Ming Lo Investing

Stock Gurus: Bill Miller

Posted by admin on March 28, 2011  |  No Comments

Non-investors do not know him, but Bill Miller is one of the best investors of all-time.  He is also a reminder of the dangers of value investing, and why you can’t listen to Warren Buffett all the time.

Mr. Miller is a classic value investor, of the same school as Warren Buffett.  Prior to 2008, he had the longest record for beating the indices.  Then came the 2008 crisis, in which he made the classic mistake of buying as the market declined.  His portfolio was decimated.  He has since recovered, but 2008 remains an unfortunate year in an otherwise extraordinary career.  Mr. Miller freely admits that he mistook what was a balance sheet recession – one in which the values on the balance sheet actually collapsed – for a liquidity one in which stocks would recover when liquidity came back into the market.

The reason I say that you can’t listen to Buffett all the time is because they essentially come from the same school of investing: buying when stocks are cheap.  The difference, I would argue – and one which few mention – is that Buffett actually owns businesses, whereas Mr. Miller is an investor.  That means Buffett actually owns the cash flow from the businesses, not just the stock.  This buffers Buffett on the downside.  Also, Buffett gets a lot of his funds from insurance and from operating businesses.  In contrast, an investor is limited to the pool of funds he has started with and the returns he earns.  An entirely different scenario.

On the market as a whole.  Mr. Miller is rather bullish on the market as a whole and gives a simple calculation.  If you look at the S&P’s earnings at the bottom in 2009, forward expected earnings were $54.  Now the market is up 90% and earnings are up 90% at $95.  You’re not paying that much more right now, and the economy is in a much better place.

Mr. Miller also does a PVGO calculation, or the present value of growth opportunities.  He takes the last quarter of the S&P 500, multiplies by 4 to get an annual, and capitalizes it at 6% real rates + 2% inflation.  That yields a number that is 10% less than the market today, which means that the value of future expectations is 20%.  Normally,  the calculation yields 30% rather than 10% below the current market.

On Microsoft.  Mr. Miller expects Microsoft to be a stronger capital allocater than in the company has a 44% ROE and trades under 9x forward earnings and 13x current earnings.  There is a 2.5% dividend yield, the balance sheet has $4o billion in cash, the dividend was raised 230% last time, and  bought back $13 billion in stock in the last three quarters.  So it is relatively cheap.

By the way, Hewlett Packard is favored by Mr. Miller’s guest, Brian Rogers of T Rowe Price.  It’s expensive and selling at a low double digit free cash flow yield.  Mr. Rogers also likes Constellation Energy.  The utility sector has been hit, many sell at 9.0 – 9.5 times earnings and have a 3-4% dividend yield.  He suspects that 18 months out, this will be a time when such stocks were very cheap.

On Amazon. Mr. Miller has owned Amazon since it was $9.  He believes anyone who owns Amazon for the next 5-10 years will do well.

On Airlines. Historically, everyone will tell you that airlines are one of the worst businesses to be in.  It has terrible operating leverage and financial leverage.  There’s unionization, regulation, bad service, high capital intensity and lots of bankruptcies.

But much as changed.  Two major carriers – Delta and United Airlines – now control 50% of the industry.  Add AMR’s 15% and Southwest’s 10%, and four airlines hold 75% of the market.  Apparently two of these airlines have new ROI requirements (which in theory, would reduce the likelihood of bad capital allocation).  There are now fewer seats than there were in 1982, so capacity is limited.  Before fuel prices started rising, UAL was expected to generate $6 in free cash flow on a $21-$22 stock.  Higher fuel prices will cut into earnings, but the airlines are making it up through fare increases.  With an oligopoly structure, limited supply, and fare hikes, UAL could be a $75 to $100 stock in a several years.

JP Morgan. JP Morgan is another favorite.  With $6 per share expected in 2012 and a 10x multiple, JP Morgan would easily be a $60 stock.  Also, there’s a 30% payout, which equates to a 4% dividend yield.

These are all very interesting thoughts.  I do have to say, though, that what they’re saying is not the full story.  In other words, I doubt that it is possible to buy the stocks that they recommend and leave it at that.  Consider that Microsoft and Hewlett Packard have done nothing in the last 9-12 months.  So while they could be a part of a portfolio, they cannot be the only ones, otherwise you could not possibly have beaten the market.  Also, in these interviews, they never talk about when they take profits, allocations and hedges.  Mr. Miller mentioned that he was short a couple ETFs, but there was no discussion of how such shorts fit into a value strategy.  So, those are all things to keep in mind.

