MarketVVizard's Market Thoughts

» MarketVVizard - Roach

Stephen Roach (New York)

The world economy, as I see it, remains very much in a state of fundamental disequilibrium. A US-centric global growth dynamic has given rise to extraordinary external imbalances around the world. America, the world’s unquestioned growth engine, is facing unprecedented imbalances of its own; the national saving rate, current account, Federal budget deficit, and private sector debt ratios are all at historical extremes. And an increasingly powerful global labor arbitrage continues to keep high-wage developed economies mired in jobless recoveries. The result is a unique confluence of tensions that have left the global economy in a state of heightened instability. The venting of those tensions could well be the main event in world financial markets in 2004.

The case for global rebalancing has been an overarching theme of our macro call over the past year. The urgency of such a realignment in the mix of world economic growth has never been more compelling. Over the 1995–2002 period, the United States accounted for 96% of the cumulative increase in world GDP — basically three times its 32% share in the global economy. This was, by far, the most lopsided strain of global economic growth that has ever occurred in the modern-day post-World War II era. Two sets of forces have been at work in creating this unsustainable condition — a US economy that has been living beyond its means as those means are delineated by domestic income generation, and a non-US world that is either unwilling or unable to stimulate domestic demand. As a result, an unprecedented disparity has opened up between those nations with current-account deficits (the United States) and those with surpluses (Asia and, to a lesser extent, Europe). Such an unbalanced global growth paradigm is not sustainable, in my view. The debate is over the terms under which the coming rebalancing occurs.

The macro fix for a lopsided economy is very simple — it mainly entails a shift in relative prices. For a US-centric global economy, that implies a realignment in the dollar — the world’s most important relative price. In that vein, a weaker dollar needs to be seen as the principal means by which the tensions of an unbalanced global economy are vented. The broadest trade-weighted index of the US dollar is currently down about 11% in real terms over the past 23 months. History tells us that global rebalancing will undoubtedly require a good deal more dollar depreciation — perhaps twice as much as that which has already occurred. That poses the important question as to who bears the brunt of the dollar’s adjustment. The Europeans and Japanese believe they have suffered enough and are pointing the finger at others — mainly China — to pick up the slack. US politicians are also sympathetic to this line of reasoning. Consequently, the role that China plays in venting global imbalances is also likely to be a key issue in the year ahead. For what it’s worth, I think this debate overlooks a critical consideration: Europe and Japan are wealthy countries that have dragged their feet endlessly on reforms, whereas China is still a very poor country that has been aggressive in embracing reforms. Why should China be called on to compensate for adjustments that Europe and Japan are unwilling to undertake?

America must also bear its fair share in the coming global rebalancing. And the problem is that the US economy is not in the best shape to cope with the requisite adjustments. That’s because it has a record low saving rate, sharply elevated debt burdens, and massive trade and current-account deficits. Nor is growth alone likely to be a panacea for America’s shaky fundamentals. In fact, there are good reasons to worry that another surge of US economic growth could well exacerbate many of these imbalances The pivotal tension point in this regard is America’s anemic net national saving rate — the combined saving of households, businesses, and the government sector adjusted for depreciation. This key gauge measures the saving that is left over to fund the net expansion of productive capacity — the sustenance of any economy’s long-term growth potential. Unfortunately, in the case of the United States, there isn’t any — America’s net national saving rate fell to a record low of 0.6% of GNP in the first three quarters of 2003. To the extent that domestic income generation continues to lag — precisely the outcome in America’s lingering jobless recovery — another burst of private consumption, such as that now under way in the second half of 2004, can only push saving lower. That, in turn, puts greater pressure on foreign saving to fill the void — giving rise to increased trade deficits and private sector indebtedness.

