Analysts, Gurus &amp; Pundits

Top 568. Sep 23, 2005 11:27 AM

» Normxxx - Re: Re: The Big Lie

In response to Re: The Big Lie posted by bob90245:

I understand the normal use of the term, but Bernstein here was using it to mean that the really good small cap stocks get 'promoted' out of the class, leaving behind the poor and mediocre performers (which is why he is saying that small-cap-growth funds are naturally biased against performing well). I was assuming he was applying a similar rule to explain REITs, but you are probably right; he has just reverted to the usual definition of "survivorship" for REITs.

That's what happens when you read too quickly, I guess! Thanks.

-- posted by Normxxx

Top 569. Sep 26, 2005 6:41 PM

» hairie31 - Mark Lebovit is Short

Got a mass e-mail sent out by Mark Lebovit, sent out to anyone
who ever took his free subscription.

In it he mentioned he was short the Market now.

He's a interesting, outspoken person.

He had some good predictions in the 1999-2000 period. But his Annual Model Forcast has been quite inaccurate since.

Anyone closely follow his record?
He gives daily trading suggestions. Has anyone accurately followed his trading?

I kind of doubt he actually makes any money, or beats the market, with 100s and 100s of trades a year, plus all the commissions.

-- posted by hairie31

Top 570. Sep 27, 2005 4:11 PM

» Normxxx - If U climb a wall of worry

If U climb a wall of worry, U'll be OK

By Uncle Harry D (for Demystifying) Schultz | 27 September 2005

Dear nieces & nephews, I keep trying (though I know better) to take longer-term positions in stocks & futures & occasionally a bond, but along comes the marketplace with either a price drop— which makes me sell for fear of it developing into a really unpleasant loss, or a rise-which makes me sell to take a nice profit that may not be there for long in today's fast-reversing markets. My friend & fellow mkt advisor Chic Goslin puts it this way: "In these mkts today, concentrate on taking profits, not maximizing profits."

There's the growing risk of a sudden event— like a Long Term Capital Management cum derivatives crisis, a 2nd/3rd world central bank default (a la The Mexico Bailout, Russia default or a US-$ collapse, not to mention 1st world terrorist attacks). There are many really scary, mega-size balloons & bubbles that can burst so fast U won't be able to exit your positions after the news breaks. When the next crisis inevitably occurs, you'll know it when U hear, metaphorically speaking: "Houston, we have a problem."

This means we must have stop-loss orders in, as well as taking profits as they occur. This does not mean we must withdraw from mkts; we just need to use strategies that are in tune with turbulent, traumatic, times. There are still many good stocks to buy. And learning to sell short is a tool U should learn to utilize, now that price earnings ratios are again at historically high levels, & a number of stks deserve shorting. Likewise, futures are something U should consider. They can be used long or short. They are not high risk if stops are used. In fact, they are safer, as most people don't bother to put stops on stocks, whereas they are afraid not to use stops in futures.

In the Big Picture view, the world may well "muddle through" for quite some time. But the risks are rising, along with ocean levels, & U don't want to have to start all over again (horrible thought!) to rebuild your assets because U didn't plan on your asset house burning down. ··· The trick here is to diversify, among alternative investments, boring as that often is. It calls for buying things U don't enjoy very much just for the sake of diversification. Anyone who goes all-out for only 1-2 asset classes is gambling with his future. Avoid feeling smug just because U have made a mkt killing (U think, in your innocence) in one area (property? Oil? tech stks?). Often if I celebrate a killing, I get a backlash. Pride will bury U. Property is the "Present Danger" for those who are property-leveraged &/or using flexible rate loans. If U think U are clever, U may be headed for a fall. If U climb a wall of worry, U'll be OK.

The overall world monetary problem (potential crises above aside) is the need to "re-balance"— the new in-word to describe how everything is out of whack. Eg, trade imbalances & budget deficits/surpluses, China's overbuilding capacity, ridiculous globalization (which stresses labour mkts), pension & health care promises by many govts & corps that can't (& won't) be met. Govts everywhere are overspending & overtaxing. The US-$ itself needs rebalancing, ie, lower, which is almost certain to eventuate, but how fast/far is in the lap of Zeus.

But I said, above, the "muddling through" has a fair chance for now. I especially meant re the US-$ re-balancing (which affects a lot of areas). Why? Because the game can probably go on as long as Asian govts will accept US-$'s & keep them in US-$ bonds. Asian govts are the main ones who might bring about the most rebalancing, eg, by switching to the ¥, £, and € (& gold). But govts want to stay in power (that's all politicians live for), so most will do their rebalancing very slowly & quietly, as they're already doing.

But there are some other govts who don't mind doing it out loud, eg, Russia, Mideast & Latin nations, though their $reserves aren't as massive as Japan, China & the tigers. Regardless, the longer term will erode the US-$ for a great many reasons.

Since writing that paragraph, The Economist mag appeared. Lead article: Traffic lights on the blink? Says rebalancing is in jeopardy because the normal mechanisms, which worked in the past, have jammed. Relationships between real US bond yields have fallen, not risen, in past few years partly because Asian central banks have been keen to buy US T-bonds to prevent their currencies rising. As long as low yields continue to support the US housing boom/bubble & hence strong consumer spending, they block any reduction in US current-account deficit.

If that sounds complex, it is, & that makes investment advice by the unwashed (& even most of the washed) pretty anaemic. Euro interest rates give wrong signals to govt & consumers. The silly idea of 1-interest rate for all EU nations puts water into petrol tanks. Eg, Germany & Italy don't have the same growth rates as Spain & Greece. There's more to this story, but I'm getting dizzy writing about this camel designed by a committee. The Economist rightly says "interest rates & bond yields are the traffic lights of the global economy. When these traffic lights break down, there's a risk the global economy can get snarled up or even crash." Another way to put it: global economics are disfigured. So, be wary of dogmatic opinion; things are not black & white. More like dirty grey.

