Tuesday, May 7, 2013

Who is John Galt? A Capital Strike May be in the Offing.

During the past week the stock market hit several milestones, and everyone appears to be giddy with the improvements in their portfolio values over the past few years. Given this happy state of affairs, it seems timely to take a look at some other signals the market is communicating to us.

The price of gold gets a lot of headlines--more headlines than it deserves in my estimation. It is a non-productive asset, therefore it has very little intrinsic value. Its value ultimately depends on the opinion of the available buyers, much like artwork. I believe the price of gold conveys very little worthwhile information most of the time.

Copper is a different story. This reddish metal can be found in a multitude of finished goods throughout the economy. Pounds of it can be found in every automobile and commercial vehicle, in every commercial and residential building and even in the microprocessors in your computer and cell phone. This ultimate in industrial metals is often called Dr. Copper to those on Wall Street, because it is said to have a PhD in Economics. The price change in copper conveys a great deal of information on the direction of the economy. If you super-impose a copper-price chart over a chart of U.S. or global GDP, you will see that copper is pretty good predictor of economic activity 6-9 months ahead of time. Although copper rallied nearly 8% this week, it has declined about 26% since its mid-2011 high and is down 14% in the past 12 months.

Confirming copper's move are a host of industrial metals-- hot-rolled steel has declined 35% in the past 2 years, nickel prices are down approximately 20% over the same time period, aluminum prices are down about 18% over the past 12 months, and on and on.

The call on these economic commodities are driven by global economic activity. With much of the European continent's economic activity flat-lining or contracting for the past 5 years and with U.S. activity limping along at sub-2% growth over the same time period, any substantive growth in global activity has been driven by the Chinese and those countries largely driven by the production of industrial commodities that are sold to the Chinese. China has been the all-powerful marginal buyer of nearly all raw goods during the last decade, and recently their economy has given the world notable signals of diminishing demand for industrial commodities. The Chinese recently reported first quarter GDP growth of 7.7%, which was well below expectations of 8% and a significant climb-down from a nearly 10% reading as recently as first quarter 2011.

Since it is clear by the above arguments that U.S. stock investors cannot depend on the big foreign markets to provide them with meaningful growth in the near-term, it appears that it is up to the 'animal spirits' of our domestic companies to create new products, new markets, and new demand. How have these great domestic capitalist practicians conducted themselves recently. In the fourth quarter of 2012, the aggregate cash balances of the non-financial members of the S&P 500 hit a record of $1.27 trillion; as of March 2013, there are $1.8 trillion in excess deposits at the Federal Reserve Bank. Both are record amounts. These statistics suggest record levels of risk capital available to the most sophisticated and successful deployers of such capital, and by all outward observations, they are refusing to do so.

Meanwhile, more than half-way through company earnings reports for the first quarter, we are seeing a significant deterioration in their quality. While greater than half of the S&P 500 have beaten their earnings expectations, a majority of the company's have missed their revenue expectations and most companies that do provide Wall Street with guidance have lowered it for the rest of the year. Indeed, so far in the first quarter, U.S. company revenues are down 0.3% compared with last year

I believe the reason for the lack of capital deployment (i.e. the 'Capital Strike') has a lot to do with acceleration in the implementation of the massive regulatory laws enacted several years ago. Only now are financial institutions having to respond to the regulatory stranglehold that is the Dodd-Frank financial regulatory framework. The deadlines for the roll-out the law's various components are continually pushed out, so its strangling effects on capital deployment will continue to constrict for many years. The other law that is just being implemented is the Affordable Care Act, and its effects will continue to be felt through lower labor force participation rates (63.3%--a 34 year low).

All these issues do not bode well for corporate profits, and with the S&P 500 already trading at 16 times the 2013 consensus earnings estimates, stocks are fairly valued. Once the newly lowered 2013 earnings guidance gets factored into the aggregate S&P 500 EPS number, investors may decide that the index is richly valued, given the lack of meaningful earnings growth vs. 2011 and the deteriorating economic prospects that the commodity price action above portends. The increasingly brittle reed of Fed-induced miniscule interests rates is the only legitimate fundamental reason for investors maintaining current equity positions. However, you can only balance a stool on one leg for so long.

My advice would be to short those stocks that are most vulnerable to the continued Capital Strike. These are generally found among the NASDAQ 100. Try QIB--double short QQQ ETF. At worst, this ETF provides a hedge against the crowded trade into these stocks by most of the fund managers that are investing your 401k or mutual fund assets.

Raise cash to at least 20% of your total portfolio and do not own any fixed income securities with greater than 2 years to maturity, because when the Fed begins the Great Unwind of all its QE stimulation, those portfolios heavily weighted toward intermediate to long term fixed income securities will be quickly decimated.

Finally, I would only own stocks that trade less than 2 times their book value, or have a sustainable dividend yield of greater than 3% (payout ratio less than 50%). Deep value stocks have historically held up well in severe bond bear markets, and the initial break of 'trendy stock euphoria'. Those stocks with significant and sustainable dividends that are positioned to continue growing are another group that will hold their value well. For all other stock classifications, I would recommend taking profits now. I promise you, you will not go broke employing these strategies.

Sunday, September 19, 2010

Credit Leads the Way

In the past month, we have observed historically low U.S. interest rates. On August 31, the 10-year US Treasury Note  closed to yield 2.473%, and the 30-year US Treasury Bond closed to yield 3.522%. Outside of the credit crisis of 2 years ago, these are the lowest yields on Treasury bonds in nearly 50 years according to Federal Reserve data, which ends in 1962. Peak U.S. interest rates were observed on October 2, 1981. On that day, the 10-year US Treasury Note closed to yield 15.68%, and the 30-year US Treasury Bond closed to yield 15.07%. Fully two generations of investors have been conditioned to approach the financial markets in a way that presumes an environment of declining interest rates. That assumption is now erroneous. Everything investors knew about how to make money in the financial markets will have to be substantially altered in this knew adverse interest rate environment.

