Saturday, December 28, 2013

Jim Rogers: "Taper Will Be A Disaster"

David Collum's 2013 Year In Review & Outlook For 2014

Excellent holiday reading from David Collum who puts together a massive outlook to end every year. Click on the square at the bottom right to bring the reader full screen.

An interview with David Collum begins 4:15 into the following video:

Friday, December 27, 2013

U.S. Stock Rally Takes Center Stage While The 10 Year Quietly Crosses 3.00%

During the holiday week in the United States the 10 year treasury yield has quietly crossed over 3.00%. Yields were close to 1.70% in April of this year.

This impacts almost every asset on the planet (negatively) because it pushes up the cost to borrow. As yields rise on all debt instruments, those that own the bonds are taking losses. Rising yields = falling bond prices.

At what point will rising yields begin to impact the U.S. stock market insanity? We will find out in 2014.

Tuesday, December 24, 2013

Flashback To March 2009: What Was The Outlook For U.S. Stocks?

We enter the year 2014 with breathless optimism. The headlines are an endless stream of euphoria shouting for higher U.S. stock prices, bond prices and real estate prices in the United States.

Is this a great time to buy stocks? Writing this on December 24, 2013 it is still unclear. Investors may experience a 1998 to 2000 rush in stock prices which leaves rational market observers like myself continuing to look foolish on the sidelines.

Or they could revert back to where the fair (not cheap) value range has been over hundreds of years. Jeremy Grantham put this target somewhere around 1100 on the S&P. The S&P sits at 1829 as of this writing.

Last week we looked at what market analysts were saying about stocks during previous market peaks in December 1999 and December 2007 and found that they are saying the exact same thing they are today. This was an interesting experiment but we should take it one step further and look at what they were saying during the market bottom, in March 2009, which was an excellent time to purchase stocks.

Before getting started we'll review the four big reasons you hear today for further U.S. stock gains in 2014 and beyond.

1. Market Momentum - Prices have had an excellent 3 year run and even a less optimistic scenario should have prices rising at least 10% based on momentum.
2. Price To Earnings - Projected earnings show that the market is cheap. Why? Because Wall Street projects staggering earnings growth in 2014.
3. Sentiment Toward The Market - We hear today that markets are climbing a wall of worry. In reality, most sentiment readings reached record high bullish levels throughout 2013.
4. Blue Chip Stock Safety, Dividend Payments & Stock Buybacks - Blue chips stocks are on fire, dividend payments are rising and companies are buying back their own stock.

We will see now that when stocks were bottoming in March 2009, which was an excellent time to purchase U.S. stocks, these same four arguments were used by professionals to explain why stocks would move lower.

Flashing back to March 2009......

1. Market Momentum:

When you reach the bottoming process of markets, participants project forward from the trajectory they are currently on based on momentum. Notice the chart included in the article below which shows earnings estimates continuing to plunge downward at the current trend. The opposite occurs today where wild high earnings estimates show projections blasting upward to new highs across the board.

The Wall Street Journal: "DOW 5000? There's A Case For It"
March 9, 2009 (the day the markets bottomed)

As earnings estimates are ratcheted down and hopes for a quick economic fix fade, the once-inconceivable notion of returning to Dow 5000 or S&P 500 at 500 looks a little less far-fetched.

Looking solely at valuations, namely price relative to earnings estimates, the S&P at 500 isn't necessarily a wild stretch.

According to Goldman's data, the bottom of the 1974 bear market had a forward P/E of 11.3. At the trough in 1982, it was 8.5. Put a multiple of 10 with estimates of $40 to $50 a share and the S&P comes out at 400 and 500.

2. Price To Earnings:

You can see from the article below that earnings estimate projections are a serious problem when earnings are falling, but in today's world (December 2013) there is no discussion of this problem because stocks are rising. You can feel the despair back in 2009 that stocks will never find a bottom and the situation is almost hopeless, the exact opposite of the feeling of "no ceiling" around stock prices today.

Writers in 2009 would then say that markets found previous bottoms at P/E ratios below 10, which is the reason why markets should fall much further. The market back in March 2009 appeared over valued because it had not reached the historical bottom during bear markets. Today, with the P/E ratio at 25 there is no discussion of over valuation.

The Wall Street Journal: "To P/E or Not to P/E? That Isn't The Appropriate Question"
March 3, 2009

The current market climate has drawn comparisons to the mid-1970s, when investors dreaded coming into work, knowing the markets were in for a rough time. With that kind of despair ruling the market, "what's the difference between 12 times or eight times or 10 times earnings? There isn't demand for equities, because people can't see any signs of recovery soon," says Peter Boockvar, equity market strategist at Miller Tabak. He contrasted this with the late 1990s, when "expensive got more expensive."

The problem, according to investors, is that S&P 500 earnings expectations are constantly changing, as analysts reduce their expectations for per-share earnings. As of a few weeks ago, analysts anticipated per-share operating earnings to come in around $69 in 2009, according to Thomson Reuters, but that figure (already reduced from some kind of previously ridiculous estimate) has come down in the last few weeks, and now the expectation is for earnings of about $50 to $55 a share for the year.

Using a typical valuation at the market's nadir -- a price-to-earnings ratio of anywhere from eight to 12 times earnings -- that puts the S&P 500, optimistically, at 660. It only broke through 700 Monday. So even a more optimistic outlook still suggests more pain.

Market strategists, until recently, were quick to dismiss the consensus, knowing it was too high -- but now they are concerned that even the reduced revisions mightn't capture the depth of the economic decline.

"The risk is to the downside if the economy substantially worsens from the levels we currently see," says Fred Dickson, director of private client research at D.A. Davidson. "It's a downward moving target at the moment, and the valuation metric has just been very tough to put one's finger on."

Trader's Narrative: "S&P 500 Price Earnings Ratio (Long Term Chart)"
March 4, 2009

In any case, the data for February and March 2009 are an estimate only and take us down to 12 - which is without an argument a very low P/E Ratio. But not as low as we've seen the price earnings ratio go.
In August 1982, the PE Ratio dropped below 7. And in both July 1932 and July 1921 it went below 6. To see that scenario again, the S&P 500 would have to drop another 40-50% to the 430-360 level (assuming earnings miraculously stay the same).
The only time that the PE Ratio has dropped as precipitously as in this bear market was in the aftermath of the 1929 bull market top. At its zenith in 1929, the PE Ratio was only approaching 33 while in the 2000 market top it reached 44.

