01/04 Kelly Letter Topics
Weekly market review
Seasonal rally
Abysmal manufacturing
Horrific housing starts
Crumbling consumer conf
Rising oil price
Obama's cabinet
Is the Fed a failure?
Platinum 5-star stocks
Market forecast on track
Oil price trends
When to short Treasuries
Richard Band is not someone who makes outlandish predictions just to get headlines.
So I sat up and took notice earlier this week when he wrote to subscribers of his Profitable Investing newsletter that the stock market was ready to "rocket higher" in an "uptrend that could carry the blue chip indexes to all-time highs by late 2008 or early 2009. Dow 16,000 here we come!"
Morningstar wrote in its latest market outlook delivered yesterday: "If you compare stock prices to underlying business value, stocks are cheaper now than at any time since 2002."
Last weekend's Barron's included a discussion with James Finucane, a 67-year-old stock strategist who worked for years at Stifel, Nicolaus in Chicago but now labors as a consultant in West Lafayette, Indiana.
Mr. Finucane specializes in calling market lows, and he believes we're making one now. "In fact," wrote Jonathan Laing, "he foresees an explosive rally, with the Dow rocketing to 18,000 to 20,000 within a year from its current 12,361. The climb, he says, might begin imminently or take a few months of backing and filling before the market takes off."
Mr. Finucane says that "governments and central banks have a clear incentive to promote growth, so to bet on a prolonged slump is to bet against the government, markets and human nature."
He's further encouraged by the enormous build-up of cash on the sidelines. "Money-market cash, for example, has soared to $3.45 trillion, versus $2.2 trillion at the market low in March 2003," wrote Mr. Laing. "And U.S. domestic equity funds have seen a record nine consecutive months of net outflows, a skein that probably will hit 10 months when the Investment Company Institute releases its February numbers. The previous record was eight months, following the 1987 stock-market crash."
Thanks for yesterday's great observations from Bill Miller. I'm wondering if you can provide a few words in defense of his poor showing in recent years. I've read that he was a great manager for a while, but that he's lost his touch and doesn't understand today's market.
It's a little odd being asked to defend one of the greatest portfolio managers in recent times, but if ever there was a fat pitch to make for an easy article, this is it.
When you write that Miller was a "great manager for a while," you understate the case. He beat the S&P 500 every year for 15 years straight. That streak ended two years ago, and that two-year period since is what critics focus on. To put Miller's streak in perspective, understand that it was nearly twice as long as that of former Fidelity Magellan Fund Manager Peter Lynch, which lasted for eight years.
Beyond the duration of Miller's winning streak, the margin of his outperformance was impressive. His annual return was 16.4% per year versus 11.5% for the S&P. Given that, describing him as having been a "great manager for a while" doesn't do him justice. He's one of the all-time greats.
As for his poor showing in the last two years, he addressed it himself. The following is the first two pages of Miller's Feb. 10 letter to shareholders in review of 4Q07:
This commentary will be short and to the point: We had a bad 2007, which followed a bad 2006.
Over this two-year span, we underperformed the S&P 500 by around 2000 basis points, our worst showing since the two-year period 1989 and 1990, where we underperformed by 2500 basis points.
In the 25 years since we started the Value Equity mandate in 1982, we have had six calendar years of underperformance. Despite that 19-6 record against the market, all the losses are painful. They are also unavoidable and unpredictable. It would be great if we could figure out how to never underperform. No one has been able to do that, but that does not make it any less painful.
I will talk a bit about what caused the results of the last couple of years, and a bit about how I see the current investment environment. I will conclude by discussing the situation with Countrywide Financial, which has been at the epicenter of the present housing turmoil, and offer some thoughts on Microsoft's bid for Yahoo, one of our substantial holdings.
About the only advantage of being old in this business is that you have seen a lot of markets, and sometimes market patterns recur that you believe you have seen before. It is not an accident that our last period of poor performance was 1989 and 1990. The past two years are a lot like 1989 and 1990, and I think there is a reasonable probability the next few years will look like what followed those years.
The late 1980s saw a merger boom similar to what we have experienced the past few years and a housing boom as well. In 1989, though, the merger boom came to a halt with the failure of the buyout of United Airlines to be completed. The buyout boom had been fueled by financial innovation. Then it was so-called junk bonds, which had been purchased by many savings and loans in an attempt to earn higher returns. Now it is subprime loans repackaged into structured financial products. The Fed had been tightening credit to guard against rising inflation, which began to impact housing. By 1990, housing was in freefall, the savings and loans were going bankrupt (as the mortgage companies did in 2007), financial stocks were collapsing, oil prices were soaring in 1990 due to a war in the Middle East, the economy tipped over into recession, and the government had to create the Resolution Trust Corporation to stop the hemorrhaging in the real estate finance markets. Eerily similar to today, the situation began to stabilize when Citibank got financing from investors from the Middle East.
Although the overall market was down only 3% in 1990, we got trounced, falling almost 17%, the result of our large holdings in financials and other stocks dubbed "early cycle," and which tend to perform poorly as the economy is slowing or when it sinks into recession.
