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2) What to Buy at the Bottom.
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: (THOSE DAMN EUROPEANS!), (AAPL)
1) Those Damn Europeans! I am tearing up my Eurail Pass, returning my espresso machine to Costco, and sending my gelato maker to the recycling center. Next year's summer vacation is going to be at Coney Island, not the Italian Rivera. Those damn Europeans are spoiling everything!
The US stock markets made a determined effort to put in a bottom last week, with the S&P 500 rallying 106 points off the bottom with blinding speed. But the Europeans had other ideas.
First, France and Germany met and agreed to do essentially nothing to solve the current debt crisis. There was no announcement of any bail outs, a Euro TARP, or even the issuance of pan continental Eurobonds. All we are left with are the hemorrhaging effects of austerity. It's as if the Tea Party had learned German and suddenly took over the Bundesbank. Then they tried to staunch market volatility with a short selling ban on all equities, a measure that has a proven history of failure.
Markets understandably gave this dreadful performance a raspberry, followed by a middle finger salute. European banks were particularly trashed, some down as much as 80% in three months. The market capitalization of the entire European banking sector is now less than that of Apple (AAPL), some $340 billion.
The Swiss were even worse. They boosted liquidity in the domestic money markets 400%, from SF30 billion to SF120 billion, in a futile attempt to weaken their own currency. There is talk of pegging the Swiss franc (SFS) to the Euro. Pretty soon, the mountain paradise's largest heavy machinery production is going to be in printing presses.
This comes on the heels of efforts by the Swiss National Bank to intervene in the foreign currency markets, which have so far cost it SF30 billion. I watched the Japanese try to end their bear market in equities via bureaucratic fiat with the end result that the Nikkei made successive new lows.
This is Europe's basic problem. They have a common currency, but borrowing is carried out by the 16 individual member states, creating a gigantic asset and liability mismatch. It's as if America had no Treasury Department, Treasury bonds didn't exist, and all of our national commitments were met through borrowing by the individual states. If that were the case, Illinois and California state bonds would be trading at 30 cents on the dollar, while North Dakota state bonds would be going for $3.
The problem is that the Europeans lack the political will to carry out the necessary reforms. No one is really interested in handing over control of monetary matters to Berlin, which would almost certainly administer them with an iron hand. The last time that happened, a certain washed up artist and rabble rouser from Austria was running the country, with unfortunate results.
The bottom line here is that the European debt crisis is going to be like one of those nasty flu's that keeps coming back, no matter how much medicine you take. Write periodic tape bombs from the continent into your trading calendar for the next several years.
By the way, since we're on the topic, hands up from anyone out there who knows who originated the term 'European Community'? Yes, you out there in the back row, wearing the toga. Julius Caesar? Not a chance. The gentleman in the black beret and stripped Breton T-shirt, smoking the Gitane. Napoleon? Nope, but you're getting warmer. You sir, the one wearing the lederhosen and knee socks. Yes, that's right, you got it: Adolph Hitler. Therein lies the problem.
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There Goes Another Load of European Bank Shares
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The Last Time Berlin Ran European Monetary Policy
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: (WHY THIS IS NOT 2008), (SPX), (SPY)
3) Why This is Not 2008. Much of the investment community is now bracing for a repeat of the 2008 crash, when the S&P 500 plunged by a gut punching 52%. For proof, look no further than last week's dramatic selling, when traders could not unload equities fast enough.
Unfortunately for those puking out positions here, this is anything but a replay of the melt down from three years ago. Much like the military, they are over preparing for the last battle, and blind to the one ahead of them. Let me tell you why those capitulating now, have got it all wrong:
*In 2008, banks were essentially insolvent. Since then, they have raised over $50 billion in primary capital.
* Nonfinancial companies are sitting on the highest cash mountains since 1955, some $2 trillion, or 11% of total assets.
*In the last three years, the consumer savings rate has leapt from 1% to 5.4%.
*Public interest coverage is at a ten year high.
*Business inventories have gone from bloated to fighting lean.
*Debt/GDP has fallen from 100% to 90%.
*The cheap dollar is fueling surging exports.
*Short term interest rates have fallen from 3% to 0%, and will remain there for two years.
*Junk bond yields have plunged from 25% to 8%, opening up financing avenues for many subprime corporate borrowers.
*Companies have announced buyback programs of $550 billion, and some $450 billion of this may be executed.
If you were an automaton, and only saw these numbers, you would be loading the boat with equities right here. But you're not, and are probably still nursing scars from 2008 which only recently healed, and still need to be scratched whenever there is a sharp change in the weather. One can never underestimate emotion when it comes to stock market valuations.
My late friends, who traded the 1929 crash and continued on throughout the thirties, told me the experience was so traumatic, that many customers stayed out of the stock market for decades, if not for the rest of their lives. We may be seeing a repeat of that now.
