The Correction is Here so Mind your Vs and Ws

We wrote in January “any material pullback that could make 2012′s chart look like a V or W on renewed European default or earnings concerns is a buying opportunity.”  The correction is here, live and in person with global markets retracing 2012′s gains to date.  The V can certainly deepen further, but this is the time to begin putting some of the cash you have on the sidelines to work. 

The timing of the bottom of this correction is irrelevant and don’t expect to get it right.  Just start putting 10-20% of your cash to work on days when the market is down over 2%.  If we fall just another 5-7% from here, I will advise swapping out your boring, broad ETFs for something more fun like 2x or 3x leveraged ETFs and emerging markets exposure with more upside. 

Corrections are psychological animals and we are definitely in the midst of a Euro-led psychosis.  The faster Greece is resolved (stay with Germany’s austerity plan or leave the Euro) and Spain performs an Italian-esque political and economic turnabout, the better.  But since the timing of this correction is identical to those we saw in 2010 and 2011, we are in no big hurry to get overexcited that the worst is behind us.  The US economy is in a rough patch driven by the confidence-killing psychosis across the Atlantic.  Notice nobody is worried about France’s new left-leaning leader or the actual Euro currency which is still far from parity with the US Dollar.  All this negativity will pass and the stock market will show its strong hand again as we get closer to the Presidential election.  Markets cheer political deadlock so bet on Republican gains in Congress and another four years for President Obama.

The Economics of Luxury: Apples and Googles

I have a wealthy friend who asked the following question today:  What are the odds of Google and Apple hitting $1,000/share, respectively, in the coming 18-30 months?

I don’t have a clue, but it doesn’t seem too far fetched.  Which stock will get there first?  No idea.  This is a great topic to remind ourselves about luxury goods from Econ 101.  Between Google’s IPO in 2004 until 2007, investors couldn’t get enough – it outpaced the tech-heavy NASDAQ 100 index by 3-4x over that period.  The higher the price went, the more investors demanded shares of GOOG. 

This price action was no different than what you see with Louis Vuitton purses, Rolex watches, Ferraris, and trendy art.  But in 2008, GOOG changed its behavior and began trading like a technology stock rather than a sought-after purse.  Over the past three years, AAPL has traded in similar fashion with similar results.  This week even as Eurozone worries returned to the forefront of market action, AAPL seemed to defy gravity.

High net worth folks (politicians call them the 1%) around the globe flaunt their Apple shares at parties like a gold Rolex or red Ferrari.  Look at me, look at me.  The more AAPL stock makes up of your liquid net worth, the cooler you feel now.  This has nothing to do with ratios or earnings or any fundamentals at all since these folks could care less about them – this is about being cool and envied.  I don’t know how to time when AAPL stops acting like a luxury good, but I bet it will someday sooner than later.  Sadly, there just isn’t any reason to bet against it for now.  When it stops acting special, you will know.

Meanwhile, I take the road less traveled.  So long as the bull market is in place for 2012, I choose to own QLD or TQQQ which offer 2x or 3x the daily return of the tech-heavy QQQ ETF, respectively.  Because AAPL is the single most influential stock inside the QQQ ETF now, these leveraged ETFs will better mimic its potential for continued ascent.  If it loses its luxury luster along the way, even better.

Portfolio Checkup and Facebook Musings

It’s February and the weather in Southern California is reminiscent of spring.  Birds are singing, the ocean is glassy, and the sky is blue – it’s a nice feeling.  This is appropriate given the spring awakening stocks enjoyed so far in 2012.  Luckily there remain many negative headlines and bearish doubters out there, so we may have some room to run with this rally before an inevitable correction a.k.a gut check. 

My timing isn’t always great, so if you’re just now diving into stocks, it may be wise to hold off for a meaningful correction.  The fears that caused me to reduce equity exposure last fall perfectly coincided with the bottom in global equities so I still feel a little pain from that error.  But I followed my gut that if things didn’t play out as I expected by the end of 2011, I had to admit error and return to a more bullish positioning.  Now 2011′s tiny gain in the S&P 500 Index is followed up so far year-to-date with a 7% pop , but beaten-down European shares are up a few extra percentage points over US stocks, the tech-heavy Nasdaq 100 is up 11% along with small cap US stocks (Russell 2000 Index), and risky emerging markets are up over 15% (MSCI Emerging Markets Index).  Gold is mostly keeping up with the broad stock indices much to my chagrin.