Such an outcome only heightens the tension already bearing down on the US economy. A lasting recovery cannot be built on a foundation of ever-falling saving rates, ever-widening current-account and trade deficits, and ever-rising debt burdens. These tensions must also be vented if America’s nascent upturn is to make the transition to sustainable expansion. The bond market, in my opinion, offers the principal means by which this venting can occur. And the outlook for bonds is not good. A confluence of three bearish forces are at work — the Fed’s eventual exit strategy from a 1% federal funds rate, a weaker dollar, and America’s fiscal train wreck. Ironically, under these circumstances, you don’t have to be worried about inflation to be negative on bonds. At the same time, if financial markets ever did get a whiff of inflation, a real rout in bonds might ensue. Higher long-term real interest rates do not temper all the imbalances that are on America’s plate. But they could help — possibly a lot. The key impact would be a reduction in the growth of the credit-sensitive segments of aggregate demand. That would enable a long overdue rebuilding of domestic saving, which would then act to reduce America’s current-account and trade deficits. A lower pace of consumption growth would also go hand in hand with a reduced expansion of indebtedness. A tough bond market may be just the medicine an unbalanced US economy needs.

The global labor arbitrage is a third major source of tension bearing down on today’s global economy. The accelerated pace of replacing high-wage jobs in the developed world with low-wage workers in the developing world reflects the interplay of three mega-forces — the first being the maturation of outsourcing platforms in goods (i.e., China) and services (i.e., India) on a scale and with scope never before seen. The second factor at work is the Internet — providing ubiquitous real-time connectivity between offshore outsourcing platforms and corporate headquarters. In goods production, the Internet forever changes the efficiency of supply-chain management. But for services, the Internet is a transforming event — effectively converting the once non-tradable sector into a tradable global marketplace. With the click of a mouse, the knowledge content of white-collar workers can now be delivered anywhere in the world on a near-real time basis. The unrelenting push for cost control in a no-pricing-leverage world is the third leg to the stool of the global labor arbitrage. Such environmental imperatives only heighten the incentives for IT-enabled “offshoring.”

While the global labor arbitrage continues to push costs and pricing lower, it does have its dark side. Significantly, it continues to put pressure on job creation and income generation in the high-wage developed world. Largely as a result, consumers in the high-wage developed world end up defending their lifestyles by drawing increasingly on alternative sources of purchasing power, such as asset-driven wealth effects, increased indebtedness, and tax cuts. In my view, vigorous consumption cannot be sustained in the context of the profound income leakage that stems from the global labor arbitrage. That underscores yet another source of disequilibrium that must be vented. In this instance, the venting appears to be exacerbating the pressures bearing down on an unbalanced world. That’s because it has taken the form of heightened trade frictions and growing protectionist risks — developments that only intensify pressures on the dollar and the US bond market.

The means by which this confluence of tensions gets vented will likely be key for global economy and world financial markets in 2004. There are two conceivable paths to resolution, in my view — the benign soft landing and the ever-treacherous hard landing. Macro is not good at making the distinction between these two modes of adjustment. Instead, it basically identifies the forces that have given rise to disequilibrium and then depicts the possible adjustments that must take place to reestablish a new equilibrium. As always, the outcome is more dependent on exogenous shocks. In the current instance, the shocks that worry me the most would be those that might shake foreign confidence in dollar-denominated assets; intensified protectionist actions from Washington would be especially disconcerting in that regard. Equally worrisome is the magnitude of the current state of disequilibrium — and the distinct likelihood that these unprecedented imbalances can only be vented by big movements in asset prices. My deepest fear is that the longer the venting of these tensions is deferred, the larger the ultimate adjustments and the greater the chances of a hard landing.

-- posted by MarketVVizard

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» MarketVVizard - Sold some covered puts on NVLS

right at end of day. Expire in 2 weeks. Reaction to "good news" today was quite bearish. Tax selling leading into Jan 15th. I expect heavy selling leading into April.

-- posted by MarketVVizard

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» Normxxx - Market Wizzard: For Your Comment

<img src="http://home.earthlink.net/~intelligentbe...">

The inflation adjusted chart shows the true nature of the U.S. stock market. Note that dividends are excluded, so the chart only shows capital gains. The dividend yield of the S&P is running under 2%. The long term trend line in green shows an average return of 1.6% per year. If you factor in the long term 15% capital gains tax, the return is even worse. Since capital gains tax is not adjusted for inflation, the average tax must be based on the 5.1% trend of the non inflation adjusted chart, so 15% of 5.1% is 0.8% tax. Therefore, your 1.6% return is reduced to 0.8% after taxes. The Wall Street shills do not want you to know that this meager amount of capital gains is all you should logically expect from a long term general stock market investment.