I own MSFT and JPM.

Stock Gurus: David Tepper, Appaloosa Management

Posted by admin on September 26, 2010  |  No Comments

CNBC interviewed David Tepper of Appaloosa Management on Friday, September 24, 2010.  I found this interview fascinating, mostly because of Tepper’s perspective – he really simplifies the picture, which is very refreshing.  Main points in the interview:

• No leverage

• Buying banks in 2009 was an easy call.  The government put out a white paper in March 2009 and told you what they would do.  The Treasury said they would buy Bank of America at around $6, but no one believed them and the stock kept going down.  Appaloosa did, so they bought stock and they bought bonds at 10-15 cents on the dollar.  And things went up.  Many investors were uncertain, but the government had stated what they would do, and “you have to believe that the government wasn’t above the law” (meaning that they had to fulfill the commitment to invest in banks that they had stated in writing in the white paper).  At that point, banks would not have been nationalized – again, because it had promised to be a stockholder in the white paper (I believe it’s the capital assistance that he was referring to).  Equity could have been diluted, but he was buying BAC @ $2-3 while the government had promised to buy at $6.  ”Sometimes it’s just that easy”.

• These deals recur.  Appaloosa is a first mover, a “herd leader”.  Sometimes they get in trouble for that, but for most years it’s worked.

• Now could be one of those times.  Fed has just said that they want economic growth, and they want inflation (they don’t even care) – something that’s almost never occurred.   So two things will happen.  A), the economy gets better by itself and stocks do well.  Bonds, gold won’t do as well.  Or B) the economy doesn’t do well and the Fed comes in with QE.  Then, EVERYTHING does well in the near term, except bonds in the near term.  The market could go down, until the point where the Fed comes in with money.  After the Fed comes in, the market goes up.  So there’s a put, things can’t go down that much.  And you have to buy.  So they changed up.  Normally they’re a a bond house, but they increased equities after the FOMC meeting.

• Doesn’t own gold.  Is it stupid to own gold?  No, it’s a question of how much you expect gold to go down or up.

Why is this point in time a moment?

• In May, things were bad.
• Europe refinancings were coming up, but they managed to refinance.
• China may still crash, but so far not too bad.
• Taxes, we know the answer.  Extend, or at least extend for under $250K.
• Basel, done, we know the answer.
• M2 growing for the last 10 weeks.  Even was growing before QE.  Money supply went up before bottom in March 2009.  Money supply always goes up before the market does.
• Politics.  Don’t know Republican or Democrat, but it doesn’t matter, the political risk will be less.
• Japan, now doing QE, not sterilizing currency, so not that bad.
• Then, after all this, we get the Fed statement, which is bullish.

So all these things have changed.  Things ARE better.  In Appaloosa they have increased their holdings of equities.

Are we Japan?  We’re not Japan because with low rates and low mortgage rates, people are refinancing and using that money to buy other stuff.

What’s the exit strategy?  No special love for banks right now, they’re the same as the others.  A lot of preferreds converted, sold some.  They’re mostly in bonds.

Is it going to be a secular bear market?  S&P is trading at just under 12x, 2.5% 10-year bonds.  Where should multiples be if we’re at a 3% 10-year.  Not 11-12x.  No.  Should we be at 14x?  Maybe, we can get to 14x.  Right now multiples are low, things aren’t that bad and rates make it likely that people will spend.

Is the current decision as easy as it was in March 2009?  Can the market go down to 1100?  Yes.  Will it go to 1o00? No.  In that case, Appaloosa will be in 90-100% equities.  It isn’t as easy as March 2009.

Worst trade?  In 1998, Russia.  They got IMF deal, and thought they should devalue but not default.  But they did both, and couldn’t get out.  So they sold everything else to get cash.  Funny thing, they were waiting for the call from their broker, but they were so small they never got the call.  They were down 20% that year.

Current situation?  Still hard to tell, but think  we’re moving.  Hard to look at trend, but week-to-week data hard to read.  Looking for trend in unemployment.  Environment has changed.