The Great Mall-of-China threw UncleSam a bone via a Potemkin façade currency manipulation. They switched the Yuan from a direct $-link to an indirect $-link. "Very clever these Chinese" (old US cliché). By using a basket of currencies (in which US$ is a big portion) China gets best of 3 worlds. Gets Mr. Snow & US Congress off their back, lessens China's total dependency on US$ movements, marginally, & wins PR. The 2% move was too small to see, & the US$ actually fell on the news, but China got credit as if it was a 10% revaluation. Chinese checkers & checkmate chess. U see, China can't afford a 10-15% move (as US wanted) because they have a big unemployment problem, which threatens political stability, as well as economics. That's why I predicted no true revaluation would happen. Also, a 10% Yuan revaluation would be an ipso facto 10% devaluation of their pile of US$ reserves. So, don't join the rush to buy Yuan in hope of a windfall gain. That's far distant.

A word about inflation, which all govts promote (via money/credit supply) & simultaneously mask via corrupt CPI data to avoid paying higher social security/pensions. Why does the press never mention this reason? U know why. Press is bank/govt/big biz controlled. Inflation is rising ever faster, govt data reports. Imagine what the real numbers are! But economies are on balance gradually slipping. This will lead to stagflation, which I find is mentioned now by several credible writers & which I predicted (on 5/9/04) to occur in late 2005-2006.

Oil is now impacting inflation numbers seriously. CPI's in UK, US, Germany, etc, are climbing. If fuel was included in US CPI, it would transform everything! Excluding it was a slimy maneuver by insider manipulators.

In US poll, 84% are worried about inflation-which they wouldn't be if govt's small CPI number was honest data. People only worry when the real numbers affect them. ==> Keep your balance (via diversifying) while this global rebalancing act takes place.

The press is full of global warming news & rising sea levels. A French paper says the Riviera may become as warm as Spain or North Africa, so we should then go with the flow & do as warm weather Latins do— take a siesta every day after lunch. Siestas also preclude summertime heat strokes. That's the best idea yet to come out of climate change. Think I'll start it now, get in some practice.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of this message is not to be construed as constituting market or investment advice. It is intended for educational purposes only. Individuals should consult with their own advisors for specific investment advice.

-- posted by Normxxx

Top 571. Oct 3, 2005 11:12 AM

» Kirk - Citigroup's Ajay Kapur "Global equity returns likely to rise"

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Global equity returns likely to rise - Citigroup
Mon Oct 3, 2005 12:51 PM ET

NEW YORK, Oct 3 (Reuters) - Global equity returns may total 10 percent to 14 percent in the next six-to-12 months, according to Citigroup Inc.

"Reasonable-to-cheap valuations, the upturn in most leading indicators of earnings growth and strong momentum in equity prices in most regions are driving this more bullish outlook," Ajay Kapur, Citigroup's global strategist wrote in a research note to clients.

Kapur recommended clients to increase holdings in high-beta sectors -- more susceptible to price volatility -- such as biotechnology, brokerage/dealers, Internet, technology networking equipment makers and semiconductors.

Still, giving the risk associated to high beta sectors, investors should favor Exchange Traded Funds (ETFs), when buying those sectors, Kapur added.

Citigroup included high-beta companies such as Morgan Stanley (MWD.N smile , Goldman Sachs & Co. (GS.N) , Google Inc. (GOOG.O) , Intel Corp. (INTC.O smile and Yahoo! Inc. (YHOO.O smile , in its model portfolio, according to the note.

-- posted by Kirk

Top 572. Oct 4, 2005 11:36 AM

» Normxxx - “NOISE?!”

Investment Strategy: “NOISE?!”

By Jeffrey Saut | 4 October 2005

In his book, “Capital Ideas,” Peter L. Bernstein discusses “Noise” and contrasts it with information:

“Noise arises as people buy and sell on what they believe is information but is really rumor, badly analyzed information, misinformation, or hunch. Confused by the noise, investors respond to their brokers’ urgings to ‘Hurry, hurry!’ . . . suggesting that many people trade on noise simply because they enjoy fooling around and trading on hunches. Others are not even aware that they are trading on noise – they believe they are trading on reliable information.
. . . Noise traders who take their tips from stories told at cocktail parties, chase only what is hot and dump their stocks in a panic, lose out in the long run no matter how smart they may seem in the short run. They end up selling too cheaply to better-informed, and patient investors, or else they pay too dearly for stocks that more systemic investors are kind enough to sell them.”

For the past few weeks we have characterized the current market as “noisy.” While noise often pertains to cult-stocks like Taser International (TASR/$6.17), which has gone from $6/share to $33/share and back to $6 over the past two years, with “the lightning round” passing as legitimate investment advice “noise” has even crept into Raymond James’ universe of stocks. For example, recently rumors swirled that Linens ‘n Things (LIN/$26.70/Market Perform) was putting itself up for sale, lifting those shares from $22 to $30, where the cocktail-crowd bought the shares, and are now sitting with losses. Or how about LaserCard (LCRD/$8.87/Market Perform), which leapt from $5/share to $10 in two weeks on rumors of a large contract. Currently, the rumor du jour is that Google (GOOG/$316.46) is considering a bid for Infospace (INSP/$23.87/Market Perform). Ladies and gentlemen, investing on “noise” is a sure road to disaster, yet the difference between perception and reality is where our opportunities lie.