The news is chalk full of headlines about individual investors sitting on the sidelines, waiting.  I love that.  If you wait for your neighbor to tell you how great his portfolio is doing, you missed the boat or at least part of it.  I also enjoy reading about how February is a bad month for stocks over 50% of the time.  Pay no mind – this is no different than the sucker bet on black in a game of roulette after three or four red bets pay off.  Summer of 2011 is starting to fade into history much like the summer of 2010′s 20% drop.  That one took six months to fade from memory and make new highs.  This time shouldn’t be much different from the smell of it. 
 
Is a Eurozone financial panic and debt default still a risk?  Sure and it’s enough to keep my nose mostly out of their stock market.  But the economic picture is getting brighter in the US with steadily rising output and employment.  A slowdown in corporate earnings may well be in effect, but the powerful leverage achieved via massive layoffs during the recession can only last so long. 
 
Stay the course with your equity investments.  When meaningful pullbacks occur, I use leveraged ETFs (exchange traded funds) to add a little pop to the portfolio.  I like TQQQ (3x leveraged daily Nasdaq 100) and EDC (3x leveraged daily Emerging Markets).  These 3x ETFs should not be used as the basis of a portfolio, but rather to add some juice to returns after a 4-5%+ pullback occurs at any given time.  When this happens you can swap out a 10-15% position in a boring index fund like SPY or IWM for one of these little rockets and see how you do.  Don’t hold them over 30-60 days as leverage can be very painful when the index moves in the opposite direction of where you need it to go.  These ETFs even have inverse brethren so you can profit when markets slide.  I am a terrible short seller and I avoid these like the plague.  Use them at your own risk.
 
Republican primary coverage is constantly on television.  Obama was smiling during the debates, but now has reason to giggle a little.  The financial wizards at the Fed are helping make sure he wins a fresh 48 months in the White House.  The Fed is helping Europe push off implosion to never or at least 2013 with quasi-QE3.  Don’t worry about what that means, just know they are pumping tons of liquidity to European banks.  Employment and GDP numbers smell like roses and Bernanke promised Wall Street near-zero interest rates through 2014.  Love or hate Newt and Mitt, their whining about the economy may start to sound like a broken record in a little bit.  Is all this action artificially inflating stock prices?  Let’s not worry about that and enjoy the ride.  We can revisit this issue at year-end. 
 
Obama’s dinner buddy Mark Zuckerberg (Facebook CEO worth $20+ billion) is about to make thousands of new millionaires via their IPO.  They will buy toys, homes and pay taxes on their very public earnings.  That’s great.  Should you buy the stock when it finally trades?  Sure, why not, just don’t go crazy with the actual amount of stock you buy relative to your net worth.  A more interesting play is to figure out what public firms Facebook will buy after it gets that multi-billion-dollar cash infusion. Zynga is an obvious choice and its stock is already shooting higher.  I like LinkedIn (LNKD) as a takeover idea.  I’m not crazy about the site and its business model, but I have an account and I don’t belong to the cult of Facebook.  Mark will have to buy me and my ilk to earn our eye balls and dollars.  And I think he will do just that.

Q4 2011 Summary and 2012 Outlook

I know, I know, I have been quiet.  But for good reason.  The market is behaving like a roller coaster and investors have indigestion from the volatility.  Talking heads only add to it.  My September 12, 2011 call for a significant easing off the investment accelerator pedal has felt right, wrong and anywhere in-between so many times I should feel dizzy.  That day I said “The market may be giving a signal that a sharp drop is ahead and risky assets could drop 1.5-3x more than the broad market.”  We have had three valleys, two peaks and lots of up and down in little more than three months.  Europe and the global banks underperformed at first, but are now outperforming other sectors and countries.  One bright spot has been my gold call: “Another theory is that gold is reflecting future relative dollar strength to a basket of global currencies.  Either way, it probably makes sense to get out of its way.”  Avoiding it or being short one of the gold ETFs has been profitable and offset pain elsewhere.  The issue at hand is what to do now and we shall get to that.

