Wednesday, January 31, 2007

This Economic Porridge Is Just Right

Not too hot, not too cold but just right. It appears the economic porridge is just right with the release of 3.5% GDP growth in the fourth quarter. I just turned on tout TV to see Google's earnings and the wonderful Maria Bartiromo told us that this is the "Goldilocks" economy and Wall Street was rewarding an economy that was "just right".

The next time you turn on CNBC and someone is giving you their insight, ask yourself a question. Ask yourself what qualifications do they have on a particular topic. You don't have to be an expert to spot an expert. Think up your own questions. Let's look at an example. If they are talking about the semiconductor industry, is the person an executive in that industry? A former executive? Do they have a firm understanding of the semiconductor cycle? Do they understand where we are in that cycle? If not, do they have a technology background which might allow them to predict future trends in innovation? Are they quoting facts derived from channel checks? Have they talked to senior economists working for large semiconductor companies to get a pulse for business? Have they validated supply & demand which so significantly affects profits and pricing? etc, etc, etc. Or, are they simply a general talking head of Wall Street giving you a line of bull?

Back to "just right". Why are many industrial and transportation companies reporting growth is slowing? Given the January Chicago purchasing manager's index showed clear economic contraction for the first time in nearly four years, I'd say something doesn't add up. Could it be the porridge is too cold? Could it be that oil dropped because global demand is dropping? Could it be the Middle Eastern exchanges were crushed because of such a silly reason? It was recently announced global demand for oil dropped significantly amongst OECD nations for the first time in over twenty years. Is that a sign of growth? The last time it dropped albeit not significantly? 2002. Are we seeing the economic impact of substitution so rapidly? Do you drive a biofuels car? Hardly.

The glorious Wall Street machine has priced cyclicals and finance companies to perfection under the assumption the Fed will save the economy. Cyclicals had the highest concentration of lowered earnings guidance of any industry yet they are all at or near cycle highs. Likely not because earnings are great but because Wall Street is anticipating a rate cut. One guest this evening told us the broad market is 25% undervalued. Really? Now, money management and quant firm GMO tells us the broad small cap index will likely have a negative seven year return from here. That either portends a serious correction in the broad market or a serious rise in the broad market. Someone is seriously wrong and someone is seriously right. So, which is it? One of the most well respected money management firms globally with $140 billion in assets. The same firm which became bearish on equities before the 2000 crash. Or some "expert" on CNBC? As you can see, I have no bias and value all opinions regardless of how foolish they are. Remind me to re-allocate my portfolio to 100% small cap exposure.

Now, I wrote on here that manufacturing output was going to suffer in early 2007 because Ford & GM were telling us they were cutting first quarter production significantly. Nothing brilliant. Just common sense from what they told us months ago. Today, Ford made tentative projections of first quarter sales to be down 20%. With such high fix costs, Ford has to quickly rationalize their manufacturing base or bleed untold billions more. Because of this we are seeing massive layoffs in auto related industries. The propaganda machine will tell you manufacturing doesn't matter. But, it is still the biggest contributor to private gross output in the U.S.. Manufacturing remains a monstrous driver of wealth, innovation and employment in all economies. During a recent trip to Detroit, I was amazed at how downtown looked like the remains of World War III. Dozens of abandoned skyscrapers and nary a small business in the store fronts. Chicago's PMI is a telling sign of manufacturing weakness which is sure to spread. How far and how fast does it spread? Well, we'll get a national update tomorrow with the ISM numbers release. In the mean time, eat your porridge before it gets too cold.
posted by TimingLogic at 3:21 PM

Google Earnings

Click on the chart for a larger view. Courtesy of the great

Tonight comes Google's earnings. Looking at the open interest and volume on the options profile, it appears more than a few people are betting big that earnings will be good. Historically, those people have been rewarded handsomely. I consider it gambling but alot of people make money at it. Or, so we are told. I wonder how many don't make money that the marketing machine doesn't tell us about. I'm sure it is the majority. If the stock moves higher off of earnings, I would guesstimate a target of about $570. Simple enough to calculate. Recent pattern high of about $515 minus recent pattern low of about $460 added to pattern high. That would also Google's market capitalization at around $180 billion. Whew! Moving close to 20x sales.

The Google bulls have alot of pushing to do if they are going to get a pay off for their options bets. So far in after hours trading, Google is down about seven bucks.
posted by TimingLogic at 9:24 AM

Tuesday, January 30, 2007

A Rant On Markets, Industrialization, The Finance Industry And The Free Lunch Theory

This is a free form post without alot of preparation so I'll likely be all over the map. It's amazing to me that those expecting that we have cheated a bear market are seemingly without any concern for risk. The Bloomberg article link I referenced pretty much echos Wall Street's consensus of a blase attitude. I find blase a perfect word for this environment. One definition of blase is uninterested due to frequent exposure. The great deceiver is working its magic. Lulling people into a false sense of security. Of course, that's nothing new. I find a quote from the incredibly wise god of knowledge, John Galbraith, is very appropriate at this time in the cycle.

One of the things you must understand about 1929 and the antecedent years, as about any speculative episode, is the danger... in attributing intelligence to the simple fact that people are associated with large sums of money or large financial operations. We don't ask whether they're intelligent. We say, they're associated with all this money, so they must be intelligent. We attribute intelligence to association with financial operations. And only afterwards do we discover that error and that the people involved can be extremely successful in gulling themselves. That they can be in effect, and I use the word advisedly, marvelously stupid.

I used to be quite an optimist... I thought that by keeping the memory of the 1929 crash alive we would have a warning against the kind of feckless, fatuous optimism which caused people to get in and shove up the markets and shove it up more and get carried away by the illusion of ever-increasing wealth. I've given up on that hope because we've had it happen too often again since.

-- John Kenneth Galbraith

It's pretty clear what Galbraith is saying: most people on Wall Street don't get it to put it mildly. The human condition is alive and well. It has found a permanent home amongst us. Is that such a shock? I'm sure most of you have heard of Pareto's Principal more commonly called the 80-20 rule. I take a liberal interpretation and apply it to most everything in life.

20% of my time is most productive where I accomplish 80% of my work.
20% of clients provide 80% of profits for most companies
20% of information is relevant and 80% is worthless
20% of people are really good at what they do and 80% are at best average
20% of one particular item comprises 80% of my overeating. ie, Chocolate chip cookies.

Ok, I don't know any of those to be true but it sounded good. But, it's not hard for me to believe many on Wall Street are, well OK Galbraith said it. Why do people give deference to Wall Street professionals? I suspect it's a little bit of human nature and it's a little of of the good old boys club. And, the club has attempted to keep the general public in a state of bliss. Ignorant bliss that is. As humans, we tend to promote people beyond their level of competence. Yes, the Peter Principal absolutely exists as a societal phenomenon as well. I've heard so much baloney from supposed "experts" in many fields that I tend to be from Missouri. In other words, prove it. I'm not sure if science teaches one to be dubious or if dubious personality types chose science because within it lies an attempt at deducing plausibility. I tend to think there are quite a few personality types and professional disciplines, not just science, which encourage one's ability to find clarity. Might I add, MBAs so commonly coveted on Wall Street, isn't one of them. As Jim Simons, possibly the greatest quantitative investor and hedge fund manager ever, is famous for stating, "We don't hire MBAs." Now I'm not slamming MBAs because I've thought from time to time of getting mine. Although it isn't because I felt like I would achieve prajna by doing so. It was because certain fields covet MBAs and it might help me get to where I wanted to go in the game of business. Although, I'm not sure where I want to go anymore. About all I do know is that I want to head to Krogers and take advantage of their Super Bowl special on Chips Ahoy! cookies.

