Tuesday, August 11, 2009

So many links, so little time

Hussman Fund’s Hester on Earnings: This week we are lucky enough to have a piece from John Hussman (a must read parenthetically) and from William Hester on the markets and the economy. In this article, Hester discusses some reasons why the stock market may have gotten ahead of the economic recovery. Specifically, he highlights that earnings growth and economic growth often go hand in hand, statistically speaking. But based on current expectations for economic growth, earnings growth seems to have decoupled somewhat from this historic relationship:

By the end of the second quarter next year, Wall Street analysts expect earnings to be at about $65 a share, and then finish the year at $75 a share, recovering more than two-thirds of the decline in profits in just a few quarters.

While these expectations are not completely out of line with recent recoveries following deep profits recessions - like in 2002 & 2003 - the important distinction to make is that these past profit recoveries have typically occurred alongside above-average economic growth.

But even if we were to normalize the earnings rebound – let's say 20 percent earnings growth over the next few quarters – within the context of the chart we'd still expect that growth to coincide with economic growth roughly twice than what is currently expected.

Of course both sets of forecasts will inevitably be wrong. But I think it is interesting to note that earnings estimates are incredibly bullish in relation to growth expectations. This may be a sign that stocks are overvalued at the current levels.


Obama’s dubious deal with Big Pharma: I found this link to Robert Reich’s blog on Seeking Alpha. I somehow missed the news that the pharmaceutical companies had extracted a concession out of the Obama administration that would prevent the government under universal health care from using its purchasing power to reduce the price of drugs. Isn’t the point of this proposal, aside from covering the uninsured, to lower costs? Listen, I understand that the regulations make it very expensive to develop new drugs and these companies have to recoup their R&D expenses. I also get it that Americans pay more for their drugs and basically subsidize the cost of drugs for countries that cannot afford them. I just worry that this sets a poor precedent. What group gets the next concessions? Device makers? Elective plastic surgeons? If we have to alter the intent of the legislation just to get the support of the various factions of the medical world, all we are going to end up with is continuously rising costs and substandard coverage. Isn’t everyone, including individual consumers, going to have to sacrifice a little so that we can cover the uninsured and lower the ultimate cost?


Speculation runs rampant: In his weekly piece on The Prudent Bear website, Doug Noland presents his thesis on why the seemingly speculative stock market run up represents nothing more than a gigantic short squeeze:

The stock market has become illustrative of what we might experience in the way of Monetary Disorder. Speculation has returned with a vengeance, galloping blindly ahead of fledgling little greenish shoots. Those of the bullish persuasion contend that the marketplace is, as it should, simply discounting a rosy future. I would counter that problematic market dynamics have taken over, with prices increasingly disconnected from reality. In short, the market is in the midst of one major short squeeze.

The resulting outperformance of fundamentally weak companies spurred short covering more generally, creating a dynamic whereby heavily shorted stocks became about the best performing sector in the equities market. This dynamic put significant pressure on so-called market neutral strategies that have proliferated over the past few years. The strategy of attempting to own the good companies and short bad ones is faltering, likely causing a flow out of these strategies - and a self-reinforcing unwind of positions. The “bad” stock soar and the “good” ones languish.

As you can imagine, he doesn’t see this ending so well for the market. He sees misplaced monetary and fiscal policies contributing to further asset bubbles and making the system as a whole even more fragile. In his view, the only thing that is supporting asset prices is all the government borrowing and credit creation. Therefore, without sustainable fundamentals underlying prices, there is always the risk of another destabilizing collapse.


The impact of the great de-leveraging: Hat tip to Zero Hedge for finding this report from Comstock Funds. In a similar argument to that of Doug Noland of The Prudent Bear, this piece contends that the Fed’s money printing has caused a “mini bubble” in the stock market. Of course the authors don’t see this as sustainable:

We, however, don't believe that the U.S. massive stimulus programs and money printing can solve a problem of excess debt generation that resulted from greed and living way beyond our means. If this were the answer Argentina would be one of the most prosperous countries in the world. This excess debt actually resulted from the same money printing and easy money that we are now using to alleviate the pain.

In the long run they foresee a necessary de-leveraging cycle a result of the amount of debt taken on in recent years by consumer and the government.

In fact, we stated in the report that it took $1.50 of debt to generate $1 of GDP in the 1960s, $1.70 to generate $1 of GDP in the '70s, $2.90 in the '80s, $3.20 in the '90s, and an unbelievable $5.40 of debt to generate $1 of GDP in the latest decade.

The difference in the amount of debt required to produce $1 of GDP between the 1970’s and now is absolutely stunning. Consequently, to get back to sustainable debt levels we are eventually going to have to pay down debt and the savings rate will continue to rise. Obviously, this will limit consumption as a percentage of GDP and thus limit GDP growth. In addition, much of their analysis includes a discussion of what happened in Japan after their stock and real estate bubbles burst. While they admit that there are differences between the situations, the writers are concerned that the US may follow Japan’s path for a number of years.


Gotta know when to hold ‘em and when to fold ‘em: In this weekend’s NY Times, Mark Hulbert had an interesting piece about the state of buy and hold investing.

BUY-AND-HOLD investing isn’t for the faint of heart. It works only if you’re willing to hang onto losing stocks for very long periods, in downturns that may be far sharper than you ever imagined. If you don’t have such fortitude, you’re better off selling at the first sign of trouble and sitting on the sidelines.

Those, at least, are the implications of one of the first academic explorations of the recent liquidity crisis, “When Everyone Runs for the Exit,” by Lasse H. Pedersen, a professor of finance at New York University.

Any value investor will tell you that being successful depends as much on the right temperament as anything else. It seems that Pedersen’s research confirms what we already know:

The “strong hands” have what it takes to survive, he said. Not only are they emotionally strong enough to avoid selling into a panic, but they also have deep-enough pockets to avoid doing so for financial reasons. In fact, the “strong hands” can actually profit by buying at cheap prices near the bottom of a market.

By contrast, the “weak hands” never harbored any illusions about being able to hold on. They “fold immediately and therefore suffer limited losses,” Professor Pedersen said.

It takes patience, fortitude and a willingness to be “wrong” in the short run to consistently achieve positive returns over the long run. This is precisely why there are so few true value investors and the reason so many who follow this discipline have track records that are unmatched by other investors. After everything that has happened over the last 2 years, it’s good to know some things never change.


Why depending on consumption for 70% of GDP is a very bad thing: According this article from New Scientist that I got from Simoleon Sense, humans may actually not be much different than bacteria. Just as bacteria will multiply to the point that it occupies an entire Petri dish and ensure its own destruction, some scientists believe that humans are on the same path, with the world being our Petri dish. Even more troubling, some believe that humans are even more efficient than bacteria as a result of societal influences that cause overconsumption:

But there's another, more recent factor that's making things even worse, and it's an invention of human culture rather than an evolved trait. According to Rees, the change took place after the second world war in the US, when factories previously producing weapons lay idle, and soldiers were returning with no jobs to go to.

American economists and the government of the day decided to revive economic activity by creating a culture in which people were encouraged to accumulate and show off material wealth, to the point where it defined their status in society and their self-image.

According to this group of scientists, there are only a couple of ways in which we can prevent the Doomsday scenario in which we consumer all the resources and eventual starve to death. First:

"We need to learn to live within the means of nature," says Rees. "That means sharing and redistribution of wealth, and for that we need leadership at the highest level to understand that the competitive instinct and the drive for power and more resources is mutually destructive, so governments must act in our collective interest."


"Advertising is an instrument for construction of people's everyday reality, so we could use the same media to construct a cultural paradigm in which conspicuous consumption is despised," he says. "We've got to make people ashamed to be seen as a 'future eater'."

Yikes. If those are our only options, Americans for sure will be the first to consume our way in oblivion.


This is getting a little scary: Another hat tip to Zero Hedge for finding this press release from the aptly named American Bankruptcy Institute. You can call me a bear. You can point out that I have been wrong about the direction of the markets. But you can’t say that this financial crisis has not taken a large toll of regular people.

U.S. consumer bankruptcy filings reached 126,434 in July, the highest monthly total since the Bankruptcy Abuse Prevention and Consumer Protection Act was implemented in October 2005, according to the American Bankruptcy Institute (ABI), relying on data from the National Bankruptcy Research Center (NBKRC). The July 2009 consumer filing total represented a 34.3 percent increase nationwide from the same period a year ago, and an 8.7 percent increase over the June 2009 consumer filing total of 116,365. Chapter 13 filings constituted 28.3 percent of all consumer cases in July, slightly above the June rate.

"Today's bankruptcy filing number reflects the sustained and growing financial stress on U.S. households," said ABI Executive Director Samuel J. Gerdano. "Rising unemployment on top of high pre-existing debt burdens is a formula for higher bankruptcies through the end of this year."

I’m sure you are tired of the populist shtick, buy you have to admit that it is a bit disheartening to compare this data with the profit and bonus numbers of the banks that had a huge hand in creating this mess. I’m not expecting any justice and I don’t even know what such comeuppance would look like. My point is that something (well, maybe a lot of things) just isn’t right.


(Picture of John Hussman courtesy of investmentintelligencer.com)