Thursday, February 28, 2013

Perspective On The Sequester Spending Cuts

Rather than drone on with numbers that have little relevance to most people, I like to use simple stories and pictures whenever possible.

The following illustration shows two pies. The pie on the left is what the U.S. government spent in 2007 and the annual deficit, which was $161 billion. I remember that deficit seeming large at the time.

The next pie shows what the U.S. government will spend in 2013 and the annual deficit, which will be around  $900 billion (if everything goes perfect with economic growth and tax collections).

The small little pebble of pie below the dish represents the sequester cuts in comparison to the total size of annual spending. In many ways the removal of this little pebble is going to slow the economy significantly, which shows the sick dependence the U.S. currently has on deficit spending in order to keep the artificial economy moving forward.

A little perspective is always helpful. Click for larger image:

Wednesday, February 27, 2013

Jim Rickards On Global Capital Flows

Excellent discussion with one of the most intelligent financial minds today, author of Currency Wars, on Fed activity, capital flows, currency movements, and gold.

Sunday, February 24, 2013

Agriculture & Agribusiness Stocks Diverge

Earlier this weekend we looked at the incredible divergence in price between gold and gold mining companies and the potential opportunity it has created for investors today. See Gold Mining Shares Hated & Forgotten - Value Opportunity?

The following chart shows the same concept occurring in the agriculture sector, only in reverse. The price of the underlying commodity has sold off while the agribusiness stocks have surged. 

I am very bullish on the long term price of agriculture as a commodity during the decade ahead, while specific pockets of farmland and some stocks have currently reached levels of overvaluation. Agriculture has generally lagged most other commodities since they sold off heavily in 2008.

h/t StockTwits

The Future For Stocks: Long Term & Short Term Guides

The following charts provide both a long and short guide on the future direction of U.S. stock prices. After 12 years of a bear market most assume that we have now begun a new secular uptrend. But are we at the valuation levels where new bull markets begin? Did we reach those levels at the 2009 bottom?

The first chart shows the price to earnings ratio going back to 1880. The historic average is at 16 and bear market bottoms usually occur in the mid to high single digits (see 1982). We touched slightly under the long term average during the March 2009 low coming no where close to true capitulation, then rocketed back up to extreme overvaluation where we still find the market today. We are much closer today to the point where the market peaked in 1966.

Secular bull and bear stock market cycles tend to last 17.6 years. For a discussion on this 17.6 year cycle see Historical Guides: Stock Market Cycles & Public Ownership. That would give us about 4.3 years remaining in this bear market. Will this bear market end with stocks once again at extreme under valuation and true P/E ratios in the single digit range? Or will this time be different?

That is looking at the very big picture, but what about the short term. Corporate profits have a tendency to "mean revert" over time and corporate profits today, as seen the chart below, are currently at sky high record breaking levels. Many assume that this line will trend upward forever and that mean reversion has no place for discussion in the new fairy tale economy

In order for these record breaking profits to continue their epic levitation, you will need an endless rise in earnings growth. That is exactly what Wall Street has put on the table for estimates moving forward. Current estimates, seen in the parabolic chart below, have earnings rising 27% year over year moving forward. Analysts have completely brushed aside any concern over the January 1 tax increases, the potential sequestration cuts in government spending, gasoline prices surging, and consumer sentiment plunging. They see these as catalysts for the coming earnings surge.

We are now hearing a steady stream of calls for DOW 15,000.....17,000....and 20,000 as the new bull market has "just begun." As I mentioned earlier this week as the S&P 500 and the price of gold were close to touching each other at the mid 1500 range, it represents what I consider one of the best long/short pair trades available (long gold & short the S&P).

While this discussion looks at valuation, a second and equally important component of investing is sentiment. For a much deeper look at sentiment in stocks today see:

2013 Outlook: Should I Buy Stocks Today?

h/t Ankur Shah, Zero Hedge

Nassim Taleb On The Financial System & How He Is Investing

The following is an in depth interview with Nassim Taleb on Bloomberg. It's always nice when he has the time and the ability to speak his thoughts on the current state of the world. He is the author of "The Black Swan," which outlined the dangers to the financial system just months before it imploded.

Twin Pillars Of Europe: Germany Cracks & France Crumbles

The twin pillars of strength in Europe, France & Germany, both experienced a decline in GDP during the fourth quarter. The story gets more disturbing when you take a closer look at what is taking place in France.

Every day the bond market in France remains surprisingly calm with 10 year yields falling in 2012 from over 3% down to 2%. They have recently risen up to only 2.3% as of this writing.

Many in the markets view this as more of a gift than a true reflection of fundamentals. Up until this point France has been considered part of the "core" within Europe alongside Germany. They have been the twin pillars that stand behind every bailout and promise of future growth.

The problem is that France has recently begun to diverge significantly from Germany in terms of economic strength. The following chart shows the recent gap in PMI manufacturing data for Germany (blue line) and everyone else within Europe which now includes France (orange line).

The next chart shows the rapidly declining PMI composite in France (blue) alongside their GDP (orange) which continues to track down and follow it lower.

This contraction and divergence has been in part due to sharp increases in tax rates combined with austerity cuts coming from the leadership within their borders. The next chart from Sober Look shows that the only country within the Eurozone that is actually expected to make a cut to their government spending this year is France.

During the first chapter of this sovereign debt crisis, it has been austerity that has been punished by the bond markets (when we reach the final chapter it will be the opposite). We'll see if the same soon comes for France, and their 10 year treasury yield is one to keep a very close eye on during 2013. Italy and Spain are far too big to fail. France is much bigger.