reading the paper yesterday morning…

I’m postponing writing about my early days as an oil analyst until tomorrow.

An article in the Wall Street Journal,  “Investor Bind:  How Low Can Oil Go?,” struck my eye as I was waiting a doctor’s office yesterday morning.  Two aspects:

The article quotes a Swiss oil trader as saying the current market for petroleum is “irrational.”  He explained that the craziness consisted in the market concentrating solely on bad news and ignoring any possible ray of sunshine.

Yes, this is irrational.  But, more to the point, this is the essence of a bear market, that good news gets ignored and only bad news gets factored into prices.  (A bull market is just the opposite.  In a bull market, all the bad news goes in one ear and out the other; only the good news has an influence on prices.)  I wonder why he didn’t just say that.  Maybe he did, but the reporter didn’t understand.  On the other hand, maybe he didn’t realize.

Second, the article leads off with hedge fund Tusker Capital, LLC of Manhattan Beach, California.  The fund had been betting heavily on a decline in crude oil prices since at least the middle of last year and has just cashed in its chips after cleaning up oin a major way on the subsequent 60% fall in the oil price.

According to the article, Tusker gained 17% overall in 2014 and is up by 10% for 2015 through mid-January.  Implied, but not explicitly stated, is that the largest part of the +10% this year comes from the bet against the price of crude., with is down by 8.6%.  Why else would it be the lead in a sotry about a crashing oil quote.

The occupational disease of analysts is that they analyze.  As I sat in the waiting room–and waited–it became increasingly clear that I couldn’t make the Tusker numbers make sense.

Tusker has “roughly” $100 million under management now (I take that statement to mean the assets under management are just shy of $100 million, but let’s say $100 million is the right figure).  This means it had $91 million under management on December 31st and $78 million at the end of 2013–assuming no inflows or outflows.

Let’s say all of the $11 million gain in assets under management in early 2015 comes from the negative bet on oil.  If the same bet were maintained through the second half of 2014, it should have produced a gain of about $55 million.  But Tusker’s assets were only up by $13 million in 2014.  Either a lot of customer money left, or something really horrible happened in the rest of the portfolio, or “all” is too high a number.  My hunch is that at least the last is correct.

Let’s say half the 2015 gain comes from the negative bet on oil (regular readers will know that 1/2 is my default guess on most things).  If so, then the bet should have produced a profit of around $27 million in 2014.  Same story, although with somewhat less draconian figures–something else happened that caused $14 million in assets to disappear–disaster or withdrawals, or both–or maybe Tusker initially had a much smaller bet gainst oil that it expanded as crude began to sink.

I later Googled Tusker and found an article, from the New York Post, of all places, that said Tusker had assets of $105 million at the end of June 2013 and that the firm strongly believed that the end of quantitative easing in the US would cause a collapse in commodities prices.

To sum up: Tusker made a hugely successful bet against oil that likely made it $40 million – $70 million.  Yet it now has less money under management than it did 18 months ago (a period during which the S&P 500 went up by about 30%).  There’s certainly a story here.  It may not be about oil, though.




natural resources and economic growth

I ended up with my first stock market job, more or less by accident–and without any finance experience or training–in the late summer of 1978.  A few months later, the firm’s oil analyst was headhunted away and I took his place.  Within a couple of years (an MBA from NYU at night along the way) I had picked up a bunch of metals mining companies, too, and was in charge of the firm’s natural resources research.

The oil industry was (and still is) really non-intuitive–more about my early adventures tomorrow.  Today I want to write about the mining industry, which is a little more straightforward.

natural resources in the 1970s

I started out by reading the annual reports and 10-Ks of the major base metals mining companies for the prior five or six years.  What stood out clearly was that all the firms held very strongly a series of common beliefs, namely:

1.  that global economic growth would continue to be strong for as far into the future as one could imagine,

2.  that the availability of all sorts of base metals–lead for batteries, copper for wiring and tubing, iron ore for steel, and so on–was a necessary condition for this growth

3.  that, therefore, demand for base metals would grow at least in lockstep with GDP increases.

Implicitly, the companies also assumed that:

4. that oversupply was highly unlikely,

5.  that substitution among raw materials–like aluminum or PVC for copper–wouldn’t be an issue, and

6. that, because of 4. and 5., the selling price of output from future orebody discovery/development would never be a concern.

CEOs’ conviction was buttressed by reams of computer paper containing economists’ regression analyses “proving” that all this stuff was true.

a massive investment cycle…

Naturally, the companies, not risk-shy by nature, went all in across the board on new base metals mine development.

As I was reading these documents in 1979-80, the first (of many) massive new low-cost orebodies were coming into production.  This wave turned out to have been enough to keep most base metals in oversupply–and a lot of mines unprofitable–for the following twenty-five years!!!  Miners were also in the midst of a massive switch to exploring for gold, where high value deposits could be developed quickly and at low-cost–causing, in turn, a twenty year glut of the yellow metal.

