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SOMETHING BIG IS GOING ON, SAYS RON PAUL
Ron Paul -- as far as we can tell he is the only member of the U.S. legislative branch that understands basic economics -- believes that the central banks will not be able to paper over this latest crisis, as they have been doing for a century. With that the whole model of big government supplying both guns and butter, i.e., safety and economic security, is finally revealed to to be the failed idea that it is. The wreckage will be enormous, but the potential upside is that the "Something Big" that Paul saw on the presidential campaign trail -- where he noticed so many of the younger generation are willing to accept the challenge and responsibility of a free society and reject the cradle-to-grave welfare that has been promised them -- will have a chance to flower.
The words of Frederic Bastiat apply to today's situation: "And now that the legislators and do-gooders have so futilely inflicted so many systems upon society, may they finally end where they should have begun: May they reject all systems, and try liberty." One can only hope that if the rejection does not come voluntarily that the markets force the issue.
The following statement is written by Congressman Paul about the pending financial disaster. ...
I have, for the past 35 years, expressed my grave concern for the future of America. The course we have taken over the past century has threatened our liberties, security and prosperity. In spite of these long-held concerns, I have days -- growing more frequent all the time -- when I am convinced the time is now upon us that some Big Events are about to occur. These fast-approaching events will not go unnoticed. They will affect all of us. They will not be limited to just some areas of our country. The world economy and political system will share in the chaos about to be unleashed.
Though the world has long suffered from the senselessness of wars that should have been avoided, my greatest fear is that the course on which we find ourselves will bring even greater conflict and economic suffering to the innocent people of the world -- unless we quickly change our ways.
America, with her traditions of free markets and property rights, led the way toward great wealth and progress throughout the world as well as at home. Since we have lost our confidence in the principles of liberty, self reliance, hard work and frugality, and instead took on empire building, financed through inflation and debt, all this has changed. This is indeed frightening and an historic event.
The problem we face is not new in history. Authoritarianism has been around a long time. For centuries, inflation and debt have been used by tyrants to hold power, promote aggression, and provide "bread and circuses" for the people. The notion that a country can afford "guns and butter" with no significant penalty existed even before the 1960s when it became a popular slogan. It was then, though, we were told the Vietnam War and a massive expansion of the welfare state were not problems. The ‘70s proved that assumption wrong.
Today things are different from even ancient times or the 1970s. There is something to the argument that we are now a global economy. The world has more people and is more integrated due to modern technology, communications, and travel. If modern technology had been used to promote the ideas of liberty, free markets, sound money and trade, it would have ushered in a new golden age -- a globalism we could accept.
Instead, the wealth and freedom we now enjoy are shrinking and rest upon a fragile philosophic infrastructure. It is not unlike the levies and bridges in our own country that our system of war and welfare has caused us to ignore.
I am fearful that my concerns have been legitimate and may even be worse than I first thought. They are now at our doorstep. Time is short for making a course correction before this grand experiment in liberty goes into deep hibernation.
There are reasons to believe this coming crisis is different and bigger than the world has ever experienced. Instead of using globalism in a positive fashion, it has been used to globalize all of the mistakes of the politicians, bureaucrats and central bankers.
Being an unchallenged sole superpower was never accepted by us with a sense of humility and respect. Our arrogance and aggressiveness have been used to promote a world empire backed by the most powerful army of history. This type of globalist intervention creates problems for all citizens of the world and fails to contribute to the well-being of the world's populations. Just think how our personal liberties have been trashed here at home in the last decade.
The financial crisis, still in its early stages, is apparent to everyone: gasoline prices over $4 a gallon; skyrocketing education and medical-care costs; the collapse of the housing bubble; the bursting of the NASDAQ bubble; stockmarkets plunging; unemployment rising; massive underemployment; excessive government debt; and unmanageable personal debt. Little doubt exists as to whether we will get stagflation. The question that will soon be asked is: When will the stagflation become an inflationary depression?
There are various reasons that the world economy has been globalized and the problems we face are worldwide. We cannot understand what we are facing without understanding fiat money and the long-developing dollar bubble.
There were several stages. From the inception of the Federal Reserve System in 1913 to 1933, the Central Bank established itself as the official dollar manager. By 1933, Americans could no longer own gold, thus removing restraint on the Federal Reserve to inflate for war and welfare.
By 1945, further restraints were removed by creating the Bretton-Woods Monetary System making the dollar the reserve currency of the world. This system lasted up until 1971. During the period between 1945 and 1971, some restraints on the Fed remained in place. Foreigners, but not Americans, could convert dollars to gold at $35 an ounce. Due to the excessive dollars being created, that system came to an end in 1971.
It is the post Bretton-Woods system that was responsible for globalizing inflation and markets and for generating a gigantic worldwide dollar bubble. That bubble is now bursting, and we are seeing what it is like to suffer the consequences of the many previous economic errors.
Ironically in these past 35 years, we have benefited from this very flawed system. Because the world accepted dollars as if they were gold, we only had to counterfeit more dollars, spend them overseas (indirectly encouraging our jobs to go overseas as well) and enjoy unearned prosperity. Those who took our dollars and gave us goods and services were only too anxious to loan those dollars back to us. This allowed us to export our inflation and delay the consequences we now are starting to see.
But it was never destined to last, and now we have to pay the piper. Our huge foreign debt must be paid or liquidated. Our entitlements are coming due just as the world has become more reluctant to hold dollars. The consequence of that decision is price inflation in this country -- and that is what we are witnessing today. Already price inflation overseas is even higher than here at home as a consequence of foreign central banks' willingness to monetize our debt.
Printing dollars over long periods of time may not immediately push prices up -- yet in time it always does. Now we are seeing catch-up for past inflating of the monetary supply. As bad as it is today with $4 a gallon gasoline, this is just the beginning. It is a gross distraction to hound away at "drill, drill, drill" as a solution to the dollar crisis and high gasoline prices. It is okay to let the market increase supplies and drill, but that issue is a gross distraction from the sins of deficits and Federal Reserve monetary shenanigans.
This bubble is different and bigger for another reason. The central banks of the world secretly collude to centrally plan the world economy. I am convinced that agreements among central banks to "monetize" U.S. debt these past 15 years have existed, although secretly and out of the reach of any oversight of anyone -- especially the U.S. Congress that does not care, or just flat does not understand. As this "gift" to us comes to an end, our problems worsen. The central banks and the various governments are very powerful, but eventually the markets overwhelm when the people who get stuck holding the bag (of bad dollars) catch on and spend the dollars into the economy with emotional zeal, thus igniting inflationary fever.
This time -- since there are so many dollars and so many countries involved -- the Fed has been able to "paper" over every approaching crisis for the past 15 years, especially with Alan Greenspan as Chairman of the Federal Reserve Board, which has allowed the bubble to become history's greatest.
The mistakes made with excessive credit at artificially low rates are huge, and the market is demanding a correction. This involves excessive debt, misdirected investments, over-investments, and all the other problems caused by the government when spending the money they should never have had. Foreign militarism, welfare handouts and $80 trillion entitlement promises are all coming to an end. We do not have the money or the wealth-creating capacity to catch up and care for all the needs that now exist because we rejected the market economy, sound money, self reliance and the principles of liberty.
Since the correction of all this misallocation of resources is necessary and must come, one can look for some good that may come as this "Big Even" unfolds.
There are two choices that people can make. The one choice that is unavailable to us is to limp along with the status quo and prop up the system with more debt, inflation and lies. That will not happen.
One of the two choices, and the one chosen so often by government in the past is that of rejecting the principles of liberty and resorting to even bigger and more authoritarian government. Some argue that giving dictatorial powers to the President, just as we have allowed him to run the American empire, is what we should do. That is the great danger, and in this post-911 atmosphere, too many Americans are seeking safety over freedom. We have already lost too many of our personal liberties already. Real fear of economic collapse could prompt central planners to act to such a degree that the New Deal of the ‘30s might look like Jefferson's Declaration of Independence.
The more the government is allowed to do in taking over and running the economy, the deeper the depression gets and the longer it lasts. That was the story of the ‘30s and the early ‘40s, and the same mistakes are likely to be made again if we do not wake up.
But the good news is that it need not be so bad if we do the right thing. I saw "Something Big" happening in the past 18 months on the campaign trail. I was encouraged that we are capable of waking up and doing the right thing. I have literally met thousands of high school and college kids who are quite willing to accept the challenge and responsibility of a free society and reject the cradle-to-grave welfare that is promised them by so many do-good politicians.
If more hear the message of liberty, more will join in this effort. The failure of our foreign policy, welfare system, and monetary policies and virtually all government solutions are so readily apparent, it does not take that much convincing. But the positive message of how freedom works and why it is possible is what is urgently needed.
