Is it possible that we could get inflation in "hard" assets, and deflation in consumer prices?
I guess so.
It is hard to reconcile these two contrasting effects, but it may be possible. After all, all things are possible, but not all things are probable.
That having been said, a case could be made that monetary profligacy needs an outlet, and hard assets appear to be the place of choice. Conversely, it is also possible that a deleveraging economy based on a crippled consumer could lead to declining consumer prices.
We've already seen significant asset deflation (a 60% haircut is not much fun), but not much of an effect in consumer prices (stripping out energy and housing if you follow the core numbers...which I think is a joke but it suits the argument I am making here). With the market having bounced 39%, that looks like a correction to an overreaction, but we are still to see the follow-on deflationary effect on consumer prices take hold. I think its coming though. Rising unemployment, rising foreclosures (across the credit spectrum), less access to credit, rising savings all point to lower consumption.
Lower demand points to lower prices. After all it is still a competitive economy (just).
Friday, May 29, 2009
Thursday, May 28, 2009
Worst Case Scenario
How is this for a worst case scenario.
Rising prices among the food, energy and commodity groups underpinned by a collapse in the dollar and rising interest rates.
Declining prices for labor, consumer goods and anything discretionary (predicated on falling incomes, rising savings and increasing unemployment).
Greater govt dead-weight cost associated with weak stimulus multipliers, major policy mistakes, rising tax burdens, increasing regulation, crowded out private investment, clueless monetary authorities, and the reintroduction of trade warfare.
Instead of global stagflation, global flat-lining.
Rising prices among the food, energy and commodity groups underpinned by a collapse in the dollar and rising interest rates.
Declining prices for labor, consumer goods and anything discretionary (predicated on falling incomes, rising savings and increasing unemployment).
Greater govt dead-weight cost associated with weak stimulus multipliers, major policy mistakes, rising tax burdens, increasing regulation, crowded out private investment, clueless monetary authorities, and the reintroduction of trade warfare.
Instead of global stagflation, global flat-lining.
Chanos is onto something
Just saw some notes on a presentation Jim Chanos gave at an investment conference.
They reflect a thought I have had for sometime, but of course he puts it much more eloquently and identifies the underlying impetus for change.
I am referring to the idea that when an industry derives excess profits, this attracts the govt to increase its share of the take. Chanos puts his finger on the impetus for change coming from the cultural and political acceptance that health and education are rights and not privileges (and this changes how they should be viewed and treated by govt).
Chanos talks about a 30 year deregulatory boom in education, healthcare, defense, govt services, and finance. The govt has a stake in these sectors either directly or indirectly, whether because they are deriving outsized margins (against the public good) or the govt subsidizes them. Bottom-line: there is payback to be had. He is particularly focused on the potential for change in healthcare and education.
They reflect a thought I have had for sometime, but of course he puts it much more eloquently and identifies the underlying impetus for change.
I am referring to the idea that when an industry derives excess profits, this attracts the govt to increase its share of the take. Chanos puts his finger on the impetus for change coming from the cultural and political acceptance that health and education are rights and not privileges (and this changes how they should be viewed and treated by govt).
Chanos talks about a 30 year deregulatory boom in education, healthcare, defense, govt services, and finance. The govt has a stake in these sectors either directly or indirectly, whether because they are deriving outsized margins (against the public good) or the govt subsidizes them. Bottom-line: there is payback to be had. He is particularly focused on the potential for change in healthcare and education.
Cash on the sidelines...
So how much cash is there on the sidelines?
I dunno. Probably lots (but maybe not as much as people think).
Asian central bank reserves are pretty big (about $3.5 trillion between China and Japan).
US money market stats show about $3.78 trillion in total money market assets presently compared to assets of $3.15 trillion in January 2008 (and $2.5 trillion in June 2007).
US bank excess reserves are about $877 billion.
Mutual fund cash levels have been rising since 2007, but are still only at 5.5% or so (and have no doubt been drained by investor withdrawals).
Much of this liquidity is going to either stay on the sidelines or be drained from the system. How much stays on the sidelines is hard to tell. With all the secondaries, short covering, and bond issuance going on, it won't take much to hoover up $500 billion or so, which would leave about another $500 billion to enter the fray.
I dunno. Probably lots (but maybe not as much as people think).
Asian central bank reserves are pretty big (about $3.5 trillion between China and Japan).
US money market stats show about $3.78 trillion in total money market assets presently compared to assets of $3.15 trillion in January 2008 (and $2.5 trillion in June 2007).
US bank excess reserves are about $877 billion.
Mutual fund cash levels have been rising since 2007, but are still only at 5.5% or so (and have no doubt been drained by investor withdrawals).
Much of this liquidity is going to either stay on the sidelines or be drained from the system. How much stays on the sidelines is hard to tell. With all the secondaries, short covering, and bond issuance going on, it won't take much to hoover up $500 billion or so, which would leave about another $500 billion to enter the fray.
Friday, May 22, 2009
Relative Performance Performance
This has been a very good week in the relative performance stakes for the SMID strategy (added more than 350bp vs benchmark).
It seems that the relative performance of this strategy goes in spurts. Sometimes there are periods of underperformance, and sometimes there are periods of outperformance. Meanwhile those bursts are punctuated by periods of pretty much par performance.
I don't really know, nor can I explain, why that has been the case. But I find it interesting.
Ones main hope is that there is a positive skew to that measure (:>)
It seems that the relative performance of this strategy goes in spurts. Sometimes there are periods of underperformance, and sometimes there are periods of outperformance. Meanwhile those bursts are punctuated by periods of pretty much par performance.
I don't really know, nor can I explain, why that has been the case. But I find it interesting.
Ones main hope is that there is a positive skew to that measure (:>)
Wednesday, May 20, 2009
Financial Technique
How I approach a stock depends to some extent upon the present market environment.
For example, in the current environment the first thing I do when looking at a company is to go to the balance sheet and see what its debt load looks like and what its liquidity situation looks like (I love nice cash cushions in this environment). Next I venture to the cash flow statement and look at how well the cash flow generator is working (this also gives me a peak at quality of earnings). Finally, I'll mozy on over to the income statement and look at the company's cost structure and see whether there are any funny things sticking out of the accounts.
After a quick review of those factors, it is then onto the business of digging deeper and getting a handle on operating leverage, debt schedule, cash conversion cycle, etc., and marrying those with future growth and margin cycle implications. The trick is then to condense that into an expected present value of the company and to compare that (with an imputed risk factor) to its current market price.
For example, in the current environment the first thing I do when looking at a company is to go to the balance sheet and see what its debt load looks like and what its liquidity situation looks like (I love nice cash cushions in this environment). Next I venture to the cash flow statement and look at how well the cash flow generator is working (this also gives me a peak at quality of earnings). Finally, I'll mozy on over to the income statement and look at the company's cost structure and see whether there are any funny things sticking out of the accounts.
After a quick review of those factors, it is then onto the business of digging deeper and getting a handle on operating leverage, debt schedule, cash conversion cycle, etc., and marrying those with future growth and margin cycle implications. The trick is then to condense that into an expected present value of the company and to compare that (with an imputed risk factor) to its current market price.
Tuesday, May 19, 2009
What Is Truth?
Philosophically I think it reasonable to believe that every asset has an intrinsic value (an objective worth). The only problem is that no one knows for sure what that true value is.
And so at any point in time, the task of an investment manager is to ascertain (1) whether current market value is above or below intrinsic value, (2) determine at what point in the future market value will converge with intrinsic value, and (3) anticipate whether there will be some overshoot on the reversion back to intrinsic value.
In some ways the search for truth in investing, is like the search for truth in life. To borrow from the ancients, you are always in the process of Becoming and never quite arrive at the point of Being.
