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JIM ROGERS’S SUCCESS MANTRA: INVEST WHERE DEMAND IS LOW
When Jim Rogers’s name is trotted out one can immediately expect the free association “legendary investor.” He is also famous for taking a motorcycle trip around the world. Rogers’s was early and loud about the coming commodities bull market about a decade ago. He wrote Hot Commodities – How Anyone Can Invest Profitably in the World’s Best Market in 2004. A latecomer to fatherhood, Rogers’s latest book is titled A Gift to My Children: A Father’s Lesson in Life and Investing.
Rogers’s investment success – as with Warren Buffet’s, Benjamin Graham’s, and that of many other legends – has been built on being willing to bet against the consensus. Or, as he phrases it in this interview, to “invest where demand is low.” Going against the crowd does not necessarily mean you are right. As Graham put it, you are right because your facts and reasoning are right. But in order to buy cheap you have to be where the crowd ain’t.
Rogers is not very sanguine about stock markets in general, except for China’s and, prospectively, Sri Lanka’s. On China Rogers says: “If I am right in the 21st century then China is going to be the great country of the 21st century, and Mandarin is going to be the most important language.” He is having his two young girls learn Mandarin and study Asia. He sold his place in New York and moved his family to Asia. Let it not be said that Rogers does not practice what he preaches. Interesting, as usual, even if you have heard it before.
In this illuminating interview, Rogers discusses contrarian thinking, the relationship between uncertainty and profit opportunities, government stupidity, bubbles, airline stocks, the importance of doing your own thinking and work, China, and beating stock certificates into plowshares.
Jim Rogers is a legendary investor, a swashbuckling traveler, a man who made his fortune before he turned 40. Now, he is an author and commentator. The man Time magazine once called the Indiana Jones of the world of investing has now morphed himself into a modern dad. In an exclusive interview with Ramesh Damani on CNBC-TV18’s show RD 360, Roger discusses his latest book, A Gift to My Children: A Father’s Lesson in Life and Investing.
On the economic scenario right now, Rogers said we are in for an extended period of difficult times.
Jin Rogers’s investment strategy is to look countries where valuations are cheap or paths that are less trodden. He said, “I do try to find things that are cheap. Normally if something is cheap, it is because it is in the dustbin. People are not looking at it. If everybody is looking at something or if everybody is investing in something, you know as well as I do that it is not cheap. That is how he said he realized commodities was a good play in the ‘90s. I came to the conclusion at the end of the ‘90s that the commodities had been in a bear market for about 20 years because there had been excess supply in the ‘70s. But by the end of the ‘90s, I came to the conclusion that nobody built a drilling rig for 20 years and nobody had been discovering oil, farming had been a terrible business, farmers were going bankrupt all over the world. So, I realized that is going to mean there is less supply.”
Here is a verbatim transcript of Jim Rogers’s exclusive interview on CNBC-TV18. Also watch the accompanying video.
Q: You came into fatherhood fairly late, didn’t you?
A: Yes. I always felt sorry for people who had children. I never wanted to have a child. I thought children were a terrible waste of time, energy, and money. I literally felt very sorry for people who had children. I was never going to do something so foolish. I was totally, unbelievably wrong. I am telling you, it is the best thing that has happened to me. If there is anybody watching this show who has not had children, I urge you to get home and get on with it. You take a day off if you have to. You do not take a day off these days, go home for lunch. But you should definitely have children.
As I look around the world right now, I am not investing in many countries. The only place where I bought shares in the past year or so has been China. I have got Sri Lanka on my mind.
Let’s talk about the lessons in investing, some of which you have outlined in your book. The first lesson is, how do you size up a country? Can you give us an example of which country you are sizing now?
As I look around the world right now, I am not investing in many countries because if I am right about the world economy, we are in for an extended period of difficult times. So, the only place where I bought shares in the past year or so has been China. I have got Sri Lanka on my mind. It is just that I have been busy doing other things that I have not been able to get to Sri Lanka. But one of the things that I have learnt is that if you get to a country after a long and bitter war, you usually will find that things are very cheap, you will find a lack of capital, there is low morale, and everything is despondent, and there are usually great opportunities. So, Sri Lanka is on my list as a place where that sort of thing is happening, but there are not many, not these days.
How do you size up a country? What are you looking for?
I am looking for two things. I am looking for them to be cheap, for whatever reason: War is a good reason. Cheap and change, where there is some kind of positive change taking place. Sri Lanka is cheap, because it has had a 30-year war and if I am right there is positive change because the war is over now. So, there is going to be peace and so the country can spend a lot of its time, energy and money on pursuing peaceful pursuits.
When they ridicule your idea you are probably really on the right track.
When you gave an idea and people laughed, is that actually a good sign?
Yes. You know that, you have been investing a long time that the more sceptical people are – it does not mean you are right because sometimes I am wrong anyway and I am sure you are wrong too sometimes and sometimes the sceptics are right. But the more scepticism there is, in my experience anyway usually you are probably on to something good, especially if there is a lot of scepticism or ridicule. Ridicule is even better. When they ridicule your idea you are probably really on the right track.
The way your method works is. You look at the dustbins; you look where people are bearish because that is where you find the bargains?
Frequently, I do try to find things that are cheap. Normally if something is cheap, it is because it is in the dustbin; people are not looking at it. If everybody is looking at something or if everybody is investing in something, you know as well as I do, it is not cheap.
More certainty equals less profit?
A good lesson in investing is learning the laws of supply and demand. Can you explain that to us?
It is very simple. I came to the conclusion at the end of the ‘90s that the commodities had been in a bear market for about 20 years because there had been excess supply in the ‘70s, people found oil and a lot of things happened, huge inventories of food buildup. But then by the end of the ‘90s, I came to the conclusion that nobody built a drilling rig for 20 years and nobody had been discovering oil, farming had been a terrible business, farmers were going bankrupt all over the world. So, I realized that is going to mean there is less supply.
I had driven around the world a couple of times as you know, and I could see that demand was booming. I mean Asia was exploding. The difference in Asia in 1998 and in 1978 was very dramatic. So, I could see that demand was going up for 20 years, and supply going down and that had to mean that the bear market in commodities was going to come to an end. So, I started buying commodities for the first time in the last 15-20 years at that time. Lo and behold, I got it right. Sometimes I get it right.
That works every time, the law of supply and demand. No dictator, no monetary authority has ever been able to change that?
They all try. Not just dictators, democracies try. I mean the Indian government, the American government. They all try to abolish the laws of supply and demand, think that they are smarter than anybody else. Periodically, governments put price controls on to food. Recently, the Filipinos put price controls on rice. Now if you were a farmer, you are not going to go into the field over 12 hours a day in the hot sun to raise rice if the government says you can only sell it for 2 pesos. You are just not going to do it.
Your government is always doing absurd things, so is mine. It just does not work. You cannot repeal the laws of supply and demand.
As Russia found out also?
As everybody finds it, every time they try it they always find out. No politician is going out there in the hot sun to work 12 hours a day to sell rice for 2 pesos, I promise you. Indians find out periodically. Your government is always doing absurd things, so is mine. It just does not work. You cannot repeal the laws of supply and demand.
So the black market price is a good indicator of government policies?
Yes. You will need to find that there is a black market price with a very high premium or you will find that there is no supply at any price depending on how draconian the government is. If they execute you for selling something on the black market, there is usually nothing at any price. The governments can sit there and yell all day long. Evil capitalists or evil speculators. Listen, you set the price too low, nobody is going to produce and you will have nothing.
Anybody who has read anything to do with financial history knows that every time there is a new era or that it is different this time, or that there is a new economy, those are signals.
Whenever you hear the word new era or this time it is different, what are the lessons that you learn and are you seeing anywhere that people are talking?
Anybody who has read anything to do with financial history knows that every time there is a new era or that it is different this time, or that there is a new economy, those are signals. You hear a bell ring; you know that something is wrong. Some of the most dangerous words are, it is different this time, because it is not different this time. The laws of supply and demand, the laws of greed and fear, the laws of economics just do not change.
Everybody seems to be convinced that there is deflation in the world. Long-term government bonds are yielding nothing. In my view that is one of the next great bubbles, which is developing. I am not short bonds at the moment.
But markets can remain irrational for long periods of time?
Oh yes. It was Keynes who said that, “The market can stay irrational longer than you can stay solvent.” Well it certainly happened to me at times you know. I would sell something short. No way, it is too high, only to see it go higher and higher. I have learned the difficult way. Some of the things right now, right now everybody seems to be convinced that government bonds are going to go through the roof and that government bonds are a safe investment. Everybody seems to be convinced that there is deflation in the world. Long-term government bonds are yielding nothing.
The perceived safety?
They perceive safety and they perceive – you do not have to worry about inflation, deflation is here. So, you can buy long-term government bonds. In my view that is one of the next great bubbles, which is developing. I am not short bonds at the moment. I have them but I cover. That is a huge bubble. Apparently if you look at the market, most people do not think inflation is coming – if government bond yields are any indication – nobody thinks that inflation would ever come back. So, I am afraid, I think that that is probably the next bubble developing.
I have been buying international airline stocks.