New York Times: "Stocks Finally Looking Affordable"
March 2, 2009

But the declines over the last few weeks are starting to change the picture. I crunched some of the historical stock data kept by Robert Shiller, author of “Irrational Exuberance,” and it offers some reason for optimism. When the p-e has been between 12 and 13 over the last 125 years or so, stocks have doubled over the next decade, on average. (Adjusting for inflation, they have risen almost 50 percent.)
Over all, there is pretty direct correlation between the p-e ratio and future long-term returns. For example, when the ratio has been 15 to 20, stocks have risen only about 50 percent over the next decade. When the ratio has been above 25, stocks haven’t risen much at all.
So does this mean stocks are finished falling? No.
In the other two great bear markets of the past century, in the 1930s and the 1980s, the p-e ratio ultimately dropped to about 6 or 7. To get to that level now, the S&P 500 would have to drop below 400, from the current 701, and the Dow Jones industrial average would need to be below 4,000. So stocks may well continue to fall. They may even still fall a fair amount.

3. Sentiment Toward The Market:

Almost all sentiment readings were touching extreme lows in early March 2009. The daily sentiment index reached 2% the week stocks bottomed. That means 98% of investors polled felt stocks were going lower. Contrast that with two 93% readings over the past few weeks where only 7% of investors thought it was possible that stocks could fall in the short term.

Horan Capital Advisors: "Bearish Sentiment Hits Highest Level Since 1990"
March 5, 2009

The Economist: "Despair Springs Eternal"
March 4, 2009

So that reflects the extent of investors' fears at the moment. Either we are indeed facing another depression, in which the falls in economic output are cumulatively 10-20%, rather than 3-4%. Or central banks will only be able to get us out of a recession by inducing the kind of inflation that devastated portfolios in the 1970s.
If you can take a 10-year view, this seems like a good time to bet against that pessimism. The problem is that investors are more worried about the next six months, and the danger that stocks could get significantly cheaper in the short term.

4. Blue Chip Stock Safety, Dividend Payments & Share Buybacks:

Any outlook on the markets for the year ahead tells you that even if the overall market gets in trouble, investors will be protected in blue chip stocks. These companies have stable long term dividends, strong balance sheets and exposure to overseas markets putting a floor under any price declines. What was the discussion like back in March 2009, which was a great time to purchase blue chip stocks? Investors were dumping them across the board as they watched many stocks cut their dividends and see earnings drop due to their exposure to overseas markets.

Another big market proponent you hear today is that companies are buying back their own shares with excess capital. This occurs at the top of markets. At the bottom companies are trying to raise capital, slash costs and preserve cash.

The Economist: "Slash and Burn"
March 5, 2009

Meanwhile, a new fear haunts the markets: the mounting number of firms slashing their dividends.

That banks and insurance companies will chop their payments is now understood, but the pain has spread. General Electric (GE) has cut its dividend for the first time in 71 years, Dow Chemical for the first time since 1912. In Europe previously reliable payers like Telecom Italia and Anglo-American, a mining firm, have reduced their payouts, and even BP has said it cannot increase its dividend at today's oil prices.

Furthermore, the share of American earnings paid out as dividends has declined from a post-war peak of almost two-thirds to about one-third in 2007, with many firms preferring stock buybacks (which have now ground to a halt). 

The Washington Post: "Corporate America's Icons Crumbling Under Global Recession"
March 6, 2009

"The big surprise is that large companies that we thought were well-capitalized with abundant access to credit and that could access the global market, none of that is helping them," said Ed Yardeni, president of Yardeni Research, an investment research firm. "But a lot of these issues that we thought of as positive are turning back to bite them hard."

Analysts point to two key reasons why some of the nation's largest companies have unraveled in the current downturn. One is that they had come to rely on providing financing to their customers, lending money for sales of their own products. When the credit markets ground to a halt in mid-September, it set off chain reaction of pain, hurting consumers and manufacturers alike.

The second is their exposure to global markets. Once regarded as a way to spread risks, the diversification exacerbated a drop in sales as foreign countries grapple with more severe downturns.

"The reality is that size doesn't seem to matter much," Yardeni said.


During March 2009 everyone hated stocks. Everyone discussed how far P/E multiples would fall, how far earnings would fall and how low stocks would ultimately end up. This is an environment to put long term investment capital to work.

Today the exact opposite environment exists. I expect stocks to finish the 2014 year lower than where they stand today.

Want more history? See:

Flashback to December 2007: What Was The Outlook For U.S. Stocks?

The Kidnapper Wears Prada

Saturday, December 21, 2013

The Case For Optimism

While I like to feel this site provides a more "realistic" view on the world, the truth is that the changes I see coming to financial markets and global economy should be viewed as an opportunity, not something to fear.

Underneath all the mismanagement of our financial, political and economic system there is a growing trend of positive improvement in the real world.

The following slide show briefly walks through examples of some of these positive changes taking place around the world. When the big reset comes, it will be the opportunity of our lifetime to finally invest and live in what will be the biggest boom in human history.

Thursday, December 19, 2013

The Fed Removes The Exit Strategy From Quantitative Easing

Some quick thoughts on the taper:

The Fed chose to slow their bond buying program by $10 billion per month, reducing the amount of mortgages they will purchase by $5 billion and the amount of treasuries they will purchase by $5 billion. They are now buying $75 billion of bonds per month with printed money.

I felt the most important part of the Fed announcement yesterday was not the $10 billion reduction. When they first launched QE-ternity back in September 2012 they had an exit strategy based around the unemployment rate falling to 6.5%. This made the market nervous because as we have discussed numerous times in the past, the unemployment rate is currently falling in large part due to people giving up looking for jobs (they are then considered employed by the government). Bernanke acknowledged this problem in recent press conferences.

Yesterday they removed this barrier saying that they will continue easing "well past" the unemployment rate hitting 6.5%. Now they have removed all limits around how long QE will run.

When the mania in stocks subsides or if they begin to lose control of the bond market (which may already be happening) they will re-enter the market with even larger doses of QE heroine. 