So back to equity markets. This recent rally was really odd. Many characteristics, if taken at face value, are very worrisome. Remember, investing in equity markets is a battle. That implies investors are facing an enemy. And, they surely are. The smart money is always telling the dumb money how great an investment is right at the time they are looking to offload their shares. Those unwilling or unable to see the markets in such a light will always be fleeced by market participants who are more sophisticated. For that reason, what I see makes me very cautious of the market's deceptive cunning.

A brilliant market maven from nearly a century gone past once said the direction of the market could not be manipulated but the extent of the trend could. After seeing stock action in the late 1990s, commodities and certain equities today, including the recent post where I highlighted the insanity of Chinese and Russian equities, I'm starting to believe the markets are moved by the modern day equivalent of stock pools. Stock pools were a legal way of collaborating amongst traders to drive investments to astronomical levels in the 1920s. In other words, the historical equivalent of massive trading firms such as Goldman, Morgan Stanley, Merrill and other top hedge funds could sit around a table and effectively decide what they were going to invest in and then go jam the price to the moon and do it legally. The benefit is that they could create a frenzy, suck in other investors via the wonderful emotion of greed and all share in its profits before dumping. Hard to believe it, but yes it was legal. In hindsight there are those who say stock pools didn't hurt individual investors. Some have even written papers defending such statements but that's completely absurd. I give those making such an argument the "Big Baloney" award. When those same pools were liquidating into the hands of Ma and Pa American in 1929, how can you defend such a practice? Eventually, the government saw through this and the Securities Act outlawed stock pools post 1929. But, where there is a will, there is a way and that leads us to today.

How does one create volatility in an environment of low volatility? Pump up trading returns? By collaboratively attempting to invest in the same assets as other big money players. In other words, hot money following hot money. So, while I have no reason to believe such collaboration takes place on a personal level, there is absolutely no doubt in my mind that quantitative methods, algorithmic trading and extreme amounts of liquidity have recreated a similar environment to the stock pools of yore. If I'm hedge fund or professional trading firm, I can measure what other large trading firms are doing and follow suit in the same spirit as stock pools operated. And, I can do it legally. What has that left us with? Extreme volatility where the big money roams. Commodities, commodity related stocks, small caps, transports and many of the market leaders I've written about. Now, I'm a firm believer in history. That leads me to believe the greater the bull market, the greater the bear market. Because of this insanity, I'm more confident than ever we will have a very serious correction in global equities. The insanity of valuations and rapid price rises are no different today than heading into 2000. I've talked about the cyclicality of earnings and the unsustainability of such cyclicality. That means the S&P PE of about 18 is extremely misleading. And, many other valuation metrics of equities are frightening to me. I wonder if a serious selloff caused by this type of action could create an economic calamity by itself. In other words, a self fulfilling prophecy of reduced asset wealth causing reduced spending which eventually reduces the wealth of the sum whole. Or, better known as the Paradox of Thrift I have written about either here or elsewhere. Such an event would have global implications.

I am a firm believer there are many incomprehensible factors that drive stocks. I don't buy the Random Walk theory at all. That implies human behavior is random. So, has your behavior today been random? I mean truly random. Do you string together random words in your line of thought? Bob jello run accomplish fun computer candle? Of course not. Another "Big Baloney" award. Those calling for a 10% correction simply don't understand markets. Or maybe if they work on Wall Street, they fear losing investors by being bearish as many were and did in 2000. Were and did meaning were bearish and did lose a tremendous amount of investors. If you are a major investment firm and you lose hundreds of billions in assets by stating your bearishness, you lose a guaranteed income stream of management fees totaling billions of dollars annually. Even if you are a smaller firm, the losses could be devastating. In other words, are certain organizations more interested in keeping investment funds flowing into their coffers and guaranteeing their own success at the expense of other's life savings? A sad question but one can compartmentalize when it is convenient. Now, I have no specific evidence or certainty of any such action and I have no idea if such an act would ever happen. I am simply saying it is plausible. In other words, if I can see such risks, are you telling me a legion of professionals cannot? Or is Galbraith right? Someone has to be right on this topic.

When will a serious drop happen? That's the big question. Well, I was quite confident in the May 2006 high with a dripping fall from late 2007 to October of 2007. Or put another way, 1488 days from the bull market beginning till a drop started in earnest. That would have been November of 2006 as I wrote about last year. To date, as it pertains to commodities, small caps, technology, transports and many international markets, that peak has held. But, obviously, my time frame is wrong because the only major international markets which are down are in the Middle East. The problem we now experience is that central banker's ability to goose the economy is limited. The velocity of corporate money is just about squat as I've said on here time and again. But, that doesn't mean asset prices will collapse tomorrow. They almost certainly will correct at some point. Failure to recognize this means you believe in the "free lunch theory". Now seriously, how many times have you had a free lunch?

Let's do a brief reminder here. On a historical note, one must remember a massive rally was had during the Great Depression. And, I do mean massive. Well beyond anything post 2000. To the tune of 400% versus the rally of less than 100% we've seen this cycle. In addition, corporate earnings in the 1970s were greater than the 1990s yet stocks suffered murderous and frequent declines. I'll say it for the hundredth time, the stock market is not the economy. People blathering that global growth is great and therefore equities will continue higher are clueless. The last time we had such a long period of synchronized global growth, it was followed by what many called the second Great Depression in the U.S. More baloney.

There is no doubt my original cycles work was flawed in some way. Gee, what a surprise. My quantitative models are very accurate at determining risk but cycles are more of mysticism and, frankly, educated guessing. I don't mean the dreaded four year cycle or other commonly mentioned cycles either. Those are wrong too often and are too obvious. Hence, why I never write of them nor called for a bottom in 2006 as everyone on Wall Street did. Now they are calling for a four year cycle bottom in year five? Huh? Did I miss that math class? Let's back up. Nothing at all has changed in the cycle analysis except the ultimate finality which I expected to be in November. The same macro events are unfolding but haven't unfolded. We've also exceeded any upside target on the S&P which I placed at 1360-1400. I was quite dubious we'd actually even make new highs post May but we have.