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History is Not Repeating Itself
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: (THE HARDEST JOB IN THE WORLD), (FXI), (TLT)
3) The Hardest Job in the World. US Vice President, Joe Biden, currently has the toughest job in the world. He has gone to China, hat in hand, to convince the country's leaders to buy even more US Treasury bonds than they already have. This he must do with ten year yields approaching 2.0%, delivering some of the largest negative yields in history. He is in effect saying, 'give me a dollar, and I promise to give you 90 cents in ten years.' Such a deal!
I'm sure that Joe's lifetime spent hobnobbing with local politicos in union halls, PTA's, and Boy Scout troops in rural Delaware has left him ill prepared for the task at hand. They used to say you could walk through Joe's deepest thoughts and not get your ankles wet. How he became the second most powerful man in the world, I will never know. Like string theory and Einstein's theory of relativity, politics can be difficult to fathom. Yet, he is going up against some of the most brilliant technocrats the world's oldest civilization has to offer.
China is already the planet's largest buyer of Treasury bonds, taking down up to 50% of the monthly auctions, its total holdings approaching $1.3 trillion. It will continue on the bid. You can forget about all of those Armageddon scenarios where China dumps its holdings, sending interest rates soaring. There is simply nowhere else to go with adequate size and liquidity. China is going to have to recycle its $250 billion a year bilateral trade surplus into dollar instruments of every description. Its total reserve now exceed $3 trillion, the largest in history
However, new buying of alternative assets has already begun. The recent run up in gold has Chinese fingerprints all over it. The Middle Kingdom was also a major player of the European refi's, no doubt attracted by sky high double digit yields. Much of the strength of hard assets last year, such as with copper, came from Chinese buying, not for consumption, but to use as a financial asset. It is also attempting to spread the wealth in a more subtle fashion through buying of minority stakes in many of the world's multinational blue chips.
I wish Joe the best of luck in his venture. Just watch out for the Peking Duck state dinner. This is when the greatest number of elderly American visitors die of heart attacks, according to an embassy official I know there.
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Maybe I'll Have the Fish
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
Featured Trades: (THE US IS TURNING INTO JAPAN)
1) Brace Yourself. The US is Turning into Japan. (SPX) As a silver tsunami of 80 million baby boomers retires, they will be followed by only 65 million from generation 'X'. The intractable problems that unhappy Japan is facing will soon arrive at our shores. Boomers, therefore, better not count on the next generation to buy them out of their homes at nice premiums, especially if they are still living in the basement and not paying any rent. They are looking at best at an 'L' shaped recovery, which is a polite way of saying no recovery at all.
What are the investment implications of all of this? Get your money out of America, Europe, and Japan, and pour it into China, India, Brazil, Mongolia, Indonesia, Mexico, Malaysia and other emerging markets with healthy population pyramids. You want the wind behind your investment sails, not in your face with hurricane category five violence. Use any serious dip to load the boat with the emerging market ETF (EEM) and individual emerging market ETF's.
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The 'Graying' of America Bodes Ill for Investors
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Featured Trades: (A VISIT TO THE INSANE ASYLUM)
2) A Visit to the Insane Asylum. Watching the ten year Treasury bond tickle a 2.00% yield yesterday, I thought it would be propitious to revisit the insanity that is going on in this market.
Historically, ten year bond yields matched the nominal GDP growth rate. So an average 3.5% GDP growth for the past decade added to a 2.5% inflation rate gave you a bond yield trading around 6%. Today the math is from a different universe. A 2.0% GDP rate added to 0% inflation is giving you the 2.0% yield you see glaring at you from your screen today. The market is essentially betting that inflation will remain at zero for another decade.
There is one honking great problem with this scenario. Rampant inflation has already broken out in great swaths of the global economy. Anyone who purchases precious metals, commodities, energy, food, health care, user fees of any kind, or a college education can tell you, not only that inflation is alive and well, it is flourishing. Residents of China (FXI), India (PIN), and Turkey (TUR) and other emerging markets, and the commodity producing countries of Australia and Canada, can also tell you a lot about inflation.
The last place you can expect this stealth inflation to appear is in government statistics, a deep lagging indicator. And don't ever expect inflation to show its ugly face where you want it the most, in your wages, pension benefits, or 401k returns.
Given the strongly positive yield curve, where 30 year yields are trading at a 3.5% premium to overnight rates, this is probably the best time in four decades to sell Treasury bonds. With rates this low, the market is not telling the government that it is issuing too much debt, but that it is not issuing enough. Personally, I don't understand why the Treasury isn't floating more paper at the long end. Maybe it has something to do with politics. At this point I have to replay John Maynard Keynes most famous quote, which I keep glued to my computer monitor, 'markets can remain irrational longer than you can remain liquid.'
So, I wouldn't be betting the ranch on Treasury bond shorts just yet. Better to limit yourself to cleaning out any last remnants of Treasury longs from your portfolio. When the turn does come, you'll be wanting to jump with both feet into the 2X leverage short Treasury ETF (TBT), and day trade its younger, more athletic cousin, the 3X (TMV).
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Meet Your New Bond Fund Manager