"Cook, Cook, drink your tea.
But save some in the pot for me.
We'll watch the tea leaves in our cup
When our drink is all sipped up.
Happiness or fortune great,
What will our future be?" - From the book, "Afternoon Tea at Pittock Mansion" by R.Z. Berry
Traders spend hours trying to gain an edge over the market and most of it is like looking at tea leaves to dissect and expectation about future market movements. With the decimation of some of the most prolific momentum stocks in the past few weeks I thought it would be a good to take a look at some market indicators to see what they are telling us if anything. Now some of this may be relatively technical in nature but that is all part of the education process so bear with me and see if you can make sense of my tea leaves.
First off I took a look at the S&P 500 and while it recently made a new high of 1897.28 on April 4th, it subsequently rolled over. It did bounce but does not look like it has the momentum to regain its previous high particularly when you look at the Relative Strength Index which is showing short term weakness. Also given that the Federal Reserve continues to slash its support in $10 billion monthly increments, the catalyst for the market to move higher seems to be gone. Whether it will actually die or consolidate at this level is still open to debate but on the surface it does not look like it will take out the highs in the coming weeks and in fact may even test the 200 day moving average around 1,800 first.
Looking at the fear gauges of Gold and the VIX it still looks like the market is complacent. The VIX is a barometer of market fear as it measures the number of put options to call options in a given market. More put options (an option that bets that the market will fall) shows more concern for future market direction. A VIX of less than 15 shows complacency while a VIX of over 50 points to high risk. Right now the VIX is 14 so there is little in the way of panic. Also while the price of gold seems to have stabilized it is still not showing signs of a full blown recovery in the price. So by both of these measures the market is not expecting a huge draw down but it is at these times of complacency that the Black Swan appears.
I always follow copper closely as that is a good barometer of global industry and while it has taken a beating in the past few months it is actually showing some signs of strength. While this strength is very short term in nature and therefore cannot be considered as showing signs of strong global economic growth a recovery has to start somewhere. So with stock markets looking weak it is always interesting to see a divergence in this commodity from the market movements. More strength in this price might point to a recover in global trade and that would portend to a stronger economic platform on which markets could base a recovery.
Crude oil recently made a new 52 week high of $104 a barrel and this has had a huge impact on the price of gasoline. While this price strength can be attributed to stronger demand and therefore stronger economic growth, the impact of this spike in gasoline prices is not encouraging as a sudden spike in inflation would quickly derail any form of recovery. Consumers are still too cash strapped to handle and extended spike in this price but fortunately the price has quickly fallen to just over $100 a barrel. I would like to see this below $95 a barrel to ensure that there is not a significant impact to economic growth.
A friend of mine showed me some research on interest rate movements since the 70s. The study was done to see the impact of rising interest rates on the market returns but what I found most interesting about the study was that from 1970 to 2007 interest rates rose every 5 years or so. Since 2007 however there really has not been a significant tightening in interest rates and so this recovery is really long in the tooth. The basic premise is that interest rates have to rise soon but looking at the overall data of low inflation, high unemployment and continued significant (although slowing) stimulus I would expect interest rates to remain low for an extended period. While this may be good for the market a quick look at Japan shows that even with low interest rates particularly when those are low for an extended period of time there is no guarantee of a continued burgeoning market. In fact the length of time between raising rates is signalling problems rather than good times so more of the same will have more and more of a negative impact as the magnitude of the problem is truly understood.
Now I could go on with more indicators but the above is a good barometer that the market is really in a quandary right now. There are no clear signals that point to continued strength or to a total collapse and so I would not be surprised to see the market drift along aimlessly until a new catalyst is found. What that catalyst is I cannot fathom a guess but I would not think it a time to be overly optimistic and in this type of market caution is often your best friend.
Friday, April 25, 2014
Friday, April 18, 2014
Is Volatility Risk?
"Traders can cause short-term volatility. in the long run, the market must revert to a sensible price/earnings multiple." - Ben Stein
"Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever." - Nassim Taleb
"We are facing extreme volatility." - Carlos Ghosn
Modern society has determined that it has the tools to smooth out volatility. We can witness these efforts at work in government, central banks, medicine, work and even at home. The question is whether all of this effort to alleviate day to day variability is beneficial or is this massive effort really the cause of all the pain?
As we all know volatility is a movement around a so called norm or trend. In stocks volatility is seen as large movements in the price of the stock either up or down away from the trend line of mean. In most cases people ignore the large upward move as that more often than not is a benefit so beneficial movements (even though they are volatile) are considered good and are ignored. The same can be said for the economy, accelerating economic growth is considered acceptable but as with stocks excessive acceleration is worrisome and in most cases is met with a central banker that tries to slow the growth to a more "normal" level.
Most people consider volatility associated with their paycheck as bad but some of us (normally the entrepreneur) loves this volatility as it offers the opportunity to make a lot more money. Vaccines are constantly being created and worked on to protect the world against disease and cleaning agents try to eradicate germs. Governments that are rouge are taken out and replaced with more conservative middle of the road ideals and mothers and fathers around the world try to protect their kids from bully's and nurture them in a way completely different from the real world.
