Posted by Don Martin on Thu, Jan 12, 2012 @ 06:32 PM
Treasury Long Bond: What is the market telling us?
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The 30 year Treasury has maintained a relatively steady price after a huge run up in the summer of 2011. Since the huge upward move in July its price has stayed above the 50 day moving average except for a few days. Since late July it has been way above the 200 day moving average.
At year end the price kept rising as portfolio managers sought to make their year-end statements look better by adding Treasuries to their portfolios, so I was worried the price would go down in January. As of January 12 the price has only dropped 1% since year end.
The unemployment rate has dropped 0.5% in the past year but long term Treasury prices using the ETF “TLT” for example, have increased from 94.12 to 121.25, a 28.9% price increase. Typically when unemployment drops then bond prices go down and interest rates go up. Since hiring managers in non-financial companies may be less sophisticated about the economy than bond experts it is possible that the long term Treasury bond market is predicting a new recession. John Hussman said on January 9 that the jobless rate has gone down as the economy was heading into recession because unemployment is a lagging indicator.
Regarding the unemployment report of January 6, 2012 I wrote an article “Jobless report no threat to bears”. The improvement in the employment report that day resulted in the bond price going up 0.75%. Normally an improvement in the jobless rate would result in bond prices declining.
I continue to believe in investing in investment grade bonds, although investors should carefully assess their unique risk tolerance and sophistication to see if they can handle the risk of long term bonds which can be hurt by a sudden surprise inflation shock.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jan 11, 2012 @ 02:23 PM
Romney victory in New Hampshire Primary: How does it affect the markets?
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Presidential candidate Mitt Romney won in New Hampshire Tuesday and won in Iowa last week. It is rare to win both of those primaries.
It may be tempting to think that if Romney sews up the Republican nomination early then he can have a high chance of a victory against Mr. Obama. Then one could be tempted to assume that a Republican president will implement business friendly policies that will make the stock market go up. However, new policies need to be authorized by Congress and even if the Republicans win control of Congress and the White House there will be moderate Senators who will dilute or filibuster the Republican’s programs. Most importantly the huge Federal deficit and need for more stimulus will make tax cutting nearly impossible even if the Republicans control Congress.
In a simplistic forecast of the election one might be tempted to assume that the incumbent Mr. Obama will get the blame for high unemployment and be fired by the voters. However some of the unemployed may feel that Obama’s leftist politics and mellow nature is what they feel comfortable with rather than the stereotype of the strict, disciplined, rich job cutting businessman that Romney may be labeled. Romney is a smooth, disciplined polished candidate. But he has a critical flaw in that he could be seen as a ruthless rich businessman who got rich cutting jobs. During the 1992 election it was Bill Clinton’s mellow nature that helped him win against a well groomed professional incumbent candidate George Bush senior. During the 1960 Kennedy vs. Nixon election the more mellow person won. Same situation in 1964 in Goldwater vs. Johnson election. In 1968 it was a toss-up with a three way race. In 1972 the incumbent manipulated the economy to make it very prosperous thus allowing him to coast to reelection. In 1976 both candidates were mellow but Carter was a bit more smooth. In 1980 Reagan beat Carter because Reagan was Mr. smooth and mellow. In 1984, 1988, 1992, 1996 the cnadidate with the mellow factor won. Romney is improving on this but it is hard to change the image of the authoritarian businessman versus mellow Mr. Obama. In researching marketing and communication as a business owner I feel that Marshall McLuhan’s ideas on communication would support my theory that people will decide using the subconscious emotional effect of communication rather than use logic to vote for a particular candidate. Of course it is traditional for an incumbent president to lose his job during a period of high, persistent unemployment. Even if most voters have jobs they have still been hurt indirectly by the recession.
I wrote an article “Iowa caucus may damage your portfolio”.
Investors should seek independent financial advice.
http://www.mayflowercapital.com/blog/bid/75679/Iowa-Caucus-May-Damage-Your-Portfolio-Independent-Financial-Advice
Posted by Don Martin on Tue, Jan 10, 2012 @ 07:05 PM
How the bear case could be wrong
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The stock market is overvalued using the PE10 formula. It needs to go down to 800 points for the SP500. And some bears claim it needs to go to 450 for the SP500 to reach fair value. However the stock market rarely is logical.
