US Economic & Financial Markets Outlook: The “We‟re “Bleeped” Economy (Louis Black), Bonds vs. Stocks, and Why the Bond Market Might Be the Biggest Threat to the U.S. Economy.
Louis Black is a hysterically funny comedian, which is special, but even more unique is his use of extremes. If you have ever watched a set of his, he has a routine where the punch line of the joke ends with Black screaming, “We‟re BLEEPED, We‟re Bleeped. (screwed but with an f).” In looking at the stock and bond markets in the current environment, it seems as every piece of macroeconomic information released is treated based on the premise investors should rename the U.S. economy the “We‟re BLEEPED” market.
To be fair, there have been data which support the idea the economy is significantly weakening. For example, last week unemployment claims went above the 500 thousand totals, while this week they settled at 470 thousand. In addition, new and existing home sales both revealed a 30% reduction in sales, the worst number in 15 years. On Friday (August 27th), GDP for the last quarter came in at a revised 1.7% growth, down from the previous quarter of 3.6% growth. Some economists had forecasted growth to come in at .5%. As Art Cashin, long time trader on Wall Street, said on CNBC, “There is a bull market in pessimism.” Throwing in his two cents was famed economist Nouriel Roubini, who upped his forecast of a double dip recession to 40%.
Naturally, the stock market has reacted unfavorably to these events, closing down in each of the last three weeks. So, these events and the decidedly negative attitude in the market lead to the key question, which supporters are accurately forecasting the direction of the economy, bullish stock investors or those who favor the bond market as a superior investment alternative?
Bond investors believe deflation will continue to be the main threat to the U.S. economy and bonds will preserve capital better in a negative, low, or no inflation rate scenario. On any asset, the real return is the nominal rate of return minus the rate of inflation. For example, if inflation is zero or close to zero, and an asset yields a nominal rate of 2%, the real return is 2% (R=2-0=2%). With two year treasury bonds at .56% (a little more than half of 1%), 10 year bonds at 2.64%, and the 30 year yielding 3.67%, current prices have very little margin of error in the event inflation picks up. Consider the following quote by Michael Lewitt, president of asset manager Harch Capital Management in an interview with Lawrence Strauss in the August 30th edition of Barron‟s, one of the premier financial publications in the world.
Barron‟s (Question): What‟s ahead for Treasuries?
Lewitt: „When the yield is below 2.50%, it doesn‟t take much of either an inflation scare or something else—but it would most likely be an inflation scare to make rates rise (interest rates). And as they rise from such low levels, the mathematics are just brutal, and you can get
your clock cleaned by going long Treasuries or high grade bonds. So you have to be very, very careful. If you buy a bond and you are going to hold it to maturity, you are locked in at around 2.5% now for 10 years. It‟s an awfully long time. I don‟t think rates are going to be appreciably higher for quite a long time, either. So it is prudent, for a little more yield to go into, say, an investment grade bond fund. But you may have some price volatility when that backup (of rates) comes. I am of the school that believes that deflation is a bigger risk than inflation, and that inflation is not going to come for a while. Right now the black- swan trade is betting on inflation. Everybody seems to be betting on deflation and lower rates, so the outlier trade is that there will be an inflation scare and that low rates will pop up- and that could really decimate some portfolios.‟ Barron‟s, August 30th, 2010 Edition. Lawrence Strauss.
Stock investors, including myself, point to many factors as to why stocks are currently a good value. First, valuations are cheap with many large cap stocks in the S&P 500 trading at 10-12X forward earnings. Second, dividend yields on high quality stocks range anywhere from 2.5-4%, in many cases greater than the longest of bond yields. Third, corporate earnings have been strong and the amount of cash sitting on balance sheets is at an all time high. Fourth, companies can borrow at low rates to fund operations or engage in merger and acquisition activities. If companies can grow operating cash flow at anywhere from 5-10% per year, based on the previous factors, it is hard to see how stocks are not a much superior investment alternative than bonds, but again, I am always biased towards stocks.
Finally, in the investment world there are many choices out there, but investors are forced to live with the choices about allocating capital. I believe the most dangerous threat to the U.S. economy is the possibility the deflationist camp is wrong and there is a massive bond bubble waiting to be pricked by higher inflation or interest rates. Billions of dollars have been pouring into bond funds over the last 18 months, and the bond market has been in bull mode for 15 years. The world must have deflation for a long time for the bond thesis to hold up. If it does not turn out to be accurate, bond investors must live with the outcome, both good and bad.
Global Economic & Financial Markets Outlook: Global Indexes Are Generally Underperforming, BRIC Countries, and Pockets of Strength.
(All country index data provided by the market data section of the WSJ on August 28, 2010)
The majority of international stock indexes throughout the world have negative returns through the end of August 2010. As far as specific continents throughout the world are concerned, the consensus view in the investment community regarding economic outlooks remains the same- the mature economies of Western Europe, other than Germany, will struggle under various austerity measures to deleverage and the result will be flat to minimal growth over the next few years. Asian economies and the BRIC countries should continue to have the quickest GDP growth in the world, but that does not mean their financial markets will outperform every year.
As far as global capital markets are concerned, there is a unique situation which currently exists. The BRIC countries, which many investors consider the place where a heavy percentage of their assets should be allocated, have not performed well this year as far as investment returns are concerned. Last year, those indexes dramatically outperformed other world indexes. For
example, the Bovespa Index of Brazil is down -4.4% year to date, the Russian RTS Index is down -0.3%, India‟s Bombay Index is up +3.3%, and China‟s Shanghai composite and the Dow Jones China 88 are down -20.3% and 23.9% respectively. These data speak to time horizon as a key factor in considering potential investments as the more time an investor has, the better chance a BRIC investor will see better than average returns. In that vein, now might be an excellent time to consider specific BRIC country indexes for a potential investment.
Finally, I think it is always important to look for countries which have notably outperformed through the year. Interestingly enough, Turkey‟s index is up 12.3% for the year, Thailand has increased 22.6%, the Philippines have grown by 16.6%, and Indonesia‟s return is outstanding at +22.5%. All are excellent returns for country indexes in a very tough environment for positive returns. However, as the BRIC country index returns data shows, one year of returns is too short a time frame to make assertions about outperformance for a great length of time.
Y H & C Investments: The Psychology of Contrarian Investing: History and How Applicable it is to the Current Market Environment, and how Time is on the Side of Stocks.
The famous line about history by Mark Twain is, “History does not repeat itself but it does rhyme.” In looking at the current capital market situation, the consensus outlook by many noted economic forecasters is that the biggest threat to the U.S. economy is deflation. In looking back in history at similar economic conditions, consider the following passages from “The Davis Dynasty- Fifty Years of Successful Investing on Wall Street.” John Rothschild. Published by John Wiley, 2001. Pp 58-60.