If it were possible to forecast with any degree of accuracy, one might be able to descry a slowing economy from an examination of economic data, and perhaps adjust portfolios accordingly. But unfortunately, as I have often remarked, if it's in the newspapers, it's in the price. The process works the other way: stocks are a leading indicator, so first they go down and then the data comes in.
In 2007, financial stocks began to decline in early February, before the market corrected in March. They then rallied into May, began a slow decline that culminated in an intermediate bottom in August when the Fed lowered the discount rate, rallied into early October, and then began the precipitous fall that appears to have made a bottom around the third week of January. The decline in financials reflected the freezing up of credit markets that began in August and which still persists, and was followed by a steep drop in consumer stocks in November that also may have seen their worst days now that the Fed has begun to aggressively cut rates.
All of this was accompanied by the decline in the housing stocks, which fell almost continuously throughout 2007, ending with a loss of almost 60% on average.
The financial panic got going in earnest as we entered 2008, with global markets all dropping in the double digits or close to it as of this writing. The so-called decoupling thesis, which maintained that non-US and emerging markets and economies would be unaffected by a US slowdown, while not dead (yet), is severely wounded.
The monetary and fiscal authorities have now begun to move with alacrity, with the Fed cutting the funds rate to 3.0% (with likely more to come), and the administration and Congress coming up with a fiscal stimulus package estimated at around $150 billion dollars.
Will it be successful? Yes. More precisely, if these measures aren't enough to free up credit and stimulate spending sufficient to set the economy on a growth path, then additional measures will be taken until that is accomplished. The important point is that the monetary and fiscal policy makers are focused and engaged, and will do what is necessary to stabilize the markets and restore confidence. This does not mean that the recovery will be swift, or seamless, or without additional trauma. But there will be a recovery, and I think the market abounds with good value. Those values may get even better if the markets get more gloomy, but they are good enough now for us to be fully invested.
I think the market is in for a period of what the Greeks refer to as enantiodromia, the tendency of things to swing to the other side. This is not a forecast, but rather a reflection on valuation.
All of the poorest performing parts of the market, housing, financials, and the consumer sector -- with the exception of consumer staples -- are at valuation levels last seen in late 1990 and early 1991, an exceptionally propitious time to have bought them. The rest of the market is not expensive, but valuations cannot compare to those in these depressed sectors.
Bonds, on the other hand, specifically government bonds, which have performed so wonderfully as the traditional safe haven during times of turmoil, are very expensive. (In bond land, the only values are in the so called spread product, and there are some quite good values there.) The 10-year Treasury trades at almost 30x earnings, compared to about 14 times for the S&P 500. The two-year Treasury yields under 2%, and is thus valued at over 50x earnings!
The valuation disparity between Treasuries and stocks is as great today in favor of stocks as it was in favor of Treasuries 20 years ago. Just prior to the Crash of 1987, stocks yielded about 2% (same as today), but traded at over 20x earnings. The 10-year Treasury yielded over 10%, vs. 3.6% today. The two-year Treasury now has a lower yield than the S&P 500, and that is before share repurchases, meaning you can get a greater yield in an index fund than you can in the two-year, and a free long-term call option on growth. Even more compelling are financials, where you can get dividend yields about double that of Treasuries, which only adds to their allure, with them trading at price-to-book value ratios last seen at the last big bottom in financials.
I think enantiodromia has already begun. What took us into this malaise will be what takes us out. Housing stocks peaked in the summer of 2005 and were the first group to start down. Now housing stocks are one of the few areas in the market that are up for the year. They were among the best performing groups in 1991, and could repeat that this year. Financials appear to have bottomed, and the consumer space will get relief from lower interest rates. Oil prices have come down, and oil and oil service stocks are underperforming in the early going.
Investors seem to be obsessed just now over the question of whether we will go into recession or not, a particularly pointless inquiry. The stocks that perform poorly entering a recession are already trading at recession levels. If we go into recession, we will come out of it. In any case, we have had only two recessions in the past 25 years, and they totaled 17 months. As long-term investors, we position portfolios for the 95% of the time the economy is growing, not the unforecastable 5% when it is not.
I believe equity valuations in general are attractive now, and I believe they are compelling in those areas of the market that have performed poorly over the past few years. Traders and those with short attention spans may still be fearful, but long-term investors should be well rewarded by taking advantage of the opportunities in today's stock market.
I spent some time online conducting an informal survey of who's taking potshots at Miller and others of his caliber, and found that the most vociferous critics are non-professionals with a distinctly trading mentality.
There are two points to keep in mind when reading most criticisms of Bill Miller and others at the top of the investment field:
The dearth of respected professionals in the lineup speaks to the weakness of the charges. You won't find seething commentary from the likes of Warren Buffett, Jack Bogle, Seth Klarman, Charlie Munger, Bill Nygren, Richard Pzena, Mason Hawkins, Eddie Lampert, John Templeton, Marty Whitman, or others at the top.
