Buy Bonds, Sell Stocks

In Ken Norquay's Section of Tech Talk, Ken suggests that it is not a good time to own stocks. It is a good time to own bonds. This is a reactino to yesterday's $1.2T policy change:

This article describes the awkward corner into which the stock market has backed big US pension funds. They are over-weighted in stocks and their 10-year return is negative. They are hoping to quietly bail out of the stock market and accumulate safer, higher yielding long term treasury bonds. These giants like to move slowly and steadily from one asset class to another. They don’t want to rock the boat.

But today the US government announced that THEY would be buying long term US treasury bonds too. Ouch! Apparently the US Federal reserve board doesn’t mind rocking the boat when they are trying to save their economy. Now what will those pension managers do?

Here’s one possibility: they will accelerate their selling of their giant stock portfolios and accelerate their buying of long term US treasury bonds.

Remember how sharply the US stock market dropped in Sept-Oct-Nov 2008? Remember how sharply US treasury bonds went up in Nov-Dec 2008? 2009 could turn out to be a good year to own bonds and another not-so-good year to own stocks.

Here is the source.

Comments:
"Don't fight the Fed" is a truism that applies today. It may not apply a few months from now if (most likely when) it turns out that the Fed's action to save both the U.S., and effectively the global economy, fails.

Investors need to work on what we know today, and to re-evaluate the validity of our investment plan. In my case, TLT (long TBT) is no longer a short sale, since the demand for long-term US bonds now exists. The perception that inflation will rise will also change the short-term view of the market, too.

This is a must read: Bernanke Inserts Gun In Mouth

Peter Schiff Responds

Mish wrote a piece entitled "Schiff was Wrong." Schiff responded.

The full response is here.

I have taken parts of his response, below. In bold are points that are pertinent for investors.

<... ... >

"First of all, the hyper inflation issue is a straw man at best. While I often talk about the possibility of hyper inflation, I have always said that it would be a worse-case scenario that would play out over many years. The fact that it did not appear in the first year of the economic crash (2008) does not invalidate my position. I have always maintained that this worst-case scenario will likely be avoided by what will ultimately be a dramatic shift in policy once our leaders come to their senses. However, until then the dollar will likely lose a substantial portion of its value."

..."My actual forecast in my book "Crash Proof" was that the Dollar Index would fall to 40 (currently about 85), with a realistic worst case scenario, assuming very high but not hyper inflation, of 20 or lower."

"Third, the blogger points out that because the decoupling theory (foreign economies improving while the U.S. falters) that I wrote about in "Crash Proof" has yet to occur, that the theory itself was ridiculous. In my book I wrote that this process would not occur overnight, that initially our creditors would come to our aid, and in so doing our problems would become manifest abroad. I wrote that it would take time for the world to realize that what had been decoupled from the economic train was not the engine but the caboose. In fact, that is precisely the way it is playing out."

..."Central to the argument that my investment thesis is wrong is the belief that the crisis is over or that the recent trends will continue until it is. But the crisis is just beginning and the movements thus far in the dollar, commodities, and foreign stocks, are mere head fakes. "

..."to look only at the performance of foreign stocks, while ignoring other aspects of my investment strategy only tells part of the story. What about gold, foreign bonds, short positions in financials, home builders and subprime mortgages (or merely avoiding long exposure to those sectors), or other investments people have made, either at Euro Pacific or elsewhere based on my insights? What about dividends earned, or gains realized on closed positions?

Mainstream economists, journalists, and investment professionals have never liked my message and have never resisted the temptation to shoot the messenger. When my investment strategies were performing well, I got little credit for it. Instead, all the attention was focused on the apparent failure of my dire economic predictions to materialize. Now that the economy is collapsing along the lines that I correctly forecast, criticism is being focused on the recent poor performance of my investment strategy (a fact that I have never tried to hide). Of course by the time my investment strategy is once again in step with my economic forecasts, an event that I believe will occur sooner than most people think, it will likely be too late for most people to do adopt it."

Comments and Additional Notes:

US Bonds & US Dollar
So far, the US dollar has shown remarkable resilience. Why? The currency is simply more attractive than the other currencies, most notably the Euro and the British pound. On a relative basis, however, the massive money flow from Asia to US is showing up in the currency market. The US dollar has weakened against the Yen since the numerous bailouts have been announced since August. One trend that can be forecast with confidence is that the size of the US debt (and especially debt as a percentage of GDP) will continue to balloon.

Investors may benefit from this by buying TBT or short selling TLT.

