The Deipnosophist

Bears: Exit Stage Left

2009-07-15T09:13:00.000-07:00

It goes without saying... but Peter Tasker does a fine job of saying anyway. See article below.
-- David M Gordon / The Deipnosophist
~~~~~~~~~~~~~~~~~~~~~~~~~~

Bears: Exit Stage Left
Time for rock-star pessimists to wise up.
Peter Tasker Jul 20, 2009

A notable phenomenon of this past year of living dangerously in financial markets has been the triumph of the ultrabears: deeply pessimistic commentators and economists, such as Nouriel Roubini, who previously had only niche followings and have been propelled to rock-star status.

Million-dollar book deals, speeches at Davos, celebrities and statesmen lapping up your predictions of woe, gorgeous babes clustering around you—it's nice work if you can get it.

Am I jealous? Absolutely. More important, what does this runaway bull market in doom-mongering tell us about current investment prospects? To any contrarians worth their salt, it suggests that sentiment has reached extremes, as it did in the dotcom mania of the '90s. Back then, the talk was of "Dow 30,000" and the coming digital paradise. Now we hear confident forecasts of gold at $3,000, the collapse of the dollar, and the end of capitalism itself.

Is it fair to pair today's gloomsters with the wild-eyed dotcomers? The bears have much greater intellectual depth, they are more analytical, and they were correctly bearish ahead of the most serious financial crisis in decades. But remember that the dotcom gurus once had credibility too, having been bullish during an epochal market ascent. Being right gets you listened to, until you get it wrong; then people stop listening. And nobody, but nobody, is right all the time.

Furthermore, investment success has little relation to high IQ, doctorates, and Nobel Prizes. As Warren Buffett put it, ordinary intelligence is enough when combined with "the temperament to control the urges that get other people into trouble."

In fact, the dotcom gurus turned out to be right about a lot of things. The Internet transformed the way we work and play, devastating whole industries and turning geeky startups into gigantic global corporations. What they overlooked was the iron law of investment: the price paid is crucial to the returns generated. Pay a ridiculously high price and you'll get a ridiculously lousy return. Being right about everything else won't matter.

Today's über-bears are making the same mistake in reverse. They may be right about the challenges the world economy is facing—shaky banks, weak consumption, deleveraging, the flu pandemic, etc.—but they are paying insufficient attention to the prices that companies are trading at in the stock market. That is why they missed the sharp recovery of the past few months and are now desperate to label it a bear-market rally.

Since March, when the growling of the bears was loudest, the S&P index of Asia's 50 largest stocks has risen by 45 percent, and the Dow Jones Asian small-cap index by 57 percent. The move is much more intense than in the spring of 2003, when the last bear market bottomed.

Another bubble? Hardly. In the first quarter of this year, the entire Japanese stock market was trading below its book value, and the Korean, Taiwanese, and Thai markets were not far behind. In all four countries, the market index expressed in dollars was back at 1980s levels.

Even at the peak in 2007, global stock markets were not in bubble territory, meaning at absurdly high valuations, with the exception of China and a handful of emerging markets. There was indeed a financial bubble, but it was restricted to credit and the areas that feed off it, such as real estate and private equity. By contrast, stock markets had already been in a bear phase—if we define a bear phase as a period when stock prices fall relative to earnings—since the turn of the century. The credit crisis, in particular the astonishing policy blunders surrounding the unmanaged collapse of Lehman Brothers, accelerated the process dramatically.

At the start of this year in many countries, stock markets were trading at the lowest levels in a generation. In several European and Asian markets, stock dividend yields had fallen well below government bond yields; effectively, investors were pricing in a long deflationary slump. Common sense suggests that such an outcome would be tremendously destabilizing to our societies. Political leaders everywhere, once aware of the risks, will stop at nothing to avert it. In an era when central banks are using every trick in the book to get money flowing again, deficits are ballooning, and bailouts have become routine, it is government bonds, not corporate stocks, that seem out of kilter with reality.

So what next? According to another great investor, Sir John Templeton, bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria. Nobody can blame the über-bears for enjoying their moment in the sun; they've earned it fair and square. And if in doing so they set the stage for the birth of the next bull market, we'll have something else to thank them for.

Tasker is an analyst at Arcus Research in Tokyo.

Why I climb

2009-07-10T08:38:00.000-07:00

People often ask why I climb (mountains), but my answers always lacked a certain... something. I struggled to make concrete an intangible -- a feeling (to be atop the world), a perspective (what I see from that vantage), and how the preparation and actuality trains me physically, emotionally, psychically, and spiritually for other endeavours.

And then, as it happened, I caught this brief interview with Ed Viesturs...

The Colbert Report

Mon - Thurs 11:30pm / 10:30c

Ed Viesturs

http://www.colbertnation.com/

Colbert Report Full Episodes

Political Humor

Jeff Goldblum

Ed nails the climber's imperative in a few broad brushstrokes. The bit about testing his limitations is spot-on: whatever your (my) limitations, the objective is not to ignore them but to keep pushing them farther away so they no longer act as limitations. Now, I do not know Ed Viesturs, although I wish I did. Ed seems a genuinely nice guy, based solely on this brief interview, which also happens to be funny, thanks to Stephen Colbert's goofy manner.

Oh, btw, I will be in London on my return (early-October) from a climbing expedition of my own, so please message me if you would like to get together and share a pint or two, and good conversation.
-- David M Gordon / The Deipnosophist

One commercial...

2009-07-10T07:36:00.000-07:00

... that I would enjoy if it continued for a while more:

Such a joy, such a rarity!
-- David M Gordon / The Deipnosophist

District 9

2009-07-09T10:09:00.000-07:00

"Thirty years ago, aliens made first contact with Earth. Humans waited for the hostile attack, or the giant advances in technology. Neither came. Instead, the aliens were refugees, the last survivors of their home world. The creatures were set up in a makeshift home in South Africa's District 9 as the world's nations argued over what to do with them. Now, patience over the alien situation has run out. Control over the aliens has been contracted out to Multi-National United, a private company uninterested in the aliens welfare they will receive tremendous profits if they can make the aliens awesome weaponry work.

"So far, they have failed..."

District 9, produced by Peter Jackson (Lord of the Rings) and directed by Neill Blomkamp, opens Friday, 14 August 2009.
-- David M Gordon / The Deipnosophist

Next Shock Coming: Commercial Real Estate

2009-07-09T08:16:00.000-07:00

Include me as a big fan of Simon Johnson's analyses. The Op/Ed essay below is from today's edition of the Washington Post.
-- David M Gordon / The Deipnosophist
~~~~~~~~~~~~~~~~~~~~~~~~~~
Next Shock Coming: Commercial Real Estate