The Dow has historically moved within well defined channel. The boundaries of the channel have been touched only 4 times since 1910. The top of the channel was last touched in 2000.

They say "the market always goes up in the long term," but at an average return of 1.6% per year, it can take many years to recover from a large decline. The peak in 1929 was not ultimately exceeded until 1992 [although it briefly topped it for several periods beginning in 1958]. When the market touched the bottom of the channel in 1982, its value was about equal to the value at the beginning of the chart in 1910.

Most bubbles eventually correct back to where they began. The bubble that began in 1922 gave back all its gains by 1933, and the bull market that started in 1949 gave back almost everything by 1982. Looking at the bubble that ended in 2000, the Dow will probably correct back to its 1988 level of 3000. If you are optimistic, you could consider that the bubble began in 1995, and the Dow will only correct back to 4500. If you are pessimistic, the Dow could eventually hit the bottom of the channel at about 2200.

Borrowed from 'Fred's Intelligent Bear Site.'   full text

-- posted by Normxxx

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» MarketVVizard - Re: Market Wizzard: For Your Comment

In response to message posted by Normxxx:

I wouldn't be able to confirm his chart without serious analysis of his data but its pretty obvious that the public has a disturbingly skewed expectation of future returns from the stock market when you consider historical returns especially as they relate to valuation. There is a hilarious article in this week's Baron's (believe me, it is NOT worth posting) from a guy trying to claim that the market is extremely undervalued right now (based of course on, you guessed it, low interest rates). This nonsense has been debunked in detail by Hussman in the past.

Also from Barron's, in the newsletter survey: Story about a conversation at a recent reunion. The baby boomer he was talking to admitted taking a beating from 2000-2002 but was still invested in tech stocks because he felt it was the only hope he had of ever achieving his retirement goals. This seems typical to me. I think bullishness and complacency are peaking again. Speculation as measured by bulletin board trading volume and margin debt is near or above its 2000 highs.

It seems like too many people are expecting the bear to return in 2005. Maybe it will happen in 2004 instead. Perhaps Bush pulled out all the stops a little too early. Time will tell. Perhaps Bush already has all the momentum he needs to win regardless of what happens in '04. Dean is supposedly still the front runner but he has been getting hammered recently even by Democrats and liberal media sources. I just did a quick google and I see recent articles like this:

The Howard Dean implosion
By Rachel Marsden
Published 1/3/2004 4:31 PM
If John McCain called his 2000 presidential campaign the "Straight Talk Express," then Howard Dean should be coining his the "Straight-Off-A-Cliff Express."

If they get desperate enough, they might force Hillary into the game...

-- posted by MarketVVizard

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» MarketVVizard - Latest Hussman

Note: I bolded a few things I felt were particularly noteworthy. I just posted about many of these observations yesterday. I'm glad Hussman lambasted the Barron's piece I mentioned. It is becoming more and more clear that we are approaching a significant turning point in my opinion...

January 5, 2004
A Lemon With a Nice Paint Job Is Still a Lemon

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

Over the years, I've emphasized the fact that fundamentals don't necessarily matter over the short-term, but they invariably shape what happens over the long-term. Despite the current excitement in the stock market and the economy, the simple reality is that stocks remain priced to deliver unsatisfactory long-term returns, and the combination of low savings and high debt burdens largely ensures that consumption and investment growth is likely to fall far short of prior recoveries, despite short-term heat from tax rebates and mortgage refinancings. Short-term growth does not lift long-term constraints – it simply defies them for a while.

Presently, there's no particular reason why the current speculative tone in the markets and the economy cannot be extended even further. But it is very likely that any further gains that do emerge will ultimately be surrendered. We're not nimble enough to pinpoint major turns in the markets, and we know it. We respond to the conditions that we observe at each point in time. Accordingly, we've already partially hedged our exposure to market fluctuations, though we would still expect to benefit from further gains in the stock market if they emerge.

Advisory bullishness and insider bearishness remain extreme

Investor's Intelligence reports that “sentiment readings are the worst since 1987 for advisors, and now just below the worst ever for insiders. Insiders are now selling just under seven shares for every share bought.” Investment advisory bullishness has been above 50% and bearishness below 25% for thirty-five consecutive weeks. In 1987, bullishness was above 50% for twenty-three weeks, and even those were not consecutive. The percentage of industry groups in uptrends is an extremely overbought 92.8%.