Stock Gurus: Paul Sankey on Oil

Posted by admin on July 27, 2010  |  No Comments

Paul Sankey is a top-rated analyst with Deutschebank.  He appeared today on Fast Money, and I always like listening to him, he’s quite knowledgeable.   His main points:

• Potential Impact of Legislation. Today, Senator Harry Reid proposed eliminating the $75 million cap on liability for drilling, and the bill is retroactive, so it would include BP’s spill in the Gulf.  Because insurance costs are 2% of the potential liability, let’s say the liability is $10 billion, then that would add $200 million to the cost of drilling the well (and we know that BP’s liability is at least $20 billion, because that’s what it’s put into a fund suggested by the Obama administration).  This means very few people can drill.  Wells cost $100-200 million already, so effectively, you might as well double the oil price.  Oil companies will have to self-insure or come up with the money some other way, and that is likely to translate into higher oil prices to make up the difference. 
  

• Estimating the Price of Oil. Analysts estimate the price of oil as 4x the cost of exploration and development.  Currently, that cost is $20, so that’s how they calculate $80 a barrel for the price of oil – 25% cost, 25% profit, 50% tax.  So with $20 cost, $80 a barrel of oil. 
  

• Effect on production. Currently Gulf of Mexico production is $1.7 million barrels per day.  Effect of moratorium is estimated at < -1% in 2010, -5% in 2011 and -20% in 2012.  That means eventually down 300,000 – 350,000 barrels if the moratorium on drilling continues or if drilling costs are so high that drillers go to Canada or West Africa instead of the Gulf of Mexico.

• Additional regulatory taxes and fees. Congress is proposing that the $15 billion cost of the clean energy initiatives be paid for by raising the oil spill liability fund.  The fee that oil companies pay would increase to 49 cents per barrel from 8 cents.  So additional costs there.

• Investing in oil stocks.  Sankey is underweight oil simply because they can’t tell what’s going to happen with regulation out of Washington; they don’t know how to value the Washington overhang.  You can favor large cap over small cap, because large caps will have the resources to drill; stay away from drillers because you don’t know what the cost of safety measures will be (costs will increase).  However, there is an job problem, because they estimate 10 million jobs related to oil in he Gulf.  So Washington shouldn’t go too far, but you just don’t know.

By the way, healthcare is in the same place.  The market doesn’t like healthcare because of all the uncertainty.

Stock Gurus: Doug Kass on the Low for the Year

Posted by admin on July 8, 2010  |  No Comments

Doug Kass appeared on Fast Money yesterday and today, and called last week’s low the low for the year.  He says we are driven by fear which has caused us to disconnect from fundamentals.  I’m always fascinated by the logic behind someone’s thinking, and here are some of the things he cited for his reasoning:

• High yield bond rates were down (in June).  If we were truly having problems, high-yield bond rates would be spiking because they are even riskier in a problematic environment (like 2008).
• Two-year swap spreads were down.  Again, higher risk would mean higher spreads between swaps and the “risk-free” rate.
• 3-month LIBOR was down.  Borrowing would be more expensive during stress.
• Euro was up.  Euro tends to fall when people are de-risking.
• TED spread was down.   This is the difference between interest rates on interbank loans and short term T-bills.  TED is T-Bill and ED, or the ticker for the Eurodollar futures contract.  Now this is calculated as 3-month T-Bills vs. 3-month LIBOR.
• Spanish market was up 10%.
• ISM, if you add manufacturing and non-manufacturing index, we get 54.1 in June vs. a peak of 56 in April and in line with the 6-month average.  So not that bad.
• All this is not consistent with a drop of real GDP growth to 2%
• June ISM non-manufacturing index, employment component dropped marginally, consistently with respectable payroll growth.
• Employment trend up for 11th month in a row, leads payroll growth, and index is up 11% year over year and is up 5% above its long-term average (he mentioned an index that I couldn’t hear because they were hearing).
• Roubeni, Prechter (who says Dow will hit 1000) and other gurus of doom seem to be everywhere (the contrary indicator).
• Oscillators are “off the charts in terms of being oversold”.
• Bears have sold out – Barton Biggs said he sold most of his equities
• Put-call ratio high
• Bears vs. Bull ratio was approaching March 2009 level

Whether he’s right or this is the right set of indicators to look at is unclear in my mind, but a set of useful indicators to track (if you feel so inclined).