The Joint Economic Committee holds a hearing this morning on worsening conditions in commercial real estate – falling rents, fewer tenants, and defaults on debt down the road. This seems to be the first hearing on Capitol Hill to focus on these issues and what can be done. “Not much” seems to be the reasonable answer.

The written testimony from Jon Greenlee, of the Federal Reserve, is particularly disheartening. There is currently about $3.5 trillion of debt associated with commercial real estate, about half of which is on the books of banks. He suggests that the Fed has been following this situation closely and has stayed on top of banks’ exposures to the sector. He also has some rhetoric about the recent stress tests. Why do I not find this reassuring?

James Helsel, on behalf of the National Association of Realtors, is even more negative. He argues that this sector supports 9 million jobs and many of these are now in jeopardy. Of course, he is looking for a bailout of some kind (who isn’t?) but still he is right about emerging problems in and around the retail sector.

Jeffrey DeBoer, of the Real Estate Roundtable, has a similar line – as he sees the numbers, commercial real estate is 13 percent of the economy and it’s in trouble because there is not enough credit to go around. He wants – of course – more cheap government credit for this sector; and he has an extensive blueprint/Christmas list of items.

I’m not convinced by the economic merits of their bailout cases, but it’s good to have these lobbyists making their case out in the open – this is a refreshing change from the banking sector, which prefers to work behind closed doors.

Across all these sectors, it’s amazing to see such free market (and even some libertarian) interests come together and – with one voice – clamor for government subsidies.

The Federal Reserve, of course, is already supporting a large part of the credit market. It would not be a surprise if it moves more of this support toward commercial real estate over time, but it’s hard to see how we can afford to risk the kinds of measures Mr. DeBoer proposes at this stage.

The underlying problem here is that consumers and businesses are spending less – mostly because they feel the need to be more careful and to increase their savings. Until private-sector spending finds a sustainable level, measures to directly support commercial real estate are likely to have little impact.

There will be defaults and debt restructurings. This is an unavoidable part of our current slowdown, but watch out for the further damage to banks’ balance sheets that lies ahead.
-- Simon Johnson

NOTE: Testimony can be found on the committee's Web site.

Micropsia, part 8

2009-07-09T06:00:00.000-07:00

Today's chart (updated through yesterday's close)...

[click on chart to enlarge]

... is the final chart in this sequence.

My next post on this topic will reveal the companies, and add a few comments. Thank you for your participation, past and present!
-- David M Gordon / The Deipnosophist

The New Wikinvest Data Platform

2009-07-07T19:35:00.000-07:00

An overview of the new Wikinvest data platform.