And so at any point in time, the task of an investment manager is to ascertain (1) whether current market value is above or below intrinsic value, (2) determine at what point in the future market value will converge with intrinsic value, and (3) anticipate whether there will be some overshoot on the reversion back to intrinsic value.
In some ways the search for truth in investing, is like the search for truth in life. To borrow from the ancients, you are always in the process of Becoming and never quite arrive at the point of Being.
The Future - Unknown Unknowns
My sense is that there are plenty of folks still on the sidelines. Many of those folks have watched a 37%+ rally pass them by, and many have sold into the rally and are now sitting in non-producing cash. The skepticism is palpable, and as such will only continue to support the rally, as people are drawn into the rising market. When the last bear has been forced back into the market, then it will be time to reverse thrusters.
What I don't know is how much farther this rally can go (it has the potential to go 40%-50%), nor how long it will take (I've got no idea on this one but it could go through the end of 2Q09 and who knows maybe even 3Q09).
I'm skeptical, and that worries me. Anytime the market doesn't do what I think it should, it worries me. It worries me because I could be wrong (it won't be the first time and certainly won't be the last). Being wrong is an integral part of the occupation. How you manage that uncertainty will determine whether you separate yourself from the crowd, or simply get caught out.
I've raised a little cash, to bank some profits from the run off the bottom, and am faced with the decision whether to get fully invested, raise additional cash, or to run with what I've got and see where this market takes us.
The difficulty in navigating this market (and any market really) is in tapering your view/conviction on the fundamental outlook with feedback from what the market price action is telling you.
What I don't know is how much farther this rally can go (it has the potential to go 40%-50%), nor how long it will take (I've got no idea on this one but it could go through the end of 2Q09 and who knows maybe even 3Q09).
I'm skeptical, and that worries me. Anytime the market doesn't do what I think it should, it worries me. It worries me because I could be wrong (it won't be the first time and certainly won't be the last). Being wrong is an integral part of the occupation. How you manage that uncertainty will determine whether you separate yourself from the crowd, or simply get caught out.
I've raised a little cash, to bank some profits from the run off the bottom, and am faced with the decision whether to get fully invested, raise additional cash, or to run with what I've got and see where this market takes us.
The difficulty in navigating this market (and any market really) is in tapering your view/conviction on the fundamental outlook with feedback from what the market price action is telling you.
Regret revisited
I usually own an asset because I believe it has value over and above where it is currently trading.
It may be because it has a great outlook and I expect the business to do better than what the market is expecting.
It may be because I see some value within the business...could be intellectual property, cash on the balance sheet, hidden assets, ie. land, possible takeout, etc.
Whatever the case, whenever the stock takes a hit, I always struggle with determining whether my original investment thesis was faulty...admitting one is wrong is never easy. Not only that, but assuming I still believe in the asset, then I am left with knowing that it is obviously going to take a lot longer for that thesis to play out. What to do? What to do? That is the question.
It may be because it has a great outlook and I expect the business to do better than what the market is expecting.
It may be because I see some value within the business...could be intellectual property, cash on the balance sheet, hidden assets, ie. land, possible takeout, etc.
Whatever the case, whenever the stock takes a hit, I always struggle with determining whether my original investment thesis was faulty...admitting one is wrong is never easy. Not only that, but assuming I still believe in the asset, then I am left with knowing that it is obviously going to take a lot longer for that thesis to play out. What to do? What to do? That is the question.
Friday, May 15, 2009
Oh, the story to be told
The story to be told will be of the carnage and destruction wrought by the private equity firms.
This business model is disgusting. It appears toward the mid and late stages of a credit cycle, feeds on the old and enfeebled, and then retreats to its lair until the next time. It is predicated entirely upon low cost debt and how quickly they can extract their equity from the deal. Cov-lite loans and the like were the most crazy (and telling) sign of the apocalypse.
By the time they are done, there is nothing left but the bones.
What really roils me is that even when they get it wrong (and they usually do by staying too long at the punchbowl...the greed of man), they still manage to extract their pound of flesh. They buy old, mature companies/brands with 10% down, lever them to the gills, pay themselves a huge dividend (get their original equity out and then some), and then feast on the carcass with any additional dividends being money for jam (and if they are really lucky they might find another dupe (the public through an IPO) to flip the business).
This business model is disgusting. It appears toward the mid and late stages of a credit cycle, feeds on the old and enfeebled, and then retreats to its lair until the next time. It is predicated entirely upon low cost debt and how quickly they can extract their equity from the deal. Cov-lite loans and the like were the most crazy (and telling) sign of the apocalypse.
By the time they are done, there is nothing left but the bones.
What really roils me is that even when they get it wrong (and they usually do by staying too long at the punchbowl...the greed of man), they still manage to extract their pound of flesh. They buy old, mature companies/brands with 10% down, lever them to the gills, pay themselves a huge dividend (get their original equity out and then some), and then feast on the carcass with any additional dividends being money for jam (and if they are really lucky they might find another dupe (the public through an IPO) to flip the business).
Deja Vu
Is it just me, or am I seeing the goins on today as similar to the goins on of 2002-03.
Back then deflation was the watchword...just as it is today.
Back then, they dropped rates to historically low levels...just as they have today.
Back then, every man and his dog rushed a secondary to market (lots of convertibles)...just as they are doing today.
Will the monetary and fiscal stimulus of today provide the same escape as it did back then?
There is one thought that we are caught on a counter-cyclical policy treadmill in which each time we dip into the well, we are digging a larger and larger hole for ourselves and compress the market cycle further.
Remember, the piper doesn't play for free.
Back then deflation was the watchword...just as it is today.
Back then, they dropped rates to historically low levels...just as they have today.
Back then, every man and his dog rushed a secondary to market (lots of convertibles)...just as they are doing today.
Will the monetary and fiscal stimulus of today provide the same escape as it did back then?
There is one thought that we are caught on a counter-cyclical policy treadmill in which each time we dip into the well, we are digging a larger and larger hole for ourselves and compress the market cycle further.
Remember, the piper doesn't play for free.
Thursday, May 14, 2009
When the drain comes...
When they drain liquidity from the system, will this leave some exposed to a "crisis of confidence?"
I don't expect financial implosion to occur again, but it wouldn't surprise me if when they drain liquidity from the system, some players will be susceptible to a run. Even if a few go down (including reasonably sized banks), I don't think it will take us back to the point we were at last September.
That having been said, the only question in my mind is whether the Fed will step in and protect those entities under the gun. You can bet the market will test it.
I don't expect financial implosion to occur again, but it wouldn't surprise me if when they drain liquidity from the system, some players will be susceptible to a run. Even if a few go down (including reasonably sized banks), I don't think it will take us back to the point we were at last September.
That having been said, the only question in my mind is whether the Fed will step in and protect those entities under the gun. You can bet the market will test it.
Strategic Forecasting
Q. Why do we look at the future? Ans. Because it's in front of us.
One thing about the strategic planning/forecasting process that irks me a little, is the fallacy that once we have completed the process we feel as though we have a good handle on what the future holds. We pat ourselves on the back and smugly think we have mapped out the future with our clever intuitions and powers of reason.
And it is this hubris in the face of history and personal experience that irks me. For, we all know that predictions of the future are in general way off.
I think the process of looking at the future is important, as it can identify important variables or trends to keep an eye on, but it should only serve as a general framing within the framework of a more flexible process by which new inputs are entered into a perpetually changing evaluative description.
One thing about the strategic planning/forecasting process that irks me a little, is the fallacy that once we have completed the process we feel as though we have a good handle on what the future holds. We pat ourselves on the back and smugly think we have mapped out the future with our clever intuitions and powers of reason.
And it is this hubris in the face of history and personal experience that irks me. For, we all know that predictions of the future are in general way off.