Commodities
Many traders have been calling for a "bottom" for this sector, but it has not happened yet. Investors should know that such calls are impossible, for a bottom won't be known until after it has occurred. One might want to use the currency market as a guide of any sort in this matter. The US/Canadian exchange rate has favored the US currency. Remember, the world sees Canada as a resource market. Fundamentally, the sector should be avoided. More specifically, certain companies should be avoided for now, especially those who made massive purchases based on higher commodity prices. Rio Tinto, for example, purchased Alcan Aluminum, and has lost 80% of its value from its peak.

Even without the weight of expensive takeovers, the commodity prices have hampered earnings. Aloca, for example, reported poor earnings due to a 35% decline in the price of aluminium in the past quarter.

General Investing Strategy
I have written frequently that a defensive strategy involves actively doing nothing. There will be nice trading days due to "Obamerama," but if the value of assets is shrinking, investors still need to put in the work to determine the best sectors, and stocks, to invest in.

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Market Recovery in 2nd Half 2009

There have been some predictions from professional analysts who claim that there will be a recovery in the stock market. This is contingent on a "relief" plan by President-elect Obama to the tune of 1 Trillion dollars (I suddenly get a flashback of the Austin Powers scene where Dr. Evil asks for 1 Trillion zillion billion billion dollars).

There is no doubt that printing money will result in the stock markets moving higher. The money must be moved somewhere. The market cannot sustain having so much money flood the markets. This boost will be very short term. Perhaps 2009 is the year of a stock market rebound, but we should all know by now that nothing in life is free. If it is free, there is a catch to it.

If it's too good to be true, it probably is.

Peter Schiff has a very good argument on what will happen to the U.S. Treasury market (currently in a mini-bubble):



Another video. I wanted to post it because I like the music, too:

http://www.youtube.com/watch?v=uTkAnp1-dK4

What to do When Bad News Gets Worse?

I have a short story about cash being king. In November last year, I was in line at a bank to cash out matured savings bonds. The ticker prices were scrolling across the LED board. Citigroup had corrected to $14 (from $20) the last few weeks. In that month, the markets had only anticipated losses in the subprime arena. Business Week already speculated greater losses in other areas of lending, but that was not yet revealed. A thought had come to mind for me to use the cash proceeds to buy Citigroup.

Why?

Any experienced investor will know that cash is perceived as boring and unproductive in a portfolio. From an emotion standpoint, it is difficult to do nothing, to sit on cash, and to not invest in something in hopes of producing a higher return.

We all know the story now about Citi. Losses continued to mount, and housing prices continued to fall throughout 2008.

A year has passed since I passed this trade. The economic fundamentals are still terrible, and momentum is still building even faster now in what appears to be the worst economic storm for all eternity (well, at least as long as capitalism existed)! Does this mean that investors should be holding all cash? With the U.S. now at 0% interest rates, there is no more room for the government to lower the cost of borrowing. Its only option now is to buy up distressed debt and to spend a substantial amount next year.

Investors need to foresee the consequences of all of this:

• Tax rates must rise (the city of New York is already seeing this happen)
• The US dollar must collapse (it is already correcting) - see chart
• Gold will rise speculatively - a new bubble might form here...why? Because the only thing more attractive than the US dollar is gold (and no other currency)
• Various industries still need to fall, unfortunately (auto, housing, banking)

My investment strategy therefore remains the same:

• Cash is more than king, especially when we are in a deflationary environment
• Gold will still rally (but in a deflationary environment, money will eventually need to find a better place to be than this commodity)
• At some small, almost random point in time, something new will emerge. Identify it, and invest in it.

It is only now that I am starting to value the idea of having a money manager. Pay for someone to identify a trend (seasonal analysis) or a company/sector (fundamental analysis), and to time it correctly via basic technical analysis.

Banking Credit Illiquidity Now Global

The illiquidity problem taking place in the U.S. has now spread to Europe. Two things now must happen for liquidity to be restored in the banking system at a global level. One: the U.S.will need to take a secondary drastic but convincing step in restoring confidence. Two: European leaders must work together (not independently from one another) to come up with a concerted effort to restore liquidity.

The chances have increased that the EU will have to lower its interest rates. The US will likely do so on Oct 27th. 

Indicators

Two things to monitor in today's markets: volatility (VIX) , and the US dollar. As mentioned in Tech Talk, capitulation has not yet been reached. The VIX spiked over 35, but volumes must be far higher than average over the next trading sessions whilst VIX settles to 35 and below.

Monitor the US Dollar, as the dollar's strength is now leading the price of commodities, namely weaker oil and gold.

Fibonacci @ 38.2% represents the support level for VIX:

USD support is @ 78.87 (not far from the 81.73 close).

Charts from: http://stockcharts.com/charts/gallery.html?$USD

Important note: support prices as outlined on the charts are very speculative. Fundamentals are poor for the global financial markets. For now, price support levels should only be used as a guide.

