Is the Bear Case Really That Fragile or is Everyone Just Short?
Friday brought us a very nice rally across the US equity markets with the Dow, S&P500, NASDAQ and Russell 2000 indices all up nearly 2% or more. The rally capped off an odd week—after a strong rally on Monday, fostered by better than expected news from the Basel III bank capital accord over the weekend, where regulators gave firms more time than analysts expected to comply with stiffer capital requirements aimed at preventing future financial crises, the markets slowly began to give back the gains on the back of mixed financial data coming out of the US and Europe. Mixed data on housing starts in the US, a weaker than expected PMI out of Germany (which, of course, caused all the analysts to proclaim “the bloom is off the European rose) and the FOMC refusing to rule out further Quantitative Easing, all conspired to cause investors to start questioning the recent run up in stocks. Even Treasury yields started to head back downward again and the dollar weakened throughout the week. Then came Friday.
What happened on Friday? Thursday’s close saw the markets go from holding in positive territory all day to a strong late-day sell off. Considering that the economic data expected to be released on Friday (Durable Goods Orders and New Home Sales) was of fairly low import on the broad spectrum of impactful data, the market reaction was as odd as it was unexpected. Yet the futures opened strongly Friday morning with the one decent piece of global economic news having been released that morning being the German IFO, their version of our Business Sentiment Index, which came out stronger than expected. So what was with the rally? It may sound laughable and weak peg on which to hang one’s hat, but we truly believe that Friday’s rally was based nearly in whole on the guests who appeared on CNBC. The morning started with Jack Welch, former Chairman of GE and no fan of Obama. His strong opinions on the fate of the Obama machine and the Bush tax cuts come this election period added to the strength of the futures throughout the morning even as he declared “slow growth” in his ex-firm’s business lines. Following Jack came good old Doug Kass, the man who proclaimed the generational market bottom (and was right) on March 6th, 2009. His fairly bullish commentary on the value of stocks and own opinion on the upcoming elections added even more steam to the pre-market futures. You could almost see the shorts playing at home getting nervous as they sat at their laptops, in their boxer shorts, coffee in hand, trading on E-Trade. His final punch, however, was his call that shorting Treasuries would be the trade of the next century. Of course, outlining the reasons for this call gave him the opportunity to present some fairly bullish economic commentary, which certainly did not hurt the gathering strength.
The knock-out punch, however, was the appearance of David Tepper of Appaloosa Management, a legendary hedge fund manager who has been more right than wrong over the years and who made a killing on financial stocks last year when no one wanted them. Tepper rarely gives interviews, certainly not several hour-long appearances on financial TV, so his appearance was closely watched. Tepper didn’t disappoint. According to him, we are in a virtuous cycle (not his words) given the Fed’s stance on QE. Appaloosa typically allocates about 30% of capital to stocks and 70% to bonds and Tepper disclosed that he is still about 10% in stocks but moving more into them as he finds them cheap, particularly amid the current interest rate/Federal Reserve backdrop. To Tepper, if the economy strengthens stocks will do well. Conversely, in that scenario he thinks bonds and gold will not. On the other hand, he believes the Federal Reserve is acting as a put option for his strategy because if the economy worsens, the Fed will step in with quantitative easing, lowering long rates further and then all asset classes (except the dollar) would do well. It was his version of a win-win scenario and one could just watch the futures jump as he built his case.
All this CNBC commentary certainly added fuel to a fire that had started smoldering after the German IFO but the gasoline came at 8:30am when Durable Goods orders came in slightly better than expected, flying in the face of several back-to-back bad Philly Fed reports. Then, at 10am, New Home Sales came out mixed but overall stronger than expected and the fire was lit. Markets jumped and never came back. The funny thing about Friday’s market action was that, after the Dow hit it’s high of around +200, it sat there all day long, barely budging. No trader we questioned is quite sure why the daily stability but so much for 3pm being the most important hour of the day.
