Monday, December 5, 2011

Are Stars Aligned for a Year-End Rally?

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

December has historically been one of the strongest months of the year for equity markets. Taking a look over the past 20 years, the S&P 500 Index in December has averaged 2 percent.

December has been historically strongest month of the year

This year has been extraordinarily turbulent, though. In fact, 2011 ranks “among the most volatile market years on record,” says Oppenheimer. When you look at the average absolute daily price changes of the S&P 500, you’ll see that the period from July through the middle of November averaged 1.8 percent. This is about a percent higher than the 60-year average, and just barely above 2008’s daily price changes. The fact is a little less significant when you consider that the 2008 number represents the entire year. Regardless, stock prices have been turbulent.

One of the most volatile time periods since 1950

The S&P 500 isn’t the only index with extreme volatility, as stock markets around the world have been extremely correlated. Take a look at the chart below, which tracks the average two-year rolling correlation between the weekly price change of 23 different developed stock markets and the MSCI World Index. Stock price correlation has remained above 80 percent since 2009—the highest over the 25-year period. Gloom Boom & Doom Editor Marc Faber says that he can’t “recall in the forty years that I have been working in the investment business, equity markets which were this correlated.”

Global Equity Markets are extremely correlated

We believe that correlations will decrease along with volatility as we get more clarity on the eurozone crisis and see signs of stability in the global economy. Our investment team noted that volatility fell this week, with the CBOE Volatility Index (VIX) declining 20 percent. This could be related to the news that November U.S unemployment unexpectedly dropped to 8.6 percent, U.S. auto sales in November were the strongest in more than two years, and preliminary data on holiday retail sales appears to be strong. According to Bloomberg News, Black Friday sales hit a record high this year, with consumers spending $11.4 billion.

Oppenheimer is one bull on U.S. equities, as the firm believes that investors have overestimated the negative impact the crisis in Europe has on the U.S. economy and corporate profitability. Oppenheimer points to the fact that the U.S. is less reliant on Europe, with only 18 percent of U.S. exports heading across the Atlantic. This has fallen from 23 percent over the past two years. Meanwhile, U.S. export growth has averaged “double-digit year-over-year growth since the end of 2009,” says Oppenheimer.

Two years of double-digit US export growth

“Corporate America remains a pillar of potency and stability,” says Oppenheimer.

Multinational companies have diversified their revenue streams by heading into fast-growing markets while still keeping their costs under control, says Oppenheimer. Additionally, cash remains at record highs, which provides a cushion to handle unforeseen issues.

Positive news came out of China this week too. For the first time in three years, the People’s Bank of China announced a cut in the reserve requirement ratio (RRR) by 50 basis points. This is a step in the right direction, says Director of Research John Derrick, as China tries to balance too-low growth with too-high inflation. Over the past three years, China has been raising the RRR to curtail loan growth, and this cut is the first step to promoting loan growth. The RRR cut was also a part of a global central bank coordination to make sure there was enough liquidity in the system, says John.

China’s RRR cut happened a month sooner than ISI expected, but the stars may be aligning in China. If you look at where the country’s purchasing managers’ index, the leading economic indicators level and inflation were during the last RRR cut three years ago, these figures were all about where they are now, says ISI.

The energy sector continues to see merger and acquisition activity (See a previous discussion in Case Study: Buyouts Crystallize Value in the Market). In November, a pipeline deal was announced between Enbridge and Enterprise Products Partners, causing West Texas Intermediate (WTI) oil prices to jump. As a result of the companies’ agreement, oil which had been flowing from the Gulf Coast to the Midwest will actually be reversed. Now, the landlocked crude in Cushing, Oklahoma will be delivered to the refiners in the Houston-area. The Wall Street Journal says, the 500-mile line “could ship an initial 150,000 barrels of crude per day by the second quarter of next year.”

Evan Smith, co-manager of the Global Resources Fund (PSPFX), discussed the effect on WTI oil prices with Yahoo the week the deal was announced. Evan says that for several months there’s been a discount in the West Texas Intermediate compared to Brent crude oil. Now that the glut of oil parked in the Midwest will move to the Coast, sentiment improved and WTI pricing moved more in line with Brent crude. (click play to watch)

Lately investors have been inundated with negative news surrounding Europe. It’s important to put these facts in perspective along with other positive signs in the market, including those that we are seeing in the U.S., China and energy sector. While the past two turbulent years have made it difficult for investors to remember the benefits of long-term investing, Oppenheimer believes that, “when the future return potential of an asset class is widely doubted, the exact opposite tends to occur.” We agree with this statement, as we believe great opportunities can be found during turbulent times like today.

