Wednesday, July 30, 2014

A History Of Worst Case Scenarios For Global Stock Markets

Interesting chart below from Patrick O'Shaughnessy, which shows the worst case scenario for stock markets around the world during different time intervals from 1900 to 2012.

The United States market was one of the top performers, which is unsurprising considering the United States dominated the growth in the global economy during the 20th century. The U.S. also never had to endure war taking place on its own soil, which devastated some of the major countries during the WWII years.

There is a case to be made, however, that no market experiences exponential growth forever, especially when that market becomes enormous in size relative to the rest of the world. The common assumption is that if you buy for the long term it makes no difference when you enter the market. You'll notice that 12 of the 21 markets were down for periods longer than 30 years. 

With the United States currently one of the most expensive stock markets on the planet, do investors have 40 to 50 years to recover if something goes wrong?

Jim Grant On Russian Stocks, Gold Mining Shares & Global Debt

More from Jim on the Bloomberg set this week discussing the artificially low yield levels around the world:

35 Percent Of Americans With Credit Have Debt In Collection

The Urban Institute released a report this week titled Delinquent Debt In America, which has received widespread publicity due to a startling statistic.

They report that 35% of Americans with credit have debt in collection. This means you must actually have credit (opened credit card, auto loan, or other accounts), and it does not include mortgage debt. The summary concludes:

Financial distress is a daily challenge for millions of American consumers. Nearly 1 2 million adults — 5.3 percent of Americans with a credit file — have non-mortgage debt reported past due, and they need to pay $2,258 on average to become current on that debt. 

Further, an alarming 77 million Americans — 35 percent of adults with credit files — have debt in collections reported in their credit files, with an average debt amount of nearly $5,178. Debt reported past due, and in particular reported debt in collections, is more concentrated in the South. 

In addition to creating difficulties today, delinquent debt can lower credit scores and result in serious future consequences. Credit scores are used to determine eligibility for jobs, access to rental housing and mortgages, insurance premiums, and access to (and the price of) credit in general (Federal Trade Commission 2013; Traub 2013). 

High levels of delinquent debt and its associated consequences, such as limited access to traditional credit, can harm both families and the communities in which they live. This brief contributes to our understanding of financial distress in America by exploring the spatial patterns of delinquent debt in the United States. Future work will explore the drivers of financial distress and those factors influencing its spatial patterns.

While certain sectors of the American recovery are humming due to the Fed's liquidity injections, the larger economy continues to choke on consumer debt coupled with stagnant wages.

Monday, July 28, 2014

In The New M&A Mania Both Sides Experience Share Price Surges

Hedge fund legend David Einhorn noted in his letter this week that mergers and acquisitions have come roaring back in 2014. The merger period that occurs late in a market cycle (during peak euphoria) can be frustrating for a fund to short some of the most overvalued stocks because when they are taken over their share prices usually surge.

Companies that know they have problems under the surface are quick to agree to any deals at a premium of what their company is currently selling for (the problems under the surface are what David's team has the ability to see). Pushing a merger through allows the selling company's shareholders to cash out at a profit while the losses are absorbed in the future by the buying company. 

These periods of euphoria, as seen in the chart below, tend to occur near market tops. The Fed has turbocharged the current M&A surge because the largest beneficiary of QE has been stock prices and junk bonds which are used to put deals together. 

Normally during a takeover the company being bought out experiences a rise in the stock price while the company buying sees a decline. David noted that this takeover season has a new twist; the buyer's stock prices are also advancing in response to deals, enabling companies, to see gains as acquirers - even of other troubled companies. As an example, Zillow and Trulia announced plans for a merger this week and both shares rocketed higher on the news (I'm not saying these are troubled companies, only showing the example of both sides experiencing rising share prices).

Companies already drunk on euphoria continue to see these deals put together with both sides experiencing share surges, meaning anything could happen as we move forward in the short term. 

What we do know is that the longer this goes on and the more deals that are put together using inflated junk bonds and artificially high share prices, the more pain that will result in the end. When the madness will end is anyone's guess, but we have moved to the point where the steering wheel and brakes have been removed from the car. All that is left now is additional acceleration and prayers for a happy ending. 

Sunday, July 27, 2014

Still Drowning: An Update On Seriously Underwater Homes In The United States

RealtyTrac reported this week there are still 9.1 million U.S. residential homes considered "seriously" underwater (the mortgage exceeds the property's value by at least 25%).

The seriously underwater group accounts for 17.2% of all mortgages. The residential market has slowed considerably during the first half of 2014 and as we have discussed here numerous times; when interest rates resume their ascent higher home prices will resume their decline lower. 

Here are the top 10 states with seriously underwater homes. Click for larger view:

Mark Cuban On Tax Inversions

Corporate (Tax) Inversion Definition From Investopedia:

"Re-incorporating a company overseas in order to reduce the tax burden on income earned abroad. Corporate inversion as a strategy is used by companies that receive a significant portion of their income from foreign sources, since that income is taxed both abroad and in the country of incorporation. Companies undertaking this strategy are likely to select a country that has lower tax rates and less stringent corporate governance requirements."

Friday, July 25, 2014

Facebook Is Now Worth More Than......

Facebook is now worth more than Coca-Cola, Disney, Intel and closing in fast on IBM. I am not an expert on social media or Facebook's plans for future products and revenue, but on the surface it appears this is not going to end well for those buying Facebook shares this afternoon.