Did the favorable market opinions on TV Friday really drive the strong market reaction? And if it did, would wheeling out Nouriel Roubini and a few other bears bring it right back down? We suppose no-one will ever know the true answer but the commentary given certainly was rational, well thought out and made a helluva lot more sense to those schooled in economics (including us) than the knee-jerk “we’re the next Japan” headline grabbers that have been populating the airwaves lately. So, to answer last week’s question, are the elections already baked into market prices, we would have to say not yet. If a week’s worth of hand wringing over the margin by which Republicans will win in November managed to rock the markets back and forth only to be erased by some positive commentary from a couple of smart guys, then we think there is a lot more “kicker” left from certainty creeping into the eventual outcome of the elections and the events beyond. And to answer this week’s question, it sure seems to us like there’s a lot of non-believers out there—whether they are short or just plain underinvested, the case for being so is starting to look a little thin.
Monday, September 27, 2010
Tuesday, September 14, 2010
Ramblings of a Portfolio Manager
Running Scared, Running Right
R&D tax credits for small business. $50bn to build and improve our transportation infrastructure (none of which would be spent on signs touting such!). Extension of capital gains and income tax cuts. A $30bn fund to invest in banks to lend to small business. $17bn in tax breaks to business to hire unemployed workers. Tax credits? Tax cuts? Sounds like George Bush in year 5 of his administration. Oddly enough, in the Bizzarroland that is Washington D.C. these days, these are all proposals that have come out of the Obama administration in the last month alone! Odder still are the Republicans who are breaking rank with their party to jump on the President’s bandwagon for these plans at the same time a fair number of Democrats are jumping the ship of Obama like rats. Yup, the mid-term congressional elections are coming up and with the economy wallowing in the doldrums of no-growth, the politicians up for re-election are starting to fear for their cushy jobs. Now you understand why they call this the “silly season.” Desperate times call for desperate measures and, it seems, even the starry-eyed ideologue in the White House seems to be getting the message. We had postulated that that lone intractable zealot would wait for the election outcome to head in the right (double entendre intended) direction but it seems that he actually, albeit slowly, may be taking some cues from history. Specifically we refer to the Clinton years and it sure seems from our perspective that Obama is already taking baby steps toward the middle of the political spectrum. In the 90’s this move worked for Clinton, it worked for our economy and, ultimately, it worked spectacularly for our stock market. Now, Mr. O may not care about any of these three items but he certainly has a big concern for retaining sufficient power to push through his agendas and, well, if he has to bend a little to retain that power, maybe that’s a good idea. If any of this sounds like a 180 degree turn in the administration’s thinking, it is; and for the equity markets it has been recently, and will continue to be, a good thing.
Will it last? Since the President began his (begrudgingly) pro-business stumping, the S&P 500 has risen over 60 points and the Dow is up close to 500 points. Is the market discounting a kinder, friendlier Administration post-November? Or is it looking forward to all the congressional bums being thrown out? Or is it starting to read the tea leaves that have been showing the World economy (including the US) was and is not as bad as believed in May through August? Did interest rates get just too low? Or was the market just oversold on light summer volume? Yes. The answer, in our humble opinion, is probably a combination of all these factors. Taken with the extraordinary build up of negativity in the markets since April--which we have been discussing over the last month--all these factors conspired to take what was a very over-sold US equity market and give it a lift. But, we ask again, will it last? And if so how long? Sentiment has definitely improved, the extension of the Bush tax cuts is seen as all but a given (the only debate is how far up the income ladder to extend them), Vegas is long a Republican victory in November, Obama is obviously on some pro-business narcotic (where can we buy more?) and even Warren Buffett is out saying “no way will we have a double dip.” Is all the good news already in the market? Will the markets sell off post-election day? The trader in us says “probably.” The long-term investor in us, however, says “ we still have some way to go and if the market does sell off, buy, buy, buy.” Over the last two weeks, taking advantage of historically low rates, corporate America has been drastically improving its balance sheet. Equity issues, sub 1% debt issues, 100 year bond issues, you name it, if healthy corporations could exploit the dislocations we have in interest rates and stock prices, they did it. And that bodes well for the future—for earnings and growth.