While the broad US stock market will end 2011 darn near flat to up a little, most investments that outperformed in the bounce since the bear market bottom performed poorly.  Emerging markets and developed markets outside the US fell 15-20%. Europe and its euro currency were the worst offenders.  Technology stocks lagged the broad market.  The volatility since August has been so potent I heard a man in his sixties complain about it to a clerk at my local grocery store.  Buy and hold investors with a mostly US-focused portfolio have done just fine so far, but the traders among us are just about ready to throw up.  Hedge funds are feeling the pain the most as they are whipsawed from low to high, to subsequent low, to the next high.  They are at the mercy of psychology and trend-following no less than the average investor/trader.

If you followed my advice, you should have ~25% cash to burn at this point.  Stop day trading (you know who you are) and add a bit to those broad, large and small cap US index funds you own and keep your now reduced exposure to emerging markets and non-US developed markets in case a bounce happens.  As I said in September, “Poor stock market performance in the fourth year of a President’s term is rare as can be.”  Please don’t think for a second the volatility is over.  A plausible scenario for 2012 is a W shaped year with one or two shocks causing steep drops in the first and second quarters, followed by a nice rally into the election and an overall 10-20% S&P 500 return.  I expect the market to trick us into believing 2012 is like awful 2008, an anomaly for a fourth year in the election cycle, at least a few times in the near future.  But 2012 will buck the trend because stocks hate the uncertainty that goes along with legislation which creates winners and losers.  Losers hate losing more than winners like winning – this keeps stocks from rising when the prospect of big legislative change is at hand.  Election years like 2012 yield little in the way of change and President Obama has no real competition at this point.  Regardless of your political leanings, Romney is no more a contender for President than John Kerry two elections ago. Fourth years for lame ducks are even better historically.  There is good reason to believe Obama is essentially a  lame duck to his own second term, especially if you watched the Republican debates so far.

Europe could throw a monkey wrench into our plans for a good year and help create a W chart, but the US should continue to do better than foreign markets if for no other reason than the strength of the US Dollar.  Our economy is also recovering nicely from the recession, but not fantastically.  Beating expectations is a win even if your wallet doesn’t feel as high and mighty as it did in 2005-06.  Hedge funders like SAC Capital are even betting on a real estate stock rebound in 2012 which seems a tad premature.  Tech stocks should gain leadership once again as risk appetites return, but don’t bet on that in the first half of next year.  A strengthening USD should keep gold prices falling as speculators exit their long-held positions to lock in profits.  If some brainy solution to European banks’ sovereign debt problems arises out of the blue, we could see things reverse with the US lagging again and gold moving up.  Until then, maintain an 80-90% allocation to stocks with the remainder short gold or in cash.

Good Luck and Happy New Year!!!

Jobs Jobs Jobs

No, not Steve Jobs.  I know you love to hear about your favorite stock Apple Inc. (NASDAQ: AAPL).  It sure has defied gravity and the market as a whole, despite news of Amazon’s tablet competitor and global demand worries.  I like AAPL, but I wouldn’t build my portfolio around it solely based on the fact that it’s your grandma’s, uncle’s and next door neighbor’s favorite stock too.  That means any stumble on its path to even greater global domination could be exaggerated.  On to more important things… Congress and Obama want to fix the dismal US JOBS picture.  But how?  Probably not the way they want to do it and not the way they will try to do it.

Ben Bernanke is going around telling people unemployment is a national crisis.  He is also saying he doesn’t have the tools to help.  Congress wants to create government programs to “retool” or retrain the labor pool.  They also want to give businesses a tax break.  Sounds good on the surface.  But how does that help get demand going for the products and services businesses provide?  What about hiring – will these measures actually cause hiring?  I will speculate a little.