One of the best parts of accepting self reliance in a free society is that true personal satisfaction with one's own life can be achieved. This does not happen when the government assumes the role of guardian, parent or provider, because it eliminates a sense of pride. But the real problem is the government cannot provide the safety and economic security that it claims. The so-called good that government claims it can deliver is always achieved at the expense of someone else's freedom. It is a failed system and the young people know it.
Restoring a free society does not eliminate the need to get our house in order and to pay for the extravagant spending. But the pain would not be long-lasting if we did the right things, and best of all the empire would have to end for financial reasons. Our wars would stop, the attack on civil liberties would cease, and prosperity would return. The choices are clear: It should not be difficult, but the big event now unfolding gives us a great opportunity to reverse the tide and resume the truly great American Revolution started in 1776. Opportunity knocks in spite of the urgency and the dangers we face.
Let's make "Something Big is Happening" be the discovery that freedom works and is popular and the big economic and political event we are witnessing is a blessing in disguise.
THE BIG BAILOUT: AMERICA AS A FULL-SPECTRUM KLEPTOCRACY
William Grigg, editor of the excellent "Pro Libertate Blog," explains the full implications of the Fannie Mae/Freddie Mac bailout bill. Congress has already ceded its power to declare war. Now it has relinquished any control it had over the purse. The executive branch, in the person of Treasury Secretary Henry Paulson, has been granted unlimited authority to use whatever measures he deems necessary to assume the solvency of the two Government Sponsored Enterprises. Given the size of the two entities this amounts to a de facto nationalization of the U.S. financial system. As Grigg points out, this redounds to the benefit of the banksters and their buddies, but not in any way to the rest of us. (Similarly hard-hitting Grigg commentary was also featured in last week's Financial Digest and this week's Offshore News Digest.)
Its name somewhat anachronistically means "assembly of old men." George Washington famously -- and, it must now be admitted, with excessive optimism -- characterized it as an institutional saucer intended to cool legislation passed in the intemperate heat of the moment. Its members demand, with entirely unwarranted self-approval, to be called, collectively, the World's Greatest Deliberative Body.
Sober observers understand it to be the most corrupt legislative assembly in human history. To those characterizations of the United States Senate we must now add another, perhaps the final one: Gravedigger of the republic.
With the Senate's passage of the Fannie Mae/Freddie Mac bailout last Saturday (July 26), the United States of America has now become the world's first full-service kleptocracy, a form of government described earlier in this space as a government of, by, and for the robbers.
We are supposed to pretend to believe that the Senate, so great was its anxiety over the nation's economically distressed homeowners, met in a rare Saturday session for the sole purpose of administering the balm of Gilead on hardworking families who confront the bleak prospect of foreclosure.
There may be people who believe such a thing, or at least profess to do so. They are pretty much the kind of people who believe that peace, prosperity, and progress will magically ensue after next January 20, when the Holy One, Barack Obama (peace be upon him) ascends to the presidency, not astride a White Horse, but rather mounted upon a flying unicorn that emits healing rainbows from its butt.
No, it is not the travails of the productive that would earn such attention from the Senate. When the Senate sacrifices so much as a minute of its down time, it does so not to relieve our burdens, but to add to them in the interest of their fellow parasites.
When Congress created the Federal Reserve in 1913, it did so in a lame-duck session. The Fed's proponents described its handiwork as an independent entity that would prevent "panics" and maintain the integrity of our currency and financial system.
The Fed was presented to the public in pseudo-populist drag: It was supposedly the bane of the big banking interests. This was, in every particular, a conscious inversion of the truth. The Fed was, is, and every shall be a product and protector of those interests. It has practically destroyed the value of U.S. currency, and engineered numerous financial crises, including the one currently unfolding.
The measure passed last Saturday is being described to the public as a "homeowner" bailout. It is nothing of the sort. It supposedly creates an independent oversight mechanism to rein in the excesses of Fannie and Freddie. This, too, is an unalloyed falsehood.
Let us disambiguate the key issue right now. This is a measure to nationalize Fannie and Freddie, plundering the population at large -- through direct taxation, the more insidious tax called inflation, or both -- to bail out two fascist entities that have been used to enrich the politically connected super-rich through the most corrupt means imaginable.
Furthermore, this measure prefigures the eventual nationalization of the entire financial system under the supervision of an executive branch official with practically unlimited power to appropriate and allocate funds without congressional action. OK, sure, he has to file a report with Congress regarding his expenditures. But this takes place after the fact, and Congress will be able to do nothing but complain, if it can bestir itself even to that extent.
Congress has yielded its war powers to the executive branch. It has now effectively surrendered the power of the purse, as well. What, then, remains by way of the legislative branch's ability to check the executive?
Nobody responsible for this is willing to admit that truth. They are too busy taking refuge in contrived ambiguities.
The figure sent out to pollute headlines and palliate a nervous public last week was that fixing Fannie and Freddie will cost "at least" $25 billion. That is a bit like saying there are "at least" 25 gallons of water in Lake Michigan. The Congressional Budget Office, in an artful display of tactical equivocation, said that the bailout could cost anything from $100 billion down to "nothing." That latter estimate would be dismissed as magic thinking were it not a transparent and cynical effort to propagate such delusion among that part of the public paying attention to the ongoing economic collapse.
As the Wall Street Journal summarized, the $25 billion figure was arrived by following a time-honored government accounting algorithm: Some accountant at the CBO threw a dart at the wall. In fact, the bailout measure places in the hands of Treasury Secretary Henry Paulson the discretionary authority to pour as much money into Fannie and Freddie as he deems necessary. He can extend an unlimited credit line to either or both of those government-chartered companies. He can use federal funds to buy shares in either, or both.
There is no limit to what can be spent on the bailout, or the extent of government involvement it will entail. In his efforts to lobby congressional Republicans on behalf of the bailout, Paulson reportedly assured them that he has "no intention" of using those extraordinary powers. This means, of course, that they will be used immediately. It also means, inevitably, that Fannie and Freddie will be nationalized, and that taxpayers will pay the full burden of the bailout.
Senate Republicans -- clap-torn whores, every one of them -- put up a show of reluctance, perhaps because the White House likes a little role-playing action of that sort. This meant that Treasury Secretary Paulson had to convene several meetings with Republicans in order to pretend to overcome their reluctance to support a measure that will impecuniate their constituents in order to pay off the imponderably huge bad debts assumed by politically protected thieves.
The Fannie/Freddie bailout is another example of the familiar equation behind corporatism (or, to use the more loaded synonym, fascism): The risks are subsidized, the losses are socialized, and the profits are privatized.
There are former corporate executives who spend their days looking at striped sunlight and showing with their backs to the wall for crimes identical to those of former Fannie CEO Franklin D. Raines and his comrades. But because Raines and his posse used a Government-Sponsored Entity to commit their crimes, they are free to enjoy nearly all the fruits of their fraud.
I find it remarkable that next to nothing has been said by way of condemning Raines and his fellow corporatist thieves. Doing so is nearly as unthinkable as permitting those two government-sponsored companies to fail, as they should.
According to former Treasury Secretary Lawrence Summers, the bailout would not be necessary if people were willing to do their part by throwing their money away without the government forcing them to do so: "Emergency legislation was necessary because market participants were unwilling to buy Fannie and Freddie's debt; investors doubted that the government-sponsored enterprises were healthy enough to repay it and did not draw sufficient reassurance from the implicit guarantee of federal support." This is why, according to Summers, "Anyone who cares about the health of the U.S. economy should welcome the ... rescue plan for Fannie Mae and Freddie Mac. ..."
Imagine an armed robber lecturing his victim that it would not have been "necessary" to threaten the victim's life, and the lives of his family, if they had simply handed over their money on demand, and you will have a suitable moral parallel to the statement above. Eventually -- and for that, read "pretty damn soon" -- the entire daisy-chain of fraud we call our financial system will devolve into a scene of violent chaos akin to the denouement of Reservoir Dogs, only immeasurably bigger and unimaginably bloodier.
Already, the robber's pact holding the system together is starting to fray, as fractional reserve banks start gagging on each other's IOUs. Witness the fact that cashier's checks being issued by California's newly federalized IndyMac bank are not being honored by other banks: Customers who cash out of IndyMac are finding that they will not be able to access their funds for up to two months. It is not difficult to imagine the impact this will have on households who expected to use those funds to make mortgage or tax payments, or have other irrepressible financial needs.
It took roughly a tithe of FDIC's deposit insurance fund to bail out IndyMac. Last week's bank failures -- First National Bank of Nevada and Arizona's First Heritage Bank -- involved combined assets of about $3.6 billion.
With Wachovia, Washington Mutual, and many other major banks primed to blow, the day will soon come when -- in the words of James Kunstler -- the FDIC will simply "choke and croak on this wad of losses. ... When American depositors get screwed out of their deposits" -- as they already are; vide the observation above regarding IndyMac's dodgy cashier's checks -- "the full force of the fiasco will drag the dollar underwater like the legendary Kraken of old preying on a babe thrown overboard. Then the forces of darkness will really be loosed."