A case in point is Synagro Technologies (SYGR/$4.70/Outperform). Over the past few weeks Synagro has declined by roughly 15% on rumors that the amount of natural gas it uses to palletize wastewater sludge was “killing” the company given natural gas’ parabolic rise. In speaking with our analyst, however, we learned that most of Synagro’s contracts are written such that a rise in the company’s energy costs is a pass-through item to its customers. Moreover, as the nation’s largest recycler of biosolids, serving over 560 municipalities, Synagro has a competitive advantage when bidding on new contracts. To wit, the company is the only bidder for the upcoming Philadelphia contract. If Synagro wins said contract it will likely not be very accretive in the first year as the company builds the Philadelphia facilities. In 2007/2008, however, this contract should add $5 million to $6 million in EBITDA. Accordingly, the recent “flop” gives the patient investor the opportunity to buy shares from the noise-investors. Manifestly, if you were astute enough to buy Synagro at $4.50/share last week, a rise to our analyst’s 12-month price target of $5.00/share produces an 11% capital gain and when combined with Synagro’s 8.5% dividend yield provides a total return of nearly 20%. Indeed, the difference between perception and reality is where our opportunities lie!

More noise-induced opportunities presented themselves recently when 6.7%-yielding Enterprise Products Partners L.P. (EPD/$25.18/Strong Buy) sold-off on worries about Hurricane Rita. Likewise, Cognos (COGN/$38.93/Strong Buy), covered by our Canadian subsidiary Raymond James Ltd., has declined on worries that growth is slowing. However, growth has slowed because customers have curtailed the buying of Cognos’ existing products, awaiting the rolling-out of the new state-of-the-art “Cognos 8” product. Recall that Cognos is the leading provider of business intelligent software that helps companies transform vast amounts of corporate data into information that improves business performance. Indeed, Gartner Group recently recognized Cognos as the dominant brand in business intelligence software. Also notable is that some of these business intelligence metrics are mandated by the Sarbanes-Oxley laws. Further, Cognos has a great management team with a strong record of value creation, as reflected in its 20%+ return on invested capital (ROIC). Moreover, without the drag from its excess idle cash ($5 per share) Cognos’ ROIC rises to 50%. Yet, “stock noise” is not the only noise currently echoing down the canyons of Wall Street.

Last week we were on CNBC with two other strategists. One of these fellows knew all the statistical economic information, but had no sense of what is happening in the “real world” . . . that would be the world in which you and I live. This gentlemen espoused the belief that inflation was virtually non-existent and that the economy was doing just GREAT! As noted in these missives, we thought the economy was cooling even before “Katrita.” Moreover, as repeatedly stated, our governmental bureaus have a HUGE measurement problem when it comes to indicators and consequently their statistics, are at best, suspect; begging the question, “if you think inflation is less than 2% why is the middle-class shrinking?”

The other fellow joining us on CNBC was from the astute investment management firm Cumberland Advisors (http://www.cumber.com). Speaking to the inflation question Cumberland’s David Kotok posed the following conundrum (as paraphrased by us): The Fed says its preferred measure of inflation is the market-based core PCE (personal consumption expenditure deflator). Core PCE does not include energy. That suggests there is no inflation in the current data. . . . So, why is the Fed worried about inflation if its preferred indicator says don’t worry? Is the Fed telling us that their preferred indicator really isn’t that preferred? (Since the PCE doesn’t include energy) are they saying it is energy prices that are raising inflation expectations? If so, then the Fed should not raise rates since energy prices will not pass through to an inflationary spiral. Consequently, the Fed Funds rate at 3¾% is already way above PCE-measured inflation. If the Fed wants to use energy, it must look at the CPI, which includes energy and is approaching a 4% inflation rate. The Fed can help its search for transparency by clarifying this issue for the markets.

Clearly we agree with David Kotok given our recent statement that one of our worries is the lack of future visibility from the Fed. David concludes his comments by noting, “At Cumberland we are holding a cash reserve on the stock side. We are also keeping duration shorter than benchmark on the bond side. Risk premia in stocks and bonds are rising. We are not sure in which market they are rising faster. It could be both of them.” Obviously those words “foot” with our “predominantly defensive” investment strategy of recent weeks.

The call for this week: With the end of the quarter now behind us maybe the noise-level subsides, yet we remain cautious. Consequently, we were surprised by last week’s report in The Wall Street Journal of the Dow Jones Hedge Fund Benchmarks, which showed that the various hedge fund investment styles only produced YTD returns of between -5.3% and +5.6%. Why surprised? Because our conservative strategy has returned 16%, excluding dividends, for the Focus list YTD. We continue to invest accordingly.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

http://www.siliconinvestor.com/readmsg.a...

Top 573. Oct 4, 2005 12:07 PM

» Kirk - Prudential Lays Off Acampora

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10/4/2005 2:35:10 PM
From: sixty2nds Read Replies (1) of 25656

13:56 Prudential Lays Off Acampora, Ends Technical Analysis -- Dow Jones

-- posted by Kirk

Top 574. Oct 4, 2005 4:38 PM

» Normxxx - Re: Prudential Lays Off Acampora

In response to Prudential Lays Off Acampora posted by Kirk:

Say it isn't so!

That's got to mark the end of the markets as we have come to know and love them!

-- posted by Normxxx

Top 575. Oct 30, 2005 2:06 PM

» Normxxx - Abelson: All Trick, No Treat

UP AND DOWN WALL STREET: All Trick, No Treat

By ALAN ABELSON, Baron's | 30 October 2005

AND BILL CLINTON thought he had it bad!