The problem with all of this is that we evolve through volatility. Germs become stronger to fight back against the newest drug, they evolve into ever more powerful aliens that kill more people in hospitals than in motor car accidents. Puppet governments fall apart in time as given complete power they ultimately fail through lack of attention to detail and a sense of self-entitlement. Take Mugabe and Saddam Husein as two people placed into power by the United States to maintain the peace. There are obviously more examples of people placed in power by countries other than the United States but these are two readily available examples. Our DNA advances by learning from previous generations and fixing those weaknesses (only the strong survive).
Central governments are continually tinkering with the markets to create a "normal" environment so that in the end no-one knows what "normal" really is. What we do know is that these efforts to placate the markets has always ended in more bloodshed than if the markets were left to their own devices. Furthermore each time the market collapses the reserve bankers step in to try to "repair" the problem by adding liquidity or artificially moving interest rates which causes another problem elsewhere.
Now before you think I am advocating the complete removal of all government bodies and to live like John Lennon says we should in his song Imagine, I am not. There is a place for authorities to monitor certain situations and prevent a complete collapse caused by crowd hysterics or to provide law and order but outside of that framework the markets need to be left to handle themselves. Consider if Greenspan had not provided support for the Internet bubble. Meddling to save the market created the low interest rate environment which caused the housing bubble which has now lead to the largest experiment known to man. What would the real implications have been to let the technology bubble burst? The collapse of the banking system in 2007 was far more serious than the original problem and now that we have propped up that mess with $4 trillion no-one can even fathom a guess at the problems this will cause.
On a separate note, my friend John Cox is advocating a larger government body to repair the broken political system that is California. While on the surface this idea appears to be madness, in effect what he is offering is more volatility at the local level to ensure less trouble at the top thereby actually repairing the problem caused by too much power in the hands of too few people. This type of system is working admirably in other parts of the globe (Switzerland to name one) and could be what we need but moving the mindset of the average citizen will be a monumental task so if possible given him your support.
In conclusion, small, regular amounts of volatility is the ingredient that alleviates massive economic and political turmoil. Trying to end small uncomfortable problems associated with volatility causes greater global imbalances and will result in greater problems. Until we can accept this and change the way that problems are dealt with, the future will continue to be filled with large economic shocks to society at regular intervals. It is inevitable and unavoidable and as this idea is imbedded in most political parties around the globe (China included) the only thing we can do is prepare for large scale shocks in the future.
"Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever." - Nassim Taleb
"We are facing extreme volatility." - Carlos Ghosn
Modern society has determined that it has the tools to smooth out volatility. We can witness these efforts at work in government, central banks, medicine, work and even at home. The question is whether all of this effort to alleviate day to day variability is beneficial or is this massive effort really the cause of all the pain?
As we all know volatility is a movement around a so called norm or trend. In stocks volatility is seen as large movements in the price of the stock either up or down away from the trend line of mean. In most cases people ignore the large upward move as that more often than not is a benefit so beneficial movements (even though they are volatile) are considered good and are ignored. The same can be said for the economy, accelerating economic growth is considered acceptable but as with stocks excessive acceleration is worrisome and in most cases is met with a central banker that tries to slow the growth to a more "normal" level.
Most people consider volatility associated with their paycheck as bad but some of us (normally the entrepreneur) loves this volatility as it offers the opportunity to make a lot more money. Vaccines are constantly being created and worked on to protect the world against disease and cleaning agents try to eradicate germs. Governments that are rouge are taken out and replaced with more conservative middle of the road ideals and mothers and fathers around the world try to protect their kids from bully's and nurture them in a way completely different from the real world.
The problem with all of this is that we evolve through volatility. Germs become stronger to fight back against the newest drug, they evolve into ever more powerful aliens that kill more people in hospitals than in motor car accidents. Puppet governments fall apart in time as given complete power they ultimately fail through lack of attention to detail and a sense of self-entitlement. Take Mugabe and Saddam Husein as two people placed into power by the United States to maintain the peace. There are obviously more examples of people placed in power by countries other than the United States but these are two readily available examples. Our DNA advances by learning from previous generations and fixing those weaknesses (only the strong survive).
Central governments are continually tinkering with the markets to create a "normal" environment so that in the end no-one knows what "normal" really is. What we do know is that these efforts to placate the markets has always ended in more bloodshed than if the markets were left to their own devices. Furthermore each time the market collapses the reserve bankers step in to try to "repair" the problem by adding liquidity or artificially moving interest rates which causes another problem elsewhere.
Now before you think I am advocating the complete removal of all government bodies and to live like John Lennon says we should in his song Imagine, I am not. There is a place for authorities to monitor certain situations and prevent a complete collapse caused by crowd hysterics or to provide law and order but outside of that framework the markets need to be left to handle themselves. Consider if Greenspan had not provided support for the Internet bubble. Meddling to save the market created the low interest rate environment which caused the housing bubble which has now lead to the largest experiment known to man. What would the real implications have been to let the technology bubble burst? The collapse of the banking system in 2007 was far more serious than the original problem and now that we have propped up that mess with $4 trillion no-one can even fathom a guess at the problems this will cause.
On a separate note, my friend John Cox is advocating a larger government body to repair the broken political system that is California. While on the surface this idea appears to be madness, in effect what he is offering is more volatility at the local level to ensure less trouble at the top thereby actually repairing the problem caused by too much power in the hands of too few people. This type of system is working admirably in other parts of the globe (Switzerland to name one) and could be what we need but moving the mindset of the average citizen will be a monumental task so if possible given him your support.
