A Tale of Two Cities (Grant)

Friday, May 25th, 2012

From Mark Grant, author of Out of the Box

A Tale of Two Cities

 Euro bonds “didn’t find much support” at the EU conference.

-Jean-Claude Juncker

 “A majority of European Union leaders at a Brussels summit this week backed joint euro-area bonds.”

-Mario  Monti

Encapsulated in these two comments is the problem that Europe is now facing. Two views, two radically different positions and no agreement on a middle ground because there is not one. Of course the periphery countries, the weaker nations want Eurobonds because it would dramatically drop their cost of funding. Of course Germany and their stronger EU countries do not want it because it would dramatically raise their cost of funding. Nations, in the end, will act in their own self-interest, this has been proven more than enough times in history, which is why I stand by my conclusion that Eurobonds will not be forthcoming regardless of the polite rhetoric attached to them. Germany cannot and will not ever accept Eurobonds not only for this reason but because it would not only raise the cost of their borrowing dramatically and because it would lower their standard of living, over a period of time, to the median of all of the Euro-17 nations and that would not only be political suicide in Germany. I therefore state that regardless of any and all pandering in the Press that Eurobonds will not happen because it is a political non-starter in Germany, Austria, Finland et al. They are like the Titanic; dead in the water.

Beyond this single issue is also the widening rift between the European Socialists and the Conservatives. Without assuming any moral high ground; Europe is now split between one view of the world and a distinctly separate second viewpoint and this will make the governance of Europe not only difficult but very close to impossible. I fully expect any number of issues where you have a Socialist majority and an intransigent  German led Conservative minority where vetoes will be used, threats will be made and no compromise will be found. All of the pushing by the weaker nations will result in a backlash where the funding countries will not allow themselves to be impaired by the lifestyles of the poor and begging and the flare-ups could become quite intense. Nothing was achieved at the summit this week and nothing of substance will be achieved at the one in June and floundering on the beach may be the only actual result. The fish is out of the water; let the sputtering commence.

“Waste forces within him, and a desert all around, this man stood still on his way across a silent terrace, and saw for a moment, lying in the wilderness before him, a mirage of honorable ambition, self-denial, and perseverance. In the fair city of this vision, there were airy galleries from which the loves and graces looked upon him, gardens in which the fruits of life hung ripening, waters of Hope that sparkled in his sight. A moment, and it was gone. Climbing to a high chamber in a well of houses, he threw himself down in his clothes on a neglected bed, and its pillow was wet with wasted tears.”

-Charles Dickens, A Tale of Two Cities

• The Strategic Death Wishes
• Eurobonds will be forthcoming shortly.
• The ECB will be doing another round of LTRO any day now.
• Greece will not exit from the Eurozone.
• Spain will not need to approach the EU for financial assistance.
• Germany and France will reach a compromise position.
• Portugal and Ireland will be just fine and not need any further funding.
• America has decoupled and will not be impaired by the recession in Europe.
• The Euro is stable and will not decline further.
• Treasuries cannot have lower yields from here.

Mark J. Grant, Managing Director of Corporate Syndicate and Structured Products for Southwest Securities, Inc

Copyright © Mark Grant

Tags: Brussels Summit, Conservative Minority, Conservatives, Dead In The Water, Encapsulated, Eu Countries, Euro Bonds, Eurobonds, European Socialists, European Union Leaders, Germany Austria, Jean Claude Juncker, Mario Monti, Mark Grant, Moral High Ground, Periphery, Political Suicide, Self Interest, Vetoes, Viewpoint
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Jim Rogers Talks to CNBC About the Current Dire Straits

Saturday, September 24th, 2011

by Trader Mark, Fund My Mutual Fund

Sometimes Jim Rogers gets repetative since he usually pounds the same theories – which is not bad from the viewpoint he has a long term outlook, but in this interview with CNBC yesterday there are some interesting items regarding his current positions (currently long dollar even though he does not believe it to be a safe haven), and some trade / currency tensions developing.  I must have missed the news about Brazilian import tariff on Chinese goods.

