 | | The Daily Reckoning | Tuesday, September 21, 2010 |
- Investors turn to emerging markets for profits, cut US growth forecast,
- Could there be another 30% left in the mother of all bear market bounces?
- Plus, Fellow Reckoners have their say on the looming catastrophe that is Social Security...
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|  | | US Still the Number One Choice for
Investors*
| | *Statistic does not include Brazil, China or India | |  | | Joel Bowman |
Reporting from Buenos Aires, Argentina...
Another day, another blister. Or is it another dollar? We can't remember.
In any case, stocks managed a reasonable rally yesterday. Well, they managed a rally...whether it had any grounding in reason or not is for the pages of history to decide. For its part, the Dow jumped nearly 150 points. Month-to-date, the 30 bluest stocks in the US are up over 700 points. That's a pretty handsome mood in anybody's book. The broader S&P 500 index indicates a similar dose of optimism pumping through investors' veins.
From whence, we wonder, did this font of shiny-happy optimism spring? And, more importantly, how long is it likely to last before the well runs dry and the slow, inevitable creep of reality takes over?
It's tough to say. Nay, impossible. Analysts and economists like to treat the stock market as if it were a rational, objective entity, delicately responsive to the whim of its many participants and impartially voicing their opinion as one perfect declaration of truth and goodness.
Seems a little simplistic to us. Perhaps even a bit naïve.
Of course, this doesn't stop us from taking a guess now and then. In a recent poll conducted by Bloomberg, 1,408 investors, analysts and traders did just that. They took a few guesses.
Asked to name their preferred place in which to invest, those polled dropped the US from the number one position they had it at last quarter in favor of Brazil, China and India, respectively. Although the world's largest market still ranked first among developed nations, the consensus saw fit to revise their growth forecast downwards for the coming year - from a median forecast of 2.9% in June down to 2.5% in September.
It's difficult to tell whether the collective opinion of a thousand or so "experts" is a leading or lagging indicator. Certainly there has been much to cheer about for equity investors since the last such survey was conducted, back in June. Since then, the S&P 500 has risen about 3.6%. Not bad...but not great when compared to measures in Brazil and India, which each notched up gains north of 10% over the same period. Investors, naturally, look to chase gains when and where they can get them.
Aside from outsized rallies offshore, what else might be motivating the crowd to look further abroad for their share of the profit pie? Here's a clue from the same survey:
"A 53 percent majority sees a big or moderate risk the budget deficit will provoke a crisis of confidence within two years that will spur 'a dramatic rise' in long-term interest rates."
Ahh...the dreaded "D" words. According to Federal Reserve data released on Friday, federal government debt expanded at a 24.4% annual rate during the second quarter, up from a 20.5% increase in the first quarter. Call that a crises of overconfidence.
Businesses, meanwhile, were not so brazen. Excluding financial institutions, companies increased their debt load a meager 0.1% in Q2. Individuals, continuing a "post"-crisis trend toward downsizing and leaner living, pared their borrowings. Consumers trimmed their debts at a seasonally adjusted annual rate of 2.3% - the ninth consecutive quarter in which they did so.
All this would seem to indicate a pretty decisive vote of "no confidence" from the private sector. Which begs the obvious question: how long can the world's largest debtor continue to borrow on "behalf" of a citizenry determined to clean up their own books? In other words, how long can the public sector affect to do the private sector's work for it? And what happens when the jig is finally up?
Well, we've got a fair idea of what might happen but, as usual, little clue as to the when. Stock markets may well rally over the coming months, for example, even if that rally takes them right into the path of an oncoming freight train.
In today's issue, Chris Mayer takes a look at how such a rally might take shape, even if trading it requires the nerves of "the bold and the nimble." Details below...
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| The Daily Reckoning Presents
| Which Way for Stocks? Bonds Give a Clue
| |  | | Chris Mayer |
Sherlock Holmes sometimes solved great problems just by lolling around in his smoking jacket and puffing at his pipe for hours. In "The Man With the Twisted Lip," Holmes solves the case with ease without leaving his flat.
An incredulous Mr. Bradstreet asks, "I wish I knew how you reach your results."
Holmes replies: "I reached this one by sitting upon five pillows and consuming an ounce of shag."
In that spirit - sans pillows and tobacco - it seems I've spent a lot of time this week sitting around reading odd stuff and mulling over clues. I did find some clues in the bond market that tell us where the stock market may go next.
You'll be surprised at what these clues say.
They come from a look back at history. One analyst found that when the beauty contest between stocks and bonds sets up as it does today, bonds get destroyed. "For the third time since the 1850s," he writes, "30- year rolling real bond returns are near equity returns, and on both previous occasions, multi-decade bond bear markets followed."
And for stocks? Well, this same fellow deduces from the same history that stocks could rise 30% or more as inflationary expectations rise.
Before you scoff at this outbreak of optimism, consider that this is from one of the great students of bear markets. He knows their ways and histories. Heck, he wrote a book about them, The Anatomy of the Bear. And he thinks we're in a secular bear market for stocks now. ("Secular" being a cherished Wall Street fancy dan word. It means "long-term.")
So who is this guy and what gives?