Last week, Congress went on record regarding its priorities: With a handful of noble exceptions (conspicuous among them the stalwart Rep. Ron Paul of Texas), they demonstrated a willingness to ruin what remains of the dollar and destroy the Middle Class in order to rescue -- temporarily -- the uber-rich Robber Class.
The people responsible for this betrayal will be campaigning in their districts during the coming weeks. It would be instructive to them, and may be heartening to their victims, to see at least a few of them on the receiving end of timely and forceful rebukes, delivered in language -- and other expressive conduct -- appropriate to the occasion, and prevailing security environment.
Terminate Fannie Mae and Freddie Mac
With extreme prejudice.
Written before the bailout was enacted, here is why Freddie and Fannie should have been allowed to fall into the graves they had dug for themselves.
I am a minority of one, or a very small number, in thinking that the failures of Fannie Mae and Freddie Mac are good news.
These two companies should not exist. No private companies should have lines of credit to the U.S. Treasury, that is, U.S. taxpayers. No private companies should be linked to a government mandate that they facilitate affordable housing by buying up mortgages. No private companies should issue debts that investors believe may have an implicit guarantee provided by taxpayers.
The only bad thing about these failures is what the Federal government may do next to keep them alive. The only bad thing is that the Federal government will probably make matters worse. ...
DO HOME PRICES LOOK INFLATIONARY TO YOU?
Bob Prechter and company are back beating the deflation drum, saying today looks nothing like the 1970s, etc., etc. We agree in part, but think they doth protest too much at times. We are at a different stage in the debt supercycle, so there are bound to be some differences. But there exist major similarities as well.
The 1970s featured raging commodities inflation, consumer and producer price inflation, housing inflation, and stock/bond price deflation -- the later especially when measured vs. the CPI or commodities. Today we have raging commodities inflation, incipient raging CPI and PPI inflation (when using non-government rigged statistics), housing deflation, and early stage stock/bond deflation. Housing is the obvious difference between now and the 1970s.
In the 1970s the overall amount of debt (consumer, business, and government) overhanging the economy was small compared to today. Stocks were going through a major retrenchment after a vigorous 20+ year bull market that culminated in the new issues/concept stock/conglomerate manias in the late '60s, and the "one-decision" (you buy and never sell) "Nifty 50" large growth stock mania in the early 1970s. Stock margin debt was contracting because the (modest) debt excesses theretofore had been concentrated in the stock market. Housing was still considered a place you lived in back then, if you could come up with the required 20% down payment, or something you rented out for a modest but reliable return. The hyper-excesses were a good 25 years in the future, even though previews of coming attractions flared up locally starting soon thereafter (oil patch, California, the Northeast in the 1980s).
Today we have excessive debt overhanging the stock market -- the LBO and private equity operators, and their like, not to mention the stock index futures market players, all buy stocks on far less than the 50% margin required of individual investors -- and the housing market. That is the major difference versus the 1970s. All major asset classes are in bear markets this time around, as the credit balloon loses air.
So now what? Well the big issue comes down to, as always, what happens going forward. The Elliott Wave International folks seem to think that because we are in the middle of "a deflation" that the current commodities inflation will eventually join the other assets. This we are unwilling to bet the ranch on, or even the cow shed. Governments and central banks have shown great willingness to monetize everything that has a pulse, and some things that don't. Hyperinflation is a genuine risk. In that case, we would bet that houses and stocks will decline in real terms, but not nominal. EWI seems fairly oblivious to this possibility.
The only way that today's home prices could possibly look "inflationary" is if you are standing on your head. Which begs the question: If the most dependable hedge against inflation -- namely real estate -- is crashing like the approval ratings of the U.S. Congress, then where does main street get off saying "Inflation" is the bane of our economy's existence?
See: May 2008 Economist cover story "Inflation's Back," and a June 23 Reuters claiming, "The curse of the 1970s is staging a comeback."
Not even close. The 1970s economy epitomized "Inflation," as wages, credit, gold, oil and commodities all soared in value -- to the point that President Richard Nixon imposed the first-ever peacetime "price controls" in U.S. history, in addition to eliminating the gold standard.
And few years after Gerald Ford (and his "Whip Inflation Now" policy) left office, the U.S. inflation rate was above 14%, the core Consumer Price Index at 13%, and the Federal Reserve's lending rate at 21.5%, an all-time high. At the time, American humorist Art Buchwald joked: "It's cheaper to borrow money from the Mafia than the local bank."
Last but not least: Home values during the 1970s also experienced a period of rapid price increases, as this chart makes plain.
Flash ahead to today. To say that inflation is staging a comeback is like announcing a "Beatles" reunion tour minus three band members. As of June 2008, the core C.P.I. stood at 2.3%, the overall C.P.I. at 5.0%, and the Fed funds rate at a subterranean 2% -- hey Art Buchwald, it does not get any cheaper than that.
Then there is the most glaring difference between today's economy and that of the 1970s: The worst housing market since the Great Depression, which, according to recent data, shows no signs of bottoming. To wit: S&P/Case-Shiller Home Price Index (measures 20 Metropolitan areas) tumbled 17% in May from a year ago -- the biggest decline since records began in 1987. Also, the number of homes in some stage of foreclosure increased 121% since last year, and the cost of new homes just saw its steepest year-end decline in four decades.
Consider this fact: The same experts who see a "New Era Of Inflation" underway in today's economy are the same ones who in 2005 saw a "new paradigm in real estate in which prices rise indefinitely," a "Loveable Housing Bubble" in 2006, and a "Soft-landing" of home prices, a "well-contained" subprime mortgage crisis, and a "manageable" downturn in banking in 2007-8.
Hitting the economic bull's eye has not been mainstream economists' strong point. As for anticipating the end of the 5-year long Housing Bull -- and subsequent turndown in every leading financial sector before it occurred, the March 2005 Elliott Wave Financial Forecast led the way with a special segment titled "Real Estate Bust Begins."
In that issue, EWI's analysts likened the near vertical rise in the S&P Homebuilding Index to the notorious NASDAQ rally from October 1998 to 2000 and suggested the "potential for a serious unraveling of the housing market" was due. As the following close-up reveals, the S&P Homebuilding Index has plunged 80% from its 2005 peak.
Does not look like inflation, does it?
Home Prices in 20 Major Cities: You Are OK if You Bought Before ...
The latest S&P/Case Shiller Home Price Indices was released on July 29. A good measure of how far home prices have fallen is how long ago you had to have bought in to still be above break-even today. How are what the statistics say for major U.S. metropolitan areas.
The average experience in the 20 largest metropolitan areas is that July 2004 marks the dividing line between profit and loss.
If you bought before the following dates, then you probably have a profit.
The average buyer who purchased a house after the months noted above [probably] has a loss.
Atlanta February 2005 Boston February 2004 Charlotte April 2007 Chicago January 2005 Cleveland May 2002 Dallas March 2006 Denver May 2004 Detroit January 1999 Los Angeles April 2004 Las Vegas March 2004 Miami September 2004 Minneapolis April 2003 New York March 2005 Phoenix January 2005 Portland May 2006 San Diego September 2003 San Francisco March 2004 Seattle June 2006 Tampa January 2005 Washington D.C. September 2004
These conclusions are based on inspection of the S&P/Case Shiller Home Price Indices released on July 29, 2008, reflecting data through May. These conclusions reflect the average home, and there is substantial variation around the mean.
WHAT IS NEXT FOR THE DOW NOW THAT THE CREDIT BULL MARKET HAS ENDED?
Freefall territory, here we come.
Elliott Wave International's chief honcho Bob Prechter chimes in with his latest explanation of why the stock market is going to tank. He has been predicting such since about 1995, and it makes sense to us fundamentally (e.g., the low dividend yield). The Elliott Wave technical analysis also looks reasonable enough, as that kind of analysis goes. But it all made sense to us before too. As others have pointed out, just because something is inevitable does not mean it is imminent.
The Silent Crash that Bob Prechter named and described back in late 2006 is getting noisier, thanks to the implosion of the credit markets, the rescue mission for Fannie Mae and Freddie Mac, and the specter of more banks teetering on the brink of bankruptcy, similar to IndyMac. For his latest Elliott Wave Theorist, [Prechter] has recorded a presentation with 27 charts that updates the picture since December 2006. In it, he explains why the crash is beginning to be noticed on many fronts. Here is an excerpt to give you a glimpse of his analysis. ...