U.S. Equity Market Radar (December 4, 2011)

The domestic stock market as measured by the S&P 500 Index was higher this week by 7.39 percent. All ten sectors of the S&P 500 advanced. The best-performing sector for the week was energy which increased 10.08 percent. Other top-three sectors were financials and materials. Utilities was the worst-performer, up 3.93 percent. Other bottom-three performers were consumer staples and telecom services.

Within the energy sector the best-performing stock was Alpha Natural Resources, up 28.18 percent. Other top-five performers were Newfield Exploration, Peabody Energy, Denbury Resources, and Consol Energy.

S&P 500 Economic Sectors


  • Some of the best-performing groups this week were cyclically-related groups, many of which had sold down in the face of the macro concerns pressuring the market in recent months. The coal & consumable fuel group, the best-performing group for the week, was a good example of this type of group. It was up 18 percent with all three of its members (Peabody Energy, Alpha Natural Resources, and Consol Energy) advancing.
  • The tires & rubber group, another cyclical group, advanced 18 percent, led by its single member, Goodyear Tire.
  • The steel group was also typical of this week’s cyclical outperformers, rising 15 percent, led by U.S. Steel in price performance, but with the other four group members also displaying significant gains.


  • The healthcare facilities group was the worst-performing group for the week, up 0.24 percent, led by its single member, Tenet Healthcare. A major brokerage firm initiated coverage of the hospital company with a “Market Perform” rating, stating that while the opportunity for growth is real, the current valuation leaves little room for share appreciation.
  • The specialty stores group underperformed, up 1 percent. Office supply store firm Staples Inc. increased while high-end retailer Tiffany & Co. declined. Tiffany reported quarterly earnings above the consensus estimate, but it guided fourth-quarter earnings below consensus.
  • The soft drinks group underperformed, gaining 3 percent. Groups in the consumer staples sector, such as soft drinks, typically are more defensive groups and do not usually advance as much in strong up-markets as do cyclical stocks.


  • There may be an opportunity for gain in merger & acquisition (M&A) transactions in 2011 and 2012. Corporate liquidity is high, thereby providing the means to pursue acquisitions.


  • A mid-cycle slowdown in the domestic economy would be negative for stocks.
  • An escalation in concerns over sovereign debt obligations in Europe would be negative for stocks.

It’s Time To Dump U.S. Treasury Bonds Again

First let’s make sure we understand the basics of bonds.

Bonds are a form of debt. When a company or a government needs to borrow money it can borrow from banks and pay interest on the loan, or it can borrow from investors by issuing bonds and paying interest on the bonds.

One advantage of bonds to the borrower is that a bank will usually require payments on the principle of the loan in addition to the interest, so that the loan gradually gets paid off. Bonds allow the borrower to only pay the interest while having the use of the entire amount of the loan until the bond matures in 20 or 30 years (when the entire amount must be returned at maturity).

Two main factors determine the interest rate the bonds will yield.

If demand for the bonds is high, issuers will not have to pay as high a yield to entice enough investors to buy the offering. If demand is low they will have to pay higher yields to attract investors.

The other influence on yields is risk. Just as a poor credit risk has to pay banks a higher interest rate on loans, so a company or government that is a poor credit risk has to pay a higher yield on its bonds in order to entice investors to buy them.

A factor that surveys show many investors do not understand, is that bond prices move opposite to their yields. That is, when yields rise the price or value of bonds declines, and in the other direction, when yields are falling, bond prices rise.

Why is that?

Consider an investor owning a 30-year bond bought several years ago when bonds were paying 6% yields. He wants to sell the bond rather than hold it to maturity. Say that yields on new bonds have fallen to 3%. Investors would obviously be willing to pay considerably more for his bond than for a new bond issue in order to get the higher interest rate. So as yields for new bonds decline the prices of existing bonds go up. In the other direction, bonds bought when their yields are low will see their value in the market decline if yields begin to rise, because investors will pay less for them than for the new bonds that will give them a higher yield.

Prices of U.S. Treasury bonds have been particularly volatile over the last three years. Demand for them as a safe haven has surged up in periods when the stock market declined, or when the eurozone debt crisis periodically moved back into the headlines. And demand for bonds has dropped off in periods when the stock market was in rally mode, or it appeared that the eurozone debt crisis had been kicked down the road by new efforts to bring it under control.