Let me preface this discussion by saying that I don't usually like to guess about where the stock market may go next. We simply play the ball where it lies, like an honest golfer. Besides, in my investment letter, Capital & Crisis, we don't buy the stock market. We buy specific stocks. I think it is infinitely more useful to spend my time looking at specific stocks and to just be picky about what we buy.
Still, I sometimes like to think about the great ebb and flow of market movements. Today is one of those days.
Anyway, the analyst quoted up top is Russell Napier, the global macro strategist for CLSA, an investment firm. He lays out his case in a report titled "It's Not the Economy, Stupid." Napier shows that relative to bonds, US stocks are cheaper now than at any time in the past 50 years. He speculates that this is probably due to widespread fears of a "double-dip" recession. "But unless that double dip produces a 60%-plus decline in earnings," Napier writes, "equities are cheap."
Of course, we can't rule anything out, and Napier doesn't. But Napier writes that "at these relative valuations, investors have consistently made material positive returns in every period since the late 1950s. Yield compression alone could push US equities up more than 30%, and if inflation concerns increase, gains could well exceed this."
Now, before you declare the man insane, I think there is some merit to what he is saying. And it comes with a powerful qualifying comment, which I'll get to below.
But here is the key...
Napier compares bond yields with stock dividend yields. Dividend yields on stocks are very close to those of 10-year Treasuries. This situation last existed from December 2008 to May 2009. Investors who bought stocks then did well. You otherwise have to go back to June 1962 to find such a narrow gap. Again, investors who bought then cashed in as stocks rose 26% over the next 12 months. There are other historical examples.
As Napier writes, "Investors have consistently made good profits at the current yield gaps and ratios since 1958."
In any event, this is where we are.
Napier's qualifier is that he's making a relatively short-term call. Longer term, he says stock valuations ought to decline as bond yields rise. In the early going, though, stocks often rise. As he writes, "This is likely to be the beginning of a very long bear market in bonds, but there is much in the historical record to show that equity prices can continue to rise in the early stages of a bond bear market."
I won't tackle that historical record. I will add that valuations can come down without stock prices dropping. Earnings can rise and stock prices can rise more slowly. This is what we've seen this year, as the market overall showed much-improved earnings, but the stock market is pretty much where it began the year.
Long term, Napier is not fond of stocks. He simply recognizes the ability to make large gains even in the context of a downward-sloping market. As he points out, the 1970s were an awful time to buy and hold stocks. Yet the 1970s also produced some of the best one-year holding periods for stocks. "Another such great opportunity now presents itself for the nimble and the bold," Napier writes.
In short, bonds look sunk; but as for stocks, there is room to run. We'll see if this clue-deducing is as good as Sherlock Holmes'.
Chris Mayer,
for The Daily Reckoning
Joel's Note: Mr. Mayer, ever the unconventional investor, knows where to look for deep value plays in any market. Right now he's got his eye on an unconventional natural gas play. You can find the details in his newly released report, "America's New Resource Miracle."
| | | | If This Iran News Leaked, There'd Be Panic in the Streets |
Nobody in the Pentagon knows how to handle this. Nobody in the White House has a clue what to do.
This epic, 1,354-year old conflict could be about to boil over - bringing suffering on par with what Europe experienced during the 1930s.
Watch this new presentation before it's too late, right here.
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| | | | We haven't heard from Bill today...so we thought we'd turn the final words of today's issue over to our fellow reckoners...
"In response to your Social Insecurity conundrum article," writes one reader, referring to Ian Mathias' weekend column, "this 'news' is an old story...an old story that was never addressed! I can remember back in 1980 or 1981, US News & World Report chronicled a story about social security paying huge benefit amounts to workers who had only paid into the system a few years and about other boondoggle uses of the fund. However, since lawmakers had their 'own' plan, the problem was merely 'kicked' down the road until today."
"I have the perfect solution for those of us who have paid into the social security scam all these years," offers another reader. "We should be exempt from paying any tax for the remainder of our lives. This includes state, federal, income tax, capital gains, etc. This should include luxury tax, property tax, sales tax, etc. This should continue until the amount we have paid into social security, plus interest, to be determined later, is paid back to us. Let's give our so-called politicians this request. I am not expecting the politicians to agree, but there is always civil unrest to cure this problem, LOL!!!"
Writes another: "We recognized that SS will for all [intents and] purposes be toast when our kids retire. (They are in their 20s now.) So what we did was put their inheritance in a trust and they will get it in their 50s. They can access it for a down payment on their residence or for serious medical problems. They are both college graduates so they should be able to take care of themselves till then, and they will not be able to spend it during their youth."
Ian, who recently joined Jim Nelson on Agora's income desk, is busy penning the second in his Social (In)Security series. We hope to have it to you later in the week. In the meantime, keep those emails comin'.
Regards,
Joel Bowman,
for The Daily Reckoning
P.S. In case you haven't heard, Social Security is set to "officially" turn cash-flow negative on Sept. 30...less than two weeks away...and about 6 years earlier than the government had forecast. Jim Nelson has prepared a special presentation on what this means for America and how you can avoid the fallout by taking advantage of another, lesser-known program. If you want to give it a quick listen, here it is.
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Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor atjoel@dailyreckoning.com |
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