How many elephants do you own?

Today, many investors use Exchange Traded Funds (ETFs) as their main investment vehicles. ETFs have many advantages: they are liquid, have relatively low management fees, transparent and, usually, are fairly diversified. However, not all ETFs are built equal, and some carry risks that may not be so visible at a first glance.

While some of these ETFs are relatively easy to understand, the complexity begins to compound fast as additional investments are added. Although it could be relatively easy to grasp the concept of a “classic” portfolio consisting of a 60% global stock index and a 40% global bond index, once the portfolios gain more exposure via additional funds, the picture can become more complex and the risks can become harder to identify.

Let us discuss one of these risks: concentration risk. Concentration risk could be defined as a risk an investor is undertaking when investing in a portfolio of only a few holdings. In such a portfolio, an individual holding exposes the investor to a higher degree of risk. Of course, Concentration risk becomes more apparent when holdings exhibit high price volatility. A good example of such a holding can be Apple Inc. (NASDAQ:AAPL). Apple had a price of $411 on January 3, 2012, proceeded to reach $700 in September 2012 and gave up all of those gains, finishing at $413 on June 21, 2013.

It makes sense to assume that if an investor owned an ETF with a concentrated (i.e. large) Apple position, his portfolio would have, as a result, experienced a higher degree of volatility. How many such ETFs are out there?

By screening ETF Database (etfdb.com), I found 20 ETFs that had a 5% or higher Apple exposure. To illustrate the potential impact of such concentration, let us construct a hypothetical portfolio of ETFs for an investor who is bullish on the US Technology Sector:

20% Dow Jones U.S. Technology Index Fund (16.9% in AAPL, 135 holdings)
40% iShares Core S&P 500 ETF (2.7% in AAPL, 501 holdings)
40% iShares Core Total U.S. Bond Market ETF (0% in AAPL, 1918 holdings)

Such a portfolio would have a total 4.5% Apple weighting. To drive the point further, while Apple represents only 0.04% of total holdings (1/2554), it has a significantly disproportionate weighting of 4.5%.

To visualize our result, let us engage in a brief mathematical exercise: assume that we gathered 2,554 people (total number of holdings in our portfolio) and decided to determine how our “Apple-person” would look like.

With an average human weight of about 150 pounds, the total weight of our gathering would be 150 x 2,554 = 383 thousand pounds. However, our “Apple-person”, at 4.5% of the total, would weigh like a very large African elephant, clocking in at a whopping 17 thousand pounds.

While having such “elephants” in a portfolio can be both a good and a bad thing, it is absolutely critical for investors to be at least aware of their potential existence.

Sources: etfdb.com, ishares.com, finance.yahoo.com

Apples and The Universal Law of Gravitation

"If I were one of the nutty hedge fund guys, I would go short Apple, long natural gas, and leverage it 100x"
                                                                                                                                         Jeffrey Gundlach

I agree. Ripe it is.

No loan for you, come back one year!

This market is something else. Range-bound or not, I fail to see what's cheap and safe here. What is expensive? Why is it all Fed and nothing else matters?
Anyway, back to what may be cheap. iShares seem to tell me that US Home Builders (gasp) and US Regional Banks (gasp-gasp) are yer losers for the "cumulative return since inception" beauty contest. MSCI's Mexico, Latin America and Emerging Markets indices are the winners. So having established the historical performance dogs, let's give them a look.

(Reuters) - The government is investigating labor practices at top U.S. home building companies, an action described by one industry trade group as "overbroad" and potentially very costly.

Oh, that may hurt, doctor. Litigation, check. Headwinds in the form of high unemployment, numerous foreclosures and the general buyer apathy, check. But there is at least one variable that looks a bit better than others. Prices are kind of low. And they have been in the negative territory on 3-mo, 6-mo, YTD, 1-yr, 5-yr and since inception. From the glorious days of 2006, iShares Dow Jones US Home Construction index lost not less than 80.72%. Even the Japanese stocks are more expensive YTD.

So here is a question based on this rather simplistic comparison. Having been down 80 percent, how much more air is left in the balloon? I mean, of course, there is a big fat zero that can be waiting for you as an investor in a company that goes bust. However, let's assume that a lot is already priced in. I mean, it's been a while. So yes, they can, and probably will dip more. Maybe we all get into this "lost decade" thing and Fed will be unable to inflate us out of it. But something tells me that the US might play out a bit differently. This here ain't Japan.

Will the American people share tiny apartments and ride Vespas around the palazzo in the city? Will public transportation become the place to be seen? Will it be cool to live with your parents forever? Will raising kids in tiny apartments become really cool?

I don't think so. Americans want a backyard, a dog, 3 bedrooms plus central air and a barbecue grill. They want the American Dream, damn it.

Let's check demographics and call it a night?