Last year I amended my estimated timing for a top to be near the end of the first quarter of 2007. Maybe that will happen and maybe it won't. What one is attempting to do by predicting cycle tops is basically predicting the future. If I could do that, I would be lying on a beach on the South Pacific with every winning lottery ticket. Before the bulls gloat they should think about one fact. If all is well, why have stock market returns in the U.S. been awful comparatively? It has nothing to do with the U.S. headed for the dung heap or the Red Army taking over the world. It is because U.S. assets are still overpriced coupled with many macro issues at hand. Of all bull market advances of any significance since 1900, this qualifies as one of the weakest as measured as a function of time. (Extra points for anyone who can derive a time function of historical bull market returns. It's too damn time consuming to consider, but I'd love to see it if anyone else has done so.) So, while we have had a long bull market, it has been incredibly weak sans commodities. One could take that fact optimistically and say we have alot further to advance but the probabilities of that statement are not in your favor. In fact, they aren't even close to being in your favor. More upside? Maybe. But a big picture explanation which is more plausible is that after five years, we have only be able to make minimal upside movement and that should be an extremely ominous warning sign. After the impulse rally in 2003, the major average returns are awful. Many believe the bears have been gored by the bulls and most reasonable experts have reduced their call for any correction to 10%. I believe a bloody and lengthy decline is still in the cards. Remember, the market is the great deceiver. It is extremely cunning and failure to respect it almost always leads to financial ruin.

Along the same line of thought, it is interesting that a recent BusinessWeek has a short blurb about financial industry insiders selling options and stock at a frenetic pace. This isn't a minor slice of the finance industry but a study of over 1,000 companies as I recall. Remember my post last year where I said the finance industry was peaking? And, how I am personally steering clear of finance companies as an investment? Now, that has not come to pass but it's ironic how that statement is now being backed up by what appears to be extremely bearish behavior by finance industry executives. While stock buy backs aren't a sign of future returns in many situations, mass selling across an entire industry taken in context of the current cycle should not be interpreted as "general diversification" of their portfolios as the press constantly blathers. More baloney. Remember my post in the summer of last year where I noted insiders were selling at a frenetic pace in the oil industry? That coupled with my quantitative analysis meant much lower energy prices regardless of what the "experts" were saying. Any Peak Oilers ever expect to see $50 oil again? Before I kick the bucket, we will see $15 oil again.

I find it interesting that the finance industry is likely topping right about the time when some delirious Wall Street types have actually said manufacturing doesn't matter anymore. More baloney. So much baloney, they've likely pegged that statement at the peak of their industry and a trough in industrialization. When I say trough, I mean some time in the not too distant years, not literally today. Some in the financial press and on Wall Street have even gone so far as saying we should move our remaining manufacturing to China. Good God, Wall Street never ceases to amaze me with their brilliance. And what qualifications do they have to say we should move all manufacturing overseas? Do you know what that statement says? Manufacturing is not a differentiator. Manufacturing technology is not a competitive advantage. Manufacturing adds no innovation or competitive advantage to a business. Manufacturing is only about how little you can pay someone to build something. The Wall Street economy of pushing around paper is the future of human industriousness. That is so goddamn stupid I can't believe I am even writing about it. I might also add in that same vein the U.S. is still the dominant manufacturing powerhouse globally. Manufacturing output in the U.S. is at record levels and while employment is down in manufacturing, it's down in every country. I even read where it is down in China. That's called productivity and should be expected. Some day we might not have anyone working in certain manufacturing sectors. But, that doesn't mean manufacturing won't be a powerhouse industry or those sectors won't still be manufacturing yet doing so with entirely automated factory floors. In fact, that will be the day when shipping jobs overseas for even the most mundane manufacturing tasks has zero ROI and manufacturing will be done locally to support end markets. In other words, all mundane, highly human capital intensive manufacturing that has gone overseas will come back to the U.S. I mean really. What the hell does Wall Street know about making anything? If you want to talk about making something, talk to Toyota, P&G, Boeing, Intel, BASF, Amgen, Siemens, DuPont, Hitachi or Caterpillar. Wall Street pushes around paper for a living. How does what they do add to the industriousness or advancement of humanity? How does that make them an expert in manufacturing or most anything else? (Now, I must preface this by saying I am not lumping everyone in the finance industry into this statement. I'm talking about the propaganda machine we call Wall Street.)

I spent two hours this weekend running through some calculations and I keep coming up with 2,732 days from the 2000 peak as a new time series for an new end to this bull market. That is September of 2007 if I calculated correctly. Of course, it is done using a Ouija Board and any real decline of declines could start pronto. But, I doubt it. Any declines we see now will likely be followed by subsequent rallies. The fly in the ointment is the Chinese and Russian equity markets. They are screaming absolute tops are near. I suppose money could continue to flow into American and European investments through September thus propping up asset prices. If that happens and developing markets don't follow suite, we will likely see a strengthening dollar along with it. How far American and European markets can rise is debatable. Small caps in particular are extremely overvalued. People think they will have time to react to any decline and they may. But, in 1998 small caps fell nearly 40% and it happened very quickly. Not days but people usually react to their investments by waiting. They see stocks going back up in prior dips over a cycle and expect it to happen again. So, by the time the pain is severe enough, they are usually selling near the bottom. That said, one needs to remind themselves that markets can go higher and lower than makes rational sense. In that same theme, it's interesting to me that Wall Street is so enthusiastic with the 2006 rally. The S&P is a few percentage points above the May 2006 high and most every other index is right at the May 2006 highs. Yet, this recent rally has people enthusiastic. About what? A zero percent return and extreme risk since May? More baloney. Risk adjusted returns in the U.S. equity markets are pathetic. The market is playing tricks with their minds. Fear of being left behind is deceiving them.

I hate to sound so, well, bearish, but I see nothing to convince me that we are able to escape an asset repricing. As a little bit of sanity checking, I arbitrarily went back to look at equity prices in the 1950s. A time of great prosperity and innovation for Americans with minimal global competition which should be reflected in equity valuations. Today we hear about how cheap the markets are. More baloney. Most industries had a PE of less than 10 during the 1950s. Transports had a PE of about 4 for years. Transports have been run off of a cliff this cycle. Let's just say the PE isn't 4. Yeah, yeah. Chinese imports, high energy prices driving transports, blah, blah, blah. Industries with the highest PEs appear to be tobacco and oil from what I looked at. The reason? Investors were willing to discount future earnings as relatively guaranteed. Isn't that almost funny? Today, we buy Google at a price to book of 11 and a price to sales of 16 and a PE of 70 with no dividend. You or someone like you is willing to pay for 70 years worth of earnings and get paid nothing other than stock appreciation to own a glorified search engine. A technology that has been around as long as half of the readers of this blog. I don't care if people are willing to drive Google to 1,000. That just means people are insanely foolish or momentum traders are on a pump and dump mission where the retail investor would be left holding the bag.

With that, happy trails!
posted by TimingLogic at 8:47 AM

Monday, January 29, 2007

The Perfect Set Up. Let's All Go To Davos.

I was readying another post and saw the Bloomberg article, Davos Elite Rebuff Risk Warnings. It is simply a perfect introduction. I get a chuckle out of this annual event. I'd love to go to see what they actually talk about. It's an odd event bringing together the most unusual of bedfellows in the who's who world of elitists. Brad Pitt, Angelina Jolie & Bono sprinkled in with the world's self important government and business types. "Brad, might you advise us on how we ....."

They all gather to contemplate the future of mankind but nothing substantive ever comes of it. In other words, a goat rodeo. Hopefully, they'll find the time to share some profound insights in between their foie gras crepes and baked goat cheese with raspberry coulis. I suspect what they ought to be serving is a big plate of baloney or bologna. One of the two.