We’re buyers into mid-October when we will get a better read on the political polls. Investors will probably take whatever those polls say as an opportunity to take profits. Late October and early November may be rocky but that’s when you buy—economic data and the political landscape will be better then than they are now, earnings estimates will be higher and the market will start focusing on 2011 earnings, which are sill around $90 for the S&P500, an all time high. Remember, stock prices are a function of the multiple (Price/Earnings, for example) and that which the multiple is measuring. Right now we have a good number to measure (S&P earnings) but sentiment is keeping the multiple down. We expect late November and December will bring us a lot to be optimistic about and with both multiples and earnings estimates high, we could see a very, very nice Santa Clause rally.
R&D tax credits for small business. $50bn to build and improve our transportation infrastructure (none of which would be spent on signs touting such!). Extension of capital gains and income tax cuts. A $30bn fund to invest in banks to lend to small business. $17bn in tax breaks to business to hire unemployed workers. Tax credits? Tax cuts? Sounds like George Bush in year 5 of his administration. Oddly enough, in the Bizzarroland that is Washington D.C. these days, these are all proposals that have come out of the Obama administration in the last month alone! Odder still are the Republicans who are breaking rank with their party to jump on the President’s bandwagon for these plans at the same time a fair number of Democrats are jumping the ship of Obama like rats. Yup, the mid-term congressional elections are coming up and with the economy wallowing in the doldrums of no-growth, the politicians up for re-election are starting to fear for their cushy jobs. Now you understand why they call this the “silly season.” Desperate times call for desperate measures and, it seems, even the starry-eyed ideologue in the White House seems to be getting the message. We had postulated that that lone intractable zealot would wait for the election outcome to head in the right (double entendre intended) direction but it seems that he actually, albeit slowly, may be taking some cues from history. Specifically we refer to the Clinton years and it sure seems from our perspective that Obama is already taking baby steps toward the middle of the political spectrum. In the 90’s this move worked for Clinton, it worked for our economy and, ultimately, it worked spectacularly for our stock market. Now, Mr. O may not care about any of these three items but he certainly has a big concern for retaining sufficient power to push through his agendas and, well, if he has to bend a little to retain that power, maybe that’s a good idea. If any of this sounds like a 180 degree turn in the administration’s thinking, it is; and for the equity markets it has been recently, and will continue to be, a good thing.
Will it last? Since the President began his (begrudgingly) pro-business stumping, the S&P 500 has risen over 60 points and the Dow is up close to 500 points. Is the market discounting a kinder, friendlier Administration post-November? Or is it looking forward to all the congressional bums being thrown out? Or is it starting to read the tea leaves that have been showing the World economy (including the US) was and is not as bad as believed in May through August? Did interest rates get just too low? Or was the market just oversold on light summer volume? Yes. The answer, in our humble opinion, is probably a combination of all these factors. Taken with the extraordinary build up of negativity in the markets since April--which we have been discussing over the last month--all these factors conspired to take what was a very over-sold US equity market and give it a lift. But, we ask again, will it last? And if so how long? Sentiment has definitely improved, the extension of the Bush tax cuts is seen as all but a given (the only debate is how far up the income ladder to extend them), Vegas is long a Republican victory in November, Obama is obviously on some pro-business narcotic (where can we buy more?) and even Warren Buffett is out saying “no way will we have a double dip.” Is all the good news already in the market? Will the markets sell off post-election day? The trader in us says “probably.” The long-term investor in us, however, says “ we still have some way to go and if the market does sell off, buy, buy, buy.” Over the last two weeks, taking advantage of historically low rates, corporate America has been drastically improving its balance sheet. Equity issues, sub 1% debt issues, 100 year bond issues, you name it, if healthy corporations could exploit the dislocations we have in interest rates and stock prices, they did it. And that bodes well for the future—for earnings and growth.
We’re buyers into mid-October when we will get a better read on the political polls. Investors will probably take whatever those polls say as an opportunity to take profits. Late October and early November may be rocky but that’s when you buy—economic data and the political landscape will be better then than they are now, earnings estimates will be higher and the market will start focusing on 2011 earnings, which are sill around $90 for the S&P500, an all time high. Remember, stock prices are a function of the multiple (Price/Earnings, for example) and that which the multiple is measuring. Right now we have a good number to measure (S&P earnings) but sentiment is keeping the multiple down. We expect late November and December will bring us a lot to be optimistic about and with both multiples and earnings estimates high, we could see a very, very nice Santa Clause rally.