"According to an annual state of the nation's housing from Harvard University's Joint Center for Housing Studies, once the U.S. emerges from recession, strong demographic trends will restore health to the housing market. The key is echo boomers, the 75 million Americans born between 1979 and 1995.

"There will be 5 million more echo boomers than there were boomers when they first started swelling housing markets," said Eric Belsky, executive director of the Joint Center.

As a result, household growth during the next 10 years should range between 12.5 million and 14.8 million, according to the report. All those new households mean demand for many new housing units.

"This is a powerful, powerful underpinning of future demand," said Belsky."


This was said in 2009. Two years later, with the builders trading like the nuclear winter is here already, with much lower prices and cheaper mortgages, what has changed? Cash will do better in the next 20 years? Gas and food will get cheaper? Landlords will be lowering rents? Possibly yes, but probably not.


Yes, there are negatives. Prices will drop more. Harder to qualify for the loan. Unemployment is high. Sentiment is low.

But the American Dream is an awfully persisting creature. I would be pressed hard to bet against it in the long run. Not to mention that it seems to be on sale now.

Safe still?

The contrarian in me wants to stay in USD because everybody seems to hate it.
The contrarian in me wants to short a little bit of gold because everybody seems to love it.

Dollar-bashing is fashionable nowadays and articles named "Why the Dollar's Reign Is Near an End" are in vogue on WSJ. Gold, and increasingly silver are the "place to be"? This vaguely feels like real estate 3 years ago, with one major caveat: people don't borrow yet to buy precious metals. That, and the portability of the little shiny rounds, coupled with a number of other considerations (sovereign debt levels of the developed countries and etc.) that play in favor of gold/silver/platinum and the like.

I agree with the notion that it's not that gold is so great but the alternatives are kind of bleak right now. I think owning some stable global businesses that are reasonably priced, shareholder-friendly, have healthy debt levels (somebody recently said that right now a CEO who hasn't issued debt should be fired) and generate dividends may make sense to some of us?

However, my gut tells me that more or less everything looks kind of fully-priced right now. Granted, sitting on some zero-yielding scary deteriorating safe haven no more paper is a tricky proposition. But what if China slows down, Fed gets a bit more hawkish and Middle East cools down a bit? If we deem worst-case scenario as probable why not deem the opposite as possible? I might be 1000 percent wrong but I fail to see people exchanging little silver bits for coffee at their friendly local coffee shop in the next 12-24 months.

Yet, I know that gold has something that paper dollar does not. Have you held an ounce of gold lately on the palm of your hand? When you do you KNOW it's money.

"Gold still represents the ultimate form of payment in the world. Fiat money in extremis is accepted by nobody. Gold is always accepted."

Alan Greenspan

P.S. I am still waiting for a correction here. Will the end of QE2 bring us some long-awaited discounts?

14%

"Some 42.9 million people collected food stamps last month, up 1.2% from the prior month and 16.2% higher than the same time a year ago, according to the U.S. Department of Agriculture.

Nationwide 14% of the population relied on food stamps as of September but in some states the percentage was much higher. In Washington, D.C., Mississippi and Tennessee – the states with the largest share of citizens receiving benefits – more than a fifth of the population in each was collecting food stamps."

via WSJ

And markets are not cheap, either. Holding onto some cash looks about right?

What's cheap?

"The Bank of Japan is under terrific pressure to respond to the deflationary pressures within the system, and we believe it is only a question of time before the current regime in the Bank of Japan is either removed, or of its own volition provides a stimulus beyond simply currency intervention to the embattled Japanese consumer. If this happens in decisive style, we think the yen will be forced sharply lower, and the stock market sharply higher. This is truly one of the few markets which is cheap in almost any environment. We feel like the schoolboy with sixpence in his hand, and finding that the sweet shop has knocked 50% off all their stock. Which is it to be? The rum butterballs of financials, or the sherbert dip of exporters? This has the capacity to be a really exciting market."

Jonathan Ruffer

"David Marcus, chief investment officer of Evermore Global Value, sees opportunities in efforts of European companies to cut costs and restructure...

Marcus likes Siemens, the German industrial conglomerate that provides technology for factory automation and wind power. The company has been reducing costs by cutting deals with unions and expanding production outside Europe. Marcus figures the company sells at a 40% discount to its fair value.

Marcus also owns RHJ International, a Brussels-based holding company that's buying up troubled financial companies around Europe. The company recently bought Kleinwort Benson, an old-line U.K. private bank.

"They are buying things at unbelievably low prices," Marcus says..."

TheStreet.com

Stocks vs Bonds

"No one should view the great popularity of bonds relative to stocks without reservation."

Howard Marks

Some unloved European equities, anyone? I will be taking a closer look in the days to come.