In the meantime, gold, silver, agriculture, strong emerging market stocks and currencies may all fall on the news. I'll be a buyer. 

Wednesday, December 18, 2013

Marc Faber Dumps Cold Water On CNBC's U.S. Stock Market Celebration

Marc Faber provided the shocked CNBC studio with a sobering outlook on the financial markets yesterday afternoon. He feels that cash and precious metals are currently the two most hated assets on the planet. I am steadily accumulating both of those assets right now, which comforts me to hear from Faber (who travels and speaks with people continuously all over the world) how hated they actually are. The reason why it comforts me is a topic I reviewed in detail a few months ago, where I discussed how I look through the lens of the world in terms of both investment and business decisions. See:

Newton's Cradle: Visualizing Asset Prices Through Capital Movement

Sunday, December 15, 2013

Flashback To December, 1999: What Was The Outlook For U.S. Stock Prices?

Here's how it all worked out:

Next stop on the history tour:

Flashback to December, 2007: What Was The Outlook For U.S. Stock Prices?

Flashback To December, 2007: What Was The Outlook For U.S. Stock Prices?

The following shows the rising and falling periods for the U.S. stock market over the last 17 years.

After the fall in 2008-2009, we have once again risen relentlessly for five straight years. Any bearish sentiment toward the market has been completely washed away like the ocean tide. Open any outlook on the future direction for stock prices in 2014 and the answer is higher or much higher. See Here's What 14 Top Wall Street Strategists Are Saying About The Stock Market In 2014.  

In order to put this time period in perspective we can flashback to December 2007. Remember that the United States at this point was already in recession, and the market had already topped a few weeks before the forecasts were provided.

See if you can spot the major themes, which you will notice are the exact same themes you hear today on why the market will move higher in 2014.

1. The Fed's Easing Will Push Stock Prices Higher
2. Prices To Future (Estimated By Wall Street) Earnings Show Stocks Are Cheap
3. Cash On The Sidelines
4. Stocks Are A Good Buy Relative To Bonds

The following are the forecast summaries from Bloomberg's Where To Put Your Cash In 2008, December, 19, 2007.

WILLIAM GREINER, Chief Investment Officer, UMB Financial 

Greiner expects a combination of low stock valuations and lower interest rates to push the Dow up some 8% over today's levels. Moreover, he notes, "the market has a tradition of rallying pretty hard in the second half of a Presidential election year." Greiner favors companies that manufacture products consumers cannot do without, such as food and drugs. He expects such companies to deliver strong profit gains—of some 8% in 2007 and 10% in 2008—even as corporate bottom lines elsewhere stagnate. His favorite stock, Starbucks (SBUX), trades at about 23 times earnings—or "its cheapest level ever."

Greiner's Calls
DJIA: 14,400 (December, 2008)
S&P 500: 1520 (December, 2008)

TOBIAS LEVKOVICH, Chief U.S. Equity Strategist, Citigroup (C)

Citigroup's U.S. stock strategist is advising clients to buy beaten-down financial and retailing stocks and steer clear of stocks that have seen big run-ups. Of course, Levkovich's call amounts to good, old-fashioned investment sense ("buy low, sell high"). But there's no guarantee his timing is right. "Markets don't ring bells at the top or bottom," he replies. "If you wait, you will miss out." Levkovich believes bank earnings are likely to surpass analysts' ultralow expectations for next year. Why? A series of interest-rate cuts from the Fed, extending into 2008, will allow banks to reduce the rates they pay on deposits and repair damaged balance sheets. Meanwhile, he predicts retailers will benefit from healthy consumer spending, fueled by continued job growth. By Levkovich's calculations, stocks are at bargain levels seen in only 90 of the past 550 months. "In every single instance," he adds, "the markets were higher 12 months later."

Levkovich's Calls
DJIA: 15,100 (December, 2008)
S&P 500: 1675 (December, 2008)
Earnings: expects a rise of 5.2%

JASON TRENNERT, Chief Investment Strategist, Strategas Research Partners

His recommendation for 2008 is to stick with U.S. stocks. With corporate balance sheets strong and the U.S. unemployment rate low, Trennert figures the odds of a recession are low. He expects the Federal Reserve to cut the Federal Funds rate from 4.25% to 3.5% by midyear—averting a major credit crunch and fueling stock gains. At 15 times 2008 earnings projections, Trennert argues U.S. stocks are a good buy in comparison with bonds: The ten-year Treasury bond's 4.2% yield equates to a price-earnings ratio of 25.

Trennert's Calls
DJIA: 15,150 (December, 2008)
S&P 500: 1680 (December, 2008)

BERNIE SCHAEFFER, Chairman, Schaeffer's Investment Research

Schaeffer—a past winner of BusinessWeek's annual stock market forecasting contest—remains optimistic about the outlook for stocks in 2008. He expects a series of "aggressive" interest-rate cuts by the Federal Reserve to bolster consumer spending, economic growth, and stock prices next year, and for a weaker dollar to inflate the overseas earnings of multinational companies.

Schaeffer also scrutinizes various technical indicators, most of which, he believes, are currently flashing positive signals. For instance, he cites indicators of negative investor sentiment which, counterintuitively, are positive for stocks, since they signal there's a lot of money on the sidelines waiting to move into stocks upon good news.

Schaeffer's Calls
DJIA: 15,300 (December, 2008)
S&P 500: 1700 (December, 2008)
Earnings Growth: 7%
Asset Allocation: 80% to stocks

LEO GROHOWSKI, Chief Investment Officer, BNY Mellon Wealth Management

Overall, Grohowski is expecting the Dow to finish 2008 some 10% higher. But along the way, he warns, investors will be in for a choppy ride, as uncertainty about the economic outlook fuels "above normal volatility." Grohowski recommends a defensive portfolio. He likes U.S. stocks, because he thinks valuations are reasonable and because there aren't a lot of attractive alternatives.

When it comes to bonds, Grohowski favors municipals, which on an after-tax basis currently yield more than comparable Treasuries. "In almost any tax bracket, it makes sense to buy munis," he says. Later in the year, Grohowski thinks investors will be rewarded for taking more risk. He's expecting financial stocks to rebound. And he thinks international stocks still have room to outperform.