New functionality, new charts, industry metrics, and as always, intuitive and easy to use.

-- David M Gordon / The Deipnosophist

Peter Schiff says, "Of course, we're not gonna pay back the Chinese"

2009-07-07T08:38:00.000-07:00

"An excerpt of the Peter Schiff speech at the 2009 Henry Hazlitt Memorial Lecture. Recorded at the annual Austrian Scholars Conference, Ludwig von Mises Institute."

Enjoy!
-- David M Gordon / The Deipnosophist

Micropsia, part 7

2009-06-30T00:03:00.000-07:00

Today's chart...

[click on chart to enlarge]

Chart current through close of business yesterday (Monday).
-- David M Gordon / The Deipnosophist

Micropsia, part 6

2009-06-29T06:03:00.000-07:00

Today's chart...

[click on chart to enlarge]

-- David M Gordon / The Deipnosophist

Micropsia, part 5

2009-06-26T06:09:00.000-07:00

Today's chart...

[click on chart to enlarge]

Again, the chart above is up-to-date through yesterday's (Thursday) close.

Only a few charts more; please contine your comments! (Especially with these next few.)
-- David M Gordon / The Deipnosophist

A pocket full of posies...

2009-06-24T09:25:00.000-07:00

By now you have heard that Harry Schultz (Harry Schultz Letter) reports of scuttlebutt that...

"Some U.S. embassies worldwide are being advised to purchase massive amounts of local currencies; enough to last them a year. Some embassies are being sent enormous amounts of U.S. cash to purchase currencies from those governments, quietly. But not pound sterling. Inside the State Dept., there is a sense of sadness and foreboding that 'something' is about to happen ... within 180 days, but could be 120-150 days."

And that...

"Another FDR-style 'bank holiday' of indefinite length, perhaps soon, to let the insiders sort out the bank mess, which (despite their rosy propaganda campaign) is getting more out of their control every day. Insiders want to impose new bank rules. Widespread nationalization could result, already underway. It could also lead to a formal U.S. dollar devaluation, as FDR did by revaluing gold (and then confiscating it)."

What do you think -- possible, even probable?
-- David M Gordon / The Deipnosophist

Micropsia, part 4

2009-06-24T06:01:00.000-07:00

Today's chart...

[click on chart to enlarge]

Same item applies:
The chart above is current through the prior day's close of business (cob); in this instance, Tuesday, 23 June.

In addition, the recent highs also are all-time highs.

Your comments...?
-- David M Gordon / The Deipnosophist

The importance of excellent grammar and syntax

2009-06-24T04:35:00.000-07:00

"You should read this book (or watch this movie, etc); it was really good!"

To which I reply, "What do you mean, 'WAS good' -- is it no longer available for me to read (watch)...?"

Of course, in my silly example above, the first speaker makes the comment in the past tense because the reading (or watching) experience is in his past; stated correctly, though, the speaker means, "You should read this book; it IS really good!"

Incorrect grammar, syntax, and word choice sum as a pet peeve of mine; they expose the parties of a conversation to probable misinterpretation, and consequential problems. And one reason why my posts drip with academic exactitude -- the necessity is not to slip into jargon and catch-phrases etc.

Communication skills also expose the listener or reader or viewer to propaganda, as George Orwell showed us; although, good propaganda requires excellent communication skills. Go figure.

So why this post? Note this snippet from the Wall Street Journal...

"[The] Memphis, TN hospital said Tuesday that Steve Jobs received a liver transplant there and that his prognosis was 'excellent'..."

Um, what do you mean, "was excellent" -- his prognosis initially was excellent, but no longer is (excellent)? Something somehow changed for the worse? Or is your "was excellent" only a figure of speech, poor grammar and syntax?

I suspect the answer is the latter -- I doubt the hospital spokesperson to be Machiavellian -- and yet, Apple, in its quest for corporate secrecy and privacy, especially as it regards Steve Jobs's health, can be quite Machiavellian.

Which all means that the writer is guilty of slack analysis and lazy writing, and his editor did a lousy job of editing. And that we, the readers, are no closer to the truth of Steve Jobs's health than if the hospital spokesperson said nothing, and the WSJ reported that.
-- David M Gordon / The Deipnosophist

Micropsia, part 3

2009-06-22T04:30:00.000-07:00

Today's chart...

[click on chart to enlarge]

Same items apply:
1) Chart is updated through the most recent close of business (cob); in this instance, Friday, 19 June 2009
2) Recent highs are all time highs

Your comments welcomed.
-- David M Gordon / The Deipnosophist

"P A Y it," I said, "pay it!"

2009-06-21T10:33:00.000-07:00

There was a time that I was mean, often out of control, with the people whose job was to help me; typically, customer service agents.