Meanwhile, in the background the U.S. Federal Reserve has affected bond yields and prices with its QE2 and ‘operation twist’ efforts to hold interest rates at historic lows.

As a result of the frequently changing conditions and safe-haven demand, bonds have provided as much opportunity for gains and losses as the stock market, if not more.

For instance, just since mid-2008, bond etf’s holding 20-year U.S. treasury bonds have experienced four rallies in which they gained as much as 40.4%. The smallest rally produced a gain of 13.1%.

But they were not buy and hold type situations. Each lasted only from 4 to 8 months, and then the gains were completely taken away in corrections in which bond prices plunged back to their previous lows.

20 year bonds 2008-2011

Most recently, the decline in the stock market during the summer months, followed by the re-appearance of the eurozone debt crisis, has had demand for U.S. Treasury bonds soaring again as a safe haven.

The result is that bond prices are again spiked up to overbought levels, for instance above their 30-week moving averages, where they are at high risk again of serious correction. In fact they are already struggling, with a potential double-top forming at the long-term significant resistance level at their late 2008 high.

Here are some reasons, in addition to the technical condition shown on the charts, to expect a significant correction in the price of bonds.

The current rally has lasted about as long as previous rallies did, even during the 2008 financial meltdown. Bond yields are at historic low levels with very little room to move lower. The stock market in its favorable season, and in a new leg up after its significant summer correction. Unprecedented efforts are underway in Europe to bring the eurozone debt crisis under control. And this week those efforts were joined by supportive coordinated efforts by major global central banks that are likely to bring relief by at least kicking the crisis down the road.

Holdings designed to move opposite to the direction of bonds and therefore produce profits in bond corrections, include the ProShares Short 7-10yr bond etf, symbol TBX, and ProShares Short 20-yr bond, symbol TBF. For those wanting to take the additional risk, there are inverse bond etfs leveraged two to one, including ProShares UltraShort 20-yr treasuries, symbol TBT, and UltraShort 7-10 yr treasuries, symbol TBZ, designed to move twice as much in the opposite direction to bonds. And even triple-leveraged inverse etf’s including the Direxion 20+-yr treasury Bear 3x etf, symbol TMV, and Direxion Daily 7-10 Treasury Bear 3X, symbol TYO.

3 International Stocks to Hold Forever : TEVA, PBR, DEO

I’m always on a quest to find stocks that can be bought and held for many, many years. These are companies that, for some reason, are so intrinsic to our experience as human beings that they will never go out of style. More to the point, we will always be buying what they are selling. That means these companies always will be profitable, be growing and have cash flow to either keep growing or keep giving back to us in the form of dividends. I tend to focus my selections on domestic stocks, but this time I thought I’d cast a wider net and hunt globally to see if I could find any candidates.

Teva Pharmaceutical Industries

My first choice is a company I’ve known about[1] for more than 15 years. In fact, it was one of the first stocks I ever purchased. Teva Pharmaceutical Industries (NASDAQ:TEVA[2]) has quite a history. Based in Israel, Teva had been a big player in the generic pharmaceutical industry for some time when it began developing its own multiple sclerosis drug, Copaxone. That diversified its business model. Since then, Teva has acquired a number of smaller firms while ramping up its generic and proprietary businesses.

Today, Teva is one of Israel’s largest companies and is one of the biggest generic players in the pharma world, offering 1,450 generic drugs in more than 60 countries. Management always has been ahead of the curve and managed the company beautifully. With a five-year annualized projected growth rate of 10%, well more than $3 billion in annual free cash flow and a 1.8% yield, I see Teva as so far ahead of the competition that it won’t be giving up any ground for a very long time. TEVA shares are trading near historic lows of its P/E range, so it’s a great time to get in.

Petroleo Brasileiro SA

Black gold, commonly known as oil, is a must-own asset[3] in any portfolio. Rather than own the volatile commodity outright, I prefer to own the folks who explore and produce it. Petroleo Brasileiro SA (NYSE:PBR[4]), commonly known as Petrobras, is pretty much the only game in town in Brazil, where it produces, refines, trades and transports the black stuff.

As with the big oil companies here in the U.S., Petrobras makes billions upon billions every year in profits. It carries low interest debt (5%), pays a little dividend (0.7%), and its net margins of 16.5% exceed those of all of our companies, which are all 11.8% and under.

