Monthly Archives: August 2011

toe in the water?–five days later, on the weekend

August 14, 2011 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Stock ideas, Technical Analysis, Trading Tags: , , , , , , , , , 2 Comments

where we find ourselves

The S&P 500 has recovered from its intraday low of 1106 on last Tuesday afternoon to close at 1179 on Friday.  Trading will resume in Asia at 8PM eastern time, with very little more clarity about the global economic situation than that world stock markets appear to have stabilized for the moment.

The key question remains whether the market weakness we’ve seen over the past several weeks indicates the US and the EU are in the early states of a significant economic downturn that will last, say, a year.  If so, and if past patterns of market performance hold true (I don’t see why they wouldn’t, then:

–we’ve only seen about half the decline we are likely to, and

–it will be some time in early 2012 before we can expect markets to begin to anticipate cyclical strength.

While this scenario may play out, I don’t regard it as the most likely outcome.  My guess is that we have a period–maybe a long period–where the US and the EU simply go sideways economically. Developed workd stock markets would probably follow suit.

“Sideways” would actually be a dynamic concept, however:

–the financial and housing/construction sectors would continue to oscillate around zero as they continue to heal from the excesses of the last decade;

–export-oriented/import-competing industries, as well as those in the forefront of technological change (in other words, those not dependent on overall domestic GDP growth) would advance steadily.

what to think about/do

1.  Last week has given all of us–as if we needed another one–a reason to think about our risk preferences.  All of us should ask whether we’re comfortable with our asset allocation.  If stocks were to decline by 15% from Friday’s level over the next six months, would we be content to ride through the storm with our current portfolios?

2.  Does the low of last Tuesday mark a significant market bottom– a defining event, as it were?  I don’t think so; I think of recent trading as a ratcheting down of markets that are absorbing the fact that a long period of US government support for equities is over.  Stocks have to make it on their own from now on.  That’s actually a healthy development, in my opinion, although it is a cause for near-term worry.

Significance?  If I’m wrong, and Tuesday was a significant bottom, stocks will likely rise for a month or six weeks and then return to “test” the bottom.  I have no idea why this happens, it just always does.

3.  Look at relative outperformers/underperformers from Tuesday on.  Start with your own portfolio.  Call up a Yahoo chart and compare the performance of your stocks with the S&P during Wednesday-Friday.  Keep doing this over the next few days.  The process will hopefully let you see what the sectoral direction of the market is.  It may also give you ideas about how to rearrange the names in your portfolio.

4.  Go shopping.  There may be stocks you’ve always wanted to own but have thought they were too expensive.  As a result, you’ve bought weaker companies that were trading at more reasonable prices.  Now may be your chance to trade up.

 

the generational impact of low interest rates

August 12, 2011 By in Current Market Thoughts, economics Tags: , , , , Leave a comment

recession SOP = negative real interest rates

Standard procedure for central banks during times of economic weakness is to lower the short-term interest rate to the point where it’s negative in real terms–meaning the nominal rate is less than inflation.  By thereby making loans in effect free, the idea is that corporations will use this gift to boost capital investment, hire new staff and, by doing so, get the economy back on a positive footing again.  In the US (but not elsewhere), such a decline in rates has also almost (until now) always been a signal for consumers to head back to the malls.  And, of course, lower borrowing rates may also give a jump start to housing.

Where does this economic windfall to borrowers come from?

…from savers.

The idea is to shift purchasing power from people who are less likely to consume to those who are more likely to spend–and to borrow money to do so.  The shift is from holders of fixed income instruments to borrowers–from old to young, from wealthy to less affluent.

In a world where the holders of fixed income were by and large the very wealthy, where older citizens had defined benefit pensions and where the period of negative real interest rates was relatively brief, this idea works fine.

not so good for today

In today’s world, however, Baby Boom retirees have only 401ks and IRAs and there’s no end in sight to the time of zero interest rates (the Fed has just said it will continue for at least the next two years).  As a result, “orthodox” money policy has two unintended consequences.  Both relate to older Americans.

a simple example

Suppose you’re on the verge of retirement, have a $50,000 salary and think you will adjust to a $40,000 a year lifestyle after you stop working.  Let’s say you expect to collect Social Security benefits of $15,000 a year and will rely on Medicare for medical benefits.

That leaves $25,000 a year to come from your savings.  At today’s money market rates of, say, .1%, how much do you need to have to avoid dipping into principal if all your savings are in vehicles like this?   Answer:  $25 million.

Suppose you have a blend of half cash and half 10-year Treasuries.  How much do you need then?  Answer:  $1.9 million.

If your retirement savings are $250,000, you’re going to run out of money in a little more than ten years after you stop working!