Life (finally) burnished my rougher edges. What was the point of yelling at these people? Their day is difficult enough without added grief.

A lesson this caller (sound file below) has yet to learn:

(The file above is straight from the firm where this call occurred.)

The real 'fun' begins about 3:30 in, so keep listening!
-- David M Gordon / The Deipnosophist

Today's headlines

2009-06-20T18:52:00.000-07:00

Among the more interesting and usable sites is named, cleverly, Newseum. Especially in light of the rapidly changing dynamics of... well, everything (Iran's election, Ug99, etc).

The site is easy enough to navigate: Place your mouse cursor on a city and that city's newspaper pops up, etc.

The site updates for the publication of daily editions.
-- David M Gordon / The Deipnosophist

"Ugh!" or Ug99

2009-06-20T07:33:00.000-07:00

"'This thing has immense potential for social and human destruction.' Startling words - but spoken by the father of the Green Revolution, Nobel laureate Norman Borlaug, they are not easily dismissed. An infection is coming, and almost no one has heard about it..."

New Scientist magazine was among the first to warn us -- more than 2 years ago. Today, despite the hope expressed in the NS article, the problem only worsens, as it spreads far and wide.

Money is there to be made for investors... but what of it if we all die of hunger? And, of course, between now and then, food costs (with wheat as the core item) will ratchet higher by leaps and bounds that will offset monies made in various speculative investments.

Your comments welcome.
-- David M Gordon / The Deipnosophist

Ever wonder...?

2009-06-20T03:46:00.000-07:00

Several funny speculations of a different sort, courtesy of an email forward...
-- David M Gordon / The Deipnosophist

Only in America...
· Do drugstores make the sick walk all the way to the back of the store to get their prescriptions -- while healthy people can buy cigarettes at the front.
· Do banks leave both doors open -- but chain the pens to the counters.
· Do we leave cars worth thousands of dollars in the driveway -- but put our useless junk in the garage.
· Do we have drive-up ATM machines with Braille.

EVER WONDER...
· Why the sun lightens our hair, but darkens our skin?
· Why you never see the headline, Psychic Wins Lottery?
· Why 'abbreviated' is such a long word?
· Why lemon juice is made with artificial flavor -- but dishwashing liquid made with real lemons?
· Why is the time of day with the slowest traffic called rush hour?
· Why isn't there mouse-flavored cat food?
· Why Noah did not swat those two mosquitoes?
· Why they sterilize the needles for lethal injections?
· You know that indestructible black box that is used on airplanes? Why don't they make the whole plane out of that stuff?
· If con is the opposite of pro, is Congress the opposite of progress?
· If flying is so safe, why do they call the airport the terminal?

Micropsia, part 2

2009-06-18T18:09:00.000-07:00

This sequence of non-identified and non-annotated charts continues with entry #2...

[click on chart to enlarge]

1) The chart above is current through Thursday's close;
2) Is not at all time highs, although close.

I look forward to your comments. In fact, keep 'em coming; the more comments from you, the longer this sequence will endure. btw, my comments are in abeyance to allow each of you the opportunity to offer your thoughts.
-- David M Gordon / The Deipnosophist

Micropsia, part 1

2009-06-17T06:08:00.000-07:00

In which I begin a sequence of charts, sans annotations and commentary by me -- and open to your comments and interpretations. (Please do not waste your time, leave alone mine, with the misunderstanding the objective is to identify the company/stock behind the charts.)

[click on chart to enlarge]

Several items:
1) Each chart in this sequence will be current through the prior day's close;
2) In the case above, the stock hit new all-time highs two days back (Monday).

So, what do you see...?
-- David M Gordon / The Deipnosophist

Some give and take

2009-06-16T06:23:00.000-07:00

Martin writes...

"I read your articles about CMGR and I am a beginner investor struggling to make money in the market. But still fighting. I was watching this stock since April 2009 and I bought it in my virtual account (at that time I wasn't ready to use my real money). Then I decided to buy a real shares couple days ago. But may I ask you what you think about today's movement, or better to say a few days ago movement? Would you consider this as the end of the rally or just a correction and why? The price for the first time created low high, touched 21 day MA on high volume (and is damn close to my stop loss), would this be a red flag? I also found some articles on the net that it is time to prepare for shorting this stock. What do you think? Thanks for your answer."

Excellent question, Martin; thank you.

And a thesis I have mulled on for the past 1 or 2 weeks for a new post. (Which means I will have a lengthier post, and partial reply, than this one late this week. Albeit, not with GMCR as its focus chart.)

