One of my accounts has the Royce Special Equity Fund, it is a small blend portfolio, that has a pretty stellar track record. I do not like mutual funds, I prefer ETF’s as I have stated numerous times, but this one account I had left behind in a former 401k plan so it has funds in it. It has OK funds and it is a small account, so I never did anything with it and left it alone, I am lazy.
Regardless, this portfolio has done very well over the long-term. Last year it was done some 19% vs. the Russell which was down 33% and even in 1999 this fund moved to value when it wasn’t popular. Sure, in 1999 it had negative returns, big deal because look at the 2000-2003 returns, the PDF is below. However, the bulls say everything is great and the markets will shoot up another 20 or 30%, but here is this fund, which has killed the market over the long-term, and look at its cash position, it is currently holding 20% cash or cash equivalent.
Now, call me crazy, but that seems odd for a fund that is a long only fund and that has performed extremely well over the long-term. In fact, this flies in the face of “the everything is great” argument the bulls give us now. Based on the track record of the fund manager I am guessing they are a lot smarter than I and know the market pretty well. Considering they are holding so much cash seems a bit odd and bearish from my view point. I think we should pay attention to these guys considering they returned 16%, 30%, and 15% in 2001, 2002, and 2003, respectively, when most fund managers got crushed.
This stunning statement came across the close of CNBC from Tyler Methison who apparently quickly polled strategists after the close today for confirmation. How this is not the beginning of a correction is beyond me as this week’s trading has been nothing but negative, unless you are short the market of course, however this is the stance CNBC is taking. I am afraid much like 2007 and early 2008 it will take much more for the bulls to believe that the market is overheated and ready to come back to reality.
What is causing the pullback? Pick your poison. The technical’s, today the S&P smashed through its 50 day moving average, compliments of Mark, and the transports have been signaling trouble for about a week now. There is the weak consumer confidence which suddenly sank yesterday and, frankly, should have sent the market far into the red. Then there is the weak top line earnings which I have been warning about since the second quarter as the consumer is dead broke and credit is contracting at a 15% annual rate, you cannot have an economic expansion without credit creation. Finally, there is the dollar, my personal favorite indicator lately, which has gained some strength lately which is drawing money out of equities.
Goldman Sachs was also no help today as they announced they are trimming their 3Q09 GDP estimates from 3% to 2.7%, which is really not surprising given a weak consumer. This may have been the ultimate trigger considering stocks have priced in a V shaped recovery with a strong GDP number built in. As a matter of fact, not only did the market price in a +3% GDP for the third quarter, but I have a feeling it priced in a much stronger 4Q09 and 1Q10 GDP figure as well, which is kind of crazy since may retailers are starting to warn about weaker holiday sales. Wal-Mart now has some 100 toys priced at $10 or less compared to last year at only 10 or so toys prices at $10 or less, that is Wal-Mart entering a price war, but with who exactly, The Dollar Store?
Under Armour also, in a roundabout way, warned its 4Q numbers were going to be weaker than expected. This is the shopping season and these are popular products warning that sales are going to be weak during the holidays. If this doesn’t tip you off that the recession is not over I don’t know what will. I realize that employed economists who do not leave their ivory towers much and place way too much emphasis on government transfers think the recession is over, but if they talk to real people perhaps they would realize that data points are more than just data points, they are people and they are hurting.
Some 500K a week initial jobless claims is not good news, it is horrible news and bad for the economy. Cost cutting means nothing if you are firing the very people who you depend on to buy the products you sell. That is exactly what is going on and why unemployment is a leading indicator of our problems. As long as economists are unwilling to listen to that basic fact and try to get you to believe in a jobless recovery, which is a myth I might add, then nothing will get solved.
The markets could get much, much worse in the near future, especially if unemployment or GDP numbers are slightly worse than expected. If the numbers are better than expected we will have a bounce, but I would not expect it to last very long. Traders are getting tougher to please as they are expecting more because they were told everything is better and as they see things progress in the opposite direction they will take the market lower. Yes, I am a bear and I am short, but you already knew that or should have known that as I made no secret about it and I tried to give everyone fair warning.
Disclaimer: I currently hold SPY Jan 2010 100 puts, SPY March 2010 90 puts, SPY June 2010 89 puts, SDS, SKF
Perhaps the most absurd statement anyone can make is that if you are not always bullish on US equities you are not patriotic. That type of talk is eerily similar to that of the Soviet Union or some other regime that discourages freedom of speech or thought. Unfortunately, that is what I get a lot from some readers and media personalities.
Tonight Dennis Kneale said, in his Blog You!, segment that because I am negative on US equities I am not a patriot. He seems to think that blind patriotism and belief that things will always get better because we are America is the way to go. He seems to think that things improved so much over the past 12 months that nothing can go wrong. That cannot be further from the truth and let us not forget that it was about 12 months ago that this guy had no idea what the VIX was and said Citi was a screaming buy at 25 a share or so.