Grohowski's Calls
DJIA: 14,800 (December, 2008)
S&P 500: 1675 (December, 2008)

THOMAS McMANUS, Chief Investment Strategist, Banc of America Securities

McManus is expecting the Dow to decline by 3% in the first half of 2008 before rebounding to finish the year a solid 10% above current levels.

McManus' Calls
JIA: 14,700 (December, 2008)
S&P 500: 1625 (December, 2008)

DAVID BIANCO, Chief U.S. Equity Strategist, UBS Investment Research (UBS)

UBS's chief U.S. equity strategist expects economic growth to slow next year, to about 2%. But he believes the odds of a recession are less than 50/50, thanks to the Federal Reserve, which he expects to cut interest rates enough to provide relief to banks and, to a lesser extent, consumers. By yearend, Bianco sees economic growth heading modestly higher and the Dow at 15,250, or 14% above today's level.

Bianco's Calls
DJIA: 15,250 (December, 2008)
S&P 500: 1700 (December, 2008

Here's how it all worked out:


Next stop on the history tour:

Flashback to December, 1999: What Was The Outlook For The U.S. Stock Market?

2014 Outlook: Rogue Wave 3: The Global Housing Bubble Is Back

- Nouriel Roubini 
  December, 2013

The world property price index has crossed above the record high reached in the third quarter of 2008. This past year, price increases took place all across the world, with only a few major markets experiencing declines.

The froth in the global real estate market, as seen previously during the 2000 to 2008 price surge, has been concentrated in the major cities. 

In Australia the poster city has been Sydney, which has launched to new highs.

Sydney's year over year rise:

In Canada, the largest cities such as Toronto and Vancouver have experienced the largest amount of speculative froth. The following shows the staggering rise in real estate prices in Toronto:

In the U.S., coastal markets like San Francisco are relaunching toward their previous record highs.

However, nothing around the world compares to what is taking place in China. Hot money has plowed into Chinese real estate simply to speculate that prices will move higher (many real estate properties purchased just sit empty) in a way that would make the 2005 market in Miami, FL look tame.

Here is how China's home price appreciation stacks up against some of the other (very frothy) markets:

The key metric to follow is the price to income ratio. In many of these major markets, the ratio has moved to unsustainable levels.

In Hong Kong it now takes almost 14 years worth of income to purchase a property, which surpasses the ratio seen in 1997 (their last property bubble peak). Prices fell 65% from that point in 1997, with the price to income ratio falling to only 6 years and creating an amazing buying opportunity. 

Hong Kong is pegged to the U.S. dollar, so the interest rates are virtually zero. You can receive a mortgage in the 2 to 3 percent range, but here is the most crucial point: they are adjustable rate mortgages. When interest rates reset, it will be catastrophic for their property market.

The Fed, Bank of Japan and Bank of England are pumping printed currency into the global economy at a staggering rate. Hot money is chasing property in the same exact speculative way it did in the first part of this millennium. Major cities such as Sydney, Toronto, Shanghai, Dubai, London and San Francisco are experiencing the greatest benefit of this hot money. 

The story will end the same. If you live in a major city around the world, I would suggest taking a hard look at the price to income levels in your region before making a decision to buy, sell or hold.

With home prices now at new record highs in the U.K., residents are being forced to move into shipping containers.

Up Next: Investment Opportunities In The Year Ahead

h/t Bloomberg, FRED

Rick Santelli & David Stockman Review This Week's U.S. Budget Deal

Saturday, December 14, 2013

Mike Rowe On The Broken Education System In The United States

Mike Rowe, host of Discovery Channel's Dirty Jobs, sums up the interview below eloquently in the opening statement:

"If we are lending money that ostensibly we don't have to kids who have no hope of making it back in order to train them for jobs that clearly don't exist, I might suggest that we've gone around the bend a little bit."

Student loan debt, which is over $1 trillion in size, has recently surpassed credit cards as the most troubled debt category in America. The number of student loans over 90 days delinquent has risen to 11.8%.

"There is a real disconnect in the way that we educate vis-a-vis the opportunities that are available. You have - right now - about 3 million jobs that can't be filled," he says, talking about openings in traditional trades ranging from construction to welding to plumbing. "Jobs that typically parents' don't sit down with their kids and say, 'Look, if all goes well, this is what you are going to do.'"

Wednesday, December 11, 2013

Las Vegas Real Estate Begins To Tremor

Las Vegas has been the poster child for the real estate bubble in the United States. The chart below shows the epic rise in prices during the first bubble, the first collapse, and the second bubble that began to build steam early last year.

I discussed the economic fundamentals behind the rise in Las Vegas home prices a few months ago (there are none) in Behind The Curtain Of The Artificial U.S. Residential Home Market. This week we received a real time update on the Las Vegas market from Mark Hanson, who is tracking the data in real time.

Las Vegas housing demand has crashed.  "Crash"...there is no other word to use.  This is not hyperbole.  "Crashed" is absolutely the appropriate word to use here given sales are suddenly the weakest levels since Armageddon 2009.  I mean come on...sales at the same pace as when the stock market was in the midst of one of the greatest plunges in history speaks least to me.  Volume precedes price.
Supply is surging in Vegas with "months-supply" back to nearly 7 months (over 7 for condos), and at 2010/11 levels.  There certainly is NO LACK OF SUPPLY in this market.  And ponder about this for a minute...and apply it to all these other "investor-centric" regions around the nation.  That is, in Vegas there are 10s of thousands of single-family houses being readied for rent by new-era "investors".  This flood of freshly rehabbed "for rent" supply will competes at some level with resale and builder "for sale" supply.  Even if it competes at a factor of .4, then Las Vegas "normalized" month's supply could right now be back to a year.
Lastly, houses are as expensive on a monthly payment basis -- and relative to the income needed to qualify for a loan -- then they were at the peak of the bubble in 2006.  But, this is a fact masked over for the past year by the plethora of all-cash buyers who are not governed by employment, income and safe & sound mortgage lending requirements.  Like Sacramento, Phoenix, regions in the Inland Empire, and a dozen other "hot" real estate markets around the nation -- that, "not"-coincidentally are the regions in which private and new-era "investors" swarmed with cash regularly paying 10% to 20% over appraised value / list price using flawed cap rate models as a guide -- when the stimulus go-go juice ran out this market hit a literal "brick wall" the size of 2007.
With house as expensive on a monthly payment basis than they were in 2007, when this market turns back towards "organic" being the incremental demand driver (people that can only buy as much house as their job, earnings, and mortgage qualifications dictate) serious double-digit percent points of house price downside will occur.  That's in the process of happening now.
The next year in Vegas could easily bring a 50% retracement of the past two years historic annualized gains, which to all the investor models predicting 10% appreciation in perpetuity, will feel like a crash.
h/t Zero Hedge

David Stockman Bloomberg Interview

Monday, December 9, 2013

A Cyclical Bear Market Within The Secular Bull Market In Commodities

The following chart from the Short Side Of Long shows the performance of the commodity index since the secular bull market began in 2000. After reaching a peak and falling during the 2008 crisis, the index reached a new all time high in 2011. It has since experienced a relentless fall downward.