That strong uniformity of industry uptrends confirms what we observe from our own measures of market action, and is an indication that investors remain willing, for now, to take speculative risk. This speculative merit - alone - is why we continue to hold a generally positive (though moderate) exposure to market risk. However, given that market action is also extremely overbought, we also hold a small “contingent” position in put options (a fraction of 1% of assets) sufficient to hedge another 20-25% of our market exposure in the event of an abrupt decline.

In short, the market continues to have a favorable, but increasingly precarious speculative tone.

“People are most credulous when they are most happy” – Walter Bagehot

On the valuation front, one of the classic signals of an emergent bubble is the appearance of new measures of valuation to justify the elevated prices. John Kenneth Galbraith noted this phenomenon decades ago in his book The Great Crash 1929: “It was still necessary to reassure those who required some tie, however tenuous, to reality. This process of reassurance eventually achieved the status of a profession. However, the time had come, as in all periods of speculation, when men sought not to be persuaded by the reality of things but to find excuses for escaping into the new world of fantasy.” We saw this during the late 1990's in the form of valuation measures based on “hits” and “eyeballs,” Harry Dent's demographic models, and incredible contortions of finance theory like Glassman and Hassett's Dow 36,000.

Not to be outdone, the recent advance has engendered a new fantasy valuation approach from the latest of Arthur Laffer's liquor-soaked cocktail napkins, dutifully featured this week in Barron's. Laffer reports that after calculating the S&P 500 P/E ratio using an earnings measure that isn't actually based on S&P 500 earnings, adjusting that P/E using interest rates of a far shorter duration than are relevant for pricing stocks, and modifying that adjusted P/E with numerous ad-hoc assumptions about tax impact, it turns out that the actual P/E ratio on the S&P 500 is ostensibly 3.3 (three point three - that's not a typo). Notably, Laffer's cartoonish P/E ratio was already below-average at the year 2000 bubble peak, which is a nice thing to know when you're about to lose half your money.

As Glassman and Hassett argued with a straight face, if earnings were dividends, and growth needed no investment, and stocks were bonds, and risk was safety, the Dow's P/E could be 100. To seriously entertain valuation theories like these, or even variants of them, requires the willingness to make endless substitutions that interchange fact with fiction. To any serious analyst of the markets, the entertainment value in doing this runs out very quickly.

Rich valuations

On the basis of price-to-peak-earnings, the S&P 500 now trades at a multiple of 21, which is higher than the final peaks of 1929, 1972 and 1987. Moreover, those prior peak earnings (achieved in 2000) were on the basis of unusually strong profit margins and return on equity. In other words, those earnings were out-of-line with revenues and book values (not to mention dividends) observed at the same point. On the basis of a wide variety of fundamentals - the most relevant to us always being linked to the generation of free cash flow - the market has been more richly valued during only one other span of history, which was the approach and early decline from its bubble peak in 2000.

Reported cash flow has certainly picked up in recent months, but I remain skeptical of the source. Charles Mulford, who oversees the Financial Analysis Lab at Georgia Tech agrees: “At least some of the recent improvement in cash flow is from liquidating the balance sheet; it is not earnings produced. That kind of growth is not sustainable.”

Market Climate

This is not to say that stocks must decline over the short run. In stocks, the Market Climate remains characterized by unusually unfavorable valuations yet still moderately favorable market action. It is essential to understand that regardless of overvaluation or overbought conditions, there is no hard or natural limit to investors' speculative impulses. You can't stand in front of investors and say, “no, that's enough, you're truly insane, really, and it's going to end badly, so that's enough.” The only thing you can do is to carefully monitor the strength of those speculative impulses as they are revealed through the quality of market action, and to allow for the possibility (though not the probability or expectation) that this speculation might end abruptly. Having done this, we remain comfortable being about 50% hedged against market fluctuations in the Strategic Growth Fund, while adding a tiny “contingent” put option position amounting to less than 1% of assets.