Forgetting his past indiscretions let’s just take a look at the facts which determines why I am bearish on US equities. Real estate, both commercial and residential are in serious trouble and since most mortgages were securitized and sold to banks, later used as collateral, then it is safe to assume that banks have billions more in bad debt on their books. That fact alone should scare any normal person about the banking system by itself, not to mention that the Fed and the FDIC are both very concerned over commercial real estate as you read this post. A banking system that holds this much bad debt is not good and our actions will either postpone the inevitable or, in the best case scenario, create zombie banks.
Equities got way ahead of themselves and are currently trading about 130x their current earnings, 26x future earnings. The current pricing of the S&P 500 means that GDP has to have 4% growth in order to maintain these prices, I do not see that as a possibility no matter how they use hedonics to play with the numbers. I think a rational person would say 2% GDP growth is what we should expect which places the S&P 500’s fair valuation at about 850 or so. Earnings are down some 26% year-over-year and very few firms beat on revenue which means they are firing people to make their numbers, is that patriotic?
Monetary policy is a mess and I do not see how anyone could think differently. The Fed has monetized debt, propped up who knows how many banks, printed tons, literally, of money, have interest rates at zero, refuse to let us know exactly how bad the banking system really is and the list just goes on and on. While inflation is clearly not a problem, deflation is here for some time to come, it is highly unlikely that the Fed will be able to rein in this extremely accommodative monetary policy in a timely fashion and inflation will be a major problem in the future. Also, when foreign banks question the value of your currency and have voiced very public concerns over your currency that is a major problem, especially as we depend on them to fund our deficit spending.
Unemployment is a catastrophic problem because consumption is 70% of our GDP and anyone who thinks that the consumer is coming back, you might want to reevaluate that thought. Considering unemployment is going up it is highly unlikely that the consumer will spend on anything other than the basics. There is no sign of unemployment declining in the near future which will remain a problem for economic growth until we either get used to the new normal or change the structure of our GDP, guess which will happen.
Government subsidized growth is not growth as we must pay for it through our taxes sometime in the future. The programs that have been successful cash for clunkers and the first time homebuyer tax credit is the cause of all the demand that we have seen and will more than likely skew the GDP to positive for 3Q09. However, this artificial demand is not sustainable and eventually we will have to pay for it through taxes. Essentially the government is in the banking business, financial services business and the mortgage business all of which is bad for the free markets.
Based on that information how in the world can you be bullish? Long-term I am sure we will be fine, but if we look around the world I am sure we can find better investment opportunities than in the US at the moment. Until things get back to a new normal or until we are fully aware of the risks banks have n their books I think it is incredibly dangerous to just blindly invest on patriotism. After all America is about opportunity to better yourself and if that means you invest in China or India to make more money than that is as patriotic as you can get.
It is unbelievable that a media personality would go to the, if you don’t invest in America then you’re a traitor’ level. I think that is childish and it looks desperate, kind of like picking a fight with bloggers I might add, for ratings. I am in fine company with my bearish call with the likes of Doug Cass, at the moment at least, Paul Tudor Jones, the folks at Horseman Capital, Peter Schiff and a whole host of others. Of course there is the possibility that I am wrong, but based on the evidence I see I really don’t think that is the case, but in the event that I am wrong I will admit it.
Frankly, I consider myself more patriotic than most as I voice my dissent to the status quo and calling out things in the media that I see as blatantly false or spinning. Anyone voicing their opposition to what they see as wrong is a patriot no matter if it is on healthcare or the way our politicians blatantly vote against their constituents. In the days of old it was the media who was inquisitive about the government and tried to get the real facts, but somewhere along the way the media thought that the latest Britney Spears news was more important than reporting on what our government is up to. I guess they forgot why the Constitution gave them such wide power.
I can say with 100% certainty that I am not sure which way the markets will trade. What I do know is that perfection has been priced into equities and they currently trade at 130x current earnings and 26x future earnings. I know that only 25% of the S&P 500 has beaten earnings expectations with even fewer beating on the bottom line and estimates have been substantially reduced.
I realize that my bearishness has not paid off, well not totally at least. I called a top on August 7th and we basically have seen slightly higher prices over that close, but nothing to be jealous about. In fact, we are trading right in the area that I said was the top and we are on our way back down, kind of. Frankly, this is not the selloff I was looking for, but there are telling signs that I am correct. Treasuries had not sold off during this parabolic rally, which should make you nervous, and that is currently my largest positions, 2 year notes to be exact.