I think the process of looking at the future is important, as it can identify important variables or trends to keep an eye on, but it should only serve as a general framing within the framework of a more flexible process by which new inputs are entered into a perpetually changing evaluative description.
Israeli Stocks!
Israeli stocks always seem to disappoint.
They come to market with great growth, great margins, great balance sheets and great potential...and invariably disappoint.
I wonder whether the mid cap Chinese stocks will end up the same way.
They come to market with great growth, great margins, great balance sheets and great potential...and invariably disappoint.
I wonder whether the mid cap Chinese stocks will end up the same way.
Are Bond Economists Better Than Equity Economists?
Q. Is there a difference between bond economists and equity economists?
Ans. I doubt it. At least I suspect that would be the case if you did an empirical study of the question.
Having said that, why do I feel that bond economists tend to be more pessimistic and equity economists tend to be more optimistic?
Much, no doubt, has to do with the markets they are speaking to. We all want to hear, what we want to hear.
Ans. I doubt it. At least I suspect that would be the case if you did an empirical study of the question.
Having said that, why do I feel that bond economists tend to be more pessimistic and equity economists tend to be more optimistic?
Much, no doubt, has to do with the markets they are speaking to. We all want to hear, what we want to hear.
Wednesday, May 13, 2009
Are The Bears Getting Suckered...Again?
Over the last eight weeks we've had the bears getting drawn in by a 30%+ rally.
Now that they've covered some or all of their positions, there is a chance they may getting suckered on this retracement.
With regret weighing heavy on their minds, and risk aversion brought on by a traumatized portfolio, this sell-off may well be inducing bears, who have bought in or who are still on the sidelines, to sell the sell-off. If this turns out to be only a consolidation, rather than a sizeable sell-off, they will again be exposed to the upside.
I don't know what will happen. But the market seems a master of preying upon ones greatest weaknesses.
Now that they've covered some or all of their positions, there is a chance they may getting suckered on this retracement.
With regret weighing heavy on their minds, and risk aversion brought on by a traumatized portfolio, this sell-off may well be inducing bears, who have bought in or who are still on the sidelines, to sell the sell-off. If this turns out to be only a consolidation, rather than a sizeable sell-off, they will again be exposed to the upside.
I don't know what will happen. But the market seems a master of preying upon ones greatest weaknesses.
I Don't Know Much...
I don't know much, but this I do know...
Over this coming century (and beyond), the third world (lead by China, India and Brazil) will grow at a faster rate than the developed world - it is the simple absorption of existing technology applied to an underutilized human resource coming off a low economic base...no rocket science there.
What I don't know is how to play this trend (getting quality exposure to the growth you want can be very difficult given the narrowness of developing country equity markets and the weakness of their regulatory regimes...among other things). Probably the easiest trade I can see is going long the Renminbi. There are a couple of ETFs to do this. One is a Morgan Stanley ETN* (CNY) that got hammered when the banks were all in doubt, but has since made a recovery, the other is a Wisdom Tree ETF (CYB) which has been pretty stable.
*Now Market Vectors.
Over this coming century (and beyond), the third world (lead by China, India and Brazil) will grow at a faster rate than the developed world - it is the simple absorption of existing technology applied to an underutilized human resource coming off a low economic base...no rocket science there.
What I don't know is how to play this trend (getting quality exposure to the growth you want can be very difficult given the narrowness of developing country equity markets and the weakness of their regulatory regimes...among other things). Probably the easiest trade I can see is going long the Renminbi. There are a couple of ETFs to do this. One is a Morgan Stanley ETN* (CNY) that got hammered when the banks were all in doubt, but has since made a recovery, the other is a Wisdom Tree ETF (CYB) which has been pretty stable.
*Now Market Vectors.
Great Quote from Bloomberg
Great F. Scott Fitzgerald quote on Bloomberg this morning.
"At 18 our convictions are hills from which we look; At 45 they are caves in which we hide."
"At 18 our convictions are hills from which we look; At 45 they are caves in which we hide."
Tuesday, May 12, 2009
Suckled on the Greenspan Put
No surprise, but the financial services industry has an inherent positive bias. And, it is no surprise that most participants in the financial markets are "free market" ideologues.
And so it strikes me as a little strange when the financial markets and its predominant denizens are clamoring for more monetary stimulus, more fiscal stimulus, more bailout.
The answer lies in the heart of human nature. If it takes compromising ones principles in order to bail one out of an underwater position, then they'll take it.
And when the sector has been suckled on the Greenspan Put, why would you expect it to change its spots.
And so it strikes me as a little strange when the financial markets and its predominant denizens are clamoring for more monetary stimulus, more fiscal stimulus, more bailout.
The answer lies in the heart of human nature. If it takes compromising ones principles in order to bail one out of an underwater position, then they'll take it.
And when the sector has been suckled on the Greenspan Put, why would you expect it to change its spots.
Proportionality - Moderation In All Things
In a world of limits, proportionality has important implications.
For example, if New Zealand runs a 10% current account deficit, that has very serious implications for New Zealand, but very little effect on the rest of the world. A 10% current account deficit requires $12B USD of external funding. Alot of capital for a small country like New Zealand, but not alot in the global scheme of things. Conversely, if the US runs a 10% current account deficit, then that requires $1.4T in external funding. That $1.4T is a big call on global savings ("crowding out").
Under Bretton Woods II the game has been for surplus countries to recycle those savings back into the US. But in the current environment, those surplus countries are looking more inward, and are looking at utilizing those savings for domestic purposes. The question then becomes, where is the money going to come from to fund the US deficits?
I dunno. But moderation in all things is what my mother used to tell me. When you get too far out of whack, that is when crazy things happen.
For example, if New Zealand runs a 10% current account deficit, that has very serious implications for New Zealand, but very little effect on the rest of the world. A 10% current account deficit requires $12B USD of external funding. Alot of capital for a small country like New Zealand, but not alot in the global scheme of things. Conversely, if the US runs a 10% current account deficit, then that requires $1.4T in external funding. That $1.4T is a big call on global savings ("crowding out").
Under Bretton Woods II the game has been for surplus countries to recycle those savings back into the US. But in the current environment, those surplus countries are looking more inward, and are looking at utilizing those savings for domestic purposes. The question then becomes, where is the money going to come from to fund the US deficits?
I dunno. But moderation in all things is what my mother used to tell me. When you get too far out of whack, that is when crazy things happen.
King Kong vs Godzilla
We're shaping up for a right royal battle between King Kong and Godzilla.
On the one hand, we have King Kong representing the myriad of risk factors likely to weigh on and mitigate against recovery (inflation specter, massive debt funding, twin deficits, global imbalances, dollar deterioration, rising taxes, anemic job market, consumer saving, debt deleveraging, etc., etc.).
And on the other hand, we have Godzilla representing the natural pull of a recovering business cycle (including massive fiscal and monetary stimulus).
You can't stay down forever, but you sure can wallow in the mire for a while.
On the one hand, we have King Kong representing the myriad of risk factors likely to weigh on and mitigate against recovery (inflation specter, massive debt funding, twin deficits, global imbalances, dollar deterioration, rising taxes, anemic job market, consumer saving, debt deleveraging, etc., etc.).
And on the other hand, we have Godzilla representing the natural pull of a recovering business cycle (including massive fiscal and monetary stimulus).
You can't stay down forever, but you sure can wallow in the mire for a while.
Monday, May 11, 2009
Talk About Muddle Through
John Mauldin was an early and vocal proponent of a "muddle through" economy.
He made a point in his recent newsletter regarding unemployment which I haven't heard spoken about too much and which I think is true - with important implications. He said,
"But we are permanently destroying jobs in this recession, all up and down the food chain and in numerous industries. There will be fewer cars made, for a long time. Less demand for financial service jobs. Housing construction will be a long time recovering, well into 2011 or 2012."