Most now believe that the secular bull market in commodities that began in 2000 ended in 2011. The following shows the performance of individual commodities within the index. The price of oil (red) has held up the best, while most other commodities have taken a beating since 2011.

Since mid 2012 the commodities charts have been an almost mirror image of U.S. stocks. As stocks rise relentlessly day after day, commodities have continued to fall. This makes investors far more excited about the future potential for stocks and makes them hate and sell out of commodities positions.

The daily sentiment readings toward U.S. stocks have reached over 90% bullish during the past few weeks and months while the daily sentiment index on silver hit 9% on two consecutive days last week (91% percent of investors believe that silver will move lower from here).

After selling out of all their long positions, hedge funds have now piled on short positions for the worst performing commodities. This is the exact opposite of what is occurring in the U.S. stock market where there is now the greatest leveraged long position in history.

I believe that we entered a secular bull market for commodities in the year 2000 which has not ended. I believe this is a cyclical bear market cycle within the larger bull market trend. Supply/demand data combined with record low sentiment and a steady supply of printed currency around the world (chasing a stable or falling supply of commodities) paints an incredible picture for the future.

I believe we entered a secular bear market for stocks in the year 2000 and the rally since 2009 has been a cyclical bull market cycle within the larger bear market trend. At the end of cyclical rallies there are no believers remaining that stocks could possibly fall or commodities could ever rise again. That is close to where we are today. Opportunities like this rarely present themselves during secular bull and bear markets.

For more see: Jim Rogers On The Secular Bull Market In Commodities

Central Banks Around The World Are Providing Code Red Monetary Policy

I had the opportunity over the past few weeks to read John Mauldin's new book Code Red. The book is far and away the best finance and economics book released this year.

It provides a phenomenal background on how we got here with central bank policies, the impact on the markets today and how we will move forward in the future.

There are chapters on Japan, leading economic indicators and previous Fed forecasts. Mauldin walks through the reasons why quantitative easing programs are not helping the real economy, and why they are boosting paper asset prices (a topic I discussed briefly in How Quantitative Easing Raises Stock Prices & Why Stock Prices Will Fall).

The following is an excellent interview with Mauldin and Steve Forbes discussing a few of the topics found within the book, which should be at the top of your list if you have some reading time during the holidays.

Friday, December 6, 2013

Jim Rogers On The Secular Bull Market In Commodities

Kyle Bass Interview: The New House Of Money

By clicking on the following link you will be redirected to a page where you can download the first chapter of a book titled "The New House Of Money" by Steven Drobny.

The New House Of Money

The first chapter is an extensive interview with hedge fund manager Kyle Bass. He discusses the history behind his bet against subprime mortgages, the bet against Greece government debt and his current bet against Japan. He reviews his macro outlook for assets around the world.

Tuesday, December 3, 2013

Jim Rickards Discusses Gold & Global Currencies

Investors Already Counting & Spending U.S. Stock Gains For 2014: Too Soon?

Interest rates are currently sitting at the bottom of their 30 year channel downward. This allows individuals, governments, banks and corporations to borrow cheap. No major forecast around the world shows what would occur if this channel were to reverse course and begin a secular move upward.

Corporations have seen their profits soar since 2009 due to their ability to access inexpensive capital, the reduction of costs (mostly employment costs) and productivity gains. Can this continue at the same pace over the years ahead? Some question if borrowing costs will move lower (see above chart) or the ability of corporations to cut costs further (is there anyone left to fire?). The chart below shows that over time corporate profits mean revert to GDP. The ratio of corporate profits to GDP is now 70% above the historical norm.  

A measure of U.S. stock market valuation, the Tobin Q, has reached a high above any previous market peak in history before the 2000 bubble.

The Shiller P/E ratio is telling a similar story. Bull markets move closer to beginning when the P/E ratio is under 10 and move closer to ending when they cross above 23. The ratio has now crossed above 25. The creator of this valuation metric, Robert Shiller, warned of a stock market bubble in an interview with Reuters this week.

Measuring the market cap of the S&P 500 against GDP shows that the market has been expensive since Greenspan's "Irrational Exuberance" speech in 1996. The final washout and cleanse of this QE induced speculative mania still has not come.

There is relentless talk that the U.S. stock market is cheap due to forward earnings. We heard the same exact story in 2007 when forward earnings showed a P/E multiple of 12 times earnings. Why was the multiple so low? The price (P) of the stocks were divided against estimated earnings (E) of $120. This provided a P/E of 12 times. 

Then in 2008 earnings came in at $60 making the 12x forward earnings projection in late 2007 an actual 24x earnings. This is how the market can always be shown as cheap. These same exact discussions and forward projections took place in late 1999 explaining how the market could easily double again in the next few years. Both times the market crashed 40% or more.

How about money on the sidelines?

Individuals investors have been pouring money into stocks (dark blue line below) over the past 12 months, just as they did during the peaks in 1999 and 2007.

Optimism toward stock prices moving higher has set records in almost every sentiment measure available over the last 11 months. A new record occurred this week when the Investors Intelligence Survey showed the lowest percentage of bears (those that believe the market will fall) in history. Investors Intelligence studies over a hundred independent market newsletters to gain their stance on the market.

Snapchat received an all cash buyout from Facebook this month for 3 billion dollars. A China company, Tencent Holdings, then offered 4 billion dollars. Both were turned down. You can simply cross out the words "dot com" from the technology bubble in the late 90's and replace it with the "social media" technology bubble of today. While the names and characters are different, the story will end the same.

