Wednesday, November 24, 2010
When to Buy Stocks
Since October 2008’s dark days, investors have wondered when, or if, they should again invest in the stock market. The years 2009 and 2010 witnessed a massive repudiation of stock funds as investor sought the perceived safety of fixed income (bond) funds. $235 billion moved from stock mutual funds in 2008 and 2009. Seven months into 2010 $34 billion have followed that same path. Retail investors have turned their noses up at the risk associated with stock mutual funds (and with good reason- the majority of stock mutual funds are underperforming their benchmark, meaning investment results from buying an indexed ETF (Exchange Traded Fund) was greater (with much less risk) than paying for an active fund manager).
Institutional buyers and traders with their stock trading computers churning algorithms have brought the market back to levels that are starting to lure retail investors back into the “risk trade” or least provoke thought along those lines. Minuscule returns in the fixed income market are making many investors itchy to get back in the stock market. So how do you know when to make the move?
Here is a tried and true method for making the decision.
Rule number one- never try to time the market. If you feel like it is time to buy- that is the best indication it is time to sell and vice versa. When, and if, you decide to get back into the market, deploy a “dollar cost averaging” strategy. For example if you decide to put $100,000 back in the market do so at $10,000 per month. This takes out the emotional aspects of market timing and smooths out any unfortunate market swings. Only ignorant rookies violate rule number one and they end up paying for it.
Rule number two- done try to catch a falling knife. If the market is down and stocks look cheap some people will buy. Retail investors are more likely than not to fall into a what is known as a “value trap.” Judging that a stock is worth a price just because its price was higher just recently, is not a good way to value stocks. Let the professionals do that. Trying to pick a bottom in the stock market is a fool’s game. Wait on prices to show a steady increase. The risk associated with buying stocks in a rising market is exponentially less than picking winners amongst a bunch of losers.
Deciding to get back into equities means answering the fundamental question of whether or not an increase in the market’s value is foundational or just traders moving money around. A good rule of thumb is that the market reflects foundational value when the S&P 500 (forget about the Dow Jones Industrial Average) shows gains with three characteristics. First the volume is high on days when the market is up, secondly the rally is led by the financial sector and third the move is confirmed by an increase in the transportation sector shortly after the first two criteria have occurred.
Information to make these determinations is straight forward and available to anyone who can sign on the internet. Comparative volume figures in chart form can be found at Market Data. Just type “volume” in the sites search prompt.
To judge whether or not a rally (increase in S&P index) is being led by the financial sector go to Yahoo Finance. At the symbol prompt, enter XLF which is the symbol for the financial sector ETF. With a little effort one can use the new interactive charts on Yahoo to overlay the S&P index chart on the XLF chart. If the market is on a sustained uptrend and the XLF line is above the S&P line, its time to pay attention to what’s going on and start looking for conformation from criterion number three.
If the volume is high and the rally is being led by the financials it’s time to check the transports. The ETF for the Dow Jones transportation sector is IYT. Just go to Yahoo Finance and put “IYT” in the symbol prompt and the chart will come up just like a stock symbol.
If the market has a stable foundation on an upswing the financial sector will be leading the way (the XLF will have a greater gain in value than any other sector) with high volume. The confirming metric will be a slight uptick in the transportation sector.
This is a logical progression. Banks make good loans and start making money first. The markets recognize this and begin to buy broadly across the economy. Once the money loaned is put to use, the transportation sector revenue finally begins to increase. Sequence is important because a firm foundation is built in the stages I have described.
Right now NYSE market volume is low, everything is going up except the financials and the transports are flat. In other words, hold tight.
Market fluctuations in this environment can play havoc on an investors nerves. Low returns in fix income coupled with the losses suffered in 2008, fuel anxiety not to miss the next big move up in equities. Use these tools and they will protect you from your emotions. In this game emotional decisions equal losses.
Happy Thanksgiving to all of you and thank you so much for your support!
