Bear Market

A rare moment of optimism from David Rosenberg: "I've said it once and I'll say it again. And believe me, this is no intent to wrap myself up in stars and stripes. But there is a strong possibility that I see a flicker of light come November. The U.S. has great demographics with over 80 million millennials that will power the next bull market in housing, likely three years from now. After an unprecedented two straight years of a decline in the stock of vehicles on the road, we do have pent-up demand for autos. I coined the term "manufacturing renaissance" back when I toiled for Mother Merrill and this is happening on the back of sharply improved cost competitiveness. Oil production and mining services are booming. Cheap natural gas is a boon to many industries. A boom in Chinese travel to the U.S. has triggered a secular growth phase in the tourism and leisure industry. The trend towards frugality has opened up doors for do-it-yourselfers, private labels and discounting stores.... Few folks saw it at the time. But it's worth remembering, especially now as we face this latest round of economic weakness and market turbulence. It is exactly in periods of distress that the best buying opportunities are borne...and believe it or not, when new disruptive technologies are formed to power the next sustainable bull market and economic expansion. Something tells me that we are just one recession and one last leg down in the market away from crossing over the other side of the mountain. And believe me, nobody is in a bigger hurry to get there, than yours truly. At the risk of perhaps getting too far ahead of myself, but you may end up calling me a perma-bull (at that stage, I must warn you, folks like Jim Paulsen will have thrown in the towel)."

Billionaire investor George Soros significantly increased his shares in the SPDR Gold Trust in the first quarter. Soros Fund Management nearly quadrupled its investment in the largest exchange-traded gold fund (GLD) to 319,550 shares - compared with 85,450 shares at the end of the fourth quarter. John Paulson maintained his large stake, the ETF’s largest stake and other large and respected institutional buyers were PIMCO and the Teacher Retirement System of Texas. Paulson, 56, who became a billionaire in 2007 by betting against the U.S. subprime mortgage market, told clients in February that gold is a good long term investment, serving as protection against currency debasement, rising inflation and a possible breakup of the euro. Eric Mindich’s Eton Park Capital also bought  739,117 shares in the SPDR Gold Trust during the first quarter. The New York-based fund held no shares of the exchange-traded product as of December 31. Overall holdings in the SPDR Trust rose just over 8% in the first quarter, after a 2% gain in Q4 2011.

When given the opportunity to expand on his thoughts, Marc Faber, of the Gloom, Boom, & Doom Report, provides dismally clarifying detail on the state of the world. In this excellent (must-watch on a day when nothing changed but European stocks dead-cat-bounced) Bloomberg TV interview, the admittedly ursine Faber reflects on the US (slowing of revenue growth and the real linkages to European stress) noting that unless we get a huge QE3, there will be "a crash, like in 1987" noting he believes we have seen the highs for the year; on the likelihood of QE3 (agreeing with us that the Fed won't act unless asset markets plunge first); on Greece's exit of the Euro and whether policy-makers can manage the exit properly "bureaucrats in Brussels and the media are brainwashing everybody that if Greece exited the euro, it would be a disaster. My view is the best would be to dissolve the whole euro zone"; on the difference between investment markets and economic reality (thanks to financial repression); and on the global race-to-debase "I do not have a high opinion of the U.S. government, but the bureaucrats in Brussels make the government in the U.S. look like an organization consisting of geniuses. The bureaucrats in Brussels are completely useless functionaries".

Dollar vs. Stocks 

If the greatest trick the devil ever pulled was convincing the world he didn’t exist, the greatest trick our central bank ever pulled was convincing the world we couldn’t live without it. For most of that past twenty years, that PR campaign has been centered on the Great “Moderation”, so called because it apparently represented the full embodiment of economic management – a period of unparalleled prosperity, a Golden Age of soft economic central planning. Give the central bank enough “flexibility” and it will produce unmatched economic and financial satisfaction.

We doubt many tears will be shed over the now official departure of Europe's most embarrassing political figurehead: the head of the Euro-area finance ministers, one Jean-Claude Juncker, whose presence did more documented damage to the credibility of Europe than... well, we would say virtually anyone else, but then again since everyone else in the European pantheon is a shining example of DSM IV-level sociopathology, we are kinda stuck. But anyway: Juncker is finally gone "he’s tired of Franco-German interference in managing the region’s debt crisis." And while the decision was known for a while, the ultimate catalyst is rather unexpected, and exposes just how frail the entire Eurozone is: “They act as if they are the only members of the group,” Juncker said today at a podium discussion in Hamburg." If this is coming from the man who admittedly lies for a living, we can't imagine just how bad the truth about the internal fissures within the Eurozone must be. Actually, we can.

Hugh Hendry is back with a bang after a two year hiatus with what so many have been clamoring for, for so long - another must read letter from one of the true (if completely unsung) visionary investors of our time: "I have not written to you at any great length since the winter of 2010. This is largely because not much has happened to change our views. We still see the global economy as grotesquely distorted by the presence of fixed exchange rates, the unraveling of which is creating financial anarchy, just as it did in the 1920s and 1930s. Back then the relevant fixes were around the gold standard. Today it is the dual fixed pricing regimes of the euro countries and of the dollar/renminbi peg."