„The recent past had told people bonds were attractive and safe but the present was telling Davis they were ugly and dangerous. Interest rates were fast approaching what John Maynard Keynes called the “balm and sweet simplicity of no percent.” Keynes was exaggerating, but not by much—the yield on long term Treasuries hit bottom at 2.03% in April of 1946. Buyers would have to wait 25 years to double their money, and to Davis, this was pathetic compounding. He saw the threat in the “sea of money on which the U.S. Treasury has floated the costliest of wars.” With the government deep in hock and forced to borrow another 70 billion to cover its latest shortfall, he was certain lenders soon would demand higher rates, not lower. The most reliable inflation gauge, the Consumer Price Index (CPI) rose sharply in 1946. Bond bulls turned a blind eye to the inflationary outlook and ignored a basic lesson from Investment 101- Avoid bonds when the CPI is rising. A second lesson is avoid bonds after a costly war.” (pp 58-59)
I find it interesting the current situation is one where the U.S. Government is running far larger deficits (than 1946), has 50 trillion in unfunded pension liabilities, and the 30 year Treasury bond yields 3.67%, which one might find similar to 1946, but in a more extreme way. Is inflation roaring today- not right now, but conditions can change quickly, and if they do, consider the following from the same book:
“Is it a cruel joke that the most popular asset of each era will impoverish its owners? Every 20 years or so in the 20th century, the most rewarding investment of the day reached the
top of its rise and started a long decline, and the least rewarding investment hit bottom and began a long ascent… In the late 1920‟s, yesterday‟s proven winner was stocks, and the love for equities wrecked the net worth of a generation. A skeptical minority escaped into government bonds, a move that gave them an excellent and steady income for the next 17 years. Stocks never fully recovered. The late 1940‟s brought another turning point. By that time, bonds were yesterday‟s proven winners and were hailed as the safest and smartest investment. What followed was a 34 year bear market in bonds that lasted from the Truman Era to the Reagan years. The 2-3% bond yields in the late 1940‟s expanded to 15% in the early 1980‟s, and as yields rose, bond prices fell and bond investors lost money. The same government bond that sold for $101 in 1946 was worth only $17 in 1981. After 3 decades, loyal bondholders who had held their bonds lost 83 cents on every dollar they invested.” (Pp 60-61)
From my perspective, investors need to consider this history when evaluating investment alternatives. I believe time is currently on the side of stock investors as the mathematics of investing favors buying companies with growing revenues which pay a dividend yield of 2-4%, and a dividend which has consistently grown over time. If inflation or interest rates rise in the next 30 years, bond prices will go down, making a flat stock investment a more attractive alternative than a government bond. In some cases, stocks can go up 5-15% in a day, let alone considering what can happen over 30 years. The great thing about capital markets is asset allocation determines your outcome (return) based on your analysis. One thing is certain, father time will determine how intelligent (or not) a stock or bond investment is today versus 1, 3, 5, or 15 years from now. Lastly, for another perspective on the current market, here is a link to a nice article by famed financial writer Roger Lowenstein. (Please copy the link into your browser) (http://www.nytimes.com/2010/08/29/magazine/29fob-wwln-t.html?_r=1&ref=business)
Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, please email me at info@y-hc.com
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
Tuesday, August 31, 2010
Sunday, August 1, 2010
Y H & C August 2010 Newsletter
WWW.Y-HC.com
Y H & C Monthly Newsletter- August 2010 Edition #27
(Please note: Investments results do not include dividends reinvested or received)
Index- 2010 Return Yearly Return from Date of Picks
Dow Jones +.003%
S&P 500 -.012%
Nasdaq -0.06%
Russell 2000 +.04%
July 2010 Picks +2.41
June 2010 Picks -1.67%
May 2010 Picks -03.14%
April 2010 Picks -1.42%
March 2010 Picks -3.46%
February 2010 Picks -0.86%
January 2010 Picks -13.70%
December 2009 Picks -10.80%
November 2009 Picks -04.60%
October 2009 Picks +9.90%
September 2009 Picks -0.15%
August 2009 Picks +21.93%
July 2009 Picks +21.27%
June 2009 Picks +21.08%
May 2009 Picks +109.89%
April 2009 Picks +71.00%
March 2009 Picks +145.17%
February 2009 Picks +95.10%
January 2009 Picks +64.80%
US Economic & Financial Markets Outlook: Low Volumes, Wide Trading Spreads, and is the “New Normal” correct?
During the month of July 2010, U.S. Financial Markets had a good month on the equity side as the Dow gained almost 7%, the Nasdaq advanced 6.99%, the S&P 500 tacked on 7.48%, and the Russell 2000 gained 2.58%. The most notable observation I can make about July is the lower volumes which took place in almost every stock I look at. On almost any non-earnings report day, the average trading volume of any stock was down at least 10-20% from an average non summer day. With lower volumes, bid-ask spreads become wider, so what happens is large price swings in individual stocks become normal.
With these wide price swings the typical situation on the equity trading floor, fixed income funds became far more aggressive on the publicity front, commenting on television at every opportunity on the inevitable doom and downfall in the equity markets. Why might bond funds become so vocal about the horrible outcomes in the stock market which have to take place? The answer lies in self interest, not a shock to most investors, even non astute ones. Over the last few years bond funds have seen massive capital inflows, and the funds must put the cash to work and boy have they ever. With bond yields trading as low as they have in many years (2 yr treasury-.61%, 10yr-2.99%, 30yr-4.07%), the interest rate risk for bonds, especially treasury bonds, has probably never been higher. These bond funds want to make sure capital keeps flowing in, and as such, their fees continue to go up, not hard to understand.
The standard line from bond fund managers is the world is now facing the “new normal.” The phrase means the developed world economies face a new situation of deleveraging (reducing debt), overcapacity in many industries, high unemployment which will last longer than usual and ultimately slower economic growth, resulting in lower returns for riskier assets. Investors have reacted favorably to the new normal hypothesis, if only evaluating it on a capital flow basis. However, I wonder is the new normal theory totally accurate, or are there parts of it that render more opportunity, especially in the equity markets?
I believe on a macroeconomic level, the new normal thesis makes sense, and many facets of the argument are presently occurring. Consumers are paying down debt at record levels, and there is plenty more of it to pay down before debt totals would approach normal levels (something like 5-10 years). Many industries are indeed suffering from overcapacity, and financial institutions are deleveraging and being forced to adapt to more stringent financial regulations which could lower profit levels and force institutions to provide higher reserve levels to make up for losses on impaired assets. Risk management and risk avoidance are the central priority in the investment community, which means money flows into fixed income products and away from riskier assets, like stocks and commodities. However, because of these conditions, greater opportunities are present in equities as poor macroeconomic data leads to massive equity selloffs where all companies are painted with a broad brush.
As such, high quality businesses become available for long periods of time at attractive prices. For example, for 6 months in a row, Verizon (VZ) has been trading anywhere from 26-33$ a share, and at a very cheap multiple in many different valuation areas. The stock yields 6-7% and throws off about 30-35 billion dollars a year of cash, with debt levels 3X cash flow. The company recently reported a nice quarter (it also spun off its holding in Frontier Communications) and the stock reacted favorably. The key point is the environment today is filled with broad negativity regarding the equity market and the result is there might be more opportunity in the equity market than many people believe, which is certainly not the “new normal” regarding equities.