Until then, though, several data points in reply...
1) Know your time frame;
2) Place your interest (investment dollars) in a favored investment's appropriate periodicity;
3) Listen to no one's counsel (me included) but your own. No one knows as well as you your objectives, risk tolerances, and time frame;
4) Acknowledge that stocks oscillate always, but within trends (up, down, sideways). Invest your money when the trend verges on becoming favorable, not when it is long in the tooth.

I could continue, but the markets open within minutes, so I will close with this final comment: Yesterday's action does not concern nor frighten me. More than this precis, though, must await the future post.

Full Disclosure: Long Green Mountain Coffee Roasters/GMCR
-- David M Gordon / The Deipnosophist

Jeremy Grantham's Warnings to Investors

2009-06-03T20:34:00.000-07:00

Jeremy Grantham says the US equity market is now fairly valued, with the exception of one sector - high-quality growth stocks. But investors must beware of several risks, which he spelled out in his two talks at the Morningstar Advisor Conference last week. Robert Huebscher shares his notes of the two presentations below...

By the by, the best part of Grantham's comments re the current market? That they will prove no surprise to readers of this blog. I could quote snippets, but instead encourage you to read the entire article.
-- David M Gordon / The Deipnosophist
~~~~~~~~~~~~~~~~~~~~~~~~~~
Jeremy Grantham's Warnings to Investors
By Robert Huebscher

Of the thousands of investment letters penned in the industry, only one draws as much readership as Warren Buffet’s annual letter to his shareholders: The quarterly commentary written by Jeremy Grantham.

Grantham, the Chairman of the Boston-based investment firm Grantham Mayo Van Otterloo, was a featured speaker at Morningstar’s Investor Conference last week, and he spoke at two breakout sessions. Those who, like me, attended both were richly rewarded, as he gave two distinctly different talks, addressing many subjects not covered in his commentaries.

Grantham’s March quarterly commentary was titled “Reinvesting When Terrified,” which he says he wrote for himself – not for anyone else. Beginning in February, he sensed a déjà vu of 1974, when he felt he had lost the power to make changes. That bear market, like the most recent one, “hugely reinforced” the resolve of those who held cash as the market when down, and left those fully invested praying for a miracle.

He concluded there was only one answer: follow a simple battle plan (“plans that are too fancy mess you up”) where the key decision was how cheap the market would have to get for investors to “throw in all they have.” Otherwise, he said, if market opportunities evaporate, so does enthusiasm.

Grantham’s 2009 battle plan

But Grantham did not advocate “throwing in” everything at once, instead recommending a three-step plan, gradually increasing equity allocations to their normal levels as the market neared its target valuation.

In his standard asset allocation accounts, for 19 of the last 20 years he maintained a 50% allocation in global equity, to facilitate the marketing of his funds. By October of 2008, the market had declined to his first trip point, and he increased equity allocations by 7.5%. Later that year, when the S&P hit 740, it reached his second trip point, and Grantham increased equities by another 7.5%. The final move occurred very close to the market bottom, when the S&P reached 666.

Grantham almost over-weighted US and global equities, which he said were overpriced for most of last 20 years, and were close to becoming undervalued.

Grantham called this discipline “Plan A,” which he said was absolutely critical. “Most of us fail and are left behind. That’s what I was writing about – when you are left behind it causes panic.”

Those who fail at Plan A must follow Plan B: “You take a deep breath, recognize you lost round one, and plan to take a year to 15 months and average into the market,” he said. “Give the market plenty of time to have second thoughts. You may win a few months and lose a few months.”

Locking yourself in – staying in cash – and praying for a major setback is a mistake which Grantham called “regret minimizing.” On the other hand, if you barrel in, you are exposed to the market overcorrecting. “Either way you are screwed,” he said. “You have to balance those regrets. That is the real world.”

Investing based on bubbles

Grantham’s plans for timing his equity exposure belie his true investing style. “Normally,” he said, “we do nothing.” He waits for extreme outliers and then “whacks them.” He will patiently “sit around” and wait for outliers and “silly things.” “I have been blessed by many incomprehensible things. In time they will be less ridiculous and eventually will be normal,” he said.

Outliers are identifiable only in the context of fair value, a core principle of Grantham’s investment philosophy. “Fair value is like gravitation pull; it is not very powerful but is absolutely unrelenting. Everything catches up and eventually reaches fair value.”

“It’s incredibly easy to see the outliers,” he said “but we don’t do much when they are only 10 or 20 percent away from fair value.” He might underweight an asset a little bit, but will hold back his “fire power” until the divergence increases.

For a long time, Grantham was puzzled by an apparent paradox. He acknowledged that the movement to fair value is unreliable over periods as short as one year. So, how can this movement be reliable over many years, which are nothing more than the sum of one year periods?

