he concludes that his policy preference for maintaining is supportive of asset prices in the medium-term but not so supportive that we are going back to the gold rush of yesteryear.

If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get. Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point.

While I disagree with Gross, his is a very good piece if you want to know which way the wind is blowing. I have linked to it below.

Enjoy.

Source

Midnight Candles – Bill Gross, Pimco

Related posts:

• Bill Gross: Fed on hold through 2010
• Gross isn’t buying corporates, high yield or equities even with zero rates
• Bill Gross: “Stop the decline in asset prices”
• Bill Gross: the new normal means investors should shun risk
• Bill Gross: “Staying Rich in the New Normal”

Jeremy Grantham is out with his much anticipated Quarterly Letter and it’s a good one. “Just Deserts and Markets Being Silly Again” is a cutting, snarling, and sarcastic rejection of the prevailing V-shaped recovery bull market view.  But Grantham is far from ultra-bearish, giving a more nuanced and realistic assessment for the medium and longer-term.

He starts his letter with sarcastic allusion to Obama’s Nobel Prize, titling the section “Just Deserts.”

I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just deserts? Let’s review some of the more obvious examples.

But, he is just warming up, as he goes on to heap vitriol on 13 groups he feels are equally undeserving of rewards in a scathing condemnation of status quo ante in the economic and financial establishment.

They are:

1. Ben Bernanke
2. Larry Summers and Tim Geithner
3. Mortgage Brokers
4. Homebuilders
5. Over-spenders and under-savers
6. Too-big-to-fail banks
7. Over-bonused financial types
8. Overpaid large company CEOs
9. Stock holders of overleveraged Corporations
10. The U.S. Auto Industry
11. Over-vehicled America
12. Stock options
13. And, of course, Sir Alan Greenspan

This letter is a polemic against the financial elites of a ferocity the likes of which I have never seen from a major fund manager. I see it as a must-read.

As for the markets, he is not all doom and gloom.  But the point that certainly jumped out at me was this:

Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year.

Translation: the market is so overvalued now that you should expect pretty meager long-term returns in equities.  Does that mean a crash is right around the corner? Not necessarily – but a brutal correction is probably in the offing. Grantham says:

I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at -15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19). 

Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.

The bottom line here is this: the market is significantly overvalued at present levels because of a technical rally super-charged by stimulus. This necessarily means lower returns over a longer-term horizon. The possibility of a major correction is high.

Update: the full letter with a lot more detail, market history and asset allocation recommendations is now linked below instead of embedded due to copyright restrictions.

One other thing: a GMO representative reminded me you that can register with their site and subscribe to the letter and receive it automatically as well.

Source

Jeremy Grantham’s 3Q 2009 letter – GMO website

(the link to the GMO splash page above will guide you to registration in order to view the letter – and to subscribe to future letters)

Related posts:

• More bullishness from Jeremy Grantham
• Jeremy Grantham: “Pull the trigger”
• Jeremy Grantham: “Keep telling yourself… you’re a long-term investor”
• Jeremy Grantham: “Many shares priced for… economic collapse”
• Jeremy Grantham: Overheating in China, speculative rallies and fair value

In today’s morning with Dave article, Gluskin Sheff’s Chief Economist and Strategist says the macro environment makes it look like 2007 all over again – as if the crisis never happened.

It’s like 2008 and early 2009 never happened. Hong Kong’s Hang Seng index just hit a 14-month high as the island benefits from Chinese growth, U.S, interest rates and competitively supercharged currency link. In fact, the entire MSCI Asia-Pac index added 1.0% today, with broad-based gains and taking the index to its highest level since September 1, 2008.

The VIX index, at 21.49, is back to where it was on September 3, 2008, when most economists didn’t even know we were knee deep in recession, strategists believed we were only in for a mild correction and the Fed still thought it was fighting a liquidity battle as opposed to a credit contraction. In fact, to show just how complacent the market is now regarding that dirty, but now forgotten four letter word called “risk”, the VIX index is flirting near levels we saw back in October 2007, when the S&P 500 was just coming off its all-time high of 1,565 and market pundits were dreaming up new ways to redefine ‘global liquidity’.

Meanwhile, the DXY (USD index) is still recovering a bit but still on very shaky ground (Japan reiterated that it will not intervene in the FX market) and the commodity complex is bid with copper enjoying a nice session yesterday (though off a tad this morning) and oil heading for $80/bbl. It is amazing that the surge in oil prices and the challenge to the economic outlook isn’t making front page news, but it is arguably very tough to push Dow 10,000 off the front pages of the morning papers. The market seems to like Apple’s earnings — my kids sure love its products — and Texas Instrument’s too with futures up and the tech sector on a big roll right now — the Nasdaq is up 38% so far for the year!

Corporate bond spreads have continued to tighten (even in the face of a massive supply boom, a record $1 trillion of new U.S. issuance has hit the market this year) and the “undervaluation gap” in this once-very-cheap sector has now closed given that it is de facto discounting 2.5% U.S. economic growth in the coming year (equities now are close to 5% — not far off from what they were pricing back at the October 2007 peak). Question that still must be asked is that if we are into some big reflationary trade here, why are U.S. Treasuries not getting absolutely smoked? In the last couple of sessions, they have rallied (10-year T-note yield at 3.38%) and being led lower by real rates, which is generally not consistent with pro-growth cyclical beta performance.

It’s what’s called reflation!  And it will end in a very bad way.

More here.

Related posts:

• Rosenberg: The Grinch who stole Christmas
• Rosenberg: Market rally is just multiple expansion
• One on One with David Rosenberg, Chief North American Economist at Merrill Lynch
• UK real wages falling
• Rosenberg: Still a bear market rally

Roger Bootle sat down with the Telegraph and ran through a few themes in regards to the stock market, the financial crisis, government debt, currencies and compensation in the financial sector.  He has a lot to say, in particular on banks, which he argues do not operate in competitive markets – one reason they pay so well. He argues there is a cartel of too big to fail institutions which should be broken up.

The video of his comments runs just over five minutes. Catch his book “The Trouble with Markets” at Amazon. A link to the article accompanying the video is below.

