SPECIAL MODEL PORTFOLIO ISSUE

 

1) My View of the Stock Market for the Rest of 2011. Down, then up, then down again. How about that? I believe that the global risk markets will bottom sooner than people think, and that the time has come to compile a shopping list of investments to pick up on distressed days in the market.

I think that at the most extreme, the S&P 500 will bottom at 1,000 at the lowest from yesterday's 1,123 close. More likely are important bottoms at the Fibonacci levels of 1,045 and 1,065. At 1,000, the index will be showing a 28% decline from the April 29 peak. The market multiple will have collapsed from 14 to 10 times earnings. That is against a 30 year range of 10-22. In other words, we will have discounted a full scale recession. Ten year Treasury bond yields are telling us the same with a 2.03% yield, against a 3.6% inflation rate.

The likelihood is that this recession is not going to happen. Virtually all the current economic data is consistent with the forecast I have maintained all year of 2%. Car sales show that the industry is recovering. Major exporters like Caterpillar and Freeport McMoran show the demand from emerging markets is booming. An enormous reconstruction package in Japan is just starting to kick in. Add all this together, there will be enough demand to assure 2% growth for the full year, which would represent a modest improvement from the first half.

Mind you, I am not proclaiming the birth of an entire new bull market. I believe that we put in the top for stock prices for this economic cycle on April 29 at 1,384, and it is unlikely that we see that print again. My best case scenario will be for a recovery of the 200 day moving average at 1,285. If we start this move off of a 1,000 bottom then there is room for a 28% move, certainly something worth taking a bite of.

What will be the drivers of such a move? In September, we will start releasing Q3 corporate earnings, which are likely to be buoyant. We will also start to see the traditional yearend liquidity push. Europe will hopefully go quite again, once the leadership returns from summer vacation. The icing on the cake would be any surprises from the Federal Reserve on the monetary front, as they did last year. All of this will pave the way a rise in risk assets everywhere that could last three to four months.

That gets us into 2012, when the real challenges reassert themselves. Very little about the presidential election is likely to be equity friendly. Arrest Ben Bernanke for treason? Really? Where's the rally in that? Gale force headwinds on the demographic front start to kick in and the first baby boomers reach the age of 66 and dramatically pare back spending. Corporate earnings will then hit diminishing returns.

Real estate promises to take another leg down, possibly as much as 25%. This will put the banks through the meat grinder once more, but this time there will be more TARP. You can forget about getting any help from congress on the economy either. It all sounds like a replay of 1937 to me, when the government ended stimulus too soon, triggering a secondary great depression. This could all add up to a real crash of the 2008 variety, with declines of 50% or more on the menu.

So what I am proposing here is not an investment, but a trade. It assumes a dead cat bounce in PE multiple from 10 to only 12.8. Preserving your capital will be the name of the game, while pulling in what incremental trading income that you can.

How could I be wrong? If failing stock prices deliver a self-fulfilling prophesy. If this summer's melt down in risk assets frighten consumers into paring back spending and corporations into backing off from capital investment, then my growth targets above will like high, and we are already in a recession. Call us 'dead men walking.' It is also possible that structurally low growth is forcing a permanent downshifting of the market's multiple range from 10-22 to 8-16. Then risk assets will begin plumbing far greater depths. This could also happen if any of the long list of structural negatives listed above accelerate. The only way to stay alive in these markets is to believe that all things are possible at all times.

SPECIAL MODEL PORTFOLIO ISSUE

 

3) The Method to My Madness. The portfolio that I have assembled here capitalizes of the major long term trends that will dominate the global economy for the next decade. Long term followers of this letter will know the names well, as these were the ones we rode up from the March, 2009 bottom, with spectacular results. Those trends include:

*The growth of the global population

*The rise of the emerging market middle class

*The scarcity of essential natural resources

*The shift from paper to hard assets

*Demographic investing

*The rise of technology

*Deflation and then inflation

Let me go through my picks on an industry by industry basis, and I will explain the logic behind them.

Energy-This is no longer a commodity, but a financial asset with a near perfect correlation with risk assets around the world. This is a 'peak oil' play that particularly targets the growth of demand in energy hungry China. Don't forget that they're not making the stuff anymore. For a speedy, leveraged position, buy the (DIG) ETF.

Autos-This industry is seeing demand climb from a low of 9 million units in 2008 to 15 million by 2013. This gets us back to just above the scrapage rate of 14 million. There is also a ton of deferred purchases still in the pipeline, holdovers from the 2008 recession. I picked Toyota because they have a triple comeback to price in from the economic cycle, the brake problems, and the tsunami.