A powerful analogy resolved the paradox, and showed Grantham how something can be certain in the long run but dangerous in the short run. If you go to Florida in a hurricane and stand on top of a building with a bag of feathers and throw them in the air, some will hit the ground two or three blocks away. But some will go all the way to Maine in eight or nine days.

“Amongst that swirling uncertainty, every feather will hit the ground,” he said. “We are in the feather predicting business. Every bubble will hit the ground and, unlike that analogy, some will bury themselves deep in the ground.”

Grantham said high-quality growth stocks are the only mispriced asset class today. These companies are debt-free, as opposed to companies at the bottom which are burdened with massive debts.

“The only things that matters in life are the bubbles. The rest of the time just show up for work,” he said.

Career risk and the business of investing

During the height of the Tech Bubble, when the market P/E was 31, Grantham asked 1,200 equity professionals: if P/E ratios go back within 10 years to below 17.5, will it guarantee a major bear market? They responded unanimously “Yes.” He then asked how many think such a move will occur. Only seven of those professionals believed it would not come back down. A staggering 99% believed in data guaranteeing a major bear market, but were apparently unwilling to communicate this to their clients.

“Those running the engine rooms knew this, but not their clients. This was a betrayal of trust,” Grantham said. “If those in the engine room squeaked publicly that there was going to be a major bear market, they were through.” He noted that Goldman Sachs’ Abby Cohen was the icon of that group, but she was not alone. The spokespeople of major investment firms were bullish, with almost no exceptions.

“It is not good for business to be bearish. In general, our industry was not bearish, because it understands how to make money,” Grantham said. He called the rationalizing of 35-times earnings “simply splendid.” “You can’t deliver the hard truth and prosper,” he said. Paraphrasing Keynes, Grantham said “if you’re right on your own it’s a bit dangerous, when you are wrong on your own will not receive much mercy.”

His advice, which underlies his investment philosophy, is to look and see what everyone else (brokers, institutions, mutual funds) is doing and do the same, but be quicker and slicker on the draw. “We are not picking winners in beauty contest; we are picking what others will pick.”

Markets move in herds, and Grantham said every single asset class is driven by momentum. “In the long run the economic fundamentals do matter, but the problem for the long-term fundamentalist is that the feathers fall at different rates. The force that drives this, though, is overwhelming and gravitational.”

Sometimes the movement to fair value takes longer than the institutional client’s “3.0 years of patience. That career risk makes that game so difficult to play.”

“There is a lot of career risk in moving assets.” Grantham said endowments, foundations, and pension funds knew market was overpriced and dangerous prior to 2008 and have paid a huge price. “Jeremy Siegel is never right [about stocks for the long run], despite what people hope.” Siegel’s mistake is not recognizing that valuations drive returns. He said “stocks for the long run” was a “very dangerous contribution.”

Markets have a pyramid-like structure. At the bottom are “little stocks” which carry very little career risk. “It is not easy to lose your job picking insurance company stocks,” Grantham said. But once you start betting on oil stocks against insurance stocks your head is on the block. The risks go up as the decisions go to the asset sub-class and asset class levels. “The killer is at the top, when you must decide between equities and cash,” he said. “Then, life expectancy drops quickly.”

Grantham reduced investing to a “battle between career risk and avoiding herding.”

P/E ratios and presidential election cycles

Understanding herding is central to forecasting price movements, but it is not the only cause of mispriced markets. Grantham closely monitors P/E ratios and profit margins which, in a rational world, would be inversely related – when margins are high, P/E ratios should be low, and vice versa. That has not been the case, as the two variables have a positive correlation of .32. “The market can’t even get the sign right,” Grantham said.

During the five years ending 2007, GDP grew at a faster rate than at almost any time previously, mostly driven by the BRIC economies. But P/E ratios remained elevated. Conversely, in 1982 profit margins were at their nadir, but so were P/E ratios.

Presidential election cycles strongly influence markets. Grantham showed that US markets have registered performance of -3.4%, -10.1%, 15.3% and -0.3% in years one, two, three and four of presidential terms since 1932. His explanation is that by the third year in office, US presidents have figured out what is important and actually get it done. In tandem, the “completely independent” Fed makes money freer and rates lower, but this alone does not drive the 25 percent difference between years two and three. In addition, investors benefit from moral hazard; if they speculate in years one and two, they lose. But by year three, presidents will bail them out, even if inadvertently so.

Overall, Grantham respects the power of the Fed, which he said “rules the way everywhere and is the dominant force in the world.”

Seven lean years and the risks ahead

Where are we today? “Global equities are within noise levels of normal,” Grantham said, which is the case only about 20% of the time. But he is not willing to commit to normal equities allocations, because of a series of fears which he collectively labeled the “seven lean years” – “a series of long, slow burning negatives.”

