What Next? Is it like 2008 or 2010?

Over the past 60 days, it has been hard to predict the direction of markets for the next day, let alone forecast where markets will be 30 days in the future. Uncertainty and volatility has been extreme. The S&P 500 has fallen 17% from it’s peak in April.

Last year, in 2010, we saw a similar pattern, with uncertainty about European debt and continued high unemployment in the US driving fears of a double dip recession. The S&P 500 fell 17% from it’s peak in April 2010 before rising 33% to the April 2011 peak.

So are we going into a recession or can we expect another 33% gain in the next few months?

In June, I introduced you to the Citigroup Economic Surprise Index. It can be viewed at Bloomberg http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND#
(under the ticker CESIUSD:IND ) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”. This indicator reached an extreme low on June 3, improving since, but still with a negative reading. The debate about the debt ceiling and brinksmanship of the US government was shocking. The downgrade of the US by S&P was also shocking.  It seems like every talking head and prognosticator has felt the need to go on the record predicting a "possible" recession: 20%, 30%, 50% Chance.  NONE OF THEM KNOW!  (Remember, news media maintains your attention with stories meant to stir your emotion.)

The Federal Reserve QE2 stimulus ended in June. The debt ceiling debate reduced the likelihood of any government fiscal stimulus. In other words, this time, it looks less likely that the US government will, or even can, ride to the rescue of the economy. The really big deal is Europe.

In the US, banks lent too much money to individuals with mortgages. In Europe, banks lent too much money to governments. The individuals had at least some collateral.  Loans to governments are more dangerous--sort of like signature only loans with no collateral.  Too much “tough love” and “austerity” in Europe to reduce this government debt may result in a economic contraction there—a real recession that then might spread all over the world. Concurrent reduction of stimulus by the US Government actually increases the risk.

What many fail to appreciate is that while the end of QE2 ends the increase of Fed stimulus, the Fed is not withdrawing stimulus. Zero Interest Rate Policy (ZIRP) is in place for two more years and the QE balance sheet is being “maintained”. And, while clearly there will be reduction in deficit spending, the US will still be stimulating the economy with deficit spending higher than any time in history except for 2009-2011.  Franklin Roosevelt would never have even dreamed that it was possible for the US Government to throw so much money at the problem. Those that claim the war brought us out of the Great Depression should remember that the US is presently waging two wars.

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. While there are some economic indicators pointing to a slower economy, AT THIS TIME, none of what I deem to be Reasonably Reliable Leading Indicators are showing a pending recession. Retail Sales do not show signs of a pending recession. Industrial Production data does not show signs of a pending recession. Corporate Earnings Guidance indicated an expected slowing, but not a pending recession. The Interest Rate Yield Curve is still very steep. Unlike almost every recession in history, corporate bonds are rising or maintaining value as stocks have fallen—a bullish sign that indicates the recent market action is probably just an old fashioned panic and crisis of uncertainty.  When a real recession is likely, people typically sell corporate bonds and stocks at the same time.

Certainly the risk regarding Europe is significant—a lot will depend on the resolve of Germany and how much they are willing to give up in order to bail out the banks that lent too much to Spain, Italy, Greece, and Portugal. Let's hope the ECB stops raising interest rates and learns how to implement intelligent monetary policy.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. (See graph) We invest in companies. Not only are companies profitable—they have accumulated cash and most have real “staying power” to survive downturns. This is not 2008. It is also probably not 2010 either.

Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.”

It is very possible that the worst case scenario is already priced in. A 17% drop is a significant correction. (We are also down 28% from the 2007 highs. Some would argue that we are still in a recession--it hasn't ended yet.) History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. The biggest danger is probably fear itself where fear and resulting collective actions to avoid potential losses actually creates the economic slowdown that people fear and are tryiing to avoid. Emotion is the economy's (and your money's) worst enemy.

In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions. Keep your mind on what you believe the companies you own, or want to own will be worth in 2-3 years from now—that is what investors do. Let the foolish speculators spend their energy on what the markets will do in the short term.  Keep in mind: long term investors make money; speculating is a zero sum game.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Worried about Greece?

I don’t often write commentaries on a daily basis, but the developing saga and fear based market moves related to the current Greek credit crisis deserves your attention and a bit of understanding.

It is estimated that the total amount of Greek debt is well above $300 billion. That would make a default there one of the largest in history for one country. Larger than Argentina in 2002. And, Greece is not the only European country that has more debt than it can repay. It is a big deal.

Defaults like this (but not necessarily this large) however are not as uncommon as the average person thinks. Between 1998 and 2004, there were 15 governments that defaulted on their debt. Between 1976 and 1989, there were more than 40!