Does banking contribute to the good of society? – Telegraph

Related posts:

• Greed is not good
• More on why big capital markets players are unmanageable
• Are European banks sitting on 16.3 trillion in toxic assets?
• Regional banks: Zions falls
• Doubling down at AIG

Meredith Whitney downgraded Goldman Sachs from ‘buy’ to ‘neutral’ today.  Previously, Goldman had been her only buy recommended stock, all of the others rated neutral or ‘sell.’  Why did she do it?

FT Alphaville has the answer:

We are downgrading shares of Goldman Sachs to Neutral from Buy after over a 34% run in price since their second quarter results. At $190, shares have exceeded our $ 186 12-month price target, and we believe upside could be limited over the medium term. Specifically, we invoke a "why be greedy" rationale with such a stunning move in shares over such a short period of time. From here, we believe upside to GS’ shares is more of a "market call" and that shares should trade more or less in line with moves in the market.

In essence, Whitney is making a call based on valuation more than fundamentals.  She believes Goldman’s fundamentals still remain good. After all, Lehman and Bear Stearns are gone – so competition is less. But, the stock has run up too much to warrant buying at these levels.  This makes sense if you look at how Goldman’s stock has fared over the last two years.

Goldman Sachs is trading at its highest level since May 2008, well before Lehman failed.  So I do think taking profits is warranted. That said, should you sell now or wait for the price action to dictate when you sell? I am saying cut exposure now but Jeffrey Saut of Raymond James uses a quote to make a compelling case for waiting for the stock to roll over so as to not sell early (hat tip Barry Ritholtz).

“The absolute price of a stock is unimportant. It is the direction of price movement which counts.”

“During major sustained advances in stock prices, which usually occupy from five to seven years of each decade, the investor can complacently hold a list of stocks which are currently unpredictable. He doesn’t worry about the top because he knows he is never going to sell at the top. He knows that the chances are overwhelming in favor of the assumption that he will get far better prices by waiting until after the top is passed and a probable reversal in trend can be identified than he will ever get by attempting to anticipate the top, and get out on the nose.

In my own experience the largest profits we have ever taken have come from stocks purchased while they were making a new high in a market which was also momentarily expecting the top. As I have already pointed out the absolute price of a stock is unimportant. It is the direction of the price movement that counts. It is always probable, but never certain, that the direction of the price movement will continue. Soon after it reverses is time enough to sell. You should sell when you wish you had sold sooner, never when you think the top has arrived. That way you will never get the very best price – by hindsight your individual transactions will never look daring. But some of your profits will be large; and your losses should be quite small. That is all that is necessary for a satisfactory, enriching investment performance.”

“Stock Profits Without Forecasting,” by Edgar S. Genstein

This makes sense if you don’t have a price target for the stock you buy. But, on the whole, I say pick an exit point when you buy a stock and stick to that target. This is what Whitney is doing. And this is essentially what I have recommended for selling equities based on a Jeremy Grantham S&P target.

As for banks stocks, the whole sector is through the roof and I certainly do not believe the fundamentals warrant this as I laid out last week.  Goldman is a broker-dealer and a bank in name-only. Its model has not changed, so it is operating in an environment far more inviting than its big bank cousins like Bank of America and Wells Fargo.

So while Goldman and Morgan Stanley are looking at better prospects there are numerous obstacles to for banks.  Two articles I linked to yesterday point out some of the headwinds.

First, from the Financial Times:

A surge in fixed-income underwriting opportunities during the quarter is expected to boost revenues not just at Goldman, but also the investment banking divisions of JPMorgan Chase, which reports on Wednesday, and Bank of America, which announces results on Friday.

However, the non-investment bank operations of JPMorgan and BofA will be hit by loan losses in the commercial area as well as the consumer area, says Richard Bove, an analyst at Rochdale Securities.

“They will have to go back to increasing the size of their reserves,” Mr Bove adds.

“This could result in losses for the quarter and into next year.”

Notice how this article distinguishes between proprietary trading and broker-dealer activities on the one hand and traditional banking operations on the other. The credit cycle is still in a downswing and this will hurt banks.  But there are also other forces at work.  Marshall Auerback pointed out a Bloomberg article to me regarding the huge book of business the big banks do as mortgage servicers and how accounting rules there look unfavorable going forward.

The four biggest U.S. banks by assets may have to take writedowns on $55 billion of mortgage- collection contracts after marking them up by $11 billion in the second quarter, casting a shadow over earnings.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. wrote up the value of the contracts, known as mortgage-servicing rights or MSRs, by 26 percent in the quarter as mortgage rates climbed by about 0.35 percentage point. Net gains on the contracts added more than $1 billion to Wells Fargo’s record earnings in the quarter and $1 billion to JPMorgan’s first-quarter profit.

Mortgage rates fell about 0.26 percentage point in the third quarter, according to Freddie Mac, and servicing costs are rising, meaning the four banks, which handle collections on more than $5.9 trillion of U.S. mortgages, may face writedowns.

“We’re very bearish on MSR valuations,” said Paul Miller, a banking analyst at FBR Capital Markets in Arlington, Virginia. “They are overvalued. There are higher costs associated with the servicing, and we’re very concerned about it.”

Add these to my other concerns in commercial real estate, deposit insurance payments, credit card losses, loss of government subsidies, the need to keep higher levels of capital, and a flattening yield curve and you see an environment in which bank stocks should underperform the market.

The long and short is bank stocks have run up too much too quickly. Now is the time to lighten up on them. This is true whether you are talking about Goldman, which is going to earn a lot of money, or the likes of Bank of America, which faces a more challenging environment.

Related posts:

• Goldman crushes earnings estimates
• Bill Miller and Meredith Whitney: The Bull and the Bear
• Is Meredith Whitney bullish now?
• Goldman loses $2.1 in the third quarter
• Warren Buffett backs Goldman

In my last post, I presented you with a bunch of data on debt levels broken down by sector of the economy (see “A brief look at the Asset-Based Economy at economic turns”).  I found it interesting that a secular pattern seemed to be at play when looking at the household debt charts.

Notice the three areas boxed in red on the chart to the right.

The chart measures the differential between the year-on-year change in household debt and nominal GDP.

The three areas show three distinct periods of household debt accumulation.

