Wednesday, December 30, 2009

The Oughts—A Lost Decade?

While we’re eager to move forward, the start of the ‘10s is a good moment to reflect on where we’ve been. And this decade was anything but boring.

The world didn’t end as advertised with Y2K. And three months following that non-event, the exuberance of the Tech boom gave way to a crash. March 2000 marked the decade’s first bear. A short, shallow recession followed a year later—March 2001 through November 2001—though the bear market was fairly brutal, ending with a second bottom in March 2003.

A bull market followed for over four years. And, as is typical, a variety of fears failed to derail the bull.

2003: The Iraq War began. Some mutual funds were found to be engaging in overnight trading, which erupted into a major scandal and fears of widespread corruption. SARS was feared to explode into a deadly pandemic. World stocks rose 33%.

2004: The US dollar started tanking, and the whole world feared America’s big and ballooning triple deficits—trade, budget, and current account—would drag the world into another recession. It didn’t happen. World stocks rose 15%.

2005: Oil was on the rise—hitting a historic $70. Those who believe high oil is bad for stocks braced for a bear market that never came. Then, Hurricane Katrina effectively wiped out a US city, doing billions of dollars in damage, and displacing hundreds of thousands. Global stocks had an OK year—up 9.5%

2006: North Korea started saber rattling in earnest, even testing nuclear weapons. The dollar was weak yet again. The Iraq War entered its third year and things looked bleak. And there was nonstop talk of a US housing bubble. World stocks boomed 20%.

2007: The war in Iraq dragged on as housing bubble fears reached a fevered pitch. Banks who’d made bad bets on subprime loans began raising capital. No one knew it then, but globally, stocks had reached their peak and began grinding down. Still, for the year, stocks rose 9%—besting other similarly liquid alternatives.

By December 2007, the US entered its second recession of the decade and the world followed. Stocks ground slowly down, picking up speed in 2008. With Lehman’s failure, stocks began falling in earnest. Though earlier in the year, Bernanke and Paulson hatched late night deals to save AIG and Bear Stearns, they simply let Lehman go—with no explanation for the distinction. A true crisis followed as credit markets froze, exacerbating the recession and what had been a fairly smallish bear.

The decade was bookended by recession, leaving world stocks overall flat—hence the “lost decade.” But this implies stagnation—not what we saw. Steep drops were supplemented by significant rises—the bull market of 2002-2007 saw a return of over 150%. Few would’ve wanted to miss that.

While it’s human nature to want to assign meaning to nice round numbers, analyzing stock returns by 10-year periods is arbitrary—it just so happens this period included two big bears. Negative returns over a 10-year period are rare in stock market history. And when they have occurred, they’ve unfailingly been followed by positive returns.


Thursday, December 24, 2009

The Yield Curve Signals Bigger Growth

What's a yield curve and why is it so important?
Well, the curve itself measures Treasury interest rates, by maturity, from 91-day T-bills all the way out to 30-year bonds. It's the difference between the long rates and the short rates that tells a key story about the future of the economy.
When the curve is wide and upward sloping, as it is today, it tells us that the economic future is good. When the curve is upside down, or inverted, with short rates above long rates, it tells us that something is amiss -- such as a credit crunch and a recession.

The inverted curve is abnormal, the positive curve is normal. We have returned to normalcy, and then some. Right now, the difference between long and short Treasury rates is as wide as any time in history. With the Fed pumping in all that money and anchoring the short rate at zero, investors are now charging the Treasury a higher interest rate for buying its bonds. That's as it should be. The time preference of money simply means that the investor will hold Treasury bonds for a longer period of time, but he or she is going to charge a higher rate. That is a normal risk profile.

The yield curve may be the best single forecasting predictor there is. When it was inverted or flat for most of 2006, 2007, and the early part of 2008, it correctly predicted big trouble ahead. Right now it is forecasting a much stronger economy in 2010 than most people think possible.
So there could be a mini boom next year, with real GDP growing at 4 to 5 percent, perhaps with a 6 percent quarter in there someplace. And the unemployment rate is likely to come down, perhaps moving into the 8 percent zone from today's 10 percent.