In conclusion, small, regular amounts of volatility is the ingredient that alleviates massive economic and political turmoil. Trying to end small uncomfortable problems associated with volatility causes greater global imbalances and will result in greater problems. Until we can accept this and change the way that problems are dealt with, the future will continue to be filled with large economic shocks to society at regular intervals. It is inevitable and unavoidable and as this idea is imbedded in most political parties around the globe (China included) the only thing we can do is prepare for large scale shocks in the future.
Friday, April 4, 2014
The Elephant and the Bicycle
"China is like an elephant riding a bicycle. If it slows down, it could fall off, and then the earth might quake." - James Kynge's book China Shakes the World
After 30 years of economic growth of more than 8% a year it appears that China has finally reached the end of the road. During the 30 years of expansion there were a few bumps in the road but nothing like the Great Recession. Like most investors that get used to an extended bull market the Chinese government did what it always had done and that was to support their economy. They had the resources and so they sprang into action running a massive deficit, pushing interest rates down to extremely low levels and injecting large quantities of debt. The idea, as with all stimulus packages, was to weather the storm from the West and ramp up in preparation for the coming global expansion. When that global expansion took hold they could mop up the excess liquidity and stimulus and profit from the continued economic growth of 8%.
Unfortunately 8 years later the world still has not recovered and the stimulus has created bubbles and excesses all over China making it look like economic growth in China may finally stall bringing the elephant off the bicycle. Should this happen the repercussions will be felt across the globe as China is now the world's second largest economy, it has massive foreign reserves invested in all the developed nations and has grown itself into a hugely important consumer and industrial market.
As with all attempts to stimulate an economy with debt, the economy becomes addicted and unless more is produced exiting is painful. Debt produces excesses as why not risk the farm if it is owned by the bank anyway? It is not your money so keep producing until your line of credit is taken away and then, taking the remaining cash, head onto the next project and leave the mess to the bond holders. This should sound pretty familiar to most of you who follow this blog and certainly China is not alone in this quandary but let's look at some of the metrics pointing to excesses:
1. China has only consumed 65% of the cement it has produced in the past 5 years.
2. Steel production is larger than the next seven largest producers combined.
3. More than 27 billion square feet of new construction is vacant but more than 1.8 billion more is currently under construction.
4. Property prices in large metropolitan areas is almost 40 times the rental cost.
These are just some of the metrics that show the large excesses that their stimulus has created and the problem is that unless there is significant economic growth these problems will be transferred to the banks and we have all witnessed the problems associated with a financial crisis. Furthermore a large part of the globe's economic recovery was based on China and the continued growth of the BRIC nations. These nations continued to expand while the United States continued to print money but, with the reduction in stimulus from the Federal Reserve, the quick money is leaving these markets and showing them to be very vulnerable.
So for the past 30 years China has been seen as an economic miracle and has managed to avoid the kind of hard landings felt in the rest of the world for the simple reason that their economy was based on solid economic growth. This has now changed as they have finally succumbed to the West's economic stimulus models and with it we could witness for the first time the elephant fall off the bicycle and this shock will be felt across the globe.
After 30 years of economic growth of more than 8% a year it appears that China has finally reached the end of the road. During the 30 years of expansion there were a few bumps in the road but nothing like the Great Recession. Like most investors that get used to an extended bull market the Chinese government did what it always had done and that was to support their economy. They had the resources and so they sprang into action running a massive deficit, pushing interest rates down to extremely low levels and injecting large quantities of debt. The idea, as with all stimulus packages, was to weather the storm from the West and ramp up in preparation for the coming global expansion. When that global expansion took hold they could mop up the excess liquidity and stimulus and profit from the continued economic growth of 8%.
Unfortunately 8 years later the world still has not recovered and the stimulus has created bubbles and excesses all over China making it look like economic growth in China may finally stall bringing the elephant off the bicycle. Should this happen the repercussions will be felt across the globe as China is now the world's second largest economy, it has massive foreign reserves invested in all the developed nations and has grown itself into a hugely important consumer and industrial market.
As with all attempts to stimulate an economy with debt, the economy becomes addicted and unless more is produced exiting is painful. Debt produces excesses as why not risk the farm if it is owned by the bank anyway? It is not your money so keep producing until your line of credit is taken away and then, taking the remaining cash, head onto the next project and leave the mess to the bond holders. This should sound pretty familiar to most of you who follow this blog and certainly China is not alone in this quandary but let's look at some of the metrics pointing to excesses:
1. China has only consumed 65% of the cement it has produced in the past 5 years.
2. Steel production is larger than the next seven largest producers combined.
3. More than 27 billion square feet of new construction is vacant but more than 1.8 billion more is currently under construction.
4. Property prices in large metropolitan areas is almost 40 times the rental cost.
These are just some of the metrics that show the large excesses that their stimulus has created and the problem is that unless there is significant economic growth these problems will be transferred to the banks and we have all witnessed the problems associated with a financial crisis. Furthermore a large part of the globe's economic recovery was based on China and the continued growth of the BRIC nations. These nations continued to expand while the United States continued to print money but, with the reduction in stimulus from the Federal Reserve, the quick money is leaving these markets and showing them to be very vulnerable.
So for the past 30 years China has been seen as an economic miracle and has managed to avoid the kind of hard landings felt in the rest of the world for the simple reason that their economy was based on solid economic growth. This has now changed as they have finally succumbed to the West's economic stimulus models and with it we could witness for the first time the elephant fall off the bicycle and this shock will be felt across the globe.