In bonds, the Market Climate remains characterized by moderately unfavorable valuations and moderately unfavorable market action, holding us to a short-duration stance of less than 2 years (so a 1% or 100 basis point move in interest rates would be expected to impact the value of the Fund by less than 2% on account of bond price fluctuations). In addition to short-dated Treasury securities, which account for an appropriate (but not typical) share of nearly half of the Strategic Total Return Fund, we continue to hold a variety of alternatives to straight bonds, including Treasury Inflation Protected Securities and utility stocks. We also hold modest positions in foreign government notes and precious metals shares, though these positions are the most subject to change from time to time. In any event, the potential for upward pressure on interest rates is substantial here, and a short-duration position is precisely what the Market Climate in bonds demands.

The economy – burning lighter fluid, but still no bed of hot coals

On the economic front, it's clear that the fourth quarter will show strong GDP growth, which was predictable on the basis of inventory rebuilding. The real question, given that stock prices have thoroughly discounted a strong economic boom, is whether recent growth is sustainable at the widely projected 4-5% rate for the year ahead (we don't rely on forecasts like that, but for what they're worth, our estimates come in closer to 2.5% real GDP growth for 2004).

The always thought-provoking analysts at Bridgewater note that even the growth we've seen in recent months has been largely driven by last summer's tax rebates:

“Spending has moved with after-tax income, but to a lesser degree. The fact that spending rose less than after-tax income in July and August implies that consumers did not spend all of their refund checks (we estimate that they spent roughly 60% of the checks then). We also see this in the higher than normal savings rate in those months. But in the past couple of months the savings rate has been lower than normal, implying that consumers are still spending some of their tax cuts and tax refunds, providing a boost to spending. In other words, the tax refund impact has not yet cleared the system… It is still important to keep in mind that this expansion is very unlikely to be as strong or as long as the one in the 1990's which was driven in large part by a 4% decrease in the savings rate (it is more likely that the savings rate will move in the opposite direction [here]).”

Bridgewater also observes “corporate borrowing has yet to turn around. Typically borrowing leads investment, but so far companies are financing their investment from profits. With [credit] spreads at five year lows and not much higher than before the Asian/Russian crisis, it would be a bad sign if corporate borrowing doesn't pick up in the first couple of quarters of 2004. Commercial loan growth remains negative, as it has been for two and a half years. And commercial paper issuance has also dipped into contraction after improving earlier in the year.”

As I've noted before, the weak level of domestic savings and the gaping current account deficit all but ensure that neither consumption nor gross domestic investment will grow at rates anything comparable to those of past expansions. What we're seeing right now in the GDP and Purchasing Managers figures is the impact of helicopter money – a one time tax jolt combined with an historic surge in mortgage refinancings (which have begun to plunge more recently). All investment must be financed by saving – an accounting identity unaffected by monetary or fiscal policy – so the growth that we see in capital spending (which I do anticipate to some extent) is likely to come at the expense of housing investment in the quarters ahead, with relatively stagnant growth in overall gross domestic investment.

The bottom line

In short, I continue to view the fundamental underpinnings of the stock market and the economy as far weaker than Wall Street appears to believe. Still, there is clearly a speculative element that is playing itself out, and there is no particular reason why it has to exhaust itself quickly. What emerges from this is a market that is priced to deliver very unsatisfactory long-term returns, but continues to hold some speculative merit. As our recent addition of contingent put options should suggest, we aren't willing to accept that speculative risk without carefully considering the potential losses as well as the potential gains. Still, we remain positioned in a way that will primarily benefit from further advances in the market.

On a relative basis, the winning themes over the past year were low-quality, small-cap, high leverage, and speculative growth. That's not an unusual tendency for a market advance right out of the gate, but as I noted fairly early in the year, investing shareholder capital in low quality, weak balance sheets and overvalued securities is not an element of our discipline. Fortunately, our approach has performed as intended without reaching into those gutters. While I don't rely on particular forecasts or “style” tendencies, it's at least worth mentioning that the fourth year of a Presidential term tends to be particularly kind to value, and I believe that our holdings heavily reflect that characteristic. In an overvalued and potentially vulnerable market, that's exactly where we're comfortable standing.

-- posted by MarketVVizard

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» MarketVVizard - S&P 500 PE chart based on peak earnings

Take a good hard look. What years did we hit 20? What happened soon thereafter?