The normalization of the Treasury curve is corroborated by the rising stock market and a normalization of credit spreads in the bond market. I note that as the curve has widened in recent weeks, gold prices have corrected lower and the dollar has increased somewhat. So the edge may be coming off the inflation threat. If market investors expect the economy to grow, inflation at the margin will be that much lower as better growth absorbs at least some of the money-supply excess created by the Fed. My hunch is that inflation will range 2 to 3 percent next year.

It also could be that the health-care bill about to pass in the Senate is less onerous from a growth standpoint -- and certainly less onerous than the House bill. For example, the Senate bill does not contain a 5.4 percent personal-tax-rate surcharge, which also would apply to capital gains. So if the Senate bill becomes the final bill, it will be less punitive on growth. That could explain the fall in gold and the rise in the dollar. We'll still be stuck with a tax hike from the expiration of the Bush tax cuts, but at least we won't have a tax hike on top of that. That's the optimistic view, at any rate.
But really, pessimists have missed the big rise in corporate profits, the resiliency of our mostly free-market capitalist economy, and the monetarist experiment from the easy-money Fed. The optimal policy mix on the supply-side is low tax rates and King Dollar. We don't have that. So as good as 2010 may be, with investors moving to beat the tax man, it could be a false prosperity at the expense of 2011.
But let's cross that bridge when we get there. Right now, rising stocks and a wide and positive yield curve are spelling strong economic growth in the new year.


Investing During Stagflation.

At some point, even if the economy is slowing, the Fed will have to step in and fight inflation. The question becomes: How much employment and growth do you sacrifice today in order to not have to deal with inflation in the future?Unfortunately, the 1970s also give us the formula for solving the inflation problem: Higher interest rates. Then-Fed Chairman Paul Volcker bled double digit inflation out of the economy in the early '80s by raising the overnight bank lending rate (and thus the prime rate) to as high as 20%. While no one is predicting a repeat of that scenario, there's little doubt interest rates will have to go up. That raises the question of how to be invested when interest rates are rising, even as the economy struggles to grow and inflation is still running amok.Once again, if you believe that the coming decade will look a lot like the 70s, you can find reasons to believe all major investment classes will perform similarly. In a stagflationary environment, stocks, bonds, and real estate are likely to underperform commodities and gold. In fact, during the stagflation of the '70s , bonds were called "certificates of confiscation" by many professionals in fixed income. From June 1970-1980, the best performing asset classes were oil (+34.7%), gold (+31.6%), U.S coins (+27.7%) and silver (+23.7%). The worst performers were T-Bills (+7.7%). foreign exchange (+7.3%), bonds (+6.6%) and stocks (+6.1%) In summary, hold only short term domestic bonds. Keep a diversified equity portfolio, but focus on companies that are immune to, or can benefit from inflation. That means favoring growth stocks over value.

Crude Outlook: 2010-11

Oil prices staged a remarkable rally this year on the back of a weak dollar and a nascent economic recovery. In 2010, it's likely that these same factors will combine with an increase in global energy demand to push oil prices back up over $100 a barrel.

