MarketVVizard's Market Thoughts

Top 520. Nov 21, 2003 9:19 AM

» Normxxx - Re: How would you buy/invest in Natural Gas?

In response to message posted by Kirk:

The current natural gas shortage is largely due to the 'unexpected' shift of utilities to 'clean' NG and the lack of exploration/drilling in North America during recent years when the prices for oil fell below $20pb. Also, we have not (yet) developed the facilities to import NG (except from Canada or Mexico) in large quantities. Everyone is now falling all over each other to 'accommodate.'

I suspect that there will be plenty of NG by next winter (2004/5) and probably a glut by summer of 2005. I may be a little early in my estimates, but the principle will still apply. That means that the time to load up on NG stocks is when their prices drop precipitously in anticipation of, or during the actual occurrence of, an NG glut.

Of course, this scenerio also needs to account for (but does not) the price of oil (since many new facilities will be able to switch back and forth). And the price of oil depends on the geopolitical situation, Russia's and OPEC's levels of export, and China's and the rest of the world's consumption needs.

You may want to dabble in a few domestic or foreign NG stocks, in case there is no glut. Foreign NG stocks are a gamble on the speedy construction of large NG importation facilities. They are also a gamble on there being no major 'accident' (like 3-mile island) which could effectively cause the public to ban such facilities (like the nuclear power industry). Otherwise, it is a little late in the game to invest in NG stocks.

-- posted by Normxxx

Top 521. Nov 21, 2003 11:16 AM

» MarketVVizard - Re: Re: Mortgages

In response to message posted by Jas_Jain:

-- Every idiot I know, and every Crook on financial TV I follow, is bearish on bonds and bullish on inflation. Draw your own concusions. Jas

I gave up watching financial TV. Just curious though, what TV crooks & idiots are bearish on bonds and bullish on inflation? My spidey sense tells me the typical schmuck analyst is only bearish on bonds because they think the stock market is going higher (they think money comes out of bonds and into stocks). And from what I'm hearing, they are actually using low inflation and low inflation expectations as a reason to be bullish about the economy (how many times have you heard them talking about how the Fed is going to keep rates down because there is no inflation)?

I guess our media eyes & ears are picking up very different signals... what do others think?

I don't see how you can even believe there WON'T be inflation. We have the most incredible deficits of all time right now. Dollar has already plunged, and commodities have moved substantially higher. Inflation is already here, it just hasn't shown up in the CPI and treasuries yet.

-- posted by MarketVVizard

Top 522. Nov 21, 2003 1:40 PM

» Jas_Jain - Re: Re: Re: Mortgages

In response to message posted by MarketVVizard:

--

"I gave up watching financial TV. Just curious though, what TV crooks & idiots are bearish on bonds and bullish on inflation?"

What part of "every" you don't understand, VViz? NOT a single person on the three financial network has been bullish on bonds or expects deflation. Has anyone heard otherwise?

"And from what I'm hearing, they are actually using low inflation and low inflation expectations as a reason to be bullish about the economy (how many times have you heard them talking about how the Fed is going to keep rates down because there is no inflation)?"

Yeah, low inflation is NOT the same as 0% or negative CPI change. They mean 1-3% inflation, which would be good for corporate profits, and hence stocks, everything else being equal.

"I guess our media eyes & ears are picking up very different signals... what do others think?"

You just said that you stopped watching fn TV.

"I don't see how you can even believe there WON'T be inflation."

Yeah, I heard that blind people have trouble seeing.

"We have the most incredible deficits of all time right now."

I am assuming that you are talking about the fed govt deficits. Have you heard of Japan? Or, do you think that Japan is on another planet? Japan has more than twice the deficit as a % of GDP.

"Dollar has already plunged, and commodities have moved substantially higher."

And where were you when commodities were falling for some 21 years? On Mars?

"Inflation is already here, it just hasn't shown up in the CPI and treasuries yet."