No, you'll read it from people who go by tptrader, zmaster, user9321, hipshooter, or similar handles.
The lack of accountability from part-time online ranters like zmaster and friends reduces their observations to chatter. Blasting off a quip between meetings at work in a field unrelated to investing is a far cry from amassing a multi-decade track record of market beating performance. I suggest paying closer attention to comments from proven market beaters.
The reason seasoned experts don't take potshots at their temporarily underperforming colleagues is that they understand cycles of the market. Even Miller pointed that out in his February letter. The last two-year down cycle of his was followed by the history making 15-year winning streak. Something tells me Miller will regain his stride.
So, beware the hoi polloi online. They'll kill your long-term performance with their short-term trading blinders. Besides, you have no way of knowing if they're even any good at trading. Odds are, they aren't. It's probably just a hobby that creates for them more tax deductions than new cars or vacation homes.
Limit yourself to reading only respectable voices. Life's too short and money's too important to do otherwise.
I love the Bill Miller section in [the 2008 edition of] your book. I was wondering if you know what he thinks of this financial crisis and whether he's buying stocks, as you are.
I don't just think Bill Miller is buying, I know so. He's publicly called this one of the best buying opportunities in recent memory.
Coincidentally, I included comments from his January 17 conference call in last weekend's note to Kelly Letter subscribers. Here are some timely excerpts from the call:
Excerpts From Bill Miller's Jan. 17 Conference Call
These sorts of periods provide opportunities on a longer-term basis. In the last 20 years, we've had six financial panics similar to this one in order of magnitude. And it's always funny to me how people's memories change.
I was reading somebody who was talking about how, "This one is so bad because it's not like the other ones. It's not like the tech bubble which got over fairly quickly." And I'm thinking, the tech bubble got over quickly? It was a three-year bear market -- the worst since the Great Depression. But now that it's over, and it was five years ago, it seems to have gotten over quickly.
And I think what you'll see in the next six months to a year is this will be over -- and then within the next couple of years, people will be talking about this being over quickly, as well. It's never quickly when you're in it. But it always seems quick after you're out of it and things are going well.
What I learned from 1990 is it's too late to sell stuff that's down and get a little bit more defensive just because things are falling. As things fall, you've got to play more and more offense, not defense.
So the people that have a lot of financials, homebuilders, retail or consumer discretionary right now -- those are the portfolios that it's way too late to think about playing defense. Those portfolios should be positioned offensively to really benefit maximally when things get better -- as they undoubtedly will.
I think that right now is the time to begin to get more aggressive.... The market and the psychology has officially entered a "panic zone" right now. And those panics typically last from as low as eight days -- that was how long the panic lasted to the bottom of the market in 1990 -- to about a month or two at the very outside.
So you're looking at somewhere between the next week and two months to give you one of the best buying opportunities we've seen since July of '02.
Shareholder Question: The comment that we're getting from clients is: "This time is different. It's worse than the prior crises." How do you respond to that?
Miller: Well, every time is somewhat different. But to say it's worse...I mean, the '02 collapse was such that you had companies like AES, which was $75 in 1999, trade at 75 cents in 2002. So you had junk bond spreads blown out to the highest level in history. I think what you have in every crisis like this is something which is "the worst it's ever been" -- but that doesn't mean that the crisis is the worst there's ever been. The reason you have a crisis is in something, it's the worst there's ever been.
In this one, the damage to big financials' balance sheets -- the losses they are taking -- is the worst it's been since the Great Depression. And in some companies, it's the worst it's been in history -- like Bear Stearns, or Merrill Lynch. But that doesn't mean the crisis is the worst it's ever been.
In fact, if you talk to any of the big industrial companies, like the fertilizer companies, they're telling you things are great. The unemployment rate is still 5% -- it's not 8% or 10% -- and we still have economic growth.
So we haven't even gone into a recession yet -- at least we don't have one officially. And interest rates are down with the 10-year sitting at 370. And the market is not that far off its all-time high, right? We're 10% to 15% maximally below that.
So I have a hard time seeing how this is such a catastrophe...
It's now widely known that The Kelly Letter began buying into the weak market last Monday, following my March 16 advice to build positions gradually because nobody gets the exact bottom. The letter's pick for a financial sector recovery is up 36% so far.
The overwhelming tone of recent emails is that the stock market is no place for money you want to keep, and that is usually a great buy signal. Readers have lamented the "insanity of this market" and the "utter detachment from reality" that recent news has exposed in the minds of some readers.
I don't see any detachment. This is reality for the stock market. It has been volatile, but volatility is not an unusual characteristic for stocks. Moreover, it's the key ingredient. When studies show that the S&P 500 has returned a little over 10% per year over the long term, too many people take that to mean a smooth, consistent line rising at a pace of 10% per year.
That's never been the case. Only one year, 1971 at +10.8%, had a return in the clean +10% area. The long-term average performance is the result of almost every year being above or below +10%, often by a lot. The annual trading range is around 24%. That means the average range from a year's low point on the index to its high point is 24%, a wide berth.