With stockpiles still high and energy demand rebounding sluggishly, most forecasts are calling for the "black gold" to edge up into the low-triple-digit price range. That's 40% higher than where oil is trading right now - but is still well below the record high of nearly $150 a barrel that was established in 2008.Money Morning Chief Investment Strategist Keith Fitz-Gerald is even more bullish. He believes that a price of $100 a barrel is "easily attainable" and says that some sort of unforeseen market shock could cause crude oil to spike as high as $150 barrel by the end of 2010."Overall consumption is going up, not down, and the dollar is the other wrinkle. A weaker dollar generally means higher oil prices," Fitz-Gerald said. "But oil prices will surge next year not just because of the recovery, but because of a global macro event that could send prices soaring as high as $150 a barrel."
Investors who prepare for this possibility will have a shot at windfall profits. At the same time, however, consumers will feel the pinch.Take pump prices. Rising crude prices will help boost the average retail price of regular-grade gasoline from $2.35 a gallon this year to $2.83 in 2010, and pump prices will approach $3 a gallon during next year's driving season, the U.S. Energy Information Administration predicted in a forecast report released earlier this month.Utility bills will also increase, as heating oil and electricity prices escalate, the EIA and other forecasters say.
Conflicting DataIf investors are feeling whipsawed by oil-price forecasts that are bullish one day and bearish the next, that's not a surprise. The lack of uniformity in the forecasts is understandable - given the mountains of often-conflicting data analysts have to work with.For instance, commercial-crude-oil storage among industrialized nations of the Organization for Economic Cooperation and Development (OECD) stands at about 60 days of demand. The Organization of Petroleum Exporting Countries (OPEC) has said 52 days of forward demand cover was reasonable.What's more is that an estimated 90 million barrels of oil are being hoarded on seaborne tankers by speculators looking to profit from bigger long-term gains. Of course, supply has been ample all year. But that hasn't stopped oil prices from rising for most of 2009. In fact, since hitting its low for the year - $34.03 a barrel - on Feb. 12, crude oil has zoomed 116%.The weak U.S. dollar has sustained the oil bull to this point. The dollar has tumbled about 18% against the euro since Feb. 12, and the Dollar Index - which measures the dollar against a basket of currencies - has slid more than 8% this year. And going into 2010, the dollar will likely continue on its downward course.
The Downtrodden DollarThe expansive monetary policy pursued by the U.S. Federal Reserve over the past two years has sucked the life out of the greenback.The Fed has pumped in excess of $2 trillion into the U.S. economy since the financial crisis began more than two years ago. It has lowered its benchmark federal funds rate to a record-low range of 0.0% to 0.25% and has stepped up purchases of U.S. Treasuries and mortgage-backed securities. As its most recent meeting concluded Dec. 16 Fed Chairman Ben S. Bernanke said the fragility of the U.S. recovery demands that interest rates be kept low for "an extended period" of time. "With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the committee expects that inflation will remain subdued for some time," Fed policymakers said. Unfortunately, the Fed will soon discover, expectations may not match up with reality.With the dollar in a nosedive and its prospects for a turnaround dim, investors are fleeing the currency and taking refuge in hard assets."The dollar is the single most important factor in the market," Eugen Weinberg, senior commodities analyst at Commerzbank AG (OTC ADR: CRZBY), told Bloomberg News. "It's not the fundamentals. The weaker dollar is a really big concern for many investors and they try to protect themselves by buying into commodities."Indeed, commodities prices across the board have soared in response to the dollar's decline. Gold futures have added 38% this year and could climb as high as $2,000 an ounce next year. Silver prices have jumped, as well, and are at their highest level since July 2008 at about $20 an ounce.Industrial materials - bolstered by stronger-than-expected economic growth, particularly in China - have also seen increased investor demand. Aluminum prices have surged more than 60% since March, when the global rally in stocks began, and copper prices are up more than 70%. "There is security in hard assets ... the U.S. economy and the dollar aren't looking too pretty," Kimberly Tara, chief executive at fund manager FourWinds Capita Management, told Reuters. "It is clear that the ability of the dollar to rally in the near future is extremely limited and that does impact where investors want to put their money."