1. 1951-1966. The first shows household debt changes generally outstripping nominal GDP by a wide but decreasing margin. This period coincided with a secular bull market in equities.
2. 1966-1982. This second period is more volatile, but with the overall numbers lower.  In general, debt was accumulated less rapidly compared to the growth in nominal GDP. And when recession hit in 1970, 1974 and 1980, it induced a retrenchment (at least relative to nominal GDP growth). This period coincided with a secular bear market in shares.
3. 1982-?. This last period shows an enormous increase in debt growth relative to GDP growth during the 1980s followed by minor retrenchment after the 1990-91 recession and strangely also in 1997 (could this be a butterfly effect to the Asian Crisis?). But after that it was off to the races right through the 2001 recession until mid-2007.  This period coincided with a secular bull market in equities.

The pattern seems to indicate that there is a relationship between debt build-up in the household sector and stock prices.  The build-up in debt relative to nominal GDP troughed in Q3 2008 at -0.4%. As of Q2 2009, the number was +1.2%.

I see this as evidence of the so-called Wealth Effect. The data suggest that the secular bear market may not have begun in 1998 or 2000 as I have generally believed. And they also suggest that, despite the recent rise in shares, a new secular bear market may have just started in 2007. I will be curious to see what the data look like for the second-half of 2009.

Source

Z1 Data Series – Federal Reserve

Related posts:

• Americans are not increasing savings
• A brief look at the Asset-Based Economy at economic turns
• Chart of the day: household debt vs. savings
• Consumer credit falls 4.4% from year ago levels
• Data on past consumer deleveraging during recessions

Gold hit a record high of $1,044.30 an ounce, beating the previous record of $1,032.35 set back in March and up a monster $26 on the day. The impetus is the crashing dollar, brought down by a report (later denied) that OPEC states and the Chinese were organizing a secret abandonment of the US dollar (see story here).

It is still rising.  In fact all commodities are rising sharply against the dollar. WTI Crude is up 2%, oat futures are up 3%, wheat futures are up 4 1/2%,  and corn futures are up almost 7%. And, we are seeing parabolic moves in silver (up almost 6%) and copper (up over 3%) as well.

But, of course, the Dow is up over 160 points despite this news of dollar revulsion. A little gallows humor over at Zero Hedge captures the mood amongst the shorts (hat tip Scott). This rally is absolutely turbo-charged. Can nothing take it down?

Sources

Spot gold – Kitco

Commodity futures – Bloomberg

Related posts:

• The dollar collapses
• The dollar rally spells trouble for some investors
• Has anyone noticed the Dollar has gone into freefall?
• US Dollar rising dramatically
• Chart of the day: US Dollar

In July, I blogged on an interesting take on how employment affects equity returns during cyclical recoveries by Van Hoisington and Lacy Hunt. Their thesis was that a recovery in which employment lags the overall upturn significantly is bearish for stocks. Since then, employment has indeed lagged other economic indicators.  Witness the most recent employment situation summary released earlier today.

Nonfarm payroll employment continued to decline in September (-263,000), and the unemployment rate (9.8 percent) continued to trend up, the U.S. Bureau of Labor Statistics reported today. The largest job losses were in construction, manufacturing, retail trade, and government.

Household Survey Data

Since the start of the recession in December 2007, the number of unemployed persons has increased by 7.6 million to 15.1 million, and the unemployment rate has doubled to 9.8 percent…

The civilian labor force participation rate declined by 0.3 percentage point in September to 65.2 percent. The employment-population ratio, at 58.8 percent, also declined over the month and has decreased by 3.9 percentage points since the recession began in December 2007.

Establishment Survey Data

Total nonfarm payroll employment declined by 263,000 in September. From May through September, job losses averaged 307,000 per month, compared with losses averaging 645,000 per month from November 2008 to April. Since the start of the recession in December 2007, payroll employment has fallen by 7.2 million.

In September, construction employment declined by 64,000. Monthly job losses averaged 66,000 from May through September, compared with an average of 117,000 per month from November to April. September job cuts were concentrated in the industry’s nonresidential components (-39,000) and in heavy construction (-12,000). Since December 2007, employment in construction has fallen by 1.5 million.

Employment in manufacturing fell by 51,000 in September. Over the past 3 months, job losses have averaged 53,000 per month, compared with an average monthly loss of 161,000 from October to June. Employment in manufacturing has contracted by 2.1 million since the onset of the recession.

In the service-providing sector, the number of jobs in retail trade fell by 39,000 in September. From April through September, retail employment has fallen by an average of 29,000 per month, compared with an average monthly loss of 68,000 for the prior 6-month period.

Government employment was down by 53,000 in September, with the largest decline occurring in the non-education component of local government (-24,000)…

In September, the average workweek for production and nonsupervisory workers on private nonfarm payrolls edged down by 0.1 hour to 33.0 hours. Both the manufacturing workweek and factory overtime decreased by 0.1 hour over the month, to 39.8 and 2.8 hours, respectively. (See table B-2.)

In September, average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls edged up by 1 cent, or 0.1 percent, to $18.67. Over the past 12 months, average hourly earnings have risen by 2.5 percent, while average weekly earnings have risen by only 0.7 percent due to declines in the average workweek. (See table B-3.)

The change in total nonfarm payroll employment for July was revised from -276,000 to -304,000, and the change for August was revised from -216,000 to -201,000.

A few points here:

1. Losing over 250,000 jobs per month nearly two years into recession is an indication of a still weak employment market.  This is 400,000 jobs per month below where we want to be.
2. Why is the labor force participation rate still falling? This is a sign of a deteriorating, not improving labor market.
3. Manufacturing is still shedding workers even though industrial production is rising. That demonstrates a weakness whose source is record low capacity utilization.
4. Local and state governments are cutting workforce and countering the stimulus provided by the Federal Government as I indicated in January they would.
5. The workweek is a record low and this is crimping earnings power.

Conclusion: the labor market is till weak, weaker than it should be at this point in a cyclical recovery. Unless this changes in the fall and winter, a double dip recession is going to be more likely. While the preceding points stress the negative, I should point out that my baseline view is for job losses to continue to diminish, albeit at a slow pace. I would anticipate job gains to appear by the end of the year or early in 2010.