For those newer to trading I think his view on the dollar is important to understand from a lesson standpoint.  Even if you the dollar is ‘cooked’ long term, time frame is important.  For the near term, the U.S. dollar still is considered a safe haven (best house on a street full of crack homes) and in panic people flee to U.S. Treasuries and the dollar.  So while Jim believes U.S. leadership (I use that word loosely) is constantly doing damage to its currency, he understands the way the other people in the market will react and will take advantage of it.  (Rogers is a huge long term bear on the currency)

8 minute video

• The U.S. dollar is going higher “against major currencies,” well-known investor Jim Rogers told CNBC Thursday. The dollar “is going up against everything right now” for a number of reasons, said Rogers. One may be that everybody is panicking “and for some reason they’re rushing into the U.S. dollar.” “The U.S. dollar is not a safe haven, if you ask me, but I do own it,” he added.
• Also, Rogers noted he would own the U.S. dollar, or the Swiss Franc, or agriculture. “Agriculture prices [are] getting banged right now. I am kind of planning on buying Swiss francs, more dollars and agriculture.”
• In addition, he weighed in on China’s economy, saying, “They’re doing their best to cool things off … I expect them to continue to do it, and that is causing more slowdown around the world.”
• But “the major problems are coming from the west,” Roger stressed. “They are coming from Europe and the [United States]. We are much worse off than we were in 2008 because the debt has gone through the roof.”  “At least in 2008 there was the possibility that the governments could bail us out. Now, of course, the governments have gotten deep, deep, deep into debt themselves,” he added. “Everybody is in much worse shape.”
• Plus, there are all sorts of trade tensions and currency tension developing, Rogers went on to say. “Brazil  is sort of ignited a trade war [by putting a 30 percent import tariff on China and Korea ]. And right now China is trying to get the Europeans to let them open up the trade with China more. The Europeans are saying no, so China is saying, ‘No, we won’t bail you out.’”
• “I hope the trade war doesn’t break out” because throughout history when it does it has “caused depressions,” Rogers added. “You saw what happened in the 1930s. It led to depression and it also led to war. So I hope it can be contained.”
• Ben Bernanke’s idea that low-interest rates are good, “is killing the people who save and invest, and that’s really hurting a very, very large part of the population,” concluded Rogers. (something we’ve said countless times)  [Mar 31, 2010: Ben Bernanke Content to Sacrifice Savers to Recapitalize Banks and Benefit Debtors]

Tags: Agriculture Agriculture, Agriculture Prices, Brazil, Chinese Goods, Cnbc, Currency, Dire Straits, Import Tariff, Jim Rogers, Mutual Fund, Outlook, Safe Haven, Slowdown, Standpoint, Swiss Franc, Swiss Francs, Tensions, Term Outlook, Term Time, Time Frame, Treasuries, Viewpoint
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Goldman’s Jim O’Neill on Commodities, Equities, Currency

Monday, May 9th, 2011

by ZeroHedge.com

Jim “BRIC” O’Neill predicts the opposite of everything his other colleagues at Goldman anticipate. Indeed, in his latest note, the BRICster not only directly contradicts David Greely’s latest note that the long-term prospects for commodities are strong as ever by saying that “This suggests to me that commodity prices could weaken further.” (for what “this” is, read the note). As for Thomas Stolper’s soon to be stopped out prediction of a EURUSD hitting 1.50, O’Neill has some contrarian cold water for that too: “In my book, even with the likelihood that the Fed will remain friendly post QE2 termination, the Euro belongs in a 1.20-1.40 range.” So there you have it: one firm, an infinite number of outlooks.

From Jim O’Neill.

Can Equities Rally Without Commodities?