The higher it gets, the better it looks

I argued in June that iShares Dow Jones US Real Estate (Public, NYSE: IYR) is a ripe candidate for shorting. It subsequently went down 10 percent and then bounced back to the $53 level.

In an absence of a rapidly occurring economic rebound, a strong deterioration in the value of the US dollar and/or strong inflationary pressures, I fail to recognize a justification for ownership of the asset class (at least in the short term). If anything, I tend to think that at these price levels, this particular slice of a US real estate proxy is even a better target for a rather skeptical look.

However, that does not mean that I am bearish on actual properties, given that they are carefully selected, deeply discounted and financed with low interest rates. But maybe they should not be bought for speculative purposes. The pure investment aspect should be a very distant second/third consideration. If one's cash flow can service the debt and one is looking for home/business property with long-term outlook and a realistic income-generating agenda, the logic behind the thinking looks certainly better than in 2007.

Generic coup d'état (slow motion edition)

I am back from my summer vacation. Montana and Northern Idaho are beautiful and I hope to return there some day to fish, hike and enjoy the scenery for more than a week.

The subject of today's post is "the invisible hand" that is helping retailers and is certainly being easier on consumers' wallets: generic brands. Like them, ignore them or hate them, but they have arrived. The other side of this door could be closing on the brand-name manufacturers/distributors.

According to Timothy Calkins, a professor at Northwestern University’s Kellogg School of Management, generic products have built momentum during the last several years and the current economic situation is actually helping them.

"In January 2008, the private-label market share was at 14.2 percent; two years later, it increased to 16 percent, according to a Credit Suisse report released March 4.

With more stores investing in their private labels, these generic products are slowly saturating retailers’ shelves.

“A lot of retailers are looking to optimize the shelf,” Calkins said, pointing to Wal-Mart’s decision last month to dump certain national brand products, such as Glad and Hefty food-storage bags, in favor of its Great Value private-label brand."

via Northwestern University

P.S. If the current trends take significant hold and the economy does not generate enough jobs/confidence in the next decade, I think that there is a space for contemplating on relatively/marginally stronger retailers vis-a-vis brand-name manufacturers. And they will be fighting over a shrinking pie of consumer spending. Arguably, on a macro-level, this is a deflationary development. Note: Glad is owned by Clorox and P&G.

Food for thought

Last week I had a chance to read the latest commentary by Bill Miller (of Legg Mason). Yes, Mr. Miller the investor had his ups and downs and let's leave it at that. He is a very smart person and I listen carefully when he has something to say. This does not mean that I take everything he says at face value. It just means that I pay a good deal of attention. In this commentary, that can be found in its entirety here, Mr. Miller has some interesting things to say.

"...the top 5% of the population, those making more than $210,000, account for about 33% of total spending."

Note: what do the rich actually buy and in what quantities? Yachts, villas, caviar and luxury cars, while being expensive, may not represent adequately the overall US consumption picture. For example, if I bought a Lexus from a dealer that has 100 Corollas on a lot across the street, I may have accounted for a chunk of his daily profit, yet in terms of jobs my spending did not really move the needle. Selling 5 Corollas could be maybe the same in terms of dollars gained from sale, but producing/selling/servicing/driving 5 cars is, arguably, more beneficial for the economy. But let us continue:

"The rich sharply cut back on spending as stocks plunged during the financial crisis, pushing their savings rate to over 20% in the fall of 2008, compared to about 5% in the immediate pre-crisis period. As the stock market recovered in 2009, their spending accelerated, the economy recovered, and their savings rate fell to negative.

With the stock market faltering in the last few months, they have again curtailed consumption, and economic growth has decelerated...

The common view seems to be that the weak stock market reflects a weakening economy. More likely is this: the weak stock market is causing the economy to weaken..."

Now, there is correlation and there is causality. For all this analysis is worth, Mr. Miller may see patterns in places where they do not exist. Or, if he is right, this is a great way to think about one of the ways the stock market is linked to the economy. This is excellent food for thought. He finishes by saying that "U.S. large capitalization stocks represent a once in a lifetime opportunity... to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951."

Well, the world in 2010 is arguably not the same as in 1951, and in many different ways. And pursuing relative value could be dangerous. Yet, everything is relative in investors' minds. What is cheap today?

Not so fast

"The two month average of 298,500 homes sold was the lowest two-month level ever recorded. Sales of new homes are at 47-year lows, down 80% from the number being sold in 2004, and a wave of foreclosed homes will be hitting the market over coming months, giving new home sales even more competition. Foreclosures on mortgages backed by Fannie Mae and Freddie Mac increased 21% in June from May."

via Forbes

"The recession and shifting demographics will swell the ranks of people who will rent, not buy, housing over the next five years."

via Barron's

P.S. How about the swelling ranks of those who cannot afford renting, not to mention buying?

