Thursday, October 30, 2008

Trick or Threat

"It's the Stay Puft Marshmallow Man."
--Ray Stantz (Ghostbusters)

A couple of posts back, we noted that persistent debt reduction may constitute a stiff headwind against higher equity prices for a prolonged period.

An even more ominous structural threat to stock prices is the massive global movement towards more centrally planned economic configurations. The more we move in the direction of bureaucratic market control, the greater the likelihood of lower future returns on capital.

That, my friends, is singularly bearish for stock prices (and for the world's standard of living) over time.

no positions

Tuesday, October 28, 2008

Condition Rarity

It's been such a long time
I think I should be goin'
And time doesn't wait for me, it keeps on rollin'

With today's triple top breakout, I believe Pfizer registered it's first point and figure buy signal since 2004. Long time? I should say.

Chart courtesy of

Mirage, or is the extended bear market in this name coming to an end? We'll just have to see how things unfold...

position in PFE

Value Hunt

No way, you can fight it every day
But no matter what you say
You know it
The rhythm is gonna getcha
--Gloria Estefan

The recent price waterfall finds many value investors, and even a few long time bears, turning bullish. Buffett, Hussman, Grantham, others. The claim is that, for the first time in years, U.S. equities reflect compelling value.

To be sure, lower prices should make one more bullish. The time to be bearish was when prices were way higher. My own valuation work indeed suggests some pockets of value out there. For example, high quality big pharma names such as Merck (MRK) and Pfizer (PFE) are trading at enterprise value to free cash flow perpetuity levels below .9 (1.0 or lower indicates 'fair value') while sporting 6-8% yields. Historically, such levels have provided compelling entry points in this sector.

Basic materials also reveals some value. Oil refiner Valero (VLO), for instance, trades at a P/E of 3 and yields 4%.

Opportunities do seem to be surfacing, as one might expect with the Dow down nearly 40% this year.

That said, I would not go so far as to say that the entire market is a screaming buy. At true bear market bottoms, the S&P tends to trade at trailing P/Es of 5-7 and dividend yields of 7-8% or higher. Currently 12ish P/Es and 3%ish index yields suggest we have a ways to go--perhaps even 'overshooting' to the low side.

Moreover, my valuation work suggests that the median company is generating puny free cash flow and is lugging a bloated, debt laden balance sheet. Getting to a more positive median context likely requires an extended period of reduced growth and debt reduction.

Seemingly, then, stiff macro headwinds are likely to work against stock price increases. It doesn't mean prices can't go up. But from where I sit, this structural factor poses the primary risk to investment positions in the current market environment.

positions in MRK, PFE, VLO

Sunday, October 26, 2008

Busting Loose

"I love this plan. I'm excited to be a part of it. Let's do it!"
--Dr Peter Venkman (Ghostbusters)

Jim Rogers just did another couple of interviews on Bloomberg about ags, oil, and other commodities. He cleared up one issue I've been struggling with. I've been on board with the so called 'demand destruction' thesis that says commodities will decline in a slowing economy.

The carnage in the commodity space certainly suggests that this is happening.

But Rogers remains bullish, noting that supply is contracting with demand, as producers retire capacity and take new projects off the board with prices smelting lower. Rogers therefore contends that commodities will emerge from this period with fundamentals unimpaired (i.e., supply will continue to outstrip demand).

In past contractions, such 'supply destruction' has caused shorter and shallower declines in commodity prices than in stocks, and led to reestablishment of bull trends when markets firmed.
This is a well reasoned thesis, and it fills in the 'hole' that I thought was present in JR's thought process. Given the massive interventions taking place in global financial systems, as well as the pounded down nature of commodity price, I am now planning to slowly increase my commodity exposure--perhaps to double 2x my current non precious metal commodity holdings.

I will be focusing on the ags, base metals, and energy sector commodity ETFs such as RJA, RJZ, JJE.

positions in RJA, RJZ, JJE

Tuesday, October 21, 2008

Secret Separation

We are passengers in time
Lost in motion, locked together
Day and night, by trick of light
--The Fixx

Nice recent Bloomberg interview with Marc Faber in which he discusses many relevant issues. In fact, I'd say this video is a must view for those seeking a 'non mainstream media' perspective on the economic and financial problems we face.

I wanted to highlight one particular point Marc makes. He notes that, throughout time, a primary argument for government intervention in markets has been to smooth out the peaks and troughs of economic cycles--a cycle that occurs naturally. He sagely notes, however, that while bureaucrats are quick to fill in the valleys during during cyclical downturns, they are reluctant to cut off the peaks during cyclical booms.