What a week! In last weekend’s Viewpoint, in addition to highlighting the historical tendencies of markets in May, I suggested that commodity price strength didn’t make much sense to me. One week later, after the stunning correction to many commodities, I am struggling to get my head around the question: why does commodity price weakness go hand in hand with equity weakness? Put another way, if equities are to develop another leg to the rally that has been taking place since 2009, it will probably have to be led by something other than commodities.

ECONOMICS, EQUITY AND COMMODITY MARKETS.

There was a day when commodities, as an asset class, were seen as an alternative to both fixed income and equities. I know that many of my colleagues from various parts of the GS family can statistically prove that this remains the case. However, at times during the past decade, it has seemed that commodity prices have been a “bellwether” about the world. Furthermore, strength in commodity prices has been related to strength in many equity markets (as well as a major influence on some other markets such as some currencies).

From an economic perspective, at its most basic level, the price of any commodity is determined by its supply and demand and expectations about both. An increase in the price of a commodity can happen because of a rise in demand relative to supply, or a decline in supply, or some combination of both. In the years before the global credit crunch, it was often perceived that commodity prices were rising because of very strong global growth and limited supplies. Post credit crunch, the same general mood has prevailed.

Linked to this thesis, application of the GS long term 2050 growth projections and the potential rise of the BRIC economies suggest a general environment of very strong demand for commodities relative to supply. The GS Economics, Commodities and Strategy (ECS) department have published a number of articles to show this. In particular, Global Paper Number 118, October 12th, 2004; Crude, Cars and Capital, authored by D.  Wilson, R. Purushothaman and T. Fiotakis applied the original 2050 projections to the crude oil markets, and one of its conclusions was that there was likely to be a major supply and demand imbalance between 2005 and 2020.

Many market themes that have played out over recent years often relate to the basic tenet of this paper. Simply stated, Mr. Market seems to regard strength of commodity prices as a symbol of world economic strength, and weakness of commodity prices as a symbol of economic weakness.

THINGS ARE CHANGING?

Many market participants appear to have forgotten the days of the 1980’s and 1990’s where economic strength was not symbolized through rising commodity prices. During that time, we had two decades of declining commodity prices and, while there were periods of recession, we experienced two decades of global economic expansion. Could such days ever return?

Over the past 12 months, three different economic issues have developed in my mind that lead me to wonder whether things might be changing.
First, as commodity prices recovered sharply post the global credit crisis, headline inflation has, in turn, risen in many countries. And, in those less wealthy nations, including many of the Growth Market and emerging countries, rising commodity prices are a real challenge. In some developed economies that were most challenged after the credit crisis, rising commodity prices are quite a burden for those societies too. A feeling of  unsustainability about this has been going through my mind for much of this year.

At a minimum, we are likely to encounter more mini periods of volatility, where rising commodity prices, food and energy in particular, choke off some economic activity as consumers and business adjust to the higher costs. In countries where overall inflation rises more because of these rising prices and central banks tighten monetary policy, subsequent tightening financial conditions will slow down growth and probably lessen their contribution to the demand for the commodities in the first place. It appears as though we might be going through such a period right now.

Suddenly, economic data in many economies has disappointed, and while there could be a number of explanations, it seems quite feasible that the degree of increase in energy and food prices might be a guilty culprit.

Second, and linked to the first point, as I mentioned last week, the role of China in particular is key. GS has a proprietary GDP indicator for China called the GSCA, the GS China Activity indicator. In recent years, it has had a very good relationship with commodity prices, presumably signaling the critical role that Chinese demand plays in the commodity markets. In recent months, the GSCA has slowed a lot, and yet, commodity prices – at least until the past week – hadn’t. This suggests to me that commodity prices could weaken further.

More broadly, softening in key global leading indicators following the release of many May PMI and ISM indices would suggest the same trend.