You've got to read this before my next post so there will be a little delay.
posted by TimingLogic at 3:19 PM

Thursday, January 25, 2007

Wall Street's Exhuberance In Chart Form

Nasdaq 100 ETF from the start of this rally in black. A measurement of big market buyers in red. A lull before a move higher? A sign of things to come? A sign that the Three Bears are about to eat Goldilocks? A temporary top in progress? A December lull? A bull market top developing? An illusion? Nothing to worry about? Let's watch and see. Maybe they'll surprise me.

I wonder if now would be a good time to buy some of those Chinese and Russian equities blowing upward with pure insanity? "You've got to ask yourself one question: Do I feel lucky? Well, do ya punk?"

posted by TimingLogic at 8:12 PM

Tuesday, January 23, 2007

Need I Remind Anyone This Is A Dangerous Market?

Update on Wednesday
Be honest. How many of you thought today would be a down day based on yesterday's chart? If you thought today would be down, you didn't think very hard. Where did I say it would be a down day? One person got it right. I posted the original chart at 5pm yesterday. The futures market had already popped significantly in after hours pointing to a high probability up day. In addition the S&P was still in an uptrend on the intraday chart and S&P buying pressure was increasing. Smart traders follow the S&P. The selloff in the Nasdaq at the end of yesterday was very weak. In addition, every single time in the last year buying pressure had reached this level of oversold, we had a rally even if it was a few days. A commonly used and readily available data point, RSI(5), was below 30 nearly guaranteeing a rally in an uptrending market. Down 5% in a week? That's a drop to zero in a month. The market is a deceiver and I might be as well. In order to beat the market, you need to free your mind and think.

Original Post
Ok, I said it would be the end of the week or next week before my next post but I had just a few minutes here so I'm going to put up a telling chart in the interim.

The tone of the market has changed significantly starting in late October. In fact, the tone has changed more than one could begin to imagine looking at generally available data. Now, this situation has happened before. Two times I've seen this same situation occur were mid way through 2003 before an assault on new highs and the other time was at the peak in 2000. This could be a repeat of either situation or neither situation. And, since I don't give investment advice or share my proprietary work, I'm going to refrain from giving commentary on what is happening. But, I will give you something to think about.

Below is a chart of the Nasdaq 100 ETF. It is the first time I've thrown up an intraday chart and you won't see this too often as I focus on the long term. Overlaid on the chart is the buying pressure calculation I've referenced on daily charts. As you can clearly see, it was screaming sell well before the recent market dump. I thought the bulls would respond given some data points I was seeing in the futures market but they didn't. Not only is the direction of buying pressure important but so is the expansion or velocity. In other words, the extremely weak rise on the 19th and today likely means only retail investors and the medium & small investment firms are participating in these failed rallies while big money is dumping. The cumulative buying pressure of the underlying Nasdaq 100 stocks, which isn't on the chart, is showing similar weakness. Hence there are no large buyers in the ETF and there are no large buyers in the underlying stocks.

This doesn't mean the stock market is going to zero tomorrow. But, remember this is a dangerous market. The Nasdaq 100 is down almost 5% in a week. This is a sign of increased volatility I said would come to pass. With oil all over the map the last two days and gold following today, we can expect all markets to chop up the inexperienced investor and a few experienced ones as well.

By the way, who ever said you couldn't predict the future? If you would have looked at this chart on the 16th, where would you say a high probability move would be? Up or down? Based on this chart, what is the probability of tomorrow's action? Now, I'll preface this by saying intraday movements sometimes whipsaw but more often than not, they don't.

posted by TimingLogic at 4:56 PM

Monday, January 22, 2007

I'm Not Dead Yet!

Much to the chagrin of many, I'm still alive. I will be out for the better part of this week so posting will likely resume later this week or early next week. Have a great week.
posted by TimingLogic at 9:09 AM

Friday, January 19, 2007

U.S. Consumer Confidence At Three Year High

The University of Michigan consumer confidence survey has reported the highest reading in three years. Does this vindicate a bullish consensus on the economy and the stock market? Well, first the two aren't the same as we've witnessed many times in the past. Second, the last time the survey showed such a positive reading was January of 2004. While the economy was strong at the time, the equity markets were making a major intermediate term top in January of 2004. Historically consumer confidence is very limited in it's "usability" except at extremes. What happened after January of 2004? The semiconductor stocks fell by one third and still have not retaken their January of 2004 price to the upside three years later. The technology laden Nasdaq fell about twenty percent as well. As I've stated on here time and again, sentiment is a tricky indicator best used by professional traders as confirmation. With unemployment at less than 5%, oil dropping and the stock markets at multi-year highs, what would one expect of consumer confidence? It would be strong just like Wall Street sentiment I talked about a few days ago. What does that mean about the future? Well, as January of 2004 points out, it means nothing. If oil were $80 a barrel and the stock market was down 20%, where would one expect consumer confidence? To be down of course. Consumer sentiment is, at best, a coincident data point of economic and/or investment returns.
posted by TimingLogic at 11:40 AM

Thursday, January 18, 2007

An Ode To A Bullish Wall Street

Wall Street, Oh Wall Street, will you ever learn
As the economy starts to take a turn
Stocks are one asset class we should all spurn
But before we do so, there will likely be much more churn
Then we'll witness the typical Wall Street crash and burn

Ok, that was awful. I liked the title so I had to take my shot at poetic fame. Does my work follow iambic pentameter? It looks like I'm about to get a thumb in the eye for posting this as the market appears to be headed for a big up day. It's only 9 AM, so we have to see how it unfolds. Back to the post.

A recent
Bloomberg story highlighted the overwhelmingly bullish sentiment on Wall Street. Such a group consensus deserves to be recognized for its historical brilliance. As Bloomberg points out, the last time Wall Street consensus was bullish, we entered a recession and the markets fell off of a cliff. That year? 2001. In order to celebrate this year's consensus, I think it is appropriate to break out the Wall Street Opinionator commentary from those glorious days.

If you don't read Paul Farrell's commentary, you should. It's sardonic and informative. My type of journalism. I consider Paul the poor man's Alan Abelson. In other words, you don't need a Barron's paid subscription to read similar views on Wall Street gibberish. Below are quotes taken directly from Paul's write-up titled "B.S. Is Wall Street's Official Language."
If your favorite market opinionator is in the list below, you might ask for a refund. Enjoy!

March 1999: Harry S. Dent, author of The Roaring 2000s
"There has been a paradigm shift." (Translation: "This time it's different, a New Economy!")

October 1999: James Glassman, author Dow 36,000
"What is dangerous is for Americans not to be in the market. We're going to reach a point where stocks are correctly priced, and we think that's 36,000 ... It's not a bubble. Far from it. The stock market is undervalued." (Warning, don't choke on your popcorn!)

December 1999: Joseph Battipaglia, market analyst
"Some fear a burst Internet bubble, but our analysis shows that Internet companies account for only 7% of the overall Nasdaq market cap but carry expected long-term growth rates twice those of other rapidly growing segments within tech." (The Internet Index lost two-thirds in the next six months.)

December 1999: Larry Wachtel, Prudential
"Most of these stocks are reasonably priced. There's not reason for them to correct violently in the year 2000." (Fact: The Nasdaq lost 50% in 2000.)

