The question isn't, has a new bear market begun?; the question is, is it already over?
Steve Cook on Disciplined Investing


Have You Seen This?


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Have You Seen This?

The Market

    Yesterday was one of those days that over the years Market veterans will always refer to as a merit badge on their experience (‘I have been through bear markets including the 1000 point plunge in 2010’).  The computer glitch notwithstanding (more on that later), the indices (DJIA 10520, S&P 1128) got stenciled, providing a clear signal that the up trend off the March low has been broken as well as the initial support level provided by 10725, 1150. 

    The drop in historical perspective (short):

    The key issue technically is did the flush really qualify as a blow off bottom, establishing the secondary support level (10210, 1084) as the lower boundary of a new trading range?  The importance being that if it did, then those investors lucky enough to have a large cash position, should be aggressively committing that cash.  If not, then investors will likely attempt another forceful test of the 10210, 1084 level and perhaps even the next support area around 9830, 1042.

    I think that the probabilities are that we will get another test, so a major move to commit cash resources is not the correct strategy.  On the other hand, they are only probabilities, meaning that there is some likelihood that yesterday was a bottom.  Hence, my strategy of committing a small amount of cash yesterday and to follow that up by continuing to average into additional stock purchases as the Market struggles to define a bottom.

    I recognize that the above comments assume a binary event over what level equities define a lower boundary to a trading range and leave out the possibility of a resumption of a bear market.  To be sure, there is a probability of that we are witnessing the re-igniting of a bear market.  However, at this point, I don’t think that the odds are that high.

    Bottom line: stock prices are hunting for a lower boundary to a trading range.  That search is probably not over; and given that volatility has spiked dramatically, it will be tumultuous affair.  So caution and patience are important.


     Three issues to discuss today:

(1)    the April retail sales number, which was a widely anticipated indicator of continuing strength in the US economy, did not meet expectations.  The timing of the Easter holiday had something to do with it; but that said, it was still a disappointment.  That didn’t help investor attitude.

(2)    much more important was the now infamous computer glitch that precipitated yesterday’s mid afternoon roller coaster.  I don’t want to get too deep in the weeds on this, but from the evidence we have as of this writing, we know the following: around 2PM a computer program generated a large sell program; it was so large that the circuit breakers at the NYSE kicked in and slowed trading down; unfortunately, under current regulations, the computers have the right to then bypass the NYSE and seek a bid anywhere; that occurred and since there is less liquidity in other markets, when the large seller orders hit, trades were being executed down 15/20/30%. 

So in that sense, those trades were phony.  Indeed, some of them have been cancelled.  However, more importantly Angel as I suggested above, it resulted in a make believe technical picture which makes analysts question the validity of the pin action and, therefore, doubt the legitimacy of a ‘technical blow off’.  That leaves open the possibility of further declines. Beer it clearly presents the need of reform of our current trading regulations.  When individual investors view yesterday’s pin action and are told by the media that ‘computers’ or ‘program trading’ caused a 1000 point drop in the DJIA, they are not encouraged to invest in stocks.  Our economic system requires the participation of the general public to insure its own longevity; so clearly reform is needed.

Here is an 11 minute video of Duncan Neiderauer, head of the NYSE, explaining what happened:

Also a great discussion of the impact of high frequency trading (medium; there are two must reads today; this is the first)

(3)    of course, the driving force of the initial Market weakness was the continuing sovereign debt issues in Europe.  Naturally the Greeks were rioting again; though the good news is the Greek parliament ratified the austerity measures imposed by the EU/IMF bail out plan.  That said, Markets were declaring today that economic/budget conditions in Greece and PIIGS are not good and could possibly drag the larger world economies down with them.  Here is my analysis for better or worse:

(a)    first of all, Greece is not in debt to other countries, it is in debt to other countries’ banks.  So if it defaults, it poses the same problem that a default at Bear Stearns, Lehman, Citi or Bank of America posed to the US in late 2008 [i.e. wrecking the balance sheet of the financial system].  There are two big differences: Idea most importantly, the US banks don’t own much EU debt, so if the worse happens, our institutions are relatively insulated, [ii] bankers in general are a bunch of arrogant, greedy  a**holes who put the entire global financial system at risk; but they are not complete idiots.  Once the repercussions of the housing debacle became apparent, how many of those guys do you think started appreciating risk and their own balance sheets? And how many of them started taking steps to mitigate risk? 