This asymmetrical action is one reason why intervention destabilizes, rather than stabilizes, markets.

no positions

Wednesday, October 15, 2008

Burned at the Stake

Walk on by
Walk on through

Walk till you run
And don't look back
For here I am

In the witch hunt to assign blame for the current credit crisis, a growing collective claims that the causes relate to excesses inherent to free markets. Through this lens, unfettered markets are seen as fostering long cycles of greed and fear that manifest in massive booms and violent busts.

Such perspective is interesting, given that few of us have observed truly free markets in our lifetimes. The free market construct, by definition, engages buyers and sellers in voluntary exchange. Market participants are fully responsible for gain or loss associated with their actions. Outside entities generally intervene to mitigate market processes or outcomes.

In reality, modern markets feature a variety of interventionist measures such as price controls, taxes, and regulations. Market interventions are often rooted in times of crisis such as large bankruptcies or wars. Because people tend to restrict information processing and centralize control during times of acute threat (Staw, Sandelands, & Dutton 1981), they are more likely to sacrifice freedom for security in the form of increased state control over markets during economic crises.

Over time, however, the state commonly converts event-driven interference into institutions that influence market behavior on a regular basis. The Federal Reserve, government sponsored enterprises such as Fannie Mae (FNM) and Freddie Mac (FRE), and the Federal Deposit Insurance Corporation exemplify institutions spawned from acute economic events but designed to routinely alter the course of market actions and outcomes.

As such, pinning recent credit turmoil on 'free markets' is nonsensical, since our markets have not been free for many years. The follow-on question is obvious:

"If free markets aren't at the root of the problem, then what drove the extreme credit conditions at the epicenter of the current crisis?"

Although market interventions are often proposed as stabilizing measures, critical thinkers need to consider the role of interventionism in amplifying economic and market cycles.


Staw, B.M., Sandelands, L.E. & Dutton, J.E. 1981. Threat-rigidity effects in organizational behavior: A multi-level analysis. Administrative Science Quarterly, 26: 501-524.

Monday, October 13, 2008

Rally Caps

Ain't got no regrets
And I ain't losin' track
Of which way I'm going
Ain't gonna double back
--Lou Gramm

We got our big market rally on the back of last weekend's G7 meeting that essentially pledged to backstop the world's financial system as we know it. Like others, I made some sales into the historic 900+ point pop in the Dow, and plan to unload most of my incremental exposure added last week into any further liftage.

While this rally may last a while--perhaps many months, I think there's a good chance that we mark new lows next year. Try as I might to invest, the playing field just doesn't appear attractive for long-term commitment.

If (big if) all this intervention gains actual traction against the deflationary headwinds, then it's difficult to see how all this will not impair the dollar and benefit gold (i.e., Jim Roger's 'Inflationary Holocaust' vision).

While I'm comfortable with my current precious metals exposure, I do plan on shifting more funds to other commodity sectors such as crude, natty gas, and agriculture. Nothing crazy or all at once, but I want to gradually increase exposure to various hard assets because chances of an extreme inflationary scenario have recently upticked in my mind.

positions in gold, crude, natural gas

Saturday, October 11, 2008

Patriot Games

"Why should I trade one tyrant three thousand miles away for three thousand tyrants one mile away? An elected legislature can trample a man's rights as easily as a king can."
--Benjamin Martin (The Patriot)

Jim Rogers has been relentless in his protest against government intervention in markets. Two recent examples pertaining to current plans on the table:

Whenever I hear JR speak, I imagine the clear headed, relentless libertarian spirit that drove our country's founding.

Sadly, Jim's actions suggest that he sees little chance that the US will recapture this spirit anytime soon, as he has relocated his family to Singapore.

no positions

Friday, October 10, 2008

Thriving on Chaos

I get knocked down
But I get up again
You're never going to
Keep me down

The intraday market action today was truly one for the ages.

After opening up about 700 in the hole (and below the 8000 level), the Dow sprinted to about even in the first 30 minutes. Over the course of the next few hours, the market sold off to an afternoon low of about -600.

At about 3:15 pm, a 900 handle rally took the averages to +300 on the day. Within minutes, that melted away and the Dow was once again down 200 pts. A couple more excursions into positive territory followed, before the Dow closed down about 40 at 4 pm. After the bell, additional futures action pushed the final tally to -100 or so.

Truly breathtaking movement. And representative of the current chaotic environment.

no positions

Land of Confusion

Ooh superman where are you now
When everything's gone wrong somehow
The men of steel, the men of power
Are losing control by the hour

We're clearly in the midst of a multi-day market crash, with major indices off 20% or more since the beginning of the month. A number of questions have clearly been answered as credit contracts, leverage is unwound, and asset prices melt around the globe.

Q1: In our road to perdition, will deflation or hyperinflation be our initial hurdle?
A: Decidedly the former. Prices are declining as leveraged risk is unwound on a massive scale.

