The Rise of the Fourth Reich
Wednesday, May 25, 2011
Market veteran Biggs: Bears are wrong about U.S. stocks
From Bloomberg:
Barton Biggs, the hedge fund manager who bought stocks when the market bottomed in March 2009, said he is bullish on U.S. equities and likes industrial shares even though the global economy has slowed.
"The U.S. and the global economy have clearly slowed pretty significantly," Biggs, who runs New York-based Traxis Partners LP, said in a radio interview with Tom Keene on Bloomberg Surveillance. "That's arousing the bears, who believe we're going to slip back into a long soft patch at best or maybe even a double-dip at worst," he said. "For a number of reasons I don't think that's right."
Biggs favors companies such as Caterpillar Inc. (CAT) and Deere & Co. (DE) because their earnings growth continues to exceed expectations and demand for farming and construction equipment remains strong.
"I don't see anything the matter with Deere and Caterpillar and the big American industrial companies, and in terms of valuation they're still very reasonable," he said.
The Standard & Poor's 500 Index climbed to an almost three- year high on the final trading day of April. It slumped 3.4 percent from that point through yesterday as economic data missed economists' estimates and investors prepared for the Federal Reserve to complete its $600 billion bond-purchase program, known as quantitative easing, at the end of June. The benchmark equity gauge rallied 4.8 percent from the end of 2010 through yesterday amid government stimulus measures and higher- than-estimated earnings.
Investor Reaction
Biggs, who oversees $1.3 billion, said last week that investors are overreacting to negative economic news such as the European debt crisis, housing and reduced stimulus from the U.S. Federal Reserve. Housing starts in the U.S. unexpectedly fell in April as flooding and tornadoes in the South shut down construction, the Commerce Department said May 17. Those issues will be resolved, while the U.S. market remains reasonably priced on an earnings basis for the next year.
"I still believe in emerging markets, particularly Asia," he said today. "China is going to be a terrific stock market in the second half of the year. China maybe has one or two more tightenings ahead."
The Shanghai Composite Index dropped for the fourth time today, losing 7.5 points, or 0.3 percent, to 2,767.06. The measure has lost 9.5 percent from the close of 3,057.33 on April 18, after earlier sliding as much as 10 percent, a level analysts say means the market has entered a correction.
'They Have Succeeded'
The Shanghai Composite, which tracks the bigger of China's stock exchanges, plunged 2.9 percent yesterday, erasing this year's advance of as much as 8.9 percent, after a manufacturing gauge fell to its lowest level in 10 months. China's preliminary manufacturing index, known as the Flash PMI, was at 51.1 in May, compared with the final reading of 51.8 in April, HSBC Holdings Plc and Markit Economics said yesterday. A number above 50 indicates expansion.
"It's apparent from the PMIs that came out yesterday that they have succeeded in slowing the economy very significantly," he said. "At the same time it's still a very dynamic economy. Now, is it going to grow 10 or 11 percent in real terms? No, it's not," Biggs said. "They're going to slow it down to 7 or 8 percent, but with a moderate inflation rate I don't see anything the matter with that and we can find a lot of attractive companies to own in China."
"The U.S. and the global economy have clearly slowed pretty significantly," Biggs, who runs New York-based Traxis Partners LP, said in a radio interview with Tom Keene on Bloomberg Surveillance. "That's arousing the bears, who believe we're going to slip back into a long soft patch at best or maybe even a double-dip at worst," he said. "For a number of reasons I don't think that's right."
Biggs favors companies such as Caterpillar Inc. (CAT) and Deere & Co. (DE) because their earnings growth continues to exceed expectations and demand for farming and construction equipment remains strong.
"I don't see anything the matter with Deere and Caterpillar and the big American industrial companies, and in terms of valuation they're still very reasonable," he said.
The Standard & Poor's 500 Index climbed to an almost three- year high on the final trading day of April. It slumped 3.4 percent from that point through yesterday as economic data missed economists' estimates and investors prepared for the Federal Reserve to complete its $600 billion bond-purchase program, known as quantitative easing, at the end of June. The benchmark equity gauge rallied 4.8 percent from the end of 2010 through yesterday amid government stimulus measures and higher- than-estimated earnings.