One of the things that I thought we learned in the past is that in most cases, by the time default is contemplated, the situation is usually so bad that a large part of the loans need to be written off. Here are some quotes from the EMTA’s site (link below) “The Brady Plan, the principles of which were first articulated by U.S. Treasury Secretary Nicholas F. Brady in March 1989, was designed to address the so-called LDC debt crisis of the 1980's…..From 1982 through 1988, debtor nations and their commercial bank creditors engaged in repeated rounds of rescheduling and restructuring sovereign and private sector debt, in the belief that the difficulty these nations experienced in meeting their debt obligations was a temporary liquidity problem that would end as the debtor nations' economies rebounded. However, by the time the Brady Plan was announced, it was widely believed that most debtor nations were no closer to financial health than they had been in 1982, that many loans would never be entirely repaid, and that some form of substantial debt relief was necessary for these nations and their fragile economies to resume growth and to regain access to the global capital markets.” Read more at the site:

http://www.emta.org/template.aspx?id=34

What I thought we learned from past was that some sort of market based solution is necessary. Repackaging and reselling the debt. Something similar to the Brady Plan has been proposed by Daniel Gros, Director of the CEPS and Thomas Mayer, Chief Economist of Deutsche Bank. You can download their plan at the link:

http://www.ceps.eu/book/debt-reduction-without-messy-default

One thing that is different this time is that those same pesky Credit Default Swaps we learned about during the mortgage bond credit crisis here in the US are involved in this crisis too! Seems like the French and German banks bought “insurance against default” on Greek, Irish and Portuguese debt—from US banks! So, it gets a bit more complicated. And, it is logical that a possible and probable default in Greece is creating a “not this again” fear in stock markets. i.e. 2008 all over again.

What is probably different however is that companies have prepared for this storm with strong balance sheets. And, hopefully, the US banks have prudently “reserved” for losses from their CDS "insurance" they have issued, with more capital. The Greek people vote on June 29 and June 30 on whether they will accept more “austerity”—a condition placed by lenders for more “bailout” money. It appears that markets are getting ready for the possibility that they will refuse and the crisis escalates. (Think Wisonsin.) Be prepared for volatility, risk and great uncertainty in this case. My best guess is that a temporary solution will be implemented, and then, sooner or later, the losses will be recognized and the crisis will end. We are at the end of the beginning of a resolution. I think this issue will be in the news for quite some time. I do not think that this week’s actions will merit any major portfolio changes, yet, as markets are likely to snap back very quickly. Be sure all of your present investments are long term oriented--the bottom of this may be a very good entry opportunity.


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Borrowing Money is Fun! Paying it back--Not so much.

Ben Bernanke (06/22/2011).......“We don’t have a precise read on why this slower pace of growth is persisting,” Bernanke said. Referring to “frustratingly” slow job growth and weakness in the financial and housing industries, Bernanke said “some of these headwinds may be stronger and more persistent than we thought.”

You have got to hand it to a man who is honest and straightforward, but markets get spooked when the man who “should know what to do” tells us that the Fed does not know why growth is so slow and that they underestimated the headwinds holding back the economy. Add this to continued worries about the fiasco in Greece and it is no wonder that markets trend down.  (Remember that markets are driven by fundamentals and sentiment.)  Mr. Bernanke is a good man and a great economist--perhaps he is not the best at inspiring confidence.

The chart above is one illustration of the biggest problem: Too much debt and the consequences of debt reduction. Borrowing money is fun—paying it back—not so much fun. (Sort of like gaining and losing weight.) Households in the US took on too much debt—in fact you might say we went on a debt binge from 1994 until 2008. Since then, we have been paying off debt—fast and furiously! The good news—we are rapidly approaching a “sustainable” level of 10-11% of our income.

Oil prices had been rising rapidly for a year. But, recently they changed direction and have been falling. Today, the US and other nations agreed to release a lot of oil from strategic storage reserves. This will tend to accelerate the drop in the price of oil and is a big stimulus to global economic growth.

The one thing out there that is not necessarily “about to turn the corner” with certainty is the debt problem in Europe. Banks lent too much money to homeowners in the US. In Europe, banks lent too much money to governments. When a homeowner can’t pay the loan back, there is at least some collateral that can be sold in a foreclosure. Lending to governments is like a signature only loan or credit card debt—you can’t exactly foreclose—your only collateral is government revenue from taxes. When governments continue to run deficits, spending more than they take in from taxes, there is no surplus left to pay back the loans.

So, the problem in Greece specifically and with European government debt in general is yet to be resolved. I have no sure idea what the final outcome will be, but my understanding of history (specifically in Latin America) tells me that a great deal of the debt in Greece, Ireland and Portugal will have to be written off and restructured. Will that hurt the stock market? In the short run—you are seeing it today as this scenario is being “priced in”. In the long run, reducing debt and getting back to being “fit and trim” economically is probably very good for the economy and the stock market.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Who Moved My Cheese?