Grantham’s concerns begin with the big imbalance between over-consuming countries, such as the U.S. and the U.K., and over-saving countries – Japan, China, and Germany. As a result, the great deficit created by the U.S. has flooded the market with dollars that have been monetized, creating deficits elsewhere around the world.

Grantham lamented that consumers are not as rich as they thought they were, as a result of the residential housing and stock market collapses, which he fears will be followed by a collapse in the commercial real estate market over the next six months. “We missed a decade of savings,” he said, which will not be recovered. “We just have to work longer and learn to have a more frugal retirement.” Frugality will be an important theme for investors, as he believes vendors like Wal-Mart are far better positioned than luxury providers like Mazeratti.

Our political and financial institutions have done a “disastrous” job of managing the crisis, and the loss of confidence in these institutions will erode growth. Grantham called out the Fed, Treasury and SEC for encouraging crime, such as when they beat back attempts by the Chicago Board of Trade to control subprime lending.

Grantham cited the adage that capitalism works best when there is a policeman on the corner, but the policeman was taken away when the Glass-Steagall Act was repealed in 1999. He faulted former Fed Chairman Alan Greenspan for encouraging this repeal, which Greenspan said would increase the safety of the financial system.

For Grantham, no failure was as great as that of political leadership during the peak of the housing bubble. “The housing market had been a flat plain that rose to a Himalayan peak,” Grantham said. While he and others warned of a bubble, Bernanke said that the U.S. housing market merely reflects strong demand. “I have no idea what he was thinking, other than the possibility that he believes so much in market efficiency that bubbles are impossible,” Grantham said.

As for former Treasury Secretary Henry Paulson, Grantham said he – more than anyone – understood the inferior quality of the securitized debt instruments. Paulson should have “done some arm-twisting” early on, before AIG ran into trouble, and forced institutions to raise capital. Paulson should have delivered an ultimatum: raise capital and be the government’s friend or else institutions would be on their own.

In April of 2007, when Paulson said “the subprime problem seems to be contained,” Grantham wrote in his quarterly commentary at the time that the container is likely to be Pandora’s.

“Our institutions have been incredibly badly led and it should make us nervous about the future,” he said.

Next on Grantham’s list of worries is a scarcity of resources, which include demographic shifts which are shrinking our workforce to the depletion of raw materials, all of which will squeeze profits.

“China and India together have caused us to enter a new era,” he said. Real prices of commodities are rising, following decades of decline. “We are running out of everything.” He believes there will be plenty of cheap energy, since higher prices spur the development of new sources. But supplies of every mineral, oil, coal and arable land will run out, after which “we will be on our own using our brains.”

The market outlook

Grantham compared the current market to the 1970s when he made a lot of money, but warned that investors must recognize we are in a range-bound market.

His team does a forecast every month, and project returns by asset class over a seven-year period. Just over 10 years ago, in September of 1998, they forecast real returns of -1.1% for the S&P 500 and 10.9% for the emerging markets. This 12-point gap translated to a 310-to-1 performance advantage by picking the right asset class.

Grantham faulted institutions that spend time chasing alpha through mutual fund or security selection, questioning how many correct choices they must make to improve performance. “Big asset classes drive success and are very inefficiently priced – amazingly inefficiently priced,” he said.

Current bearish sentiment is fueled by analysis which projects S&P valuations based on comparisons to historical markets. If the market follows the path of the Great Depression, the S&P will bottom at 300. The equivalent for the 1974 bear market is 450, and the 1982 market’s equivalent is 400.

“You can see why there are bears,” Grantham said, but added he has “parted with the bears.” He has more confidence in the resilience of economies than they do, based on the experiences of Germany and Japan after World War II. “We are not the delicate flower that the bankers tell us we are. We can handle a couple of Lehman-like bankruptcies,” he said.

“What separates me from the bulls are the seven lean years,” Grantham said, noting that his sentiment lies between the bulls and the bears.

He is markedly optimistic about the long-term prospects for the US economy. “Debt doesn’t matter – it’s just an accounting entry and not real life,” he said. “Unless you blow up factories, the economy will come roaring back.” He expects the developed economies to grow at 2.4%, but emerging markets to grow at 4%.

He warned of an emerging emerging market bubble, and cautioned investors that there is no connection between making money and top-line GDP growth. Leaders in those markets have objectives, such as protecting jobs, which may conflict with maximizing shareholder return. “You make money in companies through the filter of return on equity,” Grantham said, and not by betting on high growth economies.