That gets me back to Hunt and Hoisington and partial recovery. Even if we see job gains by Q1 2010, this will be a full 6 months after the manufacturing sector turned up. This must limit consumption because spending can only increase through higher employment and income or increased debt and leverage. As most of the cost-cutting and productivity gains inherent in those cuts is now behind us, the heavy lifting begins. Earnings growth is likely to be weak in this environment.

How a fully priced equity and corporate bond market continues to rally in the face of these factors is beyond me. I see government bonds as a better bet than either corporates or equities for the medium-term.

Update: I failed to mention the rather large (over 800,000 jobs) benchmark revision of prior unemployment data.  It’s this sort of thing which makes people not trust the numbers.  But, revisions are always necessary if you are going to do month-to-month measurements in an economy as large as the United States. 

Here’s what the BLS said:

Preliminary Estimates of Benchmark Revisions to the Establishment Survey

In accordance with usual practice, the U.S. Bureau of Labor Statistics is announcing its preliminary estimates of the upcoming annual benchmark revision to the establishment survey employment series. The final benchmark revision will be issued on February 5, 2010, with the publication of the January 2010 Employment Situation news release.

Each year, the Current Employment Statistics (CES) survey employment estimates are benchmarked to comprehensive counts of employment for the month of March. These counts are derived from state unemployment insurance tax records that nearly all employers are required to file. For national CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus two-tenths of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates a downward adjustment to March 2009 total nonfarm employment of 824,000 (0.6 percent).

Related posts:

• US Unemployment shows 5.5%, net loss of 62,000 jobs
• Unemployment rate climbs to 9.4%
• U.S. unemployment rate 7.2%, 524,000 jobs lost
• 651,000 jobs lost but unemployment rate at 8.1% in U.S.
• 467,000 jobs lost in the U.S. in June 2009

How about all three. Faber released another provocative newsletter this month that has a little grist for investor of all stripes.

Boom. His short-term outlook is bullish because he believes money-printing will underpin the market even after the 60% increase in the S&P 500 from March 2009 lows. This puts him in the same camp with Rich Bernstein and Jim Grant. Interestingly, he says that a “very weak” economy is best for stocks because it will induce more money printing from central banks.

Gloom. However, he says this will only make matters worse over the longer-term as the U.S. government has no stomach for reigning in budget deficits expected to reach $2 trillion. It is merely underwriting the bankers’ mistakes. Down the line a point of debt revulsion will come.

Doom. In five to ten years, Faber sees major problems as a result.  In the September Gloom, Boom & Doom report he writes:

The future will be a total disaster, with a collapse of our capitalistic system as we know it today, wars, massive government debt defaults and the impoverishment of large segments of Western society.

Let’s call this Financial Armageddon. While he certainly presents a dire worst-case scenario, I sympathise with this view because, as I have warned in the past, unsustainable debt bubbles like the one we are now witnessing usually end in depression, war and strife.

Below are three videos of Faber on Bloomberg earlier today spinning his tale of waste and woe.  Pretty entertaining and they run twenty minutes in total.  Faber likes drug stocks.  He thinks that bonds and cash will be the worst long-term investments because of inflation.  Faber also would be overweight Asia as he believes emerging markets will grow faster than the West.  He has good things to say about Goldman. “They are really a smart group of people.”

See also Bullish Today, Marc Faber Is “Highly Confident” the Future Will Be Very Bleak and the attached video at Tech Ticker with Aaron Task. Faber gives another entertaining performance there as well.

(three videos embedded)

Related posts:

• Marc Faber: “A huge move is coming in the dollar, in bonds and in equities” but…
• Marc Faber: “Monetary policy in the United States will stay expansionary”
• Marc Faber: China’s numbers are fake
• Marc Faber: “I am 100% sure that the U.S. will go into hyperinflation”
• Mobius: Still bullish on Emerging Markets

Bill Gross is a bond man.  In fact, he is often called the “Bond King” because Pimco, the organization where he is founder and Co-Chief Investment Officer, is the largest bond fund in the world. In Bondland, what Gross says has a lot of weight.

And Gross has been talking about a “new normal” of deleveraging, deglobalization and reregulation. In his view, this means weak consumer demand counterbalanced only by heavier government intervention, leading to slow growth for the foreseeable future (See my post ‘Gross: The new normal for “the next 10 years and maybe even the next 20 years”’).  In essence, he sees a scenario that is bullish for bonds (especially longer duration types like the 10-year and the 30-year) but not particularly bullish for shares.

But, Gross is also reducing risk.  There has been a huge run-up in corporate bonds, especially in high yield bonds. And Gross believes now is the time to take profits and reduce exposure to riskier assets, a view he first put forth in his monthly newsletter at the beginning of July (see my post, “Bill Gross: the new normal means investors should shun risk”).  And Gross is re-balancing his portfolio quite heavily to reflect this “glass half-empty” bias. His portfolio has its heaviest concentration in five years of Treasuries, considered the U.S.’s risk-free financial assets.

Below is a video of Gross talking on CNBC along with two other market experts, Bob Doll and Dan Tishman, regarding their view of the economy and financial markets. Gross goes as far as to say point blank that one should sell equities and other riskier assets like high-yield bonds.

Before you watch the video, be aware that two other formerly bearish analysts, Richard Bernstein and Jim Grant, have flipped to bullish recently.  Gross mentions Grant by name and disagrees with his take on the economy, calling it “disingenuous.” Articles by or on Bernstein and Grant’s view’s are below the video.

This is the third in a series of posts about reducing risk. See also:

• Sell equities
• Way too much risk in the equity market

Related articles
From Bear to Bull: James Grant on Recession and Recovery – Jim Grant, WSJ.com
Bernstein: Best Value In Junky Names – CNBC.com

Related posts:

• Bill Gross: Fed on hold through 2010
• Sell equities
• Gross isn’t buying corporates, high yield or equities even with zero rates
• Bill Gross: the new normal means investors should shun risk
• Marc Faber: "I don’t think that you’ll see gold below $1,000 per ounce probably ever"

Following up on my “Sell equities” post, I want to highlight a factoid from today’s David Rosenberg’s Breakfast with Dave distribution.