Let’s talk about something that you have been bullish on, the dustbin of history: Airline stocks?
Yes, I have been, they are not doing much good right now. I think I see that the supply demand – I mean nobody has been building airplanes. All the airlines have lost huge amounts of money over the past nine years now. It is a terrible place to be. Many of them went bankrupt. Normally, when I see a lot of companies in an industry going bankrupt, it is a good sign that we are near a bottom, which is what initially attracted me to the airlines this time around. So, I have been buying international airline stocks. Most of them are down from where I bought them, fortunately not down a whole lot.
I am still convinced because I do not see anybody building a lot of planes. I don’t think we are all going to take boats to London again, or New York. I think we are probably going to continue to fly.
It is almost an irreplaceable business?
It seems to me. We also know that throughout history many people who have managed airlines have not done a horrible job of managing airlines, which again means that if you don’t have enough seats eventually we are probably all going to fly on planes and eventually they are going to make money. So, I am convinced this is one of the places that will come out of this, if we have to come out of this in a good way. I am much more optimistic about commodities than I am about any stocks right now. But that is one place where I bought some shares a year or so ago.
One lesson you mentioned that you wanted to teach your daughter is that, economics and markets are two different things. Can you explain that?
Yes. Let’s look at China. The Chinese economy has boomed for quite some time. But between 2001 and 2005, the Chinese stock market went down every year for four years in a row, even though the economy was going through the roof. So, just because an economy is strong does not mean you can have a good stock market, and just because an economy is weak – they don’t necessarily go together. In the long-term of course there is some correlation. But do not think that good news means good stock market.
Philosophy and history are important subjects to learn?
In my view, yes. Philosophy teaches you how to think. I was not very good when I was in university in philosophy. In fact I think that was probably one of my worst subjects. Later I realized what they were trying to do. They were trying to teach me after I had graduated but it certainly did teach me.
I have learned that when you hear all that kind of stuff, when everybody is thinking the same way, somebody is probably not thinking and so you better do your scepticism.
Why is it important in investing?
It teaches you to be sceptical. It teaches you to think. Like if you hear something from somebody it makes you stop and think. Now, could that possibly be true? Merrill Lynch says it, Morgan Stanley says it then it must be true. I do not know if it was the philosophy that I studied or what but I have learned that when you hear all that kind of stuff, when everybody is thinking the same way, somebody is probably not thinking and so you better do your scepticism. That is one of the things that philosophy taught me, as I though I was not very good at it when I was in University. History teaches you that the world is always changing. Pick any decade, 15 or 20 years later the world is dramatically different.
There are lessons that you interrelate to the market with this, in terms of Asian or the American century?
Again, whatever you see now is not going to be true if somebody comes to you and says that this company is a great growth stock and in 15 years they are going to own the world. Rarely has that been the case. Remember the projections that were made about dot-com companies, only 10 years ago. Well if those projections had been true, the whole world would be one big dot-com. Dot-com has come a long way but it not one big dot-com world.
One of the things you stress, in your own personal life and for your daughters, is savings. Tell me about it, tell me about the lessons, savings you did and how you teach your daughters?
My oldest daughter is six years old. When she was born, I got her a piggy bank and a globe, an atlas so that she can learn about the world, but she has got five piggy banks now and I tell her that she has to earn her money and she has to save her money and if she wants to buy something like a Barbie doll, which she loves, she has got to go take her own money.
She always tries to get her daddy to buy it for her. I certainly buy her clothes and things like that. But things like Barbie Doll and she has got to get her own Barbie doll, and I see that she is learning the value of money because I see that she does not want to take her money out of the bank and put it to buy something. So, I think she is learning the value of money and that is the main thing.
You must know this, many people just don’t seem to understand money or be able to handle money or control themselves with money. I know that is extremely important. If you have savings, and something goes wrong, you are in much better shape than the people who do not have savings when something goes wrong and you can cope better.
Equally important, if you have some money saved up and an opportunity comes along, you can do something about it. If you have got Rs 10,000 and you see a great opportunity, you can see opportunity. But if you are Rs 10,000 in debt, and a great opportunity walks in the door, you sit there helpless.
The one thing that stood out in your career and a lot of successful investors is passion, the importance of being 24 hours in the market. Talk to me about the importance, why is it important to have that in children?
I try to speak to my little girl. The thing that I have found, people who love what they do are normally successful people. It does not matter what you love. If you want to be a gardener, and your parents say no you have got to be a lawyer, or a doctor or an accountant, you should really go be a gardener because that is what you are going to love.
People may laugh at you but you love it so much, you will never go to work. You wake up every day and you can hardly wait to have fun. You are going to be much more successful at it. Some day you are going to be the gardener at Buckingham Palace, some day you are going to be the gardener for Hyde Park, some day you are going to have a chain of gardening shops all over the world, and be listed on the Mumbai Stock Exchange or the New York Stock Exchange. And you will be extremely rich and really successful, and even if you are not terribly rich and successful you are going to be a lot better off than all those guys who are lawyers who hate being lawyers and are doing it because they have to make money because their parents said become a lawyer, or their wives said we need the money. No, pursue your own passion. And that is where you will be successful.
If I am right in the 21st century then China is going to be the great country of the 21st century, and Mandarin is going to be the most important language.
The best advice that you said in the book that you could give anyone was learn Mandarin. Why?
If I am right in the 21st century then China is going to be the great country of the 21st century. The 19th century was the century of the U.K. The 20th century was the century of the U.S. The 21st century is going to be the century of China.
My little girls were born in 2003 and in 2008. I think that the best skill that I can give people born in those years is to know Mandarin and to know Asia. We sold our place in New York and we moved to Asia because I want my little girls to know Asia and specifically I want them to know Mandarin. There are other countries in Asia; there are other countries in the world. But in my view, China is the one that is going to dominate this century and Mandarin is going to be the most important language.
What would be the best piece of investment advice that you ever got?
Buy low and sell high. No, the real one is do your homework. Do not listen to what other people tell you.
If you read an annual report for a company on Wall Street, you would have done more than 98% of the people on Wall Street.
Attention to detail?
Be very attentive to detail. Cover all the bases; most people do not cover the bases. If you read an annual report for a company on Wall Street, you would have done more than 98% of the people on Wall Street.
Come on, you know that. How many people in India ever bother to read the annual report? They get hot tips if somebody says, they see it on TV or read it in the newspaper and very few of them read the annual report. None of them read the notes to the annual report. If you just do simple things like that, you are way ahead of everybody else, but that does not mean you are going to be successful. I promise you. But if you have learnt to cover all the bases, if you cover attention to detail, and you are sceptical, chances are that you will be a successful investor.
Stock traders should learn how to drive tractors. Farming is going to be one of the great professions in the next 30 years.
You also said stock traders should learn how to drive tractors? That is where the money is, the next decade?
What I said was, the last 30 years has been an era in the developed world where finance has been the center. The ‘80s, ‘90s and this decade, people in Wall Street, the City of London, once you had all the money and the influence. We have had many periods like that in history but we have also had many periods in history when it is the people who produce real things, whether it is miners or farmers or whatever, where they have been the center. In my view, we are in a historic shift now away from the financial centers to the people who produce real goods.
Farming has been one of the worst professions, the worst jobs for the past 30 years. I am telling you that in my view, farming is going to be one of the great professions in the next 30 years. All these people who were stockbrokers should turn in their degrees and go down and learn how to drive a tractor. They will be a lot better off. At least they will be working for rich farmers if nothing else and if they are smart they will become the rich farmer themselves.
Why Jim Rogers Is Bullish on Sugar over Gold
Sugar is already up 80% this year but Rogers thinks it could set all-time highs, which leaves another 70% upside. No super-gold bug, Rogers keeps buying gold from time to time – but that is apparently it.
Global commodities investor Jim Rogers no longer loves gold. Instead, he is going to shift focus to commodities like sugar.
On gold, he says: “If it goes down I will buy some more, and if it goes up I will buy some more. I periodically buy some gold. I do not have a method to it. I just buy it.”
Rogers is these days bullish on sugar. Sugar prices are rising dramatically these days. Last week, the price of sugar breached the 21 U.S. cents per pound mark for the first time since 1981. It is up 80% this year alone, and many believe it is set to go way higher.
Rogers says sugar prices might reach the all-time peaks it hit in the 1970s – 70% higher than it is now.
Eugen Weinberg, an analyst at Commerzbank, says that net long positions on sugar contracts traded on the New York Board of Trade are running at four to five times their normal levels, at more than 200,000 tonnes. “This situation hasn’t been observed in years. I think we are seeing a combination of very important fundamental factors and the price being driven by speculative interest,” he said, adding that hedge funds, cash-rich and looking as ever for profit opportunities, might have developed a taste for sweet things.
The International Sugar Organization agrees. “There is a lot of speculation there,” said Leonardo Bichara Rocha, an economist with the ISO in London. “This year’s deficit – the difference between supply and demand – is running at 7 to 8 million tonnes, and next year it will be between 4 and 5 million tonnes. India has seen a massive drop in production. The harvest in Brazil has been good, though they have had heavy rain there. In China there have been weather problems, but the issue there and elsewhere is the lack of real investment. Sugar is not a lucrative crop compared with using the land and people to make consumer or industrial goods. Also, there is a shortage of water in China and no new land to exploit for sugar production.” He said it might take between 18 months and two years for supply to respond.