Global Economic & Financial Markets Outlook: China Retreats, No Blowups from Europe, Chile Outperforms.
The most recent economic and financial news from continents around the world reveal a theme of the status quo. The various countries around mainland China continue to grow quickly, with questions about an impending real estate bubble in China, and what the repercussions are if the bubble pops? European countries released the results of the much publicized stress tests of their banks, yet questions remain about the true status of these institutions and the quality of their capital. India and Russia have been relatively news free regarding any economic problems, and these markets are relatively flat on the year.
Many international stock indexes remain underwater for the year, especially those related to China. The Shanghai composite is down -19.2%, the DJ China 88 Index retreated -22.0%, and DJ CBIN China 600 has lost -17.1% for the year. Certainly, all of these indexes might be a place to consider for investment, but require extensive research before putting down hard earned capital. On a positive note, a country which is investor friendly (stable government, transparency with rule of law, low tax rate) is Chile, and it has been reflected in the index returns during the year, +21.1%, as well as for the last three year, +9.8%. Anyone want some Chile, and I am not talking about Chile with beans?
Y H & C Investments: The Psychology of Investing: In the Midst of a Typical Summer, Where Are the Growth Markets and What to do About Them?
The summer of 2010 is 2/3 complete and is typical of most summers in the equity markets. Some volatility, lots of low volume days, and a continuation of the growth of a large overvaluation in a specific asset class. Two years ago during the summer, oil traded at 150 dollars a barrel. This year, I continue to believe the bond market is where the bubble continues to inflate. At some point, fixed income investors should be ready for severe pain when interest rates rise. One might also look at gold as another market loaded with bubble type risk. Amongst all the bubbles, it is more important for equity investors to look for potential markets which have bright growth prospects for many years in the future.
First, I think the small business market, in the U.S. and internationally, is a huge growth opportunity. In the U.S., around 60% of all businesses are considered small, and they drive most of the new hiring in the economy. Internationally, I would imagine small businesses outnumber large by a ratio of 3-1, and any products which can be sold to small business on a global scale offer a huge possibility for profits.
Second, health care related industries should be growth markets for many years to come, both domestically and globally. The need for better health care, especially personalized, is something which will benefit society in many different ways. Most important, it should improve quality of life and increase duration of life expectancy.
Third, alternative energy will be a growth industry for decades. Alternative energy in the U.S. accounts for just 1% of all energy produced. Solar, wind, electric grid improvements, electric cars, lithium production for batteries (just for you Sean), geothermal, and shale conversion are all areas to look into. With a massive market for energy, alternative resources which can lower their cost of production through quick consumer acceptance should ultimately reap the rewards of increasing market shares.
Fourth, the wireless and digital economies will see more consumer adoption for many years. With the growth of smart phones, wireless book readers, or any product which can be produced, distributed, and sold electronically, the digital economy will only become a more integral part of modern society. Younger generations are already increasingly forming habits on the internet using social networking, and look for the trend to continue.
Finally, a critical point is to focus on a specific industry and compare the competitive positions of the various companies in the segment. An investor only has so much capital available, so you want to find enterprises which you believe have the ability to last (balance sheet), as well as grow through intelligent reinvestment of profits. Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, please email me at info@y-hc.com.
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
Y H & C Monthly Newsletter- August 2010 Edition #27
(Please note: Investments results do not include dividends reinvested or received)
Index- 2010 Return Yearly Return from Date of Picks
Dow Jones +.003%
S&P 500 -.012%
Nasdaq -0.06%
Russell 2000 +.04%
July 2010 Picks +2.41
June 2010 Picks -1.67%
May 2010 Picks -03.14%
April 2010 Picks -1.42%
March 2010 Picks -3.46%
February 2010 Picks -0.86%
January 2010 Picks -13.70%
December 2009 Picks -10.80%
November 2009 Picks -04.60%
October 2009 Picks +9.90%
September 2009 Picks -0.15%
August 2009 Picks +21.93%
July 2009 Picks +21.27%
June 2009 Picks +21.08%
May 2009 Picks +109.89%
April 2009 Picks +71.00%
March 2009 Picks +145.17%
February 2009 Picks +95.10%
January 2009 Picks +64.80%
US Economic & Financial Markets Outlook: Low Volumes, Wide Trading Spreads, and is the “New Normal” correct?
During the month of July 2010, U.S. Financial Markets had a good month on the equity side as the Dow gained almost 7%, the Nasdaq advanced 6.99%, the S&P 500 tacked on 7.48%, and the Russell 2000 gained 2.58%. The most notable observation I can make about July is the lower volumes which took place in almost every stock I look at. On almost any non-earnings report day, the average trading volume of any stock was down at least 10-20% from an average non summer day. With lower volumes, bid-ask spreads become wider, so what happens is large price swings in individual stocks become normal.
With these wide price swings the typical situation on the equity trading floor, fixed income funds became far more aggressive on the publicity front, commenting on television at every opportunity on the inevitable doom and downfall in the equity markets. Why might bond funds become so vocal about the horrible outcomes in the stock market which have to take place? The answer lies in self interest, not a shock to most investors, even non astute ones. Over the last few years bond funds have seen massive capital inflows, and the funds must put the cash to work and boy have they ever. With bond yields trading as low as they have in many years (2 yr treasury-.61%, 10yr-2.99%, 30yr-4.07%), the interest rate risk for bonds, especially treasury bonds, has probably never been higher. These bond funds want to make sure capital keeps flowing in, and as such, their fees continue to go up, not hard to understand.
The standard line from bond fund managers is the world is now facing the “new normal.” The phrase means the developed world economies face a new situation of deleveraging (reducing debt), overcapacity in many industries, high unemployment which will last longer than usual and ultimately slower economic growth, resulting in lower returns for riskier assets. Investors have reacted favorably to the new normal hypothesis, if only evaluating it on a capital flow basis. However, I wonder is the new normal theory totally accurate, or are there parts of it that render more opportunity, especially in the equity markets?
I believe on a macroeconomic level, the new normal thesis makes sense, and many facets of the argument are presently occurring. Consumers are paying down debt at record levels, and there is plenty more of it to pay down before debt totals would approach normal levels (something like 5-10 years). Many industries are indeed suffering from overcapacity, and financial institutions are deleveraging and being forced to adapt to more stringent financial regulations which could lower profit levels and force institutions to provide higher reserve levels to make up for losses on impaired assets. Risk management and risk avoidance are the central priority in the investment community, which means money flows into fixed income products and away from riskier assets, like stocks and commodities. However, because of these conditions, greater opportunities are present in equities as poor macroeconomic data leads to massive equity selloffs where all companies are painted with a broad brush.
As such, high quality businesses become available for long periods of time at attractive prices. For example, for 6 months in a row, Verizon (VZ) has been trading anywhere from 26-33$ a share, and at a very cheap multiple in many different valuation areas. The stock yields 6-7% and throws off about 30-35 billion dollars a year of cash, with debt levels 3X cash flow. The company recently reported a nice quarter (it also spun off its holding in Frontier Communications) and the stock reacted favorably. The key point is the environment today is filled with broad negativity regarding the equity market and the result is there might be more opportunity in the equity market than many people believe, which is certainly not the “new normal” regarding equities.