Never before has the S&P 500 rallied 60% from a low in such a short time frame as six months. And never before have we seen the S&P 500 rally 60% over an interval in which there were 2.5 million job losses. What is normal is that we see more than two million jobs being created during a rally as large as this.

In fact, what is normal is for the market to rally 20% from the trough to the time the recession ends. By the time we are up 60%, the economy is typically well into the third year of recovery; we are not usually engaged in a debate as to what month the recession ended. In other words, we are witnessing a market event that is outside the distribution curve.

I had been pretty bullish in March and April.  But almost immediately, this rally just went straight up in a moon-shot kind of way that makes someone like me who is more oriented toward fundamentals a bit nervous. After months of wondering how long this thing could last, I’ve finally said sell.

I’m not saying that the rally can’t continue (after a correction).  That depends in part on the economy and reflation. What I am saying is that a two- or three-sigma move should have you asking yourself a lot of questions. And since this is a two- or three-sigma move to the upside, you should be taking profits, not chasing that last dollar.

The video below from 7 Sep with Cazenove’s Robin Griffiths gives one the bigger picture.  Going into treasuries is a flight to safety. Going into gold is the same. Notice that Griffiths dispels the notion that Gold is an inflation hedge alone.  In reality, it is a paper money hedge and its rise represents a fiat currency rejection as much as a portend of inflation.

Source

Breakfast with Dave, 18 Sep 2009 (PDF) – David Rosenberg, Gluskin Sheff

Related posts:

• Rosenberg thinks U.S. market may Test March lows
• Sell equities
• Overbought?
• Rosenberg: Market rally is just multiple expansion
• Rosenberg: Still a bear market rally

In late August, I wrote a post called “Getting bearish again” in which I said that the bear market rally I had anticipated back in March was long in the tooth.  At the time, I mentioned 1026 on the S&P 500 as a sell signal.  With the S&P 500 now well over 1060 and gains of well over 50% from those March lows, it’s definitely time to sell.

And when I say sell, I’m not talking about going overweight bonds or commodities by putting additional new money disproportionately in other asset classes – which is what you should have been doing in August.  I am talking about lightening up on equities and selling existing positions. 

Now, if you missed the rally, I’m sorry but, now is not the time to get in. And if you have been there from the start, remember, bulls make money, bears make money but pigs get slaughtered.

David Rosenberg sums up the logic.

The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation — usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs — during this extremely flashy move, the U.S. has shed 2.5 million jobs (as may as were lost in the entire 2001 recession).

Do you really think there’s huge upside here? After a 60% run to the upside?  Laszlo Birinyi does and sees 1200 before year end. I’d rather sit this one out. The downside is a lot greater at these levels than the upside. I would say lighten up on risk all around. High quality over low quality. Low beta over high. Consumer staples over discretionary.

But, if you are not going to run with the liquidity-seeking-return crowd and chase high beta and low quality stocks or high yield bonds, where do you put funds?  After all, Bernanke and company have made sure cash is trash by lowering rates to zero. 

Here are three ideas.

Government Bonds

Has anyone noticed the yield on treasuries?  It’s falling. For example, a month before Labor Day on 7 Aug the 30-year yielded 4.61, the 10-year was yielding 3.89 and the 5-year got you 2.84 (see 2009 data here).  Today, we are looking at 4.18, 3.40 and 2.38 (data here).

Meanwhile the dollar is getting crushed – approaching parity with the Swiss Franc. Everyone is shouting “recovery, recovery,” as if that’s the reason that the U.S. Dollar is falling. So then, why are government bond yields exploding to the downside even while the U.S. government budget deficit spirals upward?  It doesn’t sound like the bond market is expecting a very robust recovery. Pimco, the world’s largest bond fund, is already in this trade. They have been loading up on treasuries of late – bringing them to their highest relative weight in 5 years.

Gold (or platinum)

As I see it, the U.S. is likely to use the U.S dollar as an escape hatch for a very intractable debt problem.  That is dollar bearish, but not necessarily bearish for U.S.-based treasury investors.  A scenario in which the Dollar tanks and there is a flight to safety in Treasuries is also one in which Gold could outperform at the same time. And Gold has also been surging as well, last trading well over $1000 at $1015.  If you like precious metals as a hedge against a dollar run, then platinum is a good bet as well as it has outperformed gold.

Out of the money puts

If you think this cyclical bull market (aka bear market rally) has legs like Laszlo Birinyi does, why not do a Taleb Black Swan trade via out of the money puts on Spiders (SPX) or QQQQs or some other broad market ETF?  This would be a hedge – and that’s all. The benefit of such a trade is that you don’t have to sell outright. And it is de minimis in cost right now. The VIX, a broader market volatility index, is at a one-year low. So, this insurance bet will cost you less.  But, the decrease in the VIX should also be treated as a contrarian indicator.

Sources

Breakfast with Dave, 17 Sep 2009 – David Rosenberg, Gluskin Sheff

Update: I just noticed that Barry Ritholtz has a post out discussing why he thinks markets can and will go higher. See his comments here.  He makes valid points  – based more on technicals than fundamentals.  On a fundamental basis, the market is overvalued. To the degree you hold Barry’s view that the rally will continue because of liquidity, then you would want to employ the Black Swan strategy I mentioned as a hedge against downside risk.

Related posts:

• Bill Gross: Sell equities and buy Treasuries
• Way too much risk in the equity market
• Treasurys are getting killed again
• Kass: Bearish on equities
• Marc Faber: "I don’t think that you’ll see gold below $1,000 per ounce probably ever"

This comes via TheStreet.com and Doug Kass, a noted market strategist:

Many strategists (both bullish and bearish) assume that a fair value P/E multiple — based on interest rates and inflation — rests at about 15.5 times. Averaging the 2009 and 2010 S&P consensus forecasts produces a melded $67.50 S&P EPS, a year-end target of 1045 and a mid-2010 S&P target of 1130 on an EPS of $73 a share — against the current S&P level of 1043.

Bearish strategists such as David Rosenberg (this weekend’s Barron’s interview) believe the current S&P level is discounting a 40% increase in 2010 earnings over 2009, but the consensus believes (above) that about 10% growth is being discounted.