Economic Growth Accelerates, But Oil Production Stagnates While the dollar is poised to carry on its decline, the global economic recovery is picking up steam. The OECD, in its most recent economic outlook released in November, more than doubled its 2010 forecast for developed nations, saying that strong growth in Asia - particularly China - would help pull the "more feeble" West out of its financial malaise.After predicting in June that the combined economy of its 30-member nations would grow 0.7% in 2010, the OECD raised its forecast for developed economies, projecting growth of 1.9% next year and 2.5% in 2011. Economic output will contract by 3.5% this year."We now have the numbers that support a recovery in motion," Jorgen Elmeskov, the OECD's acting chief economist, told Bloomberg. "It's still a slow recovery because of considerable headwinds from the need to adjust the balance sheets of households, enterprises and financial sectors."While pointing to China as the main catalyst for a global rebound, the OECD also cautioned that the recovery in developed nations remains fragile."The upturn in the major non-OECD economies, especially in Asia and particularly China, is now a well-established source of strength for the more feeble OECD recovery," said the OECD, whose only two Asian members are Japan and South Korea.U.S. gross domestic product (GDP) should expand by 2.5% in 2010 and Eurozone growth will accelerate to 0.9%, the group said. In June, the OECD had projected 0.9% growth for the United States and flat growth for the Eurozone. The OECD said Japan should expect GDP growth of 1.8% in 2010, instead of earlier forecasts of 0.7% growth.By contrast, China's economic output is projected to expand at a10.2% rate in the new year.The OECD also released its first 2011 forecasts, suggesting 2.8% growth for the United States, 1.7% growth for the Eurozone, 2% growth for Japan, and 9.3% growth for China.As economic growth rebounds, so, too, should oil demand. The International Energy Agency (IEA), the oil watchdog for the West, forecasts a sharp pickup in oil demand in 2010, up 1.5 million barrels per day (bpd) from this year's level.OPEC is more restrained in its forecast, but believes consumption will increase by 800,000 bpd in 2010. That's only about half the increase predicted by the IEA. But that isn't necessarily bad for oil prices: It will enable OPEC to keep a lid on production.During the precipitous price decline that oil experienced from 2008 to 2009, OPEC - supplier of 40% of the world's oil - issued three production cuts totaling 4.2 million bpd, an amount equal to almost 12% of its capacity. Despite some foot-dragging from Iran and Venezuela - two countries that rely heavily on oil revenue to fund massive social programs - OPEC has gotten an uncharacteristically high rate of compliance. Last month, OPEC pumped about 2 million bpd less than it did a year ago. "With global demand growing and OPEC holding production flat, stockpiles are going to come down, and that's bullish for prices," Mike Wittner, the head of oil market research at Societe Generale SA (OTC ADR: SCGLY) told Bloomberg.Wittner, an energy analyst at the U.S. Central Intelligence Agency (CIA) during the 1980s and the IEA in Paris between 1997 and 2002, said purchases by hedge funds and investors seeking protection from inflation will support prices. "In contrast to some other banks, we acknowledge quite openly, and believe, that non-fundamental factors do play a role in setting oil prices," he said.Oil prices will end 2010 near $88 a barrel, according to Wittner. But some analysts are more optimistic.Technical analyst Richard Ross, head of global technical strategy for Auerbach Grayson, told Forbes that the price of crude oil will trend upward to $85, then $90, settling in at as much as $103 per barrel by next summer.Ross noted that prices of $103 a barrel would represent a 61.8% retracement of the entire bear market decline in oil, and as such, serves as a vital statistical indicator for traders and analysts.But each of these price scenarios is