Stock Gurus: Meredith Whitney

Posted by admin on June 21, 2010  |  No Comments

Meredith Whitney was on CNBC today.  I don’t always agree with her, but I always listen.  She’s always reasoned, and right or wrong she always backs up her thinking.  Here’s her main points:

Economic Outlook.  Meredith has been bearish for a long time.  The government has supported the economy for a while, but now we’re on our own.  She’s concerned that states and local governments will have to cut jobs significantly.  Probably at least 2 million jobs, and in some states the government is 10% of state GDP.  Taxes are being raised on the high end, state jobs on the low end, so we’re getting squeezed on all sides.  States with the highest GDP are the ones most tied to real estate, so the second half will be rough.  Obama has proposed a $50 billion bailout for the states, but the states are $200 billion under water.  These problems are structural and hard to fix.

The Consumer. Government and banks provided mortgage modifications, and consumers have not paid their mortgage, figuring they’ll get a better deal later.  So they paid their other bills first instead – credit card, auto bills.  Non-performing loans have doubled over the last year.  At the top four banks which control 2/3 of the mortgages, NPLs stand at over 1x all the chargeoffs since 2005, so there’s a massive pool of “rotting mortgages” sitting there.  Meredith never imagined this (and I didn’t either, the uptick in retail spending in Q1 was a complete surprise to me).  Banks are now accelerating their foreclosure/short sale processes, so people will have to start paying their “rent”.

Real Estate.  So no doubt  that there is a double dip in housing (I agree), especially when you foreclose or have a short sale, a ton of supply comes on the market.  Meredith is amazed that this is questioned.

Employment. Large corporates cut 3 million jobs, small business fired 5 million people, and states she estimates will cut 2 million.  Small business responsible for 60% of jobs since 1994.  Small businesses also benefitted from securitization – home equity loans, credit card loans.  Credit card loans cut by $1.5 trillion, Meredith thinks it goes up another $1 trillion.  There’s another $50 billion program for small businesses from the White House, but this nothing compared to $1 trillion cut in securitization.

Europe.  Banks will be hit in Q2 because there was no banking activity in May in Europe.  Revenue expectations will be very disappointing.  And last year in Q2, banks were raising equity and doing really well [so comparisons will be weak].

China. Hard to say what the impact is, time will tell.

Financial Regulation.  Changes everyday, but whatever the outcome, this will slow down the velocity of money.   All banks will have a lower return on capital.  So banks are “zombies” because their consumer assets and their commercial assets are not growing, and their fee income will be crushed.  Banks are not creating capital.  Last year, they created their capital by writing up the value of their own CMBS.  In Q1 2010, first decline in capital for banks.  Now declining, so why would you pay more than capital for a bank that is not creating its own capital?  So they will have to raise capital.  Banks are shrinking to free up capital.  So you are buying a shrinking entity.  There must be a better way to invest.  Politically this is also maddening, because this only squeezes the middle class.

Opportunities.  Lots of dispositions at very good prices.  So if you have money, you’ll make money, but if you’re poor, it’s going to be lot more expensive to be poor.

Comments. While Meredith didn’t say this outright, her comments imply short real estate; short the consumer; short banks.

Stock Gurus: Jim Chanos Shorts Oil Majors, Ford, China

Posted by admin on June 17, 2010  |  No Comments

I always find it fascinating to listen to short sellers.  They almost always seem to have a contrarian view and seem to be looking in places where others aren’t.  So they can alert you to issues that haven’t caught investors’ attention, and if nothing else, it’s always wise to consider their arguments, even if you don’t agree in the end.  Today, Bloomberg posted an interview with Jim Chanos, famed short seller.  Here’s the main points:

1) Short Oil Majors. Chanos argues that the oil majors haven’t replaced their oil reserves in years, and their revenues haven’t increased in years, and yet their capital spending eats up their cash flow.  This means that they’re borrowing their dividend, and that they’re “in effect liquidating”.  The market does realize this, to a certain extent, which is why the yields are so high.  But the majors are not earning their yields.  Chanos has been short the majors, even before the Gulf oil spill.

I’m going to have to take a look at this in more detail.  Chanos seems to be saying that the oil majors are spending lots of money on capital spending, and yet their oil reserves aren’t increasing, nor is their revenue.  Meaning that their return on investments and their return on assets is terrible.  This could very well be, and it occurs to me that this might be why Buffett sold Conoco Phillips a couple years back (Buffett called it a “mistake”).  As for “borrowing the dividend” and “liquidating”, it’s a bit less clear to me what Chanos means by that.  I assume he’s saying that the declining return on investment doesn’t justify the dividend, and that payment of the dividend means that cash is going out without reserves or assets coming in (so the true value of the company is falling).  It’s also interesting to note that most Wall Street analysts are bullish on the majors, especially after the Gulf oil spill.  They argue that the offshore drilling moratorium will eventually cut supply and increase oil prices.  This does make sense, so the question would be, if Chanos is right, at what point would the oil majors’ weak financials become an issue for the markets?