The rest of the article quotes Rogers covering some of the points made in the main posting above.
THE FIRST WORLDWIDE CRACK UP BOOM
Bill Bonner assesses that we are in a “crack up boom,” as he explains here. There seems to be some confusion of nomenclature. Ludwig von Mises defined a crack up boom as the terminal stage of a money/credit creation scheme whose dénouement is hyperinflation as the former currency of the realm degenerates into worthlessness, a la the American Continental currency in 1781 and the German mark in 1923. But we are clearly not there, yet. The overwhelming demand is to acquire the U.S. dollar and other currencies, in order to pay off debt, rather than to get rid of it.
What Bonner instead depicts is a current worldwide bubble as a prelude to a crack up boom. Perhaps. The question is when the bubble, if ever, gives way to the crack up boom. If and when are both known unknows – Bonner recalls Donald Rumsfeld’s turn of phrase. Harder to deal with than these questions are the unknown unknowns. We are viewing the unfolding bubble within a certain framework which our limited minds and perspective allows. Who knows what we are just plain totally ignorant of? Stay humble.
A kiss is still a kiss ... and a bubble is still a bubble. When a kiss is over, it is over. When a bubble pops ... well ... that’s all she wrote! All kisses end – even the wettest “French” kisses. And so do all bubbles – even sloppy mega-bubbles of liquidity.
“This one will be no exception,” we remember thinking before the carnage got underway. But, of course, it is not the certainties that make life interesting; it is the uncertainties – the known unknowns and the unknown unknowns, as Mr. Rumsfeld said. We are all born of woman and end up where all men born of women end up – dead. But that does not mean we cannot have some fun between baptism and last rites.
The worldwide financial bubble we faced was both worldlier, and more financial than any in history.
And, in the summer of 2007, it was still very much alive. So much alive that the media could hardly keep up with it. Forbes magazine, for example, tried to estimate the wealth of the world’s richest people. But the rich do not typically give out their balance sheets, telephone numbers, and home addresses. So, there is a fair amount of guesswork in the calculations.
When it came to guesstimating the net worth of Stephen Schwarzman, founder of Blackstone, the Forbes crew wandered off into fiction. They put his wealth at about $2 billion. Recent filings in connection with the new Blackstone IPO show he earned that much in a single year!
In that phase of the bubble, it is as if your neighbors were throwing a wild party and you were not invited. You detest them ... envy them ... and want to join them, all at once. A very small part of the population is having a ball; everyone else is getting restless and wondering when the noise will stop.
Meanwhile, the experts, commentators, kibitzers, and analysts were saying that there is a whole new phase of the giant bubble about to unfold. Things could get a whole lot crazier. Even many of our respected colleagues were pointing to a text by the great Austrian economist, Ludwig von Mises, for a clue. What we have here, they say, is what Mises described as a “Crack-Up Boom.”
Before we go on, readers should be aware that the “Austrian school” of economics is probably the best theory about the way the world works. Like our newsletter, The Daily Reckoning, it is suspicious of efforts to control the natural workings of an economy, in general ... and suspicious of central banking, in particular. The fact that it was a one-time “Austrian,” Alan Greenspan, who became the most celebrated central banker in history, only increases our suspicions. He was able to master central banking, we imagine, because he understood what it really is – a swindle.
What Is a “Crack-Up Boom?”
This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.
But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against “real” goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.
It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.
Mises is describing the lunatic phases of a classic inflationary cycle.
At first, no one can tell the difference between a real dollar – one that is earned, saved, invested or spent – and one that just came off the printing presses. They figure that the new dollar is as good as the old one. And then, prices rise ... and people do not know what to make of it. Later, they begin to catch on ... and all Hell breaks loose.
You see, if you could really get rich by printing more currency, Zimbabweans would all be as rich as Midas, since the Mugabe government runs the presses night and day.
Von Mises died in 1973 – long before this boom really got going – let alone cracked up. He may never have heard of a hedge fund ... or even a derivative, for that matter. A world money system without gold? He probably could not have imagined it. People spending millions of dollars for a Warhol? Twenty million for a house in Mayfair? Chinese stocks at 40 times earnings? He would have chuckled in disbelief. He understood how national currency bubbles expand and how they pop, but he probably never would have imagined how insane things could get when you have a whole world monetary system in bubble mode.
He would have recognized the beginning of this bubble ... and he would have recognized the end, but the middle ... or the beginning of the end – that would have dumbfounded him. During his lifetime he saw a Crack Up Boom in Germany in the ’20s ... and a few more here ... but he never saw a worldwide Crack Up Boom.
No one, anywhere, has ever seen a worldwide Crack Up Boom. We are the first, ever. Pretty exciting, huh?
A highly speculative stock market increasingly detached from reality and vulnerable to wild swings in sentiment.
Doug Noland continues with his thesis that the strong stock market is a reflection of disorderly monetary dynamics layered onto a fundamentally broken financial and economic system. Rather than forecasting some economic recovery, the stock market’s move since March is due to bulls fueled by an almost endless supply of credit routing the bears and driving them out of their short positions.
Meanwhile, very weak economic data apparently continues to confirm the bullish bond view. However, Noland believes that “over-liquefied” bond markets are subject to their own vulnerabilities. Fixated on the weak U.S. economy, they downplay reflation risks. So Noland tends to fall in the inflation sooner rather than later (although not necessarily hyperinflation), unlike with those in the deflation camp – see posting immediately below and many others in the past several weeks’ Finance Digests. “For bonds as well, the backdrop is set for a wild, speculative market ride.”
No problem with that conclusion.
Stock prices traditionally lead economic recoveries. Securities markets tend to react swiftly to loosened monetary conditions, while it takes some time for loose credit to work its way through to the bowels of the real economy. Highly speculative markets react haphazardly, sloshing liquidity out and about. As is commonly understood, employment conditions are a somewhat lagging economic indicator. Most analysts have been content to read nothing of significance from ongoing poor jobs and housing data. Overwhelmingly, the bulls rely on faith – and history – that surging stock prices are discounting the usual “V” rebound.
Data this week should have those of the bullish persuasion on edge. July retail sales were much weaker-than-expected (down 0.1% vs. expectations of a rise of 0.8%). Retail Sales excluding auto sales were down 0.6% for the month (down 8.1% year-over-year), the largest drop since March’s 1.1% fall. Looking back, there was no mystery surrounding first quarter consumer weakness. But even after a dramatic stock market recovery, July’s Department store sales were down a dismal 1.6% for the month (down 9.6% y-o-y). Even Wal-Mart management commented that their customers were “selective” and remained keenly focused on value.
Today’s preliminary report on August University of Michigan Consumer Confidence was also a big disappointment. The consensus called for this confidence reading to jump three points to 69. The actual report came in down to 63 – to the lowest level since those dark days of March. Readings on both “Economic Conditions” and “Economic Outlook” dropped to 5-month lows.
Yesterday, RealtyTrac reported that U.S. foreclosures jumped to a record 360,149 in July. This was up almost 7% from June and 32% higher than the year ago level. And there is no relief in sight. American Bankruptcy Institute data had 126,000 Americans filing for bankruptcy in July, up 34% from a year earlier. It is now expected that 1.4 million will file for bankruptcy this year.
Meanwhile, the economic optimists take comfort from this week’s readings on Non-farm Productivity, Wholesale Inventories, Industrial Production, and Capacity Utilization. Positive data out of Europe and Asia also seem to confirm that some type of global economic recovery has taken hold.
From my perspective, this week’s data confirm important aspects of credit bubble analysis. First, ongoing headwinds will restrain rebounds in U.S. housing markets and household consumption – for an extended period. Second, the overall U.S. consumption-based economy will lag those of most of our more manufacturing-oriented trading partners. In short, we are witnessing anything but typical reflation dynamics, and those expecting a typical U.S. recovery will be disappointed. Our economy remains overly exposed to U.S. consumption, while having insufficient manufacturing capacity (and resources) of the type to benefit significantly from heightened global demand.
Market dynamics likely explain much of the divergence between ongoing weak underlying economic fundamentals and robust stock prices.
Returning to the stock market, I see nothing typical going on there either. With the Morgan Stanley Retail Index and the Morgan Stanley Cyclical Index up 56% and 49%, respectively, the marketplace apparently has no issue with the recovery. I suspect these gains have been inflated by short covering. Indeed, market dynamics likely explain much of the divergence between ongoing weak underlying economic fundamentals and robust stock prices (especially in the consumer arena).
Unusually large bearish hedges and bets had been placed against the (consumer-driven) U.S. economy. Unprecedented fiscal and monetary policy crisis response stabilized the credit system, setting in motion a self-reinforcing unwind of “bearish” positions. In the past, such a reflationary dynamic would have seen stock prices for the most part accurately discount the future direction of economic activity. Stated differently, the reversal of bearish positions (and resulting short “squeeze”) would traditionally have (reflating) stock prices portending recovery and a return to the previous trajectory of economic performance. In general, a rejuvenated credit system – and the resulting recovery of financial flows – would ensure that the “bear” case was proved wrong.