Third, bringing it back to China, and getting really specific to energy and oil in particular, China’s long term economic planning is increasingly based on a world different from the one modeled by ourselves in 2004. If you reanalyze global oil demand assuming that China will deliver on the energy consumption plans it has unveiled as part of its latest 5-year plan, their oil demand will not grow even close to the magnitude shown in Dominic and team’s 2004 paper. Indeed, Anna Stupnytska and I showed in another paper, Global Paper Number 192, The Long Term Outlook for the BRICs and N11 Post Crisis, December 2009, if you substitute the Chinese plans into the same equations as the 2004 paper, 2050 global oil demand would be 20 pct less.

If I think about all three of these things together, what happened in commodity markets last week was not surprising at all, and more weakness in the near term wouldn’t be that surprising either.

MARKETS NEED TO BEHAVE FOR THEIR OWN DETERMINANTS.

As this relates to other markets, it doesn’t necessarily follow that any additional weakness in commodity prices will translate into more equity market weakness, except in the obvious cases where commodity companies are a major market component. It certainly shouldn’t follow that correlated risk reduction on the back of commodity price declines should have lasting consequences for other market prices, for example additional Yen strength. This would seem somewhat ludicrous and, if needed, I suspect G7 policymakers may have to act again.

As it relates to the directional trend of equity markets, however, the last week’s events do draw me to a conclusion that if equities are to develop another leg into higher prices, it probably won’t be sustained if it is simply the result of commodity prices recovering. If commodity prices go straight back up, it will add renewed pressure to headline consumer prices in China and elsewhere, probably resulting in additional monetary tightening.

If commodity prices don’t move back up, one of the beneficial consequences is that it will make it probable that a number of central banks won’t need to tighten as much as otherwise, possibly not at all, including China and maybe also the ECB. It is interesting that ECB President Trichet didn’t utter the magical phrase “strong vigilance “at this week’s press conference.

Can equity markets rally without leadership of commodity companies and prices? Of course they can, but I shall leave the sectors most likely to all of you to ponder.

EURO WOES.

There is one other topic that I need to touch upon. After already showing a big response to Trichet’s less hawkish stance than expected, the Euro took another hit late Friday as rumours circulated of a special meeting to discuss Greece and a possible debt restructuring and even talk of them exiting the Euro. Not surprisingly, these rumours were denied but, despite this, the Euro ended close to its lows for the week, having given back 6 big figures of its latest strength. I am not overly surprised by this Euro decline either, as the case for the ECB tightening further has just been weakened. And, it continues to seem to me that some risk premia is warranted, as Europe’s leaders struggle to come to grips with the immense challenges of creating a more credible and successful European Monetary Union. In my book, even with the likelihood that the Fed will remain friendly post QE2 termination, the Euro belongs in a 1.20-1.40 range.

THE BEAUTIFUL GAME.

Actually there is one other topic too, my usual favourite. May 28th will now see arguably the two best European football clubs slugging it out again when Manchester United meets Barcelona at Wembley. What an evening in prospect and what a build-up the next 3 weeks will be. Will it attract as many viewers as the Royal Wedding? Apologies to all those of you asking me for help with tickets, it is exceptionally difficult.

Jim O’Neill
Chairman, Goldman Sachs Asset Management

Tags: asset class, Bellwether, BRIC, Cold Water, Commodities, Commodity Markets, Commodity Price, Commodity Prices, Crude Oil, David Greely, Economic Perspective, Eurusd, Fixed Income, Gold, Goldman, Infinite Number, O Neill, Outlooks, Price Strength, Stolper, Term Prospects, Viewpoint
Posted in Emerging Markets, Markets, Oil and Gas | Comments Off

A “Gold Tsunami” Coming, according to Richard Russell

Tuesday, May 3rd, 2011

I do not always agree with 86-year old Richard Russell, author of the Dow Theory Letters, but there is no disputing that he has been on the money with his gold recommendations ever since the low of $250 ten years ago. He believes a final explosive phase the yellow metal is approaching – a viewpoint I concur with. The paragraphs below are an excerpt from a recent report.

“We’re moving nearer and nearer to the edge of the hurricane. I can feel it in my bones. Every newspaper now carries an ad for gold. The ironic clincher was this ad below that I clipped from a weekly newspaper.