2) Short Ford.  Here Chanos is saying that the unions control a substantial piece of GM and Chrysler, and not as much of Ford.  He believes that the car companies are run more for the unions and the retirees than for the shareholders (I agree).  People are forgetting about UAW contract negotiations in 2011.  Chanos has been short the automakers in a “major way” since 2003, less so during the credit crisis, and is adding to positions now in 2010.

Another argument that need some evaluation.  Presumably he’s saying that when contract negotiations come up, the unions will really hurt the company and the shareholders.  And given that unions own a big piece of GM and Chrysler, they’re likely to favor these two companies over Ford.  Very interesting argument.  It still raises timing questions in my mind – why not short in 2011, that seems to be more optimal than 2010?  Chanos often says he’s hedged, and he doesn’t reveal his positions in detail, that it may be that he’s comfortable being short early because of his hedges.

3) Short China and China related. This has been a running theme for Chanos.  Until recently, it was hard to directly short China, so Chanos was short Chinese stocks listed in Hong Kong, Singapore, US and London.  His shorts have been focused on Hong Kong listed H shares, and derivative plays – mainly commodities companies selling into China.  We’re not close to capitulation, there are still a lot of people invested in China and China is still seen as the place of growth, the place that will save the rest of us.

I agree with Mr. Chanos on this one.  I’m not personally short China but can’t find a reason to be long.  And there are still many who are bullish on China.

4) Short For-Profit Education. There wasn’t much detail here, just that it’s a business that relies on government funding, and that it’s only going to get worse as pressure grows to cut the deficit.

5) The Short Selling Environment. Chanos admits that 2010 has been a struggle.  A lot of risky assets have gone up, a lot of value stocks have gone down.  That means short sellers and their hedges have had a difficult time this year.

Energy & Commodities: Deutschebank Analyst Paul Sankey on Oil

Posted by admin on June 4, 2010  |  No Comments

Paul Sankey, a very  good oil analyst, was on Fast Money today:

• BP does not want to give up the dividend, will be seen as a failure in the company.  Asset sales are more likely (discussion of sale of Alaskan assets is already rumored)

• Shallow water drilling.  To clarify rumors, Mining and Minerals Management Service (MMS), is not banning shallow water drilling, there’s a 2-3 day delay to look things over.

• Gulf has huge implications for global oil supply.  Fastest growing area in oil supply was deepwater drilling, fastest area within that was the Gulf of Mexico.  In the short term, excess supply of oil, but long-term, huge supply problem.

• Canadian Tar Sands even more important.

• Exxon (XOM) looks smart because they had problems in deep water drilling in the Gulf and stayed away; decided to favor shallow water drilling. Exxon also bought XTO.  Chevron has problem, is long super deep water – 7-8,000 feet, going to 28,000 feet drilling.  So long Exxon (XOM), short Chevron (CVX).

Stock Gurus: JP Morgan’s Thomas Lee Calls the Correction Bottom

Posted by admin on June 2, 2010  |  No Comments

I always find it interesting to see what indicators people use to call a bottom or top.  Thomas Lee, JP Morgan’s Chief US Equity Strategist, says the May correction has bottomed, for three reasons.  I’m not sure his reasons are enough to bet on, but his arguments are worth putting in the back of your mind.

Here’s some links to an article and a video interview, published May 30, 2010 and June 1, 2010:

http://pragcap.com/three-reasons-weve-seen-the-market-bottom

http://pragcap.com/jp-morgans-lee-buy-this-dip

1. Bull vs. Bear Sentiment Indicator.  So Lee’s first indicator is the American Association of Individual Investors (AAII) Sentiment Survey, which is published every week.  He uses the %Bulls – % Bears, and on May 27th, this number was -30, the lowest it’s been in some time.  On Bloomberg, he provided the following chart, and you can see sentiment is very low.  He notes that historically, this has been a good contrarian indicator.   76% of the time, after a strong bearish indicator, the S&P is higher 6 months later.  The theory is, it measures capitulation at the extreme.  If you want to go to the horse’s mouth, here’s the site page where you can find historical data from the survey:

http://www.aaii.com/sentimentsurvey/sent_results.cfm.