As a small business owner, I know what it takes to get me to hire a new employee.  Promises of more demand from the government won’t do it.  Now if the phone starts ringing and old clients start asking about new programs, that’s a different story.  How about a lower payroll tax?  I think this is a waste.  Small business owners aren’t making the kind of profits they would like these days, so that little extra money will go right into the S Corp owner’s pocket.  What about big business?  Giving them tax breaks right now is pure nonsense.  They have the cash to hire if they want.  So if Uncle Sam focuses on small businesses, how can he help?  Money, that’s how!  Congress should pick up the tab for new workers and IT CAN. 

Let’s work through a reasonable scenario:  Congress can spend $48 billion over the next 24 months to create one million new jobs.  So we add to the national debt – it’s $14 trillion already.  This money is peanuts compared to what we spend fighting the Taliban and securing Iraq and the bailout we gave big banks a few years ago.  The math is easy.  Start with $2 billion a month.  That’s 20,000 salaried employees making $50,000 a year for two years.  Since Congress won’t agree to foot the entire bill for a new employee, let’s cover 50% of each new employee’s wages for two years.  Now we created 40,000 long-term positions in a month.  Let’s do this for 24 straight months and we only spent $48 billion to generate 960,000 jobs.  We can probably double that easily and spend $100 billion to put 2 million people to work.

Let’s open this program only to businesses with under $100 million in revenue to make sure it hits its intended target.  Put a cap in place on the number of employees a business can hire under the program and you have something raw, but relatively viable.  I can tell you with certainty that small business owners will start hiring if they know a 50% tax credit is coming for their new employee for two straight years.  Call your congressman :)

The Market Speaks… Listen Up

Watching stocks daily is a loser’s game, but as we come to the end of September, it’s high time to pay attention.  Study after study shows individual investors time their buy and sell decisions poorly, buying high and selling low.  There are, however, those moments when a decision can change the long-term course of portfolios.  

Equities and commodities may be sending a signal not to be ignored for the rest of 2011.  Recession fears are the wrong reason to sell any portfolio holding now – this is the oldest news around.  The US was somewhat insulated from declines in Europe and emerging markets so far this month, but we are retesting August’s lows.  Even gold is making new lows.  The market may be giving a signal that a sharp drop is ahead and risky assets could drop 1.5-3x more than the broad market. 

US stocks, especially our favorite technology names, enjoyed some level of insulation this month from worries over the health of the Euro currency and the survival of European banks.  Investors may be concerned about US banks now too after the Fed shared its innermost thoughts with us common folk today.  Bernanke’s crew fears it has no more tools left to fix the economy aside from long-term bond purchases.  Such purchases mean lower long-term bond yields and that can mean a heap of trouble for banks.  Banks make money by borrowing near zero now at the short end of the yield curve and lending at the long end.  When the long end falls, so do banks’ profit margins.  Meanwhile, Republicans and Democrats are very publicly fighting over tax increases and markets hate that regardless of the eventual outcome.  Whether taxes on millionaires and government program cuts matter or not, nobody wants to go out and spend while their income and benefits sit on a giant chopping block. 

Should’t gold be going up now?  Investors who profited from gold’s rise may be freeing up cash to meet future potential margin calls or make quick investments as a rare opportunity presents itself at some point in the intermediate future.  Another theory is that gold is reflecting future relative dollar strength to a basket of global currencies.  Either way, it probably makes sense ot get out of its way.

Poor stock market performance in the fourth year of a President’s term is rare as can be.  And there is no reason to panic over 2012 just yet.  But it’s time to make prudent decisions about the remainder of 2011.  Taking 25-50% of your risky assets (financials sector, non-US equities, gold, commodities) off the table is probably wise.  This may be accomplished with inverse ETFs that go up when markets drop, index put options, or simply holding more cash.

Looking Forward to Labor Day

As Labor Day approaches, the school year is off to the races.  Pardon my ignorance, but I figured this out standing in line at Rite-Aid this weekend.  There were throngs of kids buying pencils, backpacks, and colorful folders.  I just wanted a diet coke, but their angry parents wouldn’t let me cut in front of them.  We recently moved to the suburbs for the first time in our adult lives and it turns out “back to school” is quite the local event. 