Friday, March 28, 2014
The Energy Giant
"But Big Oil and Big Coal have always been as skilled at propoganda as they are at mining and drilling. Like the tobacco industry before them, their success depends on keeping Americans stupid." - Jeff Goodell
Quick question - who is the energy giant of the world at present? No it is not Saudi Arabia or Russia or any of the other OPEC nations, it is the United States with strong support from Canada. Fraking for natural gas and opening areas to drilling plus new drilling techniques has unleashed a new global powerhouse in the world of energy. The United States is awash with natural gas and is producing more oil per day than Saudi Arabia (some people question this last metric but all agree that if it is not producing more oil right now it will be by the end of 2015). I have argued that this change in the balance of power is more important than anything else we have witnessed in the past 20 years as not only does this shift the global balance of power once again firmly towards the United States, it could be the source of renewed wealth and growth in a country in dire need of a way out of the hole dug by years of overspending.
Let's first look at the job requirements for this energy boom. There are reports of a shortage of welders to weld the pipes and other steel structures required, ships, storage units, refineries, dredgers to keep the Houston water way deep enough to allow larger vessels to navigate the ports, ports, engineers, construction crews, LNG plants and more all needed to support this huge and growing industry. Wages are spiraling higher in this industry as the shortage of skilled workers is being felt. The industry is hiring thousands of people who are relocating to places like North and South Dakota and various other inland states. Small towns are bursting at the seams trying to accommodate the influx of people. All in all it is a great time to be in the oil trade in the United States.
The export of refined oil is also growing and refineries are running at full capacity. More are needed to keep up with both the global demand for refined oil and the supply of oil flowing in from the north (the bulk of the refiners are in the southern states). As the Keystone pipeline is locked up in congress oil is being shipped in trucks, barges, ships and railroad cars. With all this oil moving around the country it is surprising that there have not been more catastrophes, particularly when you learn that a lot of the railroad cars shipping the oil are old and do not have the safety features of newer cars. The reason is that there is no requirement to have new cars built but I would imagine that this law will soon be changed.
Assuming that congress or the environmentalists do not shut this industry down, the longevity of the business could be enough to suck up a large enough portion of the population to make a dent in the stubborn unemployment numbers. While I doubt that congress will create policies to shut off this massively important and hugely influential lobby group, the environmentalists may slow down growth with lawsuits and other maneuvers (just look at the Keystone pipeline project). They are alarmed (with good reason) at the impacts that another massive spill could have; not to mention the issues with fraking such as leaking oil into aquifers, earthquakes and the release of toxins into the atmosphere to name just a few. That said it appears that this industry will win out and that the economic benefits will be felt for years to come.
So if that is the case then there is suddenly a huge shift in global power. Russia for example has relied on its energy and particularly its natural gas shipments to Europe to bully its way to concessions. The United States and northern African nations now have more than enough natural gas capacity to provide Europe with natural gas. As time progresses Europe should and is building LNG facilities to allow for shipments of LNG to come from these nations undermining the Russian threat. While this will take a while it certainly is something I am sure is at the back of the Kremlin's mind during these tense times.
The Middle East has always been a hot spot and the United States has spent trillions of dollars over the years trying to secure its oil requirements. With this requirement waning it will be interesting to see how this impacts future administrations and how they view conflict in that region. Certainly the United States will want to ensure a peaceful region and continue to purchase energy from the Middle East but with a stable supply of energy at home it may make it less prone to attack and more prone to sanctions. A smaller military requirement would also save the country tens of billions of dollars a year and go a long way to getting the budget back in order.
So while I am not going to go out and say that this is our way out, what I will say is that handled correctly the explosion in the energy business in the United States is going to have a profound economic and social impact on the globe over the next twenty plus years. Let's hope that the industry manages itself with integrity and that congress uses the new influx of tax dollars to invest wisely rather than fritter away another, if not their last, opportunity.
Quick question - who is the energy giant of the world at present? No it is not Saudi Arabia or Russia or any of the other OPEC nations, it is the United States with strong support from Canada. Fraking for natural gas and opening areas to drilling plus new drilling techniques has unleashed a new global powerhouse in the world of energy. The United States is awash with natural gas and is producing more oil per day than Saudi Arabia (some people question this last metric but all agree that if it is not producing more oil right now it will be by the end of 2015). I have argued that this change in the balance of power is more important than anything else we have witnessed in the past 20 years as not only does this shift the global balance of power once again firmly towards the United States, it could be the source of renewed wealth and growth in a country in dire need of a way out of the hole dug by years of overspending.
Let's first look at the job requirements for this energy boom. There are reports of a shortage of welders to weld the pipes and other steel structures required, ships, storage units, refineries, dredgers to keep the Houston water way deep enough to allow larger vessels to navigate the ports, ports, engineers, construction crews, LNG plants and more all needed to support this huge and growing industry. Wages are spiraling higher in this industry as the shortage of skilled workers is being felt. The industry is hiring thousands of people who are relocating to places like North and South Dakota and various other inland states. Small towns are bursting at the seams trying to accommodate the influx of people. All in all it is a great time to be in the oil trade in the United States.