Bearish strategists (again) like Rosie expect real GDP growth of about 1% to 2% next year, but the consensus now anticipates 3% to 3.5% growth in 2010.

The market’s P/E multiple is up by 5.5 points, or more than 40%, since equities bottomed in early March. So, even for the bullish strategists, the phase in which expanding price-to-earnings multiples contribute to the market’s advance is largely over and future stock market gains will be dependent upon the achievability of a healthy growth in S&P operating earnings toward the consensus.

As Kass later points out, the anticipated earnings growth fuelling this rally must be predicated on continued leverage. The present multiple and earnings growth has come from cost-cutting which lowers employment and income – and, thus, aggregate demand in the absence of more leverage (See Tom Toles’ not-so-funny depiction of this via Prieur du Plessis).

According to Kass, other headwinds include poor commercial real estate fortunes, lower local government spending, and higher taxes. All of this makes the market rally seem more bear market rally than secular bull.

And I can think of no secular bull markets that began with a 40% surge in earnings multiples.

More here.

Related posts:

• Rosenberg: Market rally is just multiple expansion
• Getting bearish again
• Overbought?
• Rosenberg: Still a bear market rally
• Avoid consumer stocks

If you’re looking for a good laugh over the weekend, you might try Dow 36,000 by James Glassman, just hired as custodian of the George W. Bush legacy (hat tip Scott). It’s about the new strategy for profiting from the huge rise in the stock market. Here’s what Wikipedia says:

The argument of Glassman and Hassett has been summarised by John Quiggin, writing in the Australian Financial Review.

Glassman and Hassett believe that both investors and official commentators have misperceived stocks as a risky investment which should require a premium return, when compared to ‘safe’ investments such as government bonds.

If stocks and bonds were treated as equally risky, Glassman and Hassett argue, the Dow Jones index would be around 36000. Hence, anyone who gets in now and stays for the long haul, can expect returns of around 300 per cent (in addition to the normal interest rate) as the rest of the market wakes up. Once this historic correction is over, the efficient markets hypothesis will hold sway

Sounds pretty hilarious!

If you don’t bust a gut reading that one, I have a few others I recommended last year right here. They are definitely laugh out loud funny.

Related posts:

• Five Books not to buy
• Goldman says fund managers expect deflation
• Bullish
• Corporate defaults mean more hedge fund blow-ups
• James Montier sees “deep value” in markets – he is bullish

So we started September in an ugly way. With the markets down 2% across the board, and oil and bond yields also falling.  Forgive me for thinking this is a bad sign, but selling on good news doesn’t sound very bullish.

  And the ISM data definitely was bullish. Production 61.9 – Yay! New orders 64.9 – Hurrah! What’s not to like? But the Dow was down 185 points – Boo!  What gives? 

Well, for one, bank shares were decimated (see the sea of red in the chart to the right?). But, there’s more to it than that; Wal-mart was the only stock to rise in the Dow. For the S&P, we had breadth of 16-1 for decliners to advancers.  This was a broad-based selloff – and one that took place with the backdrop of positive economic data from manufacturing and housing.

To me, that is a very worrying sign. Now, obviously I expect a market correction (see posts here and here). But, I neither expect nor want a crash (I do think this is a possibility, however, given how far stocks have run without a correction).

It is now September, the month of market jitters,  and the financial services industry is headed back from their long slumber.  Things get serious in September. Let’s hope they don’t get too serious or Paul Tudor Jones is looking like a financial prophet yet again.

Related posts:

• Wood warns of correction, says “key variable in the West is government policy”
• Are the markets set for a pullback?
• Richard Bernstein: Once a huge market bear, now a bull
• Major selloff coming?
• Jeremy Grantham: The market is 25% overvalued; 15% correction coming

You have probably noticed a change in tone at Credit Writedowns since about June, but a lot more in the past month or so. Once mildly bullish due to the deeply oversold levels this Spring, I have become increasingly alarmed at the unjustified strength of the recent market rally.

My most recent post explaining my concern, “Major selloff coming?” kind of gives you the timeline. I really would like to be bullish, but I have major issues with this rally on both a technical and fundamental basis:

Technicals

1. The technicals all point to stock markets in the U.S., Europe and Emerging Markets as being overbought. This has been the case for at least two months now. As the market continues up without a pullback, you have to be concerned that any pullback will be violent.
2. There has been an enormous multiple expansion, which is usually what occurs in the middle to latter stages of a secular bull market, not in the beginning of one. It certainly makes one think this is a bear market rally and not a secular bull move.
3. I have said that the massive liquidity dumped into the system is not going to fuel inflation when capacity levels are at historic lows in the U.S.  There is absolutely no pricing power, either for businesses or workers. But, all that money is going somewhere eventually. Right now, it looks like it’s going into asset prices. Liquidity is seeking return.

Fundamentals

1. If you look at the deflationary pressures, they are almost all still at work: poor employment markets, producer price inflation at record low levels (Germany down 7.8% through July y-o-y for example), overcapacity in Europe, China and Asia, back breaking debt levels, etc, etc.
2. But, then, where is the demand?  It’s not there. The consumer is not going to be jumping in here. A lot of the uptick in the economy is inventory-related, not consumption-driven.  So either former exporters, government or business will have to pick up the slack.
3. And let’s not forget my favourite whipping boy, the financial sector. In the U.S., there are a lot of toxic assets on balance sheets, while leverage and equity capital ratios are still poor.  That speaks to the need for continued deleveraging and low loan growth in the financial services sector.

So while a snap-back rally was inevitable given how oversold things had become in March, this rally has been a bit over the top.  I am not alone in this assessment.  The Wall Street Journal has pointed to Jeremy Grantham and a few other March bulls who are now speaking in more cautious tones.

…Jeremy Grantham, penned a note on March 10 entitled "Reinvesting When Terrified" that encouraged investors to buy, suggesting stocks were 30% undervalued.

Since then, the market has roared ahead, without stopping for a correction of 10% or more. Standard & Poor’s 500-share index ended last week at 1026.13, up nearly 52% from its 12½-year low on March 9 and its highest close since Oct. 6. The Dow Jones Industrial Average is at 9505.96, up 45% since its March low.

