Friday, November 21, 2008

In Transit...

I'll be taking a few days off from posting. I'm at YVR now awaiting my flight to Duesseldorf (you gotta see the new fish tank in the international departures area! Way cool!) I'll be staying in Cologne for a few days before arriving at my ultimate destination of Muenster.

Trying to get myself organized for this move has been especially difficult with the recent volatility in the markets, which have been, as one could imagine, screaming for attention (or complete ignorance, depending on your preference.)

At one point this morning, seeing Citigroup trading at a number similar to Roberto Luongo's Goals Against Average, I remember thinking that nobody in their right mind would want to own financial stocks right now. Without pausing further, I signed into my brokerage account and placed an order for UYG - the double long leveraged US Financial ETF. If it felt that wrong, it must have been right. And sure enough, we got some big time rippage into the close on news that Timothy Geithner will be the new Treasury Secretary. Why that was seen as good news is beyond me. But I wouldn't be surprised to see some "coordinated efforts" this weekend so he can wear a smile at his official press conference on Monday and claim to have "saved the day."

I'm not sure what makes me more cynical. Anticipating a big rally or continued weakness. But it just seemed to me that anyone buying stocks today was doing it with a wink, wink, nudge, nudge. Nobody really wants to own anything, just borrow them. 'Tis a great market for traders, and I hope to do quite a bit more of that than usual once I get settled.

All the best!

Tuesday, November 18, 2008

Seeing Both Sides of the Tape

"Surely, this can't be happening again" I said to myself in the last hour of the market today. Once again, the US and global markets went parabolic into the close on no news. "I don't think I've ever seen a chart pattern like this before," was something I thought numerous times in the last few days.

Anyone who has read my thoughts in the past knows I've been extremely bearish on equity markets. And I remain that way for a number of reasons (poor valuations, poor demographics, poor policy making, etc.) But one of the first things I learned about trading and investing was that I should never, ever allow my convictions trump discipline. Following this one rule has saved my butt so many times that I have lost count. So while I expect the markets to break down into another leg lower, I have enough respect for the market to know that it may not happen right away.

Bear markets have an uncanny ability to stage massive short and intermediate term rallies back to previous levels of support. Support becomes resistance and the next leg down begins. Such an occurrence for the S&P 500 would be toward 1200-1250. That would be a 50% rally from our lows of today. Doubtless, there would be massive opportunities for profit in an event like this.

Additionally, it should be noted that depending on your time frame, buying certain stocks at these levels may not be a poor choice when looked upon in 5 or 10 years. I outlined a small number of companies that I think would fare the best in a poor economic environment in Looking for Relative Strength. I've got my eye on a few others that I will share with readers at a later date.

In this week's note from John Hussman, he points out the other side of my analysis on the potential pitfalls in earnings estimate reductions. From the article:
Investors can get a good understanding of market history by examining a great deal of data, or by living through a lot of market cycles and learning something along the way. Only investors who have done neither believe that current conditions are “uncharted territory.” Veterans like Warren Buffett and Jeremy Grantham have a good handle on both historical data, and on the concept that stocks are a claim to a very long-term stream of future cash flows. They recognize that even wiping out a year or two of earnings does no major damage to the intrinsic value of companies with good balance sheets and strong competitive positions. Most importantly, these guys never changed their standards of value even when other investors were bubbling and gurgling about a new era of productivity where knowledge-based companies would make the business cycle obsolete, and where profit margins would never mean-revert. They knew to ignore the reckless optimism then, because they understood that stocks were claims on a very long-term stream of cash flows. They know to ignore the paralyzing fear now, because they still understand that stocks are a claim on a very long-term stream of cash flows.

Indeed, nobody should buy or sell a solid company because of fears or euphoria over next year's earnings. That is a rational argument. Unfortunately for Mr. Buffett, the market is not always a rational place. Fears about lower earnings this year can evolve into lower expectations for not only the next year, but the next 10 years. A company that has performed well in the last 60 years of consumption binges may not necessarily perform well in a prolonged period of social aversion to excess consumption. That is, what has performed well in inflation, may not perform well in deflation. Mr. Buffett included.