Resilient smokes

An update on Tobacco sales:

"Some of the world's largest tobacco companies showed this week that even in a sluggish global economy they have the power to raise prices in most countries and beat earnings expectations."

"The tobacco companies' figures helped mitigate concerns that a large increase in the U.S. tax on tobacco last year and high global unemployment would force a switch by consumers to lower-priced smokes."

Reuters

What's booming?

"Over the past 27 years, wholesale shipments for handguns, long guns and ammunition have increased at a combined compounded annualized growth rate (CAGR) of 5.5%. However, the CAGR has almost tripled to 15.1% during the past five years..."

via Barron's

Ok, Firearms: check. As we established in a recent post, Alcohol is doing well, too. What's left? I will do some research on Tobacco sales tomorrow. Forget Bloomberg and WSJ, dear reader. Will the Bureau of Alcohol, Tobacco, Firearms and Explosives become the investment insight resource of the year?

Caveat emptor

A very brief case against Treasuries:

"... while government bonds are generally seen as defensive, the sub-3% yields they pay right now aren't much compensation for the risk of dollar depreciation, future U.S. interest hikes, or inflation over the net 10-years."

… and stocks:

"We also believe that this market will not bottom out until it reaches 10 times or lower the smoothed earnings. Although this may sound implausible, we note that the S&P 500 sold at a P/E of 10 or under smoothed earnings in 17 of the past 60 years."

via Business Insider

A friendly reminder

WSJ reports that "small investors flee stocks... moving the money to bonds, certificates of deposit and bond-like annuities."

The subject at hand is the perceived safety of those assets. A skeptical investor would have a couple of questions to ask here. How much are they paying for the "safety"? And, what kind of "safety" are they getting for their money?

Given the popularity of the "safe" assets, the prices are high and the yields are nil. Bonds, CDs and annuities are in fashion, even if the soon to be retirees' actual investment horizon extends beyond 5-10 years? Zero-yielding and exposed to the Fed's persistent desire to reflate? Granted, it might not work after all and we may have a prolonged Japanese-style deflation. But it is hard to imagine that the Fed will not try. Besides, and I have no opinion on the future of the asset classes mentioned above, one should ask whether the past performance of Treasuries and the like is a good guarantee of future results. Sounds like buying high and doing it collectively.

When they panic, a contrarian in me wakes up. Let them rush to the exits, and I will stand at the gates ready. Take my "safe" CDs and give me your "unsafe" equities. I will buy all I can, at a right price.

Sounds about right?

“Deflation is just a natural reaction to rampant debt-induced growth over the past 30 years. Forcing price to remain high by pumping money into the system will only delay the inevitable. There is no deflation cuz [sic] price is just beginning to go back to what it should have been. You shouldn’t have made as much you did back in 06, your house shouldn’t have been worth as much as the price when you bought it and everything around you should have been worth less, far less had the economy not been artificially propped by up the government during successive administrations starting with Reagan…”

An anonymous comment on WSJ

Unappealing Asymmetry

"Current yields on government bonds in most advanced economist are at very low levels. Under only one condition – that the world follows Japan’s experience of prolonged deflation – do they offer any chance of a reasonable return. But this is not the only possible future. For other outcomes, long-dated government bonds offer a limited upside with a potentially uncapped downside. As investors, such asymmetric pay-off profiles don’t appeal to us."

Edward Chancellor

On gold and sugar

“Gold has been extremely strong of late, but I’m not rushing out to buy gold. I don’t like to buy things that have been going straight up.”

“Not many things are 75 percent cheaper that 36 years ago, but that’s true of sugar... Agriculture commodities are desperately cheap compared to 20, 30, 40 years ago.”

Jim Rogers via Bloomberg

Headline impact

"We are hearing consistent laments (aka, whining) from hedge managers of all types that fundamentals matter little as markets are now trading almost completely on the basis of headline news. Correlations across markets remain very high."

via Greycourt

What's booming?

No, the US employment is certainly not booming yet. But that's hardly news. However, there are pockets of optimism in the market. What's in vogue?

"Scotch prices continued to rise during the recession, and the Scotch Whisky Association reported record export figures amid booming demand from emerging markets. Diageo itself recently opened a new £100 million distillery, the first new one built in Scotland in 30 years."

WSJ

Bearish Albert

"... although our deflationary arguments are gaining some traction in the bond market, investors have yet to fully acknowledge we are now walking on the deflationary quicksand that will inevitably suck us towards total fiscal and financial ruin – you ain’t seen nothing yet. With core inflation rates now sub-1% in the eurozone and the US, we are only one recession away from Japanese-style deflation.... The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant. The super-inflationary end result will become obvious to all."