Monday, November 22, 2010
The Irish Banking Bailout
The Irish banking bailout story on the front page of the WSJ this morning spawned a reflection on how the 2008 financial crisis unfolded. Surveying the damage in December of 2008, Wall Streeters collectively wondered, “how did we miss it?” The collapse of Bear Stearns, the plunging stock prices of US financial institutions and the fiasco at Freddy and Fannie left market watchers mystified as to how blind they had been not to see the sign post. The crisis had been a massive freight train barreling down the tracks, blowing the whistle, and they had missed it. After the fateful weekend in which Lehman Brothers filed for bankruptcy and Merrill Lynch was purchased by Bank of America, the market actually ended higher for the week the following Friday.
If the global economy “double dips” pundits and economist will look back at the episode in Greece as the first overt sign that systemic problems were lingering and much graver than was thought at the time. I can mentally overlay the Greek inability to publicly fund their debt to the break down in auction market securities in early February 2008. In retrospect the destruction of the ARS market should have been a siren alert that the situation was extremely dire and was sure to get out of hand. The Greek situation has all the same markings.
The Irish banking crisis validates the foreshadowing characteristics of the Greek bailout. It offers two concerning aspects that fit a scenario of a developing crisis in which the significance of the Greek debacle is under estimated.
Last week the Irish policymakers were declaring that no “bail out” was necessary. Something obviously changed their tune. Circumstances were not what the financial leadership perceived or the circumstances changed at light speed. In either case, such sudden direction adjustments indicate Irish financial matters are unstable.
The other indication that things might not be going as plan across the pond is the use of EU funds to bail the Irish out. When the 175 billion euro fund was created, the IMF and EU officials speculated that by its very existence fears regarding European banks’ liquidity would be quelled, making the actual use of the funds unnecessary. This is obviously not the case in Ireland.
Those of us who feel we are not out of the woods yet view these conditions with great suspicion. We cling to the notion that until the employment situation improves, residential home prices stabilize, the government stops issuing debt at historical levels and the Federal Reserve stops printing money at historical levels the economy is on very shaky ground at best.
No thinking person suggest that our global monetary and fiscal policy is sustainable. It’s like a long distance runner sprinting out of the gates to conquer a marathon. The runner and the crowd know he has no chance to complete the race unless he hits a maintainable stride. If he continues to sprint, the question is not if he will collapse short of the finish line, but when. The Irish banking bailout is analogous to our runner feeling a blister starting to form on his heal. A Spain and Portugal banking bailout will indicate a blister is forming on the other heal. Run Forrest, run!
Meanwhile, we have the stock market trading at pre crisis levels and bullishness is rampant. Looks and feels a lot like November of 2007 if you ask me.
Hal Blackwell is the author of “Secrets of the Skim” and foresaw the 2008 financial crisis.
Saturday, November 20, 2010
GOB (Good Ole Boy) Economics
I have undertaken to write this blog for the purposes of translating complex economic concepts expressed by eggheaded, intellectual pontificators, and other such offenders, for the benefit of people who actually have a life. The cause is noble since these issues effect American families in profound ways and will only become more important as the financial crisis matures. But I want to take a pause and reverse the flow of information. Hopefully the intellectual pontificators will muster the humility to learn a thing or two from the “folks.” Somehow I doubt it but here’s my attempt.
As the Federal Reserve embarks on QE2 (the second round of printing money on a historically massive scale) the time is right to apply some common sense thinking the eggheads and intellectual pontificators would do well to consider. Sometimes those charts and graphs mix with other academic accruements to garble the obvious. There are a few principles any “good ole boy” (GOB) could share with these “masters of the long words” which are pretty darn profound.
First, any GOB can tell you that nobody gets something for nothing. Although your average GOB doesn’t understand the actions of the Fed, he could tell Fed chief Bernanke that trying to bail out the US economy painlessly by printing money ain’t gonna work, at least the way you think it is gonna work. If you give something to somebody you’re taking from another. GOBs know there ain’t no free lunch. GOBs wouldn’t be buying into the line that when inflation rears its ugly head a masterful exit strategy will make all this free money disappear painlessly and we will all live happily ever after. GOBs know better than that to their credit, and to the discredit of those making monetary and fiscal policy.