Investor Reaction
Biggs, who oversees $1.3 billion, said last week that investors are overreacting to negative economic news such as the European debt crisis, housing and reduced stimulus from the U.S. Federal Reserve. Housing starts in the U.S. unexpectedly fell in April as flooding and tornadoes in the South shut down construction, the Commerce Department said May 17. Those issues will be resolved, while the U.S. market remains reasonably priced on an earnings basis for the next year.
"I still believe in emerging markets, particularly Asia," he said today. "China is going to be a terrific stock market in the second half of the year. China maybe has one or two more tightenings ahead."
The Shanghai Composite Index dropped for the fourth time today, losing 7.5 points, or 0.3 percent, to 2,767.06. The measure has lost 9.5 percent from the close of 3,057.33 on April 18, after earlier sliding as much as 10 percent, a level analysts say means the market has entered a correction.
'They Have Succeeded'
The Shanghai Composite, which tracks the bigger of China's stock exchanges, plunged 2.9 percent yesterday, erasing this year's advance of as much as 8.9 percent, after a manufacturing gauge fell to its lowest level in 10 months. China's preliminary manufacturing index, known as the Flash PMI, was at 51.1 in May, compared with the final reading of 51.8 in April, HSBC Holdings Plc and Markit Economics said yesterday. A number above 50 indicates expansion.
"It's apparent from the PMIs that came out yesterday that they have succeeded in slowing the economy very significantly," he said. "At the same time it's still a very dynamic economy. Now, is it going to grow 10 or 11 percent in real terms? No, it's not," Biggs said. "They're going to slow it down to 7 or 8 percent, but with a moderate inflation rate I don't see anything the matter with that and we can find a lot of attractive companies to own in China."
Half of Americans Found to be 'Financially Fragile'
Half of Americans have been dubbed "financially fragile," meaning if asked to come up with $2,000 in 30 days, they probably couldn't, according to a paper published by researchers at the National Bureau of Economic Research, the George Washington School of Business, Princeton University and the Harvard Business School.
The survey asked the question, "If you were to face a $2,000 unexpected expense in the next month, how would you get the funds you need?"
In the United States, 24.9 percent of respondents reported being certainly able, 25.1 percent probably able, 22.2 percent probably unable and 27.9 percent certainly unable, The Wall Street Journal reports.
The $2,000 figure "reflects the order of magnitude of the cost of an unanticipated major car repair, a large copayment on a medical expense, legal expenses, or a home repair," the report says.
That also doesn't apply just to lower-income Americans.
"The more surprising finding is that a material fraction of seemingly 'middle class' Americans also judge themselves to be financially fragile, reflecting either a substantially weaker financial position than one would expect, or a very high level of anxiety or pessimism," the Journal reports.
The U.S. economy may be officially out of the recession, but high unemployment rates and rising food and grocery prices are making many nervous, even if inflation stripped of volatile food and energy prices remains tame.
"Households appear to be reacting to recent inflation data in a way that is not warranted by the actual dynamics of inflation," says San Francisco Fed research adviser Bharat Trehan, according to Reuters.
The survey asked the question, "If you were to face a $2,000 unexpected expense in the next month, how would you get the funds you need?"
In the United States, 24.9 percent of respondents reported being certainly able, 25.1 percent probably able, 22.2 percent probably unable and 27.9 percent certainly unable, The Wall Street Journal reports.
The $2,000 figure "reflects the order of magnitude of the cost of an unanticipated major car repair, a large copayment on a medical expense, legal expenses, or a home repair," the report says.
That also doesn't apply just to lower-income Americans.
"The more surprising finding is that a material fraction of seemingly 'middle class' Americans also judge themselves to be financially fragile, reflecting either a substantially weaker financial position than one would expect, or a very high level of anxiety or pessimism," the Journal reports.
The U.S. economy may be officially out of the recession, but high unemployment rates and rising food and grocery prices are making many nervous, even if inflation stripped of volatile food and energy prices remains tame.
"Households appear to be reacting to recent inflation data in a way that is not warranted by the actual dynamics of inflation," says San Francisco Fed research adviser Bharat Trehan, according to Reuters.
An “Unsettling” Similarity to 1970s Inflation?