“Is there a gold bubble? Are you kidding me? Here’s an ad that somebody paid for suggesting that people should turn in their gold (!!) for Federal Reserve Notes. They’re not telling you to buy gold during one of the greatest bull markets in history – hardly, they’re asking you to throw parties in which the object is to get ignorant people to SELL their gold.

“I can feel them caressing my face – the early breezes. They are blowing gently and hinting of the forthcoming gold hurricane that will sweep across the US and the planet with all the force and power that was seen when gold was first discovered at Sutter’s Creek during the California gold rush of 1849. The gold rush of the 2000s is in the wings. The old phrase is ringing in my ears again (I haven’t heard it since the late ’70s): ‘There’s no fever like gold fever’.

“If the temperature of full gold fever is a hot 106, we’re only at 99 now, but I can feel it, I can tell you that the temperature is rising, rising.

“The panic to buy gold will override everything else. It will be one of the greatest financial phenomena that most of today’s investors will ever see. It will blot out everything else like a cloud blotting out the sun.

“After the calm, comes the storm. We’ve been watching ten years of gold climbing amid an atmosphere of calm. The great gold tsunami lies ahead. It will be historic.

“… BEFORE the great gold tsunami we might have a frightening gold correction that would clean out all the gold sceptics. This ‘clean out’ may be necessary prior to the big gold tsunami, and it’s a reason to hold some cash and not put ALL your money into gold at this time. Remember the old adage – ‘The market always does what it’s supposed to — BUT NEVER WHEN’.”

Source: Dow Theory Letters, April 21, 2011.

Tags: 2000s, Breezes, Bull Markets, California Gold Rush, California Gold Rush Of 1849, Calm, Clincher, Dow Theory Letters, Excerpt From, Federal Reserve, Financial Phenomena, Gold, Gold Fever, Gold Rush Of 1849, Hot 106, Ignorant People, Paragraphs, Richard Russell, Ringing In My Ears, S Creek, Viewpoint
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Canadian and Australian Dollar vs. the Price of Crude; Reflections on the PPI and the Commodity Bubble

Monday, March 21st, 2011

Canadian and Australian Dollar vs. the Price of Crude; Reflections on the PPI and the Commodity Bubble

by Michael ‘Mish’ Shedlock

Here is a pair of interesting charts showing the correlation between the Canadian and Australian dollar vs. the price of West Texas Intermediate crude.

Australian Dollar vs. Crude

Canadian Dollar vs. Crude

Both the Australian and Canadian dollars have a strong correlation with crude going all the way back to 1997. Should the correlation continue to hold, and there is no reason to believe it won’t, then if the price of crude drops, the Loonie and the Australian dollar will both likely drop as well.

Reflections on the PPI

Earlier today someone told me via email that my “silence on the PPI and CPI was deafening”.

Actually I have seldom directly commented on the CPI or PPI recently even when the CPI was low.

However, I have commented on commodity prices on many occasions expressing the viewpoint “those looking for inflation can find it in China and India where credit is running rampant”.

Commodity prices are set at the margin and China is overheating. When China cools (and it will in my opinion), commodity prices will drop.

Commodity Bubble

People are entitled to believe what they want, but I will side with John Hussman who thinks commodities are in a bubble.

