When I look back at my writing, my estimation of the recession, recovery was flawed in two major ways:
- I underestimated the amount & duration the market would move against the Fed & the government during the panic phase
- I underestimated the amount & duration the market would move, responding to stimulus & recovery
Ultimately, of course, the stimulus & emergency measures taken by the Federal Reserve & government didn’t halt the decline; it was the removal of mark-to-market accounting. So: the market knows what’s important…
The prevailing question to those like myself who are underweight equities: the S&P 500 is up 75% from its cycle lows. Have we missed the boat?
Has the pilot executed a perfect landing?
Nassim Taleb equated correctly tuning the economy for recovery to landing a 747 between the mountain & sea on a very short run-way.
Let’s consider our current economic context:
Job losses have peaked, and we are once again heading into positive territory. The rate of NFP change has been been historically very sticky to the prevailing trend. Although I would not rule out a negative NFP in this cycle, I suspect that some very strong positive releases are coming in the next 6 months. I even expect it to be strong enough to take the unemployment rate down – perhaps to 9% by the end of the year.
2009 was still brutal for corporate earnings. S&P 500 earnings require a +47% move to match their 2006 peak. Consider a selection of multiples:
Also, consider the companies still in the red: BAC, C, BK, PNC, MET…
Valuations and earnings are all over the place. As a whole, the largest stocks are positioned aggressively for growth, but many stocks could see a sharp earnings recovery & subsequent share price lift. I would look for 2010 EPS for 70 or better – giving a forward P/E of 17.
This is already priced into many stocks, but probably not into many financial stocks in particular.
So: the great battle between inflationary and deflationary forces seems to have tipped over to the side of growth & risk. Massive co-ordinated efforts globally by both government and central banks have saved the capital markets from a 1929-1933 style cliff-dive.
This isn’t sustainable. A Keynesian response is leading to awful mal-investment from every sector: governments (particularly the American government, pissing their productivity away with health-care, taxes & inflation, and spending their stimulus dollars on stemming the tide, maintaining the energy dependent status quo, and not building out new infrastructure for the future), central banks (liabilities taken on during the waterfall decline), people (buying new cars & houses they can barely afford) & investors (buying stocks & bonds at prices that ultimately will fall prey to deflation).
Generally, I think we can expect longer busts, and shorter booms. We’re in a boom, until the awful foundation of mal-investment & energy structure pulls us back into the flames.
What’s left to buy?
I am overweight institutions that stand to gain the most from a recovery that haven’t quite seen the effects on their balance sheet yet. Apart from the usual things I like, I think a possible list of candidates are:
- Financial institutions in the red: BAC, C, BK, PNC, MET
- Natural gas
- Short long treasury yields
I just want to make sure that I’m ready to jump off the train…
Although I didn’t place my first trade until a few years later, I wrote & backtested my first trading system some time around 1998. My father & his three brothers were all actively trading the bubbling dot-com boom. My father, the cynic, successfully forecasted the dot-com bust, and the subsequent crash in global equities. In late 1999, my father & I went to our TD Bank financial advisor to liquidate the mutual funds my family had put away for my education. The advisor not only attempted to convince us out of it, but recommended to my father that he re-mortgage his house, and invest the proceeds in the stock market.
As the market topped and came crashing down, my father bought Dow futures puts. He cited many of the same concerns that we’ve heard more recently: the spread between Eastern & Western/developing & developed standard of living was too wide, our outsourced manufacturing replaced with current account, government & private sector deficits, and the over financialisation of the economy.
He was right on every count. His puts made a tonne of money.
Ultimately, my father thought that our Western economy was trapped in a death spiral, and that the stock market was going much lower. He was probably right about the former, but he continued to hold his puts through the recovery, and negated the winnings he made on the way down. That was his evolution into a perma-bear.
There are a couple of problems with the perma-bear scenario. The principle arguments revolve around indebtness & the standard of living (perhaps around cars). Here’s the thing: if the equity markets gave a single greenish-brown floater about the plight of the common man, we’d be in a 40 year bear market. Every facet of American life is inferior with the exception of technology: the quality of our food, our disposable income, the cost of energy, our moral superiority, our economic prospects, the number of hours we work, our buying power…
How can all of those things decline — and in some cases, fall off a cliff — while the market posts 9% yearly returns?
The answer is that the economy changes. Stock market prices are a simple combination of available capital, an appetite for risk, and corporate earnings. Where the common man loses in quality of food, or disposable income, corporate earnings can gain. As long as the central bank keeps printing money (which it does), there will never be a long shortages of capital. This leaves us with the most important factor: appetite for risk. That’s all that really matters.
The conclusion isn’t that the equities are going to 0: I think it’s more correct to say that our booms are getting shorter, and our busts are prolonged.
9 years after my father & I went to our TD Bank financial advisor to liquidate my mutual funds, I shorted stocks, and bought precious metals because everything I knew about the financial world was ending. The spread between the developing & developed standard of livings had finally reached the tipping point. The current account imbalances, debt balloon and financialisation of the economy had finally boiled over. Our global currency system was irreparably broken.
My father has since reconciled with the up-side. It took me until June of 2009 before I jumped back into equities. Even now, my exposure is pretty low: I own a few equities, but mostly write some options & wait for the chaos to return so I can do what is more intellectually comforting to me: shorting the spread between the East and the West. I have that nagging feeling, though: am I now a perma-bear? Like father like son?
Well, at least on the last part: definitely.
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- Birth of the Perma-Bear
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- Global Market Overview
- Themes & Forces for 4Q
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- State of the Global Markets
- Another Bounce To Buy
- Answer Unclear; Try Again