Kevin Depew had a fantastic article on the changing social mood today, titled, "Social Mood Shift Brings Stark Changes." He outlines perfectly why certain symbols of affluence are being shunned at a rapid pace. I'm wondering what the perception of America's role in "starting" this crisis will have on foreigners' willingness to purchase symbols of Americanism - things like Mr. Buffett's beloved Coca Cola Co (KO). Consumer preferences are extremely finicky. Anything can happen in a time of social revolution.

For this reason, I think the Buffett model of "buying for the long term" may turn out to be extremely dangerous. Even when it comes to presumably safe companies of what could be an old paradigm.

As always, there are two sides to the tape. One side points toward the buying opportunity of a lifetime in companies with historically predictable cashflow, or in companies that may lead the way out of a massive recession. Another side points toward a major shift in social mood where values of the past are rejected in favour of something else.

The massive volatility in the markets over the last 3 months seems like a see-saw between the two ideas. One hour, market participants are sure that what was old will be hung out to dry along with the ideals of American-style materialism, risk-taking and the willingness to go into debt. The next hour, participants are sure that the former are over-reacting, and after a little bit of pain, things will return to normal.

It is my belief that the former are correct, for the reasons Kevin Depew lays out, and for other reasons. But in the interest of full disclosure, that may just be my own personal preference bias as one who loathes our lack of social values. I'm prepared to be wrong and am willing to make major adjustments to my current investment posture of doing *almost* nothing.

In summary, this is about more than stocks being cheap or expensive. It is a battle between the status-quo and a new paradigm. Hopefully, seeing both sides can assist you in making the right decisions.

Note: This will likely be my last post for a while. I am relocating to Germany for an undetermined amount of time. Please bear with me while I make the transition. As always, thanks for reading.

Sunday, November 16, 2008

Misdiagnosing the Disease

World markets appear to be kicking off another week disappointed, as the G-20 meeting failed to accomplish anything other than talk.

I really don't know what was expected by all of these analysts, but it is clear there is very little consensus on what the problem is, let alone what a possible solution would look like. They all still seem to be clinging to the precedent of the last 30 years, when any little problem in the economy was quickly dealt with by politicians, and markets would respond favourably.

Clearly, the problems are far bigger than any of these people had imagined. Yet, somehow they manage to maintain their expectations for profit growth in this quarter over last year - and for the entirety of 2009. How is that possible, when retail sales are dropping like a stone and while unemployment and mass layoffs skyrocket? Good question.

From a technical perspective, I see no reason for the stock market to bottom here. The S&P 500 and the Nasdaq 100 both closed below previous weekly closes despite Thursday's absurd 11.3% rally from it's low. As I mentioned in The Largest Rallies Occur in Bear Markets, such a meteoric rise in the markets on a single day basis is nothing to be excited about, rather feared. These violent swings in the market suggest that participants have no clue what the value of businesses are. And when there is such uncertainty, the natural direction for stocks will be lower. Eventually, all hope will be lost and a meaningful multi-year bounce can then take root - even as economic fundamentals deteriorate. But in order for that to happen, I need to see forward earnings expectations slashed considerably. So much that they not only incorporate current economic weakness on a realistic basis, but that they also factor in future economic deterioration.

Unfortunately, as analysts make these adjustments, stock prices will be cascading even lower to reflect the lower "E" part of the P/E ratio. Currently, stocks are selling for about 18x earnings. The historical mean is 14. The Law of Mean Reversion states that, not only will prices invariably revert to their mean, but will usually overshoot the mean before reaching an extreme. I see no reason for this statistic to become invalid now, as it has worked for centuries. A total earnings number of $45-50 in 2009 for the S&P 500 remains my target, and I see no reason stocks will not trade at a multiple of 10x those earnings, as risk aversion grows. I see the possibility of this eventually being optimistic. But that depends on how our policy makers react to this new reality.