Well, at least the quality improvements of the iPad2 weren’t mentioned…
This paper by the San Francisco Fed’s Bharat Trehan, who, like most government economists has clearly drunk the Federal Reserve kool-aid, argues that Americans’ inflation expectations are unduly influenced by the rising cost of food (which they must buy in order to survive) and energy (which they must consume in order to travel back and forth to work) rather than the many low priced items we import from Asia.
This Economic Letter argues that the jump in household inflation expectations is a reaction to the recent energy and food price shocks, following a pattern observed after the oil and commodity price shocks in 2008. The data reveal that households are unusually sensitive to changes in these prices and tend to respond by revising their inflation expectations by more than historical relationships warrant. Since commodity price shocks have occurred relatively often in recent years, this excessive sensitivity has meant that household inflation expectations have performed quite badly as forecasts of future inflation.
Then again, maybe inflation, as calculated by government economists, does a poor job of reflecting what people actually spend money on, particularly at low income levels where food and energy make up a much larger share of their expenditures.
My uneducated guess is that if consumers at different levels of income or wealth were surveyed, you’d get a dramatically different picture of inflation expectations from the top to the bottom. Those whose food and energy expenditures constitute a relatively small portion of their overall spending would likely have their inflation expectations in line with the official measure of inflation, whereas, the growing number of people who struggle to put food on the table and gas in their cars would tell you that inflation in the U.S. is a lot like it is in Vietnam – about 20 percent.
Mr. Trehan goes on to note that professional economists are much better at predicting future inflation (presumably, in much the same way that foxes are good at watching hen houses), but he partially redeems himself by asking a few innocent sounding (and largely impenetrable) questions about 1970s style inflation.
At the same time, the high sensitivity of household inflation expectations to noncore inflation is puzzling. One could argue that this excess sensitivity reflects the fact that consumers buy things such as food and gas more frequently than they buy home furnishings or haircuts. In this case, expected inflation should come down relatively quickly because households will buy enough nonfood and non-energy goods at some point. It’s also possible that households’ sensitivity to noncore inflation goes up following substantial, sharp increases in the price of energy and food items, suchas those that occurred in the 1970s and over the past few years. This would be consistent with higher household sensitivity to noncore inflation at either end of our sample in Figure 2B. This similarity to the 1970s is unsettling because it suggests that consumers are not accounting for the ways monetary policy has changed over this period.
Maybe what they’re really accounting for is how the inflation calculation has changed…
Trehan should probably have a look at what St. Louis Fed President James Bullard has had to say about core vs. noncore inflation before he pens his next paper. From this report in Bloomberg earlier today:
Bullard, repeating a theme from a speech last week, urged that the Fed drop its focus on core inflation, which excludes volatile energy and food prices.
“The ‘core’ concept has little theoretical or statistical backing” and is very arbitrary, he said. “Headline inflation is the ultimate objective of monetary policy with respect to prices,” Bullard said.
Core, noncore, whatever. I’m just thankful we never had to see any “Whip Deflation Now” buttons.
Why India is a Better Investment Than China
Misallocation of resources and outright fraud are two major problems in China.
We’re all familiar with the arguments for global investing. There are 117 stock markets outside our borders. At any given time, some market somewhere is almost certain to offer greater profit potential than New York — probably quite a few markets, in fact.
If you latch on to these emerging markets in the early stages of an upswing, you can reap a bonanza.
However, as I’ve said before, the current global bull market for stocks is no longer a youngster. It’s 27 months old, and showing signs of age. For example, many bourses around the world have skipped a beat lately over the prospect that high prices for oil and other raw materials might crimp economic growth.
In this mature phase of the market cycle, we want to own countries (and companies) with the ability to keep growing even if global headwinds pick up.
Growth on a Giant Scale
On emerging market that fits the bill is India. By the standards of the industrialized world, India is still a poor country. GDP per capita, according to International Monetary Fund figures for 2010, amounts to only $1,265, less than a third that of mainland China ($4,382).
But India has some advantages over China. It’s a democracy, with free and open debate. The legal system, while creaky and inefficient, is based on English principles. The Chinese economy, by contrast, is riddled with government-mandated misallocation of resources, as well as outright fraud in the private sector. I’m leery of most Chinese stocks listed on U.S. exchanges.
India, on the other hand, seems to be grappling more or less honestly with its problems, and making progress toward solving them. To curb inflation, the central bank has repeatedly jacked up interest rates over the past year. (The key overnight rate stands at 7.25%.) And yet, the country’s “real” (inflation-adjusted) output of goods and services is still expected to grow at least 8% in 2011 – triple the pace of the United States. Recent local elections also cemented the leading position of the business-friendly Congress party.