As you can see, volatility is not new. It's not special for our time. It's no different this year than it was 77 years ago, when not one of us was involved.
Now, let's come back to today. For all the nasty headlines and talk of the end of the financial system and calling of names at anybody who dares look for bargains and near hatred of the Federal Reserve, the S&P 500 has lost a Great Depression worthy, widow and orphan killing, devastating, er hold on a sec, can this be right, 9.5%? Yes, so far this year, the S&P 500 is down just 9.5%.
Even if we trace the current decline from the October high, the S&P 500 is still down just 16%. That's not even in bear market territory yet, which starts at -20%, much less the devastation zone, which to me starts at -30%.
For real devastation, we don't have to look back far. Here's how the S&P 500 did in the tech burst:
2000 -10% 2001 -13% 2002 -23%
You think that was bad? Look at the Nasdaq:
2000 -39% 2001 -21% 2002 -32%
Anybody who invested and lived through that is scratching their head a little at the collective moaning taking place these days. If people are gnashing teeth and rending garments at -9.5% before the year is even 1/4 over, one has to wonder what they're doing in this business.
One also has to wonder: Do people think the news was encouraging during previous bad times in market history? Do they think the Fed was not involved before? Do they think companies didn't go bankrupt before? Do they think talk of the end of it all never happened before? We've seen all of what we're seeing today. The market is a repeating pattern.
A whopping 44 of the last 90 trading days have been moves of 1% (+/-) or more in the S&P 500. Fifteen of the last 90 trading days have been 2% days. While we've been constantly reading and hearing that the current period of volatility is unlike anything ever seen before, it isn't. The number of 1% days reached 64 out of 90 back in October 2002, 56 out of 90 back in 1988, and 54 out of 90 back in 1974. And the 15 out of 90 that have been 2% days are nowhere near the highs reached during those periods either. The reason why so many people are so frantic about volatility is because it was extremely low preceding the current period. It was rare to see a 1% day from about 2004 to 2007, and 2% days were non-existent.
Welcome back to the norm.
Here at The Kelly Letter, we've done well through the recent volatility. Only two of our positions are down a worrying amount and I'm confident that each of them will recover for us, as I wrote to subscribers last week.
The permanent portfolios are down, but they're designed to return twice as much as their indexes in both positive and negative directions, so it's no surprise that they're down. These last few months have been a great time to put money to work in Double The Dow and Maximum Midcap. People are going to be happy when those recover, and there's no doubt that they will.
Fluctuation is what stocks do best. When they've fluctuated downward as much as they have, it's time to buy. We're at such a time and that's why we're buying.
Expect a bear market rally. Why? There is cash on the sidelines, in the hands of managers who believe stocks are cheap, and the end of the quarter is close. Many may want to use that cash to buy stocks before the quarter is up.
My call over the weekend to start buying brought a flood of email. I'll respond to the most common points.
You really don't grasp how severe this financial crisis is. You and other so-called experts need to wake up to what we're facing here and stop telling people to buy cheap stocks on their way to worthless. Did you notice what Bear Stearns went for?
What, you thought buying opportunities came with happy headlines? I agree with Warren Buffett that we should be greedy when others are fearful and fearful when others are greedy. There's a lot of fear on the street these days.
I grasp how severe the crisis is, and I also grasp two other key points: (1) the bad news has been more than sufficiently reported, which is why everybody gets angry when I suggest buying and, (2) cheap is cheap even in a bear market because short-term bear market rallies are among the stock market's most profitable events. My analysis tells me that building positions at current prices will pay off. I don't know how long I'll hold and I don't care right now. I'm staring across a different bridge at the moment.
Finally, yes, I did notice what Bear Stearns went for. I wish I'd been quicker on the phone. I would have paid $2.25 per share for the whole company.
I know I'm supposed to subscribe to your letter to find out your specific buy targets, but could you at least reward a loyal site visitor with a hint as to how you're approaching the financial sector, if at all?
Anytime a sector is as much under the gun as financials are now, it's wiser to buy the basket of stocks instead of a single company stock for precisely the risk that was shown in neon lights last weekend with Bear Stearns. Groups of 100 stocks don't go bankrupt. I suggest using an ETF or mutual fund that focuses on the financial sector. The Kelly Letter bought one yesterday.
Do you think the rate cuts will ever help?
Absolutely. Doubts about the Federal Reserve's power are common near the end of a rate cutting cycle when the economy is still disgorging bad news and the stock market has yet to show a hint of recovery. Pay no attention. Rate cuts always take a while to soak in, that lag time is always when critics show up in droves, then the rate cuts start working and the critics fade away. The biggest smiles belong to those who had the courage to buy before the good news began.
Is it too late to buy gold?
Yes. The liquidity created by the Fed's rate reduction campaign will probably begin drying up sometime after summer. It's that accomodative policy that has been the jet fuel behind gold ever since the tech bubble burst. Don't chase yesterday's great contrarian call. Find today's.
Is it too late to buy yen?