All he had to face was impeachment at the office and mad-as-a-hen Hillary at home. Actually, those two equally powerful antagonisms acted as counterirritants, providing a bit of relief for Bad Boy Bill.

In any case, he had it easy, compared to the multiple afflictions being visited on Dubya. Man, Job had it easy compared to Dubya.

Mr. Bush's trustiest aide and lethal political operative, Karl Rove, is still on the hook, and his vice president's No. 1, Lewis Libby, has been indicted, for outing a covert CIA agent whose ex-diplomat hubby took public exception to the rationale for invading Iraq. It figures that Karl and Scooter would botch a leak, since there's not a trace of evidence that either ever had occasion to learn which end of a wrench you grip.

Woe enough that Mr. Rove, who is known among intimates of the president as "George Bush's Brain," might no longer be available to do whatever a brain is supposed to do. But all the publicity about the possible indictment of two White House officials (typical of the media mudslingers, they make such a hullabaloo about those two, never mentioning the hundreds of White House flunkies who weren't indicted) made the whole world aware of the fact that the war in Iraq isn't quite going as advertised.

And it didn't help a whit that the indictment stuff hit right on top of the administration's, shall we say, measured, reaction to Katrina. As if the hurricane were Mr. Bush's fault. For gosh sakes, if they wanted a weatherman as president, they should have elected Willard Scott.

And let's not forget Harriet Miers. All that guff and from his own base— and, boy, were they ever base— about her being unqualified for a spot on the High Court. What better evidence of her judgment can you ask than that she thought Mr. Bush was the most brilliant man she ever met (true, she doesn't get out much, but the sentiment tells you all you have to know? She was borked, the poor woman; even Bork borked her.

Not the least of the indignities inflicted on Mr. Bush was that darn Gallup poll showing that, given their druthers, something like 55% of Americans preferred Anybody-but-Bush as president. In all fairness, we ask you, What did Anybody-but-Bush ever do for this country? Just as a guess, we'd hazard that poll sure doesn't increase chances of Dubya's getting his mug on Mount Rushmore, along with the other greats.

So now, in addition to making nice to all those visiting popinjay foreign dignitaries who come looking for a photo op, a meal and a handout, the president has to drum up another candidate for the Supreme Court and mull a possible replacement for Karl Rove. Of course, he might always persuade Sandra O'Connor to stick around for another few years, and even if Karl Rove eventually is indicted, maybe Mr. Bush can work out a deal to keep Karl on, if he wears one of those electronic ankle bracelets (although word is that Karl isn't very keen on jewelry).

The only good thing that has happened to the president as he's engulfed by a sea of troubles is that his choice to replace Alan Greenspan seems to be going down pretty well. To tell the truth, though, Mr. Bush is still not 100% sure of Ben Bernanke; the guy— can you believe?— wears tan socks with blue suits.

And the thought did occur to the president that maybe, given that business of Bernanke and the helicopters— he vowed to drop money from helicopters to help a stressed economy— he'd have been a natural to head up FEMA instead of the Fed. Moola from heaven would have been just the ticket for New Orleans, Biloxi and South Florida. (And wouldn't you just know, with all the warning, the response to Wilma was bungled by the governor of Florida, who, rotten luck, has the same surname as the president).

You'd think the least Dad could have done was warn Dubya there'd be weeks like this.

THE SELECTION OF BEN Bernanke has prompted a lot of mostly inane chatter by economists and press pundits, along with the inevitable befogged blah from bloggers. What a waste of words!

All we really know about Mr. Bernanke is that he has degrees from Harvard and MIT, was head of the economics department of Princeton, read Ayn Rand as a callow youth, served an abbreviated stint as a Fed governor, has been briefly chief of the Council of Economic Advisers and is something of a monetarist. All of which could be held against him, but for now we won't.

What we don't know about Mr. Bernanke is how he'll react under pressure, whether from an unforeseeable bad turn by the economy or the very predictable political arm-twisting. We can only hope, in either instance, he shows more wisdom and backbone than his predecessor. Not a very high bar, obviously, but as much as you can reasonably expect.

New Fed chairmen, as we all know, tend to prove they've mucho macho by giving the monetary screws a good tightening. We haven't the faintest notion as to whether Mr. Bernanke will follow that template. But we'll find out soon enough, so why the rush to speculate?

What can be said is that the new guy in charge at the Fed is inheriting quite a financial mess the much-admired Mr. Greenspan has been complicit in creating. Mr. Bernanke's challenge is to clean up the mess without incurring blame for it or the consequences of remedying what his predecessor wrought.

We wish him luck. He'll need it.

THE ILL POLITICAL WINDS blowing in from that den of iniquity, Washington, together with those serial killer gusts blowing in from the Caribbean, have been among the prime elements vexing the markets and just plain folks alike. In both, they've inspired a sense of unease, occasionally bordering on foreboding.

What makes the sight of the president and his mates in hot water particularly disquieting is that the perception had been of a cool, efficient and, above all, in-control administration. As Iraq and Katrina demonstrated beyond cavil, the impression of competent, coherent and firm leadership that Bush & Co were so careful to cultivate simply hasn't held up. The disillusionment has been greater because expectations, fed by the president's engaging persona and stirring rhetoric, were inordinately high. Mr. Bush has lost the air of invincibility that so nicely saw him through past stretches of disfavor and enabled him to push through so many of his priorities.

Consumers and investors have also been bugged— we're not telling you anything you don't know— by more than just political disarray. The usual culprits— surging energy costs and a lackadaisical job market— continue to burden both their psyches and their pocketbooks. And although the public has continued to spend like it hadn't a care in the world, there are ominous signs that the spring of its exuberance— housing— may be finally beginning to run just a tad dry. Not only is there slippage in prices and even sales are threatening to slough off, but, as David Rosenberg of Merrill Lynch reports, the inventory of newly-built homes that haven't been sold is up a whopping 20% over last year, the biggest such increase in more than two decades.