This time may be different. I would not be surprised if the confluence of unusually large bearish positions, unprecedented policy response, and a resulting major “squeeze” created a backdrop where the stock market was turned into a rather poor foreteller of future prospects. From my vantage point, I certainly do not believe stock prices today generally provide an accurate reflection of underlying company fundamentals. And from an economic perspective, I suspect the stock market is missing some key underlying dynamics that will shape future economic performance.
Massive fiscal and monetary stimulus has been implemented with the policy goal of sustaining the existing economic structure. The market has been content to play this dynamic expecting policymaker success.
In particular, equities seem to be discounting a return to business as usual when it comes to the U.S. economy. Retail and the “consumer discretionary” sectors have been among this year’s stellar performers. And, yes, this does fly in the face of my analysis of new economic realities and a permanently downsized role for household consumption in the U.S. economy. At this point, I view this as an anomaly at least partially explained by the hastened reversal of bearish positions. But I also recognize that massive fiscal and monetary stimulus has been implemented with the policy goal of sustaining the existing economic structure. The market has been content to play this dynamic expecting policymaker success.
As I attempted to explain last week, I view the impairment of the stock market discounting mechanism as a key facet of Monetary Disorder. The reversal of bearish plays not only created huge buying power throughout the markets, it decisively reversed The Greed and Fear Factor. Notwithstanding today’s (Friday, August 14) sell-off, the bulls are greedy and the bears are on the run. And the more that inflated stock prices entice shorting, the more games that can be played to “squeeze” the timid bears.
The end result is a highly speculative stock market increasingly detached from reality and vulnerable to wild swings in sentiment. Yet I do not expect the emerging global reflation to this time disprove the U.S. bearish thesis, although it will no doubt be a wild market ride.
The bond market was happy with this week’s developments. The Fed confirmed it will be especially unhurried in raising rates and ending quantitative easing. Weak U.S. economic data was seen as confirming the bullish bond view. To be sure, low market yields at home and abroad are imperative for global reflation to gain a head of steam. And I would argue that (over-liquefied) bond markets are subject to their own pricing anomalies. In contrast to stocks, bonds have been fixated on U.S. economic vulnerabilities and the Fed, while content to downplay reflation risks. This week’s data does not have me second-guessing the thesis of bond market vulnerability to global reflation dynamics. For bonds as well, the backdrop is set for a wild, speculative market ride.
INFLATION NO THREAT IN A COLLAPSING ECONOMY
Being needlessly concerned about $9-a-gallon gasoline and other supposed inflation threats.
A “friend” of Rick Ackerman’s takes on the inflation-or-deflation debate. He sides with Mish Shedlock and the other deflationists: You cannot have inflation when credit is collapsing under our current monetary system. He does foresee a marked-down dollar accompanying that deflation, however, which means that some prices could go up. For example, he is comfortable with a forecast of $1600 gold being “the new normal.”
I have harped endlessly on the point that stagnant-to-falling incomes, soaring joblessness, imploding credit and collapsing asset values make inflation nearly impossible at this time. Here is our friend Señor Cuidado once again, explaining this more lucidly than I have. He is responding to statements posed (in italics) in the Rick’s Picks forum by “Edward,” who is needlessly concerned about $9-a-gallon gasoline and other supposed inflation threats:
Gas will be 8 or 9 bucks a gallon – and people will pay for it, because they will have no choice, just as they don’t in Europe already.
Edward, the U.S. is not Europe. Our geography requires a lower gas price in order to keep our transportation grid flowing. Our economy would experience a devastating deflationary shock from $8-9 gas. I suppose the people might “pay for it,” but then they will not have any money to go to restaurants, or buy any clothes, or go to the dentist. A quick tripling of the gas price from the current level would cause an extreme unemployment spike when discretionary income retailers are simply wiped out. Or prices will collapse along with demand for other items and services.
But I say the $9 price is not even possible because domestic gas demand will fall rapidly in response in any climb above $4. We were in the red zone at $4 gas last year. Even a $6 gas price probably means total defeat for most sitting politicians in the U.S., and radical new political pressures on the Saudis/OPEC. And $8 gas is radical: It probably means an outright military takeover of the Saudi Oil fields or the sudden end of new car sales in America.
Groceries and Gas
The price of oil is also the basis of the price of food. If Americans will be spending all of their money on gas and groceries ... then that means a nasty deflationary outcome for every other sector of the economy. Debtor nation status, de-industrialization and off-shoring (global wage arbitrage) preclude a 1970s outcome here for the U.S.
I suggest you read Jim Sinclair to understand that the dollar is on its way to a devaluation and what that means. Also, you are not up to date on your Denninger, because he is changing his tune about the prospects for hyper-inflation.
I read Sinclair and Denninger regularly. A dollar devaluation does not necessarily equal hyperinflation. We hit Peak Credit as per the Mish Shedlock thesis, and we are nowhere near a reversion to a corrective level of credit. Consider that the coming vote of no confidence in the American finance sector is going to collapse credit much further from this level of August 2009. That trend will be hyper-deflationary. The dollar will take the haircut, and balance things out a bit, but the credit collapse prevents inflation of the total money supply.
Credit Is Key
The credit collapse is the key to the inflation-deflation debate. Best to believe the Mish maxim which states there is no inflating out of the backside of a real estate bubble. So it is possible to take a massive hit to the currency yet still have deflation within the rules of our system ... because of the collapse in credit. Think: Since 2006, we have already taken a big hit to the dollar, right alongside a huge deflation in asset prices (equity markets, houses, cars, boats etc) ... because of the contraction in credit. I am simply saying that this dynamic continues to wind its course, which is much further from here.
Notice Sinclair passes off any higher gold price prediction than $1650 to Alf, or whomever. I think he is smart to do so. Volatility will be extreme, and Sinclair has pegged the $1600 area as the new future fixed-gold price. OK, fine. But credit will be in a state of complete collapse by his target date of early 2011 (very few businesses or persons will have credit lines, aka we have a cash economy). Meanwhile the oil price will face huge demand-drop pressure and huge geopolitical pressure and not go through the stratosphere, and imported foods will face drastically lower demand and mostly disappear from shelves.
Strong Gold, Weak Stocks
It is all going to be extremely chaotic ... and deflationary. I will stick with a prediction of a strong gold price in the neighborhood of Sinclair’s target in response to the credit collapse, plus an equity market collapse as a response to the credit collapse, plus a substantially weaker dollar (as foreign investors respond to our credit collapse). That will be the new status quo. And, yes, the sum total situation will be deflation as defined by: Deflation = Reduced Supply of Money AND Credit.
At some point the oil price [he must mean gasoline price] might reach, say, $5, but it cannot stay that high for long. And the dollar can briefly rally again in the panic ... but it is going to take the big haircut and then stabilize at a lower “new normal.” It is not the 1970s all over again, but it is not the 1930s exactly either. The dollar would have gone to the moon if this was the 1930s and we were a manufacturing/producer/creditor nation. And, paradoxically, glossing over the differences between today and the 1970s is also a big mistake. Mish’s deflationary real estate maxim is in play for the foreseeable future, and that card was not on the table during the 1970s, and neither was our current insane level of debt and dependence on foreign creditors.
Also, some will argue that future high interest rates will boost the dollar back up to the levels of the past decade – but remember that the dollar never returned to its pre-1970s level. Even after the Volcker era the dollar was dropped to a much lower “new normal” and stayed there for about three decades as measured in gold. Sinclair is smart to predict the higher “new normal” for gold.
In response to a couple of reader comments, Señor Cuidado appended his own comments. He allows that the U.S. could experience some combination of inflation and deflation due to misguided – a given – government policies.
Step out of the box for a moment, and think of this in current social terms – i.e., social trends and social “norms.”
A deflationary environment – albeit devastating, is somewhat “boring” – and slow, over time. It is a grind-down of say ~100 grit sandpaper spread out over 10 years or more. That could happen – per Mish’s expectations. Consider though, the socio-economic state of our “State.” Do we do “boring”? Does our political “leadership” – and the electorate that repeatedly votes them in office, take on society’s ills with a reasoned, patient and measured approach?
Or are we a (3) second, sound-bite oriented society, with the patience and temperament of a flea?
And what about our ability to persevere – our “grit” so to speak? Do we have any? Or, is it more like that at the first sense of trouble, we clamor for somebody (Namely: Government), to step in and “Do Something ...”?
You know the answer.
Let that answer be your guide as to what the Government is prepared to – and will do, to keep the fat, unattentive and slovenly populace inebriated with anything and everything in their power to keep them in office for one more election cycle.
Yes, it is “different” this time. We have become Totally and Completely Politicized. It is Politics from top to bottom – from D.C. to Wall Street and all of their fawning followers in between. What ever can be done to protect the incumbant’s tenure will be done – even if it means totally destroying the currency in the process.
We could very well have the “best of both worlds” – high inflation in a deflationary environmnet. Given the time and circumstances we live in, it is not out of the realm of possibility.