I expect treasuries will outperform in the near term as the dollar gains strength, although today we are seeing a weaker dollar along with weak stocks and weak commodities which is a bit odd. Perhaps we are seeing the decoupling of commodities from the dollar and stocks, but I do not think that is the case. What I do think is happening is people are taking profits from some commodities like gold and oil, both of which have done fairly well this year. However, industrial metals are fairing OK today with silver up 8 cents and palladium, one of my favorites, up over a dollar which is more than likely due to the weaker dollar, but it is possible people see these metals as the recovery play, which is what I am doing on a longer term basis.
Regardless, I do believe this is the beginning of the selloff which could be as little as 7-8% to as large as 20%, depending on who you listen to. I am in the camp of somewhere between the 8-20% range based on a severely overbought market and the underlying fundamentals. If we do not produce 4% GDP growth then there is simply no way equities can remain at these prices which mean there is a lot more pain for those who are not defensive at this stage. I do like corporate bonds which have only 2% GDP growth built into their prices which makes them much less risky than stocks.
I just finished reading an article on CNBC.com where they tell you that selling may happen in September, but you do not have to be the seller, which I found odd. Basically, it said that you should hold your stocks even though a correction could be coming (I thought we were over the buy and hold philosophy?). Frankly, I think that since we do not know how severe the selloff might, or might not, be one would be more inclined to reduce some risk now and be ready to buy when they think it bottomed.
Now, I sold all but about 7% of my equity holdings, which is my comfort zone, and am ready to buy when I think prices are right. I may or may not be right to do this, but so far I have done OK with this strategy and I do believe, based on what rising treasuries are telling me, that I am correct. I just do not see how one can be so completely bullish on the market right now, but that is what makes a market work. The only reason I can foresee strong equity prices is because the liquidity provided from the Fed is so great that there is no place to put assets, but even that philosophy is setting you up for disaster as the Fed could rein in that liquidity fairly quickly.
No matter what you may think I am sure you can agree with me on a few points. Nothing goes straight up and when AIG, Fannie and Freddie are the leaders in the market, up over 200% apiece, there is a problem. There is virtually no equity left in those firms and the government also indicated that they will replace Freddie and Fannie with something else in the future. As for AIG there is nothing there to really salvage as they owe the taxpayers some $130B, but for some reason the stock is parabolic. That type of leadership is not what you want to see in a market that is up some 50% from its lows.
For those reasons, plus slightly less bad fundamentals is why I do not want to risk capital at this stage on the long side. Being short is just plain dangerous as well mostly because of the massive liquidity, but the fact that you really cannot borrow shares to short is another major reason to not short anything, you can’t. The whole thing is just odd and anyone who thinks that it is not weird that the market never goes down is simply not thinking logical. Whether you agree with me or not you know that nothing, ever, goes straight up like what we have seen since July.
I suppose if I was a conspiracy theorist I would have a logical explanation like the Fed is buying stocks or some other government controlled entity. However, I am not that demented, I don’t think at least, but I do think something stinks to high heaven here. How long can we see stocks and bonds trade up in tandem? It just doesn’t make sense, period.
While I feel comfortable in my bearish position I am also willing to say that there is nothing stopping the market from going to the moon. Especially if you cannot short stocks or you make it so expensive that shorting the stock is not a realistic solution, which is not a conspiracy theory as we all know this is happening. Either way we will see what happens, but I cannot stress, based on the pure mathematics, not just my opinion, that there is just a ton of risk in stocks right now.
The only way this market can continue its parabolic climb is if the dollar gets taken down. This morning as I watched equity futures at 6 AM I thought it was odd that the dollar had strength while futures were up. Then it happened.
Right around 7:30 the dollar began to drop as futures keep their gains, this has been typical during this new bull market. While this might make people feel better about the economy, keep in mind that the markets had decoupled themselves from equities, many may be shocked to learn that the market’s gains were at their expense. If the dollar looses value and equities go up, which is typical, then your net buying power has actually decreased which nullifies your gains.
I am sure not many people are paying attention to this fundamental fact, but nonetheless it is there and a reality. Even the likes of Cramer are not connecting the dots as he cited higher oil prices for the market’s rally last week while it had little to do with oil at all. It had to do with the decline in the dollar’s value which drove oil higher, along with significant draw downs in inventory.
I am not sure if the media is intentionally ignoring this fact or not, but it is there which also explains higher commodity prices as well. At this rate the Dow could hit 14,000 again, but your buying power will be diminished. A weak dollar is good for your multinational companies and commodities, but nothing else. I do not know about you, but I am not a fan of our currency being devalued in order to prop up a failing bank system which is exactly what is happening.
To maintain your buying power you should consider having commodities in your portfolio. I favor gold, silver, platinum and palladium, but you may favor something else like oil. It does matter what commodity you choose as you want a liquid investment with strong fundamentals. For that reason is why I heavily favor precious metals, but your risk is if a black swan emerges. If we have another 2008 event money will pour into the dollar driving commodities lower. This is why you need to be diversified between asset classes, however if you do not own any commodities, what are you waiting for?
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