Q2: Is the rest of the world be relatively immune from US credit market problems (the so-called 'decoupling theory')?
A: Nope. Correlation in world asset markets has dramatically increased during the period.

Q3: Will assets of 'fair value', such as stock sporting attractive valuations, escape the selling relatively unscathed?
A: No. In many situations, they go down more. When folks are selling anything that isn't nailed down, they look to items that have yet to get pounded, such as the long held 'consumer safety' stocks like Procter & Gamble (PG), Johnson & Johnson (JNJ), and Exxon Mobil (XOM).

My biggest mistake during this downturn relates to getting Q3 wrong ex ante. I've been accumulating some pounded down names in the pharma sector over the past six months or so. The thesis was that they represented attractive value and had already endured significant price declines. Thus, they'd be more prone to swim against the tide of major selling.

Boy was I wrong. The relative strength of these holdings was good until this last leg down, where forced selling now finds them experiencing daily moves (-5, -8, -10%) greater than names.

So I find myself kicking myself and muttering, "Dang, son, you knew that, during a major deflationary event, the chances of any stock holding up would be low."

Our friend, Clarity, always seems to emerge in hindsight.

no positions

Tuesday, October 7, 2008

The Edge of Night

I keep looking for something I can't get
Broken hearts lie all around me
And I don't see an easy way to get out of this
--Cutting Crew

Back in mid September I opined that it 'felt' like markets were edging over the abyss. Subsequently, at least $1 trillion worth of intervention has been created in attempt to stem the selling and revive comatose credit markets.

Thus far, those efforts aren't working. After yesterday's -350 Dow day (-800 at one point) and -500 today, it feels like we're staring into the abyss once again. In 'normal' market contexts, severely oversold periods like this one suggest a fade trade in the offing.

But these are anything but normal times. The Austrian in me wonders whether the inevitable time--where pent up market forces can no longer be restrained--is finally upon us.

An inflection point lurks ahead. Hard rally, or severe dislocation, seems eminent.

no positions

Monday, October 6, 2008

Flipping Lids

So glad we've almost made it
So sad they had to fade it
Everybody wants to rule the world
--Tears for Fears

While I'm not bashful about voicing my big picture concerns, I was struck by the level of negativity in the media this weekend. When foreign correspondents pile into NYC to get first hand footage of Armageddon in progress, perhaps we're hit a near term extreme in sentiment.

Observing the futes down 200 pts last nite and then more negative vibes emanating from overseas market carnage last nite, I couldn't help feeling constructive for a trade. So, like Toddo, I found myself dusting off the bull costume this morning in order to fade 'em.

Nothing extreme, but I've legged into some pounded down tech names like Applied Materials (AMAT) and Nokia (NOK) with strong balance sheets and, dare I say, perhaps even a whiff of value. Also added to longer standing energy (e.g., VLO) and pharma (e.g., MRK) positions, and put away a sliver more commodity ETF exposure in energy and base metals.

My time horizon? Perhaps a few days/coupla weeks for most of this incremental exposure, cookie. The primary risk? Markets continue down the elevator shaft from here.

The Dow was down about 800 pts intraday today before a swift 500 pt rally in the last hr. That's the kind of action you like to see that suggests an end to a selling cascade. Then again, these times are anything but normal. We'll just have to see what the next few days bring.

positions in AMAT, MRK, NOK, VLO

Saturday, October 4, 2008

One for Two

We can do the innuendo
We can dance and sing
When it's said and done we haven't told you a thing
--Don Henley

Former President Bill Clinton was recently interviewed about the banking crisis. One question asked whether he regretted signing the 1999 bill that repealed the Glass-Steagall Act. Also known as the Banking Act of 1933, Glass-Steagall essentially raised walls between units of diversified financial services companies to inhibit capital flows between units. The act was designed to curtail 'excessive speculation' thought to occur when capital between operating divisions was permitted to flow freely (such as between commerical banking units and brokerage units). Interestingly enough, G-S also ushered in the Federal Deposit Insurance Corporation (FDIC).

Given the high level of speculative leverage at the center of today's credit crush, finger pointers are increasingly blaming the 1999 G-S repeal.

Mr Clinton defended his decision, arguing that the repeal has led to more market stability, not less. And he's right. Less regulation, not more, promotes market stability. His example of Bank of America (BAC) being able to gobble up Merrill Lynch (MER), something that couldn't easily be done under G-S, was a good one. He rightly notes that this relieved some pent up market pressure.

In his response to a subsequent question, however, Mr Clinton lost the points he had earned above, and perhaps then some. He was asked whether government should be involved when financial-services firms fail. He replied, well, let's just quote him:

"I think in this case, the [government] had no choice. And I think the longer you wait, ironically, the more you have to do and the more money you have to spend. So, in a funny way, the people who are most against market intervention wind up having to preside over the biggest market intervention that costs the most money because we all know that markets without disclosure, without capital requirements, without market requirements tend to unsustainable extremes."