based on conventional supply-and-demand scenarios. What happens if there's an unexpected "shock" to the global energy economy, asks Fitz-Gerald, the Money Morning chief investment strategist who also the author of the best-selling investing book, "Fiscal Hangover."For instance, Iranian troops last week entered southern Iraqi territory and temporarily took control of the al-Fakkah oil field. They left the field within days of the incursion, but the incident should serve as a stark reminder to investors that oil production is still vulnerable to political instability in the Middle East. And it's highly unlikely that 2010 will pass without incident."Don't think for a minute that was casual," said Fitz-Gerald. "It was a highly provocative move designed to see what the U.S. response would be."An incident such as that could be enough to send oil prices back up to the record level of $150 a barrel, he said.
Profiting From the 2010 Oil SpikeMany companies benefit from high oil prices, but one of the best plays this year could be U.S. oil major ExxonMobil Inc. (NYSE: XOM).A recent cover story in Barron's called Exxon the Goldman Sachs Group Inc. (NYSE: GS) of the energy business, except "Exxon out-Goldmans Goldman.""Like Goldman, Exxon has a distinctive ‘best-and-brightest' corporate culture, and relentlessly focuses on return on investment and efficiencies at the expense of egos," Barron's said. Indeed, with a world-leading market capitalization of $325 billion, Exxon isn't hiding from anyone. However, the company that set a world record with $45 billion in after-tax profit in 2008 has underperformed this year. While oil prices have surged 60% since Jan. 1, shares of Exxon have dropped more 14%. Its peer companies have seen their shares advance by more than 33% during that same period.The company is currently trading at 16 times earnings - a bit below the industry-average Price/Earnings (P/E) ratio of 17.5.The consensus estimate for 2010 is for the company to earn nearly $6 a share. At current valuations, that projects a price of $96. Were the company to deliver on the projected $5.95 a share in 2010 earnings - and to trade at the industry multiple of 17.5 - Exxon shares would trade at more than $100 each. That would represent a 48% return from yesterday's (Monday's) closing price of $68.51.No matter which valuation is used, it's pretty clear that Exxon's shares have some room to run.The energy giant had proved nearly 23 billion barrels of oil and natural gas at the end of 2008. Its total energy resources - proven reserves as well as deposits that don't yet qualify as proven - are the equivalent to 72 billion barrels of oil and gas. Exxon has improved its competitive position with its proposed purchase of XTO Energy Inc. (NYSE: XTO), the largest U.S. natural gas producer, in an all-stock deal valued at $31 billion. The buyout is to close in the second quarter of the new year. The XTO purchase will give Exxon the equivalent of about 45 trillion cubic feet of natural gas throughout the United States and puts the world's largest publicly traded oil company in prime position to expand in shale gas, the fastest growing area in the natural gas sector. Since 1977, Exxon has returned 15% annually, including reinvested dividends, versus 11% for the Standard & Poor's 500 Index, Barron's reported. The company's dividend has doubled in the past 10 years, and could increase by another 5% or more this year, according to the magazine. Money Morning's Fitz-Gerald suggests that investors focus on operators of oil transit systems such as pipelines and shipping. These companies stand to make profit transporting oil and gas almost regardless of their price.For instance, on Feb. 12, Fitz-Gerald recommended Kinder Morgan Energy Partners LP (NYSE: KMP) to subscribers of Money Morning's sister publication, The Money Map Report. Kinder Morgan is one the largest pipeline operators in the United States. Its stock has jumped 35.92% since Fitz-Gerald's recommendation. (Click here for more information on stocks in the Money Map portfolio.)A riskier play might include a look at Petroleo Brasileiro SA (NYSE ADR: PBR), more commonly known as Petrobras. Petrobras has made headlines with the massive discoveries made off its coast in recent years. While deep-water fields like these are costly to develop, they may see a lot of attention if oil prices make another run. For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (NYSE: USO) or the iPath S&P GSCI Crude Oil Total Return Fund (NYSE: OIL).