Not only do I think he is right, ie. that there are numerous industries in the US that have been significantly changed, but it also brings up the question of where will the new jobs will come from? What industries/sectors will lead us out of recession? What will be the positive catalysts? (govt spending!). If our last recovery was characterized as a jobless recovery, what is going to make this one different? The most startling revelation is that it implies a longer and deeper recession than what the consensus is currently factoring.
He made a point in his recent newsletter regarding unemployment which I haven't heard spoken about too much and which I think is true - with important implications. He said,
"But we are permanently destroying jobs in this recession, all up and down the food chain and in numerous industries. There will be fewer cars made, for a long time. Less demand for financial service jobs. Housing construction will be a long time recovering, well into 2011 or 2012."
Not only do I think he is right, ie. that there are numerous industries in the US that have been significantly changed, but it also brings up the question of where will the new jobs will come from? What industries/sectors will lead us out of recession? What will be the positive catalysts? (govt spending!). If our last recovery was characterized as a jobless recovery, what is going to make this one different? The most startling revelation is that it implies a longer and deeper recession than what the consensus is currently factoring.
The Benefit of the Doubt
By moving 39% off the bottom in a nice V-shape, the market is essentially giving the economy the benefit of the doubt.
The move is one of relief (that the financial sector hasn't imploded) and hope for so-called green shoots. If neither of those propositions are substantiated then we will likely see a sizeable retracement (not sure whether we will go below 666...but who knows).
As it is, the bears are trapped and are being squeezed into the market, and we are unlikely to get economic clarity until 3Q09.
Enjoy your Summer!
The move is one of relief (that the financial sector hasn't imploded) and hope for so-called green shoots. If neither of those propositions are substantiated then we will likely see a sizeable retracement (not sure whether we will go below 666...but who knows).
As it is, the bears are trapped and are being squeezed into the market, and we are unlikely to get economic clarity until 3Q09.
Enjoy your Summer!
Sunday, May 10, 2009
Eternal Optimism of the Spotless Mind
It struck me the other day that good equity managers operate in the realm of faith and hope.
And never is that in more evidence, than at the bottom of a market. When any number of rational people are fretting about the future, good equity managers are buying.
They are buying, not based on any tangible evidence per se. Rather they are buying on faith that things will get better, and hope for a better tomorrow.
And never is that in more evidence, than at the bottom of a market. When any number of rational people are fretting about the future, good equity managers are buying.
They are buying, not based on any tangible evidence per se. Rather they are buying on faith that things will get better, and hope for a better tomorrow.
Friday, May 8, 2009
Summer - The Quiet Before the Storm
The damage is done. The financial sector is irrecoverably impaired.
Financial companies are holding on in quiet desperation.
The dam could well burst during the summer, when all those who can't make it anymore, "spit the dummy."
The same is true of retailers, energy services, and small industrials.
Financial companies are holding on in quiet desperation.
The dam could well burst during the summer, when all those who can't make it anymore, "spit the dummy."
The same is true of retailers, energy services, and small industrials.
The Ball's In Your Court
The ball's in your court, Mr Europe.
The US has passed the stress test (at least for the time being), now the ball is in the Europeans court. Are they going to address their problems, or are they going to continue hoping against hope?
If European financials break, then we could go back to square one (or awfully close to it).
The US has passed the stress test (at least for the time being), now the ball is in the Europeans court. Are they going to address their problems, or are they going to continue hoping against hope?
If European financials break, then we could go back to square one (or awfully close to it).
Thursday, May 7, 2009
Don't Overstay Your Welcome
The most important thing for me to remind myself of right now is that, in spite of being highly sanguine on the medium term economic outlook, after a 58% decline, the market is offering up the best long term expected returns we've seen since probably 1992.
I need to be careful that I don't miss the forest for the trees.
I mention all this after reflecting upon Jeremy Grantham's quarterly letter (hit the spot), and looking at some of the bear market charts at dshort.com (this guy has put together some great charts). The problem for most people who are right about something is that they tend to overstay their welcome, and that is the problem facing the bears at this point.
I need to be careful that I don't miss the forest for the trees.
I mention all this after reflecting upon Jeremy Grantham's quarterly letter (hit the spot), and looking at some of the bear market charts at dshort.com (this guy has put together some great charts). The problem for most people who are right about something is that they tend to overstay their welcome, and that is the problem facing the bears at this point.
Callidus (CALD) and SaaS
A note out from Gartner on software-as-a-service (SaaS) included Callidus (CALD) among the names mentioned. That surprised me. CALD is a two bit software company and would not normally be mentioned in the company of global software players.
That having been said, I owned the company in my personal account a few years ago (probably around these levels, but I can't remember exactly) and always thought that they had a good position in a niche market (sales performance management/incentive compensation applications). The risk for them is a big boy developing a similar tool and running rough-shod over them. The upside was always the hope that a big boy would take them out to get into the space.
Everytime I look at these guys they are struggling to make any money (and I am not sure they ever have...except maybe pre-IPO...what a have). They've got a dollop of IPO cash that has been sitting on their balance sheet forever and gives them life. One day they are either going to have to right size the business, or sell it off. In the meantime, management sits there with a bloated cost structure, not caring about the world around them, because their paycheck is not going anywhere (at least, not anytime soon).
Disclosure: No position in this stock in either my personal or professional portfolios.
That having been said, I owned the company in my personal account a few years ago (probably around these levels, but I can't remember exactly) and always thought that they had a good position in a niche market (sales performance management/incentive compensation applications). The risk for them is a big boy developing a similar tool and running rough-shod over them. The upside was always the hope that a big boy would take them out to get into the space.
Everytime I look at these guys they are struggling to make any money (and I am not sure they ever have...except maybe pre-IPO...what a have). They've got a dollop of IPO cash that has been sitting on their balance sheet forever and gives them life. One day they are either going to have to right size the business, or sell it off. In the meantime, management sits there with a bloated cost structure, not caring about the world around them, because their paycheck is not going anywhere (at least, not anytime soon).
Disclosure: No position in this stock in either my personal or professional portfolios.
When Are The Pension Actuaries and Asset Consultants Going To Be Sued
Question of the day.
When are the pension actuaries and asset consultants going to be sued?
If you haven't been following it, there is a guest blogger on Naked Capitalism who is basically going balistic everyday about the pension bomb in the system.
When that bomb finally goes off, it seems to me that the actuaries (who provide advice on valuing liabilities and massaging expected returns) and consultants (who provide "all care, and no responsibility" advice on asset managers) will be likely targets.
Stay tuned.
When are the pension actuaries and asset consultants going to be sued?
If you haven't been following it, there is a guest blogger on Naked Capitalism who is basically going balistic everyday about the pension bomb in the system.
When that bomb finally goes off, it seems to me that the actuaries (who provide advice on valuing liabilities and massaging expected returns) and consultants (who provide "all care, and no responsibility" advice on asset managers) will be likely targets.
Stay tuned.
Probably A Good Level To Lighten The Load
Just looking at the S&P 1000.
Hit a high of 3317 today (a 49% bounce from the March 6 low of 2225). The last time it hit that level was November 5th (and that was at the top of a significant bounce from the Oct 28 low of 2727).
Technically resistance would appear to be around 3308 (the 200 day MA). But eyeballing it, I would say a level closer to 3350-3400 is more like it, given that it reflects the new level from the early October cascade.
In the big scheme of things, 3300+ is probably not a bad level to take profit.
Hit a high of 3317 today (a 49% bounce from the March 6 low of 2225). The last time it hit that level was November 5th (and that was at the top of a significant bounce from the Oct 28 low of 2727).