Tuesday, September 7, 2010
Ramblings of a Portfolio Manager
The Culture of Pessimism
The markets just closed out their worst August since 2001. After a strong July, based on good corporate earnings reports and guidance, the markets looked to be poised to continue the rally. Unfortunately, that rally lasted exactly one day into the month and then fizzled. A string of mixed economic data during the month trumped what were some fairly impressive numbers from Corporate America and investors, having been once burned in 2008, chose to shoot first and question later. The August Federal Reserve meeting, which was intended to calm the markets instead caused fear and renewed discussions of deflation and a double-dip recession. By the way, a strict definition of a double-dip assumes we have already emerged from the prior slowdown to the pre-recession GDP—we haven’t so yet just keep that in mind when the CNBC talking heads get going on their “double dip” talk.
In terms of Q2 earnings reports we had over 75% earnings beats with similar results in raised guidance. While these statistics are near an all time high and contributed to a strong July, the market’s mood turned sour in August on some of the macro economic data, particularly the Philly Fed Index, and good earnings reports, rather than being rewarded, in fact, turned into an opportunity to SELL.
The equity markets are now in a culture of pessimism. Time Magazine just ran an article questioning whether Americans should own homes. A poll of Hedge Fund managers showed the highest degree of pessimism regarding the equity markets since 2008 (47%) . The AAII index of investor bullishness is at 20%, a 5 year low. Yet another poll put investor sentiment at the lowest point since March of 2009, the “Generational Low” we hit after the financial crisis. Outflows from equity funds and into Treasury Bond funds is at the level of late 2008. Gold and US Treasuries have become cult investments with gold just off its all time high and the 10 year bond yield near its all time low. Wall Street Analysts, usually a lagging indicator, have for the first time in more than a decade, rated the percentage of stocks as Buy below 29%, down from 75% in 1997, according to Bloomberg. Paradoxically, analysts aren't telling investors to sell either, with Sell ratings remaining near a low 5%. Instead, Hold ratings have ballooned to a record 66%. All along these analysts are raising their earnings estimates for companies while dropping their target prices for their stocks. Finally, the London FT just ran an article that it has become fashionable to be negative both in the financial and popular press. Typically, all this pessimism would signal that we are nearing a low in the equity markets. But one has to have a strong stomach and a good dose of contrarianism too hold ones nose and jump into the equity markets. We have both.
We think this is an excellent time to build a portfolio in equities. Why? First of all, we were on almost every earnings conference call and spoke with management during earnings season. The tone and the guidance we heard was almost universally positive. And, nowadays, when Managements lie they do so to the downside so they can sandbag the upcoming quarter. This means the rest of the year is probably going to be better than to what they are guiding. The problem is, no one believes it. That’s why there is so much cash sitting on the sidelines and in bonds. One little hiccup in bonds and there will be a panic move into stocks, small cap stocks in particular. What will cause the hiccup? Getting those idiots out of Congress for one, better economic data (as we have seen in the last few weeks) is another. We’ve had 13 months of improving manufacturing data. At some point even the dense guys sitting in cash will get it.
We believe that the markets are discounting an economic scenario that is much worse than what exists. In addition, we have several catalysts ahead of us to further bolster equity returns. Republicans now have a 10 pt lead in the polls versus the Democrats going into the mid-term elections, the largest in 68 years. This signals political gridlock at the least, usually good for the markets, or a Republican sweep, which would ensure that the Bush Tax cuts will be extended for all income classes. Additional tax cuts may also follow a Republican regain of control. One little tidbit: the six months following a mid-term election have shown strong positive equity gains every year since 1950.
Last week we got a little taste of what a rally based on “not as bad as feared” data might look like. It was strong with many of the indicies erasing nearly all of their August losses in just three days. Will it last? That depends upon the data we continue to get but imagine the rally that would ensue if the data actually turned positive and beat consensus, if we get regime change and Obama chooses Clinton’s wise course when he lost his majority in the mid-terms and moved to the center . World equity markets have been moving up strongly for a few weeks now on strong economic data. We have not. The ‘decoupling” adherents are starting to come out of the woodwork. Their record had been very consistent—100% wrong. So if the Worlds’ economy is humming along better than expected, perhaps so is ours.
