4/25 Kelly Letter Topics
Weekly market review
Earnings season
SEC GS politics
Fin reform toothless
Money always talks
Greece still sinking
Japan's sliding credit
AAPL > MSFT
Falling bullishness
Grant on fin reform
Unwinding hedges
Who will buy JGBs?
Tempur-Pedic
Of snow and stocks
2010 EDITION
Much has changed; good investing has not
The Neatest Little Guide to Stock Market Investing, 2010 Edition
Bill Fleckenstein thinks stocks will head lower over time, "as the complications from inflation and higher interest rates eventually compress price-to-earnings multiples and expectations are lowered about what sort of earnings power companies actually have." He's also certain that "the dollar will head lower and precious metals will trade higher."
He'll get no argument from Prieur du Plessis, who wrote last Friday that as "printing presses are running at full speed to produce ever-increasing quantities of fiat money as governments engineer the greatest asset price reflation in human history," the long-term case for gold is "arguably positive."
Lots of people are worried about the next oil shock, despite the commodity's current low price following last year's shock.
Much of the world's "easy" oil has already been extracted, or is in the hands of nationalist governments that will not allow foreigners to exploit it. That leaves firms to hunt for new reserves in ever more inhospitable and inaccessible places, such as the deep waters off Africa or the frozen oceans of the Arctic. Such fields take a long time and a lot of expensive technology to develop. Worse, new discoveries tend to be smaller than in the past and to run dry faster.
So oil firms must work doubly hard to replace declining fields and to increase output. Yet the oil industry is short of equipment and manpower, thanks to underinvestment in the 1980s and 1990s, when prices were low. As soon as the world economy starts growing again, the theory runs, demand for oil will once again outstrip the industry's ability to supply it.
In other words, the global recession has only interrupted the "supercycle" of which many analysts used to speak, during which the normal boom-and-bust cycle of oil and other commodities would give way to a protracted period of high prices, as ever-growing demand from emerging markets swallowed everything the extractive industries could produce.
At last week's Joint Economic Committee of Congress meeting, University of California San Diego economist James Hamilton said, "Even if we see significant short-run gains in global oil production capabilities, if demand from China and elsewhere returns to its previous rate of growth, it will not be too long before the same calculus that produced the oil price spike of 2007-08 will be back to haunt us again."
At the same meeting, IHS Cambridge Energy Research Associates chairman Daniel Yergin said that "half of the expected growth in oil production capacity over the next five years is 'at risk' of deferment or cancellation in today's economic environment" and "cannot be counted upon."
He acknowledged that the "future U.S. automobile fleet will be more efficient" but noted that "auto sales will grow substantially in other parts of the world, which means more vehicles will need fuel."
Moreover: "All this underlines the reality of cycles. During this downturn, there is a natural tendency for memories to fade about the acute concerns of a year ago -- and the impact of such dramatic price increases as seen in 2007 and 2008. But it is important to keep a longer term perspective that accords with the longer-term investment horizons and the long lead times that are inherent in developing oil and other energy resources."
Meanwhile, the nut jobs in Pyongyang are up to their old tricks. They conducted a nuclear explosion test yesterday, the yield of which was somewhere between 2 and 20 kilotons, judging from seismographic data. The Japan Meteorological Agency said it produced a ground shake that registered 5.3 on the Richter scale.
Stratfor says that while the world debates the actual size of the blast, the more important point is that North Korea continues testing at all. It's "the only country in the world to have tested a nuclear device in the 21st century. It has now done so twice. In so doing, Pyongyang has provided North Korean engineers with a wealth of technical data and information on the performance of its weapons architecture and design. The North Korean nuclear program marches on."
The world might not blow up before you retire, so make contingency plans in case Social Security and Medicare go bust. Robert Samuelson wrote in today's Washington Post that "the programs will ultimately go bankrupt" due to a $46 trillion gap in today's dollars between income and expenses over the next 75 years.
What a shame, then, that life expectancy is rising.
Don't expect presidents to do anything about Social Security's date with destitution. Samuelson recaps:
They profess concern, but their proposals are cosmetic, ineffectual or both. "We must save Social Security for the 21st century," proclaimed Bill Clinton. "The system . . . on its current path, is headed toward bankruptcy," warned George W. Bush. Now, Barack Obama seems to be reverting to this familiar form.
"What we have done is kicked this can down the road," he told The Post. "We are now at the end of the road." Great rhetoric -- but that's all.
Do you think last week's dip was just a gathering of market strength for another push higher? Do you believe the next secular bull market is upon us?
Paul Lim at The New York Times reminds you to define your terms carefully, "because a new secular bull would require not only rising stock prices, but also new all-time inflation-adjusted highs in major stock indexes. That means the S&P 500 would have to climb to at least 1,890, which represents its March 2000 peak of 1,527, adjusted for inflation. With the S&P now at 883, the market would have to soar an additional 114% -- on top of the 31% it has already climbed over the last two months."