How good a value are Indian stocks? Not the screamer they were at the March 2009 low, obviously. However, the blue-chip Bombay Stock Exchange index (Sensex) is quoted these days at less than 15 times estimated year-ahead earnings. Over the past 20 years, the forward P/E on the Sensex has averaged about 18 times. So the market appears to have at least as much upside to fair value as, say, the NYSE does, with greater long-term growth potential.
For safety, I prefer to own a basket of Indian stocks via an exchange-traded fund (ETF). I like the India ETF PowerShares India Portfolio (NYSE: PIN).
If you want to shoot for bigger gains with individual stocks, you might consider one of India’s premier growth enterprises, car-and-truck maker Tata Motors (NYSE: TTM).
Auto manufacturing a growth business? Maybe not in the United States or Europe, but India is a world apart. TTM’s April sales ran 72% ahead of two years ago. Profits have quadrupled in the past five years. From the tiny Tata Nano to the Jaguar/Land Rover luxury brand, which TTM acquired in 2008, this outfit boasts a complete product line catering to Asia’s rising consumer class.
Yet the stock remains incredibly cheap at only 7 time estimated FY 2012 earnings (ends March 31). I say slide in behind the wheel and feel the power!
Capital Market Forecasts and Recommendation Updates
This report is in response to requests for our various capital market Supercycle forecasts and associated investment recommendations in light of recent market action, which has further confirmed all of them, including the currently all-important, incipient aftershock double double-dip in the U.S. business cycle.
See the first chart below of the Conference Board's Coincident Economic Indicators Index as we uniquely adjust for population growth, which peaked in January, the four components of which the National Bureau of Economic Research primarily relies upon to date, with the increased certainty of hindsight, U.S. business cycle expansions and contractions. (We've explained previously where our more in-depth business work disagrees with their "official" declarations.)
Chart 1: Conference Board Coincident Economic Indicators Index and the S&P 500
Following our various advance calls for the dot.com bust that started 11 years ago and the U.S. housing bust that started five years ago, the second and likely final downleg in the commodity/China bust that started in the summer of 2008 is now clearly underway. This follows our bullish call on China and simultaneous bearish call on Japan 22 years ago. See the second through the sixth charts below.
Continuing our repeated buy-again calls to buy Treasury notes and bonds over the past 30 years with the most recent one in mid-Dec, we remain firmly bullish and expect further Supercycle lows in both interest rates and eventually inflation during the K-Cycle's downtrend (the combination of the Supercycle disinflationary Autumn and the ultimately deflationary Winter economic seasons). See the seventh through ninth charts below and the Supercycle Economic Seasons, associated asset classes and some of their key driving factors in the table at the bottom.
Although 10 to 12 years ago we first became extremely long-term or Supercycle bearish on the U.S. dollar (bullish on foreign currencies money markets) and bullish on precious metals, on May 1 for the RIA clients for which we are the investment strategist, we recommended the final partial-position sales to again realize profits in their client account investments in these asset classes. We expect to recommend re-establishing full portfolio allocations — again — in these asset classes, during the next several months.
Shorter term, keep in mind that the five- to six-month Weak Season in the stock market's annual cycle — starting at the highest high in Mar, Apr or May — is finally clearly underway from the May 2 SPX intraday high at 1371, and historically it has yielded net declines more than 90% of the time through the lowest low in Sep, Oct or Nov, as we've uniquely defined and reported before.
Also, despite the very popular notion that the stock market should be up this year because it has been up in all third years of the Presidential Election Cycle, which has only been true since 1943, seven of the nine (77%) such years during the previous two Supercycle Winter Periods ended their calendar years below their Feb or Mar highs (equivalent to the SPX Feb 18 high at 1344 this year): 1883, 1887 and 1895, and then again in 1931, 1939, 1943 and 1947. Since it's a mean-reverting phenomenon, and because (rather than despite the fact) it did not occur four years ago in 2007 (like 1935), we also fully expect such a net decline through year-end to occur during this third current Supercycle Winter since 1881.
The mean-reversion, or statistical "catch down," in this third election-cycle year is being driven in part by political events that will adversely impact the stock market.