Just about. Here in Japan, economists are saying 80 yen will be the bottom for the dollar. I doubt it will go that low, but I think 90 is a good bet. We're at 97 now. It might be worth the trouble to buy some yen quickly to catch the last gasp, but I'd rather just look at ways to buy the cheap dollar as it forms a bottom.
In general, it's better to avoid buying what today's headlines say to buy. Current headlines are banging you over the head with these messages:
Stocks are awful
The dollar is awful
Real estate is awful
Gold is great
Oil is great
Foreign currencies are great
These will flip around in the future, so positioning money accordingly is a fine idea. So fine, in fact, that I'm doing it.
If you were to ask me last year what it would take to become more constructive in this sector, however, I would have pointed to four primary points.
The first is time and price, both of which have come to pass. The second is analyst recommendations, which have flipped from table-pounding buys to a litany of "sells" and "holds." The third is sentiment, which is now the mirror image of where we were. Finally, I would have said that a high profile bankruptcy would be needed and Bear Stearns qualifies as such.
It's important to remember that the Depression was an era rather than an event. During that period, equities enjoyed rallies that littered hope amongst the despair. I believe we're in for a similarly sullen stretch, one that lasts a lot longer than most people think. But that doesn't mean we can't rally along the way.
The following is from this morning'sKelly Lettersent to subscribers. Because of the recent volatility in the market, I decided to publish it publicly as well. To see what the letter is actually buying, please sign up for a one-month trial.
I've been writing for half a year or so that the financial crisis would not end until some banks fail. With Bear Stearns's bailout last week, we're entering that stage.
Technically Bear didn't fail, but that's because of the bailout. It's on life support from JPMorgan and the New York Fed, and that's close enough.
Notice that I wrote "we're entering that stage" as opposed to "we've hit bottom." A bottom is a process, not a point in time.
People have been talking about a double bottom in the market but what they're leaving off is the final phases of a true double bottom. We don't know yet if we've made one.
A double bottom pattern has six points. They are:
1) The first low (Jan. 22 at S&P 500 1,310)
2) The turn down from overhead resistance (Feb. 1 at 1,395)
3) The support test near first low (Mar. 10 at 1,273)
4) The initial surge higher (Mar. 11 to 1,321)
5) The follow through back up to overhead resistance (not yet)
6) The breakout through overhead resistance (not yet)
As you can see, we're missing a third of the process needed to call this a successful double bottom. The S&P 500 needs to close above 1,400 before we can be confident that it's heading higher for real, according to the double bottom pattern.
There are other ways of viewing the market. I've written about MACD and relative strength before, both of which I've found to be helpful in timing.
On Jan. 22, the S&P 500's MACD was -35 and its relative strength was 26, both showing extremely oversold conditions and a market ready to bounce. It did.
On Monday, MACD hit -18 and relative strength 31, both low but not as extreme as in January. At the end of last week, MACD closed unchanged at -18 and relative strength a little higher at 39.
These measurements are unclear because we don't know if they never got low enough for a true washout and are just fluttering in a range, or if Monday was the washout and now they're turning higher as the market follows through on its way back to resistance. Sometimes these don't give a clear buy signal even when it's a good time to buy.
One factor that's screaming to buy now is sentiment. I'm a believer in sentiment gauges as I tend to be a contrarian in all walks of life. I drive roads few people know, I go to amusement parks and other public places on weekdays in the off season, I buy winter clothing during spring clearance sales, and I tend to buy stocks when others are panicked and sell them when others are euphoric.
These days, people are panicked.
Bill Luby at VIX and More showed Friday that the ratio of the VIX to the yield on the 10-Year Treasury Note "is currently at levels seen only during extreme crisis or panic market environments."
SentimenTrader examined other times when the ratio has been at current levels and found that the S&P 500 rose an average of 2.0% in the next 5 days, 3.7% in the next 10 days, 4.2% in the next month, and 10.6% in the next 3 months.
The percentage of times that each time frame registered a gain instead of a loss was impressive, too: 85% of 5-day periods, 92% of 10-day periods, 77% of 1-month periods, and 92% of 3-month periods.
Here's what all that tells me:
> Don't short, don't hedge.
> Don't sell what you already own.
> Look to buy during this time.
The reason I can't say to just wade right in and buy with all you've got is that we don't know how many more Broken Bears are waiting in the wings. We'll probably see more big trouble in banks. Will that tell investors that we've finally seen the worst, or that they need to brace for more?
I would feel much more comfortable buying now if we'd seen a selling climax to an even lower level on huge volume, extreme readings on the MACD and relative strength, and a few more big bank failings. It seems that all of that could lie dead ahead, and that the difference between buying now and buying in a couple of weeks could be significant.
The best way to take advantage of the search for a bottom is by moving gradually. Buy in thirds if you're nervous, in halves if you're not. If you want to own 150 shares of something, buy 50 now, another 50 later, and the final 50 after that. It's a way to feel good no matter how events unfold.
