Thursday, August 25, 2011

Gold--That Didn't Take Long!

The price of gold has fallen nearly 10% over the last three days.  The Chicago Mercantile Exchange and the Shanghai Gold Exchange both raised margin requirements that will increase the cost of speculating in gold futures.  That is as good a catalyst as any in starting an overdue correction in the price of gold, which had developed accelerating momentum in rising nearly 30% this year, the 11th year of its bull market.

Though it is difficult to get solid information about gold holdings among institutional and individual investors, my sense is that gold does not yet comprise a significant portion of the typical portfolio (institutional or individual). 

It is even more difficult to assign a reasonable value to gold.  If gold is considered an alternative form of money, one could add the outstanding amounts of currency in circulation and set the price of gold so that the value of aggregate gold reserves held by central banks would equal the amount of money in circulation.  Under this approach, gold would still be sharply underpriced.  But that seems to have no bearing to the short-term price of gold.

Yet gold has historically done well when real short-term interest rates are negative, as they are now and will almost surely be for a couple of more years.  And seasonally, gold has had a strong tendency to rise sharply in August and into the annual gold conference in Denver in September.

It may be that this time the price peaked out a bit early, and the bull market is over.  I doubt it.  With global monetary policies as they are, a correction in the price of gold would seem to be a good entry point for those who don't own gold.  In addition to gold, I still like instruments tied to prices of farm products on a long-term basis and would combine these with gold holdings.

Steve Lehman

Sunday, August 21, 2011

Buy Some Stocks--Again

The 17% decline in the S & P 500 in about a month has gotten people's attention.  As is typically the case, individuals have responded by dumping stocks.  Withdrawals from long-term stock funds last week were the highest since the autumn of 2008, close to the market bottom (according to the Investment Company Institute).  Sentiment measures, such as the put/call ratio, also signal broad pessimism among investors.

On the other hand, corporate insiders were buying at the highest level since the market bottom of March, 2009.

Such conditions have historically been associated with at least interim market lows and the opportunity for significant capital gains.  Given the volatility of stock prices these days, I recommend using limit orders and setting pre-determined buy points for stocks based on valuation analysis--or if you choose, technical analysis.

Steve Lehman

S & P 500:  1124

Saturday, August 20, 2011

Conventional Wisdom (cont.)

I recently noted the overwhelming consensus when the S & P downgraded U.S. Government debt that U.S. Treasury notes and bonds should be avoided or shorted.

Related to that thinking is that the U.S. and other developed nations are in inexorable decline, and emerging nations are where the action is.  The BRICs (Brazil, Russia, India, and China) have indeed posted rapid economic growth.  That hardly went unnoticed, as individual investors in the U.S. withdrew $344 billion from domestic stock funds from 2007 through June, 2011 but added $68 billion to emerging-market funds (according to the Investment Company Institute).  

Some of that might have been the usual performance chasing behavior that has caused investors in mutual funds to significantly lag the returns from indexes or the mutual funds themselves.  Part of that shift in assets, though, was probably an appropriate strategic shift in asset allocation that reflects the increased relative size of emerging economies and their stock markets.  Allocations by both institutional and individual investors are likely still far too small on a longer-term basis.

The other day, however, I emphasized the importance of strategic versus tactical investment decisions.  While the strategic, fundamental case for emerging economies and their currencies, bonds, and stocks is compelling, the tactical position is different.  Though it has drawn little attention, in two of the key emerging economies--India and Brazil--the yield curve has inverted.  This condition of short-term rates being higher than long-term rates has typically preceded economic recessions and bear markets.

Brazilian authorities have struggled with massive popularity of their country's currency, bonds, and stocks.  The Brazilian real has risen sharply and with local interest rates in the double digits, a surge of foreign funds into the domestic bond market led the authorities to impose fees on the inflow of foreign bond investments.  The Brazilian stock market has already fallen 25% from its peak during the last year, so perhaps the inverted yield curve and an economic slowdown--if not an outright recession--are already being discounted.

I just think that the bullish case for emerging markets might seem a bit obvious and would be cautious in the short term.  China is crucial to global commodity markets and the risk tolerance of market participants, and I think trouble in China is not yet sufficiently discounted in markets.

If global markets have another leg down in the next few weeks, then I'd feel more comfortable in raising the allocation to emerging markets in line with the strong secular case.

Steve Lehman

Thursday, August 18, 2011

This Is News?

Stock prices are falling sharply around the world today and as usual, observers are trying to identify news items to explain why.  Consumer confidence is down, unemployment claims are up, Europe's banks are shaky, and global economic growth forecasts are coming down.  What is new in all of this?

I've long maintained that market participants decide to buy or sell and then rationalize their decisions by selecting from various items for support.  It does not work the other way around.

Seizing the latest bit of economic news to trigger investment decisions bemuses me.  In an economy with a labor force of more than 150 million people, is it significant that the latest week's initial unemployment claims rose by 9,000?  That amounts to 0.006% of the labor force.  How accurate can that number be?  To me, it suggests an unwarranted precision (like that of many economic statistics).