Perverse beast that it is, the stock market on Friday cheerfully shrugged off the hobgoblins that had been spooking it and staged a rousing rally. The ostensible spark was a better-than-anticipated number for third-quarter GDP. Not too many investors, apparently, paid heed to the fact that most of the thrust came in July and August, and that, in any case, on close inspection, there was less to the figure than met the bullish eye. Or maybe they were just celebrating the White Sox win in the World Series after all these years.

However welcome, the rally, we suspect, was nothing more than one of those bounces that happen when sentiment temporarily droops excessively. Investors Intelligence's survey of advisory opinion, early last week, showed 44.8% of the cockeyed seers were bullish, 29% bearish, a ratio that usually presages a rally. Ditto the American Association of Individual Investors' sounding of how its members feel, which registered over 46% bearish and a merely 32% bullish.

But the presence of a powerful negative undertow in the market evidenced by such disconcerting stuff as the lopsided number of stocks setting new highs for the year over those setting new lows and notably feeble breadth (advances versus declines) is a strong argument against taking the plunge. Unless you're among the lucky few in desperate need of tax losses. Not a pretty picture.

<img Align="Left" hspace="10" vspace="5" src="http://bigpicture.typepad.com/photos/unc...">STEPHANIE POMBOY, WHOSE scintillating and informative MacroMavens is on our short list of must weekly reads just put out one of her periodic issues devoted to trading tips. Stephanie, by way of brief background, is flat-out bearish on the economy and most markets.

Speaking of pictures that aren't very pretty, as we just were, take a gander at the two charts that adorn these scribblings. They're both lifted from Stephanie Pomboy's latest MacroMavens commentary and, frankly, they're more than a little ominous. For what they show is how dependent this quixotic economic recovery has been on IOUs.

The remorseless decline in wages as a percentage of personal income has reached an historic low of 62% (the chart to your left). Meanwhile, consumer spending as a percentage of wages continues to spiral upward (the chart to your right). In the past three years, Stephanie reckons, shop-happy consumers, cheerfully determined to live beyond their means, leaned a lot more heavily on borrowings ($675 billion of non-mortgage debt) than paychecks ($530 billion) to cover the $1.3 trillion increase in their spending.

As she points out, "The consumer has become so debt-dependent that he now borrows 11 cents of every dollar he spends, compared to 9 cents in the 2001 recovery episode."

Great while it lasts, but even the best of sprees— and it hurts to be the bearer of sad news— can't go on forever. And this one looks like its time is almost up. Higher interest rates, obscene gasoline prices and the rising cost of just about everything are starting to sap consumers' confidence, to say nothing of their capacity to consume. Retail sales this month, Stephanie takes somber note, have been the weakest since the last recession.

Over on the other side of the fence that separates presumed investment sophisticates from us poor civilians, risk-consciousness is suddenly the in thing. The spread in yields between junk and Treasury paper— a handy gauge of how venturesome or apprehensive the folks who speculate in bonds are— has begun to widen, and the flow of corporate bond issues is contracting sharply. Which Stephanie proclaims as clear proof of the dearth of liquidity in the corporate bond market.

Making things infinitely more disturbing is that the companies in the crosshairs, as she puts it, are the very creators of credit— the likes of GM, Ford, Fannie Mae— along with the facilitators (nice euphemism, Steph) of credit— AIG, Ambac, MBIA, to name only a few.

That the demon debt is finally exacting its due from consumer and corporate borrower leads her to the melancholy but unsurprising conclusion that "the great credit boom is now drawing to a close." And here we were so hoping Mr. Greenspan could take his leave smiling."

Envisioning the twin drags of higher interest rates and energy prices carrying us into recession, her first theme is what to do when credit problems bubble to the surface. Among other things, she points out, that almost a trillion dollar's worth of mortgages, of which $543 billion is sub-prime, is going to have to be reset sometime in the next eighteen months, a time when interest rates are supposed to be higher than they are now, and no less than half will hit subprime borrowers. Already the amount of interest people owe on the floating-rate mortgages is up 14% year-over-year, and so Pomboy figures that delinquencies are "sure to rise." That's destined to take a toll, not only on the lenders, but on the poor souls who can't cough up the extra dough and on discretionary spending generally.

Meanwhile, finance companies are still gorging themselves at the mortgage-refinance trough. According to Stephanie, RE lending represents a record 40% of total bank lending, up from 17% two decades ago, which leads Pomboy to surmise that there is a related bubble-ette in the shares of finance companies. The recent fascination with Financials is starting to bear an uncanny resemblance to the blow-offs in Energy in 1980 and Tech in 2000...

"Bubble or not, one thing that is beyond debate is that the credit quality of banks' real estate loans is clearly deteriorating," Pomboy concludes. "While the redefinition of 'delinquency' has kept an artificial lid on those stats, 'foreclosures' have risen dramatically. Indeed, when viewed in the context of the 40-year lows in interest rates, foreclosures have never been this high."

No one can say for certain how high is too high. Nasdaq 4,000 seemed
pretty high...until we reached Nasdaq 5,000. Today's refi activity
still seems unsustainably high but, of course, it might soar unsustainably
higher. Still, the risks seemed skewed to the downside. In short, don't
rule out the possibility that the "American Dream" is about to become
a "Nightmare on Elm Street".