<img src=http:\\www.creationfaq.net\VViz\PEPeakEarnings.gif>
Source: Sebastian Danconia
His Notes on Methodology:
"What I did was take Prof. Shiller's historical data (from the Cowles Foundation) and updated it through the end of 2003. The data is monthly, with the quarterly earnings "smoothed" in such a way as to give a monthly number. The SP500 Index for each month is also a smoothed number derived from daily data throughout the month. The peak earnings number I used was the peak of the previous ten-year (120-month) period."

-- posted by MarketVVizard

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» azxcvbnm - taking money off of the table?

Anyone taking money off of the table now? I took a small amount out of stock index funds two weeks ago and am planning to sell more in the coming weeks. What concerns me is that people expect the market to go up 7-10% this year, but the DOW is already up 5% from when those people made those calls. Definately the hardest thing about selling is watching the market go up and up. It's like getting left out of the party, yet if stocks go down and you didn't sell, well you just share in the misery of everyone else.

-- posted by azxcvbnm

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» Normxxx - Re: Market Risk

In response to message posted by MarketVVizard:

I use a measure of market speculative risk which is the NYSE High Beta Index ($NHB or NHB) divided by the S&P 500. In March/April, 2000, this measure was about 1.2. It is now 2.0; or, in other words, the market is now about twice as risky as at the bubble peak.

For more on the $NHB, see
http://www.suite101.com/discussion.cfm/i...

From a previous post:
For my stock asset class, I separately calculate a financial/interest rate risk (using the Fed model), a speculation risk (using a model based on $NHB, the high beta index, vs. the SPX), an inflation risk (using gold/oil/CRB indexes), and stock market liquidity risk (using Rydex fund categories as proxies-- e.g., all bear funds, all bull funds, and the cash fund).

The financial/interest rate risk is low, but rising; the inflation rate risk is moderate to high, but rising; and the liquidity risk is high and still rising (indicating that all bulls are about fully invested, and there are hardly any bears or fence-sitters left).

-- posted by Normxxx

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» MarketVVizard - Re: Re: Market Risk

Not a good day to be short!

Big volume and only 70% up vol as we break to new highs sure looks bullish. Put/call action was somewhat bearish though. We are approaching the top of the 3-day up/down vol overbought range:

<img src="http://tal.marketgauge.com/dvmgpro/chart...">

Although I said I thought we were nearing a turning point (still do) I do NOT have much confidence in the timeframe (days, weeks, or months). The stupidity can last much longer than I can remain liquid.

-- posted by MarketVVizard

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» MarketVVizard - Google

OK -- Just another stupid guess on my part, but I bet the Google IPO will hit the market within 2 weeks of a significant top.
__________________________________

Google IPO

Jan. 5 (Bloomberg) -- Google Inc. hired Morgan Stanley and Goldman Sachs Group Inc. to arrange its initial public offering, a sale that may raise as much as $4 billion, a banker involved in the transaction said.

Morgan Stanley and Goldman Sachs will lead a group of underwriters that includes Citigroup Inc., Credit Suisse First Boston, J.P. Morgan Chase & Co., Thomas Weisel Partners LLC and WR Hambrecht + Co., two bankers in the sale said. They spoke on condition they not be named.

The sale by Google, the world's most used Internet search engine, would be the biggest IPO since CIT Group Inc.'s $4.87 billion deal in July 2002. It ``will certainly be the deal of the year,'' said Sanford Robertson, who founded San Francisco-based investment bank Robertson, Stephens & Co. before starting private- equity firm Francisco Partners LP.

About a third of Mountain View, California-based Google may be sold in the IPO, giving the company a market value of about $12 billion, the bankers said. The company will probably register the shares for sale with the Securities and Exchange Commission this month and sell them by April, they said. Google spokesman David Krane, Morgan Stanley's Melissa Stonberg and Goldman Sachs spokesman Andrea Rachman declined comment. Citigroup spokesman Duncan King, CSFB spokesman Pen Pendleton and J.P. Morgan spokesman Brian Marchiony declined comment.

Thomas Weisel Chief Operating Officer Blake Jorgensen and Hambrecht spokeswoman Sharon Smith didn't return calls seeking comment.

-- posted by MarketVVizard

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