From Hussman Anatomy of a Bubble

In the stock market, I believe that there is indeed a “bubble” component in current prices, but it is not nearly as large as we observed in the approach to the 2000 peak, nor as extreme as we observed on the approach to the 2007 peak. My hope is that investors have learned something. That’s not entirely clear, but we’ll be as flexible as we can while also being mindful of the risks.
While my view is that bubble components can come and go in the markets, they sometimes become so large and well-defined that they take on a very distinct profile. Such bubbles included the advance to the 2000 stock market peak, the housing bubble, the advance in oil prices to their peak in 2008, the advance in the Nikkei in the late 1980′s, and other clearly parabolic advances.
On that note, it’s clear to me that we’re seeing classic bubbles in a variety of commodities. It is very unlikely that this is simply due to global demand growth. Even with an exhaustible resource, it is a well-known economic result (Hotelling’s rule) that the optimal extraction rule is one where the price rises at a rate not much different from the interest rate. What we’ve seen lately is commodity hoarding, predictably resulting from negative real interest rates provoked by the Fed’s policy of quantitative easing.
Fortunately for the world’s poor, the speculative dynamic that has created a massive surge in commodity prices appears very close to running its course, as we see very similar “microdynamics” in agricultural commodities as we saw with oil in 2008. That’s not to say that we have a good idea of precisely how high prices will move over the short term. The blowoff phase of a bubble tends to be steep, but so short-lived that it affords little opportunity to exit. As prices advance in an uncorrected parabola, the one-sided nature of the speculation typically gives way to a frantic effort of speculators to exit simultaneously. Crashes are always a reflection of illiquidity in two-sided trading – the inability of sellers to find eager buyers at nearby prices.
On the subject of commodities, it’s a natural question whether gold falls into the same category as agricultural commodities. After all, gold and other hard assets have an important role as an alternative to money to store value, and it appears clear that the world is monetizing in a way that is unlikely to be fully reversed even if policy makers wish to do so down the road.
In my view, it’s not clear that gold is in a bubble here, but it will be important to watch for the earmarks of a classic bubble. Below, I’ve plotted the price of gold against a “canonical” log-periodic bubble. Already, we’re seeing some behavior that is characteristic of a bubble-type advance. A Sornette-type analysis generates a finite-time singularity as early as April, but there are other fits that are consistent with a more sustained advance. If we observe a virtually uncorrected advance toward about 1500 in the next several weeks, the steep and uncorrected advance would imply an increasing hazard probability.

My response to the above was Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?

I agree with Hussman about the bubble in commodities not only because of the speculation angle but also because of unsustainable growth in China. When China stalls, it will likely take commodities and the commodity producing countries down with it, notably Australia and Canada.
Finally, gold is acting more like a currency than a natural-resource commodity (because that is what it is). It may or may not be immune to a commodity-related selloff, and much depends on the actions of central banks down the road.

Those who insist on a direct quote regarding the recent PPI report, here it is: “Commodities are in a bubble and the PPI is reflective of that bubble.”

Of course bubbles can always get bigger. Oil hit $140 in 2008. Perhaps it does again in 2011, but barring a major disruption in Saudi Arabia or Iran, I rather doubt it.

Mike “Mish” Shedlock

http://globaleconomicanalysis.blogspot.com

Tags: Anatomy, Australian Dollar, Bubbles, Canadian, Canadian Dollar, Canadian Dollars, Canadian Market, China, Commodities, Commodity Prices, Correlation, CPI, Currency, Going All The Way, Gold, India, inflation, John Hussman, Loonie, Michael Mish, Mish Shedlock, oil, Ppi, Reflections, Stock Market, Viewpoint, West Texas Intermediate
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Higher Long Bond Yields, but no Yield Curve Flattening Yet

Tuesday, December 21st, 2010

“The rise in bond yields that we have been expecting since November has been much faster and more forceful than we foresaw. Stronger economic data and the U.S. fiscal stimulus have lifted the ‘fair value’ for 10-yr Treasuries by around 40 basis points from just a month ago, to around 3.2% currently,” said the Goldman Sachs Global Economics team in a recent report. “This accounts for about half of the move in actual yields. Positioning after a strong rally has accelerated and amplified the repricing.”

Importantly, Goldman Sachs has revised their end-2011forecasts for 10-year U.S. Treasuries upwards from 3.3% to 3.75%, and made adjustments in the same direction for other major bond markets.

“We project no sustained flattening of yield curves until US unemployment is on a clearly declining trend. This is unlikely to occur until H2:11 and into 2012,” said the report.