That 114% gain may be especially hard to pull off considering that "S&P 500 earnings have declined over 90% over the past 20 months," according to Chart of the Day. That's "by far the largest decline on record" all the way back to 1936, and is shown in jaw-dropping glory on this chart:
Your eyes have not deceived you. "In fact, real earnings have dropped to a record low and if current estimates hold, Q3 2009 will see the first 12-month period during which S&P 500 earnings are negative."
Given that, it's easy to see why Donald Luskin at SmartMoney was surprised to learn that Robert J. Gordon, an "acclaimed macroeconomist and professor at Northwestern University, ...thinks the recession is over." Gordon is one of the seven members of the committee that decides for the record books when recessions begin and end, but usually well after the fact. Luskin is "unaware of any previous case in which a member of this Committee has ever stepped forward and declared the end of a recession in real time."
What brought forth Gordon's gutsy call? Claims for unemployment benefits. "According to Gordon's research, in every recession since 1974, the peak in jobless claims came within weeks of the bottom of the recession." How does Gordon know they've peaked for this cycle? By seeing that "the pattern of the decline in magnitude and timing nearly perfectly matched all the previous instances, in which no subsequent higher peak developed."
That's great news if it's true, but believing it sure requires a leap of faith. According to Shadowstats, the current unemployment rate is still rising at a disconcerting angle and is already 20% if calculated to include "discouraged workers," which were "defined away during the Clinton Administration." It calls the figure calculated in that manner the SGS Alternate Unemployment Rate, and provides the following historical chart:
It's enough to make up Jeff Clark's mind. He thinks the S&P 500 will bounce a little higher from support at 875, but that the decline will resume again after that. His best-case scenario calls for the S&P 500 to bottom again at 800, but his worst sees "a new low on the year." It's too soon to tell, but it's not too soon to sell in May and go away.
He says you shouldn't "listen to the talking heads on the business shows who are telling you to buy into this decline. That's a recipe for disaster. A reversal is unfolding, and it has the potential to wipe out a lot of the gains stocks have made since March."
Remember that this entire economic crisis originated in the banking sector. That's kept many economists and analysts looking for yet another shoe to drop from that gang of misfits, especially after the stress tests proved to be a good deal less stressful than we'd hoped. One popular place to look for dropping bank shoes is credit card defaults. They're not looking good.
CNBC reported last Friday that credit card defaults reached record highs in April, "with Citigroup and Wells Fargo posting double digit loss rates, as the recession slashed more than 2 million jobs since the beginning of the year."
Keep in mind that April is one of the better months for consumers because of tax refunds. Even so, Citigroup's "annualized charge-off rate rose to 10.21% in April from 9.66% in March." That 10% level already breached at Citi bears watching because if "credit card losses across the industry top 10%, as some analysts and bank executives expect to happen later this year, loan losses could reach between $70 billion and $75 billion."
Of course, that's no problem in the new America because the Treasury will just borrow funds from taxpayers like you to save the poor bankers from credit card deadbeats -- exactly how you saved them from subprime mortgage deadbeats. With good citizens like you across the land, what bank needs customers?
As Timothy P. Carney points out in The American Spectator, "today, bailouts are commonplace. We all assume that more struggling industries will get on the federal dole in the coming months, and in our next recession we can expect bailouts as a matter of course."
It's sad to see our once great nation reduced to that. Could it really be that subprime losers and greedy bankers mark the end of the road started by our forefathers in the heat of revolution and defended by our grandfathers at Omaha Beach and Iwo Jima?
Bill Bonner at The Daily Reckoning says that "if America really wanted to protect its wealth, its power, and its position in the world, it should fight the depression in an entirely different way." Here's how:
Instead of bailing out failed businesses it should let them go bust. Instead of coddling the executives who mismanaged their companies, it should turn them loose. Instead of shoring up reckless banks, it should help knock them down.
And instead of spending money on stimulus programs...it should give money back to the taxpayers so they can stimulate the economy, or not, as they choose. Taxes should be cut in line with government spending. This would boost savings, reduce debt, and...gradually...increase investment and consumer spending too.
But that is not the road Americans have chosen. Instead, they found a president willing to go along with history. Instead of scaling down, he is scaling up. Instead of reducing America's indebtedness, he is increasing it. Instead of going for safety, he's going for broke.
So much for that rising stock market. Andy Kessler at Opinion Journal thinks it was a sucker's rally "because there aren't sustainable, fundamental reasons for the market's continued rise." He offers three reasons for the brief bull: the Federal Reserve and Treasury succeeded in taking armageddon off the table now that "No more failures" is policy, the Fed has succeeded in driving short-term rates to zero so people prefer stocks over cash, and the Fed's quantitative easing via purchasing "up to $300 billion of long-term bonds as well as $750 billion of mortgage-backed securities" put cash on the street -- Wall Street, that is.