Toronto Real Estate Prices Finally Fall

National Post announced the housing boom in Toronto is finally over, because average prices have fallen for the first time in 12 years. Here are the figures from TREB (The Toronto Real Estate Board):

• Average prices fell to $393,647 year-over-year in September 2008
• Sales were down 6% from a year ago, and down 11% in Toronto
• Housing "supply" increased 19% year-over-year to 16,236
• Days on the Market increased to 36 days, from 31 (year-over-year)
• 905 sales declined 3% (to 3,878) but average price increased to $352,071 from $351,641
  

Analysis:

• 2007 was a strong year, so the figures illustrating the decline are exaggerated
• A month-over-month comparison is required to get a truer picture of the health of Toronto real estate
• Using averages is too broad: median home sale prices and an analysis

Some counter-figures:

• For Central "C" area month-over-month average prices increased 6.2% from August to September, and median prices increased 12.2%
• For Central "C" area year-over-year (Sep 08 vs Sep 07) average prices declined 7.5%, and median prices declined 2.4%
  

One thing is for certain: the days for bidding wars is long over. I find it hard to perceive buyers over-bidding for homes when the supply has increased.

Risks are increasing that the Toronto housing market will falter further, the longer the U.S. economy struggles. Ontario (and global countries, already facing substantial housing bursts) is not special and therefore not immune to the weak US economy. In short, the U.S. is an important trading partner for this province.

Lower home prices is simply good news for the buyer who is not willing to devote a large pay cheque to paying down monthly mortgage payments.

Raw Material and Commodity Prices Falling. Buy These Stocks

There is a stealth bull market brewing. FSX Players take note. Companies that benefit from lower grain prices, like General Mills, is performing well. In Canada, George Weston rallied back. It's quietly clear that the market is betting the bailout will result in dis-inflation and slower growth. Again, watch the US Dollar, gold and oil prices, and stocks like Potash.

Assessing the U.S. Economy After Any "Bailout"

The $700B bailout is hogging the news headlines and is, quite frankly, a distraction. This plan will not save the housing market nor prevent the likelihood of the U.S. entering a recession. Still, some plan is required to restore confidence in the banking system. The free market cannot function without a frozen banking sector.

Here are some recent figures illustrating economic health in September:

• ISM Manufacturing Index was 43.5 (down from 49.9 in August) - a figure below 50 represents a contraction
• Unemployment benefits +1,000 last week to a seasonally adjusted 497,000, above expectations for a 475,000 increase (highest seen since Sept. 11, 2001)

The wild trading swings over the past week will make any technical analysis less than useful. Volatility reached significant highs, meaning the direction of the stock market is neither in an up- nor down-trend.

On a more positive note, the US dollar is holding previous rallies. This suggests that foreigners are still willing to place their money in US treasuries. Commodity prices (gold and oil) fell significantly, which may have helped propped the USD.

The USD traded above the $78.08 level. This level now represents a support price.


GE represents the health of the US economy. If it is reaching multi-year lows, that cannot be a good sign of strength:


No sector has been safe in the last few massive sell-offs. It is disturbing that the commodities sector did not hold up, nor did gold.

Cash is king, but a rescue plan that causes inflation will cause its value to deteriorate. What does the investor do next? It's best to first monitor the details of rescue plan before making assumptions.

Seeing Beyond the $700B Smoke of Distraction

I found a great counter-argument to the market's assumption that the stock market is still healthy. I, personally, am having difficulty assuming the markets will rally between November and April (on seasonal strength). The current smoke screen investors are facing is the 700B bailout making its way through congress.

Let's look at the figures to see beyond today's headlines.

In the U.S. for August, 2008:

• Durable goods orders declined 4.5% .. Source: @ http://www.census.gov/indicator/www/m3/adv/pdf/durgd.pdf

• Fresh claims for unemployment benefits jumped sharply to 493,000 (it last reached the 500,000 mark in September 2001)
• Even after adjusting 50,000 jobless claims (hurricane Ike), the 4-week average of 443,000 claims was last reached November, 2001
• new home sales plunged by 11.5 percent in August, (1 percent dip that had been expected). Annual seasonally adjusted annual sales rate of 460,000 is the slowest pace since January 1991
• The average price of a new home fell in August by 11.8 percent to $263,900, the biggest one-month drop on record
• The median home price was down 5.5 percent to $221,900.

Sources:
http://seekingalpha.com/article/97377-the-perfect-storm-even-with-bailout-economy-is-hurting

http://news.yahoo.com/s/ap/20080925/ap_on_bi_ge/economy;_ylt=AkeTtzMaEZ4Qh04Yh.1sAi5u24cA

It remains clear that although I believe by sentiment that the markets will stabilize or even rally, the fundamentals are not there yet for a sustained rally.