Mish Shedlock posted several pieces on his blog, “Misguided Worries About Inflation”, “Peas In The Deflationary Pod,” and “Social Safety Nets Mask Deflationary Depression” consistent with Señor Cuidado’s views.
Hyperinflation Won’t Be Like Germany’s
Rick Ackerman is a deflationist, but like most people of that persuasion he sees currency destruction, aka hyperinflation, once deflation has caused maximum misery and run its course. Herewith some thoughts on that, thinking ahead a bit.
I thought I had overdosed on the inflation vs. deflation debate, but that was before I started reading Adam Fergusson’s When Money Dies: The Nightmare of the Weimar Collapse. Fascinating stuff. Anyone who thinks it could not happen here is right in one respect: It will not take 10 years to play out in the U.S., as it did in Germany. Far from it. My guess is that our own hyperinflation nightmare – and we will have one once deflation has had its way with all who borrowed more than they can ever pay back – will be over within 10 days of the initial panic. Then it will be back to deflation for another 20-30 years.
Are you ready for it? Investors should not kid themselves about being able to avoid all the whipsaws. Just when you are patting yourself on the back for scoring some ingots for $2000 an ounce after bullion has shot up to $5000 in mere days, quotes could plummet back down to $2000 in a blink. That would hardly be a catastrophe for long-term bulls who have been accumulating the stuff since it was $300 an ounce. But what about the guy who bet the ranch at $5000, thinking he would get $10,000 from some greater fool a week later? Which raises another tricky question: When you sell your gold, what do you accept as payment? Do you risk taking dollars whose purchasing power could fall by half overnight, as the German mark did?
Fergusson’s book makes clear that there were few winners and almost no big winners. Farmers made out pretty well, of course, because a potato was a potato no matter how many marks it took to buy one. In fact, some who borrowed heavily to buy farms when hyperinflation took off in 1922 were able to retire their mortgages with proceeds from the first harvest. A speculator these days could mimic that strategy by buying a bunch of wheat contracts when it appeared that the dollar was in imminent danger of collapse. Trouble is, the dollar could collapse tomorrow. Would you make out like a bandit if it did? And: If you have $50,000 sitting in a trading account for when the panic hits, how can you be sure the CFTC will not raise margin requirements so steeply that the only players who can afford the game are Cargill and ConAgra?
I strongly recommend Fergusson’s book, the complete text of which you can access by clicking here. Once you have read it, please visit the forum at Rick’s Picks, where we are having a thought-provoking discussion about the inflation/deflation conundrum.
CORPORATE BOND SPREADS KEY TO CONTINUED S&P RALLY
Want to know where the S&P 500 is headed? The corporate bond market likely holds the answer.
Mish Shedlock notes: “In August of 2007 the corporate bond market cracked wide open. Although the S&P 500 made a new high in November, the corporate bond market did not. It was the mother of all warning calls that most missed.”
The relevance to today? The investment grade corporate bond market rallied for 23 consecutive days, ending on August 13. Demand for investment grade debt has been tremendous and issuance is on a record pace this year. Spreads over Treasuries have narrowed by 350 basis points since the year’s beginning. Can this last? One might ask whether investment grade corporates are piggybacking on the government finance bubble, joining in on the fun.
Good questions. Mish is “skeptical the rally in bonds can last much longer, but until the corporate bond market starts showing increased signs of stress, equity bears expecting huge pullbacks are likely to be disappointed.” Conclusion: Keep an eye on bonds.
So far this year, investment grade debt sales are on a record pace according to the article Blackstone Group to Sell Debt as Investment-Grade Spreads Widen.
Bloommberg notes that Blackstone joined Microsoft Corp., the world’s largest software maker, in making a debut offer this year and that investment-grade debt sales of $774 billion are on pace to reach a record.
Meanwhile yield spreads on corporate debt vs. Treasuries have declined from 603 basis points on January 2, to 254 basis points today (August 13) according to Merrill Lynch & Co.’s U.S. Corporate Master index.
Access To Debt Markets Keeps Zombie Corporations Alive
Ability to raise cash now will keep many zombie corporations alive. GM went under when its borrowing dried up. Ford stayed in business because it had a bigger pile of cash relative to its burn rate.
Thus it is no wonder that stocks are rallying in the face of record demand for debt, demand that has dramatically reduced long term corporate borrowing costs.
“Liquidity is the name of the game for financial-related firms,” said Guy Lebas, chief economist and fixed-income strategist with Janney Montgomery Scott LLC. “Many issuers as well as buyers realize that the improvement we’ve had in spreads over the last eight weeks marks the final step in the credit rally for 2009.”
23 Day Rally In Corporates
The question now is where to from here? The article notes the investment grade bond rally lasted 23 consecutive days, ending two days ago. The widening today is a statistically irrelevant 1 basis point.
Evidence of a pullback is more readily apparent in junk bonds.
Yields on high-yield, high-risk, bonds relative to benchmark rates widened 14 basis points yesterday to 878 basis points, the third straight day of increases after 16 consecutive days of tightening, according to Merrill Lynch amp; Co’s U.S. High-Yield Master II index. High-yield notes are rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service.
S&P 500 During Corporate Bond Rally
Keep an Eye on Bonds!
As long as corporate bonds fetch a good bid, which in turn allows companies to raise cash at decreasing costs, the stock market is likely to be reasonably firm. Note that the pullback in junk bonds began 3 days ago on that last red candle.
I am skeptical the rally in bonds can last much longer, but until the corporate bond market starts showing increased signs of stress, equity bears expecting huge pullbacks are likely to be disappointed.
Either way, it will pay to keep one eye on the credit markets to help ascertain long-term equity direction. In August of 2007 the corporate bond market cracked wide open. Although the S&P 500 made a new high in November, the corporate bond market did not. It was the mother of all warning calls that most missed.
It is a familiar story. An emerging market booms, capital swarms in, real estate speculation thrives, leverage spikes, foreign banks arrive ... and then disaster strikes. How to bet on a successful rescue effort.
Latvia, a nation of only 2.3 million people, went through the standard boom/bust cycle that comes with too much hot foreign money coming in too fast. In Latvia’s case the IMF and the EU seem highly committed to preventing Latvia from playing the role of the proverbial straw that breaks the camel’s back with regard to another global financial meltdown.
As Lisa Hess puts it here, “despite the fact that bailouts induce bad behavior, in this case a debtor nation will probably not be permitted to fail.” She suggests some low-risk ways to play a Latvian recovery, or at least a successful international effort to prevent the country from failing.
Everyone has a breakup story. Mine came at the end of my first marriage, when I found myself engaged in a tug-of-war over a vinyl record. (Remember those?) The only thing I wanted to take out of the relationship was Jimmy Cliff’s The Harder They Come. The episode and the song have stayed with me always, as a reminder that an excess of passion is likely to be followed by a disastrous crash.
This axiom found expression recently in the economy of Latvia. Slightly larger than West Virginia, with a GDP of $27 billion, this Baltic “tiger” borrowed, inflated (despite pegging its currency to the euro) and traded its way to an economic boom. The main Riga stock index went from 200 at the end of 2002 to 767 by mid-September 2007. Then came the crash. By March of this year the index was back to 200. The International Monetary Fund and the European Union stepped in last December with a €7.5-billion rescue. The economic pundit Nouriel Roubini (a regular at Forbes.com) has called the devaluation of the Latvian lat “unavoidable.”
It is a familiar story. An emerging market booms, capital swarms in, real estate speculation thrives, leverage spikes, foreign banks arrive and then disaster strikes. Why has this same old story in a tiny country of 2.3 million garnered so much attention? For one thing, all of us who are old enough to remember the collapse of the Thai baht in 1997 live in fear that we might miss the warning sign of the next cascading economic disaster. The thinking goes as follows: Latvia devalues, then the other Baltic republics collapse, then Swedish banks, which are heavily exposed to Latvia, go down, and the next thing you know all of western Europe is at risk.
No, this sequence is not entirely far-fetched. But I am betting that the dominoes do not fall this way. I am buying Latvian eurobonds that were issued in March 2008. The €400 million issue was initially priced just under par to yield 5.5% through maturity in 2018. The bonds, which trade and pay off in euros, are now rated as junk (BAA3/BB+) and sell for 75.38. At that price the yield to maturity is 9.8%.
Know what you are buying. There is no assurance that the IMF will continue to release the rescue funds as expected, especially if Latvia fails to reduce its budget deficit. The price of a 5-year credit default swap on Latvia is 6.8% a year, not as high as it was six months ago but still an indication of the risk here.
Another way to profit would be to invest in the deeply depressed Scandinavian banks that have significant exposure to the Baltics. The Swedish krona, in which these stocks are traded, has also moved in response to fears of a Latvian devaluation, oscillating from a low of 10.7 cents at the end of February, when Latvia was first downgraded to junk, to 13.3 cents currently. The two banks that have the largest exposure are Swedbank (SWEDA SS, 6.91) and Skandinaviska Enskilda Banken (SEB SS, 4.94), down 58% and 41% (in krona terms), respectively, over the past year. On July 17 Swedbank reported a loss of $257 million for the June quarter, yet the stock rallied 11% as investors were relieved to find out that the bank did not need to raise capital. The bank’s $5.3 billion market capitalization is only 40% of shareholders’ equity. Core capital (essentially, shareholders’ equity plus reserves) is 9.2% of assets.