A fact to keep in mind is that nobody can say the day the market bottomed until well after it's behind us. To take advantage of market bottoms, then, it's necessary to either be a little early or a little late. If you have the stomach to fall before rising, then a little early is fine. If you won't tear your hair out by missing some of the early gains, then a little late is fine.
Only you can know your own feeling in that regard. It's important to accept ahead of time, however, that you will not buy at the exact bottom. The best you can do is get close and what you need to decide now is what way of getting close works best for your personality and portfolio.
For the first time since 1995, the U.S. dollar traded at less than 100 yen today in Tokyo. It's no coincidence that the Nikkei 225 fell 3.3% to 12,433. This is precisely the reason I've been bearish on Japanese stocks for some time now. Just last Friday I addressed it.
"The momentum is definitely downward for the dollar," said Daisaku Ueno, senior economist at Nomura Securities Co. "With the momentum going like this, no one knows where it will stop."
On the contrary, Ueno-san, I know somebody who has an idea. I found him on .
Marc Faber, editor of The Gloom, Doom and Boom Report, spoke in Los Angeles last Friday. He pointed out that all asset classes have risen since 2002, a situation that hasn't been seen for 200 years.
"The current synchronized global economic boom and universal all-encompassing asset bubble will lead to a colossal bust," he said.
He placed much of the blame on U.S. monetary policy, with its focus on consumption over capital infrastructure, and said to expect a long period of volatility with swings of 20% up and down.
Loose money and out-of-control debt have taken a toll on the U.S. economy. "Zero hour may have already arrived," he said. He believes the U.S. has been in a recession for four months.
He was most pessimistic about the value of the dollar. He said, "In the long term, the dollar is a doomed currency. It will go to zero."
It's not at zero yet, but for the first time since 1995 the yen is at parity with the penny.
So much for the decoupling theory, which goes something like this: foreign markets don't depend as much on the U.S. as they used to, so they could be just fine even if the U.S. economy slows down.
Today here in Tokyo, Q4 growth was revised downward to 3.5% and economists expect the annualized rate to drop to 2.3%.
Guess what the biggest concern is over here? That a slowdown in the U.S. will take a bite out of Japanese profits because Japan is an export economy. I'm also hearing talk that investments in the private sector are ramping down from the high levels that have helped prop up the Nikkei for the past six years.
At the same time, the yen has strengthened almost 20% against the dollar since last summer, further reducing profits brought back to Japan from the U.S.
Thanks to rising oil prices and export profits falling from (A) the slowing U.S. economy and (B) the rising yen, Japanese companies are holding salary increases down and might cut bonuses this summer. That's putting a lid on consumer spending.
All told, Japan is talking about last quarter being its peak in the recovery and whispering that a mild recession might lie ahead. That should sound familiar. Talk like that began in America about six months ago.
I've received a lot of email asking whether the Visa IPO is worth buying. I wrote the following article forThe Kelly Letterand sent it to subscribers on Saturday, March 1.
Visa will IPO around March 19 or 20 under the proposed symbol V for between $37 and $42. The company stands to make nearly $19 billion on more than 400 million shares, which would be the biggest U.S. IPO ever.
Should we buy? Let's take a look.
MasterCard went public two years ago. Since closing at $46 on its first day of trading, it's gained more than 300%. Its earnings growth is forecasted at 20% annually for the next several years.
In 2006, MasterCard processed 23 billion transactions adding up to $1.9 trillion in spending.
How does Visa compare? Impressively. In 2006, it processed 44 billion transactions adding up to $3.2 trillion.
I love the global transaction processing industry. Both MasterCard and Visa are smarter than American Express and Discover. The latter two lend money to customers and customers pay them back over time at high interest rates. At first glance, it looks like a pretty good business.
Well, way back in 1603 Shakespeare pointed out in Hamlet that it's best to "neither a borrower nor a lender be." The sub-prime mess has confirmed that notion, and anybody lending to anybody is now having trouble. AmEx and Discover are both worried that cash-strapped consumers will default on their credit card payments.
Meanwhile, neither MasterCard nor Visa cares. The reason is that they don't lend any money. They only process the transaction and the customer borrows from the sponsoring bank. MasterCard and Visa just collect a fee every time somebody uses one of their cards to buy something.
Visa's only real competition is MasterCard, and it's already proven itself to be a bigger operation.
The future of credit card transactions is very bright, for four reasons.
First, developing countries still use mostly cash, and have yet to stumble upon the catastrophe, er, convenience that is credit cards. The sad truth is that most people just can't manage cards properly in their own favor, so they end up carrying balances at exorbitant interest rates. That's neither here nor there to MasterCard and Visa, though. They just process.
Second, the steady rise of the internet means more shopping will happen online. That will boost credit card usage as well but is not as much of a factor as developing country adoption rates. People already use credit cards when shopping in physical stores. There should be a little boost from online usage, though.
Third, people are using credit cards for smaller and smaller purchases, amounts around $5. Many stores don't even require a signature for purchases under $20 or $30. Customers find it convenient and processors love it because they get a fee. Only merchants dislike it because they have to pay a fee on each transaction. The customer usually wins out, though, and this trend toward plastic payment for everything will remain.