"The latest dreadful housing sales data in the US indicate just how dependent this sector has been on steroids as well for any sort of recovery. Withdraw the stimulus and down comes the house of cards."

Albert Edwards

"Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion to uncharted levels of $5 trillion."

Ambrose Evans-Pritchard

Ripe for shorting?

The subject at hand is the state of the estate. The US real estate, that is. The proxy in the brief discussion is its ETF incarnation, iShares Dow Jones US Real Estate (Public, NYSE: IYR). It has been a steady money maker, if you bought it in March 09. Since then, it is up 98%. Yet, some cracks seem to be appearing in its shiny armor. Is it getting a bit ahead of itself, perched so high above the not-so fast growing green shoots?

A question follows: why bother with shorting murky Chinese real estate developers in HK when one can play at home?

A reference point: last time it stood at $50/share was in June 2004. Surely June 2010 has a bit of a different view from the window.

Buying Into a Pariah

T2 Partners are bullish on BP:

"If the time to buy is when blood runs in the streets, it’s time to buy BP. The stock is down 50%, it pays a 10% dividend and everybody hates it. It has nowhere to go but up, say two investment managers."

via Barron's

More of the same, for now...

"As the financial crisis has receded, the Federal Reserve has scaled back its extraordinary provision of liquidity. Eventually, the Fed will remove all remaining monetary stimulus by raising the federal funds rate and shrinking its balance sheet. The timing of such renormalizations depends crucially on evolving economic conditions.

Many predict that the economy will take years to return to full employment and that inflation will remain very low. If so, it seems likely that the Fed’s exit from the current accommodative stance of monetary policy will take a significant period of time.

Assuming unconventional policy stimulus is maintained... the recommended period of a near-zero funds rate would end at the beginning of 2012."

Glenn D. Rudebusch at the Federal Reserve Bank of San Francisco

1. Low rates push both retail/institutional money out to chase yield/risk.
2. Risky assets go up in price and miscellaneous speculations ensue.
3. Speculations imply losses.

"One of the big drivers of the equity volatility is the Fed's zero rate policy, which is forcing investors to search for yield in some very strange places. Once again, we call on our friends at the Federal Reserve Board to let interest rates slowly start to rise before this situation gets entirely out of hand -- again. As we said at the top of this comment, the banks are on the mend. Time to find out whether the US economy can grow with positive real interest rates."

Christopher Whalen

Is BP hated enough?

Not by PIMCO:

"Bill Gross... recently bought $100 million of shorter-maturity BP debt..."

via Bloomberg

Yes, it is short-term maturity. However, it is indicative of a certain set of assumptions and/or expectations. BP will suspend its dividend until the rest of the year. But if it survives as a "going concern", where would its stock be 5-10 years from now?

XOM has been up about 2100 percent since the Exxon Valdez spill in 1989. Yes, the differences are obvious to even a non-discerning eye. But, we need oil. Also, if anything, BP is gaining expertise in dealing with the situation and may be able to apply its knowledge if a comparable disaster occurs in the future. Granted, BP's future seems to be dark today. Even very dark. Dark enough not to touch it with a ten foot pole. Dark enough to make it attractive?

On relative cheapness

"The biggest decline for global equities in 15 months has left stocks at the cheapest level relative to bonds since the collapse of Lehman Brothers Holdings Inc., a sign that shares in the U.S. and Europe may rally."

“Against other asset classes, equities look really cheap,” said Barry Knapp, head of U.S. equity strategy for Barclays in New York. “It could mean that we’re completely wrong on the inflation outlook, which means it’s going to get much worse, much faster. Or it could mean that stocks are decidedly cheap and people are overly cautious.”

via Bloomberg

If one walks into a Mercedes Benz showroom, there will always be a model that will look "cheap" in comparison to the more expensive ones.

And today's sobering quote:

"Wall Street seems to have no concept at all that every bit of growth we've observed over the past year can be traced to government deficit spending, with zero private sector expansion when those deficits are factored out."

John Hussman

NY Fed on residential real estate

"The severe decline in house prices in the last few years, combined with the large number of borrowers who had little or no equity at the origination of their mortgages, has led to a dramatic rise in homeowners with negative equity... unless house prices increase substantially, many negative equity homeowners will in fact convert to renters in the years ahead, and the measured rate of homeownership will decline..."

"The Homeownership Gap" by Andrew Haughwout, Richard Peach and Joseph Tracy.
Federal Reserve Bank of New York/Current Issues.

Commodity prices. Predictably irrational?

"A recent paper by economists Ke Tang at Renmin University in China and Wei Xiong at Princeton University documents how commodity prices have become increasingly correlated with one another and with stock prices. The reason, the economists argue, is that commodities have become increasingly “financialized” by the creation of exchange-traded funds that allow investors to easily trade in and out of them. So when investors get worried by things like what’s going on in Europe, commodity prices can fall sharply even though actual demand for commodities may be running higher."