And where I live, food, clothing, all kinds of manufactured products, etc., are cheaper if you shop responsibly.

Let me repeat: Every idiot I know expects inflation. Do you know someone who is worried about deflation? True or not? Or, do you know no idiots?

Jas

-- posted by Jas_Jain

Top 523. Nov 21, 2003 2:08 PM

» MarketVVizard - Hussman on markets, interest rates, inflation

November 17, 2003
Recipe for Trouble

John P. Hussman, Ph.D.
All rights reserved and actively enforced.

The holidays are fast approaching. That means one thing, of course. Baked goods. With the exception of those peanut butter cookies with the Hershey's kisses that can be lifted out on their own, baked goods are pretty much all or nothing – accept every ingredient, or walk away. This is why fruit cakes have a bad reputation. There's usually something not to like.

The financial markets are more flexible. You can buy the fruit cake and hedge away the fruit, so to speak. You can buy the cookie and leverage up the chocolate chips. Still, the ability to select some ingredients and hedge away others – and do it well – is not universal. Many investors simply take the piece of cake that's offered to them and swallow it whole.

Those investors had better understand what's baked in the cake.

At present, three main ingredients come to mind: 1) unusually high valuations, 2) unsustainably low short-term interest rates, and 3) a mammoth current account deficit.

Long-term total returns of 4-8% on stocks might just be a tad optimistic

First, valuations. The S&P 500 Index currently trades at 20 times prior peak earnings. Except for the 2000 bubble peak, prior market cycles have only reached this level at the 1929, 1972 and 1987 market extremes. We know that measured from peak-to-peak, S&P 500 earnings have never grown significantly faster than 6% annually (even during the 1990's). We also know that the impact of favorable productivity improvement on long-term growth is measured in tenths of one percent (see last week's update for more on this). As a result, we can form very good estimates of the long-term returns priced into stocks here.

If the price-to-peak earnings multiple is held constant over the long run, stocks by definition must grow at the same rate as peak-earnings, or about 6% annually. Add in a 1.7% dividend yield, and stocks would deliver a long-term total return of about 7.7% from current levels if valuations were to remain at current levels indefinitely. This is the relevant estimate of long-term returns for investors who believe (contrary to all finance theory) that present interest rate and inflation levels justify current stock valuations. Even then, this estimate assumes that current valuations will be sustained indefinitely.

In my view, such optimism, if you can call 7.7% long-term returns optimism, is misplaced, because it ignores the concept of peak-to-trough. Specifically, once stocks have reached extremely high levels of valuation, there has always been some point, anywhere from 4-17 years later, when stocks subsequently reached moderate or low levels of valuation. Between those two valuation points, stock returns have been abysmal.

For example, suppose that a full decade from today, stocks do nothing but touch their historical average of 14 times peak earnings. Do the math. If earnings grow at a rate of 6% annually (and again, there is no historical exception demonstrating faster growth over long-periods of time), the annual capital gain on stocks over the coming decade would be [(14/20)^(1/10) x (1.06) – 1 = ] 2.3% annually. Add in a dividend yield of about 1.7% and the total return on stocks would be about 4% annually over the next 10 years. Given that most historical bear market lows have occurred at less than 9 times prior peak earnings (the modest 1990 low reached 11 times peak earnings), a 4% total return expectation might just be a tad optimistic.

In short, at current valuations, unsatisfactory long-term returns are baked in the cake. This doesn't speak to short-term returns, which are driven largely by investor's preferences to take risk (what we attempt to measure through market action). But investors taking market risk here should understand that they are taking risk on the basis of speculative merit, not investment merit.

Shorty gets a lift

The second unpleasant ingredient baked into the cake here is an inevitable increase in short-term interest rates from current levels.

Investors have a lot of beliefs about interest rate behavior. One is that an increase in long-term interest rates is a signal of coming economic strength. As it happens, long-term yields invariably fall in the months preceding an economic expansion, and typically remain well behaved as the economy enters a new recovery. Similarly, inflation rates typically decline during the early phase of an economic recovery. There is, however, one remarkably strong tendency in the data, and that is for real short-term interest rates to surge relatively early in an economic expansion.