Corporate earnings projections are clearly too high, and companies that miss analysts' estimates will likely continue to take hits to their share prices.  But there are a number of companies whose stocks sell for about ten times current earnings with strong cash flows and attractive dividend yields.  For income-oriented investors in particular, I recommend accumulating such equities instead of developed-country government debt for long-term total returns.

There are, however, strategic versus tactical investment decisions.  I think it is a time to emphasize tactical decisions because I think the longstanding strategic adage of "buy and hold" is dead.

I expect a long period of sharp swings in stock prices with only a modest net gain overall for a number of years.  As with the Japanese stock market of the 1990's, there could well be a series of 20-40% gains and losses.  So set disciplined purchase prices and be willing to sell if unanticipated sharp gains occur.

Steve Lehman

S & P 500:  1143

Wednesday, August 17, 2011

Conventional Wisdom Wrong Again--At Least So Far

A couple of items of conventional wisdom have been that the U.S. dollar is doomed to plummet even further (more on that in the next day or two), and that only a fool would own U.S. Government bonds.  

The fiasco over raising the Federal debt ceiling, combined with S & P's rating downgrade of U.S. Government debt led most investors, including some savvy institutional managers, to avoid--or even short--U.S. Bonds.  Yet over the past few weeks, the U.S. Treasury (20+ yr.) ETF (ticker TLT) has risen 15%.  The yield on the 10-yr.  Treasury Note is now only 2.16%.  Look at that number again and let it sink in.  The annual interest income from lending money to the U.S. Government over the next ten years is two point one six percent!  

Though the conventional wisdom on this might be right eventually, it is yet another example of the investment imperative to be skeptical of the conventional wisdom, or even to be an outright contrarian (if you have the temperament for that).

It is becoming increasingly clear that the U.S.--and Europe--face a period like that of Japan over the last two decades.  That would be stagnant economic growth, historically low interest rates on government debt, and periodic rallies and declines in stock prices.  As in Japan, government officials in Europe and the U.S. seem stymied by the conditions their countries face.

Steve Lehman

Thursday, August 11, 2011

A World of Imbalances

As I've said before, the massive imbalances in the global financial system would lead to a financial crisis, and the tepid reforms after the crisis of 2008 could lead to a comparable--or worse--crisis down the road.

There are numerous imbalances, such as China's extreme spending on fixed assets relative to its overall economy.  When countries allocate such a large portion of their economies to such investments, it invariably has lead to excessive lending and productive capacity, causing an inflationary boom, ultimately leading to a sharp slowdown.  

Another imbalance is in foreign currencies, where amid alarm over developments in the Europe and the U.S., currencies such as the Swiss Franc and the Japanese Yen has soared from a flood of money in the search of a haven.  While a strong currency is generally thought of as good for a country, too much strength can be a major problem.

In Switzerland, exports account for half of GDP.  The sharp rise in the Franc has made the country's exports increasingly expensive and uncompetitive.  In just the last year, the Franc has risen 31% against the Euro.  Nestle recently noted that the currency strength reduced its reported first-half sales by 14 percentage points, as revenues denominated in its overseas local currencies were converted back into very expensive Swiss Francs.  Swiss authorities are now seeking ways to reduce the exchange value of the Franc.  But as global stock markets plunge and fear among market participants is soaring, it is not just European and American officials who seem to be scrambling to keep up with--forget about controlling--world markets.

Steve Lehman

Wednesday, August 10, 2011

What to Do About Gold?

Having been bullish on gold since 2000 and being a contrarian investor, I am uneasy about the current state of the gold market.

Gold prices have risen for 11 consecutive years, and the price of bullion is up more than 45% over the last twelve months.  Sentiment measures now show a high level of optimism.

Yet, August and September are historically the strongest months of the year for gold.  In addition, gold historically has done well when U.S. Treasury Bill yields were negative, a condition that still exists.  Furthermore, gold remains significantly "underowned," with it representing only a very small portion of the typical individual or institutional portfolio
Given these considerations, it seems likely that a correction will ensure.  I now recommend not buying gold at current levels (unless one has none at all and makes a purchase of only a few percent of assets).  Though I think the long-term bull market in gold is intact given the state of the world's finances and the behavior of central bankers, I would wait for a pullback in price before making significant purchases.

Steve Lehman

Gold:  1760

Tuesday, August 9, 2011

Oversold Stock Prices Reflect Depressed Sentiment

Yesterday I urged the purchase of stocks because their prices had become "oversold," or they had fallen too sharply and were likely to rebound.  One of my favorite sentiment measures for the stock market had fallen to a level that reflected the highest degree of pessimism since March, 2009, when stock prices began a two-year rise that culminated with prices nearly doubling.  

Anecdotal signs also suggested a rebound.  When stories such as yesterday's "8 Trading Strategies for a Stock Market Crash" appear, it is likely that the bottom--at least for the near term--has occurred.

Despite my view that a short-term rebound will continue, it is important to remain disciplined and not chase prices that seem to be running away.  Set target purchase prices for your favorite stocks and be disciplined in waiting.  If the price doesn't come down to your point of attractive value, look elsewhere.  I expect significant volatility that might provide similar buying opportunities to those of the last few days.