I am really torn as an investor and as an analyst: the market is more ripe for short-term trading than for value investors who like to buy and hold. It is for this reason that one might find my notes contradictory from one entry to the next.

The market simply needs to hope that the government bailout action will at the very least restore liquidity in the debt markets in the face of declining employment, lower home prices, and higher commodity prices.

Notes on Matt Blackman's Trade System Guru Newsletter:

http://tradesystemguru.com/content/blogcategory/34/68/

Week of September 22 2008

• “As a group, 17 or the 19 stocks for which naked shorting was banned jumped nearly 20% in the three-day period (July 15-18)!” Unfortunately, this rally was short-lived.
  
  In other words, the last SEC action generated nothing more than a short squeeze where prices were temporarily driven higher by short covering. Prices then continued to fall putting in lower lows.
• There was a net loss of more than $70 billion (net sale of Treasuries) during the July low in stock markets. More concerning, the orange linear regression trend line remains strongly negative and the sales remain below the yellow dashed line that shows the approximate amount that the US Treasury must raise each month just to pay off last year's budget deficit – a deficit that has skyrocketed with all the bailouts announced so far this year! Falling purchases of Treasuries has the potential to put strong upward pressure on interest rates if it continues.

Furthermore, Matt's summary view on the market is the same as mine:

• Until there is a significant turnaround in earnings, the housing market firms and economies start growing again, any recovery will be short-lived.

Comments and Analysis:
The trading on Monday was disappointing: there was no upward follow-through, which means the market is not confident the $700B bailout will succeed. The US Government has a monumental yet simple task it needs to accomplish: convince the world that it can restore credit liquidity and be able to back it.

The huge (historic) drop in the US Dollar led to a rise in gold and oil prices. The latter will undermine consumer confidence and therefore my call to take a long on the consumer goods sector.

Eyes on the US Dollar. Buy Gold

AIG is the most recent bailout that will cost the U.S. 85 Billion. It's a big number, but in the grand scheme of things, the cost is not unreasonable. In fact, the government might even be able to make a profit from this "investment" a few years down the road. The reward of bailing out AIG is far higher than the risk of global-wide credit market liquidity.

In the short-term, the global reaction to the costs incurred by the U.S. Government need to be monitored. How? Monitor the U.S. dollar. As I had remarked in a previous entry, the USD rallied gallantly, but a sell-signal was recently triggered. My initial short-term price support target for the USD is 77.07.

To profit from this short-term trend, buy gold. It rallied 9% yesterday.

How to Profit from a Stronger US Dollar

The US Dollar's strength over the past two months has held strong. This is due to the market realizing that the US is not the only country facing slower growth. Worse is that Europe, India, and China are also facing even slower growth than that of the U.S. (from a growth deceleration perspective).


To profit from the inflow of foreign investors into the U.S., investors should be long on the US 20-year treasury bill. Boring yes, but profitable as well.
Chart Source: http://stockcharts.com/charts/gallery.html?$TLT

While the most recent rally might be at risk of pulling back, investors should consider entering TLT on a close above $96.

Note: Credit should be given to Iain Fraser for recommending TLT several months ago on DV tech talk.

Watch Gold and Oil

It turns out yesterday's entry on gold proved timely. Gold rallied +$16.90 to close at $831.50. Barrick Gold rose almost 6%. Not a bad profit if one bought yesterday. It seems that bargain hunters are starting to place bets for a rally in the commodities market.


Next, again, for discussion is oil. Is lower oil a good indicator for higher stock prices? What about a stronger US dollar against the Euro? According to Business Week magazine, if oil prices fall, due to lower demand and the Euro weakens, it could only mean weakness in economies outside of North America: Europe and Asia. This is very bad news for international US companies.

Most recently, GDP figures were reported but did not indicate the U.S. was in a recession. Those numbers were supported by strong export demand. Investors will now have to worry about the impact of a weak European economy for US large cap internationals.

Let's Make Money
It is important to avoid making comments and observations in short-term directions for stocks. It has been great for day-trading, but the goal of this site is to identify longer term fundamental and technical trends. The site is not there yet.
The trends that can be identified may be summarized as follows:

• Oil and Gold prices have corrected, but it is uncertain which way they will move
• Avoid home builder, homes, REITs and anything that has to do with the housing sector
  
• Avoid U.S. banks, mortgages finance providers and insurance

It will soon be time to start imagining where the sentiment for consumers will be after the Olympics and during the U.S. presidential elections. Again, I point back to the August 18th issue of Business week. There was an informative article that argued that neither candidate had the power to follow through with election promises (due to the U.S. government debt levels).