Technically resistance would appear to be around 3308 (the 200 day MA). But eyeballing it, I would say a level closer to 3350-3400 is more like it, given that it reflects the new level from the early October cascade.
In the big scheme of things, 3300+ is probably not a bad level to take profit.
Do You Get That Feeling
Do you get that feeling that this market is purposely giving back a little in order to draw more suckers in from the sidelines.
It will then take it up again.
And again, this will draw in those who missed the little correction. And it will keep doing so until, it has everyone with a small gain and feeling happy.
And then.
What is also interesting is the feeling that the bears are chasing this market down...selling into the sell-off because they haven't sold enough (you can never sell enough when the market goes down).
The tug of war is on.
It will then take it up again.
And again, this will draw in those who missed the little correction. And it will keep doing so until, it has everyone with a small gain and feeling happy.
And then.
What is also interesting is the feeling that the bears are chasing this market down...selling into the sell-off because they haven't sold enough (you can never sell enough when the market goes down).
The tug of war is on.
Prospective Support
Okay, I confess. I don't have a clue whether today's move is the beginning of a correction or not, and I don't have a clue as to what might be reasonable downside targets or levels.
Fortunately for me, there are much wiser people than myself who provide those kind of insights, and one person who I respect points to the following support levels on the S&P 500: 875, 827 and 780 (don't ask what is next after 780).
Now I can feel better about myself, because I have a framework for reference.
Note: I took an eyeball look at the graph myself and I would pitch pretty strong support around 800.
Fortunately for me, there are much wiser people than myself who provide those kind of insights, and one person who I respect points to the following support levels on the S&P 500: 875, 827 and 780 (don't ask what is next after 780).
Now I can feel better about myself, because I have a framework for reference.
Note: I took an eyeball look at the graph myself and I would pitch pretty strong support around 800.
Allowing the Market to Clear
Perhaps my biggest problem with the bank bailouts, fiscal stimulus and quantitative easing is the idea that these artificial insertions impede the clearing of markets.
Closely associated with this idea, is the notion that "there is no such thing as a free lunch."
The possibility* that there is no such thing as a free lunch concerns me, because we are then left with the "law of unintended consequences" (and these could be great).
*it is, in fact, as close to an immutable law as you will get in economics
Closely associated with this idea, is the notion that "there is no such thing as a free lunch."
The possibility* that there is no such thing as a free lunch concerns me, because we are then left with the "law of unintended consequences" (and these could be great).
*it is, in fact, as close to an immutable law as you will get in economics
Just An Observation About Sell Side Research
Actually I think this applies to both sell side research and independent research.
It is hard to come across an analyst (whether a stock analyst or an economist or a strategist) who operates with a coherent underlying conviction. My sense is that they tend to blow with the wind. And I think the reason is so that they don't ever get too far from the latest data point (or consensus), and so can never be too wrong at any particular point in time.
The problem with this, of course, is that they often miss the forest for the trees.
It is hard to come across an analyst (whether a stock analyst or an economist or a strategist) who operates with a coherent underlying conviction. My sense is that they tend to blow with the wind. And I think the reason is so that they don't ever get too far from the latest data point (or consensus), and so can never be too wrong at any particular point in time.
The problem with this, of course, is that they often miss the forest for the trees.
Seven Lean Years from Jeremy Grantham
Grantham's latest missive essentially relates that he thinks the market will be buoyed by the financial stimulus (short term gains), that moral hazard has increased enormously (depressing long term returns), and that we are subject to the impost of the Presidential cycle (he did a lousy job of tying it in to his main arguments).
The letter is as prescient as ever. Wide-ranging, full of insights, and he holds no punches. Definitely worth the read (here is a link to where you can link to it).
He is cautioning about the rally, but thinks the stimulus may "clip off the last parts of the bear market." He thinks false hopes and false dawns cushion the potential downside of the bear. He sounds as though he is in the lost decade camp. He talks about those who are on the sidelines with their psychological disposition toward a retracement - watching, regretting and hoping.
Interestingly, he puts S&P 500 fair value at about 880. Also, he is pitching the S&P 500 around 1000-1100 by year end, but he doesn't think the economic fundamentals will support that level.
The letter is as prescient as ever. Wide-ranging, full of insights, and he holds no punches. Definitely worth the read (here is a link to where you can link to it).
He is cautioning about the rally, but thinks the stimulus may "clip off the last parts of the bear market." He thinks false hopes and false dawns cushion the potential downside of the bear. He sounds as though he is in the lost decade camp. He talks about those who are on the sidelines with their psychological disposition toward a retracement - watching, regretting and hoping.
Interestingly, he puts S&P 500 fair value at about 880. Also, he is pitching the S&P 500 around 1000-1100 by year end, but he doesn't think the economic fundamentals will support that level.
Wednesday, May 6, 2009
How Long Can I Stand Being In Cash?
How long can I stand being in cash, while this market rockets off without me?
That is the question all those investors who fled for the sidelines are asking themselves.
This market is shaking the trees and you can bet your bottom dollar, that when most of the bears capitulate, it is time to take it down again.
That is the question all those investors who fled for the sidelines are asking themselves.
This market is shaking the trees and you can bet your bottom dollar, that when most of the bears capitulate, it is time to take it down again.
Risk - Fata Morgana
Here is a snippet from a Financial Analysts Journal Article on Models by Emanuel Derman. I like it. It succinctly encapsulates what risk is and what model risk is.
"Risk is future uncertainty. A coin flip is risky. We know the current state of the coin but not its future state. We can, however, perform an infinite number of mental flips and reliably calculate the probability distribution of heads and tails, which will match a physical coin's probability distribution to the extent that the coin is separable from its surroundings and uninfluenced by them. In that sense, a liquid stock price is risky. We know the current price and have no idea about the direction of its future change. But we cannot perform an infinite number of mental stock price moves with any reliability; the stock, the market, and the world are not clearly separable and they do influence each other, so the probability distribution of stock prices cannot be accurately known (and may not be time-invariant). The history of the world does not affect a coin flip. The history of the world does have a bearing on the next change in a stock's price. The risk of a stock price change is qualitatively different from the risk of a coin flip.
Financial models interpolate from liquid to illiquid prices by analogy and must necessarily change over time as the economic environment changes or as market participants become more sophisticated...The term "risk," therefore, inaccurately describes the indeterminate nature of financial models. If we want to describe this state of ignorance as risk, then we must not forget that it is shorthand for uncertainty, for something much vaguer than probabilistic risk. No ensemble of models exists in which each model has a known probability of being right.
The greatest danger in financial modeling is the age-old sin of idolatry. Financial markets are alive, but a model is a limited, human work of art. Although a model may be entrancing, we will not be able to breathe life into it, no matter how hard we try. To confuse the model with the world is to embrace a future disaster by the belief that humans obey mathematical rules."
"Risk is future uncertainty. A coin flip is risky. We know the current state of the coin but not its future state. We can, however, perform an infinite number of mental flips and reliably calculate the probability distribution of heads and tails, which will match a physical coin's probability distribution to the extent that the coin is separable from its surroundings and uninfluenced by them. In that sense, a liquid stock price is risky. We know the current price and have no idea about the direction of its future change. But we cannot perform an infinite number of mental stock price moves with any reliability; the stock, the market, and the world are not clearly separable and they do influence each other, so the probability distribution of stock prices cannot be accurately known (and may not be time-invariant). The history of the world does not affect a coin flip. The history of the world does have a bearing on the next change in a stock's price. The risk of a stock price change is qualitatively different from the risk of a coin flip.