The price of fine art, farmland and bitcoins are surging to astronomical levels. The wealthy are bidding up the price of sports cars to insane levels to have the best possible trophies in the garages of the homes they will probably never visit. Liquidity is sloshing around everywhere. 

Meanwhile, some of the best commodity prices based on supply/demand dynamics such as precious metals and agriculture are seeing their prices fall every day. Investors are dumping commodities across the board to load up on U.S. stocks. I feel like a kid in a candy store waking up to find silver, corn and wheat prices cheaper every morning. Some of my favorite investments such as energy companies, water companies, Asian stocks and emerging market bonds/currencies could (hopefully) see further declines as investors rush like a herd of lemmings toward momentum chasing assets. I have my Christmas list ready, hoping that investors dump more quality assets. 

Saturday, November 30, 2013

How Quantitative Easing Raises Stock Prices & Why Stock Prices Will Fall

"The market continues to rise solely on the perception that the Fed’s easy money policy can hold stock prices up indefinitely. We think that this line of thinking will prove to be no more durable than the dot-com bubble that peaked in early 2000 or the housing bubble that topped out in late 2007.  In both cases the market gave back a large proportion of the gains made during the bull market, and we believe that will prove to be the case this time as well.  When the vast majority of investors faithfully believe in a bubble, momentum takes over and the market goes up because it’s going up, ignoring all of the obvious warnings such as high valuations, over bullishness, decreasing earnings momentum and an underperforming economy.  When reality suddenly sets in, as it inevitably does, most investors are left holding the bag, hoping that the market doesn’t go any lower."

- Comstock Partners Investor Newsletter
  November 2013

"The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak."

- John Hussman Investor Newsletter
  November 2013

The chart below is one you may have seen before - showing the correlation between Quantitative Easing and the rising stock market. It implies that QE controls how high the market will rise and keep it from falling in the future. The Fed, we are told to believe, has created a true "invisible hand."

Before discussing the chart, I want to review how Quantitative Easing works and why it has been very bullish for the stock market during this cyclical recovery. 

The Fed purchases $85 billion per month in treasury and mortgage bonds. The Fed prints money electronically and purchases these bonds from a primary dealer (one of the large banks). The banks hand the Fed the bonds in exchange for the cash. The actual process occurs through numbers changing on a computer screen electronically.

The accumulation of these bonds on the Fed's balance sheet creates the growth in the green line seen in the chart above. This process drives down the interest rates on treasury and mortgage bonds (simultaneously driving their prices higher because lower rates = higher bond prices). The Fed is now purchasing close to 100% of the new issuance of both treasuries and mortgage bonds. 

The second part of this process is discussed less often...what the primary dealers do with this large stockpile of cash.

In normal times (pre-2008), the banks would use this cash as reserves to lend out into the economy. They would lend money on cars, homes, commercial real estate, small businesses or credit cards. This process stimulated economic growth.

The large banks only need to keep 10% of their cash on the books as required reserves. This means if the Fed were to hand them $10 billion in new cash through quantitative easing, they would then be able to lend out $100 billion into the real economy. The additional $90 billion of new money to be lent is created out of thin air. For example, when you open a credit card line and begin swiping your card at the stores, you are swiping that money into existence each time you make a purchase. As your card hits the machine, the large banks see it simultaneously appear on their screens as an asset. The same process occurs for mortgages, auto loans, etc. For more on how this process works I would suggest watching this brief video on Modern Money Mechanics.

Since the 2008 financial crisis, we have not lived in normal times. As the banks have received cash from the Federal Reserve, they have not lent it out into the economy. They have taken the cash and immediately redeposited it with the Federal Reserve earning 0.25% interest on their money. It is essentially a way for them to earn a return on the money with zero risk. 

The Fed currently holds $77 billion in "required" reserves. All the money above the $77 billion is considered "excess" reserves because the banks are not required to keep it there. Before 2008, the banks held no excess reserves with the Fed. Since 2008 the excess reserves have grown to $2.3 trillion. 

This $2.3 trillion creates a conundrum for the Federal Reserve. On one hand, they would like to see that money lent into the economy because it would stimulate growth. On the other hand, that $2.3 trillion could be lent out at 10 times that amount, which would create an enormous amount of inflation. Instead, it is sitting dormant on the Fed's balance sheet quietly earning interest. This is why the QE programs have not created inflation that has shown up heavily in the consumer price index. The velocity of money, or how quickly it is lent and re-lent into the economy, is stalled.

Let's now review how this money has impacted the stock market. 

Imagine that you lent your neighbor $100,000 to purchase his home. In exchange, he gives you a mortgage note promising to pay the money back with interest. The Federal Reserve gives you a call one afternoon and tells you they would like to purchase that note and they will give you $100,000 in cash. You agree, and they show up at your front door and hand you a suitcase full of money. You hand them the mortgage note and all payments from your neighbor will now go to the Fed.

Now you are sitting with $100,000 on your kitchen table so you think about how you could invest it. You give your mortgage broker a call. The broker tells you that you can open up something called a margin account. If you take that $100,000 back down the street and deposit it with the Federal Reserve you can then use that money to buy stocks. "Excellent." you say. The money is then deposited with the Fed and you go into the market and begin to purchase stocks. Your broker knows that if you run into losses, you will have access to the reserves at the Fed to cover.

This is what the large banks have done. Instead of lending the money out into the economy and trusting American consumers and businesses to pay it back, they are handing the money to their professional traders and letting them put the money to work in the financial markets. This has paid off handsomely for the banks. They earn interest on the money at the Fed AND they earn trading profits off their margin accounts as they gamble in the financial markets.

The problem is that the QE process has become a closed loop. None of the money makes its way into the real economy. The only people that benefit are the ones that already own the particular asset that the banks decide to purchase (which has been dominantly US stocks). The rest of America suffers. This divergence can be seen in the sales and stock prices of high end retailers (who have high net worth buyers benefiting from the Fed's QE programs) and the lower end buyers. 

That brings us to where we are today and sums up the non-existent economic recovery seen over the last 5 years. It also explains why people are confused at why stock prices are surging while the real economy stagnates.