On this front, the current recovery has been markedly different. Inflation rates have behaved normally, with the recent pickup in producer inflation being typical for a recovery that is now two years old, but real interest rates have remained negative at the short end of the yield curve. Much of this reflects foreign purchases of U.S. Treasuries, particularly by Japan and China, in attempt to support the value of the U.S. dollar and keep their own currencies from appreciating. With growing pressure on these countries to abandon this policy, the coming upward adjustment in short-term interest rates could be very abrupt.

As I note in Freight Trains and Steep Curves, the U.S. financial system has become disturbingly dependent on continued low short-term yields. Both corporate and mortgage debt are largely tied to low short-term yields. An upward spike would create pressure on both credit risks and the housing market. Look, if Ford bonds can be downgraded to BBB- despite auto sales that have never been higher, the outlook for corporate defaults is hardly sunny.

Moreover, the resilient behavior of Treasury bonds after last summer's slide is also the result of the unusually steep yield curve that encourages “carry” trades (borrow at low short-term yields, invest at high long-term yields). Upward pressure on short-term yields would create significant pressure to unwind these trades. Though my inclination is to believe that higher short-term yields would create enough economic difficulty to keep long-term yields restrained, there could be enough pressure on Treasury bonds from an unwinding of these carry trades to drive long-term yields higher anyway. In any event, numerous economic and financial risks are tied to the level of short-term interest rates. Unfortunately, an increase in short-term interest rates is also baked in the cake.

The virtuous trade cycle falls away

Finally, I've written enough about the gaping U.S. current account deficit that its mere mention should serve as a reminder of its consequences: an uninspiring outlook for U.S. domestic investment, a probable slowing of import growth (and with it, measured U.S. productivity growth), and upward pressure on inflation when the deficit narrows - a mirror image of the downward pressure on inflation we enjoyed while the deficit was expanding.

In short, some features of the current economic and financial environment might be affected by various developments and policies. Other features are simply baked into the cake. For buy-and-hold investors intent on choking down whatever is placed on the plate in front of them, this is just unfortunate. There are important problems and challenges in the current environment. Our willingness to take a certain amount of market risk based on speculative merit should not encourage investors to ignore these realities.

Market Climate

As of last week, the Market Climate for stocks remained characterized by unusually unfavorable valuations but still moderately favorable market action. This indicates that although stocks appear priced to deliver very disappointing long-term returns, investors still seem willing to accept market risk, at least at present.

For our part, we increased our hedging a bit last week. In the Strategic Growth Fund, slightly more than 55% of our stock holdings are now hedged against the impact of market fluctuations. Those stocks are held based on their own characteristics of value and market action, so we are very willing to hold them even in negative conditions, provided we can remove the impact of market fluctuations if necessary. For now, we're comfortable accepting at least some of those fluctuations. If and when we observe deteriorations in market action (even fairly subtle ones) suggesting that investors have become skittish about market risk, we would expect to shift to a fully-hedged investment position.

In short, we own a diversified portfolio of individual stocks that we believe have merit based on their own valuations. We're also accepting a moderate exposure to market fluctuations, but are well aware that this is based on speculative merit alone.

In bonds, the Market Climate for bonds shifted importantly last week. As a result of last week's advance in bond prices, combined with deteriorations such as a jump in producer price inflation, the Market Climate for bonds is now characterized by unfavorable valuations, but still tenuously favorable market action on our measures. As a result, we sold a substantial portion of our long-term Treasury holdings late Friday afternoon. At present, the Strategic Total Return Fund has a portfolio duration of about 4.5 years, meaning that a 1% (100 basis point) shift in interest rates would be expected to affect the Fund by approximately 4.5%.