For the June quarter Skandinaviska reported a loss of $254 million. It has core capital equal to 11% of assets. Its price is 90% of book value. Compare jpmorgan Chase, with a core capital ratio of 11% and a price/book of 100%.
An easier buy is the Barclay’s exchange-traded fund for Sweden (EWD, 19), a basket of 31 stocks. The fund has 24% of its holdings in telecommunications, 22% in banks (including Swedbank and Skandinaviska) and 13% in retail. The portfolio’s average P/E is 16, average price/book 3 and average market cap $18 billion. Overhead eats up half a percentage point of assets annually.
Why won’t Latvia end up like Argentina? There is a new religion among central bankers. As with most religions, fear has been a big factor in its widespread adoption. The world financial community barely averted a complete meltdown in 2008. Today global central banks, the European Union and the IMF are all highly sensitive to anything that could become another tipping point. A default or devaluation in Latvia could be such an event. So, despite the fact that bailouts induce bad behavior, in this case a debtor nation will probably not be permitted to fail.
ARE YOU READY FOR THE GOLD RUSH?
The last article in the Chuck Cohen series on gold we featured was “Junior Golds Offer ‘Ridiculous’ Leverage.” Here is the next one in the series.
Anyone who is familiar with the junior precious metals stock sector understands that:
Last week, I explained why junior and exploration gold-mining stocks will be spectacular investments in the impending 21st Century gold rush. I will discuss specific stocks in the weeks ahead, but first let us talk about how to accumulate them. Because juniors are quite different from other stocks, the best approach to building a portfolio is to stick with a game plan formulated in advance. For starters, you should look for stocks of companies that hold the most resources or have the greatest potential relative to their market capitalization. There are some companies that have a $10 million capitalization, with good results and the potential for one to three million ounces. If the price of gold were to rise to $1,500 or $2,000 next year, odds are excellent that such stocks would increase in value by 5 or 10 times.
Spread Your Risk
Jay Taylor, one of the best and most successful stock pickers, recommends that you initially try to put 5% of your funds in a single stock. This is an excellent way to start. If you put too much in one or two stocks, your gains might be greater, but so will be your risk, and this could lead to emotional decisions. If one or more stocks go up a lot, you can sell some and put the proceeds into others that have not moved. Remember, with most of these stocks, you are playing the odds, and some will soar while others will lag. It is okay to increase your position size if the results better your expectations, or if the company has bought a lot of contiguous property. This last point is usually a tip-off that management is very encouraged by what they are finding. Persistent buying by management in the open market can be a very positive clue. Canadianinsider.com reports management transactions. Periodically review your holdings and weed out disappointing holdings. Don’t let yourself be married to a dog.
Quirks in Buying or Selling Juniors
On the whole, juniors are much less liquid and have greater volatility. And because they trade mainly over-the-counter, they tend to have wide bid/asked spreads. If you are careless or impatient, you might be very disappointed with your executions. You must approach them differently than when buying a listed stock or a mutual fund. But many of you know this and very likely have your own stories to tell.
Remember, smart investing is about playing odds and doing as much as you can to turn them in your favor. Each of these points can move them more in your favor. Not every moment or even day is a good time to buy. For instance, over the past 8 years, Friday has been consistently a poor day to take a positions. You should also beware of buying on gaps, since sooner or later, they usually get filled. Some other tips: Take advantage of unusual drops in stocks you wish to buy or accumulate. This is doubly true if the volume is high for more than one day. That might mean that the stock has been downgraded by some analyst, or that an institutional holder has decided to get out pronto, for whatever reason.
You should never buy on good news, especially if the shares have had a good run immediately before the announcement. You should approach buying as though you had your eye on some retail item but were holding off until a discount temporarily knocked its price down. Also: Always place limits on your price. If you don’t get filled, sometimes you can pull the order and put it back in later.
Picking Bottoms and Tops
If you get in within 15% of the bottom, or, more importantly, out within 15% of the top, you will be doing well. A lot of this is luck and good guess-work. Remember, these stocks can be volatile, and once they start to move, the top might be fleeting and occur at a much higher price than you would expected. Finally, you should cultivate patience and discipline, sticking to your game plan. If you would like to consult with me on a personal basis, please e-mail me at firstname.lastname@example.org. Seeking the help of a professional is akin to calling an expert when your roof starts to leak. You could try the do-it-yourself approach, buying a ladder and going up in the roof yourself with supplies purchased at the local hardware store. Unfortunately, this is how many investors handle their portfolios. When it comes to gold stocks and especially the different world of juniors with their market liquidity problems and other peculiarities, most players will decide to do it themselves and usually get a price which several days later appears to be a mistake.
COKE’S FORTUNES ARE SET TO POP
The world’s leading beverage maker has lost some of its fizz. But it is likely to pop again, as it flexes its muscles in the overseas markets.
Coca-Cola may be the most recognized brand name in the world. The business of selling flavored sugar water to bottlers is a very good one, generating very high accounting returns on capital because the most important asset – the brand name – does not appear on the books. Cash flow is excellent. Coke obtains 95% of its operating profits from outside the U.S., hence is a conservative play on the growth of emerging markets like China and India.
So is the company stock cheap at 15 times earnings and a dividend yield of almost 3.5%? If the company can fulfill on its target of high single-digit earnings per share growth in today’s deflationary environment, yes. If the company does not the stock will probably be dead money but no great disaster. One analyst came up with a per share discounted cash flow appraisal of 72.50 vs. a current price of approximately 49. Bottom line is, the potential reward for the risk endured is decent.
After besting Pepsico in the cola wars OF the 1990s to become the King of Pop, Coca-Cola has encountered a more formidable opponent – the recession. A struggling economy, together with health concerns, has contributed to a further decline in soda consumption in the U.S., and depressed Coke’s profits and shares. Earnings are expected to slip 3% this year, while Coke’s stock has fallen 13% in the past 12 months, to a recent 48.
But this could be the pause that refreshes for the world’s leading beverage maker, which commands a 10% share of the global market in all non-alcoholic beverages. As in prior economic downturns, Atlanta-based Coca-Cola (ticker: KO) is using its copious cash, marketing muscle and unmatched global distribution system to take market share from rivals and strengthen its core business. Among other things, it is cutting costs and launching new products. Coke also is expanding aggressively overseas, to offset sluggish domestic volume. Volume in the $73 billion U.S. carbonated-soft-drink market fell 3% in 2008, continuing a protracted slide.
Significantly, Coke management is working to bolster the company’s sometimes-rocky relationship with Coca-Cola bottlers, who buy concentrate from the company and transform it into bottled soft drinks and juices. In a dramatic shift, the company is inking multi-year concentrate-price agreements with bottlers in the U.S., moving away from annual negotiations. Under these deals, Coke will charge bottlers a percentage of revenue generated, rather than a fixed rate per gallon bottled. Analysts say such agreements will give bottlers greater visibility and encourage them to make longer-term investments in growing the brand. “With these deals, the franchise model in the U.S. can be put on steroids,” says credit Suisse analyst Carlos Laboy.
Coke sells for just 15 times analysts’ 2009 earnings estimates and 15 times 2010 forecasts – near its lowest valuation in 20 years.
Yet, for all its formidable strengths, including what may be the best brand name in the world, Coke sells for just 15 times analysts’ 2009 earnings estimates and 15 times 2010 forecasts – near its lowest valuation in 20 years. Given the company’s significant exposure to fast-growing emerging markets, its strong balance sheet, a gold-plated brand and savvy management, Coke arguably deserves to trade at a multiple of at least 17 times forward earnings, which would imply a stock price of 56. Add a 3.4% dividend yield, and that is a potential total return of 20% based on today’s stock price.
Steven Roge of the Roge Partners Fund says he went looking for “top-notch franchises selling for once-in-a-lifetime valuations” – and reached for Coke in January. Using his discounted cash flow model, Roge estimates the company is worth 72.50 a share.
Roge is in good company. Coca-Cola is one of the largest equity holdings of Warren Buffett’s Berkshire Hathaway (BRKA), and Cherry Coke is Buffett’s favorite drink. Buffett holds 200 million of Coke’s 2.3 billion shares.
Coke gets 80% of its sales, and more than 95% of operating profits, from abroad, and is a blue-chip play on the growth in emerging markets.
Citing declining soft-drink sales in the U.S., some critics say Coke’s business is fizzling. But that ignores the company’s aggressive move into markets such as China, where volume is growing by double digits. Today Coca-Cola, first served at soda fountains in 1886 for five cents a bottle, is a staple in more than 200 countries. Coke, the company, gets 80% of its sales, and more than 95% of operating profits, from abroad, and is a blue-chip play on the growth in emerging markets.
Still, the critics have a point: The growth rate of carbonated-soft-drink, or CSD, sales peaked in 1994, according to Beverage Digest. In the years since, consumers have embraced alternatives such as bottled water and sports and performance drinks. Last year, for instance, the energy drink Red Bull saw a 5% uptick in average case volume, while volume at Coke and Pepsi fell more than 3%. Coke has added numerous soda alternatives to its beverage line-up, including Dasani water, VitaminWater and Nestea. Carbonated soft drinks today account for 78% of unit volume, down from 90% 10 years ago.