The assumption that has been baked into the markets is that the chart we began with will always move higher in perfect correlation: the rise in stock prices will be determined by the size of the QE program. This assumption, is false, and will soon be devastating for those that now believe it. 


The banks are not limited to purchasing U.S. stocks. The chart above showing the rise in the Fed's asset prices with rising U.S. stock prices is a coincidence not causation. The primary dealers can wake up tomorrow morning and decide that they would like to start purchasing REITs in Brazil, Asian water companies or mines in South Africa. They will ride this U.S. equity rally for as long as possible and when the music stops, I assure you they will be the first out the door. 

If the U.S. stock market began falling while the Fed was still conducting QE, the misplaced belief in the Fed's "power" to control the markets would be removed. They have already begun to lose control of the bond market. People will look back years from now and marvel at how ridiculous it was to think that the Fed has the magical powers they are believed to hold today.

“For as long as I can remember, veteran businessmen and investors – I among them – have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership and not betting slips… The professional investor has no choice but to sit by quietly while the mob has its day, until the enthusiasm or panic of the speculators and non-professionals has been spent. He is not impatient, nor is he even in a very great hurry, for he is an investor, not a gambler or a speculator. The seeds of any bust are inherent in any boom that outstrips the pace of whatever solid factors gave it its impetus in the first place. There are no safeguards that can protect the emotional investor from himself.”

- J. Paul Getty  

h/t John Hussman, Sober Look, Wall Street Journal, Armstrong Economics

Jim Rogers Interview

Rogers begins 4:30 into the video:

Friday, November 29, 2013

Bitcoin Pushes To $1,240 Taking A Ride Out To The South Seas

Last week I first discussed the price of bitcoin when it hit $450 by comparing it to the Tulip Bulb mania of 1634. A few hours later the price blasted through the $900 mark and I compared it to the Mississippi bubble during the early 1700's.

As bitcoin has not stopped to catch its breath and just a few days later has soared through $1,240, we can look at some fun charts comparing it to the South Sea bubble of 1720. For those unfamiliar with the South Sea bubble, Wikipedia provides a good summary.

The following charts come from Mebane Faber, layering the bitcoin price (blue line) against the South Sea Company (red line) hundreds of years ago.

You'll notice that because the chart is more than a few hours old it has bitcoin at $900. The price is moving higher at such an exponentially parabolic rate it makes charts like these dated quickly. You can visualize the blue line above blasting $340 higher (making it that much more absurd).

What followed next for the South Sea company (red line in the chart below) was the same experience seen in the Tulip Bulb mania and Mississippi bubble. A complete collapse.

Last night the price of bitcoin hit a historic point when one bitcoin exceeded the price of one ounce of gold.

Bitcoin will be held up by historians in the same regard as the famous bubbles discussed above. It is a true testament that while the world surrounding us can change dramatically over hundreds of years, human psychology and the subsequent madness of crowds will always be with us.

You can track the action here at the Live Bitcoin Bubble Tracker.

h/t Zero Hedge, Mebane Faber

Marc Faber Sees No Value In Stocks & Bubbles Everywhere

Faber notes the 10 fold increase in farmland and even mentions one of the greatest manias in history taking place right before our eyes, bitcoin, which I discussed this morning.

Tuesday, November 26, 2013

The Quantitative Easing Drug Has Entered The Bloodstream & Subconcious

While both the media and buyers of paper asset prices at these "frothy" levels are 100% confident that there will be no negative consequences from the Fed either removing their stimulus or just letting QE run forever, there are a select few people around the world who still pause for concern. After injecting the QE drug for 5 solid years combined with 0% interest rates, it begins to feel like a zombie movie as more and more people around you are infected with the disease.

I have discussed this topic from every possible angle, but reviewing it again is important because every day the madness builds around us making it more difficult to stay focused on what is really happening.

Since the taper off announcement back in September it has been full throttle forward on risk paper assets. The stock market is a one way rocket ship higher with every index hitting new highs on the hour. The 10 year treasury market has backed far away from the dangerous 3% level. Corporate bonds, specifically the high yield (junk) bonds, are now back at the mania yields seen earlier this year.

The following from a Reuters article this week titled "Corporate Bond Liquidity Timebomb Ticking" does a great job summing it up:

Concern about defaults, however, is most keenly felt at the more speculative end of the market, called high-yield, where issuance is at $414 billion so far.
"At the moment they are buying at low-yield levels they are being handsomely compensated for default risk because there will be hardly any defaults in the next two years," said Hans Stoter, chief investment officer at ING Investment Management, which manages $238 billion.
"But if we move to the next default cycle, which is, I think, two to three years away, and people really get worried about getting their money back and they want to exit their positions, then we are going to be in a full room heading for the exit door and the door will turn out to be a very small one."

As home prices surge higher in some markets, buyers are once again taking out home equity lines to upgrade their homes. In an article from Bloomberg titled "Faucets at $1,000 Abound As Home Equity Spigot Opens," we learn that home owners are no longer happy with their granite counter tops, they must upgrade to marble.

The QE drug has been with us for so long that it is now accepted as permanent. The longer people live in this artificial world the more they believe it will stay, and they begin to make all decisions around this new reality. This is why so many people are hurt so badly once this process is reversed and the curtain is pulled back to show that there is no fundamental economic recovery, only a heroine induced high.

The four largest areas of concern for the reversal of QE are:

1. The reversal of risk asset prices (we saw a preview of this in June). All the benefits of asset prices rising are immediately turned into negative consequences on the way down. The problem is that on the way up investors borrow money (leverage) to take maximum advantage of the new "permanent" rise in assets. This leverage creates a waterfall cascade of selling on the way down.

2. Rising treasury prices will send the annual interest on the national debt much higher. If rates normalize (back to the average treasury yield seen just over the last 20 years) then the annual cost to carry the current $17 plus trillion in federal government debt would be well over $500 billion annually. That is just interest, it does not include the money needed to roll over existing debt as it matures and the annual deficit needed to fund government spending. As rates rise further and debt continues to mount, you begin to enter the Greece like end game spiral.

3. Rising treasury prices will reprice corporate bonds, state and local government debt and mortgage bonds. You could write an entire book on the consequences of that last sentence. Rising mortgage yields will crush both the housing and commercial real estate market.