Excerpted from the Special Video Issue of The Elliott Wave Theorist, July 14, 2008
All right. So that has been the silent crash. And during that time, the nominal Dow was the thing that kept people's eye off this ball. Figure 10 shows the Dow Industrial Average from the 1974 low, in [nominal] dollar terms. ... There was a decline into 2002 -- perhaps the orthodox low in early 2003 -- and it has been crawling upwards until October of last year.
This is why people continue to say, "It is a bull market." But it was mostly due to a bull market in credit, which lowered the value of the dollar so dramatically that the Dow, in terms of dollars, could go to a new high.
All right, so what were we looking at? We did the usual Elliott wave exercise and connected the lows of waves 2 and 4 to indicate where the channel was. And if you draw a parallel line across the top of 3, you should see the top of 5, and that is exactly what we had at the final peak in 1999 and 2000.
When we extended the lower line, we found that right off the 2003 low, in 2004, the market touched that line but could not get back up through it. It spent the next couple of years crawling higher but could not even get back up to touch this line, which used to be support and has since been resistance.
So, of course, we wanted to decide, "When do we know that Wave B is over and Wave C is in force?" This dashed line beneath the channel is not an orthodox Elliott wave channel line, but interestingly it is exactly parallel to the channel lines. It is formed by connecting the outside low point back in 1982 to the two outside low points here in 2002 and 2003. The Dow sliced through that line in January. It rallied back up to it in March and again touched it twice in May. So clearly the market knows that this line exists.
And it knew that this one -- the lower line of the channel -- did, too. After 9/11, the market really collapsed, but the line held. Then it rallied up to here -- that is when Conquer the Crash came out -- and finally had another collapse in 2002 to break the line, and it has never gone back above it.
Well, we saw a mini version of those events here in 2008. The Dow broke the secondary line in January; then came back up to it, and now it is falling away. So I think the Dow is now in an area where there is no support from any trendline at this degree, which is Cycle degree. There is a long way down to go.
Now, we did not wait for these lines to break to act. We rather aggressively shorted the market about six times throughout this period. We were usually right for a month or two at each of these short term peaks, but then the market would go on and make a new high, so we were wrong.
Then came a wonderful day for us. This was in July last year, just about a year ago. And here is a quote to show you the kind of thing we are up against here at Elliott Wave International, how contrary we have to be sometimes in expressing our opinion, and how difficult it is, because the world usually disagrees with what we have to say. I must admit, sometimes the world is right and we are wrong. But here we were in July of 2007, when Fortune magazine came out quoting the U.S. Treasury Secretary saying, "This is far and away the strongest global economy I've seen in my business lifetime."
Now that [was] an amazing statement ... very much like the statements on record from the summer of 1929. Well, less than a week later, The Elliott Wave Theorist came out -- it was an Interim Bulletin, a one-pager—and we said, "Aggressive speculators should return to a fully leveraged short position now." A couple of issues later we made it clear that it was possible the Dow could edge to a slight new high before turning down hard again, which is exactly what happened in October.
Today we have 300 S&P points behind us on this. So even though we had a number of false entries on the way up, we are feeling pretty good about this particular position. In the last couple of issues I said we could not count on keeping this money, because the March lows had to be broken across the board. Well, the Dow has done that decisively. A couple of the other indicators, such as the NASDAQ, have held back. We are waiting for those to go ahead and confirm as well, but it looks as if we are getting pretty much into that freefall territory.
THE MARKET IS DOWN, NOT DOOMED
When old pros Leon Cooperman and Steve Einhorn talk, people listen. Barron's got them to speak. Among other opinions, they think the market is in the vicinity of a bottom, but probably we are not there yet. And they find lots of high quality non-financial companies selling at reasonable multiples.
Leon Cooperman and Steven Einhorn have been working together, off and on, since the 1970s, initially at Goldman Sachs. Cooperman, formerly Goldman's chief investment strategist, started his own firm, Omega Advisors, in 1991. Since its inception, Omega, which uses a long-short strategy and has about $5 billion in assets, has returned 16% annually, net of fees, besting the S&P 500 by 5.50 percentage points. During the first half of the year, it was down 4%, compared with a loss around 13% for the S&P. Cooperman, the firm's chairman and chief executive, has a reputation as a savvy, rigorous and hard-driving stockpicker. He spends a lot of time "trying to make sure we are backing the right horses." Einhorn, the vice chairman, focuses more on the macro picture, the Federal Reserve, market valuation and outlook, and structuring the portfolio.
"We are buying plenty of attractively valued securities, but this is not an environment to be complacent," says Cooperman, pointing to high oil prices and the battered housing market. Although he thinks the makings of a market bottom are apparent, Einhorn still sees plenty of head winds, including what he considers to be global money policy that is out of sync, depleted balance sheets in the financial sector and inflation worries. Other factors to consider, he says, are extreme volatility and a lack of leadership in the U.S. equity market.
Still, Einhorn and Cooperman view plenty of stocks as attractive, as Barron's learned on a recent visit to their office near Wall Street.
Barron’s: Let's start with the big picture.
Cooperman: We acknowledge that we were somewhat too optimistic about the year. And we basically pressed that optimism in March during the selloff when we largely took off all our hedges. We based that on an old tried-and-true -- and tested -- approach. We have found historically that when the S&P dropped 20%, which it did from its October peak to its March low, when the Fed and Congress were stimulating [the economy], when you are in an election year, when stocks are undervalued versus bonds and when stocks are somewhat cheaper versus their own history, you are supposed to buy. Basically, every time we went through one of these cycles, there was a vocal minority that said it was different this time. In 1970, for instance, when I was at Goldman, everyone who was negative at the bottom talked about the Penn Central bankruptcy. Thankfully for the system, after each one of those cycles, it was not different. The economy got itself together and we started anew. That was our view in March.
What has surprised you, subsequent to March?
Cooperman: Oil getting to $140 a barrel and the degree of weakness in housing was much more diverse, widespread and severe than anything we have seen. And the credit crunch turned out to be much more of a problem than we could have imagined. More of that problem migrated from Wall Street to Main Street than we allowed for.
Where does the market go from here?
Cooperman: The ingredients for a decent bottom are in place, but any significant upside is going to require help from two areas. #1, we have to see a bottoming in home prices. #2, we are going to have to see crude-oil prices recede. Frankly, we did not forecast crude going to $140 a barrel, so we are not confident forecasting that crude is going to $100. In fact, we have two energy experts, and neither believes crude is going much below $120.
Einhorn: The market is protected on the downside by some tail winds that I will elaborate on. But the market is limited on the upside because of housing and crude prices, among other head winds. So it will trade in a range until we can make progress on crude and home prices. As for crude, most of the models indicate that every $10 price increase is worth about two-tenths of a percent of real GDP growth. So if the price goes up $40, it almost costs you a full percentage point of growth in the economy, and it probably costs between $4 and $5 in S&P earnings.
Why do you think that we are close to a bottom?
Einhorn: Because there are certain tail winds, the first of which is valuation, that protect the market. The market looks attractively priced in an absolute sense and relative to inflation, bond interest rates and to other assets.
What is your price/earnings ratio for the market?
Einhorn: We have a market earnings estimate this year of $90 and next year of anywhere from $92 to $100, and we will refine that as the year unfolds. That is roughly 14 times this year's earnings, below the long-term average. At the same time, bond interest rates are low, return on equity is well above average and net profit margins are well above average. So the absolute multiple is below average, and corporate profitability, liquidity and balance-sheet strength in the nonfinancial sectors are well above average. Based on virtually any approach, the market is attractively priced. I think it is already discounting a substantial shortfall in consensus earnings estimates.
What other tail winds do you see?
Einhorn: We are not expecting the economy to be robust. But at least for now, the economy's weakness is not accelerating, as it typically does in more significant recessions. Another tail wind is that in early 2009, whoever is elected president will introduce a second fiscal stimulus package, most likely larger than the last one, to underpin the economy. Another thing to consider -- and it has been overlooked -- is that nonfinancial sector earnings have been above consensus. They may weaken, but so far nonfinancial S&P companies have reported a 10% improvement in earnings, year-over-year. There is also plenty of investor liquidity. There is also the Fed. Given the deleveraging going on in the financial sector and that financial stocks are trading close to their cyclical lows, it is very difficult to imagine the Fed lifting interest rates.
A friendly Fed is an important tail wind that will create excess liquidity in the system, steepen the yield curve and improve bank profitability, which at some point is necessary to begin to rebuild capital. And there is investor sentiment, which is pretty negative. Typically, when sentiment is negative, the market tends to do better.
These guys clearly live in a totally different world than the hyperinflation/deflationary depression is around the corner types. They seem pretty confident that while the system may bend, it won't break. This kind of thinking has been profitable for 70 years or so, hence it is the horse that will be bet on until proven to be defective.
Are there any particular pockets of the market where you have been finding opportunities?