Sunday, December 13, 2009

Jim Rogger Interview.

Q: Why do you think that we are going to have a short-term rally in the dollar? What’s behind this thinking?
A: Everybody is pessimistic, I am pessimistic too and that’s why there might be a rally.
Q: Long-term you used to worry about deficit, you are still worried about the debt that this country has?
A: Gigantic spending in Washington, incompetence in Washington where they don’t know what’s going on, they are making our situation worse. I see nothing to turn the dollar around.
Q: What you mean incompetence in Washington? Where is the most incompetence? What would you like to see done differently?
A: The Federal Reserve has tripled its balance sheet full of garbage, which you and I are going to have to pay for. They have gone out and printed gigantic amounts of money, why do we want the Fed they are making the situation disastrous for all of us.
Q: I guess you don't think that Bernanke should be reconfirmed?
A: Hopefully. Of course not.

Q: What about Tim Geithner? Treasury as well has been putting out this entire stimulus and now the troubled asset relief program (TARP) programme?
A: Mr Geithner is a smart person from what I understand but he has been wrong about everything for the last 15 years. Why are we listening to him? Why are we listening to any of those guys? They are making our situation worse. They said in writing yesterday that the solution is to spend more money, that’s what got us into the problem, too much debt too much consumption and now we are going to solve it with more debt and more consumption? That’s like telling
Tiger Woods, you got another girlfriend then you solve your problem.
Q: The one way we got into this— all this debt and leverage– the President Obama said the other day – we have to spend our way out of a recession. He said it?
A: It’s making the situation worse for us. We are all going to pay the price for this in one-two or three years. The next time we have problems in the economy, which will not be too long, we don’t have any bullets left, we have shot everything we have. What are they going to do? Quadruple the debt, print more money. We don’t have any trees left.

Q: What are the major implications? I want to ask you about Dubai, I want to as you about Greece as well as Spain. Are you worried? Tell me how this manifest itself that we are going to see?
A: We are going to have more currency turmoil and crises. You already see Vietnam devalued last week, Brazil put on special taxes for currencies, you are seeing what is happening in Dubai, Greece is in trouble, Ukraine, Argentina, Spain, there are plenty of people we can put to the list. We are going to have currency turmoil, we are going to have more debt problems. In the meantime, everybody has printed money and then what are they going to do when the problem start giving us great turmoil.
Q: The sovereign debt fears are growing; the S&P put Spain on debt negative watch, Fitch cut trading on Greek sovereign debt. Yesterday David Paterson in New York – just a press conference called – saving New York from insolvency?
A: They put the US, UK on debt watch; we are all in serious trouble. I mean in Asia there are still creditors, in the West unfortunately debtors.
Q: So do you invest in an environment where all of this gloom and doom and these headlines keep coming out?
A: I own gold as you know. But I am not buying gold. Gold shot up and whenever something shoots up it probably would go down for a while. So if gold goes down I hope I am smart enough to buy some more, other commodities are probably better like silver, agriculture. So I urge you to learn about foreign currencies as well, because there are going to be great opportunities.
Q: I am going to go through some of these investment ideas with you one by one. So let me first focus on gold. You are saying you own gold, you are not going to buy more gold right now because of the level that it is but you are not going to sell it is basically the point?
A: If gold goes to USD 1000 per ounce, I am smart enough to buy more.
Q: So do you think the fact that the Indian central bank, Mauritius — we are seeing different buyers recently. Does that change the gold story? What is behind this move or is it just the dollar hedge?

A: Until last year central banks around the world were selling gold. New you have the opposite; they stopped selling and they are starting to buy as well. That’s a huge shift in the gold market and many other people are worried about paper money as well. So I think gold will certainly go to couple of thousand dollars an ounce over the next decade. That’s not a very radical assumption only 4-5-6% a year, it would have to go up. So I am sure gold will be a great investment over the next decade.
Q: Do you own any stocks?
A: The US markets are up 70% in the last 8-10 months and I don’t like to buy anything like that. I am skeptical of the economy going forward. If the world economy gets better commodities are going to be a great place because there are shortages developing. If the world economy doesn’t get better they’re going to be printing a lot more money, so commodities and real assets are the place to be.