Global Economic & Financial Markets Outlook: China Retreats, No Blowups from Europe, Chile Outperforms.
The most recent economic and financial news from continents around the world reveal a theme of the status quo. The various countries around mainland China continue to grow quickly, with questions about an impending real estate bubble in China, and what the repercussions are if the bubble pops? European countries released the results of the much publicized stress tests of their banks, yet questions remain about the true status of these institutions and the quality of their capital. India and Russia have been relatively news free regarding any economic problems, and these markets are relatively flat on the year.
Many international stock indexes remain underwater for the year, especially those related to China. The Shanghai composite is down -19.2%, the DJ China 88 Index retreated -22.0%, and DJ CBIN China 600 has lost -17.1% for the year. Certainly, all of these indexes might be a place to consider for investment, but require extensive research before putting down hard earned capital. On a positive note, a country which is investor friendly (stable government, transparency with rule of law, low tax rate) is Chile, and it has been reflected in the index returns during the year, +21.1%, as well as for the last three year, +9.8%. Anyone want some Chile, and I am not talking about Chile with beans?
Y H & C Investments: The Psychology of Investing: In the Midst of a Typical Summer, Where Are the Growth Markets and What to do About Them?
The summer of 2010 is 2/3 complete and is typical of most summers in the equity markets. Some volatility, lots of low volume days, and a continuation of the growth of a large overvaluation in a specific asset class. Two years ago during the summer, oil traded at 150 dollars a barrel. This year, I continue to believe the bond market is where the bubble continues to inflate. At some point, fixed income investors should be ready for severe pain when interest rates rise. One might also look at gold as another market loaded with bubble type risk. Amongst all the bubbles, it is more important for equity investors to look for potential markets which have bright growth prospects for many years in the future.
First, I think the small business market, in the U.S. and internationally, is a huge growth opportunity. In the U.S., around 60% of all businesses are considered small, and they drive most of the new hiring in the economy. Internationally, I would imagine small businesses outnumber large by a ratio of 3-1, and any products which can be sold to small business on a global scale offer a huge possibility for profits.
Second, health care related industries should be growth markets for many years to come, both domestically and globally. The need for better health care, especially personalized, is something which will benefit society in many different ways. Most important, it should improve quality of life and increase duration of life expectancy.
Third, alternative energy will be a growth industry for decades. Alternative energy in the U.S. accounts for just 1% of all energy produced. Solar, wind, electric grid improvements, electric cars, lithium production for batteries (just for you Sean), geothermal, and shale conversion are all areas to look into. With a massive market for energy, alternative resources which can lower their cost of production through quick consumer acceptance should ultimately reap the rewards of increasing market shares.
Fourth, the wireless and digital economies will see more consumer adoption for many years. With the growth of smart phones, wireless book readers, or any product which can be produced, distributed, and sold electronically, the digital economy will only become a more integral part of modern society. Younger generations are already increasingly forming habits on the internet using social networking, and look for the trend to continue.
Finally, a critical point is to focus on a specific industry and compare the competitive positions of the various companies in the segment. An investor only has so much capital available, so you want to find enterprises which you believe have the ability to last (balance sheet), as well as grow through intelligent reinvestment of profits. Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, please email me at info@y-hc.com.
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
Wednesday, February 3, 2010
Y H & C February 2010 Investment Newsletter
US Economic & Financial Markets Outlook: An Overheated Bond Market, Strong Corporate Earnings, and A Culture of ‘Backseat Driving'.
In the month of January 2010, the Dow Jones Industrial Average lost %, the S&P 500 lost %, the NASDAQ lost %, and the Russell 2000 lost %. The U.S. economic outlook for 2010 remains an intriguing question which investors are eagerly trying to solve. The outlook is perplexing because many economic statistics, when viewed individually, lead to vastly different conclusions. For example, if one bases their assessment of the economy on U.S GDP growth for the past year, after three quarters of negative growth the most recent quarter saw a swing to +2.5% growth. Three down quarters followed by a positive quarter, hmmm, the facts dictate things are improving and 2010 will be a better year for the economy (maybe based on the idea that things have to get better, don’t they?). Not so fast. If one looks at current gold prices, almost $1100 per ounce, you would probably come to the conclusion the U.S. economy has major inflation and currency problems. Based on these two issues, investors won’t want any part of the U.S economy or markets.
Turning to the credit side, low bond yields, with the 2 yr Treasury at .86%, 5 yr at 2.38%, 10 yr at 3.64%, and 30 yr at 4.55%, generally are down from the previous month. The low yields would lead investors to come to the conclusion inflation is not an issue (but deflation might be a more pertinent problem). Corporate profits for the fourth quarter of 2009 have generally been strong, outside of the financial sector. Most companies have beaten their earnings estimates quite handily due to slightly improving demand, major cost cutting, and general dollar weakness. Non- financial companies have vastly improving balance sheets in as good a shape as they have been in a long time. Based on these situations, an investor would conclude, “the water is safe” as far as allocating capital, and why not, borrowing is cheap and profits are improving.
Looking at every one's favorite, the fiscal and monetary policies of the U.S. government, one contends with the vast contradiction of huge fiscal deficits and loose monetary policies (low interest rates and buying of mortgage backed and asset backed securities). If one adds to the mix an official unemployment rate of 10%, an unofficial rate of 17% or more, the strength or weakness of the dollar versus the Euro, Yen, Pound, Renminbi and others, the bottom line is for someone to try and come to a reasonable assessment of where the economy is headed, well, good luck. I would only say trying to estimate how the U.S. economy will do during the rest of 2010 is what I call “A Fool’s Errand.” One should also learn a lesson of doing significantly more research before coming to an economic conclusion based on one piece of information without putting it in the context of a complex issue.
One of the problems with being an investor today is the culture of 2nd guessing. Anybody who is married can understand what I am talking about. The culture of backseat driving exists almost everywhere. Just look at this week: During the State of The Union Address by Barack Obama, the President questioned a recent Supreme Court decision on allowing unlimited expenditures for corporations in financing political campaigns. Congress had hearings on the U.S. government assuming 80% of the insurance company AIG and the Treasury Secretary Tim Geithner was repeatedly second guessed about the terms of the deal and how unwilling Mr. Geithner was to use the government’s position to obtain better terms from large money center banks like Goldman Sachs and J.P Morgan Chase. The second guessing is enormous in the financial world with investors questioning money managers across the board on asset classes, sectors, positions, timing of buys and sells, currencies and on and on. Investing is difficult because your analysis must be accurate, but you also must have the conviction to hang in there when positions do not go according to plan. Returns on your investments often take years, not months. The second guessing does not make it any easier, I am sure, for any money manger but particularly those that handle vast sums of capital.