Financial models interpolate from liquid to illiquid prices by analogy and must necessarily change over time as the economic environment changes or as market participants become more sophisticated...The term "risk," therefore, inaccurately describes the indeterminate nature of financial models. If we want to describe this state of ignorance as risk, then we must not forget that it is shorthand for uncertainty, for something much vaguer than probabilistic risk. No ensemble of models exists in which each model has a known probability of being right.
The greatest danger in financial modeling is the age-old sin of idolatry. Financial markets are alive, but a model is a limited, human work of art. Although a model may be entrancing, we will not be able to breathe life into it, no matter how hard we try. To confuse the model with the world is to embrace a future disaster by the belief that humans obey mathematical rules."
1Q Earnings - A sign of hope
1Q09 earnings are providing a ray of hope.
Earnings are coming in better than expected (no surprise). But the downward revisions are slowing, pointing to a potential bottom in the earnings revision cycle.
This is important, because analyst estimates (which simply mirror management guidance) are generally lagging. And so, much in the same way that analyst estimates are behind the curve on the way up in the earnings/economic cycle, they have been behind the curve on the way down. This playing catch-up, usually meets at the top and the bottom of the earnings cycle.
Earnings are coming in better than expected (no surprise). But the downward revisions are slowing, pointing to a potential bottom in the earnings revision cycle.
This is important, because analyst estimates (which simply mirror management guidance) are generally lagging. And so, much in the same way that analyst estimates are behind the curve on the way up in the earnings/economic cycle, they have been behind the curve on the way down. This playing catch-up, usually meets at the top and the bottom of the earnings cycle.
Energy Cycles...What Of Them!
From what I can gather, the US is sitting on a mountain of natural gas (access to shale has been a game changer). As a result, we will continue to see significant boom-bust cycles in the natural gas space (we're currently near the bottom of the cycle).
The same cannot be said for oil. From what I can gather, global oil supply is much more constrained. The oil supply and demand curves are highly inelastic in the short to medium term. As such, any uptick in demand, will put significant upward pressure on oil prices.
Note: OPEC has taken a little supply off the market in response to the decline in global demand, but we would very quickly come up against the supply constraint should any normalcy return.
The same cannot be said for oil. From what I can gather, global oil supply is much more constrained. The oil supply and demand curves are highly inelastic in the short to medium term. As such, any uptick in demand, will put significant upward pressure on oil prices.
Note: OPEC has taken a little supply off the market in response to the decline in global demand, but we would very quickly come up against the supply constraint should any normalcy return.
Tuesday, May 5, 2009
Searching For Perspective On Bounce Potential
Been searching for a little perspective on this here rally.
For background, when I went searching for perspective on the market implosion I came up with what I thought was a reasonable level for a decline, given the uncertainties and severity of the issues we were dealing with. It made sense to me that it was going to be somewhere between 50%-70%, given the premise that its severity would be sandwiched somewhere between the catastrophe of the 1929-32 period (-86%) and the mercilessness of the 73-74 bear market (-48%).
On the flipside, I'm searching for perspective on what kind of rally we could possibly see. For perspective, I would pitch the potential bounce at being somewhere between 25%-50%, given an avg. bear market rally of 20%, a high of 60% in 1938 and the next highest rally being 48% in 1929-30. For my money, if we experience a 40% bounce (930), that is a pretty good place to get off the equity market express. The scary thing is, I think that if we reach 930, we could easily go through to 1000 (50% bounce), but 1000 is only 7.5% higher than 930, and finessing these things is pretty hard to do.
Next up, I'm searching for perspective on what kind of retracement we might get.
Note: The magnitude and duration of bounces and retracements is very much connected with whether we are in a bull market or a bear market. I'm still in the bear market bounce category.
For background, when I went searching for perspective on the market implosion I came up with what I thought was a reasonable level for a decline, given the uncertainties and severity of the issues we were dealing with. It made sense to me that it was going to be somewhere between 50%-70%, given the premise that its severity would be sandwiched somewhere between the catastrophe of the 1929-32 period (-86%) and the mercilessness of the 73-74 bear market (-48%).
On the flipside, I'm searching for perspective on what kind of rally we could possibly see. For perspective, I would pitch the potential bounce at being somewhere between 25%-50%, given an avg. bear market rally of 20%, a high of 60% in 1938 and the next highest rally being 48% in 1929-30. For my money, if we experience a 40% bounce (930), that is a pretty good place to get off the equity market express. The scary thing is, I think that if we reach 930, we could easily go through to 1000 (50% bounce), but 1000 is only 7.5% higher than 930, and finessing these things is pretty hard to do.
Next up, I'm searching for perspective on what kind of retracement we might get.
Note: The magnitude and duration of bounces and retracements is very much connected with whether we are in a bull market or a bear market. I'm still in the bear market bounce category.
Monday, May 4, 2009
"The Squeeze Is On"
The squeeze is on, but I'm not buying it.
Doubt resides in the dual unknowns of what level the market will reach, and the magnitude of its retracement.
This is what makes investing difficult.
For a little perspective, here is a potential scenario:
Trough = 666
Peak = 930
Trough to peak bounce = 40%
Retracement = 15%
Retracement level target = 790
I kind of want to see the market getting "nuttily happy" before I reverse position - it's getting there but it needs a few more days to attract more moths to the flame.
I bet there is a fair amount of regret sitting out there among investors who cashed up and stayed on the sidelines.
Doubt resides in the dual unknowns of what level the market will reach, and the magnitude of its retracement.
This is what makes investing difficult.
For a little perspective, here is a potential scenario:
Trough = 666
Peak = 930
Trough to peak bounce = 40%
Retracement = 15%
Retracement level target = 790
I kind of want to see the market getting "nuttily happy" before I reverse position - it's getting there but it needs a few more days to attract more moths to the flame.
I bet there is a fair amount of regret sitting out there among investors who cashed up and stayed on the sidelines.
Saturday, May 2, 2009
Debt - How Bad Is It, Really?
Okay, we've got a debt problem. But, how bad is it, really?
A little perspective:
Total Debt to GDP = 340%*
(about 13% is US govt, about 50% is domestic non-financial, about 30% is financial, and the remainder is debt issued overseas).
In the Depression, the debt problem revolved around corporate indebtedness. This time around, the debt problem revolves around personal indebtedness.
Example:
GDP = $100
Debt = $340
Debt financing cost = 6% = $20
Effective tax rate = 20% = $20
After tax, after financing income to cover living expenses, savings and investment:
$100 - $20 - $20 = $60
Bottom-Line: Not much wiggle room.
Another Perspective
From another perspective. Mortgage lenders often use the 33/38 rule. 33 relates to the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees. The 38 refers to the same thing, only it also includes your monthly consumer debt (car payments, credit card debt, installment loans, and similar related expenses). Looked at from this perspective the current debt level is high, but manageable, ie. 20%-25% of GDP.
*The proportion doesn't include US Unfunded Entitlement Liabilities which would add another 300% to the total (that's right, ANOTHER 300%!!!)
A little perspective:
Total Debt to GDP = 340%*
(about 13% is US govt, about 50% is domestic non-financial, about 30% is financial, and the remainder is debt issued overseas).
In the Depression, the debt problem revolved around corporate indebtedness. This time around, the debt problem revolves around personal indebtedness.
Example:
GDP = $100
Debt = $340
Debt financing cost = 6% = $20
Effective tax rate = 20% = $20
After tax, after financing income to cover living expenses, savings and investment:
$100 - $20 - $20 = $60
Bottom-Line: Not much wiggle room.
Another Perspective
From another perspective. Mortgage lenders often use the 33/38 rule. 33 relates to the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees. The 38 refers to the same thing, only it also includes your monthly consumer debt (car payments, credit card debt, installment loans, and similar related expenses). Looked at from this perspective the current debt level is high, but manageable, ie. 20%-25% of GDP.