So she recommends shorting subprime lenders and going long consumer-staples stocks, while shorting consumer-discretionary stocks. She'd also buy the stocks of companies that specialize in repossession— which she calls RepoMen stocks: Encore Capital (ticker: ECPG), Portfolio Recovery Associates (PRAA) and Asta Funding (ASFI.)

Switching to bonds, she notes that the investment-grade universe "has shriveled to almost nothing." Currently, over two-thirds of the industrial bond market merits junk status, compared to only 3% in 1980. Only seven U.S. companies are rated triple-A credits. The value of the entire Treasury market, $4 trillion, is dwarfed these days, she sighs, by the $5.6 trillion in mortgage-backed securities, $2 trillion in asset-backeds and over $3 trillion in high-yield corporates.

When trouble rears its ugly head and investors bolt from risky stuff into high-quality paper, yields on the latter should, she reasons, dramatically compress. One obvious way to play this is to go long 10-year Treasuries, while shorting junk. Another possibility: Short financials against long positions in a defensive sector like health care.

Risk, Stephanie says, "is to market liquidity what kryptonite is to Superman. Its mere suggestion is enough to cause seizures." As risk returns to its rightful place in the investment firmament, liquidity will beat a sharp retreat and "the tide that once lifted all asset boats will beach them instead."

In such an environment, she avers, "what you don't own may be at least as important as what you do. The key to survival is to underweight the most notorious liquidity lushes. Most generally this would mean underweighting stocks versus bonds, high-yield versus high-grade, and if the past is prologue, the emerging markets and resource economies versus their developed country counterparts."

Emerging markets, she worries, despite their long-term promise, likely would be roiled by fears of a U.S.-led global slowdown and are apt to be "tossed out with the bathwater." She suggests waiting for the storm to pass or hedge existing long positions by shorting those emerging markets most exposed to the U.S. against those most exposed to China, which has both the motivation and means to keep growth going. Happily, she offers a more direct and simpler approach: Go long the Nikkei, while shorting the S&P.

Imagine, Stephanie Pomboy urges her readers in her MacroMavens commentary, one morning you're looking at your monitor and a headline scrolls across saying, "Bill Gates has no plans to sell his Microsoft shares." Which is promptly followed by another headline saying, "Steve Ballmer to maintain Microsoft holdings." That'd be more than enough, Stephanie has a hunch, to make you just a mite suspicious that all might not be well at Microsoft. (And, we might interject, give you the heebie-jeebies if you happened to be a Microsoft shareholder.) How in the world, then, she marvels, is it not clear to everyone that what we're witness to is the Asians dashing for the dollar exits? But, of course, no one wants to say so; for one thing, it'd be impolite; for another it just might touch off a furious frenzy of dollar selling.

Truth is, China, Japan and Korea have already begun the process of whittling down their enormous hordes of greenbacks by a kind of benign neglect. More specifically, they're not stockpiling dollars with anything like their old zest. Stephanie observes that China, for example, whose total foreign exchange reserves three years ago were 83% dollar-denominated, has shaved that proportion to 68%.

That's by no means all of Stephanie's intriguing macro-micro trading ideas. But, alas, that's all we have room for this week.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 576. Nov 11, 2005 8:56 PM

» Normxxx - The Day of Reckoning

The Day of Reckoning or Ready or Not, Here Comes the Risk Premium

By Jeremy Grantham, Chairman, GMO | November 2005

You Have Nothing to Fear but the Lack of Fear Itself

We are nearing the end of the first year of the Presidential Cycle which, along with year 2, is typically when house cleaning gets done, and moral hazard is reduced. The normal stock market response to this is to struggle, which is exactly what it is doing. Risky assets typically do particularly badly in these first 2 years, before doing very well with the stimulus of year 3. Through May this year, risky stocks were underperforming steadily, especially small cap and volatile stocks. Then, just as we were feeling cocky— since this is what we had predicted and positioned for— there was a vicious rally in everything risky.

This continued the ebb and flow of battle between risk and caution that was described in last quarter’s letter. This time, though, it hurt us badly in the U.S. and left riskier assets ahead of conservative assets for the year. The record of this third quarter rally in risk was impressive, given that it came on top of the already extreme 2003-04 strength in risky assets. Many risk measures in fact have now reached record levels, resulting in probably the lowest risk premium on average recorded in modern times.

Even Mr. Greenspan was shocked and awed. “History,” he said, “cautions that extended periods of low concern about credit risk have been invariably followed by reversal, with an attendant fall in the prices of risky assets.” Well it took him awhile, but mean reversion lives! How embarrassing finally to be on the same side of this argument with the Chairman himself. Since, in my opinion, he produced most of the fuel for this move and threw it on the fire himself, this expressed concern gets him both the Chutzpah Award for 2005 and his fifth consecutive Career Positioning Award. When a more normal risk premium returns, its consequences will be borne by his successor (lucky fellow— it would almost be easier following Jack Meyer at Harvard Management, but not quite). And Greenspan can be the elder statesman who warned him of the risks of a sustained low risk premium.

Let’s Do the Numbers:

Asset Category 15-Yr 15-Yr
(in percentages) Peak Current Low

Emerging Debt Spread* 15.5 2.4 2.4
Junk Bonds Spread* 12.9 3.6 2.4
High Quality Stock Premium
vs. Low Quality** +8 —23 —26

* Emerging Country Debt and Junk Bonds
yields over 10-yr U.S. Treasury yields.
** High quality stocks compared to low
quality on our broadbased value model.

One of the reasons Greenspan was surprised at the risk taking rally was, of course, that he had continued to raise the rates, despite New Orleans, to 3.75 and left the world with the impression that two more raises to 4.25 are in the bag in the next few months. This will leave us for the first time in several years close to ‘normal’ real return at the short-end.