Finally, in my opinion, (repeated for a few months), the biggest area to stay from right now is the bond market. Based on what I have seen in many areas, bond prices are considerably over priced. I have read where one money manager has his biggest position in a fund which realizes 2X the inverse of the 30 yr bond market, which just means he gets double returns if the bond market goes down (bond prices go down when interest rates go up- so obviously he is betting interest rates are going up). If you look at Treasuries, Corporates, Junk Bonds, Mortgage Backed, Municipal bonds in local and state government, the prices a buyer pays are very high. Very simply, many investors have piled into this asset class on the thesis the world is ending. It may end, but for them, when interest rates rise. Time will tell if I am correct, so stay tuned on this one.
Global Economic & Financial Markets Outlook: "The More Things Change, The More They Stay the Same- Maybe Tree's Don't Grow to the Sky After All"
In 2009, global stock markets continued to go straight up, as most country indexes recorded gains around 35% for the year. So far, 2010 has proved an entirely different year and the results have been dramatically different as well. Global indexes typically lost around 5% for the month of January 2010. The old proverb about markets, "Tree's don't grow to the sky," may be a bit premature to cite, however, at least for January, it certainly is applicable.
In looking at specific countries, there are some noteworthy results. First, I believe an investor must look at the BRIC (Brazil, Russia, Indian, and China) countries to gauge how market sentiment is viewing the largest growth opportunities for the future. Brazil's market was down -4.4%, Russia was up +2.4%, India was down -6.6%, and China's Shanghai Index was down -8.6%. The two largest largest markets have the greatest volatility, it is either feast or famine, with dramatic out performance or severe under performance. I contend if January's results continue for any lengthy duration (more than 2 months), buyers will find those country attractive.
Turning to Europe, the nonperformance was dramatic in the European zone countries (-5.9%), Portugal (-6.3%), Italy (-7.1%), and Spain (-9.3%). Do you think the sovereign debt issues of Greece (Euro), Portugal, Spain, and Italy have anything to do with these outcomes (nah, couldn't be)? I also find it very interesting the PX-50 of Czechoslovakia (+6.2), OMX (Denmark) (+4.5%), and the OMX (Finland) (+2.6%) outperformed Euro zone and the U.K. as well. Lastly, I would only note 2009 started off very poorly as well, all over the world. Drawing any conclusions for the rest of the year from January's results may be very premature.
Y H & C Investments: The Psychology of Investing: What We Can Learn From the Saints, A Fashion Show, and Benjamin Graham
Well, the New Orleans Saints are in the Superbowl after 43 years of futility. If we rewind 5 years go, the Saints did not play a home game in their own stadium because of Hurricane Katrina. The city of New Orleans is understandably euphoric with the chance to be a world champion, and even if they do not win the Super Bowl, just to be in the game is an accomplishment the whole region takes enormous pride in. So what, you say, what do the New Orleans Saints have to do with investing? Actually, the key point is the world continually changes and in the investment world, what has worked for a long period of time can suddenly go very wrong, very quickly. What has not worked, especially for what seems like forever, can work and work in a big way for just as long as it did not work. Ultimately, looking for these changes in a company's condition is where big money can be made.
In many ways, the stock market is like a fashion show. During certain years, specific styles are wanted by everyone and other patterns nobody wants anything to do with. Three years later, everything flips around and old styles are the flavors in demand, and the previous trends go out the window. The stock market is very much like that in the sense specific company's have these immense valuations (currently AMZN, GMCR, HGSI, etc) where I just shake my head and wonder why anyone would buy these companies at the current prices. Other very good companies trade at much cheaper prices and cannot get anyone to touch them. And then, with no announcement, things change. With the change comes a completely different sentiment, and low and behold, different stocks start to go up. Welcome to the vagaries of the stock market.
Finally, let me close with a quote from Benjamin Graham, Warren Buffet's teacher at Columbia.
' Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.' (The Intelligent Investor, Pps 204-205. Ben Graham, 4th Revised Edition, First Collins Business Edition)
Thanks for reading and if you have any questions, please email me at info@y-hc.com.
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
In the month of January 2010, the Dow Jones Industrial Average lost %, the S&P 500 lost %, the NASDAQ lost %, and the Russell 2000 lost %. The U.S. economic outlook for 2010 remains an intriguing question which investors are eagerly trying to solve. The outlook is perplexing because many economic statistics, when viewed individually, lead to vastly different conclusions. For example, if one bases their assessment of the economy on U.S GDP growth for the past year, after three quarters of negative growth the most recent quarter saw a swing to +2.5% growth. Three down quarters followed by a positive quarter, hmmm, the facts dictate things are improving and 2010 will be a better year for the economy (maybe based on the idea that things have to get better, don’t they?). Not so fast. If one looks at current gold prices, almost $1100 per ounce, you would probably come to the conclusion the U.S. economy has major inflation and currency problems. Based on these two issues, investors won’t want any part of the U.S economy or markets.
Turning to the credit side, low bond yields, with the 2 yr Treasury at .86%, 5 yr at 2.38%, 10 yr at 3.64%, and 30 yr at 4.55%, generally are down from the previous month. The low yields would lead investors to come to the conclusion inflation is not an issue (but deflation might be a more pertinent problem). Corporate profits for the fourth quarter of 2009 have generally been strong, outside of the financial sector. Most companies have beaten their earnings estimates quite handily due to slightly improving demand, major cost cutting, and general dollar weakness. Non- financial companies have vastly improving balance sheets in as good a shape as they have been in a long time. Based on these situations, an investor would conclude, “the water is safe” as far as allocating capital, and why not, borrowing is cheap and profits are improving.
Looking at every one's favorite, the fiscal and monetary policies of the U.S. government, one contends with the vast contradiction of huge fiscal deficits and loose monetary policies (low interest rates and buying of mortgage backed and asset backed securities). If one adds to the mix an official unemployment rate of 10%, an unofficial rate of 17% or more, the strength or weakness of the dollar versus the Euro, Yen, Pound, Renminbi and others, the bottom line is for someone to try and come to a reasonable assessment of where the economy is headed, well, good luck. I would only say trying to estimate how the U.S. economy will do during the rest of 2010 is what I call “A Fool’s Errand.” One should also learn a lesson of doing significantly more research before coming to an economic conclusion based on one piece of information without putting it in the context of a complex issue.
One of the problems with being an investor today is the culture of 2nd guessing. Anybody who is married can understand what I am talking about. The culture of backseat driving exists almost everywhere. Just look at this week: During the State of The Union Address by Barack Obama, the President questioned a recent Supreme Court decision on allowing unlimited expenditures for corporations in financing political campaigns. Congress had hearings on the U.S. government assuming 80% of the insurance company AIG and the Treasury Secretary Tim Geithner was repeatedly second guessed about the terms of the deal and how unwilling Mr. Geithner was to use the government’s position to obtain better terms from large money center banks like Goldman Sachs and J.P Morgan Chase. The second guessing is enormous in the financial world with investors questioning money managers across the board on asset classes, sectors, positions, timing of buys and sells, currencies and on and on. Investing is difficult because your analysis must be accurate, but you also must have the conviction to hang in there when positions do not go according to plan. Returns on your investments often take years, not months. The second guessing does not make it any easier, I am sure, for any money manger but particularly those that handle vast sums of capital.