*The proportion doesn't include US Unfunded Entitlement Liabilities which would add another 300% to the total (that's right, ANOTHER 300%!!!)
A Quick Few Thoughts On Deflation
These are superficial musings.
(1) We've seen substantial asset deflation thusfar in this crisis, but very little consumer price deflation (we have seen a substantial deceleration in consumer price inflation, but not consumer price deflation).
(2) There is a chance we may enter into consumer price deflation. There is substantial productive overcapacity in the US and overseas, which could lead to a second wave of flow-on effects (more firings and competitive price declines...to cover fixed costs), all of which could feed upon itself in a self-reinforcing downward spiral, accentuated by global competition (pseudo protectionism).
(3) I think we have seen the first wave of this crisis, and we are now at a juncture where we are waiting and seeing if there are second order flow-on effects coming through the system. We could be in a period of the "lull before the storm."
(4) If a second wave arrives and we enter into a period of consumer price deflation, then the market is going to take a bath again.
(5) The market is currently rallying on the premise that we will avoid consumer price deflation and the consequent debt deflation of Irving Fisher fame.
Holding my breath! You should hold yours also.
(1) We've seen substantial asset deflation thusfar in this crisis, but very little consumer price deflation (we have seen a substantial deceleration in consumer price inflation, but not consumer price deflation).
(2) There is a chance we may enter into consumer price deflation. There is substantial productive overcapacity in the US and overseas, which could lead to a second wave of flow-on effects (more firings and competitive price declines...to cover fixed costs), all of which could feed upon itself in a self-reinforcing downward spiral, accentuated by global competition (pseudo protectionism).
(3) I think we have seen the first wave of this crisis, and we are now at a juncture where we are waiting and seeing if there are second order flow-on effects coming through the system. We could be in a period of the "lull before the storm."
(4) If a second wave arrives and we enter into a period of consumer price deflation, then the market is going to take a bath again.
(5) The market is currently rallying on the premise that we will avoid consumer price deflation and the consequent debt deflation of Irving Fisher fame.
Holding my breath! You should hold yours also.
Where There Is Smoke, There Is Fire
Excellent Weekend Interview in the WSJ, highlighting the rot (basically poor structure, corrupt practices, and perverse incentives...sound familiar) that exists within the US legal system ("He Fought the Tort Bar - and Won").
Given our recent experience of an unsustainable imbalance (financial crisis), it reminded me of the importance of identifying other areas in the system that are rotten. These will be ruled by Stein's law "if something can't go up forever, it will stop."
There is a price to be paid for corruption. And, there is a day of reckoning. Getting a handle on how and when it will play itself out is the hard part. But first you must identify where the problems lay.
Here are a few suggestions of unsustainable imbalances:
Political/democratic process and systems - perverted by money
Healthcare - perverted by vested interests
Tertiary Education - 10% pa inflation unsustainable
Defense spending - military/industrial complex + political ideology
Unfunded Entitlement Liabilities - self-evident
Fiscal Deficit, Current Account Deficit, Govt Indebtedness - not sustainable, but...
I think that each will have their "Minsky Moment" but the damage from their fallout, in most cases, will be less severe than an overly leveraged financial system (the multipliers there are huge).
I will talk much more about these things at another time, as well as possible ideas as to how each of their unravelings may play out.
P.S. While we are essentially on the subject of systemic risk factors, here are two other substantive risk factors with systemic possibilities - inflation and deflation. More on those at another time also.
Given our recent experience of an unsustainable imbalance (financial crisis), it reminded me of the importance of identifying other areas in the system that are rotten. These will be ruled by Stein's law "if something can't go up forever, it will stop."
There is a price to be paid for corruption. And, there is a day of reckoning. Getting a handle on how and when it will play itself out is the hard part. But first you must identify where the problems lay.
Here are a few suggestions of unsustainable imbalances:
Political/democratic process and systems - perverted by money
Healthcare - perverted by vested interests
Tertiary Education - 10% pa inflation unsustainable
Defense spending - military/industrial complex + political ideology
Unfunded Entitlement Liabilities - self-evident
Fiscal Deficit, Current Account Deficit, Govt Indebtedness - not sustainable, but...
I think that each will have their "Minsky Moment" but the damage from their fallout, in most cases, will be less severe than an overly leveraged financial system (the multipliers there are huge).
I will talk much more about these things at another time, as well as possible ideas as to how each of their unravelings may play out.
P.S. While we are essentially on the subject of systemic risk factors, here are two other substantive risk factors with systemic possibilities - inflation and deflation. More on those at another time also.
Friday, May 1, 2009
Bear Markets - The Tyranny of the Numbers
Bear markets are the best places in the world to hang out - if you get it right. The converse is true, if you get it wrong.
Here is an example:
Index at Point 1 = 1575 Starting Wealth = $100
Index at Point 2 = 787 Return = -50% Wealth at Point 2 = $50
Index at Point 3 = 1417 Return = 80% Wealth at Point 3 = $90
Index at Point 4 = 850 Return = -40% Wealth at Point 4 = $54
Index at Point 2 = 1275 Return = 50% Wealth at Point 5 = $81
But you get the picture. A bear market throws up great rally opportunities. In the example above, we had two rallies that averaged 65% returns, while we had two declines that averaged -45%. But the tyranny of compounding in a volatile market skews the return distribution against you.
The current rally notwithstanding, one of the strangest things about this market so far, has been the relatively benign rallies we have seen. Of course, if you measure the start of the bear market from 2000, then you might object to that characterization (Oct 2002-Oct 2007 was a pretty good time), but I am, of course referring to the recent crisis (post Oct 2007).
Here is an example:
Index at Point 1 = 1575 Starting Wealth = $100
Index at Point 2 = 787 Return = -50% Wealth at Point 2 = $50
Index at Point 3 = 1417 Return = 80% Wealth at Point 3 = $90
Index at Point 4 = 850 Return = -40% Wealth at Point 4 = $54
Index at Point 2 = 1275 Return = 50% Wealth at Point 5 = $81
But you get the picture. A bear market throws up great rally opportunities. In the example above, we had two rallies that averaged 65% returns, while we had two declines that averaged -45%. But the tyranny of compounding in a volatile market skews the return distribution against you.
The current rally notwithstanding, one of the strangest things about this market so far, has been the relatively benign rallies we have seen. Of course, if you measure the start of the bear market from 2000, then you might object to that characterization (Oct 2002-Oct 2007 was a pretty good time), but I am, of course referring to the recent crisis (post Oct 2007).
What About The Risk Factors
We seem to have forgotten about the problems in the system that should be sources of significant risk. Perhaps the market has discounted all these things already (I don't think so).
(1) Eastern Europe is bankrupt.
(2) Western Europe is struggling to formulate a response and could easily be dragged down by Eastern Europe and declining US demand.
(3) Significant overcapacity in China.
(4) Consumer debt - credit cards will get you every time.
(5) Commercial real estate implosion.
(6) Deleveraging US (and Australian, and English, and Kiwi) consumer = higher savings, lower consumption.
(7) Rising unemployment tide.
(8) 1st wave of lay-offs past - now it is a wait n see game.
(9) State and local govts a mess - nuff said.
(10) State and local pensions, and corporate pensions a mess.
(11) Massive fiscal deficits leads to higher taxes. But who is going to buy that stuff.
(12) Just for added measure...the swine flu.
*don't forget the potential for a terrorist attack (although I highly doubt, even a successful one would have 1/100th the impact that 9/11 had).
(1) Eastern Europe is bankrupt.
(2) Western Europe is struggling to formulate a response and could easily be dragged down by Eastern Europe and declining US demand.
(3) Significant overcapacity in China.
(4) Consumer debt - credit cards will get you every time.
(5) Commercial real estate implosion.