Cooperman: To some degree, I feel like a kid in a candy store. We find a tremendous number of values in the stock market. Consider that Anheuser-Busch was trading at 47 when it got acquired by InBev for $70 a share in cash, or 22.4 times 2008 earnings. That is about a 45% premium. Hercules was selling at $16 when earlier this month it agreed to be acquired by Ashland [ASH] for $23, or 14.1 times earnings -- a 40% premium. Rohm & Haas is getting acquired by Dow Chemical for 21 times earnings, a 74% premium. These are cash deals, so there is plenty of money around. We have two markets, one being the financials, where companies are losing tens of billions of dollars that they are equitizing to replace their losses. And you have the industrial economy, which has done fairly well. Its assets are selling at well below replacement cost.
So these transactions bode well for the market?
Cooperman: Yes, and they are really different than the transactions of five years ago or four years ago or even three years ago, because these recent deals were all strategic in nature. We went through this period of private equity having a very low cost of capital. It was very important that they had a low cost of capital because they were leveraging five to 10 times debt to EBITDA [earnings before interest, taxes, depreciation and amortization].
Einhorn: These recent deals highlight two tail winds. One is the nonfinancial sectors. There are many high-quality companies selling for low absolute multiples and generating significant amounts of free cash flow. That acts as a safety net under the market. Second, even within the financial sector, there will come a time when there will be consolidations that will help start the healing process.
What is your view of the financials?
Cooperman: The financial economy is in disarray and that is really a result -- and you can quote me on this -- of imprudent financial activity by the commercial banks and investment banks. They levered themselves up. They did things that were foolish. They should be ashamed of the way they conducted themselves, and now they have to right that, so they are de-leveraging.
Did they get too greedy?
Cooperman: You better believe it. Now, Wall Street is in the penalty box. We are not an investor in that space. I determined many years ago that if you want to make money on Wall Street, you work there; you do not invest there. They just pay themselves too well. I would rather look elsewhere for investment opportunities.
Words of wisdom from one who knows.
Let's talk about specific stocks.
Einhorn: This is a market where you want dominant companies with good balance sheets and that are not dependent on financial intermediaries to fund their growth. There are plenty of dominant companies out there that are selling at attractive multiples.
Cooperman: Step back and think about Corning [GLW]. There are thousands and thousands and thousands of retailers that sell flat-screen TVs. There are roughly 50 companies that make the panels. There are only three guys that make the glass. Typical U.S. companies are earning 14% or 15% on equity. Corning earns 27%. If you put in the recent numbers, it is higher than that. The stock sells at 10 times what we think they will earn next year, compared with about 13 times for the S&P. At the beginning of the year, the consensus for this year's earnings was $1.70 a share. Now it is $1.92. Next year, they were supposed to earn $1.84 and now it ius up to $1.99. We think they will do better than that. They are a world-class company in a growing industry. They claim -- and I just visited the company -- that just 10% of the market opportunity in flat-screen TVs has been penetrated.
How about another pick?
Cooperman: Another holding is Transocean [RIG], which has one one-third of the world's supply of deepwater drilling rigs. It is basically the only area of the world where the opportunity exists. Most onshore deposits around the world have been discovered. Look at what is happening in Brazil, which has had a huge discovery offshore. I also think we are going to open up the outer continental shelf to drilling. Transocean has a backlog of more than $40 billion, which is about the same as its market cap.
Cooperman: The HMOs are very cheap, selling at about eight times free cash flow, with decent balance sheets.
Which ones in particular?
Cooperman: We own WellPoint [WLP], UnitedHealth Group [WLP] and Aetna [AET]. These stocks have gotten decimated much more so than their businesses have.
What recommends these companies?
Cooperman: It is valuation, basically. If you buy things at the right price, that is half the game. We do not need sex appeal. UnitedHealth is generating a 12% free-cash-flow yield, and they have bought back a lot of stock. They generate tremendous amounts of free cash flow. It sells at half the market multiple and, over time, you are probably looking at maybe 1% growth in employment, with 5% health-care inflation. So you have the top line growing 6%. We think the bottom line will grow 8% to 10%. These guys could afford to buy back 8%-10% of their company annually. As far as ranking these companies, I would start with UnitedHealth, followed by WellPoint and Aetna.
Any financials look interesting?
Cooperman: One is Sallie Mae [SLM]. Probably 95% of its loans are government-guaranteed and the stock sells at 10 times earnings. A year ago, a private-equity firm wanted to buy Sallie for 60 bucks. You can buy it now at 18.
Funny what you will pay when you are playing with OPM (other people's money).
What about CIT Group [CIT]?
Cooperman: That is more speculative. Its book value is about $15 a share. We think they can earn $1.50 to $2, and we would not be surprised if the company is sold.
Any parting thoughts?
Cooperman: I do not want to come across like the outlook is duck soup and in the bag. We admit that we would have thought that, at this market level, we would be a lot more bullish and a lot more confident than we are. But we are very confident in the companies we own because they incorporate a margin for error.
Thanks very much, gentlemen.
CAPITULATION? NOT YET, BUT IT IS COMING
Prepare to take more punishment. A return to $80 oil?
A technical concept of longstanding repute is that bear markets end when "the market capitulates." Investors cannot take the pain any more, get out at whatever price they can obtain, claim they will never buy another stock as long as they live, and walk away ... until the next bull market tempts them back in. When the last worrywart has been flushed out there is no one left to sell, so stocks have nowhere to go but up. The "buy when there is blood on the streets" advice attributed to one of the Rothschilds speaks to the same idea.
Fine in theory. The only trouble is that sometimes/most times it is hard to discern the "capitulation" while it is happening. We well remember in August 1982 when many technicians were looking for some kind of final high-volume bottom, the market just blasted off without looking back. After the fact the explanation was that the multiple bottoms of the previous September, March, June and then August were a kind of stealth, stretched out equivalent of capitulation. The fact that stocks had been in a 16 year bear market and were dirt cheap as long as the world did not end certainly helped things, but that kind of reasoning contaminates the techical analysis with some fundamentals. More generally, if investors are itching to buy they may jump in before the satisfying capitulation unfolds.
However lacking the capitulation concept might be in practice, technicians are now telling us that the current bear market is not over because capitulation has not happened ... yet. On July 15, the S&P 500 set an intraday low about 24% off its high, which qualifies as an official bear market. The action on that day could also be interpreted as having the nature of capitulation. But no, we are told, there was not enough capitulation that day. But the capitulation is coming, we are told.
Remember when you were a kid and the local bully had you down on the sidewalk, twisting your arm behind your back? "Say uncle," he would demand repeatedly. "No!" you would scream, until finally the pain got so bad you capitulated. You said "uncle!" and then, through the tears, you got up off the ground, forgot about it, and eventually felt much better.
Is the rally since the tumultuous action of July 15 evidence that the market finally uttered "uncle" to the bear? Probably not, though the market does seem closer -- as the bear plows methodically through it, sector by sector -- to its appointment at Appomattox.
"It was a bottom, but not The Bottom," avers Wachovia's head of equity strategy, Stuart Freeman, who does not see capitulation just yet. "On the way down, the volume was good, but not crushing, and on the way back, it has not been dramatic either."
The pain investors have felt since the October market top -- bad as it has been -- still is not as awful as the average 30% bear-market drop nor has it gone on as long. And it pales in comparison with some of the blackest periods of market history, like October 19, 1987, or the 2001-2002 bear stretch.
Ahead of that one giant, desperate cry of uncle yet to come, the bear so far appears to be twisting investors, sector by sector, asset class by asset, until the white flag goes up. Slowly but surely, each of the major asset classes, for example, has found itself down from highs: real estate, stocks, bonds, commodities and the dollar.
Bear markets eventually get to all equity sectors, notes Mike O'Rourke, chief market strategist at broker BTIG. After housing, retail, financials -- and energy last week -- have been hit, technology might be next for a further mauling, given the poor trading action and recent disappointing news out of Apple, Google and Microsoft, he says.
The good news is the process is unfolding. The bad news is that there are plenty of stock groups not nearly as beaten-up as the ones mentioned above, and even a few that are up since the market hit a high last fall. Eventually, the bear will get to most, if not all, and investors will collectively cry "uncle!"
If you ask me about capitulation, I have not see it yet. But it is coming.
Thus sayeth the Barron's writer, who now moves on to the oil market.
The past half-decade of strong, 4%-5% global economic growth lulled the oil market into a false sense of security: that energy demand was completely inelastic, rising always and everywhere. But it was unwise for oil bulls to think that consumers the world over were not going to blanch at some point to a doubling of prices in one year. Sure, Americans loved their SUVs, but they like to hang on to their money more.
"Americans do respond to oil price signals. It takes a lot, but we got a lot," says Federated Investors' chief investment officer, Steve Auth, who is looking for crude to drop to as low as $80 a barrel in the medium term, on slowing consumption and easing geopolitical tensions. Oil has dropped 15% from highs to about $123 a barrel.