WSJ

Used to be macro plays... Not anymore?
Used to be diversification vehicles... Not anymore?
Used to be the supply of oil meeting the demand and voila! the price is born... Not anymore?
I am going to read this paper. I want to know the break-down of commodity price movements: by how much (degree) and for how long (sustainability) is it driven by the ETFs? Are fundamentals still responsible for the majority of the movement?

Tired of inflation-adjusted peaks

Richard Bernstein is selectively bullish on US and bearish on China:

"I think China is already imploding ... from an investment point, it is... My argument is as an investor, you don't care about the Chinese economy but about the valuation of Chinese assets... You have to be careful in terms of the prognosis, especially for the United States, that this is going to become Argentina."

Richard Bernstein via Reuters

Back to the subject of the yellow metal. A sample of recent quotes follows:

"On an inflation-adjusted basis, however, gold is far from its peak level of 1980..."
"When adjusted for inflation, however, gold remains far short of its all-time high..."
"Gold’s rally to a record means prices are still 53 percent below the 1980 inflation-adjusted peak..."

Following this "logic", stocks have to repeat their year 2000 highs very soon. How about 1936 lows, anybody?
By the way, gold hit its 1980 peak and then retreated very rapidly. Within a month, the game was over, followed by a 22 year-long bear market. Makes one think.

Market Sentiment

"Stocks in U.S. Decline... Spreading European Fiscal Deficit Crisis... Economic Rebound in U.S. Seen Slowing Most Since 2002..."

via Bloomberg

And to the quote of the day:

“People are trying to protect themselves and they are willing to overpay for it... Bearishness is high. The best time to buy stocks is when the level of bearishness is at a peak.”

Byron Wien via Bloomberg

An Outlier

This, of course, does not mean anything and is just an observation. Only one component of the S&P 500 had a gain today. It was a biopharmaceutical company called Cephalon, Inc. (Public, NASDAQ:CEPH) and it was up 0.53%.

But the more familiar to some of us Krispy Kreme Doughnuts (Public, NYSE:KKD) fought its way up, too.
In today's brutal market, the maker of the Original Glazed was up 6.78%.

Can doughnuts provide a meaningful hedge in down markets? :)

The usual suspects (Gold, Treasuries) gained. Natural gas was also up.

From China, with concern

"The media would have you believe that the ongoing "official" correction in the U.S. equities market is all about the southern member states of the Euro-zone – Greece, Portugal and Spain (GPS). Although concern about the economically-weak and highly-indebted Euro-zone states have played a role in the U.S. equities market correction, we think there is more to the correction than GPS. Moreover, we believe that the problems of these challenged Euro-zone members will not have a significant effect on U.S. or global economic activity in the foreseeable future. China might, but not Greece, Portugal and Spain."

Paul Kasriel/Asha Bangalore

Indeed. We need to refocus on the real elephant in the room: China. Because, as much as the Mediterranean fellows above would like to matter a lot, maybe they don't, relatively speaking. Greece is a great nation. But just not as big as China. Should China slow down its commodity hoarding: down the market goes. And not the puny 10 percent down. Should it really cool off its infrastructure spending: down. Should it talk about buying less Treasuries: yields up right away, in a meaningful way. But not yet.

China sure has its hands full. The whole export-internal consumption reorientation and etc. And some of us may talk about shorting its real estate companies being a sure bet. But I suspect that the Chinese government will do everything it can to limit the downside and not to lose face. And it may as well be able to deflate this slowly, without major blow-ups, at least officially. Instead of a burst, we may get a prolonged, controlled decline. Isn't that at least a possibility?

Let's not forget that in China, the private sector does not end where the Party starts and vice versa. If we bailed out pretty much everybody, I am pretty skeptical on China not doing the same for its lenders/developers. Debt "restructuring" and robust/ongoing cap infusions will follow. This is not 1998 and China is no Russia. Nobody is defaulting on anything and the show must go on. Monetize and Infuse. And if it goes long enough it might as well outlast the current deflationary spell in the West and James Chanos' shorting effort.

"It’s not yet time for China to discuss reducing or stopping policy support for the nation’s real estate industry, the Securities Times reported today, citing Li Fuan, head of the China Banking Regulatory Commission’s department of banking innovation."

via Bloomberg

Not yet.

Market Sentiment

"Treasury Prices Fall as Sentiment Improves... Euro Gains as Worries Recede... Gold Slips as Safety Play Simmers on Back-Burner"

WSJ

Overall, looks rather positive. Time to sell?