Which brings me to my next topic of "Depression Economics." All the talk about bailing out the big 3 automakers on both sides of the border goes in the category of making my above expectations optimistic. As does the recent application of nearly any kind of US financial company to become a bank holding company, making them eligible for bailout money. As does the entire $800 Billion Federal Bailout (TARP) or any other "stimulus packages" President-Elect Obama may have up his sleeve.

All of these politicians, from Jim Flaherty in Canada to Nancy Pelosi Stateside, are exercising backward economics. And it all stems from a misunderstanding of the problem. Here are what the real problems are:

1) Fractional Reserve Lending. Central banks minting money out of nothing and then lending it (at interest) to member banks who leverage it 10 to 1.
2) Government deficits. Deficits always result in higher taxes which make businesses uncompetitive and slow the economy in the future.
3) Poor lending standards. Government mandates of "affordable housing" inevitably lead to foreclosures and losses to holders of the mortgage security.
4) Lack of bank balance sheet transparency. Allowing for Level 3 accounting, where banks state how much they wish their assets were worth, and then recording it as such.
5) Interest rate micro-mismanagement by central banks. Misallocations of capital result from too high or too low interest rates.

All of the solutions offered by our politicians amount to more of the above. It defies logic that the solution can be the same as the problem. Our economy is in cardiac arrest. A defibrillator will jump start it but won't cure the disease. We need a transplant - an overhaul of our entire financial system. Here are my solutions:

1) Eliminate the Central Banks. Allow regular people to determine what money is (as they had done for millenia) and at what rate of interest it should be lent to others.
2) Demand that banks value their assets at realistic prices. If this means they go bankrupt, so be it. New banks will buy their assets and conduct business in a more responsible manner.
3) Get government out of the business of promoting growth. Business cycles will be so mild without the capital misallocations that the words "boom" and "bust" will essentially disappear from our vocabulary.

There have been literally dozens of government "solutions" to the economic problems we face. Our policy makers continue to diagnose the symptoms (falling stock prices, less lending, unemployment, business bankruptcies, etc) as the disease. It is no wonder their dozens of prescribed cures have accomplished nothing.

All along, a group of economists have been saying, "I told you so." Just as they did before and during the Great Depression. People would be wise to start listening to them. More information can be found at

More information on the growing campaign to end the Federal Reserve can be found at

Wednesday, November 12, 2008

Looking for Relative Strength

As the markets approach their October lows and fear percolates once again, it is easy to get caught up in the hype surrounding big name stocks that are in the news. All eyes are on the big 3 automakers and people are questioning whether they will survive or be bailed out by the government. It is very difficult to imagine what the auto industry would look like without Ford and GM. But it is very easy to try and make an emotional bet on whether they survive or not.

And that is all it would be. An emotional bet. Same goes for buying any of the major financial institutions, commodity producers, or even junior explorers for that matter.

It is very emotionally satisfying to be able to say, "I picked the bottom in XYZ stock 3 years ago and am up 1400% since then." It's the type of talk that makes one look like a genius (or an arrogant jerk - depending on the tone) at dinner parties. So this is where most investors and fund managers spend their time. Trying to pick the bottom in the most beaten-up sectors.

I don't buy beaten-up companies because they're probably beaten-up for a reason. Sure, there will be the odd baby thrown out with the bathwater. But more often than not, stock prices fall because management did not properly prepare their business for unfavourable business conditions. Or perhaps their balance sheet is not transparent, their future profitability is jeopardized by a number of 'unknowns,' they are at risk of government nationalization, or a host of other potential pitfalls.

I prefer to make money.

What I am prepared to buy, are companies whose stock has not been majorly affected by the credit crisis. Companies who have no debt. Companies that have been, even for the past year, experiencing positive growth.

Additionally, I ask myself the following questions:

1) Does this company have new ideas? Or do they rely on old ideas to work again?
2) Does this company provide services or goods more efficiently than could be done before?
3) Does this company provide something that we need more of?