…that didn’t work out

The mining CEOs turned out to be wrong in a number of ways:

–like any capital-intensive commodity business where the minimum plant size is huge, industry profits for base metals are determined by long cycles of under-capacity followed by massive investment in new mines that causes long periods of over-capacity

–although it wasn’t apparent in the 1970s, substitution of cheaper materials has been a chronic problem for base metals.  Take copper.  There’s aluminum for heat dissipation and wiring, PVC for plumbing, and glass/airwaves for audiovisual transmission.

–Peter Drucker was writing about knowledge workers as early as 1959.  Nevertheless, the mining companies and their economists weren’t able to imagine a world where GDP growth might not require immense amounts of extra physical materials.

I’ve been looking for a sound byte-y way to put this all into perspective.  The best I can do is a gross oversimplification:

–real GDP in the US has expanded by 245% since 1980.  Oil usage is up by about 10% over that period; steel usage is down slightly.  The supposed dependence of GDP growth on increased use of natural resouces simply isn’t true.

Why am I writing about this today?

…it’s because I continue to read and hear financial “experts” say that weak oil and metals prices imply declining world economic activity.  To me this argument makes no sense.




Jim Paulsen’s latest on US stocks in 2015

Although I don’t think I’ve ever met Jim Paulsen, I like his work.  He’s fundamentally sound, with an optimistic bias–kind of the way I’d hope others would describe me.

As I read his most recent Economic and Market Perspective release, he’s trying awfully hard to be bullish   …but can’t find enough facts that will support a bullish position.

The basic issue he’s dealing with is that, as he puts it, the S&P 500 entered 2015 trading at 18x trailing earnings, a high rating the index has achieved only about a quarter of the time in the past.  On the surface, that’s not overly worrying.  If we look at the wider universe of all US stocks, including smaller-cap issues, the NYSE Composite and Nasdaq, however, the US market is trading at record-high levels based on PE, price/cash flow and price/book.

Not only that, but the high valuations aren’t concentrated in a few market sectors, as was the case during the Internet Bubble of the late 1990s.  The median stock has all the characteristics of the averages.

Paulsen’s thinks the best that we can hope for is that stocks will move sideways until value is restored through higher corporate earnings–a process that will probably take all of 2015.  As I read him, he believes it’s highly unlikely that stocks can go up during this period.  There’s a good chance of one or more declines of 10% during the year.  Declines could be deeper.  The only safe haven he can see is in stocks outside the US.

my take

The one factor Paulsen may not be giving enough weight to is the price of alternative investments–here I mean bonds, not hedge funds.

Generally speaking, stocks and bonds are in equilibrium when the interest yield on bonds  =  the earnings yield on stocks, i.e. 1/PE.

In 1973, just before the onset of a major bear market, the 10-year treasury rate was 6.5%.  This would imply a stock market multiple of 15.  The actual multiple on the S&P was 19.

In 1987, just before another major market downturn, the 10-year yield was 7%, implying a stock market multiple of 14.  The actual multiple was about 20.

In 1999, just before the Internet Bubble popped, the 10-year was yielding 6.7%, implying a stock market multiple of 15.  The actual multiple was 30!

Right now, the 10-year Treasury is yielding 1.82%, implying a stock market multiple of 55!  The actual multiple is 18.

My conclusion is that today we’re in a weird situation where there’s little relevant historical precedent.

working backwards

If we work the bonds-stocks equivalence equation the other way and ask what 10-year Treasury yield an 18 multiple on the market implies, the answer is 5.5%.  Even if we take Paulsen’s median multiple for all US stocks of 20, the 10-year Treasury yield should be 5.0%.  This suggests the hard-to-fathom result that current stock prices already factor in all the tightening the Fed is likely to do over the next two or three years.

Looked at a little differently, significant stock market downturns come either when PEs are out of whack with bond yields or when earnings are about to evaporate because of recession, or both.  Neither appears to be the case today.  The closest I can come is the idea that the sharp depreciation of the euro will undermine the 2015 results of US companies with significant euro-based earnings or assets.  But that exposure isn’t big enough to offset even tepid US domestic earnings growth.  And I think the US will be much better than “tepid.”

the bottom line

The fact that an experienced dyed-in-the-wool bull has turned bearish is a cause for worry.  It is also true that PEs are high.  The key difference between Paulsen and myself is how we regard bonds as influencing stock pricing.





what just happened to the Swiss franc (CHF)


Pre-financial crisis one euro bought close to 1.7 chf.

As progressive waves of bad news about the EU financial system broke–that, for example, its banks were stuffed to the gills with worthless US mortgage derivatives, or that Greece had faked its national financial statements for years and was unable to pay its (euro-denominated) national debt–EU investors began to sell their currency and buy the chf, whose value began to rise.