What is a contrarian way that the bears could be wrong?
If the marketplace fears inflation and feels that commodities are a bubble that incurs carrying costs then some investors may decide that stocks are a place to park money to avoid the effect of inflation. I don’t believe in that argument, however, if the masses of investors make an emotional decision to believe in it then they could use that as an excuse to overpay for stocks in an attempt to avoid a crash in the bond market caused by inflation. (I don't believe inflation is coming back in the near term). Assuming that China, Europe and Japan all have problems that will get worse then capital will flee to America and the flight will make Treasuries go higher, thus reducing interest rates, thus motivating investors to seek a 2% yield on stocks instead of a below 2% yield on ten year Treasuries. The rally could then trigger an irrational wave of momentum buying of stocks.
The problem is that ultimately the truth comes out and the market adjusts to a correct view. If a stock’s PE is too high then eventually it will go down. If the whole world except the U.S. suffers from economic chaos the problems would spread into the U.S. and corporate profits would plummet. The world economy is too integrated to have a bona fide long term decoupling where one country becomes an economic paradise while the rest of the world goes into crisis. Eventually the world economic crash would reach a bottom where investors would want to start investing in Europe, Japan, China and they would pull out funds from the U.S., thus causing a crash in U.S. stocks. So even if I’m wrong about my bearish view for 2012 I still think any U.S. stock rally in the current market conditions of 2012 is incorrect and would be an irrational emotional leap of faith.
Remember the bubble of 1998-2000 where the bears said the stock market was too high but the market kept going up. Bubbles can last for years and can keep getting bigger beyond any reasonable limit.
I wrote an article “Three bear market strategies you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jan 09, 2012 @ 05:33 PM
Bear Vs. Bull Case Using Shiller PE 10 versus Current PE
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The Bear versus Bull case for stocks could be summed up as a debate about whether to use the current Price earning (PE) ratio versus the ten year inflation adjusted average PE ratio. The Bulls claim that the ten year average of earnings is 70% of current trailing earnings, so they claim the ten year figure misses important data.
My response to that is that first one needs a filtering mechanism to get a clear unbiased view of earnings, so taking a long term inflation adjusted average of earnings is one way to do that. The problem with using current trailing earnings is that a company can go through a temporary growth spurt that is unsustainable due to some faddish product or due to some unethical accounting trick that will be found out in a few years. Look at all the tech companies that were hot for a few years and then faded into obscurity.
Further, current earnings as a percent of GNP are unusually high. This is due to either tech companies with temporary spurts in product popularity or to companies using foreign subsidiaries in tax haven locations, which reduces, taxes thus raising corporate after-tax profits. This is unsustainable and dangerous because Congress could easily take this away. The IRS has already cracked the nut of foreign bank accounts by gaining cooperation of Swiss Banks, etc. So it seems logical that eventually Congress will change the corporate income tax to outlaw foreign corporate tax shelters. This alone could dramatically reduce corporate income.
Open the secrets of investing
When evaluating investments one must examine risk and part of risk are unsustainable corporate earnings that are artificially and temporarily too high. That is why the responsible way to invest is to examine earnings for sustainability and one of the best ways is to examine the long term average, adjusted for inflation. The component of a corporation’s earnings that has jumped at an exceptionally high percentage is analogous to a little small cap company that is undergoing a sudden growth spurt: they both have high risk of faddish unsustainability. The small cap component of a successful large cap stock should be carefully evaluated as a source of hidden risk that can lead to sudden disappointment. Using a ten year average of earnings helps to filter out incorrect information.
I wrote an article “Three bear market strategies you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Jan 06, 2012 @ 02:06 PM
Today’s Unemployment Report is Misleading
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Today’s unemployment report is misleading because the “headline” gain of 200,000 net new jobs is 40,000 less if temporary hiring of couriers is removed according to Dean Baker.“Without the quirk in courier jobs, employment increased by 160,000”. David Rosenberg said adjusting for weather and the skew of online shipping the net gain was 140,000.
Bears like to joke when the unemployment rate improves it is due to McDonald’s hiring, but in this case it was due to temporary hiring of Christmas online delivery couriers.