(6) Deleveraging US (and Australian, and English, and Kiwi) consumer = higher savings, lower consumption.
(7) Rising unemployment tide.
(8) 1st wave of lay-offs past - now it is a wait n see game.
(9) State and local govts a mess - nuff said.
(10) State and local pensions, and corporate pensions a mess.
(11) Massive fiscal deficits leads to higher taxes. But who is going to buy that stuff.
(12) Just for added measure...the swine flu.
*don't forget the potential for a terrorist attack (although I highly doubt, even a successful one would have 1/100th the impact that 9/11 had).
Just Had A Terrible Thought
What if I am wrong about a double-dip and/or subdued economic recovery!
I have a tendency to be late to trends (which is not a good thing), so this is a real risk for me.
There are lots of smart people, making lots of smart arguments as to why we could get a recovery in the 4Q09. Am I stuck in an old paradigm? I bought the argument that it took a long time to wind ourselves up into this mess, and that it will take longer than normal (or expected) to get us out of it. What if the US/global economy is much more resilient than I am giving it credit for? Then I need to be careful and not expose myself too much, one way or the other.
The other risk is that much in the same way the equity markets overshot on the downside, there is always a chance they will overshoot on the upside. The hard part in all this chaos was determining the extent to which equity market values/levels reflected economic reality.
When the market was down 60% it was reflecting an awful lot of bad news - that was not a bad bet to take. Now we're off 44% (which is huge) and the market has to wrestle with how much this reflects reality.
Happy investing.
I have a tendency to be late to trends (which is not a good thing), so this is a real risk for me.
There are lots of smart people, making lots of smart arguments as to why we could get a recovery in the 4Q09. Am I stuck in an old paradigm? I bought the argument that it took a long time to wind ourselves up into this mess, and that it will take longer than normal (or expected) to get us out of it. What if the US/global economy is much more resilient than I am giving it credit for? Then I need to be careful and not expose myself too much, one way or the other.
The other risk is that much in the same way the equity markets overshot on the downside, there is always a chance they will overshoot on the upside. The hard part in all this chaos was determining the extent to which equity market values/levels reflected economic reality.
When the market was down 60% it was reflecting an awful lot of bad news - that was not a bad bet to take. Now we're off 44% (which is huge) and the market has to wrestle with how much this reflects reality.
Happy investing.
From "The Dark Side of Optimism"
Took this from Naked Capitalism. The quote captures the essence of the pitfalls surrounding the optimistic proclivities within our industry.
Is Optimism All It's Cracked Up to Be?
Americans are a profoundly optimistic people. While it's part of the national mythology that it makes us resilient, it comes with a price. As Susan Webber noted in "The Dark Side of Optimism":
Overly positive thinking is difficult to reconcile with the need to make realistic, objective assessments. Finding the right balance between healthy optimism and delusion is harder than one might imagine, for both individuals and institutions.
And despite years—decades—of sobering examples, we don’t seem to be any closer to that balance. The recent recklessness
of residential and commercial real-estate lending was in plain view, and a vocal minority wrote about it. But the financial and business communities dismissed all the warnings, insisting that any damage—should it ever arrive—would be contained to the subprime sector. The folly was obvious: Even if decision-makers had deemed the grim forecasts to be of low probability, the potential outcomes were so dire that they demanded contingency plans...
We acknowledge these problems and their seriousness—and then put them out of mind. Instead of treating worrisome developments as new information and looking dispassionately at the risks, we tend to avoid working through downside scenarios because they are upsetting. It’s simply easier to put on blinkers and believe everything will work out than to confront the complexities of modern life.
“Negativity,” an awkward coinage, has widely come to be used pejoratively. Magical thinking, too, has become increasingly
popular as a way to gain the illusion of control in an uncertain world. Rhonda Byrne’s motivational best-seller The Secret, for example, basically says that you get what you wish for. If you don’t have the things you want, it means you don’t have enough faith. In this construct, neither insufficient effort nor bad luck plays a role.....
The end result is a bias against critical thinking. It’s hard enough, in the delicate social web of most organizations, to question the merits of any given proposal offered in good faith. But now decision-makers stagger under the weight of larger social trends and management fads that favor belief and force of personality over dispassionate analysis. Detached, rigorous thinking simply doesn’t fit any of our cultural models.
What Happens Next
What happens after the banking crisis is averted. There is so much stress over the stress tests. Not sure why. The stress tests are a total sham and the results have been telegraphed far in advance.
My sense is that the effects of this crisis and the consequent deleveraging will be with us for some time. We've got to go through the consequent regulatory hearings, legislation, lawsuits, and lingering solvency concerns. The end result will hopefully be a de-fanged financial sector, with more limited ability to take risk and leverage, but where basic banking functions will flow.
Time will tell. Here's hoping.
My sense is that the effects of this crisis and the consequent deleveraging will be with us for some time. We've got to go through the consequent regulatory hearings, legislation, lawsuits, and lingering solvency concerns. The end result will hopefully be a de-fanged financial sector, with more limited ability to take risk and leverage, but where basic banking functions will flow.
Time will tell. Here's hoping.
"Consumer Discretionary You're Goin' Down"
The Consumer Discretionary sector is up 21% in both the Standard and Poors 400 and the Standard and Poors 600 year to date, and is the leading sector in the Standard and Poors 1000 (comprised of the 400 and the 600). In fact, the sector was up 30% in the smalls (S&P600) for the month of April.
Much of the rally was predicated on the relief that the world might actually survive. But I am mystified as to why the Consumer Discretionary sector, which hadn't been hit as hard as a number of other sectors, would lead us out. This, of course, is not surprising, given that I'm not a believer in a strong and/or uneventful recovery.
But it is what happens when the market sees light at the end of the tunnel. Note to self: Remember to get on board with the early cyclicals when there is no hope.
For the record, I'd be looking to take profit in that space if I had anything to take profit in.
Much of the rally was predicated on the relief that the world might actually survive. But I am mystified as to why the Consumer Discretionary sector, which hadn't been hit as hard as a number of other sectors, would lead us out. This, of course, is not surprising, given that I'm not a believer in a strong and/or uneventful recovery.
But it is what happens when the market sees light at the end of the tunnel. Note to self: Remember to get on board with the early cyclicals when there is no hope.
For the record, I'd be looking to take profit in that space if I had anything to take profit in.
Been Fading
Been fading this rally, and will probably continue to do so. One of the reasons has been, because that was one of my mistakes on the way down (not fading the bounces...I tried numerous times but was always looking for larger bounces than what occurred). So I don't want to be caught out again by another leg down. But it is looking more and more likely at this point that the play going forward will be to "buy the dips" vs "sell the rips."
I'm probably more pessimistic on the fundamental economic outlook than the consensus, but have also been pretty bullish on long term equity market returns. Anytime you get a 60% collapse in equity prices, this usually portends significantly higher expected returns in the future.
Having pitched Standard and Poors 500 fair value around 900-950, we have obviously had tremendous overshoot on the downside. But the difficulty is managing long in an environment where fear and momentum are running rampant, and you just don't know where the bottom is.
Given my dour view of the likely economic recovery, I think we're going to trade a range on the Standard and Poors 500 of between 700-1100 over the next 2-5 yrs.
I'm probably more pessimistic on the fundamental economic outlook than the consensus, but have also been pretty bullish on long term equity market returns. Anytime you get a 60% collapse in equity prices, this usually portends significantly higher expected returns in the future.
Having pitched Standard and Poors 500 fair value around 900-950, we have obviously had tremendous overshoot on the downside. But the difficulty is managing long in an environment where fear and momentum are running rampant, and you just don't know where the bottom is.
Given my dour view of the likely economic recovery, I think we're going to trade a range on the Standard and Poors 500 of between 700-1100 over the next 2-5 yrs.
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