I am looking for something called "relative strength." Here are a few examples of stocks displaying good relative strength, and that fit my above criteria:

Emergent BioSolutions (EBS) - They make an anthrax vaccine and have a pipeline of other drugs with potential. Their biggest customer is the government. Stock is hitting 52-week highs even as the market craters. 30% revenue growth y/y.

Aecom Technology (ACM) - Company provides support for major infrastructure projects. Again, their major customer is the government. Stock price is 25% higher than October lows. 20% revenue growth y/y.

Insituform Technologies (INSU) - This company has a proprietary trenching system for replacing or upgrading underground pipe systems. Stock is nearly 50% higher than it's Oct low. Constant revenue growth.

Telecom Sao Paolo (TSP) - Operates land-line telephone, television and internet services in Brazil. Stock is 30% higher than October lows. Constant revenue growth. Pays a 12% dividend.

IShares MSCI Chile ETF (ECH) - Chile is probably the best performing emerging market over the last few weeks and is still 30% higher than it's October lows. It also fell less from it's highs earlier in the year, demonstrating a stronger economy. After living there for 3 months last year, I know that these are very smart and motivated people. If (big if) I were to make a bet on an emerging market recovery, Chile would be the first place I look.

It may seem counter-intuitive to some that I am looking at stocks that have not yet experienced big price decreases or that are way higher than they could have been had only 3 weeks ago. But during these enormous market declines, the true colours of companies are shown. We are in the process of separating the men from the boys. I want to buy companies that are strong, not weak.

So although it is my belief that stock prices in general have the potential to go much, much lower as earnings estimates get slashed, these are the types of companies I believe will be the strongest during that decline, and into the eventual recovery.

I would much rather own a basket of these stocks, coupled with a double inverse index ETF (like SDS) as a hedge than a basket of troubled companies with only a hope and a prayer that this was all just a bad dream.

But that's just me.

Disclosure: I own shares in EBS

Monday, November 10, 2008

Understanding Generational Patterns

I have had some readers ask me about my references to certain generations and what appears to be a certain "laying of the blame" on the Boomer generation or the Gen-X generation for the credit crisis. So I think it is time I address this issue to clear up any misperceptions about what I am saying.

A number of years ago I read a relatively obscure book that made me completely rethink the nature of economic cycles. Prior to reading that, I had read extensively on economic crises and military crises of centuries past. I could not get over how strikingly similar they were to one another. This book offered a very simple explanation: Once all the previous participants of the prior crisis were dead or in their twilight years, the younger generations would begin making the same mistakes their ancestors had many decades prior.

The name of the book in question was The Fourth Turning - by William Strauss and Neil Howe. The theory is also closely followed by a writer who I often reference, John Xenakis and his website, "Generational Dynamics."

There are many that refer to such theories as heresy. The Kondratiev Cycle is another one - and he was sent to the Gulags by Stalin for his opposition to the idea of perpetual communist utopia. I don't hold any theories as gospel. But I do believe there can be some use for any economic theory under the right circumstances - especially when used in conjunction with other analysis. I have found this theory to be the most logical, and will attempt to explain the basics and how it could potentially be used for investment purposes.

The theory revolves around major economic crises and major wars and it holds that they inevitably happen every 70-90 years (the average lifespan of one person). The crisis naturally has enormous effects on social attitudes, birthrates, political ideology and much more. Crisis eras are always followed by "Highs" or "Recoveries", which are followed by "Awakenings," which are followed by "Unravelings." The era that a person grows up in shapes a lot of his/her social attitudes for the rest of their lives, and this gives them one of four different generational archetypes: Prophets, Artists, Nomads or Heroes. Furthermore, as the generation become Adults (or "come of age" as the authors put it), the conditions around them shape much of their direction in life. From the book:

* Prophets are values-driven, moralistic, focused on self, and willing to fight to the death for what they believe in. They grow up as the increasingly indulged children of a High, come of age as the young crusaders of an Awakening, enter midlife as moralistic leaders during an Unraveling and are the wise, elder leaders of the next Crisis. The Boomers are an example of a Prophet generation.