Most economists believe that the first 125,000 of net job gains are needed to keep up with population growth, so if the true net gain was 140,000 per Rosenberg and then we subtract 125,000 for population growth then we have a true gain of 15,000, in my opinion. If annualized that is 180,000 a year or a 0.14% annual increase. So if unemployment needs to be reduced from 8.5% to 4% then at this rate it will take 33 years to get to 4.0%.
The value of the improvement in the jobless rate
Today the ten year Treasury interest rate went down 4 basis points to 1.956% and the price of Treasuries using TLT as a proxy were up 0.85%. When the jobless rate improves that is supposed to be inflationary and should result in interest rates going up; instead interest rates went down. Since the bond market is more logical and efficient than the stock market then the invisible hand of the market is trying to tell us that the unemployment report is misleading and that there is essentially a deadlock with no true improvement in unemployment. Add to that the fact that in in 2012 the Eurozone will have more problems and in 2013 there will be a massive U.S. tax increase and less stimulus due to expired programs. This implies good reason for the marketplace to keep interest rates low and for jobless rates to stay high.
More news stories are being printed that indicate that China’s rapid growth rate may be due to an unsustainable debt bubble which will come to an end. Once investors believe this then they will stop buying commodities and will adjust for a global economic slowdown. So if China and the Eurozone both slow down and the U.S. suffers a tax increase in 2013 then that implies a prolonged global economic cooling for several years which justifies my bearish jobs forecast.
I wrote an article “Unemployment problem unsolved”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jan 05, 2012 @ 10:53 PM
One of the most important parts of financial planning is to have adequate insurance. When someone is hit by a catastrophe then they may need to sell their investments to pay for the rebuilding of damaged assets. Selling investments during a market crash instead of holding on until a recovery is not a good idea as it could result in selling at a loss during a temporary dip. Also selling investments to fund the cost of recovering from a catastrophe could incur tax on the capital gains.
A basic rule of thumb is that if someone can’t afford to self-insure against a catastrophe then they need to insure against it. The temptation by consumers is to rationalize that a catastrophe won’t happen to them so they fantasize that they don’t need insurance. One should ask oneself how badly would one be hurt if they were uninsured when hit by a crisis rather than use a probability theory that the hypothetical value of the insurance payoff is less than the cost of the premiums.
An insured person may be able to use the insurance company to get leverage against vendors after a catastrophe by telling vendors that they must reduce prices and conform to insurance company standards in order to get paid.
When dealing with a catastrophe the insured may find that some insurance companies offer poor service at a time when the insured has lost a lot of energy and confidence. So the insured may find it difficult to get the energy and discipline to pursue their insurance claims. Then the insured would not get the full reimbursement due. So it is important to get an insurance contract with a company that offers reasonable service, rather than the cheapest insurance policy. The opportunity cost of taking time off work to deal with a recalcitrant insurance company could be a substantial portion of a year’s wages in the case of some painfully complicated catastrophes. Insurance companies may have narrow profit margins and may be tempted to make it difficult for a crisis victim to get their claim fully reimbursed.
When suffering from a catastrophe if the victim receives rapid, full insurance reimbursement with minimal conflict with the insurance company the victim may have a greater feeling of control over their life and a greater feeling of emotional recovery from their crisis.
This feeling of emotional recovery can lead to better investment decisions as an investor can regain his lost confidence and begin to feel comfortable with taking riskier higher return investments instead of hiding in the safety of low yielding cash. By contrast, an insured person who encounters a difficult experience getting reimbursed would be likely to not trust risky investments and thus may be tempted to hide in the safety of low yielding cash rather than take risk to earn a fair return on investments. So the implications of having a bad experience with an insurance claim go beyond the math of the cost of merely hiring a contractor to rebuild a burned down home or the cost of hiring a doctor to heal a hospital patient.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jan 04, 2012 @ 02:29 PM
2012 Financial Advice: High Stock Correlations Ruin Traditional Investing
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A Wall Street Journal article today quotes BCA Research about rising stock correlations are expected to persist. (Correlation is when stocks move in the same direction at the same time, thus defeating the purpose of diversification).
Their theory is that the benign conditions of the 1990’s and the rise in financial leverage are the source of these conditions.