Now, the chairman of Boston asset-management firm GMO and his colleagues say the S&P 500 has zoomed right past what they consider fair value of about 880, based on earnings estimates and historical price-to-earnings ratios.

Notice the part about not having had a correction, which I see as a contrarian indicator.  Back in May, Grantham said a leap up to 950 and then a sideways move between 950 and 1050 on the S&P meant the market was modestly overpriced.  That is not a sell signal. This is where we are right now. But, at 1026, we are dangerously close to breaking out of that range to the upside – which would be a sell signal.

With the City and Wall Street ready to return to full speed soon, we will get a better taste of what is to come due to higher trading volumes.  But, for now, I am mildly bearish on shares.

Related posts:

• Rosenberg: Market rally is just multiple expansion
• Kass: Bearish on equities
• Are the markets set for a pullback?
• Overbought?
• Jeremy Grantham: The market is 25% overvalued; 15% correction coming

Right now many economists believe the US economy is poised for recovery.  Even I believe the economy will recover by year’s end. But for the man in the street, things hardly look like a recovery right now. Harried by falling house prices, foreclosure and lost employment, the US consumer is over-indebted and has run out of gas. Ordinary Americans are probably more concerned about building a savings cushion and reducing credit card debt than buying the latest SUV or flat screen TV. Naturally, one should then ask, “what is this recovery that economists and market pundits keep talking about and when’s it going to happen?”

Mark Thoma does a good job of explaining it in his recent post “How Will We Know when the Economy Turns the Corner?” He points out three areas that need to recover: the banking system, business investment, and personal consumption. His conclusion: when these three areas can show sustainable growth without the helpful aid of government stimulus, we will be in a real recovery.

Therein lies the problem. The banking system is systemically weak because it is being propped up artificially by government. Commercial property is to 2009 what residential property was to 2007 and 2008. And the US consumer will be in balance sheet repair mode for years. Clearly, a real recovery is not coming anytime soon.

But a recovery is still likely to come. It will be a fake recovery, a technical recovery, a statistical recovery, a partial recovery, not a real recovery.  And this has major implications for the economy and for your investments. Let me explain.

The fake recovery

Back in April, I wrote about the apparent desire of the Obama Administration to recapitalize the fragile US financial system by relying on a cyclical rebound and government largesse to increase bank profitability before another crisis came ashore. Team Obama seems to believe we have had a liquidity crisis in the financial sector, not a solvency crisis.  In this view, aggressive policy action and time would heal most wounds.

And, indeed, here we are in August with the US economy looking much more robust. This quarter might even see positive growth in the economy.  But, it is not a liquidity crisis we have been witnessing in the US; it is a solvency crisis.  US financial institutions still have hundreds of billions of toxic assets on their balance sheets which have not been written down. Any recovery we experience would be a fake one, papering over weak balance sheets and overcapacity in the financial services sector. At the first sign of economic weakness, these problems would magically re-appear, doing untold additional damage to the economy.

The technical or statistical recovery

And signs of economic weakness are already on the horizon.  The recent employment and consumption data have been poor – below expectations, causing equity markets to sell off globally. As I mentioned at the outset, ordinary Americans  are still in a world of hurt.  The economy is at a much lower ebb today than it was in, say, November 2007, the last month before recession took hold. Recovery will begin as a technical recovery only. For most people, the rest of 2009 and even 2010 will not feel like a recovery because people will still be losing jobs and homes and we will still be operating below that November 2007 level. The recovery becomes real to most people only when we reach and surpass the previous level of economic output we had before the downturn began.

The partial recovery

Likely, we will start a technical recovery in manufacturing as today’s Empire State index report suggests. This will move into the services sector later. That’s the output-oriented view. Looking at this from who’s doing the consuming, government spending is already expanding aggressively.  Business Investment will probably be soon.  Last will be personal consumption. So, there could be a long lag between between when output and production turn up and when income, employment, and retail sales do.

Van Hoisington and Lacy Hunt have coined the term partial recovery to describe this disparity. Their analysis reveals that from 1967 until 1999, there was a fairly uniform recovery in all five of those economic factors in all business cycles.  However, in the 2000-2001 recessionary period, employment and income lagged substantially.  The US only had a partial recovery for a year-and-a –half. This is very bad for stocks.

The S&P 500 bottomed before the economy in those other business cycles.  However, at the beginning of this decade, because of the partial recovery, the S&P 500 bottomed 15 months after the recession had ended.

Translation: stock prices anticipate a complete, not a partial recovery. If employment and retail sales data continue to disappoint, shares will turn down and test new lows.

Major themes

1. Look to the industrial sector as a leading indicator of recovery. Since manufacturing is clearly leading out of recession, one should expect this sector to be the canary in the coalmine telling us how robust the upturn is likely to be.
2. Expect the banking sector to continue to benefit from government largesse.  The only way we get recovery is if the financial sector recapitalizes by making a lot of money now when firms can borrow cheap funds due to low interest rates.  No bank recovery equals no recovery.
3. Sell retail stocks.  Retail was at the forefront of the rally in 2009. These stocks have had an enormous run-up with bank stocks. Their stock prices reflect expectations of a V-shaped recovery that is not going to happen.  But, unlike banks, they don’t have government policy padding their bottom lines.  Consumption growth is likely to be weak. The only way that individual retailers can earn more money is by stealing share or cutting costs.
4. Watch for signs of a partial recovery as a market sell signal. If we see the ISM Manufacturing Index is hitting 50, but retail sales remains disappointing and the employment market is still weak, you know we are going to have a partial recovery.  That’s a big market (SPX) sell signal.

I expect the macro data to be the key to market direction in September and October. So, point 4 is the most important one.  Data that reflects a unified recovery would be bullish even if it disappoints.  Weak retail and employment data, on the other hand, means this rally is about to hit a brick wall.

Related posts:

• Partial recovery will mean new lows for stocks
• Unemployment numbers still point to partial recovery
• Looking beyond the fake recovery
• Philly Fed survey points to manufacturing rebound
• Wood warns of correction, says “key variable in the West is government policy”

Stock markets are seriously overbought right now.  But, the rally in shares has been bolstered by better than expected economic data and earnings reports.  I first pointed to a rally in shares in March, but I didn’t get fully onboard until April (after all, people like Louise Yamada were still pointing to downside risk).