December 1999: Ralph Acampora, Prudential Securities
"I'm not saying this is a straight line up. I'm not saying you can't have pauses. I'm saying any kind of declines, buy them!" (He also predicted a 14,000 Dow by the end of 2000 and an 11-year bull.)

February 2000: Larry Kudlow, CNBC commentator
"This correction will run its course until the middle of the year. Then things will pick up again, because not even Greenspan can stop the Internet economy." (He's still an economist, hosting his own show.)

April 2000: Myron Kandel, CNN
"The bottom line is, before the end of the year, the Nasdaq and Dow will be at new record highs." (Later in September he predicted a rally to 12,000 by election day.)

September 2000: Jim Cramer, CNBC commentator
"SUNW probably has the best near-term outlook of any company I know." (Within four months Sun Microsystems went from $60 to $30, down to $10 in a year, below $3 in two years.)

November 2000: Louis Rukeyser on CNN
"Over the next year or two [the stock market] will be higher, and I know over the next five to 10 years it will be higher." (We crashed, fell into a recession, and in two years tech lost 70%.)

December 2000: Jeffrey Applegate, Lehman strategist
"The bulk of the correction is behind us, so now is the time to be offensive, not defensive." (That's a sucker's rally.)

December 2000: Fed Chairman Alan Greenspan
"The three- to five-year earnings projections of more than a thousand analysts, though exhibiting some signs of flattening in recent months, have generally held firm. Such expectations, should they persist, bode well for continued capital deepening and sustained growth." (And the curtain opened revealing the Wonderful Wizard of Oz.!)

January 2001: Suze Orman, financial guru
"In the low 60s here, I think the QQQ, they're a buy. They may go down, but if you dollar-cost average, where you put money every single month into them, I think, in the long run, it's the way to play the Nasdaq." (The QQQ fell 60% further.)

March 2001: Maria Bartiromo, CNBC anchor
"The individual out there is actually not throwing money at things that they do not understand, and is actually using the news and using the information out there to make smart decisions." (Yes, she's serious.)

April 2001: Abby Joseph Cohen, Goldman Sachs
"The time to be nervous was a year ago. The S&P then was overvalued, it's now undervalued." (Unfortunately, the markets continued down for another 18 months).

August 2001: Lou Dobbs, CNN
"Let me make it very clear. I'm a bull, on the market, on the economy. And let me repeat, I am a bull." (Within a year the Dow and Nasdaq lost a third more).

June 2002: Larry Kudlow, CNBC
"The shock therapy of decisive war will elevate the stock market by a couple thousand points." (He also predicted the Dow would hit 35,000 by 2010.)
posted by TimingLogic at 8:39 AM

Tuesday, January 16, 2007

Empire Manufacturing Survey Released Today

The Fed's Empire State Manufacturing survey came in at less than half of expectations today. It's interesting to see inventories continuing to drop. I take that to mean companies are not willing to push product through the system and build inventories. But, then why would one doubt that? As I've said before, the U.S. CEO business surveys are not positive.

It's also interesting to note that a gauge of future inflation I follow, a variation on TIPS, is reporting the highest concern of inflation in nearly two and one half years. Will that trend continue? So, does the Fed cut rates if inflation expectations rise with a slowing economy? What would that do to housing?

Finally, as many of you know, Symantec purchased Veritas some time ago. Veritas is a leader in enterprise data and storage management solutions. Symantec reported weaker than expected results in their corporate IT business. Without digging into the numbers, I would assume Veritas is the culprit. That is on top of SAP's weak results and negative business rumblings out of Oracle. Yet, traders continue to push up EMC, IBM, HP and other IT related businesses. I've talked about this before. Buy & hold investment managers and those expecting a soft landing are rotating into early cycle stocks. Yet, as I have said, I believe doing so is a trap. All of this contributes to something I am confident will happen this year: a rise in volatility.
posted by TimingLogic at 8:37 AM

Monday, January 15, 2007

Denial Ain't Just A River In Egypt

I'm not as focused on the global housing and real estate situation as many bloggers are. We've got alot of inflated asset classes and I'm more focused on the cause, what central bankers are going to do about it and the end state. Yet, it's a good time to update this topic given the crescendo calling for a housing bottom is increasing again. There is no evidence that any such bottom is developing. Home builders are reporting no positive news, unsold home volumes are not shrinking, home sales are falling and building rates are still well above trend. To boot, I just saw what appears to be a weekly television show that focused on real estate flipping. If real estate prices and activity wasn't so far above trend, that wouldn't concern me. But, they are. Therefore, why would this situation be any different than equities being well above trend post 2000? In 2001 we had a plethora of Wall Street experts telling us the markets were undervalued and the correction was over. That was hilarious. Stocks were cheaper in 2001. Rather than being the most overvalued in one hundred years as in 2000, they were the second most overvalued in one hundred years. Many of those same people are now telling us housing has bottomed. There are many measures of activity which argue the real estate situation didn't even peak until mid-2006 although by then home builder stocks were decimated. So, how is it we've hit a bottom through a few months of negative fundamentals? The world is a reflection of irrational human emotion and those calling a bottom are manifesting the good old fashioned emotion of denial.

There are many ways to determine the strength of housing including fundamentals, equity price behavior and historical trends. One fact I find interesting is that the annual sales rate for new homes in 2005 was 1.28 million units. This number varies depending on what is measured. I've seen much higher numbers but I am using an analysis done using comparative historical numbers. So, it's the comparative I am looking at. In the 1993-1995 time frame, the average annual sales rate was 670,000 units using this same data provider. The long term trend in housing is highly correlated to new household creation. Did the U.S. some how double the number of households in ten years? The condominium data set is absolutely horrific. I've read order rates for a particular Miami condominium developer were down somewhere in the range of 80% in the fourth quarter of 2006. All of this at a time when building in that market is still off the charts.

If we are to return to trend, I suspect 1993-1995 data is most reasonable. In other words, the annual sales rate could drop by approximately 50% to reach a sustainable trend. The housing market post 1995 was fueled, in part, by perceived wealth creation in the late 1990s equities explosion. Therefore, it's plausible data for those years would also be above trend and unsustainable. It should also be noted that long term rates dropped about 50% from mid 1994 to 1999 as well. This surely fueled overbuilding in a time when perceived wealth was exploding in the stock market.

I chose the Mark Twain quote as the title of this post for a reason. You've likely seen a similar chart to the one below as variations of the investment cycle have been around forever. Where do you think we are in the housing wave? Exhaustion? Is there panic running rampant? Does panic need to be running rampant for housing to bottom? Maybe not. I suspect we are in the denial phase. ie, The true scope has actually yet to unfold. I've said it once and I've said it one hundred times, it's all about risk management. Regardless of what happens, is risk in your favor in real estate, equities, other investments? That is the key question to always ask yourself regardless of what anyone tells you.

A few days ago I was given some statistics of November Florida home sales. Again, these may be different than those you might have access to but are provided by the chief economist of a large title company.