The export of refined oil is also growing and refineries are running at full capacity. More are needed to keep up with both the global demand for refined oil and the supply of oil flowing in from the north (the bulk of the refiners are in the southern states). As the Keystone pipeline is locked up in congress oil is being shipped in trucks, barges, ships and railroad cars. With all this oil moving around the country it is surprising that there have not been more catastrophes, particularly when you learn that a lot of the railroad cars shipping the oil are old and do not have the safety features of newer cars. The reason is that there is no requirement to have new cars built but I would imagine that this law will soon be changed.
Assuming that congress or the environmentalists do not shut this industry down, the longevity of the business could be enough to suck up a large enough portion of the population to make a dent in the stubborn unemployment numbers. While I doubt that congress will create policies to shut off this massively important and hugely influential lobby group, the environmentalists may slow down growth with lawsuits and other maneuvers (just look at the Keystone pipeline project). They are alarmed (with good reason) at the impacts that another massive spill could have; not to mention the issues with fraking such as leaking oil into aquifers, earthquakes and the release of toxins into the atmosphere to name just a few. That said it appears that this industry will win out and that the economic benefits will be felt for years to come.
So if that is the case then there is suddenly a huge shift in global power. Russia for example has relied on its energy and particularly its natural gas shipments to Europe to bully its way to concessions. The United States and northern African nations now have more than enough natural gas capacity to provide Europe with natural gas. As time progresses Europe should and is building LNG facilities to allow for shipments of LNG to come from these nations undermining the Russian threat. While this will take a while it certainly is something I am sure is at the back of the Kremlin's mind during these tense times.
The Middle East has always been a hot spot and the United States has spent trillions of dollars over the years trying to secure its oil requirements. With this requirement waning it will be interesting to see how this impacts future administrations and how they view conflict in that region. Certainly the United States will want to ensure a peaceful region and continue to purchase energy from the Middle East but with a stable supply of energy at home it may make it less prone to attack and more prone to sanctions. A smaller military requirement would also save the country tens of billions of dollars a year and go a long way to getting the budget back in order.
So while I am not going to go out and say that this is our way out, what I will say is that handled correctly the explosion in the energy business in the United States is going to have a profound economic and social impact on the globe over the next twenty plus years. Let's hope that the industry manages itself with integrity and that congress uses the new influx of tax dollars to invest wisely rather than fritter away another, if not their last, opportunity.
Friday, March 21, 2014
Yellen's Unemployment Focus
"We know we're not close to full employment, not close to an employment level consistent with our mandate, and unless inflation were a significant concern, we wouldn't dream of raising the federal funds rate target." - Janet Yellen Federal Reserve Chair
The quote above is from Janet Yellen's first Federal open Market Committee and I have to say that it is refreshing that at least she is speaking in relatively easy to understand sentences. Remember Alan Greenspan? One of my favorite quotes from him was, "I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." He was the master of disguising his meanings and for some reason everyone loved him mainly because the stock market went on a tear to remember.
Yellen has a different problem to Greenspan in that no matter what she says or does it will be incredibly hard to get the economy kick started and remove the Federal Reserve stimulus and the excess money printed by her predecessors without creating either a very bad recession or huge inflation. Greenspan on the other hand was the first to print money so the impact was huge with small denominations of cash. Bernanke took printing to an unprecedented level and after it had little impact (other than to the stock market) he handed over the reigns to Yellen to try to deal with the coming issues. So it was interesting to listen to the new Federal Reserve Chair talk about her main concern at the present time which is unemployment. Her belief is that interest rates should remain low until such time as unemployment picks up and she detailed the metrics that she is looking at to track improvement. Fortunately I think she is on the right track with her employment metrics but I have little faith that her policies will have much impact.
1. U-6 - The U-6 is a broad measure of unemployment that I have been following for years. This measure captures the underemployed (those who would prefer a full time job but have to work part time as there are no full time positions open). By this measure the unemployment rate is 12.6% a far worse level than the 6.7% reported by the unemployment number.
2. Long-term unemployment - This measure looks at people out of work for 6 months or longer. In 2010 this stood at 45% of the unemployed and has since improved to 37% but is well above the 17% pre-recession number.
3. Labor force participation rate - This measure I have also tracked for years. The number reflects people able to work versus the number working and in December it fell to its lowest level in 35 years. This is terrible for growth prospects as less people working means lower GDP and economic growth prospects.
4. Quitting and hiring - People only quit their jobs if they think that a better opportunity presents itself (being fired is a whole different story of course). Therefore the more people that quit the better the health of the job market and thereby the economy. Yellen also wants to look at hiring as this also shows a poor or robust economy. So far the numbers have revealed that while the "quitting" index has improved, the number of hirings is still woefully inadequate. To me this measure smacks of people not only being fed up with their job but also relying on social handouts rather than showing opportunity.
5. Wage growth - Growth in wages has been anemic. As I have discussed in earlier blogs earnings are at the equivalent of 1980 earnings (when factored against inflation) and their current growth of 2% is still not keeping up with inflation. While the Federal Reserve has as its benchmark an inflation rate of 1.2% you and I know that this number is a very poor reflection of the true increases in our daily cost of living.
With inflation low and unemployment anemic, the Federal Reserve has a lot of latitude in what it can do to stimulate the economy. The question therefore is will the new Fed Chair implement policies to take the bull by the horns and unfortunately that answer is an unequivocal no!