But, by early June, the rally was looking toppy and soon, most savvy investors were saying stick with high quality over junk, despite the huge run up in risky stocks. Personally, I saw June as an important period on the data front, because if data disappointed, shares would sell off. Otherwise the bear market rally could continue, aided by short-covering.

The data in June was better than expected and shares continued to rally despite being seriously overbought.  However, the day of reckoning may be upon us.  Yves Smith has a good post “Is This the Start of the Big One?”up as to why.

What worries me is that the rally in shares has been pure multiple expansion. You have quality retail stocks like Nordstrom (JWM) trading for 20x forward earnings when there has been no discernible uptick in retail sales.  That’s crazy.  Moreover, as I said in May when consumer confidence was exploding through the roof, “Let’s remember that confidence does not translate into consumption, especially as most of the uptick here was in consumer expectations.” And, indeed, underlying consumer demand has been weak.

So, where does that leave us? Back to where we were in late May, awaiting another set of data points to confirm the initially bullish economic data of this past summer.  If the data is good, shares will rally yet again.  However, there is increasing concern that the global recovery will not be robust. See this morning’s CNN Money’s article.

With China in full bubble mode and stocks there having sold off over 5% today, we are seeing a major meltdown across Asia and Europe as worries that we have gone too far too fast take hold. Below is the pre-market data as of 8:45AM ET.

As we head into September and October, when many major market crashes have happened, expect investors’ nervousness to increase.

Related posts:

• Consumers ‘do believe in the green shoot story’
• Getting bearish again
• Are the markets set for a pullback?
• If FedEx is losing money, you know the economy is in bad shape
• Avoid consumer stocks

This comes via David Rosenberg of Gluskin Sheff.

The week that was
After four weeks of decline with a total loss of 7.0%, the equity market turned in a like-sized gain this past week re-igniting the bulls. With tech leading the way, the Nasdaq has managed to rally to a nine-month high. The desire to be bullish is so intense that the business media totally misinterpreted what both Nouriel Roubini (who has not, in fact, changed his cautious or bearish stance) and Meredith Whitney (she likes Goldman but that seems to be about it in the financial space) had to say last week. Meanwhile, long-standing bullish strategist Jim Paulsen is featured prominently on this week’s Barron’s (he sees 3.5% GDP growth in the U.S.). This will not win us a popularity contest to be sure, but everything we see around us smacks of a bear market rally. Real bear markets never ever end with price-to-book, price-to-earnings, dividend yields, real corporate bond yields or sentiment readings at the level they have been for most of this year.

Earning less impressive than meets the eye
There was tremendous enthusiasm last week, but it could be all the good news we get for a while. We’re not sure that others are going to be reporting similar results as Goldman, JPMorgan, IBM and Intel mustered up last week (the banks received much of their profit growth from trading revenues — not a part of the business most investors pay a very high multiple for). What is very clear is that we have a very long lineup of companies who are still making their numbers (or not) but doing so through cost-cutting and are still missing their sales estimates.

I agree we are seeing a bear market rally.  How long this continues is another question that is hard to answer at this point.  But, I would note that earnings pre-announcements and surprises have been much more favorable this quarter than in recent quarters, suggesting the news cycle is going to continue to boost shares.

More from Rosenberg here.

Related posts:

• Rosenberg: Market rally is just multiple expansion
• Kass: Bearish on equities
• Rosenberg thinks U.S. market may Test March lows
• An amazing market rally. What’s next?
• Are the markets set for a pullback?

I just read a CNBC story which fails to mention CNBC’s involvement in the apparently erroneous report that Nouriel Roubini has suddenly become more bullish. Is this omission justified? 

The controversy centers on statements Roubini made regarding the timing of a technical recovery in the United States.  Yesterday, it was reported on CNBC and elsewhere that Roubini had made a ‘change’ to his market view and was essentially more bullish on the U.S. economy.  Many market participants believe this was a major factor in the rise in shares yesterday.

However, Roubini issued a statement after markets closed repudiating the view that he had changed his view on the U.S. economy at all (see statement here).  And since that time, many in the financial blogosphere have taken CNBC in particular to task for its role in spreading the belief that Roubini’s economic outlook was more favorable.

• CNBC Report on Roubini; Denninger Response – Barry Ritholtz
• CNBC: You Owe America An Apology – Karl Denninger
• Roubini: "My Views Were Taken Out Of Context." – Zero Hedge
• Denninger accuses CNBC of falsely goosing market on Roubini’s back – Credit Writedowns
• Roubini Denies He Said "Recession Will Be Over This Year," Despite Bullish Media Reports Otherwise – Yves Smith

Clearly, this story struck a nerve in the blogosphere.  Now, CNBC has acknowledged the original thesis that Roubini is a bull was false. But, the media outlet apparently does not see itself as culpable for their part in this.  Below is part of a story they ran on their website.  Notice the parts I have highlighted in bold.

Several business news outlets, picking up on a report initially from Reuters, earlier Thursday cited Roubini as saying that the worst of the economic financial crisis may be over.

The New York University professor was quoted by Reuters as saying that the economy would emerge from the recession toward the end of 2009.

Reports of his comments helped trigger a late rally in the stock market.

Roubini added late Thursday that he sees no economic growth before the end of 2009.

So, I guess Reuters is to blame?  I see this exchange on CNBC in the video below as part and parcel of this story.

You tell me: Is it Reuters or CNBC here?

Note: Reuters has now amended its story to reflect the new non-bullish story line. The original story is nowhere on the web.

Sources

RPT-UPDATE 2-Worst behind us but more stimulus needed-Roubini – Reuters

Roubini: Views on Economy Unchanged Despite Reports – CNBC

Related posts:

• Denninger accuses CNBC of falsely goosing market on Roubini’s back
• Richard Bernstein: Once a huge market bear, now a bull
• Nouriel Roubini: we are in recession
• Meredith Whitney: “I haven’t been this bearish in a year”
• Marc Faber: “I am 100% sure that the U.S. will go into hyperinflation”