Relax, says Schaeffer's Investment Research senior analyst Richard Sparks. He told Jeff Cox at CNBC that a return to a Depression-era nosedive in stocks is unlikely. "It doesn't look like any of the really bad things out there that exist as potential worries could blow up in our face and cause us to have a very sharp downturn."
Cox thinks government is on the market's side, as its aggressive "intervention in 2009 -- as opposed to relative inaction from the public sector in the early stages of The Great Depression -- would seem to work against another prolonged downturn."
To which CXO Advisory would add that the old chestnut to "sell in May and go away" has little merit. It found that the "effect may be stronger during secular (but not cyclical) bear markets. However, there probably is no reward on average for being long stocks during either the good or bad seasons in bear markets. Conversely, there probably are rewards for holding stocks during both the good and bad seasons in bull markets."
So, the onus is on you to understand whether we're in a bullish or bearish backdrop. Don't expect answers from the calendar. (As an aside, surely you didn't think investing could be as easy as selling every May and buying every November, did you? For shame!)
If the rally is over, it will come as no surprise to Tim Duy, who never did buy the story that we're turning a corner. He thinks the cyclical downtrend that began in the second half of 2008 as commodities deflated may be wrapping up, but that the bigger problem of "an over-leveraged household sector that pushed the U.S. economy into what was initially a mild recession" faces a long path ahead.
He believes that the "story of the last 25 years has been an increasing role for household spending, rising to perhaps a peak of conspicuous consumption, with the motto 'a filet mignon in every stainless steel oven, a RV in every garage.'" Too many businesses are now built for that trend, and are in trouble because "the factors that supported the trend -- a steady march down in the saving rate to zero and a steady march up in household debt, coupled with monetary policy that had room to go from 15% short rates to zero over nearly three decades, are at an end."
The government wants people to keep buying trifles on credit cards, but people are finally -- finally! -- balking. Good for the people, bad for the economy and the stock market.
Does make you wonder, though, doesn't it? How useful is an economy in which what's good for the people is bad for the country? Seems to me a little at odds with the spirit of the Declaration of Independence and the Gettysburg Address. You may recall from the latter something along the lines of American government being of the people, by the people, for the people. A quaint notion, I know, but one a few of us think worth retaining over the decades.
Stratfor has little confidence in the Obama Administration's strategy in Afghanistan. Washington wants to reach a political settlement with the Taliban there, but must first "use military power to bring the insurgents to the negotiating table," a task made difficult by the U.S. limiting its troop commitment to 100,000.
That "deployment is not enough to make a difference on the battlefield" so the U.S. will "rely more heavily on air power in its campaign to degrade Taliban capabilities and confidence." That's a problem because air power means "civilian casualties are all but inevitable" and such collateral damage will "both strengthen the argument that Taliban forces are fighting against foreign occupiers and further erode whatever legitimacy Karzai's regime can claim."
Thus, "it seems unlikely that the Obama administration will be able to turn things around in Afghanistan as the Bush administration did in Iraq."
California's taking heat for its impending bankruptcy. It's not officially being billed as that, of course, but things are bad enough that Governor Arnold Schwarzenegger said yesterday the Golden State will suffer "a very serious cash crisis" if May 19 ballot initiatives don't pass. Too bad, then, that UPI reports polls show "California voters will handily reject the ballot initiatives, which are intended to help the state fill a budget shortfall."
Budget shortfall -- there's an understatement. Nothing happens small anymore. California's tax increases passed in February still left it with another $8 billion deficit in the next fiscal year, and that's assuming the ballot measures pass. If they don't, which is likely, the deficit will probably get as high as $14 billion.
Schwarzenegger backers accuse voters for wanting government services while refusing to pay for them. John Fund at Political Diary, however, says "the larger truth is that the Golden State is now basically controlled by public employee unions who systematically block any reform of the state's government. Governor Schwarzenegger was elected in 2003 to tackle exactly that problem, and his failure only ended up exacerbating the long-term budget disaster he inherited."
Not that Sacramento's alone. Washington, too, seems hell bent on paving the way to bankruptcy court. Andrew Taylor of the Associated Press reports that the U.S. government "will have to borrow nearly 50 cents for every dollar it spends this year, exploding the record federal deficit past $1.8 trillion under new White House estimates." That's the red zone, he points out, because as "a percentage of the economy, the measure economists say is most important, the deficit would be 12.9% of GDP this year, the biggest since World War II."
How does that compare to historical red alerts? "In the past three decades, deficits in the range of 4 percent of GDP have caused Congress and previous administrations to launch efforts to narrow the gap." Finally, polls "suggest Americans are increasingly worried about mounting deficits and debt."