GOBs know there comes a time to “man up” and take the medicine when a screw up happens. Bet on the Cowboys to win the Super Bowl when Tony Romo gets hurt means its time to pay up. GOBs hit up the boss for some overtime or sell the bass boat. Wall Street, our government and the American consumer pushed in all the chips betting on the US the real estate market and lost. A GOB would know its time to “man up.”
Economic theorist and intellectuals refuse to accept these common sense truths. GOBs know that inevitable consequences are less painful faced sooner rather than later. We face a crisis of leadership in America. We have no one out there willing to lead us into the pain we are sure to suffer. Where we as a country need to be is on the other side of this pain; and there ain’t no detours. Americans have a choice: deal with it on our own terms or have our responses dictated by events.
Unfortunately our country’s decision makers are politically unable to be proactive. Every GOB knows Congress is broken. Every GOB also knows that the worst possible time to be making important decisions is when the heat is on, mistakes are bound to happen. America’s dysfunctional way of conducting its affairs is not sustainable and these hard choices are soon to be forced upon us. Something tells me the GOBs will be more prepared and less surprised than the brainiacs who stare at the situation day after day. GOBs have a life.
(Note: the word “ain’t” is listed in the GOB dictionary)
Thursday, November 11, 2010
November 11, 2010
Debt Commission Report
The President’s Deficit Panel threw some cards on the table yesterday by releasing a “preliminary report” on how to make our nation’s economic infrastructure sustainable. One had to be encouraged that both the far right and far left hated the commission’s ideas. That’s a good start. The bad news is that President Obama and Congressional Republicans failed to offer any support. Wonder why (tongue in cheek)?
From what I can discern the commission’s recommendations deserve to be taken seriously. There is honest debate to be had on some of the finer points to be sure, but over all a good start was in evidence. The political realities in America however, make a serious, constructive conversation impossible. The only element of the debt crisis more dangerous than the debt crisis itself, is America’s political inability to make hard decisions until they are forced upon us. The commission’s report is a most poignant case in point.
Every politician running in the mid term elections caterwauled that the focus of our government should be “on jobs.” Democrats want to create jobs with more government spending while the Republicans want to provide tax cuts for businesses in hopes they will start hiring with the extra money. Both of these approaches are damaging to the deficit (the much larger issue) and are frankly out of the Constitutional preview of government. But that campaign stump speech doesn’t draw a crowd, at least not a pleasant one.
What we have now is not much different than the apparatus that centrally planned the Soviet economy into ruin. Congressmen are primarily lawyers who refuse to acknowledge their ability to manage the economy is equal to their Constitutional mandate to do so. Congress‘ job is to past laws to protect our freedoms, not manage the economy. Paradoxically, if they would stick to that mandate jobs would be created. But Americans just don’t get that concept. It is not comprehendible by an electorate epitomized by Jay Walkers on Leno’s late night gig.
I am convinced America’s greatness will be compromised because our leaders have strayed so far from this basic concept which was the very thrust of our founding documents the revolutionary movement that spawned them. Ironically, it is the one that made us great in the first place. How did we stray so far from what made us great?
All I can say to the Debt Commission is good luck. If their proposal is implemented in total America might have a chance. More likely, it’s fate will be a disembowelment by special interest groups, addicted to the power and money emanating from Washington. In the latter case America may not be delivered from the choke hold of the nation’s debt, but it’s most ardent enemies, on the far left and far right, will be outed.
Monday, November 8, 2010
Citi Bonds v Merrill Lynch Notes
I was not so shocked to find the headline “Citi Debt Funds Probed By SEC” on the front page of the Wall Street Journal this morning. The story outlines how Citi Group, through its minions at Smith Barney, was selling proprietary products designed to mimic a bond index. The products were allegedly being sold as having the same risk profile as the index, which was false.