A significant drop in U.S. demand alone, responsible for about 1/5 of the world's energy consumption, would likely have been enough to tip the bull cart eventually. That is what we have: Gasoline usage here has fallen for 13 consecutive weeks, right into the height of the summer vacation driving season, and demand is down 2.2% year to date. That will continue. And places as far afield as Italy and Taiwan also show energy use drops of 4%-6%. Even China is showing a slowdown in the growth of energy demand. It adds up.
On the supply side, drilling around the world is booming. Sometimes, oil firms even hit something. A report out last week from the U.S. Geological Survey said that the area north of the Arctic Circle contains about 2/3 the proved gas reserves of the Middle East.
Since 1986, there have been 26 oil bear markets, defined as a 20% decline from the peak, according to Bespoke Investment Group, with the average lasting 125 days and producing a 32% decline in the commodity. Meanwhile, the S&P 500 typically gains about 6% during an oil bear, and we have already achieved much of that in the most recent rally. Not surprisingly, consumer stocks perform the best, energy shares the worst. To play petroleum directly, there are several ETFs to choose from, like the MacroShares $100 Oil Down (DOY), which rises when NYMEX light sweet crude futures fall, or, for bulls, the United States Oil Fund (USO), which moves up when crude does.
LEARNING TO LOVE LOW P/E STOCKS AGAIN
Stocks such as Gannett and Goodyear Tire seem to have gotten more punishment than they deserve – while others have not gotten enough.
Assuming the lastest baling wire and string hack job keeps the financial system as we know it from falling apart, it looks like there are a lot of cheap stocks in the U.S. stock market right now. Veteran value manager Leon Cooperman above claims that he feels like a kid in a candy store. Certainly the claims floating around when the stock markets were trading in all-time high territory that there was "nothing" cheap out there can no longer be credibly made. Barron's screened through the S&P 500 for the cheapest of the cheap, and found what look like entirely reasonable buy ideas.
Some investment pros like to gripe about how hard it is to find cheap stocks. But that argument is getting tougher to make, as the market's selloff this year has left more than 100 companies in the S&P 500 trading below 10 times projected 2009 profits, based on a recent computer screen.
Noted value manager Leon Cooperman of Omega Advisors [see above] tells Barron's in our interview this week that he now feels "like a kid in a candy store."
Buying stocks with low price/earnings ratios is no guarantee of profits. Indeed, many seemingly inexpensive stocks have gotten much cheaper in 2008. Just look at the big losses in the financial sector. Over time, however, low-P/E investing has been a winning formula.
[This table] lists 10 of the lowest P/E stocks in the S&P 500, including American International Group [AIG], Gannett [GCI], Marathon Oil [MRO], ConocoPhillips [COP] and Goodyear Tire [GT]. All 10 are valued below seven times future earnings, and some now trade at or below book value.
Expensive stocks, conversely, are rare now. Not many S&P 500 companies trade above 25 times projected 2009 profits. This analysis excludes real-estate investment trusts, which usually are valued on the basis of asset value or a cash-flow measure that adds noncash depreciation to often-meager reported earnings. There also are plenty of companies expected to operate at a loss next year, like Ford Motor and General Motors.
Even Google [GOOG], often described as a high-flier, trades for a relatively modest 20 times projected 2009 profits of $24. Google shares are down 29% this year, to $490. "The high-end multiples aren't too high," says Jim Paulsen, the chief investment strategist at Wells Capital Management in Minneapolis, who prepared the screen.
Our list of 10 richly priced stocks includes Intuitive Surgical, Amazon.com, Yahoo!, Sears Holdings and the biotech outfit Celgene.
The S&P's 100-plus stocks with single-digit P/Es are dominated by two industry groups: financials and energy. Despite a recent rally that lifted financials by more than 20%, the sector remains down 28% this year. Wall Street has been willing to look past large losses in 2008 and into 2009, when ample profits may start flowing again.
Energy stocks have fallen lately with oil and natural-gas prices, amid concerns that crude could retreat to $100 a barrel. The energy sector beckons because the group has a low P/E on what could be easily achieved 2009 profits. So far, oil has fallen to $124 a barrel from a recent peak of $147; 2009 estimates generally assume $125-a-barrel crude or less. Energy stocks, down 8% this year, have badly trailed oil, which is up 30%. This suggests that the stocks, at a minimum, are attractive, relative to the commodity.
All the major U.S. energy companies -- Chevron [CVX] ExxonMobil [XOM] and ConocoPhillips -- trade for less than eight times projected 2009 net, and Conoco is the cheapest of the lot. The stock, off 13% from its June peak, to 82, fetches six times projected 2008 profits of $13.03 a share and 5.8 times estimated 2009 net of $14.13 a share. Conoco last week reported second-quarter operating net of $3.50 a share, up from $2.90 a year ago, despite a collapse in refining profits. The Street knocks Conoco for disappointing exploration efforts, but should the stock trade at a P/E of just six?
Marathon, whose shares fell 21% to 42 in the past month, also has a mini-P/E of 5.2, owing to its exposure to the refining business, which has been hurt by sharply lower margins this year. Marathon's fans, like Sanford Bernstein analyst Neil McMahon, argue that the company is misperceived as a refining play, while it should get more than half its profits next year from an attractive and growing base of oil- and gas-producing assets. Marathon also could be a takeover target, given a digestible market value of $30 billion.
The downplaying of Marathon's refining exposure is a good illustration of the fickle nature of Wall Street analysis and fashion. A couple of years ago refiners such as Valero Energy [VLO] -- on the article's cheap stocks list but not discussed -- which now trades at a little over $33 versus a 52 week high of $76, were considered highly desirable. Allegedly, refining margins had reached a permanently higher average level because of capacity limits were being hit and no new refineries were scheduled to be built. Times change quickly on Wall Street. But when sentiment falls further than value, that is where opportunities are created.
Two of the cheapest stocks on the list are Gannett and XL Capital [XL]. Gannett, whose shares have fallen this year by 54%, to 18, after a 35% decline in 2007, is the leader in what may be the most hated market sector: newspapers. Its second-quarter earnings were down 22%, to $1.01 a share, and the rest of the year looks difficult. A lot of bad news, however, already is in its shares, which trade for less than six times projected 2009 profits. Gannett is a long way from going out of business. Instead, it is a highly contrarian investment. Investors get a 9% dividend yield, well-covered by earnings.
XL's valuation looks like a misprint, at three times estimated 2009 profits and half of book value. The stock is down 56% this year, to 20, on fear the company may have to pump billions of dollars into Security Capital Assurance [SCA], a troubled, MBIA-like financial-guaranty company whose stock has plunged 84%, to 63 cents, this year. SCA was spun off by XL in 2006.
Among financials, Hartford Financial [HIG], at 62, trades for only six times projected 2009 earnings and at 1.1 times book value. At 27, AIG trades for 5 times the 2009 consensus estimate of $5.40 and below book value of $33. Lehman shares are back to $18 after dropping to $12 in panic selling earlier this month. It trades at just over half its book value [which is basically fictitious, as discussed two weeks ago].
Goodyear Tire, a victim of a weak U.S. auto market, is down 28% this year, to 19. The tire maker trades for seven times projected 2009 profits of $3.18 a share.
Terex [TEX], a maker of aerial work platforms, cranes, construction and mining equipment, cannot get much of a break from investors. It reported a 40% rise in second-quarter net income ... to $2.32 a share, beating the consensus estimate by 32 cents, while reaffirming 2008 guidance for about $7 in profits. Despite this, the stock closed the week at about 49. Terex trades for seven times this year's earnings, making it one of the cheapest industrial stocks in the market.
Among the high-P/E stocks, Amazon.com reported second-quarter results that topped estimates, boosting its shares 11%, to $78. Amazon trades at 37 times estimated 2009 profits, one of the highest P/Es for any big S&P 500 company. ...
Monsanto's valuation is more easily justified, because while the company has a price-earnings ratio of 26, it is the world leader in genetically modified seeds. Yahoo! looks expensive based on its earnings, but half of its share price of $20 reflects cash and valuable stakes in companies like Yahoo! Japan that contribute little to earnings. Intuitive Surgical dominates the field of robotic-surgery devices, but it is tough to justify the stock's gargantuan multiple (see Cover story). Weyerhaeuser's P/E is overstated because earnings are likely to be depressed in 2009. Weyerhaeuser has valuable timber holdings in the Pacific Northwest that could be worth a good chunk of its market value.
It is ironic that value investor Warren Buffett was so eager to participate in Wrigley's purchase by Mars. Buffett's Berkshire Hathaway apparently did not own any Wrigley stock prior to the deal's announcement in April. Wrigley is valued at 28 times projected 2009 profits, about double the P/E on most food companies.