As you can see from the unemployment metrics the economy is not on a good footing. Employment leads to wages, wages lead to spending and spending leads to a healthy economy. Until these measures can improve her mindset is to keep rates low as that is the key to boost economic growth. It is interesting then that she continues to cut the amount of monthly stimulus as past Federal Chairs have looked at stimulus as the only way to engineer growth and keep interest rates in check. Maybe she realizes the futility of these methods or maybe she is just testing the market to see how low she can go in terms of stimulus before things take a turn for the worse. Either way she will not be able to keep rates low without artificially supporting them with more money and in all honesty as Bernanke showed, neither of these policies will stimulate employment.
So once again we have a Federal Chair that monitors the numbers but does not provide a policy that will address the underlying issues. Until such a policy is put in place it is just a matter of time before she is forced to increase monetary stimulus in a another futile effort to grow the economy. While she is new she should take the opportunity to implement new policies but it appears that she will continue down the same path until there is a problem. Why try to improve something until it breaks? To me this is equivalent to standing in front of the Hoover Dam waiting for the wall to break even while you see cracks appearing so I choose to move out of the way of the coming floods.
The quote above is from Janet Yellen's first Federal open Market Committee and I have to say that it is refreshing that at least she is speaking in relatively easy to understand sentences. Remember Alan Greenspan? One of my favorite quotes from him was, "I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said." He was the master of disguising his meanings and for some reason everyone loved him mainly because the stock market went on a tear to remember.
Yellen has a different problem to Greenspan in that no matter what she says or does it will be incredibly hard to get the economy kick started and remove the Federal Reserve stimulus and the excess money printed by her predecessors without creating either a very bad recession or huge inflation. Greenspan on the other hand was the first to print money so the impact was huge with small denominations of cash. Bernanke took printing to an unprecedented level and after it had little impact (other than to the stock market) he handed over the reigns to Yellen to try to deal with the coming issues. So it was interesting to listen to the new Federal Reserve Chair talk about her main concern at the present time which is unemployment. Her belief is that interest rates should remain low until such time as unemployment picks up and she detailed the metrics that she is looking at to track improvement. Fortunately I think she is on the right track with her employment metrics but I have little faith that her policies will have much impact.
1. U-6 - The U-6 is a broad measure of unemployment that I have been following for years. This measure captures the underemployed (those who would prefer a full time job but have to work part time as there are no full time positions open). By this measure the unemployment rate is 12.6% a far worse level than the 6.7% reported by the unemployment number.
2. Long-term unemployment - This measure looks at people out of work for 6 months or longer. In 2010 this stood at 45% of the unemployed and has since improved to 37% but is well above the 17% pre-recession number.
3. Labor force participation rate - This measure I have also tracked for years. The number reflects people able to work versus the number working and in December it fell to its lowest level in 35 years. This is terrible for growth prospects as less people working means lower GDP and economic growth prospects.
4. Quitting and hiring - People only quit their jobs if they think that a better opportunity presents itself (being fired is a whole different story of course). Therefore the more people that quit the better the health of the job market and thereby the economy. Yellen also wants to look at hiring as this also shows a poor or robust economy. So far the numbers have revealed that while the "quitting" index has improved, the number of hirings is still woefully inadequate. To me this measure smacks of people not only being fed up with their job but also relying on social handouts rather than showing opportunity.
5. Wage growth - Growth in wages has been anemic. As I have discussed in earlier blogs earnings are at the equivalent of 1980 earnings (when factored against inflation) and their current growth of 2% is still not keeping up with inflation. While the Federal Reserve has as its benchmark an inflation rate of 1.2% you and I know that this number is a very poor reflection of the true increases in our daily cost of living.
With inflation low and unemployment anemic, the Federal Reserve has a lot of latitude in what it can do to stimulate the economy. The question therefore is will the new Fed Chair implement policies to take the bull by the horns and unfortunately that answer is an unequivocal no!
As you can see from the unemployment metrics the economy is not on a good footing. Employment leads to wages, wages lead to spending and spending leads to a healthy economy. Until these measures can improve her mindset is to keep rates low as that is the key to boost economic growth. It is interesting then that she continues to cut the amount of monthly stimulus as past Federal Chairs have looked at stimulus as the only way to engineer growth and keep interest rates in check. Maybe she realizes the futility of these methods or maybe she is just testing the market to see how low she can go in terms of stimulus before things take a turn for the worse. Either way she will not be able to keep rates low without artificially supporting them with more money and in all honesty as Bernanke showed, neither of these policies will stimulate employment.
So once again we have a Federal Chair that monitors the numbers but does not provide a policy that will address the underlying issues. Until such a policy is put in place it is just a matter of time before she is forced to increase monetary stimulus in a another futile effort to grow the economy. While she is new she should take the opportunity to implement new policies but it appears that she will continue down the same path until there is a problem. Why try to improve something until it breaks? To me this is equivalent to standing in front of the Hoover Dam waiting for the wall to break even while you see cracks appearing so I choose to move out of the way of the coming floods.
Friday, March 14, 2014
Growth AND Value - Where More IS Better
When I was playing a lot of golf my golf coach would always make fun of the fact that when I made a change to my golf swing or setup that improved my game I would naturally and unconsciously do more of the change which would ultimately result in disaster. There was a tipping point when a small change was good but more was not better! I can still hear his words ringing in my ears "More is not better!"
This tip could be taken to a number of places and in most cases finance is one of them. Buying more of a losing stock is one example as all that more did was lose you more money. Adding more risk to an already risky investment is not better and neither is adding more debt to an otherwise overly levered investment. One place where it does ring true however is finding stocks with better growth prospects than its peers and having more value. Also if you add the two together; doubly more is doubly better (I know poor English but I could not resist).