When the financial system’s liquidity evaporated, the true nature of the instruments was reflected in a 71% loss of value. Turns out these bond replacements had used debt to enhance returns. Citi stepped in to swallowed enough of the loss to only put investors out 61%. The difference might be an indication of how much money was being scrapped off the top by Citi Group when they were sold. That’s just my guess.
When is the SEC going to get around to looking at the Merrill Lynch practices I outline in my book “Secrets of the Skim”? Merrill was doing the same thing with their structured products. Enticing clients to move large cap allocations into proprietary instruments that used debt and derivatives to track an index (the S&P 500 was a favorite), Merrill Lynch misrepresented the risk associated with the investment just like Citi Group. Does the SEC think that Citi was the only player in this game?
Since the Merrill Lynch products were debt instruments on paper from such illustrious firms as Bear Stearns, Lehman Brothers, and AIG, their risk profiles were drastically different from a basket of large cap stocks. The use of debt to enhance returns also skewed the risk/return curve.
If the SEC is concerned about the bond vipers at Citi they should also be concern about the structured product masters at Merrill Lynch.
Thursday, November 4, 2010
STOCKMAN IS SPOT ON
Yesterday I saw the single best TV interview ever describing the realities of America’s financial plight. David Stockman’s (Ronald Reagan’s budget director) assertions during his appearance on CNBC with David Faber and Gary Kaminsky (link provided at the bottom of this page) was spot on. Every American should be required to see this interview before being allowed to vote. Granted Mr. Stockman has a book coming out soon, and he is trying to grab a few headlines, but the facts bare out his contentions.
Mr. Stockman asserts, and I concur, that America is riding a monetary doomsday machine. During the interview Stockman uses a lot of industry lingo so I am going to attempt an interpretation.
As you may, or may not, know, the Federal Reserve announced today a plan to start buying US Treasury debt again to the tune of $900 billion. This is an effort to bring down long term interest rates. Usually the Fed dickers around with interest rates by changing the rate banks are charged to borrow money over night. Lower interest rates spur the economy by making everything cheaper. The Fed used all the bullets in this gun back in December of 2008 when it took the rate to zero in the midst of the financial crisis.
Now the Fed is force to deploy a different strategy in order to lower long term rates. In the media you hear this plan referred to as “QE2”. “QE” stands for “quantitative easing” which is fancy language for increasing the money supply. QE1 has been tried and obviously didn’t work because we now have QE2.
The eggheads at the Fed figure buying $500 billion worth of treasury debt is the same as lowering the short term rate by .5%. This is a really big move which will, theoretically, lower long term rates. To take such a drastic step these men behind the curtain must be awfully pessimistic about our country’s economic outlook. Upon closer examination (which they know is beyond most Americans) the move looks downright desperate if one considers the downside risk to this strategy.
OK, so here is the downside:
A). Rates are at historic lows. Taking them lower will have a very limited effect. Proponents of the strategy admit the positive effect will be minimal but point out that the Fed can’t just sit by while unemployment is so high. They have to do something. This just proves that the Fed is not divorced from politics as it was designed. Making decisions this way just shreds the Fed’s credibility. When you have a fiat currency (not backed by gold or something like it) the central bank’s credibility is critical but this is a minor consideration at the moment.
B). The Fed is playing games with the world’s reserve currency, the US dollar. What I mean is that oil is priced in dollars, gold is priced in dollars and other currencies are measured primarily by their value compared to the US dollar. The Fed, by lowering interest rates, is trying to devalue the US dollar, which just happens to be the world’s reserve currency.
When the dollar’s value is low the stuff we manufacture in the US is affordable to other countries. A low valued dollar brings tourist from abroad to spend money at US vacation spots. By the same token, if, for example, Brazil’s currency is strong relative to the dollar then we Americans won’t be going to Brazil on vacation or buying stuff they make. Brazilian stuff is expensive when their currency appreciates relative to the dollar.