But why the risk premium is so low and, indeed, why does it move around so much in general and what factors move it? We will address this question and hopefully have some partial answers at our conference in November. For the time being, we have a strong hunch that the predominant input is extrapolation. That is to say, today’s conditions, whatever they are, are assumed to be permanent. Today’s much improved financial condition of the emerging countries— for example, in terms of GNP growth and improved reserves, currency strength, modest local inflation, and lack of financial crisis— is assumed to be a permanent condition, despite a long and painful history to the contrary.

Similarly, with junk bonds and equity quality spreads the difference in profitability between high quality companies and low quality has narrowed materially, as it did back in 1980 in the oil crisis. If such a narrowing were indeed to be permanent, it would justify the narrowing in P/E differentials and yield spread that has taken place. It is possible that high quality companies have permanently lost their profitability premium and that the market is right. It is of course far more likely that this ratio ebbs and flows in a largely unpredictable way and that extrapolating the current point, particularly when it is at an extreme, like now, will produce a painfully wrong conclusion.

Everyone agrees that there are extreme imbalances in the U.S. and the global economy, in part due to our extreme lack of savings and associated accumulated personal debt, and our extreme trade deficit, now at 6% of GNP. The bulls believe that all will work out, and certainly so far is so good. The bears believe that sooner or later these imbalances will come home to roost. Historians have to believe that financial conditions, and confidence at all levels, ebb and flow over time and that we have extremely favorable levels of confidence now, despite potential problems. The probable winning bet is not to extrapolate, but to expect a very mean reversal. This shift in the risk premium, back to normal levels, will dominate the ins and outs of investing, I believe, for the next few years.

As always, though, the problem is timing. What can we offer on this topic? First, the first 2 years of the Presidential Cycle are typically very risk averse and on average show poor relative equity markets and very poor returns to risky stocks. Minus 2% real in the first year and minus 4½% real in the second year is the average return since 1964 to the riskiest quarter of the market cap, with risk defined as volatility. (And I don’t mean minus 2% and minus 4% relative to the market. I mean an honest- to-goodness negative absolute return!)

Second, value matters in the first 2 years (unlike year 3), and the market is expensive now with the risky quarter of the market more expensive than the market. The low quality versus high quality spread, after a very strong return to risk in the third quarter, is now close to its lowest point ever.

Third, Greenspan is retiring and his desire to get out intact may have something to do with the unusual speculative strength this year. Moral hazard (or the Greenspan put) plays a critical role in the level of speculation, and this last year for him is more like the fourth and last year of a Presidential Cycle when the overwhelming desire is to coast up to the election and not rock the boat. For Greenspan there is only one quarter left of coasting.

Fourth, short rates are rising and are squeezing the level of comfortable leverage for speculation.

Fifth, profit margins, so critical to sustaining confidence (see our last quarter’s letter), are unsustainably high and exposed to many pressures— oil prices, rising rates, and just the plain increased competition that goes with record margins. These pressures on profit margins suggest to me that they have probably already peaked and will be revised down later, as they were in 1998 and 1999.

This is a long list of problems and leaves me feeling that the period from now to late next fall is very vulnerable to a widening risk premium, with all that portends for equity prices in general and risky assets in particular. Even this fourth quarter looks vulnerable to me, for Greenspan is engaged in a tricky balancing act between encouraging overconfidence (moral hazard) and overtly warning against it. I believe his several warnings will probably tilt the scale too much and indeed rock the boat. Long-term believers in mean reversion like us try to stay in “sooner or later” land, but this long list makes it irresistible to say that the odds of the risk premium widening in the next 12 months are at least 2 to 1 and probably 3 to 1.

Potential for a Downward Spiral in Risky Assets

Today the most accepted definition of risk is volatility. We can all agree that the degree to which a stock or asset class bounces around its long-term trend is an important part of risk. Some of us, though, can agree that it is an incomplete definition as it ignores value and liquidity. The most popular technique for measuring risk is known as VAR, or value at risk. It is used to estimate the probability of portfolio losses based on the analysis of historical price trends and volatilities. But those using VAR will consider two markets having the same volatility as having the same risk, even if one is selling at 8x P/E (1982), and the other at 33x (2000). In real life, the probability and extent of loss has directly varied historically with value, or the price you pay, and it is hard, if not impossible, to imagine that this will not continue. For example, since 1925 if you bought the S&P when it was in the cheapest quintile by price to trailing 10-year earnings and held it for 10 years, you made an average of 10.6% real per year. In the most expensive quintile, you made a measly 0.6%. Statistically it certainly seems that value had a lot to do with the risk of receiving a disappointing return.

The problem with using volatility as a complete measure of risk is exaggerated by the market’s usual tendency to extrapolate present conditions rather than to assume today’s conditions will tend to regress to normal. Thus, extremely low volatility today is seen as predicting that the market will have low risk into the indefinite future. When volatility becomes high, that too will be extrapolated. Using VAR thus results in very large changes in the ‘appropriate’ portfolio as volatility changes. Today, for example, volatility is very low and portfolios that at normal volatility would be considered very risky are now considered acceptable.

The second important missing ingredient in today’s definition of risk is liquidity. The market always demands a big risk premium for illiquidity to reflect the extra cost and delay in changing investment positions quickly and cheaply as data changes. A strong case can be made that the liquidity premium is unreasonably large, e.g., for no institution ever has to be 100% in cash by Thursday afternoon. But in a behavioral world where career risk is important and investors value their ability to stay with the pack, a large liquidity premium exists. In U.S. stocks, for example, the most illiquid quarter of the market by market capitalization has outperformed the broad market by over 1% a year over at least the last 40 years.