I hope so. The country's balance sheet is already so out of whack that China sees an opportunity to become the world's new safe haven. (See yesterday's perspectives below.)
This is a sample of the research I do every day to find opportunities for Kelly Letter subscribers, and put ideas to work with real orders. Care to join us?
I'm hearing lots of talk about the S&P 500 ending this rally at about 950, so let's call it 940-960. That range brings together a few points: it's where recently popular DeMark signals say the rally should turn down, it's the home of the 200-day moving average, and it's the one-year downtrend line. That's a lot of challenge.
Naked Capitalism doubts the rally's staying power because it hasn't "featured a new leadership group, as enduring bull markets normally do, nor has it reached the crushing valuation lows (PEs of 5-8 versus roughly 11 in early March)."
Michael Santoli at Barron's, however, thinks "broad anticipation of a correction, combined with this reservoir of skepticism and desire to buy in at lower prices, imply that the first pullback wouldn't be all that deep, absent some fresh rupture in the financial fabric."
On last week's employment report, The Kelly Letter suggested the 539,000 jobs lost was a big number even if smaller than feared. Worse, though, is that it wasn't actually much smaller than feared because "the supposedly great -539k was manipulated. Government hired 72k in preparation for Census work, and the Bureau of Labor Statistics happened to adjust its Birth/Death figures to make the number of jobs lost shrink by 60k. Subtracting those, I get -671k for April."
David Leonhardt at Economix isn't as concerned. He found the jobs report to be "pretty encouraging" because, "It's just not getting worse at an accelerating rate anymore, and that's often a sign of better days ahead."
That's not how Frank Ahrens at The Ticker sees it, as the headline 8.9% unemployment rate "tells only half the story of this recession." If we include the "unofficially unemployed" tracked by the Bureau of Labor Statistics, the "total number of Americans who are not working full-time but ought to be is actually about 22 million, or 15.8%." That figure "is the highest since the bureau began keeping these figures in 1994. Excluding the current recession, the highest previous rate came in January 1994, when it hit 11.8%."
Dan Burrows and Will Swarts at SmartMoney worry that better-than-feared news is not the same as good news and that "the recent market rally might be getting a bit long in the tooth" despite improved economic data.
Moira Herbst at BusinessWeek suggests that a true rebound will include rising business investment (currently falling at a rate of 30% over the last six months), rising consumer spending (still depressed), number of hours worked per week (still at a record low), and increased temp hiring (still falling).
In real estate, Dr. Housing Bubble sees no green shoots, certainly not in Southern California. He says the "fundamental factors that have depressed and caused the California real estate market to crash still remain" because "a tsunami of inventory is going to be flooding the market in late 2009 and early 2010" as the market moves out of the subprime frying pan into the Alt-A and ARM fires. Among ten problems he finds are rising notice of defaults, rising unemployment, sluggish sales, and this stunning fact: "Nearly 30% of all mortgaged property in California has negative equity." He concludes, "There is absolutely no rush to buy a home right now."
Meanwhile, Washington is up to its usual good-for-nothing posturing as President Obama acted triumphant over finding $17 billion in savings, which amounts to less than 0.5% of his $3.4 trillion spending plan. David Broder at The Washington Post described the number as "theoretical savings almost invisible to the naked eye." Senate Budget Committee ranking Republican Judd Gregg said, "This amounts to less than an asterisk when it comes to the amount of debt and deficit that we will be running up as a government."
Shane Oliver at AMP Capital finds China's green shoots of recovery to be "much stronger and more broad-based" than others around the globe. He notes China's low public debt, lack of a bubble in its property market, and thinks "there is significant scope for strong growth in consumer spending to underwrite sustained Chinese growth of 9% to 10% per annum."
Stephen King at The Independent sees more than just economic recovery on the line. He points out that it's "Western banks which have been making the bad loans and it is, ironically, Western governments which are now following the Chinese model of state-directed lending." Chinese banks skipped the dangers of leveraged securitization and "their loans have been funded much more through good old-fashioned deposits, reducing the risk of a domestic credit crunch."
As the U.S. government demonstrates its inability to manage its economy, "for countries fearful of their excessive dependence on the U.S. economy, China offers an opportunity to reduce their vulnerability." Because "the U.S. economy will be weighed down by private and public-sector debts over the medium term, other countries will increasingly look elsewhere to find supportive trading partners."
Most ominously: "China is already extracting a price for this process, increasingly signing long-term trade deals in renminbi rather than dollars, with the effect of slowly turning the renminbi into an alternative to the dollar as a reserve currency. Although we are still many years away from a world economy dominated by China, we may already be witnessing the first signs of America's dwindling status as the world's hegemonic economic power."