In mid-2011 a sudden spike upward in demand brought the Swiss currency to the point that a euro bought less than a single chf.

the cap

That forced the Swiss National Bank to step in to stabilize its currency, fearing that continuing gains in the chf would have terrible negative effects on tourism and on exporters.  The SNB set a cap on the value of the chf at 1.2 per euro.  The chf could trade cheaper than 1.2 per euro, but the central bank would always be there to buy euros at the 1.2 rate if needed to prevent the chf from appreciating further.


This action fixed the immediate problem of appreciation of the dhf against a key trading partner.  But it did two bad things at the same time:

–it effectively tied the currency to a now-nosediving euro, and

–it expanded the Swiss money supply in a potentially unhealthy way.


This morning the SCB made the surprise announcement that it was going to let the chf float against the euro again, effective immediately.  The currency spiked to 1.0 euro before settling in at around 1.1 euro.

Why the surprise?  

I can think of several reasons:  the Swiss government didn’t want to buy any more euros.  I imagine it anticipated it would be swamped with buy orders for the chf during any phase-out period.  Currency traders may have anticipated this move and been buying boatloads of euros from the Swiss government in recent days, effectively forcing the SCB action.

Why do this at all? 

That’s the interesting part.

Switzerland apparently anticipates that when the ECB embarks on quantitative easing, the result will be some pretty ugly currency action for the euro.


why more equity managers don’t outperform

1.  Most US equity managers, prompted by personal inclination and the wishes of their employers and their institutional clients, adopt either a value (buying undervalued assets) or a growth(buying accelerating profit growth) investment style.  In a typical business cycle, the first two years favor value stocks, the latter two growth issues.  Over that cycle, a manager is likely to have two good years, one so-so year and one bad year.  A skilled manager, however, will outperform over the cycle sc s whole, no matter what his style is.

This is another way of saying that the criterion of outperforming every year is unreasonable.

2.  a truism:  the pain of underperformance lasts long after the glow of outperformance has faded.  A manager who builds a riskier portfolio expecting fame and fortune from significant outperformance risks exploding on liftoff and outperforming badly–thereby losing both his clients and his job. He also gives his firm a significant black eye. No one, however, gets fired for underperforming slightly and being in the middle of the pack of competitors.

As a result, many long-lived investment organizations are constructed on the idea of strong marketing and so-so performance.  I’ve always regarded Merrill as the poster child of this approach in the mutual fund arena.

In other words, outperformance isn’t the most important attribute of a successful investment product.

3.  Most investment organizations find that a running a research department of their own is difficult and expensive.  Many, especially (in my view) the majority which are run by professional marketers, have long since eliminated proprietary research and have been depending heavily on brokerage houses to supply this service.   Doing so has the additional advantage that in-house analysts are no longer a drain on management fees received (brokerage house research is paid for with clients’ commissions).  That “solved” a problem and enhanced profits at the same time.

However, brokerage houses gutted their research departments during the market downturn in 2008-09.  The sharp decline has also accelerated an ongoing trend away from traditional investment managers and toward a diy approach using index funds.

So there’s no longer a plethora of high-quality brokerage reports and no “extra” management fee money to reconstitute proprietary research departments. Where are the good new ideas going to come from?  I think this new client preference for investment performance over salesmanship will create severe difficulties for traditional investment organizations.


an exercise for a choppy market

Many people think that a choppy market–up one day, down the next–like the one we seem to be caught in at the moment yields no information, either about individual stocks or the market as a whole.

This is a mistake.  It’s not as bad as failing to check your portfolio when the market is roaring ahead (everyone checks his stocks all the time in this situation, though) or falling through the floor (when even profressional sometime can’t bring themselves to look).  Still, it’s a mistake.

You don’t necessarily want to make portfolio changes, but you do want to find out two things:

–is your portfolio is geared for an up market or a down one?  …that is, whether your stocks perform well on up days and badly on down days, or vice versa.

It also possible that you have stocks that outperform all the time, or none of it.  The former are probably ones to add to, the latter to consider showing the door.

–how your individual stocks are doing.

The checking is relatively easy.  I use Google Finance, but any other online service will do as well.

Get the chart page and create a chart of the S&P 500 (.inx on Google).  Then enter your stocks/mutual funds/etfs for comparison, three or four at a time.  You can vary the charting period to be:   one day, a specific starting and ending date, or year to date.  Look for overall performance, performance during up periods and performance during down periods.

You can also try longer time periods, like three months, six months, a year or the entire time you’ve owned the stock.

Results can be surprising.  I’ve been doing thisexercise just before writing this post.  I located one clunker that I’d been thinking of as matching the market over the past six or seven months, but it’s been a chronic underperformer.  Embarrassing, maybe, but at least I now know I have a problem to fix.