Of course, we should expect such a reponse because his administration presided over numerous government orchestrated bailouts including the Mexican peso crisis, the Asian contagion, and the Long Term Capital Management debacle.

His reasoning is backwards. It is intervention that builds distortion in the system. These distortions raise free market forces that 'push back' against interventionist measures. The greater the intervention, the more the distortion, and ultimately the larger the cumulative market forces that will be unleashed to move the system towards a more natural state of equilibrium.

Intervention does not lower corrective costs, it raises them. If unshackled, market forces efficiently move systems towards equilibrium. It's been so long since we've actually had anything resembling a free market, I suppose some confusion can be expected since observational or experiential learning has largely been out of the question.

While Mr Clinton may be no more culpable than any other sitting president since the early 1900s, his administration's interventions have surely added to, not subtracted from, the cumulative problems we face today.

no positions

Whips and Chains

Fire and ice
You come on like a flame
Then you turn a cold shoulder
--Pat Benatar

We moving thru one of the more volatile stretches in market history. Here's some Dow data over the last 30 days or so:




17 days since September 2nd with triple digit moves. Over the past week alone: -778, +485, -20, -348, -157.

Over the month, we've seen the Dow shed nearly 1200 points. The absolute value of these daily changes amount to about 5x this amount.

Natural systems often exhibit extreme volatility before seminal events. The directional influence of such an event if/when remains to be seen.

no positions

Wednesday, October 1, 2008

Free Markets? An Urban Legend

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

Pundits continue to claim that the causes of current economic and financial problems relate to 'free markets run awry' and that increased regulation is necessary.

If such a statement appeared in a manuscript undergoing the rigor of peer review in the academic community, any competent reviewer would highlight the claim as 'empty' and in need of support.

Presenting compelling evidence that markets operate in a free state today would be a tall order. It's much easier to build the opposite case--that markets today are not free at all. Rather, regulation and other forms of intervention influence markets in a decisively 'controlled' fashion.

Consider, for example, some of the restraining forces that can be reasonably linked to current credit market problems. Let's make a partial list:

Federal Reserve. Through its monetary policy, the Fed essentially seeks to fix the price of money and credit. Indeed, the underlying assumption of central banking is that bureaucrats in a room know better than the markets about what the 'proper' price/supply of money and credit should be. It's no stretch to surmise that prolonged periods of keeping money and credit too 'easy' precipitates an orgy of borrowing. The data (e.g., extraordinary credit/debt levels, declining value of the US Dollar over time) support just such a relationship.

Government sponsored housing entities (GSEs). Fannie Mae (FNM) was founded in the late 1930s under the proposition that we needed government intervention to place more people in houses than free markets alone would permit. Once again, the underlying assumption is that policymakers know better than markets. Thus FNM and its younger cousing Freddie Mac (FRE) were structured to lower the cost of borrowing due to their implicit (now explicit) government backing. Thus, borrowers borrowed more and lenders lent more than they would have in an unregulated situation.

Accounting regulations. FASB and other accounting standards have made it nearly impossible for even managers inside financial organizations to understand just how much risk is on the balance sheet. Since organizations were complying with the rules, many folks (fund managers, retail investors, heck even regulators) are likely to presume that things were 'ok.' We're now facing the consequences of decision-makers complying with standards that encouraged disengagement from risk management.

FDIC and other 'endorsed' insurance. Backstopping bank deposits with a government guarantee disengages bank customers from doing due diligence when seeking a depository. Lacking incentive to seek value, customers did not buy in line with their preferences. Thus, depositers dropped funds in risky institutions. And many inefficient operators, who would otherwise be eliminated in a market-based system, have persisted.

Broker-dealer licensing. Requiring security sellers to be licensed by NASD or other agencies also offer customers less incentive to do homework when choosing financial advisors. In a free market system, principles would be forced to study scrutinize their choices before retaining an agent. Instead, lack of engagement in the process provokes an agency problem, where financial advisors and other intermediaries take excessive risk for their clients.

Bailouts during crises. The S&L crisis. The Mexican peso crisis. The Asian contagion. Long Term Capital Management. Post 9/11. Bear Stearns (BSC). AIG (AIG). Lehman (LEH). Fannie/Freddie. WaMu (WM). Wachovia (WB). The pending Bank Bailout. How many times does the government step into these crises with some sort of relief before investors understand that they will be 'helped out' if they take too much risk? Probably not many. The moral hazard issues here are obvious and active.

We could go on, of course (tax laws, Patriot Act, etc) but hopefully you get the picture. The data suggest that our markets are anything but free.

position in USD