Wednesday, July 23, 2014

The Incredibly Massive Revenue For Apple's Two Products

Apple is essentially a company composed of two products; the iPhone and iPad. That simple fact makes me very nervous as a buyer of Apple stock because I feel there are fairly easy barriers to entry in both categories.

However, when you take a look at just how powerful those two products are today it is breathtaking. The following two graphs from Slate show how big the iPhone and iPad would be if they were their own companies. Incredible....

Corn & Wheat Prices Destroyed: Buying Opportunity?

It has been a horrible few months for the agriculture grains. Corn has been in free fall for weeks (down over 30% since April) while wheat has also been slammed. Corn is now selling for $3.68 a bushel. It costs $4.50 to $5.00 to grow a bushel of corn when you include tractor fuel, seeds and inputs such as fertilizers and herbicides. Farmers have an oversupply of corn and they are switching more of their crop to soybeans.

I am buying corn and wheat right now (symbols CORN & WEAT). With 7 billion hungry people on the planet, and the population of the earth growing exponentially, I think it is possible that the price of a bushel of corn will move above the cost to produce it at some point over the next few years. Prices can (and probably will) go lower in the short term because sentiment is at extreme lows and the traders are pummeling the price daily on the exchange.
The following is an interview last night with with Marc Faber on CNBC who is bullish on agriculture and sees relative value in Chinese and Hong Kong shares in relation to other stock markets around the world. He notes, as I have many times here over the past few months, that the U.S. stock market is currently the most expensive in the world.

Saturday, July 19, 2014

Why The Reformed Broker, Josh Brown, Is Wrong On U.S. Stocks

One of the most widely followed financial sites on the web is The Reformed Broker, with articles written daily by Josh Brown. Josh is a money manager alongside Barry Ritholtz at Ritholtz Wealth Management. I read both Josh and Barry's sites daily because they provide excellent, well-written content on what is happening in the markets. More importantly, they have many opinions that are starkly different from my own.

I think you could sum up Josh's opinion of the U.S. stock market as cautious in some sectors, but bullish on the market as a whole. Anyone who has read this site for more than a few weeks knows that I am currently bearish on the near term potential for U.S. stocks and feel that only a small portion, at the most, of investor's capital should be in U.S. stocks. There is far more value that can be found overseas; see How The Home Bias Phenomenon Impacts Investors.

This week Josh wrote an article titled A Quick Lesson On Market Tops where he presented reasons why investors should stay long the U.S. stock market at today's all time highs.

Reason 1: Although we are currently selling at the same PE ratio as we were at the market’s top in 2007, there is one very important difference – we’re at about half the yield on the 10-year treasury versus back then.

My thoughts: I view the fact that we are at half the yield on the 10 year treasury as a major headwind for stocks in the years ahead. Why? The treasury yield impacts every asset in the world; especially those located in the United States. Corporate bonds tend to track track treasury yields with a built in spread so if treasury yields are low it allows corporations to borrow at lower rates which increases profits. Lower rates allow buyers of commercial and residential real estate to purchase and refinance property at a lower rate which increases profits and disposable income. It allows state and local governments to roll over and issue debts at a lower rate which provides additional capital to spend into the economy. I can go on and on.

The decline in yields has been a turbo charge to the economy since 2009, but we now need to look at what is going to happen moving forward with yields and how that will impact stocks. What happens if yields have bottomed and continue to move higher? The boost the economy has received has helped turbo charge stock prices. If interest rates were to move in the opposite direction from here it would create the opposite effect on the economy and potentially stock prices.

Reason 2: In 2007, virtually all economic growth was coming from private sector leverage, specifically in the real estate market. Today, lots of growth is also coming from leverage – but it’s mostly the Fed printing to buy bonds from the Treasury and then letting them mature and roll off. This is funding deficit spending and preventing a lot of really tough budgetary battles in Congress. This is powering a slowly-growing economy and a record amount of buyback activity which is helping to fuel corporate prosperity, which in turn, theoretically, is creating private sector jobs.The whole mutually beneficial system I’m describing is what Jeff Gundlach has called a “circular financing scheme”. He says that if it works, it’s the most important invention since the telegraph.

My thoughts: The private sector is still in a coma, and the Federal Reserve is now in the process of ending their QE program which they tell us will be followed by an increase in rates. If the U.S. stock market has moved higher due in large part to a circular finance scheme centered around the Fed's QE program, and the Fed is telling us that scheme is coming to an end, is that not a problem?

Reason 3: We’re nowhere near the PE ratio the S&P 500 printed at the height of the dot com boom.

My thoughts: The fact that we have now crossed every valuation point in history by P/E standards (including the 1929 and 2007 tops), but we are still below the 2000 mania peak should not make investors feel comfortable. That is like saying I drank 15 beers in the last 2 hours and I am good to drive home because my friend drank 20 beers in 2 hours one night last week and he did not get pulled over. In addition, a large portion of the mega-overvaluation back in 2000 was concentrated in a small portion of the technology market (as Josh correctly notes in his article). The mean stock in the S&P 500 today has a higher P/E ratio than it did in 2000.

Josh called out Rick Santelli last week on CNBC regarding confirmation bias, and I would caution him to make sure he is not making the same mistake. U.S. stock bulls have been absolutely correct in staying long stocks the last few years, which have outperformed almost every other major asset class on earth. However, I believe that since early 2012 U.S. investors have been playing Russian Roulette by remaining in the market at these incredibly lofty valuations. Just because they have not found the bullet in the gun does not mean it is not waiting for them. Now is the time to put the gun down and walk away while you are (way) ahead.