(Yes, I know that my numbers overstate the problem.  But not by that much.  Also, think about it–picking a (literal) “drop dead” date when your money runs out is a harder topic to raise than you might imagine.)

two conclusions

1.  In all likelihood, if you’re a Baby Boomer in this situation, although you’d probably like to retire, you can’t afford to.  You’ve got to hang on to your job for as long as possible.  This ends up making it impossible for a new entrant into the workforce to occupy the position that you normally would have vacated.

2.  You’re going to be very strongly opposed to changes in government entitlement plans, no matter what the arguments in favor are.  You don’t see you have any other choice.

Is there a solution to this unacknowledged problem?  Yes, an obvious one.  Use fiscal policy rather than money policy to stimulate the economy.  Unfortunately, this is unlikely to happen, in my opinion.  As a result, the plight of many Baby Boomers caused by the direction of money policy will act as a counterweight to its effectiveness.

toe in the water?–two days later: four signs to watch for

August 11, 2011 By in Current Market Thoughts, Portfolio management, Recent Market Action, Strategy, Technical Analysis, Trading Tags: , , , , , , , , , , , Leave a comment

back to the drawing board

I had thought that Tuesday’s afternoon rally in the S&P from its 1106 low to its 1172 close was a significant event for the market’s psyche, since it cut with ease above what I thought was significant resistance at 1150.   Apparently not.  Yesterday’s loss of 6% by European stocks was too much for Wall Street to bear.

four signposts to look for

I think there are four signs to watch for that will indicate that the worst of the current market fall is behind us:

1.  The market holds at/above a significant technical level.  For the S&P, the closest is 1100.

2.  No more lower lows.  The most recent intraday low for the S&P is 1106.  It would be encouraging, even if the index declines from yesterday’s close, if it stayed above that level.

3.  No negative reaction to bad news.  A very clear sign that negative events have been already discounted in current stock prices is when further negative news comes to light and the market simply shrugs it off.  That certainly isn’t happening yet, since yesterday’s fall was sparked by rumors that S&P will downgrade France.  If anything, yesterday’s market action shows the opposite.

4.  Individual stocks stop falling in lockstep.  Panic selling is by nature irrational and tends to flatten everything pretty equally.  A sign that investors are reaching for emotional equilibrium again, even in a market that continues to fall, is when the strongest stocks separate themselves from the pack and begin to outperform the others. AAPL is already one example, but we need more.

CSCO will be an interesting test of this idea today.    The company reported better than expected results after the New York close yesterday and is up about 7% in after-market trading as I’m writing this.  I’m not a big CSCO fan, but the stock is only trading at about 10x earnings, and it does yield almost 2%.  It would be a healthy development for the market if the stock can hold onto most of that after-market rise in regular trading today.

a fifth indicator–one nobody wants to see it, but we may be doing so now

At the recession lows for the S&P in 2003 and again in 2009, the dividend yield on the S&P briefly rose above that of the ten-year Treasury.  That wasn’t because companies were raising their payouts; it was because stock prices were being crushed.  But it was a very clear buy signal.

At present, the yield on the ten-year is 2.1%.  The yield on the S&P, as best I can figure it, is a shade over 2%.  It could even be higher than 2.1%.

This indicator isn’t about the market psychology of when emotion-driven selling will stop.  It’s about value.  And it shows how cheap stocks currently are.  I’ve only seen investors consistently ignore this extreme relationship once in my career–in the post-1989 Japanese stock market.  I don’t think we’re in that situation in the US today.

toe in the water?–one day later

August 10, 2011 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Strategy, Technical Analysis, Trading Tags: , , , , , , , , , , Leave a comment

yesterday’s trading

I was traveling to San Francisco today, so I wasn’t able to monitor much of the market action as it was happening.  I’m sure I would have been (even) more frightened, for the first time during this downturn, if I had experienced it first-hand.

Looking at the charts, the tumultuous day consisted of:

1.  a rally off the lows in Asia, aftermarkets there absorbed the shock of a very sharp decline seen in New York trade on Monday

2.  early weakness in Europe, followed by a sharp rally and a close in positive territory

3.  strength from the open into the afternoon in the US, a brief swoon on the Fed statement shortly after 2PM, then a rebound to a close that more or less doubled the earlier-day highs.

As I’m writing this at close to midnight Pacific time, Asian stocks are showing substantial follow-on gains.

my thoughts

The issue at hand is whether this action contains any evidence that markets will stabilize/are stabilizing at around these levels.

I think there’s a good chance that market are stabilizing, for several reasons.  None of them are strong enough to bet the farm on, however.   I also don’t see any need for me to act right away on my conviction, other than not to adopt a more defensive stance in my own portfolio.

My reasoning:

–My experience is that serious downward market movements don’t end until everyone becomes frightened by the damage done to their portfolios.  Since I’m usually optimistic, and because I’ve been around for a long time, it takes a lot to disturb me.  (Alternatively, maybe I’m just slow to catch on.)  In any event, when I finally think I should be hiding under my desk rather than looking at prices, a down movement tends to be pretty long in the tooth.  I reached the point of real fear yesterday and today.  My nonchalance had been the major reason I thought the markets had more to fall.  So, in the perverse way that equity investors think, I regard my own  fear as a good sign.