The markets just closed out their worst August since 2001. After a strong July, based on good corporate earnings reports and guidance, the markets looked to be poised to continue the rally. Unfortunately, that rally lasted exactly one day into the month and then fizzled. A string of mixed economic data during the month trumped what were some fairly impressive numbers from Corporate America and investors, having been once burned in 2008, chose to shoot first and question later. The August Federal Reserve meeting, which was intended to calm the markets instead caused fear and renewed discussions of deflation and a double-dip recession. By the way, a strict definition of a double-dip assumes we have already emerged from the prior slowdown to the pre-recession GDP—we haven’t so yet just keep that in mind when the CNBC talking heads get going on their “double dip” talk.
In terms of Q2 earnings reports we had over 75% earnings beats with similar results in raised guidance. While these statistics are near an all time high and contributed to a strong July, the market’s mood turned sour in August on some of the macro economic data, particularly the Philly Fed Index, and good earnings reports, rather than being rewarded, in fact, turned into an opportunity to SELL.
The equity markets are now in a culture of pessimism. Time Magazine just ran an article questioning whether Americans should own homes. A poll of Hedge Fund managers showed the highest degree of pessimism regarding the equity markets since 2008 (47%) . The AAII index of investor bullishness is at 20%, a 5 year low. Yet another poll put investor sentiment at the lowest point since March of 2009, the “Generational Low” we hit after the financial crisis. Outflows from equity funds and into Treasury Bond funds is at the level of late 2008. Gold and US Treasuries have become cult investments with gold just off its all time high and the 10 year bond yield near its all time low. Wall Street Analysts, usually a lagging indicator, have for the first time in more than a decade, rated the percentage of stocks as Buy below 29%, down from 75% in 1997, according to Bloomberg. Paradoxically, analysts aren't telling investors to sell either, with Sell ratings remaining near a low 5%. Instead, Hold ratings have ballooned to a record 66%. All along these analysts are raising their earnings estimates for companies while dropping their target prices for their stocks. Finally, the London FT just ran an article that it has become fashionable to be negative both in the financial and popular press. Typically, all this pessimism would signal that we are nearing a low in the equity markets. But one has to have a strong stomach and a good dose of contrarianism too hold ones nose and jump into the equity markets. We have both.
We think this is an excellent time to build a portfolio in equities. Why? First of all, we were on almost every earnings conference call and spoke with management during earnings season. The tone and the guidance we heard was almost universally positive. And, nowadays, when Managements lie they do so to the downside so they can sandbag the upcoming quarter. This means the rest of the year is probably going to be better than to what they are guiding. The problem is, no one believes it. That’s why there is so much cash sitting on the sidelines and in bonds. One little hiccup in bonds and there will be a panic move into stocks, small cap stocks in particular. What will cause the hiccup? Getting those idiots out of Congress for one, better economic data (as we have seen in the last few weeks) is another. We’ve had 13 months of improving manufacturing data. At some point even the dense guys sitting in cash will get it.
We believe that the markets are discounting an economic scenario that is much worse than what exists. In addition, we have several catalysts ahead of us to further bolster equity returns. Republicans now have a 10 pt lead in the polls versus the Democrats going into the mid-term elections, the largest in 68 years. This signals political gridlock at the least, usually good for the markets, or a Republican sweep, which would ensure that the Bush Tax cuts will be extended for all income classes. Additional tax cuts may also follow a Republican regain of control. One little tidbit: the six months following a mid-term election have shown strong positive equity gains every year since 1950.
Last week we got a little taste of what a rally based on “not as bad as feared” data might look like. It was strong with many of the indicies erasing nearly all of their August losses in just three days. Will it last? That depends upon the data we continue to get but imagine the rally that would ensue if the data actually turned positive and beat consensus, if we get regime change and Obama chooses Clinton’s wise course when he lost his majority in the mid-terms and moved to the center . World equity markets have been moving up strongly for a few weeks now on strong economic data. We have not. The ‘decoupling” adherents are starting to come out of the woodwork. Their record had been very consistent—100% wrong. So if the Worlds’ economy is humming along better than expected, perhaps so is ours.
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