Technology-This is what American does best, is our lead over the rest of the world, and is what everyone wants to buy or steal from us. These are our best of bread companies. If you want a quickie short cut to get in, then just buy the ETF (QQQ).

Rails- You need to transport the coal, iron ore, and food that we are shipping o China. When you weren't looking, this became one of the most efficient industries in the country. It takes one gallon of fuel to move a ton of freight 400 miles. This is a great emerging market demand play. Warren Buffet likes this industry so much that he bought his own railroad to play with, Burlington Northern.

Heavy Machinery-This is how you play the global commodities boom by staying at home. It also gets you into the shift out of paper assets into hard assets. And if you buy a bulldozer, they give you this cool, yellow baseball cap with a big black 'C' on it.

Banks-So you were looking for proof that I really am Mad? Bank of America has a book value of $10 a share. The problem is that no one believes them, so the stock is trading at a 40% discount. Move a patient out of a coma into intensive care, and the stock is good for a 50% dead cat bounce. 'RISK ON' will be the catalyst, along with a selloff in the bond market that widens their spreads.

Emerging Markets-So which do I choose, the country that is growing at a 6% rate, or the one that is plodding along at 2%. I'll let you figure this one out. The answer is a heavy weighting in emerging markets. I have listed the best four here.

Bonds-'RISK ON' means dump bonds. The (TBT) could nearly doubly from here if the ten year Treasury gets back to the 4% yield we saw six months ago.

Foreign Exchange-Dump the flight to safety currency, the Swiss franc, and buy the global growth currency, the Australian dollar. Don't touch the yen, which lives in a world of its own, and the operating manual is still written in Japanese.

Commodities-Recession fears have beaten copper like the red headed step child that it is. (FCX) is the leveraged play on the recovery of industrial metals.

Precious Metals-With gold at euphoric levels, it is ripe for a $200 pull back, even if the long term trend stays intact. Limit your risk through buying out of the money puts only.

Agriculture- We are making people faster than the food to feed them and this is a global problem. Also look at (JJG) and (DBA) for a more diversified play.

Featured Trades: (HOW TO PLAY JACKSON HOLE),
(DBA), (FXE), (USO), (CU), (PALL), (UUP),
(GLD), (SFS), (FXJ), (FXA), (FXC)

 

2) How to Play Jackson Hole. I remember when the meeting of economists at Jackson Hole was one of those boring, under the radar, non-stories that only those with an interest in the arcana of macroeconomic affairs bothered to take notice. In other words, people like me.

Today that is anything but the case. All eyes will be focused this week on the remote gathering, particularly Ben Bernanke's keynote speech on Friday, August 26. Unless you have been living in a cave on a remote Pacific island without a broadband connection, you probably already know that Ben launched QE2 in his address at the same event last year.

Traders will be hanging on every word, sifting for any evidence of bold, new measures to rescue our sagging economy. If Ben delivers, the markets will riot. The 'RISK ON' trade will be on with a vengeance, and you will want to pile into stocks (SPY), commodities (DBA), the euro (FXE), the Australian (FXA) and Canadian (FXC) dollars, oil (USO), and the industrial metals (CU), (PALL).

If Ben disappoints, 'RISK OFF' lives for a few more weeks, and you want to chase gold (GLD), the Swiss franc (SFS), and the yen (FXY). A weakening economy the 'RISK OFF' trade implies means that a rapidly shrinking trade deficit and the repatriation of American capital from abroad will strengthen the dollar. Please pass the steroids to Uncle Buck (UUP). Equities will probably put in their low for the year.

I vote for the latter. The Federal Reserve has a long history of taking slow deliberate, measured steps. It really couldn't be any other way, given that it is managing a supertanker of an economy. They adopt a policy, and then sit back for six months to see if it works. The tendency to panic is pretty much nil. Since the last bombshell, pegging short rates at zero for two years, landed as recently as August 8, I think the likelihood of further reparative measures this soon is unlikely.

I expect that one thing Ben will mention is that his outlook for the economy is considerably more positive than either you are I might have. He might even say that he expects the second half of the year to be stronger than the first half. If that is the case, the markets will welcome Ben's comments about as much as a loud fart at a Sunday church service.

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Casting for the Right Economic Policy at Jackson Hole

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Please Pass the Steroids to Uncle Buck

Featured Trades: (GERMAN GDP IS ANOTHER NAIL IN THE COFFIN FOR THE GLOBAL ECONOMY), (FXE), (EUO)

2) German GDP is Another Nail in the Coffin for the Global Economy. Major hedge fund strategists were stunned by German's Q2 GDP, which came in at a feeble seasonally adjusted 0.1%. This is a mere shadow of the more virile 1.5% growth seen in Q1. In one shot, economic growth has downshifted from a rapid 4.7% rate to a more American style 2.7%. Germany has been the engine that was driving the European economy. If it breaks down, all of a sudden Europe is going nowhere, and the world suffers.