Fourth, economic weakness and what appears to be the steady de-sophistication of consumers all but guarantees a broader use of credit cards. People may skip their house payment, car payment, hospital payment and so on, but they still need to buy food and other items. If they're loath to shoplift, that leaves just credit cards as an option for the cash bereft.
I used to teach financial seminars in Los Angeles. I spent two hours explaining to people the right way to use credit cards so that there were no fees or interest rate charges, and then to put the joke on the financial companies by getting points or cash back for free. In follow-up surveys, I found that less than 5% of attendees ever got themselves on the right track. And those were people interested enough in their finances to attend a seminar!
So, the storm of profit from those with enough financial rope to hang themselves is blowing harder than ever, and Visa will cash in big.
As you can see, I'm interested in owning shares of Visa.
That being clear, I'm not going to rush to get it on the first day it goes public. We're in a rough market these days, and there will probably be plenty of time to pick up shares of Visa after its IPO.
MasterCard closed its first day of trading at $46, then closed five days later at $44. Three weeks later, it spent a whole week at less than $46. Six weeks later, it spent two weeks at less than $46. See what I mean? There will probably be plenty of time to get Visa at a good price.
Also, MasterCard's success makes it less likely that we'll see as much of a run to the sky with Visa. MasterCard surprised with its strong business. Visa won't, precisely because everybody now knows what a great business credit card processing is.
Do you think the recent selling [in the U.S. stock market] is overdone, and that we're due for a bounce?
We're not at bottom yet. I'm long-term enthusiastic but short-term cautious.
Masahira writes:
Why aren't you excited about Japanese stocks? James Grant at Forbes says they're cheap.
Japan is an export based economy that does best when its home currency, the yen, is weak. The weaker the better. Toyota wants to bring its U.S. dollars back to Tokyo at 500 yen per buck. Too bad a buck buys only 102 yen today.
That's the whole problem. From 2000 to now, the yen lost 2% of its strength against the dollar while the Euro gained almost 50%. Since the middle of last June, however, the yen has led the charge higher to the tune of an 18% gain against the dollar. On June 18, Toyota received 123.87 yen for every dollar it brought back from the U.S. This morning, it receives only 101.86.
It's no coincidence that since June 18, the Nikkei 225 is down 30%.
Gary writes:
What do you think is the best way to play the financial sector?
With a violin accompaniment in a dirge.
I've said since last fall we'd need to see bankruptcies before the financial trouble is behind us, and I still think so. I expect a cannonball drop climax in selling marked by extreme oversold indicators and stretched panic sentiment. At that moment, I plan to buy a leveraged financial sector index ETF.
The beauty of buying an index is that you're protected against single-company risk. Of course, some individual banks may never be the same, but do you really think we're witnessing the end of the financial system for good? I don't, hence buying the whole group after a severe sell-off -- at twice their performance -- looks like a great way to earn a down payment on another house.
Vartan writes:
Do you think this is a good time to buy real estate?
I think we're almost there. Prices are still falling and we haven't seen the end of interest rate cuts yet. We're going to get a fabulous, and rare, chance to buy when both property prices and interest rates are low.
As an added bonus for my fellow expats in Japan, the yen is so strong against the dollar that this is a super chance to take yen back to the states to buy real estate. I plan to move by the boatload starting at parity with the penny, that is, when the exchange rate hits 100 yen per dollar. By the recent pace, that should happen in about 20 minutes.
People are talking a lot in the financial press about how awful the situation is, how deep the recession will go (if there is one), how many people are going to be on the street from foreclosure, and so on.
Don't pay attention to all that. I see opportunity everywhere I look. Property is getting cheap, stocks are getting cheap, the dollar is getting cheap.
When things get cheap, somebody gets rich. Why not make it you?
The Neatest Little Guide to Stock Market Investing made the BusinessWeekBest Seller list at #11.
It takes a team to make a book happen, and a great team to make it happen big. I'm lucky to have such a great team.
Doris Michaels at the DSM Agency is tireless and one of those people that radiates energy into everybody around her. She placed my first Neatest Little Guide and every other one since, and is the first person to hear about any new ideas I have.
Keeping Doris humming is Delia Berrigan Fakis, Director of Development, who's a nice person to have on the other end of an email when things get busy. Imagine writing a request and knowing as you press the "Send" button that it's as good as done, and you'll appreciate what a joy it is to work with Delia.
Over at Plume, my publisher, I have a great editor in Nadia Kashper and a great publicist in Mary Pomponio.
Finally, thank you to everybody who's bought and read The Neatest Little Guide to Stock Market Investing and taken the time to write me with their appreciation. There's no greater praise for a writer than compliments from a reader...except maybe hundreds of thousands of readers and -- did I mention? -- a place on the BusinessWeek Best Seller list!
All of us on the Neatest Little team will keep working hard to put today's best investing information in front of you in a form that's easy to understand and ready to be used right away. That's the spirit of the Neatest Little Guides.