2. Analysis Paralysis.  Another indicators is that despite good news, or attractive prices for stocks (meaning attractive valuations), people can’t find stocks that they’d buy at any price.  They’re afraid of another Flash Crash around the corner, for example.  This is another version of “buy when there’s blood in the streets” – you’re so busy worrying about losing more blood, you aren’t going to buy no matter what.

3. Stabilization 30 Days After Intraday Crash.  Since 1900, in the 6 previous 9%-plus intraday crashes, markets have tended to bottom by day 32.

So what would catalyze the rally?  One possibility is that sufficient good news start to offset the negatives.  Another possibility is that panic “burns itself out”.  That is, there’s negative headline, but stocks don’t go down.  The lack of reaction to a negative catalyst is a good indicator of stabilization or a turn.

Still, Mr. Lee doesn’t say jump in with both feet because credit markets are still suffering.  Now reality is, stocks and credit markets will turn at the same time, so you won’t have an early indicator.  Therefore, he’s recommending buying but not heavily.  Mr. Lee still sees this as a normal correction in a bull market.

Finally, groups hit the hardest rally the most. That will be energy and materials.  Also, look to buys companies with lots of good free cash flow.

Stock Gurus: Andy Xie on the China Bubble

Posted by admin on February 15, 2010  |  No Comments

Interview #1: Andy Xie, the former Morgan Stanley economist, has been one of the most vocal articulators of the case for a China bubble. Here’s a summary of his comments from two interviews. The first was released on February 6, 2010, with Bloomberg’s Haslinda Amin:

- Andy expects China’s economy to be okay this year because liquidity is still plentiful. On the one hand, there’s a boom, especially on the property side. On the other, poor employment in the US is likely to limit China because the export sector is so large. Nevertheless, the domestic side is overheating, and China needs to tighten or the bubble can get out of hand.

- The US Treasury yield will have to rise because the appetite for US Treasuries is not as strong as it was before. There’s a price for everything, you just need higher yields to buy the same amount or more.

- the China situation is very related to the property sector and government spending. If banks continue to lend, then the situation can get out of hand. If the banks stop lending, then many projects will be put on hold. So the situation is very delicate. You don’t want to cut back funding quickly. Currently, the loan growth rate is 17%, which is about a “7 trend”, compared to a “10 trend” last year (it’s not clear to me what he means by “7 trend” vs. a “10 trend”). So the government has cut back on lending, but it’s not a significant cutback.

- China has not yet increased interest rates, but the market is now expecting it, perhaps a 2-3% increase. But it won’t be dramatic, and it may not be enough. Before the market didn’t expect monetary tightening, which is why it reacted so sharply to credit tightening (i.e., the increase in reserve requirements and the pullback in lending).

- The data on China property is difficult to ascertain, but property sales are 14% of GDP, which is an unprecedented level. Rental yields are 2-4%, and the vacancy rate is very high, in fact “humongous”. Prices might be as much as 100% overvalued.

- China’s property bubble is in new properties, not existing. In China, the local government is the seller, it’s really a fund-raising operation for them. About half of local government revenue comes from the property sector. In a sense there is a struggle between central and local governments. The fiscal situation is very dependent on property sector.

- The government is taking steps, such as limiting mortgages on 2nd and 3rd flats. Demand is very speculative, so it’s very difficult for demand to continue without bank lending. Developers who are paying record prices for land may get trapped. In the last 7 years, land prices are up over 10x, and in some cities it’s up over 20x. The bubble is about to burst.

- The resource trend is more land lasting than others. China has a resource shortage and has huge reserves, a significant amount of money will be put into resources. This is the only story that Andy has faith in. The resource story will continue for several years.

Interview #2: These notes are from another Bloomberg interview on 2/12/10:

- China has again increased reserve requirements, but this isn’t enough to stop inflation.

- China will have to stop inflation, rental ratio is under 3%, the price income ratio in major cities is 20x or higher. They’re hoping for a softer landing but Andy Xie is skeptical

- Interest rates are too low – demand deposit rate is 0%, long term deposit rates are 3%, economy is growing at 8-10% and inflation was reported as 2% in January. Andy Xie considers this not reliable. Plus, saving incentives have gone down.

- With excess liquidity, these moves to increase reserve requirements are not enough. The government actions are only reducing excess liquidity, not turning it around. The loan deposit ratio is 67%, and the deposit reserve ratio is less than 17%. This is not enough to turn around the excess liquidity.