This is the flip side to the European debt crisis. What did the Portuguese, Italians, Irish, Greeks, and Spaniards do with the money they earned off of all that German sovereign lending? They ran out and bought Mercedes, BMW's, and Volkswagens. Take away their credit cards, and all of a sudden the highly export dependent German economy takes it on the chin.

This is why German Prime Minister, Angela Merkel, is risking her political career attempting to salvage the European monetary system, even though it will be hugely expensive to do so, and is highly unpopular with the electorate. Efforts to fix the European model will be a recurring theme in the financial markets for many years to come.

How does the intrepid, opportunistic trader cash in on this? Trade the Euro (FXE) from the short side, or buy the short Euro ETF (EUO). The execution date of the continent's mindless high interest rate policy has just been moved up, and there will be no stay.

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The German Economic Engine Isn't Looking So Good

Featured Trades: (LESSON OF THE CRASH OF 2011),
(SPX), (OIL), (COPPER), (GLD), (PALL)

2) Lessons From the Crash of 2011. The Dow only moved double digits today, down 78 points, finally delivering the sort of quiet, somnolescent, low volume day one would normally expect during the dog days of August. Last week was one of the most violent in market history and traders are bracing themselves for more. So let us take pause to analyze what we got right in the melt down, and what went horribly wrong.

Running small, limited risk positions, such as through short dated options, certainly saved the day. The source of endless abuse when the bull was running, my caution is now the reason we are still in business. While losses are painful, they were anything but life threatening.

Followers of my trade mentoring program, Macro Millionaire, are up 24% since inception. This is well down from the 42% gain we saw in the spring, but it still places us in the top 1% of all hedge fund managers. What is most important is that we live to fight another day. I know many top hedge fund managers who would kill for these returns right now (sorry, John).

My view that the current market multiples were a myth was truly vindicated. I was getting tired of the endless procession of permabulls who kept insisting that at a 15 times multiple, the S&P 500 was cheap. The last time I heard this was in 2000, when NASDAQ multiples went from 100 to 50, on their way to 10. Before that, it was in Japan in 1990, when multiples went from, guess what, 100 to 50 on their way to 10. Some 20 years later, Japanese multiples remain at 15. Here we are at an 11 times multiple in the US, and sell side brokers are still insisting that equities are cheap.

When I first entered the stock business in the seventies, typical equity earnings multiples were in the seven to eight neighborhood. If you performed exhaustive stock screens, which then involved paging through endless reams of 10-k's, newsletters, and tip sheets printed in impossibly small type, you could occasionally find something at a two multiple, the kind Graham and Dodd wrote about as 'cigar butts with one puff left.' Anything over ten was considered outrageously overpriced, fit only to be sold on to retail investors. This is when the prime rate was at 6%.

The sell off we saw this month is consistent with my long term view that we are permanently downshifting from a 3.9% to a 2%-2.5% growth rate, and the lower multiples this deserves. If you had any doubts, take a look at the $16 billion in equity mutual fund outflows last week, versus the tens of billions sucked in by bond mutual funds. I'm convinced that if the circuit breakers had not been installed, we would have been visited by another four digit instantaneous flash crash.

Another of my theories was also tested and found to ring true, that when the 'RISK OFF' light starts flashing red, there is no place to hide. While the S&P 500 (SPX) collapsed by 22%, oil (USO) was down 25%, and copper (CU) gave back 18%. Palladium (PALL) was pared by 20% in a single day. Gold (GLD) performed like a star, but don't kid yourself that it is a store of value offering a safe haven. All of the fundamentals true today were valid during the 2008 crash, when the barbarous relic gave back 32%. Gold has behaved well so far because the current crisis wasn't bad enough. The next one will be.

The flight to safety assets, bonds, the dollar, Swiss franc, and yen, did well, as I expected. The outlier here was the Treasury bond market, which saw yields plummet to new 40 year lows of 2.03%. These returns blow the mind of virtually every investment professional in the industry. How the purchasers can accept a real yield of negative 1% for a decade is beyond me and everyone else. But as the legendary economist, John Maynard Keynes, used to say, 'markets can remain irrational longer than you can remain liquid.' He should know, as he went bust twice in his career.

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Ignore the 'RISK OFF' Signal and You Will Get Hurt