While many will remember 1982 for its disco and the movie E.T., it is perhaps best known by an investing public as the end of a 16 year secular bear market. The 10% decline from 1966 was better, however, than the 38% loss from 1937 to 1941 and the 80% loss from 1929-1932 but together this triumvirate make up the secular bear markets. Luckily, as IceCap's Keith Dicker notes, for most of the investment industry they can gloss over these extended loss periods and instead focus on the long-run secular bull markets (cue Jeremy Siegel). However, he points out that unknown to many and ignored by the rest, "we are in the middle of another long and dragged out Secular Bear Market which has seen investors lose 7% since the year 2000 - that's 12 years of hopes for nothing." Understanding secular markets and how they transition from BULL to BEAR is perhaps the most rewarding investment perspective you won’t hear from anyone else. While financial markets continue to yo-yo with our retirements, the truth is, the next Secular BULL Market is not quite ready to perk its head up just yet as Dicker addresses P/E ratios during inflationary and deflationary periods summing up his view of the world rather succinctly: "As central banks continue to bail out banks and countries, they implicitly create an investment culture whereby failure is rewarded and success is taxed to reward those who failed."

It appears that when it comes to mocking consensus groupthink emanating from lazy career 'financiers' who seek protection from their lack of imagination and original thought, 'creation' of negative alpha and general underperformance (not to mention reliance on rating agencies, only to jump at the first opportunity to demonize the clueless raters), in the sheer herds of other D-grade asset "managers" (for much more read Jeremy Grantham explaining this and much more here), David Rosenberg enjoys even more linguistic flexibility than even us. Case in point, his just released trashing of the latest Barron's permabull groupthink effort titled "Outlook: Mostly Sunny." And just as it so often happens, no sooner did those words hit the cover of that particular rag, that it started raining, generously providing material for the latest "Roasting with Rosie."

One scene from the movie Titanic depicts a lounge in one of the upper class quarters of the ship as it slowly sinks beneath the waves. Notwithstanding the vessel listing alarmingly, a motley band of toff revelers are determined to go out in the finest style. Some continue to play at cards with a fatalistic resolve while others determinedly quaff spirits direct from the bottle. Having considered for some time the most appropriate metaphor for the current market environment, we think this may be it: one may be doomed, but one can still party on. Having already hit the iceberg, one major problem we see is the common perspective for both investors and the asset management industry to view debt and equity as the entire universe of investor choices available. Having long exhausted the armory of conventional policies to keep the unsustainably indebted show on the road, increasingly desperate politicians are doing increasingly desperate things, be that gifting money to the IMF in a brazen display of fiscal denial that we can ill afford (US, UK) or simply stealing from other sovereigns (Argentina). The ironic triumph of the Keynesians means that, in trying to save the economy, our central bank may end up destroying it completely by means of the printing press; as a consequence, we now get to experience some of the full-on horror of the Japanese malaise.

In simple terms, Spain is like Greece, only bigger and worse. According to the Bank of International Settlements worldwide exposure to Spain is north of $1 TRILLION with Great Britain on the hook for $51 billion, the US on the hook for $187 billion, France on the hook for $224 billion and Germany on the hook for a whopping $244 billion.

"You apparently can survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like “margin of safety” and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage."...It is the classic failing of value managers (and poker players for that matter) to get impatient and bet too hard too soon. In addition, GMO was not always optimally diversified. We are generally more cautious (or, if you prefer, “more experienced”) now than in 1998 with respect to, for example, both patience and diversification, and at least we in asset allocation always stayed away from leverage. The U.S. growth and technology bubble of 2000 was by far the biggest market  outlier event in U.S. market history; we had previously survived the 65 P/E market in Japan, which was perhaps the greatest outlier in all important equity markets anywhere and at any time. These were the most stringent tests for managers, and we were 2 to 3 years early in our calls in both cases. Yet we survived, although not without some battle scars, with the great help that we did, in the end, win these bets and by a lot. Hypothetically, resisting the temptation to invest too soon in 1931 may have been a tougher test of survival in bucking the market. Luckily we, and all value managers, were not around to be tempted by that one.

Low trade volume is sucking the fuel from the global economy

My most recent trip to Calgary gave me a welcome chance to catch up with friends and colleagues in Cow Town's oil and gas sector. I found out about new projects, investigated companies of interest, and came away with an improved feel for the current state of affairs – what's hot, what's not, and why. The outlook from here is not great. When markets turn bearish, investment strategies often turn toward income stocks, and rightly so: if market malaise is expected to keep share prices in check, dividends become a very good place to look for profits. But whenever a particular characteristic – such as a good dividend yield – becomes desirable, it also becomes dangerous. The sad truth is that scammers and profiteers jump aboard the bandwagon and start making offers that seem too good to refuse. It was just such an offer that reminded me of this danger. In the question-and-answer period following my talk in Calgary at the Cambridge House Resource Conference, an audience member asked my opinion of a new, private company that was offering a 14.7% monthly dividend yield.

In an attempt to not steal too much thunder from Gary Shilling's thought-provoking interview with Bloomberg TV, his view of the S&P 500 hitting 800, as operating earnings compress to $80 per share, is founded in more than just a perma-bear's perspective of the real state of the US economy. As he points out "The analysts have been cranking their numbers down. They started off north of 110 then 105. They are now 102. They are moving in my direction." The combination of a hard landing in China, a recession in Europe, and a stronger USD will weigh on earnings and inevitably the US consumer (who's recent spending spree has considerably outpaced income growth) with the end result a moderate recession in the US. The story is "there is nothing else except consumers that can really hype the U.S. economy" and that is supported by employment but last week's employment report throws cold water in that. "Consumers have a lot of reasons to save as opposed to spend. They need to rebuild their assets, save for retirement. A lot of reasons suggest that they should be saving to work down debt as opposed to going the other way, which they have done in recent months. So if consumers retrench, there is not really anything else in the U.S. economy that can hold things up." While the argument that the US is the best of a bad lot was summarily dismissed as Shilling prefers the 'best horse in the glue factory' analogy and does not believe investors will flock to US equities - instead preferring US Treasuries noting that "everyone has said, rates cannot go lower, they will go up, they will go up. They have been saying that for 30 years."