Saturday, September 4, 2010

Ode to the Pittsburgh Steelers

With the last pre-season NFL game for my team finally over, the new football season is upon us, and my favorite time of the year is here. I love the fall for the cooler sunny days, the brilliance of natures colors on the trees, and the popping of shoulder pads as giants on a gridiron engage in a battle of wills to achieve victory. When I was younger, I was completely obsessed with football. I would go to high school games on Friday, watch my college team (Penn State) and other college teams that might meet them on Saturday, and watch my pro team and the other pro teams that might meet them on Sunday. And, of course, the Monday night game. As I grew older, my interest waned in the high school and then the college game, and now I have lost interest in most pro games (which has not exactly disappointed my wife). But there exists a white-hot fire deep in the darkest recesses of my being, a passion, a loyalty, yes a love for the PITTSBURGH STEELERS that I think nobody except those of us from southwestern PA can really understand. This blog will attempt to explain it to you, so that you will know that no professional team has the kind of intimate relationship with their fans that Steelers fans do.

Wednesday, August 25, 2010

An effort towards frequency

As many of you are aware, disruptive change has been a constant in my life since this blog was born. Before I conceived of putting this blog together, I wanted to make a committment to post comments to it on a regular basis, in accordance with my own experience reading other people's blogs. I have failed by every objective measure of consistency thus far.

To stand out, I have tried to write things that are meaningful to me, and to fortify my assertions with historical precedent. While it may not seem obvious to my readers, I have expended a considerable amount of time and research to create my prior posts. To provide more consistency in my entries, I have come to the conclusion that I will have to sacrifice my relatively long and deliberative entries. I am not abandoning them entirely. I am hoping that they will be as frequent as they have been up to this time, but I intend to make more frequent but shorter entries that address the world in which I am immersed--ecnonomics, business and finance.

Friday, July 2, 2010

Stock Selection Shorthand

I’m going to lean more toward the ‘capitalist’ spectrum in this post, which hopefully will be a welcome change to many people. This post is again going to be pretty lengthy, and I apologize for that, as I have promised shorter posts. I guess what I am discovering is that if I care enough about a subject to actually write about it, I generally have a lot to say. My guess is as I more thoroughly lay out my point of view to you, these posts will tend to get shorter.

Throughout my career, I have worn many hats as a professional in the financial services industry. During much of that time, my family and many of my non-financial friends have had little to no idea what I actually did for a living. However, over the years many have asked me how I go about picking stocks, so I figured I would pass along the five general things I look at and what levels I am trying to find before becoming interested in a stock.

My wife is a lawyer and she has urged me to include what is called ‘a hedge clause’ at the top of this post, so here goes. I am not telling you to buy or to sell a stock or group of investments in the following post. I am not saying that this is the best way to go about picking stocks. Indeed, more than likely, it will turn out that I am completely full of crap, and I have the tax loss carry-forwards to prove it. The following post is just my opinion as to what is a good way to approach the stock market. Nuff said.

Monday, June 21, 2010

The Private Corporation--The Fulfillment of Private Property Rights

These first half-dozen or so posts have been fairly long and weighty, and have consequently led to a fair amount of time between posts to allow me to gather my thoughts and do some pertinent research. I have endeavored to lay out some first principals as to my governing philosophy in the economic and political realm. If anybody has ever seen the movie, Patton, with George C. Scott in the title role, this is the part of my blog that is analogous to the conclusion of the first 5 minutes of the movie where the General concludes his remarks to his troops by saying, "Awright you sunsabitches! Now you know how I feel!"

Indeed, you may be forgiven for thinking that this blog should be named Cambrian Republican instead of Capitalist given the nature of the first few remarks. I did so to underline a point. Capitalism could not exist without the antecedents of the American ecosystem that I outlined in the prior 4 posts:
  1. An origin that declared that man's liberty supersedes the power of the state, and that every man's rights be secured through the rule of law regardless of ethnicity, religious affiliation or other parochial associations.
  2. The creation of a precedent that instructs humility in public servants and facilitates the peaceful transfer of power from one administration to the other.
  3. The written enumeration of the processes and powers invested in the government by which all citizens' liberty and property are secured.
  4. When the success that resulted from the first 3 principles becomes self-evident to the peoples of the world, continue to remain true to your first principles by creating institutions that communicate the virtues of individual liberty, the rule of law, and more specifically the enforceability of contracts between parties.
Capitalism could not flourish in the absence of any one of these attributes. We are constantly reminded by history and in contemporary times that whenever any of the four attributes is threatened or removed from a country's ecosystem, capitalism is notably impaired and is immediately observable in the most visible component of a capitalist ecosystem--the private corporation.

Tuesday, May 18, 2010

Is America Exceptional?--Part 4 The Benign Empire

I have heard, fairly consistently, over the past 40 years that America's best days were behind it, and that was probably a good thing because we were suffering from Imperial overstretch that seemed to doom other major empires of history. Of course, that can be a matter of perspective (i.e. one man’s imperial aggressor is another man’s champion liberator).

Some of the major proponents of this theory ironically have always been the greatest benefactors of our international largess. European powers were bristling under the influence of our "authoritarian hegemony" 40 years ago, and were particularly vocal about the United States' "Imperial instincts" in recent years via the rantings of France's Chirac and Germany's Schroeder. The powers that move the European Continent have been continually frustrated by the, at times, overwhelming impact of the U.S. footprint in military/political/economic terms. In many instances over the past decade, they have worked at cross purposes with the U.S. in the pursuit of creating a "multi-polar" world order to restrain the apparent omnipotent hegemon.