Here's a few of the worst statistics:
Daytona Beach: -37%
Fort Pierce: -34%
Fort Walton Beach: -37%
Lakeland: -36%
Naples: -45%
Orlando: -36%
Tampa-St. Petersburg: -43%
West Palm-Boca Raton: -45%

With real estate activity so far above trend for many years, I'll feel confident real estate has become a great value when the human emotions of realtors and market professionals ranges from despondency to depression. Do people feel despondency with sales off this much? No. The reported price change for these markets was still positive for some and down less than ten percent as an average. Denial - The act of asserting that something alleged is not true.
posted by TimingLogic at 10:49 AM

Friday, January 12, 2007

A 500 Miles Per Gallon Automobile Here Today?

GM has been stealing the thunder from all of their competitors recently. Auto & Truck of the year, announcement of the first plug-in hybrid anticipated to get 70 miles per gallon, the Cadillac CTS expected to win the most important new car introduction at the North American Auto Show and an electromotive auto concept. As an aside, we are going to talk about turnaround stories later this year.

I would encourage you to watch this 18 minute video with Bob Lutz, the vice chairman and head of product development at GM. The Volt is not a hybrid. This is electromotive technology pioneered by GM's electromotive unit decades ago and is the basis for modern railroad locomotion. In other words, it's source of power to the wheels is always electricity. This is proven technology. Actually, somewhat ancient by technology standards although I'm sure the control system technology is quite current. A brilliant friend of mine who is an engineer for NASA told me that electromotive locomotion is a perfect fit for diesel technology given the high efficiency ratings achieved at constant speed. Hence, the diesel electromotive technology driving the rail system. I suspect this is similar technology to the 330 mile per gallon diesel auto I highlighted many months ago.

Recently Boeing has announced their space solar panel technology achieved nearly 50% efficiency in terrestrial applications. The best of breed right now for solar technology is less than 20% and the average is closer to 10-14% so that appears to be a major advance. How far off is a viable solar electromotive automobile? Traditional automotive sheet panels made of solar panels? In other words a car which runs exclusively on sunlight. You won't be pulling a four ton boat behind you but it may be plausible for a city car concept.

As an aside, I find it ironic GE is attempting to sell its plastics business while recently acquiring petroleum technology businesses. A few years ago Ford showed an auto that was almost completely recycleable and based on biodegradable plastics. More recently Mazda, a Ford subsidiary, has perfected the use of bio plastics technology which is based on corn, is mass produceable and is going into production for auto interiors. Now, I don't sit on the strategy board at GE but I believe we are likely to see a bio composites revolution. Biodegradable PC housing, consumer electronic housing, automotive plastics, consumer packaging, carpeting, home upholstery, etc. Nearly everything made of plastic can and eventually will be biodegradable rather than petroleum based. Why does GE want to sell its plastics powerhouse and move into petroleum businesses? Now, petroleum based products aren't going away but how does this fit with GE's supposed "green" marketing message? Not that I care what GE does as long as they create jobs and innovate.
posted by TimingLogic at 10:14 AM

Wednesday, January 10, 2007

The Cycle Of Volatility Will Return To Equities

First off this is an unusual post for me. You'll understand as you read further. Secondly, the spell checker is on the fritz and so is my brain so this hasn't been edited. One of my recent posts highlighted the volatility in Russian equities. I've also talked repeatedly about the lack of perceived risk and complacency in the system. This is a good time to introduce the next chart. But before I do so, let's talk a little about esoteric or unexplainable phenomenon.

Within a short period of time western culture and science has attempted to erase any form of mysticism or intuition humans have developed over the millennia. Not only do I find this unfortunate but I believe it has left us incomplete. Now, I'm not going to turn this into a philosophical diatribe but how can anyone believe man's knowledge somehow represents some form of truth? I can't recall where I was reading about man's limited intellect but the author posed a question. "Suppose there were a fourth primary color. Can you describe what it would it look like?" Or here's one I enjoy based on some of Einstein's work. What about the possibility of bending time? Can you imagine it? I mean truly imagine it. That the future is accessible as it the past or another plane of time. Or the possibility that time has no beginning and no end. Why would our cycle of birth and death and renewal be any different than what we see around us? What does that mean? Man's imagination is very limited and our cumulative knowledge is infinitesimally small. Yet our arrogance is infinitely large. Here's the true reality. Man has discovered nothing. Truth was here before us and will be here after us. Our theories and sciences are simply attempts at organizing what we can imagine, be it true or false, in a way that allows our very limited intellect to comprehend it and use it for our perceived benefit.

Now, don't get me wrong. You won't find a bigger proponent of science and research than me. My point is that it is tremendously arrogant for man to take our perceptions of what is true, ie science, as fact and discount anything which cannot be explained.

So, where am I going with this? I've posted some general commentary about cycles on here. Things you might be able to figure out on your own. But, the my cycles work, which I haven't posted, came to me in rather unusual circumstances: theories I had never thought of were presented to me in a dream. Now, as I type this, I have to laugh. Why? Because it sounds like I am crazy. Especially since I don't typically remember any dreams nor do I practice any type of mysticism. In other words, my hobbies are football, picking my nose and pizza like every other American guy. (not in that order) But, as much as I wrestled with issues time and again, explanations never came to me. One night I awoke from a dream and it was as clear as could be. I was actually drawing out the theory on a chalk board in my dream. I awoke, grabbed a piece of paper and started writing and drawing as the ideas filled in. In fifteen minutes the entire outline was complete. It was a very unusual experience.

One should never discount ideas or phenomenon they don't understand. One should never assume they have the answers to anything. This is why as we grow older, we lose our creativity of youth. Our learned experiences destroy our ability to think with a clean mind. Our creativity of a child's mind that knows no bounds is lost. It is also one of the significant causes of failed relationships should it be said. (The wrong blog for this one) Many of the world's oldest cultures have a saying that truth is never found in the obvious. How often have you found that to be the case? For me? Almost always. In a society where innovation and creativity play a significant role in economic success, you would be well served to forget nearly everything you know to be true. I might post more on this later in the year as it pertains to innovative cultures both from a business entity and a society.

This line of thought is very applicable to the graphic below. It is a fifteen or so year chart of the VIX. Does anyone believe equity returns can be predicted based on symmetry? That the future is of an investment cycle may have absolutely nothing to do with economics or the Federal Reserve? I'm not saying this is so but why not? Because you were told otherwise? Because you cannot measure it? Symmetry is found all around is in nature. We as humans are a work of symmetry. Left brain and right brain. Symmetrical physiology. On the chart there are four symmetrical major tops identified in the VIX separated by symmetrical lower lows. The 2006 peak in the VIX equidistant from a symmetrical peak in 1994. A recent outside day low in the VIX reaching the lowest level since an outside day low in 1993. The one in 1993 was preceded by higher volatility and therefore one might expect volatility will only increase from here should the past pattern be used to forecast the future. And, what is the axis of symmetry for this entire pattern? That's right. It's the 2000 bubble peak in equities, to the month. Is this explainable? Is it simply a coincidence? Maybe. Yet, I am confident we have seen the low in volatility and the future will be heightened volatility. If so, buckle up because the ride is about to get more intense.