Steve Lehman

S & P 500:  1172

Monday, August 8, 2011

That's Right: Buy Some Stocks

I've advocated holding large cash reserves and gold bullion for some time.  I also have favored gold bullion over gold stocks for reasons previously explained.  With gold bullion up nearly 3% today, it is now up 20% so far this year, while GDX, the ETF of leading gold mining stocks, is off 10% before today's likely drop.  That's a performance gap of 30 percentage points in only seven months!

I reiterate that now is time to begin investing some of the large cash horde.  It may not be the ultimate bottom in the market, but stocks are massively oversold and likely to have a snap-back rally soon.  Blue-chip multinational stocks are my favorites here, as their dividend yields are often higher even than the coupon on most 30-year government bonds around the world.  I also like agriculture as a long-term theme, and farm equipment makers Agco and CNH Global, for example, plunged 16% last week alone and now have p/e's of 10 times current-year earnings estimates.

I am definitely not optimistic about economic growth or profit estimates, but the stock market often moves sharply opposite of what the conventional wisdom would expect, particularly with respect to the economy.

While I'd like to see some market sentiment measures--such as the put/call ratio--reflect even deeper pessimism, the rush to sell anything but gold and bonds is resulting in some intriguing values in the stock market.

Steve Lehman

S & P 500:  1200

Sunday, August 7, 2011

Contrary Market Signal Flashes?

I think we all know someone who is a great contrary market signal, who always seems to be on the wrong side of major turning points.  I'm thinking today of someone who was once known as "The Maestro" for his purported mastery of global economic and monetary policy.  That's right, Alan Greenspan.  Today on "Meet the Press" he said he expects stock prices to continue their declines and that U.S. Government bonds are safe investments.  

With the 10-year Treasury Note now yielding about 2.5% and blue-chip, multinational stocks yielding 3.5% or better, I think the stocks will be superior investments.  In ten years, that 10-year T Note will still be providing an income return of 2.5%, while the stock (assuming a 7% dividend growth rate) will yield nearly 7% and appreciate in value.  Or a drug stock, for example, that now yields close to 5% will probably offer modest income growth and even some capital appreciation over the next decade.

Finally, the "Former Maestro" said there will be no economic "double dip' but will slow down.  How much slower could growth be than the recently reported 0.7%?

Steve Lehman

S & P 500:  1200

Thursday, August 4, 2011

Buy Stocks--Some, At Least

The recent decline in stock prices, culminating in today's plunge of 4-6% in major indexes, presents investors with a challenge.   The economic news is worsening, and it is likely that earnings estimates will erode in the weeks to come.  Yet, investor sentiment has plummeted.  When this has happened before, it has been a good time to buy stocks.

When market sentiment reflects widespread optimism, that is not necessarily a signal that stocks will quickly decline.  Prices often as not seem to rise even further, as it is difficult to time market tops.  Market bottoms, however, are different.  Deep pessimism has been a reliable buy signal.  And my favorite market sentiment indicators now signal a buying point for stocks, for a trade at least.

I've advocated holding significant cash levels for some time, and now is the time to start to use it (though I recommend never being fully invested, because of times like the last two weeks).  I suggest buying stocks tomorrow morning, unless of course, one's asset allocation to equities is already at or higher than the appropriate strategic level.

Steve Lehman

S & P 500:  1200

Monday, August 1, 2011

Emerging Markets—A Safe Bet or Not?

The case for investing in emerging economies—stocks, bonds, and currencies—has seemed solid.  Ever since Goldman Sachs economist Jim O’Neill coined the term BRICs (Brazil, Russia, India, and China) a decade ago, these four leading emerging economies and their markets have shown rapid growth and investor acceptance.

As the largest developed economies (the U.S., Europe, and Japan) struggle, their political systems seem gridlocked as they face unpalatable fiscal and demographic realities.  The BRICs and other leading emerging countries, however, have much lower debts and faster growth prospects.  Average sovereign debt is about 40% of GDP versus about 100% in developed countries.  The BRICs have more than $4 trillion in currency reserves as well, so the ability to withstand problems would seem much better than in previous business cycles.  The long-term conceptual case for their currencies, bonds, and stocks still seems compelling.

But now might not be the time to make major allocations to these markets.  The rapid economic growth in recent years was accompanied by a surge in credit issuance.  As with the U.S. housing and credit bubble, credit growth in the BRICs in particular has become excessive.  Monetary authorities have tried to restrain such credit growth as evidence of bad loans is mounting.

A credit-induced economic slowdown is not likely priced into the currencies and securities of emerging market countries.  It seems prudent to be very selective in making purchases of emerging market stocks and bonds.  In addition, several of the currencies—Brazil notably—are historically quite overvalued relative to the U.S. dollar in terms of relative purchasing power.  Gains in the stocks or bonds of emerging markets could be offset by currency losses if the U.S. dollar rises in price relative to emerging market currencies.  After large gains already in these markets, one should exercise caution at current levels.

Steve Lehman