Typically investors look for value stocks or growth stocks but it is only when you find a deep value stock that has extraordinary growth prospects then you truly have a home run. The idea of diversification is to scatter money around so that you might get lucky and hit one of these but this waters down the overall returns which is why people search for these stocks all their lives. I have found a few of these in my life and let me tell you they will exceed your wildest expectations of returns. The hardest part is not selling too early but that is the art. The science is finding these stocks.
Now before you get too excited I am not about to tell you the names of these companies for the simple reason that since finding DDD I have yet to find another one. If I do I will let you in on the secret but until then it is your job to search for the next one (and let me know) and believe me it is not easy and I have found that luck often plays a part. Take for example one fortuitous day when I met the CEO of Encore Capital, a local company in San Diego. Carl was an incredibly detailed person and he had the company whipped into shape during his tenure as the turnaround expert. The market capitalization as represented by the stock price was languishing at a third of cash flow. That is right, you could have purchased the entire company using only one third of one year's cash flows. The market had forgotten about this company. It was a deep value stock.
Now for those of you searching for deep value (as I have done most of my life) you will often times find that the stock price does not move for years. It remains deep value forever and you are not rewarded for your wonderful find. The reason for this is that while it may be a safe investment that is producing significant cash flow, the growth prospects do not warrant a premium over the market and for this reason it sits, stuck as a deep value stock forever, increasing in value slowly over time as the cash position improves. Holding this position results in opportunity costs and selling is hard because you are sure that the moment you sell it will take off. The result is lackluster performance.
Now Encore at the time was not only a deep value play but its growth prospects were huge. The market for their products was expanding and with it Encore's prospects. I therefore loaded up on as much of their stock as was possible without moving the price of the share and then once I was filled sat back and waited. Now as its growth started to accelerate right as I was buying it did not take long for the market to wake up to this fact and within 18 months the stock had appreciated by 1,500%!
So when you look for stocks make sure that you are digging around not only for value but also for growth. Value without growth often lags the market and growth without value increases the risk of the investment tremendously. Growth stocks can trade at price to earnings multiples in the hundreds as investors drive the stock into orbit expecting the growth to continue forever. The risk is that once the company fails to grow as quickly, not only does the stock take a hit from the reduced profitability but also from the narrowing of the multiple - a double whammy which shows the risk inherent in buying a growth stock when it has already left the starting blocks. You need to jump on the bandwagon early and this is why a search for value plays is necessary even if you are an inherent growth investor.
Finding a deep value stock with growth prospects is thus the best possible way to minimize the risk of the investment and maximize the return. This will require a lot of patience as I would be surprised if you manage to find more than 20 in your lifetime. I say that not to scare you away from looking but to let you know that the market is relatively efficient and will more often than not reward these stocks well before you find them. I also mention it because if you work hard enough at it and then find one, do not hesitate but back up the truck and load as much on board as you can as this will be a life changing investment.
This tip could be taken to a number of places and in most cases finance is one of them. Buying more of a losing stock is one example as all that more did was lose you more money. Adding more risk to an already risky investment is not better and neither is adding more debt to an otherwise overly levered investment. One place where it does ring true however is finding stocks with better growth prospects than its peers and having more value. Also if you add the two together; doubly more is doubly better (I know poor English but I could not resist).
Typically investors look for value stocks or growth stocks but it is only when you find a deep value stock that has extraordinary growth prospects then you truly have a home run. The idea of diversification is to scatter money around so that you might get lucky and hit one of these but this waters down the overall returns which is why people search for these stocks all their lives. I have found a few of these in my life and let me tell you they will exceed your wildest expectations of returns. The hardest part is not selling too early but that is the art. The science is finding these stocks.
Now before you get too excited I am not about to tell you the names of these companies for the simple reason that since finding DDD I have yet to find another one. If I do I will let you in on the secret but until then it is your job to search for the next one (and let me know) and believe me it is not easy and I have found that luck often plays a part. Take for example one fortuitous day when I met the CEO of Encore Capital, a local company in San Diego. Carl was an incredibly detailed person and he had the company whipped into shape during his tenure as the turnaround expert. The market capitalization as represented by the stock price was languishing at a third of cash flow. That is right, you could have purchased the entire company using only one third of one year's cash flows. The market had forgotten about this company. It was a deep value stock.
Now for those of you searching for deep value (as I have done most of my life) you will often times find that the stock price does not move for years. It remains deep value forever and you are not rewarded for your wonderful find. The reason for this is that while it may be a safe investment that is producing significant cash flow, the growth prospects do not warrant a premium over the market and for this reason it sits, stuck as a deep value stock forever, increasing in value slowly over time as the cash position improves. Holding this position results in opportunity costs and selling is hard because you are sure that the moment you sell it will take off. The result is lackluster performance.
Now Encore at the time was not only a deep value play but its growth prospects were huge. The market for their products was expanding and with it Encore's prospects. I therefore loaded up on as much of their stock as was possible without moving the price of the share and then once I was filled sat back and waited. Now as its growth started to accelerate right as I was buying it did not take long for the market to wake up to this fact and within 18 months the stock had appreciated by 1,500%!