You may click on the graphic for a larger view.
posted by TimingLogic at 3:26 PM

Monday, January 08, 2007

China May Further Reduce Liquidity In Economy

Another interesting article today on Bloomberg regarding China's lack of ability to control their economy. Or, at least, that is my interpretation. I find it the following comments from the Chinese central banking governor rather interesting:

"Various measures taken by the central bank since 2006 have achieved some results in slowing down lending growth in the past few months,'' the People's Bank said, announcing the increase in bank reserve requirements on Jan. 5. "However, there is a new increase of excessive liquidity in the banking system ......... and there is rising pressure for loans to increase.''

"too much attention has been paid to targeting money supply, when the final targets are inflation and stability", Zhou said in Basel.

That's an interesting statement which shows a fair amount of naivety in my estimation. Now, I'm not here to say I'm more qualified to run the central banking operations in China but what I am quite confident of is 20% per annum money supply growth over a period of longer than half a decade should be grounds for concern at the minimum. There was little inflation and instability in the U.S. up until 1929 either. Nor leading up to 2000. Money supply growth is generally positive in a healthy economy but excess money supply growth can lead to trends and investments which aren't sustainable. Especially when they are guided by a corrupt central planning body. There are many economists who would argue his position but there are many who would point to my concerns as well. Which side is right? The future will tell. Along the lines of my final comment, Frank from In The Green points to a damning article on the Chinese economy over at the Guardian which is a very worthwhile read as well.

posted by TimingLogic at 5:08 PM

Sunday, January 07, 2007

Just Call Me The Seer

I thought it was rather amusing that Chinese officials are reported to have announced the yuan may be allowed to float further after yesterday's post. Here's today's Bloomberg article. That said, I have to assume there is no imminent announcement regarding the forex market per the tone of today's story.
posted by TimingLogic at 10:02 AM

Saturday, January 06, 2007

Emerging Market Fund Flows Are Record

First off, I am wondering if anyone has heard ot the rumbling out of China re some imminent announcement? Is this the accouncement of currency float or rumors? If so, it isn't for the obvious reasons of international good will. As I have written of on here, China's monetary growth is even higher than pre-1929 and Bloomberg just announced the government had finally been able to drop it to 17% growth. That is an amazing and frightening statistic. Because the Chinese banking system is in shambles, officials are unable to raise rates. Doing so may cause a wave of bankruptcies, calls on noperforming loans and increased liquidity flows into the country. So, officials have been attempting economic control by raising reserve requirements. China's economy might be in a melt up which would be consistent with the fever in stocks recently. The government officials may not have a handle on the economy. One of the few remaining options might be to float their currency. In part, this would reduce the flow speculative money banking (no pun intended) on a currency revaluation. We might already be in a global mess. Now, all of this is heresy at this point but let's watch from afar and see if rumor turns into reality.

Now, back to other reasons for this post. I pulled a few charts early this past week after my post where I referred to the large December moves in Chinese and Russion equities. I should state I am bullish on some emerging markets over the long term. Of course, that is after their stock markets fall off of a cliff and I have time to digest the implications. I especially like India if they continue their reform movements. There is some reason to doubt they will. Or, at least that it will be a nonlinear reform effort. But, as I've mentioned before, India has tremendous synergies with democratic and western cultures. But, then I'm uber bullish on the American stock market long term as well. I'm just not bullish today.

Emerging market equity and bond fund flows set records in 2006. The largest beneficiary? China. It appears Americans and Europeans have developed a taste for communist economics since most international flows are from both markets. Let's wonder out loud. Have we ever had western investors invest in a communist economy? Do investors become honorary members of the Chinese communist party if investing in their B shares or H shares? Do they really understand the risks associated with a centrally planned economy? Hardly.

Re my post a week ago, China and Russia have had nice decade long runs in the last few months. I can't pull a decent chart on the Shanghai or Russian indices so I am using an ETF and mutual fund posted above. These charts are a few days old as I typed this up a few days ago. Above are the Templeton Russian Fund which I believe I have posted before and the FXI China ETF. Does anyone know what a parabola is?

What conclusion do I draw from this flow of funds statistic? Only one. Americans and Europeans are willing to take on unprecedented levels of risk. With credit spreads nearly nonexistent and emerging market indices doing so well over the last few years, it appears investors have been lulled into a bout of stupidity about future returns. Here we go again. Driving through the rear view mirror and listening to the chant of diworsification from Wall Street. Does anyone even know why an investor is supposed to diversify? If I eat red M&Ms, blue M&Ms, yellow M&Ms and green M&Ms, I'm still just eating M&Ms. Diversification might be acceptable if the assets are noncorrelated either historically or within a cycle with compelling analysis. But, global investments and asset classes are all highly correlated this cycle. As I said before, that should give one reason to pause.

Russia's return over the last four years has been ok. For a quarter century of investing returns that is. What does that chart show? About 10% per annum return for twenty five years achieved in a few years. So what is Russia doing different today from a handful of years ago when their currency went kaput and they quit paying their bills? Oh, I forgot. They are benefiting from a weak dollar and overpriced traditional investments in the western world. So, Wall Street drove commodities through the roof and Russia benefited. Now they are an economic miracle of emerging markets. Huh? Smart money was allocating capital to Russia in 2000 and 2001. Dumb money or fast money or both was buying near the peak. See those wide price swings in 2006? Those are volatility. 50% moves in less than two months. How fun is that? Wouldn't it be fun if the Dow went up and down from 6,000 to 12,000 in a month or so? So what is volatility synonymous with? Indecision? Market Tops? Hello! Can you hear me now?

Anyone who bought Russian equities in 2000 has alot of moxie. I'd like to shake your hand. Right after you buy me a yacht because you made a killing of a life time. Anyone who is buying Russian equities today? Well, I might be buying you lunch at the poor house.

posted by TimingLogic at 2:19 PM

Friday, January 05, 2007

Hey Boss Does This Mean We Aren't Running Out Of Energy?

Nothing like an 85% drop over 18 months to awaken the senses.

posted by TimingLogic at 12:00 AM

Thursday, January 04, 2007

Too Many Worship At The Alter Of The Federal Reserve

It seems there is a tremendous amount of hope the Fed is going to save the equity markets, the housing markets and the global economy. In fact, I've already decided that the Fed should be responsible for saving my soul. Many believe the Fed is omnipotent. In the end, I hope the Fed can save us from the imbalances we face, but I don't invest based on hope. I tried that. I hope my stock goes back up. That never worked for me. For all the hope I mustered, I could have saved the world but I couldn't save my investments from going down. Hope is an investor's worst quality. Hope will get you a wish sandwich .

The reality? The Fed has an awful track record of saving the economy. Of course, the Fed did, for the most part, save the economy in 2000. One of the shortest recessions in modern times. Did the Fed save your stock portfolio too? The economy is not the stock market. It never has been and it never will be. Those who confuse this fact are called economists. And, for some reason we look to economists for validation as to whether we should be invested in equities. Maybe that's why nearly all of them kept telling us the economy was great as the Nasdaq declined 75-80% odd percent.

In this cycle, the Fed is in a box and there is little wiggle room. I'm not going to write a thesis but it will be interesting to see how central bankers react when the economic data continues to weaken. If the Fed cuts rates, the dollar could drop out of historical bands to new lows. That would create unknown circumstances and the associated fear in financial markets. Of course, I'm not convinced the Fed and the G7 nations aren't attempting to ease the dollar lower as they did in the 1980s. Cutting rates would also likely push up the long end of the yield curve as would a falling dollar. That would put pressure on housing.