As family vacations come to a close, Labor Day coincides with investors getting back to serious business each year.  Sadly, this holiday is the brain child of labor unions in the US.  Over a century ago, our government gave in to jealousy of foreign communists.  I enjoy my day off, so I won’t complain all that much.

The markets have found some solid ground to stand on over the past week and anxiety significantly subsided.  That doesn’t mean the roller coaster is over.  But chances are, market action will pick a direction fairly quickly and move with conviction. 

While we wait for this to happen, a few headlines piqued my interest today.

One of America’s serious economists writes serious nonsense here: http://www.tnr.com/article/economy/94275/shiller-infrastructure-debt-stimulus.  Why would he advocate raising taxes, then spending the funds on some sort of government labor pool?  I guess Dr. Shiller thought he would put a new twist on Keynesian economics, but this just sounds crazy.  Dropping money from helicopters on the masses would be a better solution to our current economic malaise.  Our private sector needs direct stimulus, not a new bureaucratic spending program.  Regardless, I don’t know any out of work mortgage brokers or car salesmen ready to pick up a shovel to dig ditches.  They would rather collect unemployment.

This story shows how the economy is healing itself in new and interesting ways: http://www.bloomberg.com/news/2011-08-30/grandma-bunks-with-jobless-kids-as-multigenerational-homes-surge.html.  Nobody likes living next to a multi-generational (communal) home with six cars in the driveway.  But people do what they must to survive.  Ironically, the communal living concept comes to us courtesy of communist states like China and the former USSR, just like Labor Day.

 

Economic Anxiety Ferris Wheel

As the market figures out a direction this week, let’s examine three headlines; each worrisome for different reasons:

Some very bright men opine on the Euro’s future here:  http://www.bloomberg.com/news/2011-08-21/el-erian-joining-feldstein-fels-on-prospect-of-euro-evolving-into-new-core.html.  If you want to be part of a union, strong partners must support weaker partners in times of need.  Partners in a union also work out compromises when they disagree.  Kicking the PIIGS (Portugal, Italy, Ireland, Greece, Spain) off the Euro currency presents a real potential shock to global markets and at this time the EU will likely sidestep this immense policy blunder.  To put this issue in perspective, most US citizens would love to be rid of “housing bubble and illegal immigration” states like Florida, Arizona and Nevada.  I leave out California because it’s simply too darn big and important to the US as a whole.  You could argue the “parasite” sates are dragging the dollar down with big budgets, falling tax revenue, and localized economic problems the folks in Illinois and Virginia just don’t care about.  You can see how this argument can quickly turn to political civil war and roil markets.

Warren Buffett’s tax rhetoric gains supporters: http://economix.blogs.nytimes.com/2011/08/23/what-the-rich-can-afford-in-income-tax/.  Bruce Bartlett is a conservative guy when it comes to economics.  Why is he talking about tax increases for the rich at a time when populist headlines are all the rage?  I won’t discuss the specific merits of his argument, but opening yet another pitch fork stand for angry villagers doesn’t seem like a great idea.  It is important to note that changes in the tax code represent a shift in the distribution of wealth–markets get depressed when this happens, no matter the direction of the shift.  Losers hate losing more than winners like winning: that’s basic behavioral economics. 

So ridiculous, it’s worrisome: http://www.marketwatch.com/Story/story/print?guid=CF3F1872-CCE9-11E0-BE2D-00212803FAD6.  The future is always scary, I agree.  Human civilization will successfully deal with the challenges a more populous planet Earth presents.  We are capable of immense innovation at an exponential rate relative to what we believe is possible today.  Gloom and doom stories like this about post-apocalyptic investment ideas are about as useful as umbrellas at Chernobyl.  if you feel inspired, don’t log into your Schwab account.  Go out and buy a Nissan Leaf with some roof-mounted solar panels.

Put Economic Growth Fears in Perspective

Volatility is back in equity markets today and headlines point to slowing economic growth across the globe.  First, the market is a discounter of known information.  If you understand that, you know GDP revisions by analysts and the same old stories about high unemployment don’t move stocks.  Second, volatility is normal; it’s why stocks earn a premium over other asset classes over time.  But guessing why stocks do what they do any given day is best left to fortune tellers.  Let’s take our eyes off today’s bleeding ticker and focus on economic data from the World Bank and IMF. 