Q: Do you see a bubble in some emerging markets, you are living in Singapore, you are travelling all around, you have seen the Asia growth story on the ground and it is really alive. But people say much money has moved in to these emerging markets and it’s a bubble what do you think?
A: I sold all of my emerging markets two years ago except China. They went down, they’ve come back up, its not a bubble yet. The Chinese economy is one tenth the size of Europe and Asia. There will be bubbles in China and Brazil but now at the moment.
Q: Where do you think is the most important place to avoid right now, is it the stock market?
A: I would say it’s the bond market, the long term government bond market. Would you lend money to the US government for 30 years at 4-5% in US dollars? Who would?
Q: So you think the US bond market is a bubble?
A: Not yet. But its going to be and that is the next bubble that I see forming in the world because they are down and driving up as fast as they can and they are buying on themselves and that is not good for anyone.
Q: Are you more worried about inflation or deflation?
A: Inflation. Throughout history when people have printed huge amounts of money its led to rising prices. Also, in the commodities market we have shortages developed. Food is the lowest inventory in decades. You cannot get loans to open mines, we are having great shortages developing in commodities. Shortages combined with printing money will lead to more inflation.
Q: A lot of people feel that the biggest risk for the stock market in the US is the Fed coming in? When would expect Bernanke and company to raise rates?
A: The markets would raise rate before Mr Bernanke, he is not smart enough, he will follow the market. Just watch the currency markets you will see the rates start to go higher. We will start seeing turmoil in the currency markets and then rate would go higher on their own.
Q: You think that is a 2010 affair?
A: I know we are going to have the currency problems in 2010, we are certainly going to have atleast the semi-crisis. But its already starting as we said with Vietnam and all other countries. We are going to have serious problems in many countries and in currencies.
Q: What are the implications that our viewers will feel or will see of some of these debt worries?
A: If I am right you are going to see the dollar rally, which will be a good chance for some to buy some of the currency ETF or buy some commodities, they maybe better opportunities. If we start having turmoil, which I expect the dollar is going to rally for a while because everyone will have to cover their shorts and the dollar will go up and you can put your money into other foreign currencies.
Q: One thing we didn’t mention was Europe, the US and Britain untouched, Britain is trying to keep their AAA Credit rating what you think about Europe?
A: The UK is not going to keep its AAA rating. They are already worried about the US and certainly should be worried about the UK, the Prime Minister there has been rolling things. Its going to be a very bad situation, I use to own sterling for about 30-40 years but I own no sterling now, it grieves me to see what is happening in the UK.


Wednesday, December 9, 2009

Big Picture: Timing The Stock Market!!

Timing requires a big-picture, top-down perspective. Here's how I look at the big picture: Identify the largest constituent elements that move the stock, sector, industry or economy you are measuring. For housing, I look at the availability of credit, the cost of credit, the trajectory of growth, and the sustainability of those trends.

In 2007, I used Countrywide Financial Corp. and IndyMac Bancorp. Inc. (OTC: IDMCQ) as proxies for credit availability, and I used interest rates on adjustable rate mortgages (ARMs) and the profitability of big banks as a proxy for the cost of credit. I followed the trajectory of growth around the country simply by reading the real estate sections of newspapers. By the fall of 2007, it was easy to see strains on the proxies I was watching, even though closer to home everything looked rosy.

Both Countrywide and IndyMac faltered. That told me there was a problem with the sustainability of credit extension, especially in the subprime-mortgage market where both had made a giant push. You didn't need to read their balance sheets or income statements, the newspapers were full of telltale stories. There was plenty of evidence that teaser rates were giving way to higher rates and strains were developing on borrowers.

At the same time, big banks were having a harder time syndicating and selling off covenant-lite debt pools of leveraged loans. And there was plenty of noise about banks' shaky structured investment vehicles (SIVs), created to finance and hold risky mortgage-based assets off of their balance sheets. It became obvious that none of the trends that propelled housing were sustainable. You could just have easily seen it, too.

The tipping point for me was a couple of big quarterly losses at Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). The ultimate proxy for the entire housing market was flashing red; it was time.

No, I didn't catch the top. But, I told the readers of my blog to get out of the markets entirely and into cash in February 2008. Not cash proxies like money market funds. I mean cash.

If you were employing a timing strategy, even if you missed the exact turn - as I did - you would have locked in built-up profits, as opposed to losses.


Tuesday, December 1, 2009

Future of Crude.

John Felmy has been the chief economist of the American Petroleum Institute (API) for years. He’s well respected. And I appreciate his experience. But the two of us disagree more often these days.