Finally, in my opinion, (repeated for a few months), the biggest area to stay from right now is the bond market. Based on what I have seen in many areas, bond prices are considerably over priced. I have read where one money manager has his biggest position in a fund which realizes 2X the inverse of the 30 yr bond market, which just means he gets double returns if the bond market goes down (bond prices go down when interest rates go up- so obviously he is betting interest rates are going up). If you look at Treasuries, Corporates, Junk Bonds, Mortgage Backed, Municipal bonds in local and state government, the prices a buyer pays are very high. Very simply, many investors have piled into this asset class on the thesis the world is ending. It may end, but for them, when interest rates rise. Time will tell if I am correct, so stay tuned on this one.
Global Economic & Financial Markets Outlook: "The More Things Change, The More They Stay the Same- Maybe Tree's Don't Grow to the Sky After All"
In 2009, global stock markets continued to go straight up, as most country indexes recorded gains around 35% for the year. So far, 2010 has proved an entirely different year and the results have been dramatically different as well. Global indexes typically lost around 5% for the month of January 2010. The old proverb about markets, "Tree's don't grow to the sky," may be a bit premature to cite, however, at least for January, it certainly is applicable.
In looking at specific countries, there are some noteworthy results. First, I believe an investor must look at the BRIC (Brazil, Russia, Indian, and China) countries to gauge how market sentiment is viewing the largest growth opportunities for the future. Brazil's market was down -4.4%, Russia was up +2.4%, India was down -6.6%, and China's Shanghai Index was down -8.6%. The two largest largest markets have the greatest volatility, it is either feast or famine, with dramatic out performance or severe under performance. I contend if January's results continue for any lengthy duration (more than 2 months), buyers will find those country attractive.
Turning to Europe, the nonperformance was dramatic in the European zone countries (-5.9%), Portugal (-6.3%), Italy (-7.1%), and Spain (-9.3%). Do you think the sovereign debt issues of Greece (Euro), Portugal, Spain, and Italy have anything to do with these outcomes (nah, couldn't be)? I also find it very interesting the PX-50 of Czechoslovakia (+6.2), OMX (Denmark) (+4.5%), and the OMX (Finland) (+2.6%) outperformed Euro zone and the U.K. as well. Lastly, I would only note 2009 started off very poorly as well, all over the world. Drawing any conclusions for the rest of the year from January's results may be very premature.
Y H & C Investments: The Psychology of Investing: What We Can Learn From the Saints, A Fashion Show, and Benjamin Graham
Well, the New Orleans Saints are in the Superbowl after 43 years of futility. If we rewind 5 years go, the Saints did not play a home game in their own stadium because of Hurricane Katrina. The city of New Orleans is understandably euphoric with the chance to be a world champion, and even if they do not win the Super Bowl, just to be in the game is an accomplishment the whole region takes enormous pride in. So what, you say, what do the New Orleans Saints have to do with investing? Actually, the key point is the world continually changes and in the investment world, what has worked for a long period of time can suddenly go very wrong, very quickly. What has not worked, especially for what seems like forever, can work and work in a big way for just as long as it did not work. Ultimately, looking for these changes in a company's condition is where big money can be made.
In many ways, the stock market is like a fashion show. During certain years, specific styles are wanted by everyone and other patterns nobody wants anything to do with. Three years later, everything flips around and old styles are the flavors in demand, and the previous trends go out the window. The stock market is very much like that in the sense specific company's have these immense valuations (currently AMZN, GMCR, HGSI, etc) where I just shake my head and wonder why anyone would buy these companies at the current prices. Other very good companies trade at much cheaper prices and cannot get anyone to touch them. And then, with no announcement, things change. With the change comes a completely different sentiment, and low and behold, different stocks start to go up. Welcome to the vagaries of the stock market.
Finally, let me close with a quote from Benjamin Graham, Warren Buffet's teacher at Columbia.
' Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.' (The Intelligent Investor, Pps 204-205. Ben Graham, 4th Revised Edition, First Collins Business Edition)
Thanks for reading and if you have any questions, please email me at info@y-hc.com.
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
Monday, January 4, 2010
Y H& C Investments January 2010 Newsletter
US Economic & Financial Markets Outlook: The Year Ends Strongly, Why The Equity Markets Performed Well, and Thoughts About 2010
First, I would like to wish everyone a Happy New Year, may it be a healthy year for everyone. The equity markets in 2009 rallied strongly with the Dow Jones Industrial Average up 19%, the S&P 500 up 23%, and the NASDAQ up 44%. There were several reasons for the strong stock performance: First, the equity market was extremely undervalued during the start of the year, with investor sentiment incredibly pessimistic. Second, the steps the U.S. government took to stabilize the economy have worked at this point. Injecting capital into money center banks, keeping interest rates extremely low, and changing the mark to market accounting rules helped the banks. The steep yield curve and rising stocks helped these institutions stabilize their balance sheets, make more income, and ultimately raise more equity. Once investors gained confidence in financial companies, the market sensed the investing environment was better than what was priced in, and buying took place for months. Third, with no major Lehman type blowups, business slowly has improved, so earning comparisons have become very easy to beat and companies have complied, helped by major cost cutting in almost every industry. With 2009 ending, the key issue becomes how will 2010 unfold for investors?
I believe the U.S. economy will continue to slowly improve, as long as no large company in the financial or insurance sector has a credit issue. The reason why this is critical is because financial institutions are so intertwined as creditors of each other’s positions, not only domestically but globally, if one institution has credit issues it will affect the liquidity of 10-100 others, not to mention hedge fund positions as the banks are prime brokers to hedge funds. All of this interconnectedness can possibly put in motion a whole chain of dominos starting to fall, similar to the Lehman situation one year ago. I would expect the large institutions have been very concerned with this kind of event, and corporate boards should be doing everything possible to monitor their counterparty risks, as well as being very aware of their risk management exposures and strategies. Given the sovereign debt issues facing some European governments (Greece, Spain, etc), I believe investors will be forced to look at the U.S. dollar in a more favorable way. There is a good chance the U.S. dollar will strengthen against many major international currencies (at least the Euro, Yen, and Pound), and a stronger dollar has repercussions in both the equity and debt markets.
In my opinion, the debt market is a place investors should avoid, especially long dated U.S. Treasury securities (especially 30- yr bond, even the 10 year). If the U.S. economy continually strengthens, and the dollar also strengthens, the Federal Reserve will raise interest rates. Bond prices, especially U.S. Treasuries, are currently priced for perfection, and when higher interest rates inevitably arrive, that segment of the bond market is precisely where investors should not have a lot of exposure to.
In the equity markets, I believe investors have to be cautiously optimistic, and focused on being patient and persistent in their selection and ownership of high quality companies. The equity markets are always full of potential risk and reward, and this year will be no different.
On the risk side, the continued high unemployment rate (over 10%), threat of a rapid increase in inflation, a higher interest rate environment, the continued decline of the dollar, a more stringent regulatory and tax burden for individuals and businesses, and weak or negative GDP growth are all potential land mines for stock market investors.