–turning points in the markets are often marked by considerable volatility, as bullish and bearish ideas struggle with one another.  Yesterday is the first day that attempts to rally weren’t overwhelmed by new waves of selling.  That’s another good thing.

–a minor note.  My experience is that when the Fed speaks, the first half-hour or so of market reaction is invariably in the wrong direction and is quickly reversed.  So it really doesn’t disturb me that the initial market move after the Fed said it would keep rates low into 2013 was down. In fact, the opposite.

–I don’t think recession is in the cards.  Or if it is, it won’t result in the dramatic falloff in earnings that happens when an economy that is expanding at an unsustainably high rate goes into reverse.  Developed nations may go from being slightly in the plus column for growth to slightly in the minus, but going from +1% to -1% won’t have the same negative effect on corporate profits as if growth went from +6% to -2%.

Let’s say S&P 500 earnings are $50 for 1H11 and $40 for 2H11, meaning $90 for the year.  Assume that 1H12 comes in at $40 and 2H12 at $50.  If so, at yesterday’s close, the S&P was trading at 13x 2011 eps and 13x 2012 eps.   That seems very cheap to me in a world where the competing liquid investment, government bonds, are yielding well under 4%, even for the longest maturities.  I also feel that a 15% or so drop in the index already discounts a lot of bad earnings news.

–I also don’t think that the EU’s financial troubles will trigger another Lehman-like event. I don’t have great reasons for this belief, but here they are:

In my experience, the worst possible political outcomes rarely occur.  The surprise factor of Lehman wouldn’t be present the second time around.  And the EU isn’t that important.  Also, my take is that EU politicians know what needs to be done with Greece.  They’re just trying to figure out how to do it without getting themselves all fired.  Sharp market falls may have given them the political “cover” they need.

support and resistance imply there’s no rush to buy

Under most conditions, when an index (or an individual security) is trading above a price where a lot of buying and selling has happened in the past, that level acts as a kind of floor, or support, for the index.  It’s hard for the price to go penetrate below it.

If, however, the index/security does penetrate below the support level, it tends to start to act as a ceiling, or resistance, to advance.

Looking at the S&P, 1200, or about 3% above yesterday’s close, is one of those levels.  So, too, is 1250.  They used to be barriers to decline; now they’re barriers to advance.

what I’m doing

…watching.  I’m satisfied for now with the overall shape of my holdings.  I can, however, monitor what I own for names that have fallen less than the market and are rebounding more (that’s good), as well as names that are doing the opposite (they’re strong candidates for elimination).

time to dip a toe in the water?

August 9, 2011 By in Constructing a Portfolio, Current Market Thoughts, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , Leave a comment

dipping atow back in

I found myself buying small amounts of stock late in the afternoon yesterday–TIF and LVS.

Neither will do well in a recession.  But I’m reading the current selloff as more a cocktail of fear and (previously) relatively high valuations than as a harbinger of severe falloff in economic activity from today’s level.

Each stock has dropped by about 25% from its recent high. TIF is trading at about 16x what I think current year earnings will be.  True, LVS has the issue of ongoing litigation by the former head of its Macau operations (he’s asserting regulatory improprieties by LVS there).  But I think the stock is trading at a substantial discount to the value of its fast-growing Asian operations alone (see my recent post on LVS’s earnings)–assuming its US holdings can service their debt but are otherwise worthless.

more attractive stocks?

I’m sure there are other cheap, and perhaps more attractive, stocks but these are the ones that have caught my eye.

why now?

To me, watching myself trying to interpret the market runes, the interesting thing is that I’ve started nibbling.

How so?

We’re now seeing  a massive wave of negative emotion that’s expressing itself very forcefully in sharp stock declines.  Recognizing this, I determined that I was going to bolt myself to the sidelines.

Three observations:

–the market can’t sustain such a high level of fear for a long time, but

–personally, I tend to underestimate the force of these waves, and

–I also tend to underestimate their duration.

So, in a market like the current one–unlike the toing and froing within a clearly defined trading range that we’ve been experiencing over the past several months–experience tells me I’m better off waiting for the market to turn before stepping in.

Nevertheless, I bought a small amount of stock yesterday.

What does this mean?

It could just be one of my flaws as an investor.  It may be that I’m misreading the situation very badly.  If not, this amazingly strong downward movement, where every attempt at a rally quickly peters out, may be closer to its end than the charts suggest.

What should you do?

Obviously, everything depends on your financial situation and your risk tolerance.

I’m a very aggressive investor.  If anything, I tend to be too optimistic and therefore too early.  And all I’m doing is adding about 1% to my stocks.

The best thing for anyone else may be not to transact.  But it wouldn’t hurt to think about what, if anything, you might buy/sell and record those hypothetical trades somewhere to look at after the markets calm down.