- Also, there is hot money going to China, which will continue. China will have to raise interest rates to show that they’re serious about tightening.

Stock Gurus: Robert Prechter

Posted by admin on February 9, 2010  |  No Comments

Written Wednesday, January 27, 2010

Robert Prechter, President of Elliot Wave International, is known for the Elliot Wave Theory, as well as for predicting the 1987 stock market meltdown. He appeared on CNBC on Wednesday, January 27, to issue a new warning: that we were headed into the next bear phase. I always like to listen to the “Gurus” and see how they assess the market, what indicators they look at, etc.

March 2009. Back in late February, early March 2009, as few as 2% of traders were bullish. At that point, Mr. Prechter believes that the market is coming out of something, and it’s time to look to the upside. They had an upside target of 10,000 on the Down, and that was exceeded.

January 2010 Signs of a Top. Today, they’re seeing a lot of signals that are similar to the ones they saw at the top in 2007, as well as in the earlier top in 1999 and 2000. He’s quoted as saying, “this is the last chance to get out of the Dow in quintuple digits”. He characterizes the tops as follows:

• extreme optimism; advisors 3x bulls over bears, biggest ratio since 1987
• extreme valuation, dividend yields as low as 2.8% for Dow
• PE ratio is higher than it’s ever been in last few quarters; even if you adjust for future earnings, still expensive
• downside momentum loss in November, December and January

By the way, he published the second edition of Conquer the Crash in December, to give people time to get out.

Expectations for 2010. Not interested in commodities, that run has already occurred. Expects repeat of 2008, when real estate, stock market and commodities went down together, and safest place is in the dollar. Dollar bottomed in November, has stealth rally and they remain positioned in the dollar.  Mr. Prechter is looking for another wave, so he’s being safe. They’re staying in cash and cash equivalents.

How much weight to put on Mr. Prechter’s comments? I did a little more research to get more information on Mr. Prechter’s point of view. It turns out, he’s quite extreme. He believes that US stocks will fall below their 12-year lows hit in March 2009 and that the S&P will fall below 666. He sees bonds falling to lower levels than the panic of 2008, and gold falling 40% off it’s peak value, especially if deflation sets in.

Mr. Prechter’s Track Record. If you look back, he did call the crash of 2008 and that he did call the bottom in late February 2009, telling traders to exit their shorts when the S&P was near the 770 level. But you’ll also find that Mr. Prechter is a perma-bear. He called for traders to be 200% short in November 2009. He also was very bearish in August 2009, although at that time he admitted that just the reliable part had past, and that he could not time the turn. But the last time he called for traders to be long stocks before 2009 was in 1997, and so he’s missed lots of good stuff. According to the Hulbert Financial Digest, his newsletter is in last among all market timing strategies.

Markets: 1987 vs. October 19, 2007 – 1987 vs. 2007. Still, he does have some interested points to consider. Here’s his comparison of the 1987 market and the market on October 19, 2007 from an interview on Bloomberg (available on YouTube):

• DJIA Annual Dividend Yield – 2.6% vs. 2.0%
• Price of $1 Dividend – $39 vs. $50
• Duration Dividend < in 1929 – 3 mos. vs. 13 years
• Price/Book Value – 1.73 vs. 4.04
• Advisors Net Bullish (>97%) – 156 weeks vs. 468 weeks
• Daily Sentiment – % Bulls vs. Bears – 3x > 90% vs. 51x > 50% in last 13 mos.

The dividend yield measure is interesting, because I think that is a valid indication of a bullish market. Still, one thing to consider today is that a lot of companies eliminated the dividend following the 2008 crash. You could argue the measure is still valid despite that fact.

The third item measures how long it has been since dividend has been less than it was in 1929. The argument is that when people don’t want dividends, they think they’ll make it up in capital gains.

“Advisors” refers to newsletter advisors.

You’ll notice though, it’s very hard to use this to time the market – the bullish readings in 2007 lasted a very long time. Mr. Prechter was bearish for the two years leading into the 2007-2008 crash. In this interview on October 19, 2007, he cited the fall in commercial paper and the decline in Asian buying of US Treasuries as the indicators of cracks in the stock market.

Conclusion. In sum, it’s interesting to look at some of his indicators, but it’s hard to make bets based on his perspective. As always, he’s one of many points of view to consider.