Apparently European economic growth slowing may be contagious to the rest of the world.  The 27 nations of the European Union (EU) are no poster child for growth and haven’t been for a very long time.  2001-2010 EU real GDP growth was a “massive” 1.18% on average.  The trend doesn’t look good when you look at prior decades: 2.14% on average during the 1990s, 2.38% during the 1980s and 3.03% during the 1970s.   To provide some perspective, Asia ex-Japan and Emerging Markets GDP expanded 7.06% and 5.75% 2001-2010, respectively.  The US posted consistent showings in the low 3% range during the 70s, 80s and 90s.  US real GDP grew just 1.64% on average 2001-2010.

Economies can slow during expansions just like a stock can take a step back before heading to new highs.  Worries over the European Union’s economy are not new and add little credibility to global recession/depression fears.  Equity investors should build portfolios with powerful global exporters in mind.  This will help minimize exposure to structurally slowing economies and maximize exposure to the new engines of economic growth.

Real Clear Markets

http://www.realclearmarkets.com/ is an excellent site reposting the day’s headlines relevant to global markets from a variety of media outlets.  From time to time, I will repost articles I believe to be particularly relevant, impactful and/or ridiculous with my own commentary.  Here are a few: 

  1. Richard Salsman’s dog and pony show for a return to the gold standard: http://www.forbes.com/sites/richardsalsman/2011/08/16/gold-reagan-and-the-reds-from-degraded-dollar-to-downgraded-debt/3/.  Life is immitating art:  remember the movie “Lord of War,” where the African dictator asks the arms dealer character played by Nicholas Cage for a solid gold machine gun?  The 007 series also comes to mind with a shadowy New World Order set to control the globe’s currencies and natural resources.  I say ask the Treasury Department to hold endangered species as collateral for currency.  I think the dollar is worth its weight in black rhinos, giant pandas, and beluga sturgeons.  Caviar is the new black gold. 
  2. http://www.realclearmarkets.com/articles/2011/08/17/gov_rick_perrys_red-hot_bernanke_slam_99198.html.  A blurry picture is forming of the 2012 competition for leader of the free world.  Governor Perry says “Printing more money to play politics at this particular time in American history is almost treacherous, or treasonous, in my opinion.”  Mr. Perry is certainly no economist.  And Mitt Romney reminds me of John Kerry with a more obscure religious profile.  Doesn’t look like Barak and Michelle need to worry about packing up just yet.  Whether you approve of the President’s performance or not, Mr. Obama is more camera shy than he was during his first year.  What has he accomplished so far?  I recall something about healthcare reform and a promise to pull back from global conflicts; and oh yeah, he said he would fix the economy and create jobs.
  3. http://www.nytimes.com/2011/08/17/opinion/why-we-should-end-homeownership-subsidies.html?_r=2&ref=opinion.  The NYT proposes we kill GSEs Fannie and Freddie currently financing the vast majority of US home purchases at a time when private investors want to sit on the sidelines.  Let’s assume these are good ideas.  Unfortunately, stories like this are used by nasty politicians to argue for crazy notions like removing mortgage interest as a tax deduction.  This article says GSEs cost $700 billion in lost revenue over five years, whatever that statistical mumbo jumbo means.  That is the tiniest of fractions in relation to our aggregate spending on the military industrial complex.  Where would you rather cut?
  4. http://www.nakedcapitalism.com/2011/08/bank-of-america-death-watch-unloading-non-core-assets-aggressively.html.  This story would not be worth discussing were it not for what transpired in the US financial sector over 2008 and 2009.  Words sometimes equate to Chinese water torture.  Each word holds little weight, but add them up over time and Bank of America could end up in the hands of a competitor for pennies on the dollar.  There are only seven and a half dollars left as of this writing, so caveat emptor.  This is not some gloom and doom prediction, but confidence is key to market stability.  Just remember that Wall Street is even better at spreading rumors and manipulating feelings than making money and political contributions.