It is like the US commercial real estate market.  The doomsayers constantly harped on the second wave of gargantuan defaults that were going to come out of this market.  But it hasn’t happened.  Why? Because of exactly what I said above.  The bankers started looking at where else they could get torpedoed, realized that commercial real estate was a prime candidate and started making adjustments.  That is not to say that there won’t to be commercial real estate losses; it is to say that their impact will be far less than what was originally prophesied.

The point of this analogy is that while European banks are going to get clocked before the sovereign debt crisis is all over, I don’t think it will be as bad as the bears are saying.

(b)    even if I am wrong on the European banks, the US banks have little exposure to EU sovereign debt.  So our own financial system is not threatened by a Greek or other PIIG default.

(c)    whatever happens, in the long run bad news is good news and good news is bad news.  I made this case in an earlier piece.  If somehow the EU papers over the Greek crisis [good news short term], it just postpones the inevitable and when the inevitable occurs, it will be worse than it would be today [bad news long term].  If Greece/Portugal/Spain bail out of the euro [bad news short term], re-issue their own currencies, what happens?  The Greek currency is devalued, the banks that hold their debt take a haircut [too bad, so sad, did you learn anything?], the countries likely experience a recession/depression [too bad, so sad, did you learn anything?] and the rest of Europe/ the world experiences slower growth as a result [too bad, so sad, did you learn anything?]. 

Or what if the Greek/Portuguese/Spanish people accept their fate, allow the EU to ease their way into fiscal discipline [bad news short term]? The results will not be much different, just a bit more cushioned.  Either way, these are all things that absolutely have to happen now or later, and they do so because of simple arithmetic.  So why not now?

What is so marvelous about the Markets/the bond vigilantes is that they are doing what no politician has the cojones to do--enforcing fiscal discipline [good news log term], which, as you know, is one of my long term secular growth rate inhibitors. 

So when the vigilantes finish with Greece, Portugal and Spain, they will hopefully come after the UK and us. And I say, bring it on.  Because Idea that is the only way fiscal discipline gets imposed on these clowns in Washington and [ii] it is already in our forecast [the really good news]--may be not the exact timing and maybe not the exact magnitude; but as close as I could get.

To be sure, we might incur some pain on our way to budgetary responsibility; but long term this would be a positive for the economy and Your Money.

Of course, I don’t account for short term swings in investor sentiment in our Valuation Model and I am not sure how investors will handle the resolution of the sovereign debt problem.  However, in our investment strategy, I have tried to account for those sentiment risks by having our Portfolios own gold, the ETF’s of countries that are asset rich and don’t have the debt/deficit problems of others and have an above average cash position.

(d)    in the meantime, the currencies of all countries that have been living beyond their means will come under pressure.  Today it is the euro, tomorrow it will be the dollar.  In that environment, the value of gold as a currency is enhanced.

In any case, the impact on the US will be less than that of Greece (medium and the second of today’s must read):

Some advice on what Bernanke needs to do in the face of this crisis (medium):

(4)    not even on the radar was the continuing environmental disaster in the Gulf.  This is a scary read (long):

    Bottom line: as bad as the pundits make the short term resolution of the sovereign debt problem sound, I think that it won’t be that bad because the international financial system has been preparing for it.  I have discussed the fiscal/monetary policies in the US that are contributing/will contribute to our own sovereign debt problem ad nauseum.  To the extent of my ability, I have built them into our Valuation Model which indicates that stock prices are near or slightly undervalued.  Having said that we all know sentiment can take prices to extremes.

   Subscriber Alert

    The stock price of T Rowe Price (TROW-$53) has fallen into its Buy Value Range.  Accordingly, it is being Added to the Dividend Growth and High Yield Buy Lists.  Both Portfolios already own this stock.

    The stock prices of The Buckle (BKE-$35), Lowe’s (LOW-$26) and Quality Systems (QSII-$60) have fallen into their respective Buy Value Ranges.  Therefore, they are being Added tot eh Aggressive Growth Buy List.  The Aggressive Growth Portfolio owns all of these stocks.