Also, John Mauldin is talking about the biotech stocks and how they may become the next "it".
I like the idea of biotech because of its inherent exposure to the so-called positive "Black Swans".
In some ways, they are similar to book publishers: if one book out of 10/20/30 becomes a hit, the business is good. Downside is somewhat limited and the potential upside can be very significant. And the product is super scalable, too. Unlike dentistry (I am borrowing heavily from Taleb here).

The value of hesitation

I thought that this one was just too good to pass on:

"With such puny yields on offer in most parts of the capital markets, an investor has two choices: First, accept the fact that we are in a low-yield environment. This is hard for most investors to do. They are beholden to a predetermined return hurdle or are slaves to the persistent memory of recent experience. Second, seek out investments that have a greater propensity for capital gains or higher yields in order to increase total return."

via Annaly Salvos

Are investors currently taking on more risk than they think/believe? Is gold, at least partially, being driven up by the reasons outlined above?

A vote of confidence

"German Gref, the head of Sberbank, Russia's biggest lender, became a shareholder in the firm for the first time after buying a 0.000004 percent stake worth $2,500, the bank said on Monday."

via Reuters

Note: Sberbank's market cap is about $51.2 billion.

USD, por favor

"Nouriel Roubini... said the Brazilian, Chinese and Indian economies may be overheating and developing asset bubbles."

via Bloomberg

"With excessive levels of debt and contractionary monetary and fiscal policies in place, inflation will continue to moderate, thereby driving long term treasury yields lower."

Van R. Hoisington
Lacy H. Hunt

When whatever is the "it" trade, I tend to have the urge to find out why it should not be. If shorting Treasuries is "it", why not spend some time in deliberation of the alternatives? What if BRICs do slow down for a while? What if hyperinflation does not happen? How much of the upside is left in gold?

But not in China

Recently, I came across an interesting post on Michael Pettis’ blog, called “Chinese savings and the wealth effect”. Under consideration is how Americans and Chinese react to changes in the interest rates. When interest rates rise, Americans tend to increase their savings and consume less. Interestingly enough, Chinese do the opposite. They actually put away less and consume more. When interest rates fall, Americans save less (consume more) and Chinese save more (consume less).

Apparently, it works like this: most Chinese save via bank deposits, not investments. They keep a certain interest rate level in mind they know will allow them to save a certain amount of money in the future. When banks’ deposit rate goes down, they want to save more “to compensate”. As a result,

“Declining interest rates in the US usually (but not always) mean that Americans feel richer because the market value of their homes, stocks and bonds has risen. Declining deposit rates in China usually mean that Chinese feel poorer because the return on their savings relative to their implicit discount rate has declined.”

Rooster today, feather duster tomorrow

"...investors are going to be reassessing global growth, and reassessing the ability for governments to stimulate economies to take up the slack from lack of consumer consumption. So I think this affects the growth rate that people are going to be using for the global economy. And, in that way, it affects all nature of global investments."

Jeffrey Gundlach

I have been paying attention to Jeffrey Gundlach for a while now. If anything, his arguments make sense to me. And then, as my mind drifted into thinking about markets, Mark Mobius appeared on Blooomberg and said that:

“Despite the fact that a lot of people think that we are entering into a bear market, we don’t believe so. This is a correction in an ongoing bull market.”

Mark Mobius

Whoa… wait. This is interesting. Mark Mobius is an accomplished authority in the investment world. And he is bullish on BRICs. Well. Let's look briefly into one of them. To use a Yakov Smirnoff's antimetabole, in America, you buy oil. In Russia, oil buys you. Let’s say it slowly: one…trick…petro…pony.

"In the near-term, the pace of Russia’s recovery will depend to a large extent on the path of oil prices... But a more likely scenario is that oil prices fall back as the pace of global recovery ultimately disappoints and the dollar rebounds further."

via RosBusinessConsulting

By the way, I am not saying that investors should never invest in Russia. If you know really well what you are doing, then by all means, give it a try. But sadly, Russia's EBITDA is highly cyclical, maintenance capex is high, personnel is shrinking to the tune of 1 million/year, the product (energy) is not proprietary, and historically, it is known to be a rather unstable shop. Yes, the 7-10 percent debt/GDP ratio looks decent. But I would make a wild guess that it’s just because very few brave souls would extend credit. And this is just a tip of the iceberg of issues. So…will US-induced deflation kill commodities and possibly disappoint Mr. Mobius on the Russian front?

"All are not cooks who walk with long knives." Another Russian proverb.

Market Sentiment

"Equity funds had outflows of $6.68 billion in the last week, compared with outflows of $12.51 billion a week earlier.

U.S. equities had outflows of $4.79 billion, while $1.89 billion was withdrawn from foreign funds.

At the same time, bond funds took in $184 million, compared with outflows of $989 million the previous week, said ICI. Taxable funds had outflows of $729 million, while municipal ones added $913 million."