A market full of inexpensive stocks is a great place for value investors. And it is not a bad one for growth types, either.
WAITING FOR GOLD’S NEXT RALLY
Is the correction low already in?
Gold is in its typical summer corrective pattern, which has been a good time to enter or add to positions on the long side, largely free of the usual craziness. Here is one piece of analysis that takes a more refined look at the technicals, for those who want to get cute in their execution.
Last week we saw a bounce in the stock market that threatened to send the price of gold down to the $920 mark. After a lightening advance celebrating the approval of the quasi-nationalization of America's too-big- to-fail mortgage providers, the market caved on reports of continued stress in the homebuilders.
The Dow gave back almost five days' worth of gains in one fell swoop. So should we not have seen a better bounce in gold? Maybe it is too early to call the Dow.
Further weighing on gold prices were a lifeless bounce in oil and the market's shift in focus to signs that gas demand is ebbing. Sometimes, however, there is a delayed reaction in gold, which happens more often than efficient market theorists would like to admit. Gold's fundamentals are still bullish. Mining costs continue to increase, which pushes up the floor on gold prices.
Several months ago, I calculated that production costs had more than doubled for the gold mining industry since gold traded at under $300 per ounce some eight years ago, and, consequently, that the decision to shut down mines would today occur at $600-700, rather than $300. The supply situation is already tight. It is getting increasingly difficult to replace gold reserves. And of course, there is no end in sight to the readiness of central bankers to inflate, guaranteeing a strong flow of gold demand.
As for the prognosis, I see two possible scenarios for which there is some technical precedent.
Technically, the market is trendless. Neither bulls nor bears have gained much traction since the correction began in March. The seasonal low could be in, but it remains unconfirmed by a higher high.
A casual glance at the chart would tell you nothing except that the market could fall to $750 as easily as it could rally to $1,200. Technicians would call it a neutral pattern, though some may read bullish or bearish biases into how it is developing. I will not get into that. But one does not have to be a technical analyst in order to grasp some useful truths from the chart.
It is true that history never exactly repeats itself. But there are similarities, or regularity in the behavior of prices, that can help with our outlook.
For example, if you look at the corrections since 2001 in the chart ... you will notice that rarely have they lasted much more than a couple of quarters before the bulls took charge again. You might also notice that the first leg in each correction has been followed by a second one that usually fails to make a lower low -- 2004 being the exception. The market also likes to brush up against its 50-week moving average before completing the correction.
Moreover, we can even infer a loose relation between the extent of a rally and the depth and duration of the ensuing correction. These things are called "technical" mainly because they have nothing to do with the fundamentals. And let me tell you, it is dangerous to put too much weight on past performance and behaviors when we are talking about investors and the market.
Notwithstanding, if this were just a typical correction, we could expect to see a second "attempt" by the bears to make a lower low over the next month or two before the bulls break out, sometime in the fall. But the exception is worth considering, too.
The market is at an important number and inflection point, which threatens to complicate the situation central bankers face today -- their control of interest rates, to be precise. Naturally, the "powers" will do everything they can to resist this change.
Similar conditions prevailed back in 2004, when gold was trying to break past its old 1996 high, about $425-ish, which would reverse the downtrend in the longer-term charts and signal a new bull market -- note in [this chart] how the moves became more violent once gold broke past this level.
As it is now, the Fed was then about to embark on its tightening campaign, after having talked about it for almost a year ... making gold bulls nervous about the impact of higher rates. Of course, the Fed's job was a tad easier then. There was no series of financial crises to contend with. The stock market hiccupped, but the economy was producing jobs, and nobody much minded the Fed gradually ratcheting up interest rates.
As it turned out, however, it was just enough to keep bondholders happy, but not enough to rein in the effects of the Fed's previous inflation policy. The bears pushed down on gold prices, but did not realize just how tight the springs were and got caught in a lower chart low before gold whipsawed higher. The market has not looked back since.
So it is possible that the market could make a lower low, if only to make more elbowroom in the chart for the breakout ... sort of like pulling a slingshot back further to get a little more energy out of it.
On the other hand, the Fed's hand is weaker than it was in 2004-05. Because of this, I have to favor the former scenario, in which the correction low in gold is already in.
THE OIL BUBBLE WILL MEET THE SAME FATE AS TECH, HOUSING
There are plenty of opinions out there that oil prices are on a parmanently higher plateau -- perhaps they are a little frothy right now, but that is it for the current excesses. Here is one investor who thinks oil is an an honest-to-goodness bubble. Our opinion is that oil at $140 had "gotten ahead of itself," as the saying goes, but it does not look like the recent dot-com or real estate/credit bubbles. Then again, we could be wrong.
Over the last ten years the S&P 500 has returned a meager 2.88%. Why? Because in the long run the market does not like bubbles. We are now in the third wave of bubble euphoria and we are hearing the same underlying message that we heard during the first two, just in different terms. During the dot-com era we watched tech fly to P/E multiples of 200 and above. When fund mangers were questioned about investing in such companies back in 1999, they collectively responded by saying times had changed. Lofty valuations became the new norm -- until they crashed that is. The Nasdaq (QQQQ) still is not even half of what it was in 2000. The market's punishment of the dot-com bubble has lasted for seven years.
Real estate investment shifted into bubble status due to low interest rates and easy lending practices advocated by the Greenspan Federal Reserve. Back in 2005 it was difficult to find anyone who did not want to jump into real estate. Flipping homes was the new trend for amateurs. Unfortunately it is always the last guys in who get burned by a bubble. Those developers are being suffocated from the holding costs on their sinking investments. After watching home prices double and triple, nationwide home valuations have plunged since 2006 with more yet to come. Homebuilders (XHB) and financials (XLF) have been crushed by the bursting real estate bubble and it will likely take years before these stocks regain prior highs.
Now it is oil (USO) that is bubbling. Two weeks ago oil prices reached a 600% increase since the bull market began. The oil bulls are using the same arguments that we heard from tech analysts in 1999 and real estate agents in 2005. They will use any rationale they can find to shift our focus away from the fact that gasoline shortages do not exist and new oil is plentiful. There are now 53 commodity ETFs [Exchange Traded Funds] and ETNs [Exchange Traded Notes] that have caused average daily volumes to soar from 5 million in 2006 to well over 30 million today. History will repeat itself and the last guys in will get burned. Industry insiders believe that the proper valuation of crude is somewhere between $40-$50 a barrel. When will this bubble burst? Nobody can predict the exact time but the essential elements are in place: The Fed is done cutting interest rates, Bush is waiting on Congress to lift the offshore drilling ban, Congress in considering limits on speculation and high gas prices are decreasing demand.
The conclusion is that we are hearing the same story coming from the oil sector that we have heard in previous bubbles. They will tell you that this time is different, or that the fundamentals have changed -- when they really have not. The only thing that has changed is sentiment. This bubble will burst just like the last two and it will be ugly for those who have gotten caught up in the hype. Over the next six months investors should average in to a short position in the U.S. Oil Fund (USO). Be suspicious of alternative energy as well. Solar, wind, natural gas, etc. will all fall with oil.
The critical assertion here is whether new oil is truly plentiful, sufficient to replace the declines in existing fields and then some. The new ETFs, the newly found desire of pension fund managers and such to include commodities in their investment allocations, indexes by Goldman Sachs and the like ... all of those suggest we are well into a bull market and certainly past the initial "stealth" stage. The easy money has been made, and one cannot just buy blindly and expect to be bailed out. But this is not the same as the mania/blowoff stage. We have not taken a close look, but are small oil companies priced as if their reserves are worth $120, or even $100, above the ground? Are predictions of $250 oil common, and widely accepted? Do oil stocks sell as if all their speculative moose pasture is worth $100 an acre? That is the kind of stuff you see at bubble tops.
JIM ROGERS SEES THE COMMODITY BULL MARKET LASTING FOR ANOTHER DECADE
Jim Rogers reiterates the basic point he has been making for some time now: Commodities are in a bull market which has a lot longer to go in time and price. Short term corrections are inevitable, but that is all they are.
Renowned investor Jim Rogers thinks it is laughable that some analysts are suggesting the bull market in commodities may be over, but it is nothing he has not heard before in his nearly 40 years in the business.
"People have been telling me for seven years that the bull market in commodities is over, practically every time we have a correction, and I suspect they will be saying it for at least another seven years. The bull market is not over yet -- it has had a big correction but it is not over yet," Rogers told Dow Jones Newswires by telephone.
Asked if going long commodities is a wise investment at this stage, Rogers replied: "If you are talking about today, I don't know. But if you are talking about over the next decade, yes.
"The price of many commodities is going to be much higher in 10 years than it is today," he predicted.