Diageo PLC

I’d also take a good hard look at Diageo PLC (NYSE:DEO[5]). There’s always going to be a demand for booze (Prohibition certainly proved that), and that demand is growing internationally[6]. Diageo owns some of the world’s most famous brands, including Johnnie Walker, Tanqueray and Captain Morgan.

As you would expect, five-year annualized growth exists, and it’s in the 10% range. Diageo routinely produces between $2 billion and $3 billion annually in free cash flow, returning about half of that to shareholders in the form of a nice 4% yield.

Portugal raids pension funds to meet deficit targets

Portugal has raided €5.6bn (£4.8bn) of pension fund assets in a controversial scramble to meet its deficit targets.

The cabinet agreed to transfer the assets from four of Portugal’s biggest banks to the state balance sheet.

The assets will be used to bridge a gap needed to meet the fiscal deficit target of 5.9pc of GDP set by the terms of the country’s €78bn bail-out from around 10pc in 2010.

"This measure is more than sufficient to meet the budget deficit goal in 2011," said Helder Rosalino, secretary of state for central administration, on Friday.

Portugal said it had informed the EU and IMF and assured them it would be a “one-off”. However the 2010 budget was met by shifting three pension plans from Portugal Telecom on to the public social security system. The liabilities don’t count, yet.

There have been no complaints from Eurostat but Raoul Ruperal from Open Europe said: “This can’t be seen as a future revenue stream in any way.”

Debt Slavery – Why It Destroyed Rome, Why It Will Destroy Us Unless It’s Stopped

Book V of Aristotle’s Politics describes the eternal transition of oligarchies making themselves into hereditary aristocracies – which end up being overthrown by tyrants or develop internal rivalries as some families decide to “take the multitude into their camp” and usher in democracy, within which an oligarchy emerges once again, followed by aristocracy, democracy, and so on throughout history.

Debt has been the main dynamic driving these shifts – always with new twists and turns. It polarizes wealth to create a creditor class, whose oligarchic rule is ended as new leaders (“tyrants” to Aristotle) win popular support by cancelling the debts and redistributing property or taking its usufruct for the state.

Since the Renaissance, however, bankers have shifted their political support to democracies. This did not reflect egalitarian or liberal political convictions as such, but rather a desire for better security for their loans. As James Steuart explained in 1767, royal borrowings remained private affairs rather than truly public debts. For a sovereign’s debts to become binding upon the entire nation, elected representatives had to enact the taxes to pay their interest charges.

By giving taxpayers this voice in government, the Dutch and British democracies provided creditors with much safer claims for payment than did kings and princes whose debts died with them. But the recent debt protests from Iceland to Greece and Spain suggest that creditors are shifting their support away from democracies. They are demanding fiscal austerity and even privatization sell-offs. (more)

Dollar Starting Double Top?

The US Dollar Index appears to be setting up for a medium-term double top. This week it broke down through a short-term rising trend line drawn from the October low after reaching a level equal to the October top. The PMO made a lower top, creating a negative divergence.

Click here to enlarge

The 20-EMA crossed up through the 50-EMA in early September, generating a Trend Model BUY signal. The 50-EMA crossed up through the 200-EMA signaling that The Dollar Index is now in a long-term bull market. Since the EMAs are in a bullish configuration, it is less likely that a full bearish outcome will transpire, but we could see a decline to suport at the 200-EMA or the rising trend line drawn through the August and October lows.

The Weekly chart presents a positive picture with a rising PMO and positively configured EMAs.

Screen shot 2011-12-02 at 2.07.28 PM
Click here to enlarge

Bottom Line: The Dollar Index has been particularly vulnerable to the alternating extremes of attitude within the investing community of panic and relief brought on by the global debt crisis; however, while the charts refelct this volatility, they also seem to reflect a tendency toward a positive outcome in the long run.

Marc Faber: CNBC Interview – 03-Dec-2011

US Weekly Economic Calendar

time (et) report period Actual forecast previous
10 am ISM services Nov. 54.0% 52.9%
10 am Factory orders Oct. -0.4% 0.3%
Tuesday, DEC. 6
None scheduled
Wednesday, DEC.. 7
3 pm Consumer credit Oct. -- $7.4 bln
Thursday, DEC. 8
8:30 am Jobless claims 12-3
392,000 402,000
10 am Wholesale inventories Oct. -- -0.1%
FRIDAY, dec.. 9
8:30 am Trade deficit Oct. -$43.5 bln -$43.1 bln
9:55 am Consumer sentiment Dec. 66.0 64.1