On the positive side, the fact that the Dow Jones Industrial Average and S&P 500 are virtually in the same place as they stood 10 years ago is a very good sign for the market. In fact, the 1999-2009 decade was the worst decade ever for stocks. Will the next decade be worse? Nobody can predict the future, but certainly one can buy stocks of companies that have long term competitive advantages, great balance sheets, and the opportunity to sell more products for a long period of time. I certainly believe the continued belief the stock market is headed for a major decline only helps investors buy at much more attractive prices. Time will tell, and for long term investors of good companies, time is usually on their side.
Global Economic & Financial Markets Outlook: Mighty Fine in 2009, A Rising Tide Lifts all Boats. In 2010, Will It Happen Again?
2009 was an incredible year for investors with positions in international markets. As we all know, the international markets had a rough few months at the start of the year, but since then have strongly rebounded. For example, the overall indexes in China, Hong Kong, India, Taiwan, and Russia are all up close to 100% from the end of last year! Most European Indexes are up anywhere from 20-30%. In South America, the main index for the continent is up 35%. In Brazil, the largest country in the continent, the index is up 75%. If one compares the emerging markets index versus developed markets, the emerging markets are up over 50% whereas developed markets are up 25% for 2009. A serious difference in returns, wouldn't you say? Given all the great returns all over the world, how might 2010 unfold in global markets?
First, there are serious issues taking place in Europe. Countries like Greece, Italy, Spain, and Portugal are having problems paying their debt obligations. The structural issues in these countries (large fiscal deficits, high unemployment rates, a large government sector with inflexible labor laws and onerous pay levels) make the global competitive landscape a struggle. Many question whether the people and their governments are willing to make serious changes in their business conditions to reform the situation. Economists see the result being a depreciating Euro versus major currencies, especially the dollar. Some countries are trying to make a start in reforms, like Greece, which has dramatically cut public sector pay. Ultimately, a depreciation of the Euro could be a good way to boost exports for European companies.
Second, specific countries in Asia (ex Japan) and India have to be viewed with a selective eye, taken on a country by country basis. I believe these regions will grow above mature countries rates, but the dramatic rise in stock prices probably results in those markets being well overbought. Investors need to do their research on a case by case basis, but on any kind of significant pullback (25% or more); I would certainly be a buyer of China and India. I don't believe 2010 will see the same kind of results as 2009, so if international markets are up 5-10% for the year, I would consider that a victory for investors.
Y H & C Investments: The Psychology of Investing: 2010 Will Be A Year Where Business Results Will Determine Economic Performance
In 2009, stock markets all over the world dramatically increased. In my opinion much of the gain was simply a matter of investors realizing many stocks were very cheap, and buying an asset at 50 or 60 cents on the dollar is always going to attract profit seekers. The year of 2010 should prove very different.
If 2008 was the year when everything was sold, 2009 the year everything was bought, then 2010 probably will be the year where companies growing revenues, profits, and expanding margins through superior performance will be rewarded.
However, because of the huge run up of stock prices, there are many companies where the stock price far exceeds economic reality (a condition that is always present in the market). In 2010, look for the froth to get wiped off of many of these market darlings.
So what is an investor to do? I know that consistently looking for situations where risk is minimize and reward is potentially very large is where investors should always be striving to be positioned. The risk assessment is probably just as important as the potential reward component. In that vein, I thought I would introduce some comments by Jim Rogers, who used to be George Soros partner and is regarded as one of the world’s great investors, although he has been down on the stock market for many years and is currently bullish on commodities (as he has been for 10 years or so).
“The smart investor learns to listen to the popular press with an ear tuned for panic extremes. At market tops, the tune will run: ‘This time it’s different from all other times. Trees will continue to grow and grow and grow. Buy yourself a tree and watch it reach 50 feet, 100 feet, 1000 feet. This is an investment to put your money in and forget.” I might add that many stocks of companies do go up for decades, but Mr. Rogers is talking about the rhetoric at market tops. The key attribute of Rogers to concentrate on is he does his homework. His take on market declines:
“At bottoms, the song will become a dinge. Prices are severely depressed… Words such as ‘disaster’ and ‘doomed’ and ‘dead’ will be used to describe such a market.”
Those words should be very familiar to anyone who has been paying attention to the stock market for the last couple of years. Finally, Mr. Rogers describes the intelligent investor’s analysis of the proper psychological approach:
“The smart investor—the one who doesn’t consider himself a financial genius but trains himself to analyze the newspapers and television and to pick tops and bottoms by the extreme’s in the public’s attitude—learns to buy fear and panic and sell greed and hysteria.” (Get Smart and Make a Fortune. Pgs 61-65. The Book of Investing Wisdom. Jim Rogers. John Wiley and Sons, 1999)
I would say the gold market or treasury market might be a current situation of greed and hysteria. Regarding fear and panic, it seems like there are always places in stock markets where the world is thought to be coming to an end.
I also wanted to quickly include another personal experience. A couple of years ago, I invested money in a company in China which made natural fertilizer for farmers. The stock was trading for around 2 bucks a share. After about a year, I sold it because I did not like the way their accounts receivable was handled. The firm was growing and there was a net cash position on the balance sheet. Fast forward a couple of years and it set an all time high at around 27 bucks a share. I don’t know how many times my head has to get pounded in before I realize that the name of this game is patience. Again, when people you know discount the possibilities in the stock market, ask them where in the world is it possible to make those kinds of returns (if you are smart enough to hold the stock)? Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, or you would like to discuss your personal investment situation, please email me at info @y-hc.com
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
First, I would like to wish everyone a Happy New Year, may it be a healthy year for everyone. The equity markets in 2009 rallied strongly with the Dow Jones Industrial Average up 19%, the S&P 500 up 23%, and the NASDAQ up 44%. There were several reasons for the strong stock performance: First, the equity market was extremely undervalued during the start of the year, with investor sentiment incredibly pessimistic. Second, the steps the U.S. government took to stabilize the economy have worked at this point. Injecting capital into money center banks, keeping interest rates extremely low, and changing the mark to market accounting rules helped the banks. The steep yield curve and rising stocks helped these institutions stabilize their balance sheets, make more income, and ultimately raise more equity. Once investors gained confidence in financial companies, the market sensed the investing environment was better than what was priced in, and buying took place for months. Third, with no major Lehman type blowups, business slowly has improved, so earning comparisons have become very easy to beat and companies have complied, helped by major cost cutting in almost every industry. With 2009 ending, the key issue becomes how will 2010 unfold for investors?