* Nomads are ratty, tough, unwanted, diverse, adventurous, and cynical about institutions. They grow up as the underprotected children of an Awakening, come of age as the alienated young adults of an Unraveling, become the pragmatic, midlife leaders of a Crisis and age into tough, post-crisis elders during a High. Generation X and the Lost Generation are examples of Nomad generations.

* Heroes are conventional, powerful, and institutionally driven, with a profound trust in authority. They grow up as the increasingly protected children of an Unraveling, come of age as the Heroic, team-working youth of a Crisis, become energetic and hubristic mid-lifers during a High and become the powerful elders who are attacked in the next Awakening. The G.I. Generation that fought World War II is an example of a Hero generation. Millennials are expected to emerge as the next generation of this example.

* Artists are subtle, indecisive, emotional and compromising, often having to deal with feelings of repression and inner conflict. They grow up as the over-protected children of a Crisis, come of age as the sensitive young adults of a High, rebel as indecisive midlife leaders during an Awakening, and become the empathic elders of an Unraveling. The Silent Generation is an example of an Artist generation.

It should be noted that this theory is typically applied to the United States, but is applicable to all nations, even though they may be operating on their own unique cycles. Take a look at the table on this website which explains how the last few cycles have played out. Note the slight divergence during the American Civil War, which happened about 15 years too early and caused a generation 'skip.' This serves as reminder that no theory is airtight and anything can happen.

Clearly though, the theory has some merit, even if it is somewhat open to interpretation. Unfortunately, what this means for the present day is that we have just gone through a generational unraveling, where the institutions and oversight created after the Great Depression and WWII have been cast aside as relics of the past. Where social values of community and family have broken down. Speculation and materialism ran rampant - just as it did in the 20's. Now we are paying the ultimate price for that lack of fiscal responsibility and nearly the entire world is engulfed in financial crisis that seems to know no end.

From the perspective of Generational Theory, this crisis must escalate. The crisis must be so devastating that it changes the attitudes of children and adults for the rest of their lives. And most followers of the theory hold that it must result in a major war on the scale of previous crisis era wars. To this I would argue (and hold out some hope) that it is possible such a war is relatively bloodless and fought on more religious or ideological grounds (such as the Glorious Revolution 1648-73.)

As I mentioned before, anything is possible. If the US could have skipped an unraveling era in the 19th century, logic dictates that we could avoid a terrible crisis in the 21st. But the chances are slim. The current spike in unemployment is leaving our younger generations jobless, and their idealistic and cynical nature leave them in a position to eagerly accept going away to war.

The unfortunate part about researching these cycles is that we see how inevitable major crises are. No matter how much emphasis we put on remembering the past horrors, we seem doomed to repeat our mistakes.

However, as bad as this may all seem, the cycles also teach us something good. That no matter how terrible the crisis is, it will also end, and the world that re-emerges from the ashes of war and financial ruin will provide much opportunity. There will be amazing technological advancements, a renewed sense of social community, and an emphasis not on material want, but rather the pursuit of happiness.

So as much as we see the words "Armageddon," or "end of days," in our media, rest assured that nothing of the sort will occur. Things will likely get worse before they get better. But they will get better. Sometime.

My posting of this on Remembrance Day is no accident. I ask that my readers take extra care to remember not only the horrors we have been taught about the two World Wars, but rather all major crises the world has experienced. Let us remember the tactics used by tyrants of centuries past to awaken nationalistic fervour and the lust for blood. Let us remember the failed 'solutions' to previous economic crises. Let us remember the dangers of entangling alliances with foreign nations, whose actions we have no control over.

If we can acknowledge our past mistakes honestly, perhaps there is a slight chance that we can be a beacon of hope, truth and prosperity in a world destined to devolve further into crisis.