“China will achieve monster GDP growth, but there is no guarantee at all that it has anything to do with the returns you will make on Chinese stocks,” he said. The only correlation to high returns is investing at a low starting value.

Grantham hates gold as an asset class, and never invested in it until last fall, when he broke his vows and bought some because he thought a state of panic was about to unfold. “I was perfectly right, but I still lost money,” he admitted.

Do you like Art?

2009-06-01T08:50:00.000-07:00

That would be Art with a capital A.

Your appreciation of Art need not parallel mine to enjoy the 7 minute video, Mona Lisa Descending a Staircase...

Some of the pleasure the viewer receives from this video -- which, btw, won the Oscar for Best Animated Short Film of 1992 -- is the attempt to recognize the many excellent and iconic pieces of Art.

Enjoy!
-- David M Gordon / The Deipnosophist

Of Mice and Men

2009-06-01T00:07:00.000-07:00

Obvious by now is the knowledge that (the process of) investing is no walk in the park. When to buy? When to sell? When to hold? It all becomes crystal clear only in retrospect. The process is made more difficult by the investor's own emotions -- panic and flee (sell)? Or stand ground and perhaps buy more? The commentators and experts blare forth from the TV and other media with their sought-after but not necessarily correct 'expert' opinions that only confound further the process. Add to that combustible mix clients who correctly butt their opinions into the mix, and failure becomes the likely result. How many investors can withstand the heat of the kitchen, especially when that heat is from the kitchen burning down?

Many clues exist to ease the process. Volume, for example, is a crucial tell-tale. For example, how high is high, if a stock rises on a continuing diminution of volume? Consider Google/GOOG (below)...

[click on charts to enlarge]

Decreasing volume (participation) argues the possibility of 'air pockets' (sudden plummets of price) due to unexpected news, whether bad or good. So the investor plays the odds by favoring stocks in which increasing volume supports past and future price rises. Volume equals participation, but also power and thrust.

Recall my posts, especially the initial one, that argued for Green Mountain Coffee/GMCR. I showed that volume increased alongside the increasing share price. Something big was about to happen, despite the huge price move the stock had already enjoyed. Thus, volume qualifies as a tell-tale. Volume does not behave in a vacuum; both Green Mountain/GMCR and Google/GOOG could yet surprise investors, despite their recent volume trends.

Trend and area patterns qualify as two more of my 4 Horsemen of visual analysis. Within any trend (or continuum), stocks (always) oscillate, and those oscillations could take on the form and shape of wild but random swings or areas of price congestion (area patterns) -- even within a primary (major) up trend. Can a knowledge of past patterns and trends drive expectations? I think so, and thus base much of my market perceptions on this experiential understanding.

The stock, shown in the chart below, was a big winner; at least until recently. The most recent negative price action has not soured its longer term rising trend, though; in fact, I believe the stock merely enters into a short to intermediate term base, while it consolidates its breakout from its primary (or major) base.

Note first the double bottom made in October and November of 2008, which shows retrospectively what I shared here repeatedly then of increasing signs of bullish behavior -- amid the deafening cries of Armaggedon. Then comes the powerful 5 month up trend that runs to $50 from $18... and breaks above its all time highs at ~$40. (See chart below.)

Note how, in the chart above, the recent decline registers as barely a speed bump to date) in the profoundly bullish 6 1/2 year area pattern (ascending triangle) and base.

Talk about opportunity. Here is a stock that qualifies as a leader: it rises in advance of the general market, its price:volume trends match the ideal (volume expands with a rising price and contracts with a declining price), and whose recent price decline comes right on schedule. This all (and more) only serves to hang bullish threads on a vividly positive tapestry.

I continue to own the stock shown in the two charts above because of my expectations for its future trend action; more precisely, the resumption of its long term up trend. In fact, I likely will buy more shares at an opportune moment that I expect will occur soon. (I perceive the thesis to measure trends and patterns by time rather than price to be a fascinating, and profitable, perspective. Unfortunately no interest materialized for this topic.) Of course, I will give this or any stock only so much rope before I cut the cord to prevent that 'rope' from becoming a noose.

Three months into an intermediate term rally, and by now investors everywhere realize that it is better to perceive market trends with objective measures, not as a monolith; monolithic advances and declines are exceedingly rare. The Great Panic of 2008 (my term) was over almost as quickly as its onset was 'sudden'; it endured for even less time than this most recent up trend.

In the end, though, an investor really knows nothing in advance; he or she can only plays the odds. Unlike gambling, however, the investor can and should control the favorable outcome.

Full Disclosure: Long Google/GOOG, Green Mountain Coffee Roasters/GMCR, and the other stocks alluded to in the included charts and discussion.
-- David M Gordon / The Deipnosophist