This year’s 2nd quarter marked the 8th consecutive quarter in which Coke posted volume and market-share gains in non-alcoholic, ready-to-drink beverages. The company earned a better-than-expected 92 cents a share for the latest period, on a 9% drop in revenue to $8.3 billion, as currency translation punished reported results. Coke benefited from strong income from its bottling investments and a 4% uptick in its worldwide beverage volume, led by gains of 33% in India and 14% in China. North-American volume slipped 1% but improved from the first quarter.
The latest results support analysts’ expectations for a rebound in earnings next year. The Street estimates 2010 net income of $7.6 billion, or $3.30 a share, on revenue of $32 billion, versus this year’s projected profits of $7 billion, or $3.04, on sales of $31 billion. Coca-Cola earned $7.4 billion, or $3.15 a share, in 2008, on revenue of $32 billion.
Long-term, Coke is looking to grow annual volume by 3% to 4%, revenue by 4% to 5%, operating income by 6% to 8% and earnings per share by high single digits.
Although it will not disclose exact figures, Coke is benefiting from price increases, in some markets, especially in Latin America, as well as volume growth and cost cutting. Management hopes to save an annualized $500 million by 2011, mainly in administrative costs. Share-buyback also will boost growth in earnings per share; the company is buying back $1 billion of stock this year. Long-term, Coke is looking to grow annual volume by 3% to 4%, revenue by 4% to 5%, operating income by 6% to 8% and earnings per share by high single digits.
In an interview with Barron’s, Chief Financial Officer Gary Fayard said year-to-date results are generally in line with management’s long-term goals. “If we can hit guidance in this economic environment, that is the biggest reason why we think we will be stronger,” he said.
PepsiCo bought its two largest bottlers while Coke remains glued to its franchise model.
Coca-Cola and PepsiCo generally are linked in investors’ minds, although Pepsi is a dominant snack-food player and generates more revenue, at $43 billion. It also has a smaller presence overseas. One big difference between the two is the approach each is taking with bottlers. PepsiCo paid $8 billion earlier this month to buy two of its largest bottlers, promising cost savings and growth. But Coke seems glued to its franchise model, in which it owns stakes in Coca-Cola bottlers. Chief Executive Muhtar Kent, a former bottler who joined the company in 1978, was named CEO in 2008. He is working closely with bottlers, especially Coke’s largest, Coca-Cola Enterprises (CCE), on ways to strengthen the brands and leverage marketing and distribution investments. Coke owns 35% of CCE.
Some analysts and investors seem confident Coke’s approach will pay off but note management could change course if Pepsi’s strategy is more successful. “The franchise model is better from a return-on-capital and profitability standpoint,” says Stephen Boland, an analyst at Odlum Brown. “I would prefer to see them stick with that model.”
Having bottlers who are motivated is critical for Coca-Cola, since bottlers account for 89% of worldwide sales volume. The multi-year pricing deals, begun in Latin America, were instrumental in making that region a leading growth engine for Coke, says Credit Suisse’s Laboy. He expects the company to sign more 50/50 profit agreements with bottlers for noncarbonated beverages, and thinks they will help Coke deliver “EPS growth rates of 12% to 14% over the next few years.” Laboy has an Outperform rating on the stock and a price target of 57.
Coke reported better-than-expected equity income of $310 million in the second quarter from its bottling investments, including CCE and Femsa, or Fomento Economico Mexicano (FMX), in Latin America.
The beverage business is not immune to a downturn.
The beverage business is not immune to a downturn, and a collapse in the nascent recovery could pinch Coca-Cola’s growth. And even with a truce in the cola price wars, competition from PepsiCo, which has 31% of the U.S. carbonated-soft-drink market versus 43% for Coke, remains intense. Companies like Austria’s Red Bull also are keeping the beverage giants on their toes.
“[Coke is] a China, India, Latin America story that had better work,” says Joseph Tatusko of Westport Resources. “Otherwise, the stock will likely be range-bound for years.”
CFO Fayard says the biggest risk is in currency translations, as revenue from foreign operations is translated into dollars. Coke does not hedge in emerging markets, which hurt in recent quarters. Revenue in the latest quarter took a 9% hit from currency translation, and operating income was squeezed by 14%. Management is bracing for a 12% to 14% hit in the third quarter.
Yet, making soda is not rocket science. If Kent & Co. can keep the three critical elements of Coke’s organization – products, bottlers and retailers – working smoothly to satisfy consumers’ shifting tastes, management will have gotten the formula for the company, and its shares, just right.
Insiders Continue to Sell, Sell, Sell
The ratio of sellers to buyers continues to expand.
But certain banking company insiders number among the few buyers. They must understand that the bailout money will keep coming.
We have to send a tip of the hat, to ultra popular finance blogger at Zero Hedge for alerting us to the huge number of insiders who are selling off stock in their companies.
We have noted this sort of activity over the last few months and it appears that corporate insiders are selling with increased fervor. In late April (Insiders Are Selling Into the Rally), insiders were selling at a rate of 8.3 times the amount that insiders were buying. When we revisited the issue about two months later in June (More Evidence of Skepticism from Insiders), insiders had become even more bearish as they were selling at a rate of 9 times for each insider buy.
Now, we are nearly two months later and the ratio of sellers to buyers continues to expand. In the last week, corporate insiders sold 13.6 times more than insiders bought according to information compiled by Finviz. In terms of per transaction value, the sellers are being more aggressive than the buyers as well. Of course, this is not necessarily a sign that the market is about to falter. However, it is always interesting to see what the insiders are doing because they are some of the very most informed investors. Management may be sounding an optimistic tone on many conference calls, but actions speak louder than words. Clearly, the trends are suggesting that stocks are overbought right now, and insiders are lowering their exposure to risk.
Click here to get a graphic of the recent transactions. Interesting to note, that 3 of the 10 insider buys from last week were from Bank of America (BAC) and Citi (C).
Buffett’s Recent Portfolio Changes: What Is the Message?
Sells lots of stuff, buys a few defensive stocks.
Recent Berkshire Hathaway filings reveal significant portfolio shuffling. Among stocks he jettisoned were consumer stocks Carmax and Home Depot. At the dawn of the 1982 bull market the virtually uniform and correct consensus was that consumer stocks would lead the charge. Modulo the usual market leadership ebbs and flows one would have done well just sitting on those stocks for ... well we are not sure precisely for how long, but our guess is the rest of the 1980s. In our view we are now in the exact opposite situation. The consumer is tapped out for years. Buffett’s moves are consistent with this thesis.
If you follow Mr. Buffet (BRKA) then you already know that he made some significant portfolio changes in his recent SEC filings. Now, I do not recommend following him since he has billions and “he” can afford to hold stocks forever because it is in his corporate account, which means he really is not risking his own money. However, his recent moves are very telling, in my opinion.
He sold Carmax (KMX), Home Depot (HD), ConocoPhillips (COP), Eaton (ETN) and other health insurers. First and foremost it tells me that he expects health care reform, which is not really reform it is a public option, to pass otherwise he would not have sold those health insurers. He sees through the whole cash for clunkers nonsense as it is not a long-term solution for auto sales and it also makes a statement that he feels the consumer is not coming back anytime soon.
His reduction of Home Depot is another vote for the consumer to not return in the near-term and that housing will more than likely stay stagnant for a while. By selling COP he was simply undoing a bad decision for which he took a lot of criticism for to begin with. However, if you want to read into it further, I think this means he thinks the energy trade is dead at the moment and prices are going to be flat for sometime into the future which is good news for consumers as fuel costs should remain “low” in the near-term.
His addition of Becton Dickerson (BDX) and Johnson & Johnson (JNJ) indicates two things to me. First, it means that he thinks BDX will benefit from the public option or, in the event it does not pass, that while health insurers are dangerous to own, health care stocks are not, which he is right on about. Second, JNJ is a good company that is well diversified and a defensive play, which, again, is right on for this market.
In short, I see this report as bearish as he did far more selling than buying and his buys were defensive stocks. He is buying classic defensive stocks and stocks that would clearly benefit if the healthcare reform actually passes. While I do not mimic his moves, and have no positions in any of those holdings, I think he made some pretty good calls.
Of course my opinion really does not matter, however I did find the moves of interest to how he may view the markets at this time. It looks like he is getting much more conservative even if the media is telling you to jump in with both feet in this “new bull market” which really does not exist.
Barron’s Handpicks 12 High-Quality Stocks that Could Soon Start to Rally
All have relatively low P/E ratios, decent growth outlooks and strong financial positions. Each could rise 20% in the next year, and most have dividends of 2% or more.
None of the upside targets are home run territory. On the other hand, it is time to cultivate modest expectations. And the companies are indeed high-quality.
(1) Abbott Laboratories (ABT): The pharmaceutical firm has a diversified business mix, and unlike many other drug companies, it is still a growth stock. Sales of its top drug, Humira, could rise 20% this year and 15% or more in 2010. The stock could hit $55 within a year, up from a recent $44.36.