So when you look for stocks make sure that you are digging around not only for value but also for growth. Value without growth often lags the market and growth without value increases the risk of the investment tremendously. Growth stocks can trade at price to earnings multiples in the hundreds as investors drive the stock into orbit expecting the growth to continue forever. The risk is that once the company fails to grow as quickly, not only does the stock take a hit from the reduced profitability but also from the narrowing of the multiple - a double whammy which shows the risk inherent in buying a growth stock when it has already left the starting blocks. You need to jump on the bandwagon early and this is why a search for value plays is necessary even if you are an inherent growth investor.
Finding a deep value stock with growth prospects is thus the best possible way to minimize the risk of the investment and maximize the return. This will require a lot of patience as I would be surprised if you manage to find more than 20 in your lifetime. I say that not to scare you away from looking but to let you know that the market is relatively efficient and will more often than not reward these stocks well before you find them. I also mention it because if you work hard enough at it and then find one, do not hesitate but back up the truck and load as much on board as you can as this will be a life changing investment.
Friday, March 7, 2014
Making Sense of What They Say
Today's blog is a tongue in cheek look at some of the crazy things that are said by analysts and pundits on television screens and radio shows around the globe and how meaningless these sayings are. The funny part is that often we take these things seriously rather than realizing the stupidity of the situation. I hope you enjoy this light hearted look at the investment industry particularly as I am sure to have said numerous of these on my radio show and throughout my blog posts!
1. "We are cautiously optimistic." - and you are also an oxymoron as either you are cautious or your are optimistic but you can't have both!
2. "We are neutral on this stock." - Really? So you own the stock and are praying for a recovery or you are dumping it to some other sucker or you have really just wasted my time and yours by talking about this!
3. "We are waiting for more certainty." - Good luck with that, oh, and when you find certainty let me know as that is definitely the day I dump my entire position.
4. "He was tired of throwing his money away renting so he bought a house." - Wow he must have paid cash because otherwise he is throwing his money straight to the bank. (Obviously there is upside to owning a home that is not available to renters but then say it properly.)
5. "Today the market fell (or rose) by 85 points as investors exited (bought) on the news that ABC Corp earnings were worse (better) than expect." - Yeah right that is exactly why the market moved today, every other stock moved in tandem because of this one stock's earnings announcement. Please stop making things up.
6. "Earnings were positive except for a one time charge." - Then they were not positive they were negative and you my friend own that stock!
7. "Earnings missed estimates." - Why do earnings have to meet or exceed estimates? Obviously the estimates were wrong. Why do people buy stocks based on these estimates rather than the long term business outlook of the company (as Warren Buffet does) and why does the headline not say 'estimates missed earnings as the analyst once again failed in their prediction'?
8. "It's a stock pickers market." - So certain stocks have run and those are not part of the index in which you invested meaning that blindly investing in indices did not work this year. Let's hope that next year we can go back to business as normal burying our heads in the sand once again and expecting the future to take care of itself because we would hate to have to work to make money!
9. "There is a lot of cash on the sidelines." - I have looked and I cannot find a sideline anywhere. In fact when the person who sold their position took their cash to the "sideline" there had to be another person buying otherwise the stock would have gone to zero!
10. "The next Black Swan event will come from ..." - Poor Mr. Taleb, he must shudder every time someone mentions where the next Black Swan event will come from. The whole point here is that no-one knows where the Black Swans are and that is why they are so catastrophic when they appear. If we could predict the next Black Swan it would be a non event not a Black Swan event!
1. "We are cautiously optimistic." - and you are also an oxymoron as either you are cautious or your are optimistic but you can't have both!
2. "We are neutral on this stock." - Really? So you own the stock and are praying for a recovery or you are dumping it to some other sucker or you have really just wasted my time and yours by talking about this!
3. "We are waiting for more certainty." - Good luck with that, oh, and when you find certainty let me know as that is definitely the day I dump my entire position.
4. "He was tired of throwing his money away renting so he bought a house." - Wow he must have paid cash because otherwise he is throwing his money straight to the bank. (Obviously there is upside to owning a home that is not available to renters but then say it properly.)
5. "Today the market fell (or rose) by 85 points as investors exited (bought) on the news that ABC Corp earnings were worse (better) than expect." - Yeah right that is exactly why the market moved today, every other stock moved in tandem because of this one stock's earnings announcement. Please stop making things up.
6. "Earnings were positive except for a one time charge." - Then they were not positive they were negative and you my friend own that stock!
7. "Earnings missed estimates." - Why do earnings have to meet or exceed estimates? Obviously the estimates were wrong. Why do people buy stocks based on these estimates rather than the long term business outlook of the company (as Warren Buffet does) and why does the headline not say 'estimates missed earnings as the analyst once again failed in their prediction'?
8. "It's a stock pickers market." - So certain stocks have run and those are not part of the index in which you invested meaning that blindly investing in indices did not work this year. Let's hope that next year we can go back to business as normal burying our heads in the sand once again and expecting the future to take care of itself because we would hate to have to work to make money!
9. "There is a lot of cash on the sidelines." - I have looked and I cannot find a sideline anywhere. In fact when the person who sold their position took their cash to the "sideline" there had to be another person buying otherwise the stock would have gone to zero!
10. "The next Black Swan event will come from ..." - Poor Mr. Taleb, he must shudder every time someone mentions where the next Black Swan event will come from. The whole point here is that no-one knows where the Black Swans are and that is why they are so catastrophic when they appear. If we could predict the next Black Swan it would be a non event not a Black Swan event!
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