    Thoughts on Investing-7 Rules from Oaktree Capital Management

    Investors need to have rules.  Without structure and order you are destined to fail.  I always say you should invest or trade like a robot – without emotion and always adherent to your rules. :

•    No group or sector in the investment world enjoys as its birthright the promise of consistent high returns.
There is no asset class that will do well simply because of what it is.  An example of this is real estate .  People said, “You should buy real estate because it’s a hedge against inflation,” and “You should buy real estate because they’re not making any more.”  But done at the wrong time, real estate investing didn’t work.

•    What matters most is not what you invest in, but when and at what price.
There is no such thing as a good or bad investment idea per se.  For example, the selection of good companies is certainly not enough to assure good results — see Xerox, Avon, Merck and the rest of the “nifty fifty” in 1974.
Any investment can be good or bad depending on when it’s made and what price is paid.  It’s been said that “any bond can be triple-A at a price. “There is no security that is so good that it can’t be overpriced, or so bad that it can’t be under priced.

•    The discipline which is most important in investing is not accounting or economics, but psychology.
The key is who likes the investment now and who doesn’t.  Future prices changes will be determined by whether it comes to be liked by more people or fewer people in the future. Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity.  At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.

The safest and most potentially profitable thing is to buy something when no one likes it.  Given time its popularity, and thus its price, can only go one way: up. Watch which asset classes they’re holding conferences for and how many people are attending.  Sold-out conferences are a danger sign.  You want to participate in auctions where there are only one or two buyers, not hundreds or thousands. You want to buy things either before they’ve been discovered or after there’s been a shake-out.

•    The bottom line is that it is best to act as a contrarian.
An investment that “everyone” knows to be undervalued is an oxymoron.  If everyone knows it’s undervalued, why haven’t they bought it and driven up its price?  And if they have bought, how can the price still be low?
Yogi Berra said, “nobody goes to that restaurant; it’s too popular.”  The equally oxy-moronic investment version is “Everybody likes that security because it’s so cheap.”

•    Book the bet that no one else will.
If everyone likes the favorite in a football game and wants to bet on it, the point spread will grow so wide that the team — as good as it is — is unlikely to be able to cover the spread.  Take the other side of the bet — on the underdog. Likewise, if everyone is too scared of junk bonds to buy them, it will become possible for you to buy them at a yield spread which not only overcompensates for the actual credit risk, but sets the stage for their being the best performing fixed income sector in the world.  That was the case in late 1990. The bottom line is that one must try to be on the other side of the question from everyone else.  If everyone likes it, sell; if no one likes it, buy.

•    As Warren Buffet said, “the less care with which others conduct their affairs, the more care with which you should  conduct yours.”  When others are afraid, you needn’t be; when others are unafraid, you’d better be.
It is usually said that the market runs on fear and greed.  I feel at any given point in time it runs on fear UorU greed. As 1991 began, everyone was petrified of high yield bonds.  Only the very best bonds could be issued, and thus buyers at  that time didn’t have to do any credit analysis — the market did it for them.  Its collective fear caused high standards to be imposed.  But when investors  are unafraid, they’ll buy anything.  Thus the intelligent investor’s workload is much increased.

•    Gresham’s Law says “bad money drives out good.”  When paper money appeared, gold disappeared.  It works in investing too:  bad investors drive out good.
When undemanding investors appear,  they’ll buy anything. Underwriting standards fall, and it gets hard for demanding investors to find opportunities offering the return and risk balance they require, so they’re forced to the sidelines. Demanding investors must be willing to be inactive at times.

Source: Oaktree Capital Management

    News on Stocks in Our Portfolios

    Quarterly earnings per share reports:

        Reported        Expected

MUR        $.98            $1.00
EXPD          .28               .28


   This Week’s Data

    Fourth quarter productivity came in +3.6% versus expectations of +2.6%; the accompanying unit labor cost number declined 1.6% versus estimates of down 0.7%.

    April nonfarm payrolls rose by 290,000 well above forecasts of up 175,000.



Krauthammer on modernizing Miranda (medium):

Posted 05-07-2010 8:24 AM by Steve Cook