Thursday, November 6, 2008

Economic Outlook Dims After Presidential Hype

I got quite a few e-mails from readers asking to give my thoughts on the US election of Barack Obama and what impact I think it will have on the economy. So here are my thoughts:

The media has proclaimed Obama as an almost god-like figure. People were shedding tears of joy at his acclamation. "Change has come to America," was a line I probably heard 100 times over the course of a day. I've taken to asking random people what they think of Obama's election. Aside from one responder at a gas station who was happy that "Obama would end the foreign wars," every other respondent could only say that it is good for America to finally have a black president. Their awareness of the issues he stood for was essentially nil. That's not to say it's not a great accomplishment. It is. But if race was really made "an issue of the past," then why all the talk about it? Just askin'.

People seem to be thrilled about this supposed "change" that is coming. And who can blame them? The last 8 years under the Bush administration have been terrible on so many fronts, that not wanting change seems a bit ludicrous. But is it change that Americans want? Or do they just want to be told, "everything is going to be just fine?" Do they want to hear, "don't fret, things will be back to normal soon?" Sadly, the election of a new black president aside, Americans voted undeniably in favour of the status quo. In fact, 87% of congressional representatives (rough equivalent of MPs in Canada) were re-elected. 7.3% retired or ran for the Senate. And 5% were defeated.

If the Kansas City Royals hired a new coach but kept the same players from last year, would you bet on them to win the world series?

Obama has no new ideas (or understanding, from what I gather) on monetary policy. He has no intention to bring American troops home from the 130 countries they occupy. And he has no stated plan to address the fiscal deficit and mounting government debt. And although he is a fantastic speaker, a champion for equal opportunity health-care, and anti-poverty crusader, I fail to see where he will get the money to fund any of his grandiose plans for a utopian world where everyone is equal.

So in summary, no, I don't think an Obama presidency will do anything to stop the economic crisis. And I do have concerns, as I did equally under Bush, that Obama will attempt to lead America in a push for a one world currency to replace the dollar. I have heard the line, "It's a global problem, so we need a global solution" many times. To me that wreaks of a push toward a one-world currency and eventually one-world government. Obama, with his charismatic speaking and multi-ethnic background is the perfect vehicle to satisfy such an agenda. Individual liberties would essentially cease to exist if our legislative abilities were turned over to multinationals. Global Corporate Fascism is what we would get. The notion that the tyranny of the Bush years are over seems a little far-fetched to me. Obama retains all of the dictatorial powers Bush gave himself. And the fact he is a Gen-Xer, not typically known for their discretion, does nothing to ease my concerns.

The potential for Obama to turn out as a wolf in sheep's clothing looms large.

None of this is to say a John McCain win would have been better. I think both candidates were equally as terrible. But the great expectations being put on Obama to "fix" everything seem illogical from a non-partisan perspective.

People are likely to be very disappointed.

Of course, just because there's a new president doesn't mean the economic data is going to get any better. And here are a few examples:

From the Wall Street Journal - At the Supermarket Checkout, Frugality Trumps Brand Loyalty
Though low-income consumers have been cutting back for the past several months, now upper-income shoppers -- those with household incomes of $100,000 or more -- also are making significant changes, according to a new survey by IRI.

The report, titled "Shopper in Crisis," found that 41% of upper-income consumers reduced spending on nonessential groceries, and a fourth of these consumers said they gave up favorite brands over six months in 2008. Nearly one-third of high-income shoppers said they bought more private-label products during the second quarter, up from about 20% in the first quarter of this year.

And notions of the wealthy keeping the economy afloat can be tossed out the window.

From Times Online - Commerce Becalmed Over Letters Of Credit

The credit drought is undermining international trade in goods and raw materials with savage increases in the cost of funding for exporters. At the same time, buyers of goods are being denied access to letters of credit - the banking instruments that are the nuts and bolts of global trade.

HSBC, a leading trade finance bank, has said that the cost of guaranteeing a letter of credit, a routine instrument used for payment of goods, has doubled. Concern is growing in the shipping industry that business is foundering because of failures in trade finance, and Pascal Lamy, director-general of the World Trade Organisation, has given warning that the credit crunch is affecting global trade, particularly in the emerging markets of Brazil, India and China. He said: “Trade finance is being offered at 300 basis points above the London Interbank Offered Rate and even at this high price, it has been difficult for developing countries to obtain.”