4. The Fed itself will become insolvent. The Fed's balance sheet is now composed of long term treasury and mortgage bonds. They are leveraged at 57 to 1 on this debt. Should rates rise slightly these assets move underwater and in order to stay solvent by accounting standards they would need to begin borrowing money from the treasury to cover the difference. This would come at a time when the government would need money the most (see 2 above). I talked about this topic in detail in: Why The Fed Can Never Exit

For more on coming problems with QEternity see: The Fed's Rocket To Nowhere

h/t Sober Look

Richard Duncan On The Threat Of Deflation

The Fed's Rocket To Nowhere

The following from Peter Schiff at Euro Pacific Capital provides a summary on where we are with QE and what happens next.
Herd mentality can be as frustrating as it is inexplicable. Once a crowd starts moving, momentum can be all that matters and clear signs and warnings are often totally ignored. Financial markets are currently following this pattern with respect to the unshakable belief that the Federal Reserve is ready, willing, and most importantly, able, to immediately execute a wind down of its quantitative easing program. Although the release last week of the minutes of the Fed’s last policy meeting did not contain a shred of hard information about the certainty or timing of a "tapering" campaign, most observers read into it definitive proof that the Fed would jump into action by December or March at the latest. The herd is blissfully unaware that the Fed may not be able to reverse, or even slow, the course of QE without immediately sending the economy back into recession.
In an interview this week, outgoing Fed Chairman Ben Bernanke likened the QE program to the first stage in a multiple stage rocket that gets the spacecraft off the ground and accelerates it to the point where it is close to achieving permanent orbit. Like a first stage that has spent its fuel and has become dead weight, Bernanke seems to concede that QE is no longer capable of providing positive thrust, and as a result can now be jettisoned (like a first stage) so that the remainder of the spacecraft/economy can now move higher and faster. The Chairman's nifty metaphor provides some inspiring visuals, but is completely flawed in just about every way imaginable.
In real rocketry, when the first stage separates, it falls back to earth and is no longer a burden to the remainder of the ship. Subsequent booster rockets (which in economic terms Bernanke imagines would be continuation of zero interest rate policies) build on the gains made by the first stage. But the almost $4 trillion in assets that the Fed has accumulated as a result of the QE program will not simply vaporize into the stratosphere like a discarded rocket engine. In fact it will remain tethered to the rest of the economy with chains of solid lead.
In the process of accumulating the world's largest cache of Treasuries, the Fed has become the most important player in that market. I believe the Fed can't stop accumulating and dispose of its inventory without creating major market disruptions that will drag the economy down.
This would be true even if the economic rocket were actually approaching escape velocity. In reality, we are still sitting on the launch pad. By keeping interest rates far below market levels and by channeling newly created dollars directly into the financial markets, the QE program has resulted in major gains in the stock, real estate, and bond markets. Many have argued that all three are currently in bubble territory. Yet to the casual observer, these gains are proof of America's surging economic vitality.
But things look very different on Main Street, where the employment picture has not kept pace with the rising prices of financial assets. The work force participation rate continues to shrink (recently falling back to levels last seen in 1978),real wages have declined, and since the end of 2009 the temporary workforce has grown at a pace that is 14 times faster than those with permanent jobs. Americans are driving less, vacationing less, and switching to lower quality products and services in order to deal with falling purchasing power. But the herd is closely watching the Fed's rocket show and does not understand that stocks and housing will likely fall, and bond yields rise steeply, once the QE is removed. The crowd is similarly ignoring the significance of the Chinese announcement.
But while the Fed was gaining much attention by saying nothing, the Chinese made a blockbuster statement that was summarily ignored. Last week, a deputy governor of the People's Bank of China said that buying foreign exchange reserves was now no longer in China's national interest. The implication that China may no longer be accumulating U.S. government debt would amount to the "mother of all tapers" and could create a clear and present danger to the American economy. But the story barely rated a mention in the American media.  Over the past decade or so, the People's Bank of China has been one of the largest buyers of U.S. Treasuries (after various U.S. government entities that are essentially nationalizing U.S. debt). China currently sits on $1 trillion or more in U.S. bond obligations.
So, just as many expect that the #1 buyer of Treasuries (the Fed) will soon begin paring back its purchases, the top foreign holder may cease buying, thereby opening a second front in the taper campaign. This should cause any level-headed observer to conclude that the market for such bonds will fall dramatically, causing severe upward pressure on interest rates. But the possibility is not widely discussed.
Also left out of the discussion is the degree to which remaining private demand for Treasuries is a function of the Fed's backstop (the Greenspan put, renewed by Bernanke, and expected to be maintained by Yellen). The ultra-low yields currently offered by long-term Treasuries are only acceptable to investors so long as the Fed removes the risk of significant price declines. If the private buyers, the Fed, China (and other central banks that may likely follow China's lead) refuse to buy Treasuries, who will take on the slack?  Absent the Fed's backstop, prices will likely have to fall considerably to offer an acceptable risk/reward dynamic to investors. The problem is that any yield high enough to satisfy investors may be too high for the government or the economy to afford.
Little thought seems to be given to how the economy would react to 5% yields on 10 year Treasuries (a modest number in historical standards). The herd assumes that our stronger economy could handle such levels. In reality, 5% rates would likely deeply impact the financial sector, prick the bubbles in housing and stocks, blow a hole in the federal budget, and cause sizable losses in the value of the Fed's bond holdings. These developments would require the Fed to devise a rocket with even more power than the one it is now thinking of discarding.
That is why when it comes to tapering, the Fed is all bark and no bite. In fact, toward the end of last week, Dennis Lockhart, President of the Federal Reserve Bank of Atlanta, said that the Fed "won't taper its bond-buying until the economy is ready." He must know that the economy will never be ready. It's like a drug addict claiming that he'll stop using when he no longer needs them to stay high.
But the market understands none of this. Instead it is operating under dangerous delusions that are creating sky-high valuations for the latest social media craze, undermining the investment case for gold and other inflation hedges, and encouraging people to ignore growing risks that are hiding in plain sight.
This is not unusual in market history. When the spell is finally broken and markets wake up to reality, we will scratch our heads and wonder how we could ever have been so misguided.
Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.