As usual, shifts in our investment positions should not be construed as forecasts of market direction. Our approach is straightforward – we take risks in proportion to the average return per unit of risk associated with present, observable conditions. Specifically, we are not making any sort of a “bearish call” on bonds here. Very simply, the yield on bonds has declined at the same time that the probable risk has increased. This reduces the ratio of expected return to risk, and we have reduced our position in response. No forecast is embodied in this, except the obvious fact that a lower yield to maturity is a certain forecast of lower long-term returns from bonds.

-- posted by MarketVVizard

Top 524. Nov 21, 2003 2:14 PM

» Normxxx - Re: Re: Re: Mortgages

In response to message posted by MarketVVizard:

I just bought a passle of LT bonds as a play on interest rates coming down, near term. Long term, I guess I agree with the WS gang that interest rates have nowhere to go but up. I think the jury is still out on the kind of 'flation we are going to have. We may try a new variation of blended deflation/inflation (deflation in Chinese products, inflation in everything else!)

I have this feeling that the economy will do well, at least into 2005, but I think the stock market will shortly stop tracking the economy.

-- posted by Normxxx

Top 525. Nov 21, 2003 2:20 PM

» Kirk - Re: Hussman on markets, interest rates, inflation

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In response to message posted by MarketVVizard:

I guess he is saying he is short 50% SPY to remove 50% of the market risk from the stock he hopes will beat the market overall.

It is not a bad idea... as it avoids capital gains. As a long, it is good to know folks like him are out of the market and not calling for folks to be 100% invested.

-- posted by Kirk

Top 526. Nov 21, 2003 2:22 PM

» MarketVVizard - Re: Re: Re: Re: Mortgages

In response to message posted by Jas_Jain:

"Let me repeat: Every idiot I know expects inflation. Do you know someone who is worried about deflation? True or not? Or, do you know no idiots?"

Jaz why are you so pissed off?

At any rate, you, Precter, and Martin Weiss are the only ones I know worrying about deflation smile By the way, are "eyes" still used when reading or are they only for TV these days?

I'm not sure there is any value to "contrarianizing" views on inflation anyway, most people expect inflation because that's pretty much the law of a fiat currency backed by nothing (see Greenspan's GOLD AND ECONOMIC FREEDOM).

But as you said, we just had 20 years of commodity bear market -- where were you? It's over. Now they are burning the dollar. Compare Japan's current account surplus to our deficit. Get it?

I know, I know, I shouldn't bother responding...

"...there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

...Deficit spending is simply a scheme for the confiscation of wealth. "

-Sir Alan

-- posted by MarketVVizard

Top 527. Nov 21, 2003 2:36 PM

» Jas_Jain - Re: Re: Re: Re: Mortgages

In response to message posted by Normxxx:

"I just bought a passle of LT bonds as a play on interest rates coming down, near term."

Good for you, except that "near term" LT bonds are as likely to go down as up.

"Long term, I guess I agree with the WS gang that interest rates have nowhere to go but up."

How long is your "long term?" Ten years or two years. In the latter case, rates are likely to go down.

"I have this feeling that the economy will do well, at least into 2005.."

Let us hope that you don't invest based on your feelings. This economy is teetering on the brink of disaster any time. I say that the 2004H1 will very weak and 2004H2 might usher in recession. We shall see how that pans out.

Jas

-- posted by Jas_Jain

Top 528. Nov 21, 2003 2:38 PM

» Kirk - Re: Re: Re: Re: Re: Mortgages

In response to message posted by MarketVVizard:

Remember that Tempelton and Sorros are pretty much Europeans who have a Socialist leaning. They hate Bush and it colors their judgement.

"Sir John" loves his bloody England so much he left the country to avoid paying his "fair share" back in taxes.

I havn't pissed Jas off in awhile so I'll say I have more respect and give more weight to what a John Chambers (Cisco CEO who gives much back to society) or Jim Morgan (Ex AMAT CEO whose giving in the valley is legendary) or some of the Intel founders might have to say.

-- posted by Kirk