WSJ

Stocks: out of favor.
Bonds: out and then back in. Investors like Munis... and possibly cash?

I think that there is a palpable demand for an all-weather "safe" asset class. Treasuries do not seem to be quite "it" anymore. Gold is liked but may be experiencing too much of its own Renaissance (some say its getting ahead of itself, some say there is more room to run). Everything still seems to be kind of expensive. Do European stocks look a bit more attractive now from a relative valuation point of view?

Paper vs gold

How about “The Investment Performance of Collectible Stamps”?

In a recently published paper, Elroy Dimson of London Business School and Christophe Spaenjers of Tilburg University investigate the returns on British collectible postage stamps and conclude that during the period of 1900-2008:

“While the annualized 0.7% real return for gold over the entire sample period is significantly less than that for stamps, price patterns for gold and stamps are similar.

Stamps are a hedge against expected inflation and perhaps, like gold, a partial hedge against unexpected inflation.

After accounting for holding periods and reasonable trading frictions, stamps may rival equities for the average investor in terms of realized performance.

Stamps generate a nominal (real) annualized return of 7.0% (2.9%) over the entire sample period, worse than equities, better than bonds and comparable to art...”

Should I stay or should I go?

This nugget comes via Morningstar:

"A Strategic Look at the Euro Problem - What If Greece Stayed and Germany Left?
An evaluation of Germany's current options shows that leaving the euro could end up being vastly cheaper for the country than sticking with it."

Indeed it could.

Cui bono?

"Stocks slid on Monday, driving the Dow to its lowest level since February 10 as fresh signs of Europe's banking problems emerged."

Reuters

Gotta love all these "fresh signs". Last week/month/year's signs were not enough?

Apropos the Market Sentiment. CNBC got me all confused:

"Markets to Rise 11-14% by Year-End... 15% Correction Likely... Stocks to Come Back With a Vengeance... Markets Will 'Double This Decline' Into Year-End".

Binary outcomes, again: either up or down. Nobody said flat. Too TV-unworthy?

On the subject of the shiny metal: who is on the selling side of the counter? If gold is such a great buy/bargain, what all these gold coin peddlers doing selling it? Shouldn't they hoard it like crazy? Just hold on to it for a year and sell at a much greater profit, isn't that the case? Oh... they sell to buy to sell again. Are they "flipping"?

Sounds like flipping to me... kind of like "house flipping". With all these efforts, it might as well keep on going up for a while. Real estate was also under-priced/a storage of value/inflation hedge/sure thing/always going up. When Fed accommodates, investors always seem to find a storage of value, don't they?

Disclaimer: I am neither bullish nor bearish on gold.

Something's Gotta Give

"The US and euro zone now stand on the edge of a deflationary precipice… Impending cyclical failure and a deflation scare will trigger new lows in equities as the valuation bear market finally plays itself out with the S&P falling below 500."

Albert Edwards

Are we talking about a 50 percent decline here? When I see a headline like that, I immediately want to find a credible headline that disagrees with it. I am not a “permabear” and I think that standing in front of a huge wave of paper could prove to be somewhat counterproductive, to put it mildly. Besides, what puzzles me is the mostly binary nature of the opinions I hear. Bullish vs bearish. Inflation vs deflation. I reserve the option to assume that the reality may subsist somewhere in the combination of both.

Yes, I know that most new Federal Reserve Notes did not find their way into the broader economy (yet). The velocity of money comes to mind. Fed prints, banks do not lend, boomers buy bonds, and consumers are either unemployed and/or cautious/tapped out. But economies are not hermetic. At some point, assuming a continued and intensive reflationary pressure, paper may start leaking. But how much, how fast, where into? Stagflation, anybody?

Jim Rickards sees 5-7 percent deflation being countered by 5-7 percent inflation. I tend to agree with his assessment. A net effect may be at zero, but this is a very unstable state of affairs.

Got Cash?

"Everybody thinks there is going to be this surplus of dollars due to the government printing, but I don't think that's really the case. I don't think the markets are telling us that. I think the government is printing some money, but the destruction of value is greater than the printing of money and, therefore, the dollar is likely to move into a shortage position and go on a very big rally."

Jeffrey Gundlach

Catch of the day

"Sell in May and go away started a week early this time around. April 26 was very likely the peak of the bear market rally."

David A. Rosenberg

Relative Cookies

"Over the past year, Ben Bernanke has pushed a monstrous sack of Chips Ahoys into the cafeteria. In terms of general price inflation, the question is how eager people are for those Chips Ahoys. If there is a crisis that makes people fear that everything else they might eat will give them food poisoning, the kid's Chips Ahoys will hold their value even if he brings in three times as many. But over time, well after the food poisoning scare is past, those cookies will be worth much less."

John P. Hussman