(2) AT&T (T): AT&T has much to gain from its exclusive relationship with Apple’s iPhone. There are signs that wire-line losses may be moderating while wireless revenue continues to grow. AT&T’s P/E ratio based on its cash earnings, excluding goodwill impact, is just 10 and the stock yields 6.4%. The stock could reach $32 vs. a recent $25.45.
(3) Berkshire Hathaway (BRK.A): The company is leaving the recession in good shape and some smart investments, including in Goldman Sachs and General Electric, are producing nice yields. Berkshire should also get a boost from a housing recovery since many of its wholly owned businesses are linked to the housing market. Shares could reach $125,000 in a year vs. a recent $101,400.
(4) Comcast (CMCSA): The firm is seeing moderate revenue growth despite competition. Capital spending is down, free cash flow is up and Comcast is starting to buy back stock. Shares could reach $20 in a year vs. a recent $14.81.
(5) Exxon Mobil (XOM): Exxon is the industry leader and has high returns, a strong balance sheet, good management and stable earnings. The stock does not look cheap but the premium on Exxon shares has fallen and a forward P/E of 10 is not bad for such a top-notch company.
(6) Microsoft (MSFT): Microsoft continues to dominate the desktop, despite increased competition from Google (GOOG). The company has plenty of free cash flow and lots of room to trim costs. The stock could break $30 in the next year, up from a recent $23.70. [However, see “Microsoft: Whistling in the Dark” immediately below.]
(7) Nestle (NSRGY.PK): The food company has high sales and one of the best growth outlooks in the sector. Its U.S. shares could reach $48 from a recent $39.41.
(8) Novartis (NVS): The company has a strong pipeline of new drugs that will help compensate for some key patent expiries in 2011 and 2012. Shares have a dividend yield of 3.8% and a low P/E of around 12 times this year’s estimated earnings.
(9) PepsiCo (PEP): The firm closed a recent $8 billion deal to buy out public shareholders of two of its bottlers, and the outlook is good for snack foods, which generate over 50% of the company’s profits. Shares could rise to $71 from a recent $56.56. Rival Coca-Cola (KO) looks attractive too. [See above.]
(10) Procter & Gamble (PG): The company has struggled a bit in the recession but still has an impressive brand portfolio and good overseas growth prospects. P&G can probably provide high single-digit EPS growth in the long term. The stock carries a 3.2% dividend.
(11) Safeway (SWY): The grocer has been hurt by cost-conscious consumers and a deflation in dairy products and fresh produce. But at just 11 times this year’s estimated earnings and trading at little more than book value, the stock looks attractive. Bulls think shares could hit $25 in the next year vs. a recent $18.78.
(12) Wal-Mart (WMT): Wal-Mart is the country’s biggest and best-run large retailer. Management has grown more shareholder-friendly and the company has freed up money for a large share-buyback program. The company is an above-average retailer but trades at a discount to many of its peers. Shares could reach $62 in the next year vs. a recent $51.79.
Microsoft: Whistling in the Dark
Hold off on buying MSFT on weakness.
Our past contempt for Microsoft is unrestained, but we are not looking forward to a world dominated by Apple and Google either. Robin Bloor, writing on Seeking Alpha, says the Microsoft’s lunch is being eaten by those two companies. The biggest defect in Microsoft’s strategy is that it has no effective counter to the iPhone. Just as the PC eroded or destroyed the market for minicomputers and mainframes, the PC industry is being “eaten from below” by the likes of the iPhone. “The coup de grâce here will be the Apple tablet ... a big bad iPhone. It will start to consume the laptop market from the get-go. It will be what the Netbook should have been, but never was.”
Bloor’s conclusion: “A new market is about to emerge. Microsoft could have been there and should have been there, but it got complacent – and now it’s nowhere. Arrogance is the curse.” The Windows franchise will be a nice cash cow in a mature industry. But if maturity gives way to decline one had better have a good grip on how fast the decline and how the cash will be reinvested before buying the stock.
Recently, Steve Ballmer got all loquacious at a meeting with financial analysts, many of whom were using Apple laptops. He was moved to comment on the preponderance of Macbooks, referring to Apple as “a fine company” that was prospering from a “low-volume, high-price strategy.” He then proclaimed that Microsoft had not lost market share to Apple over the past year and any changes in the reported market share numbers were a rounding error.
Nobody needed to butt in and tell him that his statistical skills needed a little polishing, because he contradicted himself in the next sentence by saying that “market share gains by Apple cost Microsoft nothing” and “hopefully we’ll take share back from Apple.”
Ballmer is whistling in the dark. Microsoft’s revenues collapsed 17% in the last quarter, mostly from the decline in Windows revenues, while Apple still managed to post growth in Mac sales – albeit of a modest 4%. Meanwhile the iPhone was taking off like a rocket.
The tendency of CEOs whose companies are in trouble to become suddenly inept with statistics is legendary, but it is not in a CEO’s nature to stand up and proclaim “the competition is killing us.” But that is what is happening to Microsoft. Competition is killing it.
The twin threats of Apple and Google are gradually bringing Microsoft to its knees. Microsoft works fine as a monopoly and it has been skilled in maintaining its monopoly with intelligent and innovative monopolistic practices. But it is no longer good at competing outside its monopolistic domain.
It was once a skilled marketeer and public relations ringmaster, but no longer. You do not need marketing skills to maintain a monopoly, so they atrophy. It was once even an innovator in some respects, although innovation has never been its forté. Microsoft’s business model always placed the highest priority on market share and innovation is not a great contributor to building market share. With Microsoft it was mostly about bundling and the drag-along of monopoly power. ...
Barron’s Interviews T. Rowe Price’s Joe Milano
T. Rowe Price New America Growth Fund portfolio manager has a few ideas.
Barron’s has pulled most of their content for non-subscribers, but some helpful people continue to offer article summaries. This one summarizes an interview with Joe Milano, portfolio manager of one of T. Rowe Price’s mutual funds. Milano is on the hunt for growth but professes some contrarian leanings.
Its harder to find good growth stocks after the recent rally. Monsanto’s (MON) stock is down because it is out of favor but it is still a growth company [a company with despicable morals, but a growing one] and Milano likes its prospects. About 25% of the fund’s portfolio is out-of-favor stocks.
In October/November 2008, Milano upgraded the quality of the portfolio, picking up stocks like Apple (AAPL) and Research in Motion (RIMM). He also picked up Priceline.com (PCLN). Milano expected the stocks to do well in 2010 but was surprised to see growth sooner than expected. Going forward, Milano expects to be much more selective about which stocks he includes.
High-quality names are what accounted for the fund’s underperformance in the fall, but Milano would not have sold the high-quality names anyway. It is important though to look at the big picture and be prepared for crazy things to happen.
Milano is optimistic short-term but more subdued long-term. In the short-term, any return towards normal will mean some growth. Long-term, Milano sees the need to be realistic, which means expecting several years of slower growth and a changing consumer attitude.
In terms of consumer names, look for companies that have a compelling product and are taking market share. Examples include Apple and Research in Motion, but also Wal-Mart (WMT) and Carnival (CCL), which both offer good value.
In health-care, the fund holds several dental firms, including Henry Schein (HSIC) and Dentsply (XRAY). Milano sees good long-term demographics for the dental industry. Also in health-care: Medco Health Solutions (MHS). The stock is not overly-cheap but Milano is willing to pay up front for legitimate growth prospects because “the power of growth investing is compounding.”
Milano views Electronic Arts (ERTS) as a consumer stock, even though many others see it as a technology stock. “Electronic Arts is pretty much hated by everyone” and lost money last year. However, they have new management, have cut costs, it is a great consumer-franchise company and Milano is “always on the hunt for names that other growth managers shun.”
“I think China will continue to pull the global market up in its wake.”
For those wanting to play the China bubble (see “‘Bubble-Mania’ in Shanghai Spreads to Global Markets”), Jim Lowell, chief investment strategist of Adviser Investments and the editor of Fidelity Investor and Forbes ETF Advisor, has some vehicles for such a speculation. Examples: Claymore/AlphaShares China Real Estate (symbol: TAO – cute) and the PowerShares Golden Dragon Halter USX China (PGJ), which holds 120 U.S.-listed stocks that derive the majority of their revenue from China. He recommends getting out of the iShares FTSE/Xinhua China 25 (FXI) ETF.
Our advice: Have some rule, any rule, for when to get out – stop losses, a call from your favorite investment newsletter writer, your own system ... whatever.
Is this global rally for real? Has Obama’s stimulus kicked in, and is the U.S. recovery under way? While we wait for confirmation, China, home to the world’s third-largest economy and second-largest stock market by value, already has its stimulus wind at its back. Of the world’s 10 largest economies, it is the only one that has begun to grow again.
Since March the S&P 500 is up 43%. China’s Shanghai Composite is up 57%. But I am not taking profits. I think China will continue to pull the global market up in its wake, and I have made some big ETF bets on it. ...
Too Early for Housing Price Stabilization
It is far too early for housing price stabilization. There is simply too much inventory relative to sales. The reported “green shoots” are a mirage.
Here are a couple of charts from a recent Contrary Investor that shows the problem. ...
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