This is similar to what I have been saying: The market has been propped up by naïve speculators who sell naked Put options, plus the excessive leverage provided by “too big to fail” banks, plus the low or almost no cost Fed Funds borrowing rate. In addition the market is propped up by hedge funds aggressive use of leverage and Put options. However these hyper-leveraged participants need to set hair trigger stop-loss orders which result in a wave of selling at the slightest provocation. This selling pressure is so massive that the result may be that all stocks, both good and bad, come under excessive selling pressure. For example during a crash the need to instantly meet margin calls means that investors sell whatever they can, which means they end up selling the lower risk assets (because the high risk assets are not sellable during a crash) to raise cash to meet margin calls.
The stock market is overpriced and needs to go down to more reasonable levels. When it goes down and stays down then ironically it will be a much safer, less volatile place to invest and correlations will return to normal.
The traditional theory of investing is to diversify to benefit from uncorrelated assets. But that theory is dysfunctional in the modern economy because of rising asset correlations that rise dramatically during a crash precisely at the time when it is important to have assets with low correlation. This is because investors all panic and try to run through the fire escape at the same time resulting in some of them getting trampled.
Until the economy moves into a new era of a bear market capitulation phase the market will have excessive correlations with equity investors taking on extra, uncompensated risk.
I wrote an article “Three things you must know about the crash”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Jan 03, 2012 @ 04:28 PM
Today’s Iowa caucus effect on the stock market
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Tonight Iowa voters will vote in a caucus system in the nation’s first primary for the 2012 presidential contest.
If the candidate chosen in Iowa is an unreliable, unproven one with an abrasive non-mainstream approach then the risk is that Obama will beat the Republicans and the risk would be that four more years of Obama might not be the best outcome for stocks. Many of the Republican candidates have tendencies to be somewhat abrasive or controversial which could cause the Republican nominee to loose. In the U.S. presidential election the winner is often the one who is the least controversial, least offensive, most bland and most well-known. Thus the campaign style of many of the Republicans is something that scares the stock market. Perhaps today’s big 1.55% gain for the SP is due to the market’s anticipation that a strong candidate will be chosen by the voters. A strong candidate could reduce risk for the market by working to reduce job killing tax increases scheduled for January, 2013.
The biggest economic problem is an intractable high rate of unemployment. In less than year taxes will be much higher, which implies a recession is coming. So even if a Republican president can reduce the risk of higher taxes the problems are so great that a Republican president may have to accept tax increases. Thus the outcome of the election may not be as important as it seems because the budget deficit is a gigantic bipartisan problem that can’t be solved by one party alone. The need to raise taxes will result in a recession which in turn means less tax revenue, thus the economy will become trapped into a debt and deflation Japan-style long term Soft Depression.
I wrote an article “Bear forecasts a bullish stock market”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jan 02, 2012 @ 10:00 PM
One of the most important economic variables is inflation, especially for bearish advisors who advocate investing in investment grade bonds.
The three key factors influencing inflation are: unemployment rate, monetization of Treasury debt by the Fed, and Quantitative Easing or devaluation of the dollar.
David Merkel who is on Twitter @AlephBlog asked “What change in conditions would lead you to allocate money away from bonds?”
The most important change to watch for would be the unemployment rate. If it gets better that would be inflationary. The unemployment rate is expected to take until the rest of this decade to slowly return to normal. Net new jobs are increasing at a rate roughly equally to population growth so on an employment-to-population ratio there has been no net new job creation. The most important part of the unemployment rate is the employment-to–population ratio, not the “headline” figure. Only 20% of the jobs lost in the 2008 crash have been recovered despite massive stimulus and those recovered jobs were not enough to offset the increase in population.
Another inflation risk factor would be if Congress continued to cavalierly expand the Federal deficit and the bond market refused to buy Treasuries then the fed might buy the Treasury debt which would be monetizing the deficit. So if all the Tea party deficit cutting types lose elections and are replaced by those who advocate massive deficits then this would be a concern. A way this could occur would be if the unemployment rate increased to Great Depression levels of 25% then a new Congress might react with massive deficit spending financed explicitly by the Fed monetizing the deficit.
Regarding the risk of Quantitative Easing and / or devaluation increasing inflation this is a low probability event because other countries will react with competitive devaluations. Quantitative Easing may have contributed to inflation by encouraging speculators to speculate in commodities but that was merely a temporary bubble and not a fundamental reason for commodities to go up.
I wrote an article "Inflation creation machine is broken" and "what is potential source of inflation?"
Investors should seek independent financial advice.