Who Moved My Cheese? An Amazing Way to Deal with Change in Your Work and in Your Life, A best-selling motivational book by Spencer Johnson in 1998 was written as allegory. The moral: Change Happens (They Keep Moving the Cheese); and Anticipate Change (Get Ready for the Cheese to Move).

After many months of better than expected economic news, accompanied by a rising stock market, there has clearly been a recent spate of “disappointing” economic news. Over the past week, we have seen a significant reaction by stock markets to that “worse than expected” data. Somebody moved the cheese!

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. One of those indicators is particularly applicable to the present situation. It is known as the Citigroup Economic Surprise Index. It can be viewed at Bloomberg: http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND# (under the ticker CESIUSD:IND) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”.

As I have indicated in the past, markets are determined by fundamentals and sentiment. When the Citigroup Economic Surprise Index falls, sentiment falls. When the Citigroup Economic Surprise Index is negative, sentiment is negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. The Citigroup Economic Surprise Index reached an all time high (100+) around the first of March, and then fell like a rock to near an all time low (100-) this past week. The bottom line—in general, people had become too optimistic. Reality has returned. A quote from 2010 that we display on our website:

“Ever since Adam and Eve were cast out of Eden, Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist. Some will be able to recognize opportunities despite such danger and difficulty and will prosper mightily. Others will simply adopt proven strategies to survive and prosper reasonably in a changing world where the future will always be uncertain. In the longer run, the future is seldom as bad as the pessimist believes, nor as good as the optimist predicts.”

Another Reasonably Reliable Indicator is the Investor Sentiment Survey published by the American Association of Individual Investors. http://www.aaii.com/sentimentsurvey  It is considered a contrarian indicator as the vast majority of individual investors misread the markets. (According to historical data.) The normal “bearish” prediction is 30%. Last week it was a much higher than normal 47.7%.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. Sentiment (expectations about future earnings) is very negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. It is impossible to predict market movements so it is possible that we could see continued market declines as sentiment falls further and fear begins to spread. On the other hand, fear and pessimism is pretty high and history teaches that we are most probably near a turning point. Or, at least a “treading water” period, waiting to see what the next round of earnings reports tell us about fundamentals.

 

Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.” In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions.

Although unemployment and housing information has been disappointing, other information is quite good, or at least not bad. A) According to a government advisory panel in Japan: “Spending to rebuild Japan's tsunami-hit northeast will spark an economic boom later this year”; B) The US Commerce Department reported: “American companies sold more computers, heavy machinery, and telecommunications equipment in foreign markets in April--exports have finally returned to pre-recession levels"; C) The Institute for Supply Management said its services sector index rose to 54.6 last month from 52.8 in April. The reading came in just above economists' forecasts for 54.0, according to a Reuters survey. (Service Sector employment according to ADP is much larger than the Good Producing Sector.); D) According to the Association of American Railroads: “U.S. Freight Rail Traffic: Not Seasonally Adjusted: intermodal in May 2011 up 7.5% over May 2010, Seasonally Adjusted: intermodal in May 2011 up 0.8% over April 2011.”

History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. One should always remember the moral: Anticipate Change (Get Ready for the Cheese to Move).

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Is Silver (or Gold) a Safe Investment?

Silver was not a very good investment for one billionaire in 1980. Here’s the story...

Nelson Bunker Hunt is best known as a former billionaire whose fortune collapsed after he and his brother William Herbert Hunt tried, but failed to corner the world market in silver.

Beginning in the early 1970s, Hunt and his brother William Herbert Hunt began accumulating large amounts of silver. By 1979, they had nearly cornered the global market^. In the last nine months of 1979, the brothers profited, on paper, by an estimated $2 billion to $4 billion in silver speculation, with estimated silver holdings of 100 million ounces of silver.

During the Hunt brothers' accumulation of the precious metal, the price of silver during 1979 and 1980 rose from $11 an ounce in September 1979 to $50 an ounce in January 1980. Silver prices ultimately collapsed to below $11 an ounce two months later.

Hunt filed for bankruptcy under Chapter 11 Bankruptcy laws in September 1988, largely due to lawsuits incurred as a result of his silver speculation.

According to TV Investment Commentator, Jeff Macke, investing in Silver now is a strategy akin to “being reckless without getting killed… The fact is that charts like silver's 5-year (2006-2011) don't occur in nature. They are functions of a mob. Being part of a mob can be fun and lucrative as long as you don't get arrested or killed.”

It should always be remembered that during the last time the US had a bout with high inflation, the price of Gold fell by over 50% from 1980 to 1982. Precious metals are investments for people that are gambling or who are afraid. They have not done well in recent periods with high inflation and high interest rates.