And this year there are plenty of domestic political and financial potholes: Senate gridlock within the split-house Congressional gridlock, gridlock between Congress and the Administration, challenges to Obamacare, sharp conflicts over public union pensions and their collective bargaining rights, and especially the Gordian Knot of budget deficits at all levels of government, but most especially the federal deficit and its associated debt limit.
Interestingly, the last time there was Democratic President and Republican House, where financial bills must be initiated, was during 1859-60 and befittingly that was the end of a huge 26-year Supercycle Bear Market Period called The Great Debt Repudiation (available here).
On a happier note, I'm pleased to announce we're in the process of reinstituting our risk-adjusted relative-strength stock selection service started 44 years ago, which tentatively will be called Proprietary Alpha (PA). You may email me at Bob@bronsons.com to request a copy of our July 20, 1973 report illustrating and explaining the ten-stock model portfolio's 20+-fold gain in less than eight years, and Modern Portfolio Theory's alpha-beta upon which we developed our original black-box formula for selecting stocks. Our PA is based upon multi-decade data, re-optimized for various-sized model portfolios, to take the most profitable advantage of the coming Supercycle Bull Market Period (Supercycle Spring) that we continue to expect will start just before the mid-term Congressional election in Nov 2014.
We currently expect that during that ~16-year reflationary economic Supercycle Spring, the U.S. stock market will triple every eight years — if not double every five years — on a total return basis, with the Dow reaching 50,000, if not 100,000 by 2030. Of course, I would love to be working during all of next 19 years, but in any case we are putting business succession plans in place.
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The Last Tango of the Currencies will end in Golds favour
The debt problems now weighing on the Euro have inflicted a devaluation of around 6% this month with no recovery in sight for the PIIGS, Portugal, Ireland, Italy, Greece and Spain. The harder the ECB tries to badger and cajole the PIIGS into accepting a serious dose of austerity, the more the people, who will have to carry this burden, revolt.
We have seen riots in the streets in Athens, demonstrations in Madrid, marches in London, all expressing their dissatisfaction with the status quo. Heavy defeats in regional elections have been inflicted on the ruling party in Germany, which must be of grave concern to Angela Merkel, the Chancellor of Germany, assuming that she wants to stay in office. The same goes for Spain where regional elections have gone against the current incumbents.
In the mean time European Union officials are running hither and dither with arm fulls of newly printed euros in an attempt to support the latest basket case. However, Standard & Poors cut its outlook for Italy to “negative” from “stable” on Saturday, following a downgrade by Fitch on Friday for Greek debt. So we have a situation where there could be very well be political changes at the top, however, the debt, just like a rotten smell, remains.
This slippage, experienced by the Euro has had the effect of boosting the dollar as these two currencies are the main constituents of this basket of currencies. As the chart above shows a fall in the value of the euro, the chart below shows a rise in the value of the US Dollar. This race to the bottom between the currencies will continue as each sovereign state believes that a weaker currency will boost exports and ultimately will get them out of this mess. The fact that each currency devaluation negates the previous one would appear to have gone unnoticed, by those involved.
The chart above shows the dollar rallying this month as its inverse relationship with the Euro continues. The demise of the euro hides the fact that the dollar is not well, so this rally may be short lived.
So what does this tango of the currencies mean for gold? Well, sooner or later the investment community will realize that a flight to safety will be a flight from anything paper, no matter who’s portrait is printed on it.
So now you are thinking; will the summer doldrums cap the progress of the gold prices as interest wanes and trading becomes lackluster, could be. However, there are a few factors to be considered here, a civil war in Libya, general unrest in the desert, Al Qaeda, a leaderless International Monetary Fund, the US debt ceiling, a wobbling coalition government in the UK, supply side difficulties in the mining sector and the specter of inflation. All in all we expect the summer to be choppy with the real fireworks for gold and silver beginning mid August and continuing through to January 2012.
Having acquired a certain amount of gold and silver our strategy will be to look for bargains amongst the quality producers as they have production and cash flow. The junior/exploration sector still appears to us, to be an outside punt and so we will allocate only a small amount of our capital to them. To add a little spice to the mix we will look to the options sector with the view to turbo charging our trading account.
Go gently, but do prepare and get into position as this gold bull has a long way to run.
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