I believe the U.S. economy will continue to slowly improve, as long as no large company in the financial or insurance sector has a credit issue. The reason why this is critical is because financial institutions are so intertwined as creditors of each other’s positions, not only domestically but globally, if one institution has credit issues it will affect the liquidity of 10-100 others, not to mention hedge fund positions as the banks are prime brokers to hedge funds. All of this interconnectedness can possibly put in motion a whole chain of dominos starting to fall, similar to the Lehman situation one year ago. I would expect the large institutions have been very concerned with this kind of event, and corporate boards should be doing everything possible to monitor their counterparty risks, as well as being very aware of their risk management exposures and strategies. Given the sovereign debt issues facing some European governments (Greece, Spain, etc), I believe investors will be forced to look at the U.S. dollar in a more favorable way. There is a good chance the U.S. dollar will strengthen against many major international currencies (at least the Euro, Yen, and Pound), and a stronger dollar has repercussions in both the equity and debt markets.
In my opinion, the debt market is a place investors should avoid, especially long dated U.S. Treasury securities (especially 30- yr bond, even the 10 year). If the U.S. economy continually strengthens, and the dollar also strengthens, the Federal Reserve will raise interest rates. Bond prices, especially U.S. Treasuries, are currently priced for perfection, and when higher interest rates inevitably arrive, that segment of the bond market is precisely where investors should not have a lot of exposure to.
In the equity markets, I believe investors have to be cautiously optimistic, and focused on being patient and persistent in their selection and ownership of high quality companies. The equity markets are always full of potential risk and reward, and this year will be no different.
On the risk side, the continued high unemployment rate (over 10%), threat of a rapid increase in inflation, a higher interest rate environment, the continued decline of the dollar, a more stringent regulatory and tax burden for individuals and businesses, and weak or negative GDP growth are all potential land mines for stock market investors.
On the positive side, the fact that the Dow Jones Industrial Average and S&P 500 are virtually in the same place as they stood 10 years ago is a very good sign for the market. In fact, the 1999-2009 decade was the worst decade ever for stocks. Will the next decade be worse? Nobody can predict the future, but certainly one can buy stocks of companies that have long term competitive advantages, great balance sheets, and the opportunity to sell more products for a long period of time. I certainly believe the continued belief the stock market is headed for a major decline only helps investors buy at much more attractive prices. Time will tell, and for long term investors of good companies, time is usually on their side.
Global Economic & Financial Markets Outlook: Mighty Fine in 2009, A Rising Tide Lifts all Boats. In 2010, Will It Happen Again?
2009 was an incredible year for investors with positions in international markets. As we all know, the international markets had a rough few months at the start of the year, but since then have strongly rebounded. For example, the overall indexes in China, Hong Kong, India, Taiwan, and Russia are all up close to 100% from the end of last year! Most European Indexes are up anywhere from 20-30%. In South America, the main index for the continent is up 35%. In Brazil, the largest country in the continent, the index is up 75%. If one compares the emerging markets index versus developed markets, the emerging markets are up over 50% whereas developed markets are up 25% for 2009. A serious difference in returns, wouldn't you say? Given all the great returns all over the world, how might 2010 unfold in global markets?
First, there are serious issues taking place in Europe. Countries like Greece, Italy, Spain, and Portugal are having problems paying their debt obligations. The structural issues in these countries (large fiscal deficits, high unemployment rates, a large government sector with inflexible labor laws and onerous pay levels) make the global competitive landscape a struggle. Many question whether the people and their governments are willing to make serious changes in their business conditions to reform the situation. Economists see the result being a depreciating Euro versus major currencies, especially the dollar. Some countries are trying to make a start in reforms, like Greece, which has dramatically cut public sector pay. Ultimately, a depreciation of the Euro could be a good way to boost exports for European companies.
Second, specific countries in Asia (ex Japan) and India have to be viewed with a selective eye, taken on a country by country basis. I believe these regions will grow above mature countries rates, but the dramatic rise in stock prices probably results in those markets being well overbought. Investors need to do their research on a case by case basis, but on any kind of significant pullback (25% or more); I would certainly be a buyer of China and India. I don't believe 2010 will see the same kind of results as 2009, so if international markets are up 5-10% for the year, I would consider that a victory for investors.
Y H & C Investments: The Psychology of Investing: 2010 Will Be A Year Where Business Results Will Determine Economic Performance
In 2009, stock markets all over the world dramatically increased. In my opinion much of the gain was simply a matter of investors realizing many stocks were very cheap, and buying an asset at 50 or 60 cents on the dollar is always going to attract profit seekers. The year of 2010 should prove very different.
If 2008 was the year when everything was sold, 2009 the year everything was bought, then 2010 probably will be the year where companies growing revenues, profits, and expanding margins through superior performance will be rewarded.
However, because of the huge run up of stock prices, there are many companies where the stock price far exceeds economic reality (a condition that is always present in the market). In 2010, look for the froth to get wiped off of many of these market darlings.
So what is an investor to do? I know that consistently looking for situations where risk is minimize and reward is potentially very large is where investors should always be striving to be positioned. The risk assessment is probably just as important as the potential reward component. In that vein, I thought I would introduce some comments by Jim Rogers, who used to be George Soros partner and is regarded as one of the world’s great investors, although he has been down on the stock market for many years and is currently bullish on commodities (as he has been for 10 years or so).
“The smart investor learns to listen to the popular press with an ear tuned for panic extremes. At market tops, the tune will run: ‘This time it’s different from all other times. Trees will continue to grow and grow and grow. Buy yourself a tree and watch it reach 50 feet, 100 feet, 1000 feet. This is an investment to put your money in and forget.” I might add that many stocks of companies do go up for decades, but Mr. Rogers is talking about the rhetoric at market tops. The key attribute of Rogers to concentrate on is he does his homework. His take on market declines:
“At bottoms, the song will become a dinge. Prices are severely depressed… Words such as ‘disaster’ and ‘doomed’ and ‘dead’ will be used to describe such a market.”
Those words should be very familiar to anyone who has been paying attention to the stock market for the last couple of years. Finally, Mr. Rogers describes the intelligent investor’s analysis of the proper psychological approach:
“The smart investor—the one who doesn’t consider himself a financial genius but trains himself to analyze the newspapers and television and to pick tops and bottoms by the extreme’s in the public’s attitude—learns to buy fear and panic and sell greed and hysteria.” (Get Smart and Make a Fortune. Pgs 61-65. The Book of Investing Wisdom. Jim Rogers. John Wiley and Sons, 1999)
I would say the gold market or treasury market might be a current situation of greed and hysteria. Regarding fear and panic, it seems like there are always places in stock markets where the world is thought to be coming to an end.
I also wanted to quickly include another personal experience. A couple of years ago, I invested money in a company in China which made natural fertilizer for farmers. The stock was trading for around 2 bucks a share. After about a year, I sold it because I did not like the way their accounts receivable was handled. The firm was growing and there was a net cash position on the balance sheet. Fast forward a couple of years and it set an all time high at around 27 bucks a share. I don’t know how many times my head has to get pounded in before I realize that the name of this game is patience. Again, when people you know discount the possibilities in the stock market, ask them where in the world is it possible to make those kinds of returns (if you are smart enough to hold the stock)? Ok, thanks for reading this month and as always, if you have any comments, questions, or concerns, or you would like to discuss your personal investment situation, please email me at info @y-hc.com
As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.
Yale Bock, CFA
President, Y H & C Investments
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