During discussions about the financial crisis or studying the Great Depression in high school, some of you (who were awake) may have heard the term “beggar thy neighbor.” This refers to the practice of countries devaluing their currency to sell more stuff and grow their domestic economy at the expense of their trading partners. It is a short-sighted, selfish policy.
Countries (Brazil is a good example) getting squeezed like this really only have one option and that is to have their central bank buy US Treasury debt. By having US Treasury debt on the balance sheet of the central bank, a nation’s currency has a value pegged closer to the US dollar.
The Fed’s attempts to devalue the dollar is forcing these countries to buy a bunch of our debt they don’t really want. When these countries are forced to buy US debt, the price of the bond is bid up, the US dollar gains value and things balance out, theoretically. Unfortunately, the US government is borrowing, then spending money at such a rate that it doesn’t balance out. This, my friends, is a problem.
This discombobulated bond market also means that the interest rates on US treasury debt are contrived and artificial. These dynamics are allowing Congress to borrow trillions of dollars practically for free (really low interest rate). The lowest interest rates (the cheapest money) are on debt that comes due within 0 to 7 years. Americans are loading up on debt we must pay back pretty soon (smart business people are stretching out their debt to take advantage of these historically low rates).
This practice reminds me of Wiley Coyote lighting the fuse on a stack of dynamite. It is definitely, no question, certainly, positively, going to blow up in our face. No one thinks borrowing in this fashion is sustainable. Our government is borrowing $100 billion per month but our economy is only growing by $50 billion per month. This is why Mr. Stockman is freaking out. This is why I’m freaking out.
Brazil is so angry about the deal, they boycotted the G 20 meetings in South Korea to protest the “currency war being waged against them.” Other countries are also taking steps to limit their exposure to the US deficit. Our global neighbors thought they were loaning money to Bill Gates but it was Fred Sanford in disguise. They don’t want to be forced to loan Fred any more money in order to protect domestic exporters and, by extension, their economies.
The blow up is going to come when (not if) interest rates rise. Since we have no idea what a true, market interest rate is, getting your arms around the problem is difficult at best. If interest rates were to increase by 5% (which is by no means out of the question) it is probable that the US government could not make the interest payment on the national debt with the amount of taxes being collected. In other words, the US would be flat broke. America would be unable to make payments on all this debt we are forcing down the world’s throat nor able to borrow any more. Defaulting on our debt will grind the global financial system a halt. Our global popularity is going to be right up there with the Black Plague. All those aircraft carriers we bought might come in handy.
C.) Problem B is the doomsday Mr. Stockman is rightfully concern about. But should the world survive the dollar being the “reserve” currency, the US might not. When interest rates increase, the value of bonds decreases. Since our central bank is loading up on bonds at very low interest rates, an increase in rates will destroy the Federal Reserve’s balance sheet. So what does this mean? The truth is no one knows, but it can’t be good. In all likelihood hyperinflation would make our currency worthless. This happened in Germany during the 1920’s. We all know what followed that escapade.
Mr. Stockman was asked in the interview by Mr. Kaminsky if there was a point at which our national debt would be just so large that we would be past the point of “no return.” Stockman, in a candid moment, said he thought we were already there. Later he back peddled as best he could but his true assessment slipped out. He tried to say that if Congress raised taxes and aggressively cut spending there might be a ray of hope. The chances of the Republicans raising taxes is just about as likely as the Democrats cutting spending. I have zero faith that Congress can act in any manner not motivated by the 2012 presidential campaign. We are up a smelly creek with no paddle.
What Mr. Stockman articulated is what I have been concerned about now for two years. I just needed to hear it from someone other than David Rosenberg. The Fed’s attempt to devalue the US dollar so aggressively is going to end badly, very badly.
I will be blogging more on the implications of our monetary policy and provide a list of signals that the unraveling has started. Stay tuned.
Link- Stockman CNBC