Rogers and investor George Soros in 1970 founded the Quantum Fund, which gained over 3000% in the following 10 years during which time the Standard & Poor's 500 Index rose just 47%. Rogers founded the Rogers International Commodity Index in 1998. He has authored several investment books over the years, including 2004's Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market.
Despite suggestions the recent decline in crude oil may spell an end to the commodity run-up, Rogers remains bullish on the sector for the next decade as the world's population swells, and demand for food and energy strengthens while production likely remains limited.
Since reaching its highs of $147.90 a barrel on July 11, September crude oil on the New York Mercantile Exchange ... has lost 14% of its value, which has many commodity traders spooked.
But there is very little new production coming on stream, with the exception of a major offshore find in Brazil, but that is a drop in the bucket compared to global demand. Even the "wildest bulls" say the Brazil find would add the equivalent of about nine months of supply to the marketplace, Rogers said. The world uses 86 million barrels of oil every day.
"The bull market in oil started in 1999 ... and in the last nine years the oil market has gone down over 40% three times. Was that the end of the bull market?" he asked rhetorically. "Come on, you are talking to people who don't have a clue about the markets."
He contends that limited supplies and strengthening demand will continue to support the oil market in the long term. "Every oil country in the world has declining reserves, and nearly every oil company has declining reserves. Just ask these people where the oil is. ... Please tell me where all the supply is coming from that is going to end the bull market," Rogers said.
Gold futures have also declined in recent weeks, pressured by the drop in oil, speculative selling and a U.S. dollar showing signs of strengthening. September gold hit a 4 1/2-week low Wednesday [July 30].
In 1976, gold futures hit a low of $101.00 an ounce ... and then in 1979-80 shot up approximately 8-fold to reach a high of $875.00, according to a monthly continuation chart. The market subsequently declined 66% over the next two years, bottoming out at $295.00, leading many analysts to declare the surge in gold was finished.
"Everybody said, 'Well, the bull market is over; that was just a fad.' They called it a fad in those days," said Rogers.
The point here we are puzzled by. By any reasonable standard the gold bull market did end in 1980, at which point it went into a major two decade bear market. The surge in gold was finished.
Fast-forward to March 2008 and gold futures reached a historic high of $1,017.50. Prices have fallen since and on Wednesday of this week September closed at $902.90, an 11% decline but nothing to throw in the towel over, he argued.
Rogers is also bullish on grain commodities for the next 10 years, citing the decline in land devoted to wheat production over the last 31 years and the lowest ratio of food stocks to consumption in at least 50 to 60 years.
Wheat harvested area in the U.S. has declined 28 million acres since its peak in 1981, as wheat lost its competitiveness to crops such as corn and soybeans. The long-term outlook for U.S. wheat points to a slightly smaller planted area, rather than expansion, the U.S. Agriculture Department said.
The world's population is expected to grow by 1/3 over the next 30 years with more than 95% of the increase concentrated in developing countries, where pressure on land and water are already intense, the U.N.'s Food and Agriculture Organization said.
"We do know that the world has been consuming more food than it has produced for at least the last seven years. And we do know we are burning a lot of our agricultural products in our fuel tanks now," said Rogers, a development he argues is "ludicrous" given the relative inefficiency of converting grain to ethanol versus other feedstocks like sugarcane.
Besides being inefficient, using feed grain for energy drives up demand, which in turn raises prices and creates hardship for livestock producers.
"It's a totally absurd solution," said Rogers.
BUYING BERKSHIRE (OR NOT)
Berkshire Hathaway is trading at around $115,000 versus its 52 week high of over $150,000. Time to buy? First there are a few things to consider, like the portfolio concentration in U.S. financials, housing companies, and consumer durables. Ergo, look at the value carefully before you jump in.
I am not really a stock-market kinda guy, but there is a handful of individual stocks, foremost among them Apple (AAPL), which seem to be able to transcend financial-asset status and be of interest to a much broader audience, including me. And one of those stocks is Berkshire Hathaway (BRKA / BRKB).
Berkshire is interesting because it is in many ways a publicly-listed conservatively-managed hedge fund, using an enormous quantity of policyholder cash from its insurance operations to make solid long-term investments. Nadav Manham made the excellent point [see below] that no one should invest in a hedge fund unless that hedge fund can compellingly persuade you that it will outperform Berkshire: he calls it the "Berkshire hurdle".
Along the way, Nadav said that "Berkshire's stock price, $111,770 as we speak, certainly does not seem overvalued, and may in fact be significantly undervalued."
And Whitney Tilson, in yesterday's email blast, quotes a message-board posting saying that although Berkshire shares could certainly fall further from here, every time (such as now) that they have dropped more than 25% from their highs, they have gone on to perform spectacularly well the following year.
All the same, to the old Berkshire risks (a hurricane hitting an urban center on the East Coast, or Warren Buffet falling under a NetJet) must now be added a whole bunch of new Berkshire risks, which Todd Sullivan convincingly lays out.
For one thing, the firm is long the financial-services industry generally -- not just Moody's (MCO), which reported a 48% drop in net income today, and which, if sense prevails, will become increasingly irrelevant over the long term. Berkshire also has large long-term holdings in American Express, Wells Fargo, Bank of America, US Bancorp, and M&T Bank, one or more of which could easily find themselves in serious trouble if the current credit crisis gets worse rather than better.
Add to that Berkshire's exposure to the housing industry, via shareholdings in public companies -- Home Depot, Lowe's, USG -- and wholly-owned subsidiaries (Shaw Industries, Clayton Homes, Jordan's Furniture, Benjamin Moore, Home Services, Acme Brick), and it all adds up to a decidedly dodgy outlook over just about any time horizon.
And yet: Berkshire's shares still trade above the $110,000 level which they were bumping up against for the entire first half of 2007, before the credit crunch hit. Yes, they are down from their silly December highs. But I cannot shake the feeling that if $110,000 was as rich as Berkshire got in the first half of 2007, the company's valuation today should be substantially lower.
All the same, if you are thinking of investing in a hedge fund which concentrates in U.S. equities with a little global diversification, then you would probably be well advised to consider simply buying Berkshire shares instead. With the smart money beginning to go long rather than short, why not simply buy the stock that many value-oriented hedge-fund managers invest in, and cut out the middleman? The risk of a blowup is lower, and there is a non-negligible chance that you could make a very large amount of money indeed.
The Berkshire Hurdle
Any investor with enough assets to participate in a hedge fund can also buy shares in Berkshire Hathaway. Why pay a management fee of 2% of assets and 20% of profits to a hedge fund that professes to emmulate Buffett when you can get his expertise directly, at no value premium? Good question. The answer better be that the fund expects to outperform Buffet by a fair margin. (We cannot see the current hedge fund fee structure lasting.)
A month ago Fortune published an article about a hedge fund of funds group that made a bet with Warren Buffett that it could pick a group of hedge funds that would outperform the S&P over the next ten years. I remember in particular the last line of the article, in which Ted Seides, one of the bettors, said the following: "Fortunately for us, we're betting against the S&P's performance, not Buffett's."
Wait a minute, say I. That statement might be true in terms of the specific bet, but it is certainly not true in real life. As I see it, every money manager who accepts outside investors' money, especially those who call themselves value investors, is essentially "betting" that he can beat the performance of Berkshire Hathaway. Imagine the following scenario: You are interviewing a potential hedge fund manager and he says the following:
(1) "I am a value investor. All my life I have idolized Warren Buffett. I go to Omaha every year. He inspired me to start my own hedge fund. I own Berkshire shares myself."
(2) "I will charge you 2% of assets and 20% of profits for the benefit of my investment prowess, which is a combination of my own ability and the principles I have learned from my idol, Warren Buffett."
So far so good. Some variation of the above can be heard all the time in Midtown Manhattan conference rooms. Now it is your turn. You should say the following in reply:
(3) Your idol, Warren Buffett, is still alive and still working hard.
(4) I can become partners with Buffett today, simply by buying a share of Berkshire Hathaway. If I did that I would get the benefit of his ability and his principles firsthand, cutting out the middleman as it were.
(5) Berkshire's stock price, $111,770 as we speak, certainly does not seem overvalued, and may in fact be significantly undervalued.
(6) It does not cost 2 and 20 to become Buffett's partner. It costs maybe $10 to buy one A share, plus my share of Buffett's $100,000 salary: about 6.5 cents per A share per year.
(7) Given all this, does not it make more sense for me to buy Berkshire than to invest in your hedge fund?
If your potential money manager answers this question by saying "Fortunately, we are not betting against Buffett's performance," you should then say "You may not be, but I certainly am, relatively speaking, if I invest with you instead of him."
My point is this: Your money manager should be able to articulate why he expects the high-cost investment option -- his hedge fund -- to outperform the readily available low-cost option. I am not saying it is impossible to beat Berkshire, but your money manager should have the integrity to concede that that should be his goal, and you are entitled to know how he expects to do it.
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