If the Fed does nothing, the economy will continue to slow and the world's inflated assets, including housing, will start to deflate. So, what's the answer? It's time to take your medicine and it isn't likely to taste like cherry soda either. The best we can probably hope for is the Fed with one foot on the accelerator and one foot on the brake as we saw in the 1970s.

Here's the fundamental problem. Most modern day economists, including the Fed, don't have a strong belief in cycle theory or the need to purge long wave excesses and dislocations that develop. They drink from the trough of knobs and dials. Maybe they are right but there is a reasonable argument they add to the misery by fiddling. That fiddling may prolong the cleansing process and take away one of the advantages of said process which is lower prices for consumers. When modern day economic theory came to the forefront, most economists prattled on of how their theory would make the business cycle a relic. Of course, that was before we saw nearly twenty years of stagnation in the late 1960s to early 1980s. At that point they had to eat those words. I believe economics is less about knobs and dials and more about the basic irrational aspects of the human mind. (Ultimately, most economists do understand this but most aren't armed to deal with it.) Thus, it is my concern that any Fed attempts to save the economy will simply be met with more severe dislocations.

If you look at history, we have two outcomes that could develop. One is a long wave secular bear market for bonds. In other words, higher and higher interest rates. The other is a long wave of deflationary pressures and very low interest rates or even negative real rates. (Ever try to get a bank to loan money with negative real rates? That would be swell for the economy.) The future is really dependent on the past, present and future action of central bankers as much as anything. I firmly believe the Fed can only inflate the economy so far. At a certain point it becomes throwing gasoline on the fire.

In the end, I believe there is more and more evidence that we are reliving the 1930s for many reasons. That is opposed to reliving the 1970s. There is a caveat to my statement. That caveat is this is the 1930s revisited with the Fed instituting perceived lessons learned from the 1929 fiasco they helped create. In other words, this is the great Bernanke experiment and you have the pleasure of living through it. We should all hope for his success. There I go with hope again. For those of you who don't know, Bernanke is likely the foremost economic authority and the foremost central banking authority on the Great Depression and the role the Fed played in creating it. Regardless of where we are comparatively, the Fed cannot and will not save us from ourselves at all times. Nor can save asset repricing.

Here's why this isn't the 1990s where the Fed was able to avoid recession. The Fed can create liquidity but it cannot direct it. So, when the Fed cut rates post 2000, they couldn't demand it go into capital equipment, research & development, manufacturing or technology as happened in the 1990s. It went the excess liquidity pot from hell including commodities, private equity, emerging markets, etc because the capital goods sector was and still is in a contraction and they had no demand for money as I've said ad infinitum. Look at the multiple studies done by attempting to calculate the GDP effect of mortgage equity withdrawals. The end result is the economy contracted or grew marginally grew for the last six years without MEWs. The estimates depend on how the calculation is done and how much of an assumption you make for MEW's being spent. (See the Calculated Risk link to the right for more on this.)

So, if the capital goods sector won't take money today at 4.5% long rates and 5% short rates, is it going to take money at 3% short term rates? Well, given the capital goods sector is less dependent on interest rates, I'd venture to say no. As an aside, while I am an advocate of the Bush tax cuts, there is a valid argument to be had that it simply made a bigger mess. One day central bankers will learn their job is more than knobs and dials. They'll understand the social nuances in economics and plan for dislocations. Then when they arise, liquidity will be targeted with coordinated government policies such as investment tax credits, or incentives for investment. And, disincentives including tougher mortgage and banking regulations to save us from ourselves. Or, maybe I'm dreaming at that won't happen. There's an argument to be had that the government shouldn't be targeting anything. Well, except for asset bubbles.

The chart below is the monthly chart of the ten year Treasury. Notice the trend for now is up for long interest rates. That is why banks have recently come to life. The markets see a return for the bank carry trade and higher profits. But, housing has been weakening as long rates have started rising. So, who's right? Banks or housing? Time to sell bonds? The bond market appears to be concerned about central bankers blinking, or the dollar, or the forex carry trade unwinding, or something. There's alot of long positions in the Treasury market. In other words, we could see some weird and rapid Treasury movements over the next year.

In June and July when people were scared to death, some wondered if 1987 was being relived. The general commentary laughed 1987 off. While I didn't have my own blog at the time, I wasn't so quick to waive 1987 off when I was bloviating on other blogs. Emerging markets were like a yo-yo and some were down 30-50% in a month. My argument was how many times in the last one hundred years how many times has that happened in the U.S.? How about once? 1987. Now, we've recovered and everyone is all happy again. So, now as more time has passed, all has been forgotten. Many emerging markets have recovered. Some even have made new highs. Now, I'm not an 1987 expert but I also know there was a feeling of invincibility because everyone had portfolio insurance. Looks like we are closing in on a similar situation today. The U.S. won't have any one day selloffs like 1987 because we have new controls in place. But, what else was 1987? The culmination of a mini mania in mergers & acquisitions driving markets higher. Markets can go to the moon on M&A, private equity, stock buy backs or whatever you wish. That doesn't mean the markets will stay there.

The net? If the Fed cuts rates, don't expect a miracle. Companies already have record cash sitting on their balance sheets. I'm not really convinced they need more access to capital since we are swimming in it. Are you? Of course, financial institutions could always lend more credit to individuals. Not likely. So where will it go if the Fed gooses the economy? No place constructive in my estimation. In other words, more dislocations.

posted by TimingLogic at 11:08 AM

Tuesday, January 02, 2007

For The Bulls

It seems as though there are a preponderance of readers who view me as a bear. Well, I am extremely cautious to say the least. The valuations in the market are near the highest in history and I've been a fool before. No more. Models say defensive or out and I don't ask too many questions like "Is it different this time?". People have asked that question for over two hundred years.

But, I'll be like everyone else and toot my horn a little bit. I do have the ability to be an able bull. Back on June 19th I posted a list of the only stocks I would consider buying should I have a gun pointed to my head. Below is the complete list. See a theme? BIG. VALUE. They also met a few proprietary requirements as well including a clear understanding of cycles analysis and market topping processes. Or put another way, I tend to think that I've learned to get into the mind of Wall Street and can think like they think. I don't put that cap on too much because I don't want to turn into the village idiot. A joke!

Here are the returns for those picks through year's end. I would be selling on the first day of January to maximize by tax position. ie, 16 months until I have to pay for the gains. That would be tomorrow. If I was bullish on the markets or wanted to be aggressive, I would set trailing stops on all of these stocks very tight, and see if they have more room to run. But, that wouldn't be me. At least not at this time in the economic expansion. A few actually have already reached sell signals and all are starting to lose momentum. I prefer to ask questions later.

Celgene 35%
Cigna 40% - not including dividend payments
Microsoft 32% - not including dividend payments
AT&T 28% - not including dividend payments
Verizon 16% - not including dividend payments

So, yes I am defensive or more. But, that's a healthy three year return for most broad based mutual funds. Not bad for a bear.
posted by TimingLogic at 10:16 AM