We most recently locked horns at Malone University in Canton, Ohio, last week, where we were debating the future of oil. (Actually, when the invitation was made, I was supposed to debate Sarah Palin. But she pulled out to go on the road and pitch a book she didn’t write.)

Nonetheless, something disturbing emerged from the debate.

I still find John a pleasant enough fellow, but the mantra coming from the API, the mouthpiece of the oil industry, is wearing thin. They want us to believe that the oil market is still fine, still humming along, still providing the best energy value. You’ve heard the argument before: Gasoline is cheaper than milk or bottled water.

This time, John tried the latest API version of this sleight of hand: Whatever price you need to pay, oil is still cheap, still plentiful, still the energy of choice.

Sorry folks, the API just doesn’t get it. And what it refuses to get is becoming one of the most important factors investors in the energy sector will need to watch – carefully. This is all about supply and demand. But it’s not the traditional lecture from Econ 101.

This one is going to roll out differently.

Over the next several months, oil will begin losing its balance. As it falls off the wagon, risk will escalate. And that will require greater due diligence by investors. But as the risk increases, so will the number of opportunities. I’ll show you how to profit from them as they surface.

But first, here’s the problem with the API’s approach.

“Suspect” Figures Are Way Off

As John grudgingly admitted in our exchange, the API’s figures are becoming “suspect.” I have a less charitable view. (Unlike John, I don’t work for them.)

The API figures are way off.

They still portray a view of demand (low) and supply (high) that will not continue to square with reality. We have had lower demand for months only because of the financial crisis and the credit crunch. But this has had nothing to do with the oil market as such.

Others are catching on.

The Paris-based International Energy Agency (IEA), for example, has already admitted its supply estimates were too optimistic while its view of demand was too conservative. The IEA revisions have been paralleled in similar moves by the London Centre for Global Energy Studies (CGES), Russia’s Institute for Energy Strategy (IES), and even Washington’s usually impervious Energy Information Administration (EIA).

There’s a reason for this.

Worldwide oil demand, while sluggish, is nonetheless returning more quickly than anticipated. In addition to the usual suspects – China, India, a resurgence in the Far East – OPEC countries are retaining more of their own production to diversify their economies. Russia is facing rising domestic needs at the same time it tries to avoid a significant decline in crude production. Mexico is witnessing a meltdown in its oil sector while its domestic needs also rise. And new major markets are exploding in places like West Africa and South America.

Notice this is not happening in the United States or Europe. These countries are no longer the driving forces in the oil market. The most developed markets are not calling the shots, despite still being over-weighted in the data collected. The IEA finally got that. So did CGES, IES, and even the EIA.

But not the API.

Indeed, the paid spokesperson for the American oil industry continues to see crude oil as the main option. True, it gives lip service these days to alternative and renewable energy. Moreover, given its position as the in-house spokesman for the hydrocarbon sector as a whole, it is also praising the virtues of natural gas as the immediate choice when we transit from crude oil.

Unfortunately, the API still fails to provide an accurate picture. Perhaps in the final analysis, this happens because its clients are the oil producers.

Oil’s (Profitable) Reality

We currently have about 86 million barrels a day in worldwide crude oil demand. That still represents a figure below pre-crisis levels. However, all of the organizations mentioned above (with the exception of the API) are now estimating a rise to around 87.5 million over the next year, with increases accelerating thereafter.

Current global supply, on the other hand, will max out at 91-92 million barrels. That gives us a small cushion – just a few years – before the real fireworks start. Period.

Because new volume coming on line will barely replace declining production from older fields, we have little prospect of avoiding insufficient supply producing a spike in crude oil prices. This is not necessarily a bad development from the investor’s perspective, since a volatile market will provide profit opportunities, especially if the direction in price remains sustainable over any period of time.

The impact on other market sectors, of course, will be less positive.

The key here is to recognize the major benchmarks and triggers, along with early changes in what they tell us. These will not all be moving in the same direction as the unwinding ratchets into high gear. But we will be able to identify when they are changing and, more importantly, how to profit from them.