From time to time, the market has had liquidity crises in which the need to sell illiquid positions has caused extreme price weakness, which in turn has precipitated more selling. We now exist in a world of a 1 trillion dollar hedge fund industry (without counting their huge leverage) that has risen to at least 25% or 30% of total daily stock trading. Hedge funds are fairly reliably claimed to be more long on less liquid holdings than they are short, since they attempt to benefit from the risk premium. The Long Term Capital crisis was an example of what can happen as a wave of selling illiquid issues snowballs.

VAR runs the risk that illiquidity and volatility can interact. Any major liquidity crisis will show up as a spike in market volatility, causing VAR portfolios to lower their aggregate risk by selling into weakness, creating a dangerous self-reinforcing cycle of a kind that hedge funds are paid to anticipate and exploit.

As if this were not enough, rising interest rates are also involved. Low rates justify more leverage, just as low volatility does. As rates rise, the justifiable level of leverage contracts, and selling of leveraged hedge fund portfolios begins. An equal reduction of long and short portfolios, if hedge funds are long illiquid issues, will then result in less liquid issues underperforming and may start the turtles running down the beach.

High leverage and rising rates, plus rising volatility and VAR, combined with a liquidity premium and asymmetrically illiquid hedge fund portfolios is a heady brew, and a dangerous one. The usual brake on a market decline is value: as stocks and assets decline, they become cheaper and hence more attractive. In our new world that seemingly ignores value as a risk component, falling assets are more likely to merely become more volatile and hence be seen as riskier and less attractive.

Success and Failure of Recent Calls

We warned this year of a bearish, but not disastrous, outlook for U.S. equities and at zero real return for 9 months, this looks close enough. We positioned for outperformance of the stocks of foreign developed countries, and they are ahead of the S&P by 6% in dollar terms despite a decline in their weighted currency of just over 10%. In small cap we largely went to neutral, and they have drawn with large cap this year after 5 years of consecutive crushing wins. We also warned of problems with old fashioned value and reduced our value bets in U.S. Core, for example, to a level where we now have a slight overweight in growth stocks for the first year since 1991. Year-to-date, value has modestly won in the U.S. and drawn internationally. Our biggest bet was overweighting emerging market equities. We argued that a big rally was probable for emerging if the U.S. market merely hung in; the emerging index is 22% ahead of the S&P year-to-date. Our big mistake, of course, was warning of a weakness in speculative, low quality issues.

Update on the Real Estate Market

In April the quarterly letter covered the near-global land bubble. Using Australia and the U.K. as leading indicators, I suggested that the U.S. probably had at least another year, but that some of the bubbliest markets, like Boston, should peak out sooner, just as London and Sydney had led other cities. It is now clear that several U.S. cities that had appreciated the most on the way up are now flat to down on a rolling month-to-month basis. And more cities are showing rising inventories of unsold houses. My best guess now (6 months later), is that average U.S. house prices will peak after 6 months or so. For the record, as U.K. house prices flattened, growth in consumption did indeed drop rapidly from almost +10% a year ago towards zero. There was a similar but less dramatic effect in Australia. The odds are that this cooling effect will kick in sometime next year for the U.S. All the more reason to be careful.

“Double Double; Oil & Trouble”*

On the bright side, there is indeed almost endless potential supply of gasoline from coal, oil shale, and tar sands, and all from politically safe regions, except for those tricky Canadians. The problem is that it would take about 7 years for a new incremental barrel to flow and 20 to 30 years to get a serious job done even with a full court press. Even with the uncertainties of long-term oil prices, though, enormous courage along with enormous capital will be required— in the hundreds of billions— to tap these new sources. It will be hard to commit billions into a 7-year horizon knowing you need, say, $42 per barrel to make a return. Even if today’s oil is $65, you know it may be half of that or less in 7 years.

As for environmental issues— fuhged aboud it— they will be massive. We will all be lucky if enough of these new sources can be brought in at under $50 a barrel. In the meantime, traditional sources of supply will no doubt cause spikes and troughs in the price. A good guess, based on history, would be that the price range will be far wider than we care to think about: say $20 to $100 a barrel. And, as usual, horribly unpredictable!

It’s an Ill Wind

Immediately after 9/11 I wrote in a quarterly letter that it would have a negligible immediate economic cost in terms of the GNP, and probably even a positive longer term effect as it would encourage stimulus. This prediction was a good call on the economic fallout. What it badly missed was the much more important shift in political fortunes: without 9/11, President Bush would probably not have been re-elected. His re-election had important effects for the economy, the financial system (notably including the level of government debt), and the stock market.

Hurricane Katrina will have much more short-term economic effect than 9/11, particularly in the energy area. Its total economic effect in a year will be negligible once again. Its political effect, in contrast, runs a real chance, once again, of being immense. New Orleans could well prove to be a political watershed event that could change the relative strength of the two parties for years, including the outcome of the next presidential election. If that were to be the case, then the economic consequences of Katrina could indeed be immense and long lasting.

Forecasts

I’ve already heavily committed myself to an anti-market, anti-speculation forecast. Beyond that, the biggest question is: can emerging equities at least hang in if we have a general increase in the risk premium? It is probably wishful thinking, but I believe their fundamentals and relative value are so advantageous that they have a 50/50 shot at outperforming the S&P in anything up to a 10% decline for the index. I still believe that if the market surprises me and goes up, emerging equities will bury everything once again.

Summary of Advice

Once again, but with even more enthusiasm: reduce risk taking everywhere and do it now.

______________

* With apologies to Macbeth’s prescient witches.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx