Posts tagged ‘fiscal cliff’

Equity Quicksand or Bond Cliff?

The markets are rigged, the Knight Capital Group (KCG) robots are going wild, and the cheating bankers are manipulating Libor. I guess you might as well pack it in…right? Well, maybe not. While mayhem continues, equity markets stubbornly grind higher. As we stand here today, the S&P 500 is up approximately +12% in 2012 and the NASDAQ market index has gained about +16%? Not bad when you consider 15 countries are offering negative yields on their bonds…that’s right, investors are paying to lose money by holding pieces of paper until maturity. As crazy as buying technology companies in the late 1990s  for 100x’s or 200x’s earnings sounds today, just think how absurd negative yields will sound a decade from now? For heaven’s sake, buying a gun and stuffing money under the mattress is a cheaper savings proposition.

Priced In, Or Not Priced In, That is the Question?

So how can stocks be up in double digit percentage terms when we face an uncertain U.S. presidential election, a fiscal cliff, unsustainable borrowing costs in Spain, and S&P 500 earnings forecasts that are sinking like a buried hiker in quicksand (see chart below)?

I guess the answer to this question really depends on whether you believe all the negative news announced thus far is already priced into the stock market’s below average price-earnings (P/E) ratio of about 12x’s 2013 earnings. Or as investor Bill Miller so aptly puts it, “The question is not whether there are problems. There are always problems. The question is whether those problems are already fully discounted or not.”

Source: Crossing Wall Street

While investors skeptically debate how much bad news is already priced into stock prices, as evidenced by Bill Gross’s provocative “The Cult of Equity is Dying” article, you hear a lot less about the nosebleed prices of bonds. It’s fairly evident, at least to me, that we are quickly approaching the bond cliff. Is it possible that we can be entering a multi-decade, near-zero, Japan-like scenario? Sure, it’s possible, and I can’t refute the possibility of this extreme bear argument. However with global printing presses and monetary stimulus programs moving full steam ahead, I find it hard to believe that inflation will not eventually rear its ugly head.

Again, if playing the odds is the name of the game, then I think equities will be a better inflation hedge than most bonds. Certainly, not all retirees and 1%-ers should go hog-wild on equities, but the bond binging over the last four years has been incredible (see bond fund flows).

While we may sink a little lower into the equity quicksand while the European financial saga continues, and trader sentiment gains complacency (Volatility Index around 15), I’ll choose this fate over the inevitable bond cliff.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in KCG or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 11, 2012 at 5:07 pm Leave a comment

Financial Olympics: Chasing Gold, Siver & Bronze

Article is an excerpt from previously released Sidoxia Capital Management’s complementary August 1, 2012 newsletter. Subscribe on right side of page.

As a record number of 204 nations compete at the XXX Olympic Games in London, and millions of couch-watchers root on their favorite athletes, a different simultaneous competition is occurring…the 2012 Financial Olympics. So far, both Olympics have provided memorable moments for all. While the 2012 London Olympic viewers watched James Bond and Queen Elizabeth II parachute into a stadium filled with 80,000 cheering fans, investors cheered the Dow Jones Industrial Average above the 13,000 level on the same day of the opening ceremony. We have already witnessed a wide range of emotions displayed by thousands of athletes chasing gold, silver, and bronze, and the same array of sentiments associated with glory and defeat have been observed in the 2012 Financial Olympics. There is still a way to go, but despite all the volatility, the stock market is still up a surprising +10% in 2012.

Here were some of the key Financial Olympic events last month:

Draghi Promises Gold for Euro: Some confident people promise gold medals while others promise the preservation of a currency – European Central Bank President (ECB) Mario Draghi personifies the latter. Draghi triggered the controversy with comments he made at the recent Global Investment Conference in London. In the hopes of restoring investor confidence Draghi emphatically proclaimed, “The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” To view this excerpt, click video link here.

U.S. Economy Wins Bronze: Whereas Europe has been disqualified from the Financial Olympics due to recessionary economic conditions (Markit predicts a -0.6% contraction in Q3 eurozone GDP), the U.S. posted respectable Q2 GDP results of +1.5%. This surely is an effort worthy of a bronze medal given the overall sluggish, global demand. Fears over a European financial crisis contagion; undecided U.S. Presidential election; and uncertain “fiscal cliff” (automatic tax hikes and spending cuts) are factors contributing to the modest growth. Nevertheless, the US of A has posted 12 consecutive quarters of economic growth (see chart below) and if some clarity creeps back into the picture, growth could reaccelerate.

Source (Calafia Beach Pundit)

No Podium for Spain: Spain’s recent economic achievements closely mirror those of the athletic team, which thus far has failed to secure a sporting medal of any color. Why no Spanish glory? Recently, the Bank of Spain announced the country’s economy was declining at a -1.6% annual rate. Shortly thereafter, Spain estimated its economy would contract by -0.5% in 2013 instead of expanding +0.2%, as previously expected. Adding insult to injury, Valencia (Spain’s most indebted region) said central government support would be needed to repay its debts. These factors, and others, have forced the Spanish government to adopt severe austerity measures to cut its budget deficit by $80 billion through 2015. Spanish banks have negotiated a multi-billion-euro bailout, but they will have to hand control over to European institutions as a concession. Considering these facts, combined with an unemployment rate near 25%, one can appreciate the dominant and pervading losing spirit.

Global Central Banks Inject Financial Steroids: The challenging and competitive global growth environment is not new news to central bankers around the world. As a result, finance leaders around the world are injecting financial steroids into their countries via monetary stimulus (mostly rate cuts and bond buying). Like steroids, these actions may have short-term invigorating effects, but these measures can also have longer-term negative consequences (i.e., inflation). Here are some of the latest country-specific examples (also see chart below):

  • U.S. Federal Reserve Chairman Ben Bernanke has already shot a couple “Operation Twist” and “QE” (Quantitative Easing) bullets, but as global growth continues to slow, he has openly acknowledged his willingness to dig into his toolbox for additional measures under the right circumstances, including QE3.
  • The PBOC (People’s Bank of China) surprised many observers by employing its second rate cut in less than a month. The PBOC lowered its one-year lending rate by 0.31% to 6%.
  • The ECB (European Central Bank) lowered its key lending rate by 0.25% to an all-time low of 0.75% and also cut its overnight deposit rate (the equivalent of our Federal Funds rate) by 0.25% to 0%.
  • Brazil’s central bank recently cut its benchmark Selic rate for the 8th time in a year to an all-time low of 8% from 12.5%.
  • South Korea’s central bank lowered its key interest rates by 0.25% to 3%, its first such action in three years.
  • The BOE (Bank of England) raised its quantitative easing goal by 50 billion pounds (~$78 billion).

 Source (Calafia Beach Pundit)

Banks Disqualified from Libor Games: As a result of the Libor (London Interbank Offered Rate) rigging scandal, Barclays CEO Robert Diamond resigned from the bank and agreed to forfeit $31 million in bonus money. Libor is a measure of what banks pay to borrow from each other and, perhaps more importantly, it acts as a measuring stick for determining rates on mortgages and other financial contracts. In an attempt to boost the perceived financial strength of their financial condition, multiple banks artificially manipulated the calculation of the Libor rate. Ironically, this scandal likely helped consumers with lower mortgage and credit card rates.

Rates Running Backwards: Sports betting on teams and events is measured by point spreads and numerical odds. In the global debt markets, betting is measured by interest rates. So while losing, debt-laden countries like Greece and Spain have seen their interest rates explode upwards, winning, fiscally responsible countries (including Switzerland, Austria, Denmark, Netherlands, Germany, and Finland) have seen their bond yields turn NEGATIVE. That’s right, investors are earning a negative return. Rather than making a bet on higher yielding bonds, many investors are flocking to the perceived safety of these interest-losing bonds (see chart below). This game cannot last forever, especially for individual and institutional investors who require income to meet liquidity and return requirements.

Source (The Financial Times)

China Wins GDP Gold Medal but No World Record: China currently leads in both the Olympic Games gold medal count (China 13 vs. U.S. 9 through July 31st) and GDP competition. Given the fiscal and monetary stimulus measures the government has implemented, it appears their economy is bottoming. Despite the tremendous anxiety over China’s growth, China’s National Bureau of Statistics just announced a +7.6% Q2 GDP growth rate (see chart below), down from +8.1% in Q1. Although this is the slowest growth since the global financial crisis, Even though this was the slowest GDP growth rate in over three years, most countries would die for this level of growth. Adding evidence to the bottoming storyline, HSBC recently reported the preliminary Chinese PMI manufacturing index rose to 49.5 in July, up from 48.2 in June – the highest reading since early this year (February).

Source (Calafia Beach Pundit)

Higgs Wins God Particle Gold: Michael Phelps and Missy Franklin are not the only people to win gold medals in their fields. Peter Higgs and fellow scientists had 50-years of their physics research validated when the Large Hadron Collider discovered the long-sought Higgs boson (a.k.a., the “god particle”). The collider, located on the Franco-Swiss border, measured approximately 17 miles in length, took years to build, and cost about $8 billion to finish. Pundits are declaring the unearthing of Higgs boson as the greatest scientific discovery since the sequencing of the human genome. Higgs’s gold medal may just come in the form of a Nobel Prize in Physics.

Source (The Financial Times)

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in Barclays or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 4, 2012 at 8:22 am Leave a comment

Digesting the Anchovy Pizza Market

Source: Photobucket

Article is an excerpt from previously released Sidoxia Capital Management’s complementary July 2012 newsletter. Subscribe on right side of page.

I love pizza, and most fellow connoisseurs have difficulty refusing a hot, fresh slice of heaven too. Pizza is so universally appreciated that people consider pizza like ice cream – it’s good even when it’s bad (I agree). However, even the biggest, diehard pizza-lover will sheepishly admit their fondness for the flat and circular cheesy delight changes when you integrate anchovies into the mix. Not many people enjoy salty, slimy, marine creatures layered onto their doughy mozzarella and marinara pizza paradise.

With all the turmoil and uncertainty going on in the global financial markets, prudently investing in a widely diversified portfolio, including a broad range of equity securities, is viewed as palatable as participating in an all-you-can-eat anchovy pizza contest. Why are investors’ appetites so salty now? Hmmm, let me think. Oh yes, here are a few things that come to mind:

  • Presidential Election Uncertainty
  • European Financial Crisis
  • Impending Fiscal Cliff (tax cut expirations, automatic spending cuts, termination of stimulus, etc.)
  • Unsustainable Fiscal Debt & Deficits
  • Slowing Subpar Domestic Economic Growth
  • Partisan Politics and Gridlock in Washington
  • High Unemployment
  • Fears of a Hard Economic Landing in China

Doesn’t sound too appealing, does it? So, what are most investors doing in this unclear market? Rather than feasting on a pungent pie of anchovies, investors are flocking to the perceived safety of low yielding asset classes, no matter the price. In other words, the short-term warmth and comfort of CDs, money market, checking, and fixed income assets are being gobbled up like nicotine-laced pepperoni pizzas selling for $29.95/each + tax. The anchovy alternative, like stocks, is much more attractively priced now. After accounting for dividends, earnings, and cash flows, the anchovy/stock option is currently offering a 2-for-1 special with breadsticks and a salad…quite the bargain!

Nonetheless, the plain and expensive pepperoni/bond option remains the choice du jour and there are no immediate signs of a pepperoni hangover just quite yet. However, this risk aversion addiction cannot last forever. The bond gorging buffet has gone on relatively unabated for the last three decades, as you can see from the chart below. In spite of this, the bond binging game is quickly approaching a mathematical terminal end-game, as interest rates cannot logically go below zero.

Source: Calafia Beach Pundit with Sidoxia comments

Since my firm (Sidoxia Capital Management) is based in Newport Beach, next to PIMCO’s global headquarters, we get to follow the progression of the bond binging game firsthand. I’ve personally learned that if I manage close to $2 trillion in assets under management, I too can construct a 23-story Taj Mahal-esque headquarters that overlooks the Pacific Ocean from a stones-throw away.

Beyond glorified headquarters, there is evidence of other low-risk appetite examples. Here are some reinforcing pictures:

The Bond Binge

Source (The Financial Times): Bond purchases have exploded in the last three years.

Cash Hoarding

Source (Calafia Beach Pundit): Stuffing money under the mattress has accelerated in recent years as fear, uncertainty, and doubt have reigned supreme.

The Anchovy Special

Even though anchovy pizza, or a broadly diversified portfolio across asset class, size, geography, and style may not sound appealing, there are plenty of reasons to fight the urges of caving to fear and skepticism. Here are a few:

1) Growth Rolls On: Despite the aforementioned challenges occurring domestically and abroad, growth has continued unabated for 11 consecutive quarters, albeit at a rate less than desired. We are not immune to global recessionary forces, but regardless of European forces, the U.S. has been resilient in its expansion.

Source: Calafia Beach Pundit

2) Jobs and Housing on the Upswing: Unemployment remains high, but our country has experienced 27 consecutive months of private creation, leading to more than 4 million new jobs being added to our workforce. As you can see from the clear longer-term downward trend in unemployment claims, we are moving in the right direction.

Source: Calafia Beach Pundit

3) Eurozone Slowly Healing its Wounds: The Greek political and fiscal soap opera is grabbing all the headlines, but quietly in the background there are signs that the eurozone is slowly healing the wounds of the financial crisis. If you look at the 2-year borrowing costs of Europe’s troubled countries (ex-Greece), there is an unambiguous and beneficial decline. There is no doubt that Spain and Italy play a larger role than Portugal and Ireland, but at least some seeds of change have been planted for optimism.

Source: Calafia Beach Pundit

4) Record Corporate Profits: Investors are not the only people reading uncertain newspaper headlines and watching CNBC business television. CEOs are reading the same gloomy sensationalistic stories, and as a result, corporations have been cautious about dipping their short arms into their deep pockets. Significant expense reductions and a reluctance to hire have led to record profits and cash hoards. As evidenced by the chart below, profits continue to rise, and these earnings are being applied to shareholder friendly uses like dividends, share buybacks, and accretive acquisitions.

Source: Yardeni.com

5) Attractive Valuations (Pricing): We have already explored the lofty prices surrounding bonds and $30 pepperoni pizzas, but counter-intuitively, stock prices are trading at a discount to historical norms, despite record low interest rates. All else equal, an investor should pay higher prices for stocks when interest rates are at a record low (and vice versa), but currently we are seeing the opposite dynamic occur.

Source: Calafia Beach Pundit

Even though the financial markets may look, smell, and taste like an anchovy pizza, the price, value, and return benefits may outweigh the fishy odor. And guess what…anchovies are versatile. If you don’t like them on your pizza, you can always take them off and put them on your Caesar salad or use them for bait the next time you go fishing. The gloom-filled headlines haven’t been spectacular, but if they were, the return opportunities would be drastically reduced. Therefore you are much better off by following investor legend Warren Buffett’s advice, which is to “buy fear and sell greed.”

Investing has never been more difficult with record low interest rates, and it has also never been more important. Excluding a small minority of late retirees and wealthy individuals, efficiently investing your retirement dollars has become even more critical. The safety nets of Social Security and Medicare are likely to be crippled, which will require better and more prudent investing by individuals. Inflation relating to food, energy, healthcare, gasoline, and entertainment is dramatically eroding peoples’ nest eggs.

Digesting a pepperoni pizza may sound like the most popular and best option given the gloomy headlines and uncertain outlook, but if you do not want financial heartburn you may consider alternative choices. Like the healthier and less loved anchovy pizza, a more attractively valued strategy based on a broadly diversified portfolio across asset class, size, geography, and style may be the best financial choice to satiate your long-term financial goals.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

July 2, 2012 at 10:08 am 1 comment

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