Human nature is fascinating.  Some people will make a concentrated and speculative “high risk investment gamble” that they know has the potential of an almost permanent 50-78% loss in just a few months, yet a potential but temporary 10-15% drop in their diversified stock portfolio causes them to lose sleep at night.

Concentrated “investment gambles” like Silver (and Gold) sometimes pay off,  but the potential for sudden and great loss makes them an unwise choice for your serious money that you are saving for future income. There is no substitute for prudence and patience with a highly diversified portfolio.

 

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Market’s Reaction to S&P Rating is probably Melodramatic

Three days ago I wrote: “Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue?” 

Today, changing the outlook for US debt from stable to negative, Standard and Poors (S&P) said "We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns”

Excerpt  from Bloomberg, August 31, 2007 :

“S&P and Moody's Investors Service failed to downgrade bonds backed by loans to borrowers with poor credit until July, when some had already lost more than 50 cents on the dollar. …U.S. Senate Banking Committee Chairman Christopher Dodd said yesterday credit rating companies must explain why they assigned ``AAA ratings to securities that never deserved them.''

The irony of S&P’s ratings today, warning about AAA rated US Treasuries, given Senator Dodd’s comment  3 ½ years ago,  is notable. Sort of in line with "be careful what you wish for".  

Given the track record of rating agencies and their own limitations/warnings regarding their comments, one must wonder why markets would react in any major way to anything they say.  Click on the below for warnings from S&P itself regarding what ratings are and are not.
           http://www2.standardandpoors.com/aboutcreditratings/

What we know after the S&P outlook change is the same as what we knew before.  We knew we had a deficit problem. We are expecting higher interest rates.  So why have world markets lost almost $600 billion in value, in one day, in reaction?

People act irrationally when they become fearful.  Sometimes being reminded about risks that they know already exist just makes people panic from fear.  

The value of the US $ in currency trading generally  rose after the S&P report today—exactly opposite the direction it should have gone if the US is less credit worthy—it went the direction you would expect during a general rise in the level of fear and uncertainty  in markets.

As I said on Friday, the Wall of Worry Gets Taller as potential risk and opportunity both grow.  

The important news will be what we don’t already know.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

The Wall of Worry Gets Taller

The “correction” we expected as mentioned in our February 26, 2011 article did in fact occur in March.  Corrections can be likened to a room with gasoline spilt on the floor—the potential for fire exists—it only awaits the match.  In March, the “match” that lit the fire was a combination of a natural disaster in Japan, increasing tensions in the Middle East, and a new “limited” military adventure in Libya.  The correction did not last long.  After a 5% drop, the S&P500 ended March at the same level that it began.

The list of risks, any of which might derail our recovery seems to be growing.  European sovereign debt issues continue.  We are now engaged in three military conflicts in a Middle East that seems on the verge of revolution. Some believe the revolution is with the goal of democracy—others fear it is with the goal of radical theocracy.  Inflation caused by rising oil prices is threatening to permeate our entire economy. Unemployment is falling, but it is still very high. The residential real estate market continues to be weak, threatening a continuing problem of debt defaults and foreclosures.  Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue? What happens after the world’s third largest economy experiences perhaps the most serious natural disaster in modern history? Fear regarding the future value of paper money seems to be creating a new bubble in the price of commodities and precious metals. As my title suggests: the Wall of Worry seems to have gotten taller.

As I have said in the past, a Wall of Worry is an absolute requirement for a continued bull market. It means that there is still a large bank of “potential” buyers.  While any of the risks mentioned could cause a fall in markets, it is important to remember that the values of equities depend on the psychological perception about corporate earnings in the long term as compared to interest rates, and a perception of the direction of corporate earnings in the short term.   

We are now just at the beginning of “Earnings Season”. Earnings and outlooks from Alcoa, Google, Bank of America and JP Morgan last week produced a bit of anxiety.   Be prepared for a great deal of volatility as the markets try to “read” the true meaning of the corporate announcements over the next few weeks.  What has been driving the markets up, despite worries, is the belief that the economy is recovering. This is supported by facts.  The fear is just about whether this trend and recovery continues.

I am most optimistic about one key indicator. CEO Confidence as measured by the Conference Board is quite high. Says Lynn Franco, Director of The Conference Board Consumer Research Center (April 7): “CEOs’ confidence has improved, yet again, and expectations are that the economy will continue to expand in the coming months. As for the employment outlook, CEOs are more bullish than last year, with half now saying they intend to ramp up hiring.”

Our advice is to remain cautious in the short term.  However, we are also convinced that tremendous opportunity exists for those with a long term view.  Stay the course, remain conservative and diversified—but keep your eyes peeled for trouble and opportunity—we are likely to see both.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.