Anxiety about payment was pushing companies to ask for greater security, Mr Nivison said, and in such transactions, fees were soaring. He pointed to a recent case of a shipment of industrial equipment from Britain to India, where the confirmation and discounting of a letter of credit, which would normally cost 0.5 per cent of the value of the goods, had risen to more than 1 per cent. “These are big moves and reflect the nervousness in the market. People want to be sure they are paid,” Mr Nivison said.

Distrust of banks is compounding the problem. “We have received requests to guarantee the credit of top-tier banks and we have also seen cases of exporters in China saying to their UK buyers which banks they will or will not accept,” Mr Nivison said. He added: “Trade finance is the oil that keeps the wheels of commerce going. Without it, everything grinds to a halt.”

Remember that "global decoupling" everyone was talking about a year ago? Toss it out the window as well.

From Calculated Risk - Continuing Unemployment Claims at Highest since 1983.

Remember when this recession was going to be shallower than most because of "strong employment numbers?" Toss it out the window.

All over the place, long held misperceptions about the economy are unravelling. Barack Obama will be inheriting the worst economy of any president since FDR. And it is reasonable to assume he will be as ineffective as FDR was at doing anything to turn it around.

More time and lower prices are the cures for the world economy. Nothing more, nothing less. Messianic leaders included.

Wednesday, November 5, 2008

"The Largest Rallies Occur in Bear Markets"

"The Largest Rallies Occur in Bear Markets," is a phrase I'm sure many have heard before. And it is true. The notion that stocks rising by 10% a day is a "good thing" has been thoroughly discredited over and over in the last 100 years, yet the media continues to parrot this price action as a positive. Just one more reason to ignore our propagandist media.

Here is an article by Professor M.P. at Minyanville detailing the largest rallies of the 20th century.

The Top 10 Biggest Percentage Gains in the Dow Jones Industrial Average

March 15, 1933 - up 15.34%
The first trading day after the bank holiday on March 6th and after the passage of the Emergency Banking Act on March 9th; it “marked a turning point in expectations for economic recovery.”

October 6, 1931 - up 14.87%
Followed the October 5th announcement, by President Hoover, of a proposed conference with members of Congress on the country’s economic problems.

October 30, 1929 - up 12.34%
The day after Black Thursday. Per Laurence Stern of The World:

“After the stock market had come crashing down again in a veritable deluge of forced and hysterical liquidation, word sped through the financial district last evening that the largest banks in the city were prepared to exert their organized power this morning to prevent further disaster. Arrangements described as "fully adequate" were completed at a conference at the offices of JPMorgan at Broad and Wall Streets...

"Although no formal statement was issued, it was the consensus of those at the meeting that the worst of the liquidation is over and that a natural demand for investment stocks now available on the bargain counter should go far toward an immediate restoration of trading stability.”

September 21, 1932 - up 11.36%
The day after the Reconstruction Finance Corporation announced it was expanding its focus to include aid to farms.

October 21, 1987 - up 10.15%
The day after the market bottomed on the 20th during the 1987 crash, when circuit breakers on the CME and CBOE were triggered.

August 3, 1932 - up 9.52%
The day after Secretary of Commerce Robert Lamont submitted his resignation.

February 11, 1932 - up 9.47%
The day after Secretary of the Treasury Andew Mellon submitted his resignation.

November 14, 1929 - up 9.36%
The day after the failed re-test of the October crash. (Couldn’t otherwise identify a specific event contributing to the rally.)

December 18, 1931 - up 9.35%
The day after the US government announces it will provide financial assistance to the railroads.

Oct 13, 2008 saw an 11.5% gain in the S&P 500. Oct 28 saw a 10.8% gain in the same average, putting them right up in the top 5 largest advances of all time and squarely in the company of advances seen during the early years of the Great Depression.

Most analysts reject the notion that our current situation is anything like that of the 30s. The common argument is that our governments have taken far bolder steps than those of Hoover's or of R.B Bennett's, therefore a similar outcome is impossible.