The Goldman Sachs forecast is obviously bad news for the longer end of government bonds, but their viewpoint of short rates remaining low for another year or so means a monetary tailwind for equities for a while longer.

Source: Goldman Sachs Global Economics, December 2010.

Tags: Bad News, Basis Points, Bond Markets, Bond Yields, Economic Data, Economics Team, Fiscal Stimulus, Global Economics, Goldman Sachs, Government Bonds, H2, Positioning, Rally, Repricing, Tailwind, Treasuries, Unemployment, Viewpoint, Yield Curve, Yield Curves
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Plunging dollar erodes non-US investors’ returns

Thursday, November 19th, 2009

With the US dollar falling down a precipice, spare a thought for non-US investors invested in US stocks and bonds.

The graph below shows the performance of US 10-year Treasury Notes since the beginning of March in both US dollar terms (red line) and euro terms (blue line). Whereas US investors are showing a poor return of -2.8% for the period, European investors are completely under water to the tune of -17.5%. For the year to date the figures are -4.8% (US dollar) and -10.5% (euro). (Although I am using the euro in this example, the same logic applies to most other non-US dollar currencies.)

Source: StockCharts.com

The next graph illustrates the same principle for equities by comparing the performance of S&P 500 Index in US dollar terms (red line) with the same Index from the viewpoint of a euro investor (blue line). Whereas US investors have every reason to be very pleased with a return of +64.1%, euro investors are lagging quite far behind with +39.2%, which becomes more pronounced when compared to a return of 55.4% for the European Top 100 Index. For the year to date the figures are +22.9% (S&P 500 – US dollar), +15.6% (S&P 500 – euro) and +21.9% (European Top 100).

Source: StockCharts.com

It is understandable that European investors are not ecstatic about the greenback’s slide and will keep having reservations about committing funds to US assets until they see signs of the dollar forming a bottom.

Tags: 10 Year Treasury, Assets, Currencies, European Investors, Graph, Greenback, Investor, Logic, Principle, Reason, Red Line, Signs, Spare A Thought, Stocks And Bonds, Stocks Bonds, Us Dollar Terms, Viewpoint
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Shiller: Stocks fairly valued but could “go down a lot”

Tuesday, July 14th, 2009

With the S&P 500 Index after yesterday’s surge again slightly above the “neckline” (of the head-and-shoulders formation referred in a post last week), I will be monitoring things very closely over the next day or two to see if the impressive bounce was just a one-day wonder or something more enduring.

Meanwhile, the S&P 500 is now fairly valued on a long-term cyclically adjusted P/E (CAPE) basis, according to Robert Shiller (as reported by Yahoo Finance, Tech Ticker). Shiller is economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.

In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple increased to 15.8 during the March-May rally, representing “neutral” value when compared to a long-term average of 16.3.

According to Yahoo Finance, Tech Ticker, Shiller is skeptical of the “green shoots” viewpoint and is of the opinion that it would take a considerable period of time for the economy to return to normal growth. Although the stock market’s neutral valuation implies a long-term average return of 7%, he is not forecasting that outcome due to the “precarious state” of the economy that could stumble anew and cause stocks to “go down a lot”.

As mentioned in my “Words from the Wise” post on Sunday, the stock market technicals undoubtedly look ugly and investors will now focus on the second-quarter earnings reports as a test of whether stock prices have run away from fundamental reality. While investors wait for Mr Market to show his hand, a cautious approach is warranted, but that should not preclude one from finding stocks that look cheap.

Click on the image below to view Aaron Task’s interview with the famed professor.

Source: Yahoo Finance, Tech Ticker, July 10, 2009.

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Tags: Animal Spirits, Business Cycle, Cautious Approach, Earnings Estimates, Earnings Reports, Economics Professor, Fundamental Reality, Head And Shoulders, Irrational Exuberance, Methodology, Neckline, Normalised, Period Of Time, Precarious State, Robert Shiller, Second Quarter Earnings, Stock Market, Stock Prices, Viewpoint, Yahoo Finance
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