Get your copy of the best selling stock book here.
The Kelly Letter invested in Applied Materials a while back for several reasons.
It's the leader in semiconductor manufacturing equipment, which is a great business base but fraught with boom-bust cycles. To make its returns steadier, the company shrewdly started moving into flat panel displays and then solar. Now, with a solid stronghold in each, it has a fantastic portfolio of business.
The solar division is already earning its keep. AMAT gained 7.6% yesterday on news that the company had received a $1.9 billion order to install 15 solar equipment production lines in June. That's the biggest order in its history. The equipment should be able to produce solar electricity on the scale of gigawatts.
The Financial Times wrote last night: "Analysts said the deal for the world's largest supplier of equipment for the semiconductor industry was about five times bigger than any order it had ever received in its core business."
AMAT's price chart is looking good, too. The stock bottomed at $16.13 on Jan. 11, and has now marched 26% higher since then. It closed yesterday at $20.32 in what looks to be an attempt to break through the $20-$21 resistance zone. Doing so would put the stock at its highest since it broke through that same zone as support at the end of October. The last time it broke through that zone heading up was in July, when it ran to $23 by early August, then broke down.
Above $23, AMAT doesn't hit resistance until about $27. Morningstar puts AMAT's fair value at $25 and suggests selling at $32.50.
I see you haven't bought Google yet, despite all your positive articles about it. When do you expect to buy, and will you put on your website when you actually place the order?
The Kelly Letter has owned Microsoft and Yahoo for years, and is sitting on modest profits in each. My reason for owning Microsoft was to capture upward momentum from its Windows/Office upgrade cycle that started last year; for owning Yahoo it was an eventual recovery as it streamlined and improved its competitive position against Google. I thought Yahoo was a bargain compared to Google, and didn't like Google's over-reliance on advertising for profits. Remember, some 99% of its profit is from ads.
When Google kept climbing last fall to $747 on November 7, it looked far too overpriced to me. Its MACD was over 37 and its relative strength was 86 -- both stratospheric and screaming for a correction. Part of that rally came from Jim Cramer, who in October raised his price target to $750 but called even that "a total and unequivocal lowball estimate" considering the growth potential. He said a more reasonable estimate was $900. He'll be right someday, but there was no way it was going straight there from early November's precarious peak.
So, my initial hesitation with Google was two-fold. One, I was betting on Yahoo to get itself back on track. Two, I was convinced that Google was overpriced and vulnerable to some kind of setback. I was not prescient enough to know that the market would crash as far as it did in January, nor that Google would be so punished for its slowing click rates and so on. Thus, some of the good timing was just luck (and always is, no matter what anybody tells you). However, when a stock is as out of oxygen as Google was last fall, it doesn't take much to knock it down. I knew that, and held back until something happened to it.
Then, my attitude toward Google changed. What did it was Microsoft's bid for Yahoo. To me, that marked the end of Google's serious competition online because I believe that both Google and Yahoo are working on internet-based operating systems with the potential to make Windows unnecessary, and that that's the real reason behind Microsoft's buying Yahoo. It's not actually just about advertising -- although it is somewhat, of course -- it's really about bulking up for a long war against Google for control of software-as-a-service (SaaS) computing that's going to take the world by storm any year now.
I found on SnapSheet that Google Apps's revenue has gone from $0 to $400 million in just three years. It's up ten-fold from just a year ago. Granted, $400 million is still a small figure compared with Microsoft Office's $18 billion revenue, but with its blistering rate of adoption you can be sure Google Apps won't remain a mere annoying gnat for long. Also, have you used Google Apps or Docs? I already run my business with Google Docs and, let me tell you, it's fantastic.
Furthermore, I think Microsoft's proven ineptitude online is going to destroy or at least hobble whatever chance Yahoo had against Google. Thanks to Microsoft, Yahoo is on the same path to oblivion now sporting AOL's footprints. In a few years, I think we'll see the Microsoft/Yahoo conglomerate as an online dud with a smaller share of online search than they have now, an absurdly bloated online version of Office that's outflanked in every regard by Google Apps, and an operating system from Google that's a genuine alternative to Windows.
Aside from recent events, I'm fed up with Microsoft as an investment. Steve Ballmer is no Bill Gates, at least not judging by stock performance.
Microsoft has basically been dead money for five years. Since Steve Ballmer became president in January 2000, MSFT has lost about half its value. Now, he took over at the top of the internet bubble, but even if we clip off the bear market years and just examine the stock's price from, say, the beginning of September 2003, it's still down 4%. In that same time, the S&P 500 is up 30% -- even after the recent market trouble.
Given all of the above, The Kelly Letter is looking to sell both Microsoft and Yahoo at profits, and move the proceeds into Google at a cheap price.
We've been patient with Google and are hoping that investors see the Microsoft/Yahoo merger as a big threat to Google so that the GOOG share price keeps dropping. When it gets low enough, we'll begin buying.
As always, I will tell subscribers when we place the order and at what limit price. Join us!