Such arguments are historical revisionism at best. Blatant propaganda at worst. The actions taken at the time were revolutionary, just like today's actions.

No, this will not be "just like the Depression." No economic cycle is exactly like any other. But in terms of magnitude, it is apparent from a number of indications (economic indicators like home sales, retail sales, auto sales, consumer confidence, etc) that this is not just another cyclical recession, but rather a secular depression. Seeing massive rallies in the major indices is just another signal.

Healthy and growing markets do not perform like this. We have already seen a 20.7% rally off the lows of last week. Sure, the market could rally another 20%. But buyers at these levels are putting themselves in an extremely vulnerable position.

Sunday, November 2, 2008

Are US Stocks Cheap or Expensive?

As with every major rebound in price during a bear market, we constantly hear from numerous media sources that we have reached bottom, and the new bull market has begun. I refer to these folks as the Pollyannish Pundits of Perpetual Prosperity. Generally, they had no idea that this was coming and still don't understand what is happening, yet our beloved mass media affords them ample airtime to mislead investors. Upon every bounce during 2008 we heard the same mantra of, "stocks are cheap."

But on this most recent, and much more violent move lower we are now starting to hear from another group of analysts who warn that the market will continue to drift lower and that investors should exercise caution. Let's call these folks the Nattering Nabobs of Neverending Negativity. They point to various economic leading indicators suggesting the economy is due to fall off a cliff and tell us "stocks are expensive."

Who do you believe? How can stocks be both cheap and expensive? Well, it depends on what metric you are using. If one was to use trailing earnings ratios, US stocks are trading at an exorbitant 25x earnings. These are based on the last quarter's earnings reports, which have been terrible to say the least.

But if I were to instead use forward projected earnings, the US stock market is trading at under 10x earnings. Where do those projected earnings come from you ask? They come from the leading analysts at top brokerage firms, banks, etc. These are supposedly the best business analysts in the country and have made a name for themselves by correctly predicting company earnings for decades. Unfortunately, these analysts have been a little unlucky in the last few quarters. They were projecting Q2 earnings to be higher by 25% and they finished lower by 25%. They had never missed by that much before. The same thing has happened for Q3. And Q4 earnings that started out as, again, 25% higher are now being slashed. But they are still expecting earnings growth of about 12%.

Keep in mind that these are year-over-year projections. When we're talking about Q4 earnings for 2008, we're comparing them to the already poor 2007 Q4 earnings. Q4 starts in October and ends in December. We'll start learning of those numbers in January. But in the meantime if estimates are cut, stock prices will fall to reflect the new earnings projections - which is what has been happening the last two quarters.

So what we have is an enormous gap between what we have already seen and what these high-paid analysts expect for the future. This is why the stock market seems to be trading with such unpredictable volatility. People have no idea who to believe. Projected earnings were a viable vehicle to value stocks for decades. Now they're essentially useless. But if we were to all of a sudden start valuing stocks based on their dismal performance this year, the market would probably fall by, uh, a lot.

I have seen estimates for 2009 S&P 500 earnings anywhere between $45 and $95. 2007 returned about $87.50. 2008 is now looking to be around $65-70. Just for fun, let's create a few possibilities.

2009 earnings:
$95x P/E ratio of 18 = S&P 1710 - This is what most analysts still expect
$75x P/E ratio of 15 = S&P 1125
$60x P/E ratio of 12 = S&P 720
$45x P/E ratio of 8 = S&P 360

Hopefully, this gives some perspective as to why stocks are so volatile lately. You can put me on the lower side of both earnings and P/E ratios, which is why I believe we will still see much lower prices in the years ahead.

But one never knows. Those Pollyannish Pundits of Perpetual Prosperity could be right. The credit crisis could blow over like a tropical storm and everything could be back to 'normal.' I'm looking at their recent track record, the current economic conditions, and the credit markets that will be effecting next year's business operations. I don't see a flying hope of them hitting their mark.

Investors should be very careful of any analyst's declaration of stocks being historically cheap or expensive. The situation is not nearly as black & white as they claim it to be.

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