James Grant penned a commentary in the weekend edition of the Wall Street Journal (September 19, 2009). James is always worth reading (Grant’s Interest Rate Observer). He has been a moderately bearish commentator for as long as I have been reading his work (10 years), most often in Barron’s articles. He has bemoaned the high consumer and national debt and the very low (even negative) personal savings rate in America. For this, he has called for a weak dollar and higher interest rates for the past decade.
That he flys in the face of his brethren bears is of no small consequence to me. Normally James Grant’s perspective is closely aligned with so-called other “bond vigilantes” like Bill Gross at PIMCO and perma-bears like Bill Fleckenstein or Peter Schiff. Those other dollar sellers / interest rate watchers are still looking for a flat to declining economy and dollar and moribund economy. Grant really is making a departure from his club here, which is good because it is contrary.
He was early to call the stock market decline, as far back as 2005. But this is news: now he sees it is time to become Bullish, if for the all the wrong reasons in his view. James Grant is leaving the Bear camp (maybe six months late). Here is an excerpt from his article. Click here to read the entire piece from the WSJ.
Though we can’t see into the future, we can observe how people are preparing to meet it. Depleted inventories, bloated jobless rolls and rock-bottom interest rates suggest that people are preparing for to meet it from the inside of a bomb shelter.
The Great Recession destroyed confidence as much as it did jobs and wealth. Here was a slump out of central casting. From the peak, inflation-adjusted gross domestic product has fallen by 3.9%. The meek and mild downturns of 1990-91 and 2001 (each, coincidentally, just eight months long, hardly worth the bother), brought losses to the real GDP of just 1.4% and 0.3%, respectively. The recession that sunk its hooks into the U.S. economy in the fourth quarter of 2007 has set unwanted records in such vital statistical categories as manufacturing and trade inventories (the steepest decline since 1949), capacity utilization (lowest since at least 1967) and industrial production (sharpest fall since 1946)……
…..By rallying, equities and corporate bonds not only anticipate recovery, but they also help to bring it to fruition. By opening their arms wide to such previously unfinanceable businesses as AMR Corp., parent of American Airlines, and Delta Air Lines Inc., the newly confident credit markets are implementing their own stimulus program. “Reflexivity” is the three-dollar word coined by the speculator George Soros to describe the dual effect of market oscillations. Not only does the rise and fall of the averages reflect economic reality, but it also changes it. One year ago, the Wall Street liquidation stopped world commerce in its tracks. Today’s bull markets are helping to revive it.
I promised to be bullish , and I am (for once)—bullish on the prospects for unscripted strength in business activity. So, too, is the Economic Cycle Research Institute, New York, which was founded by the late Geoffrey Moore and can trace its intellectual heritage back to the great business-cycle theorist Wesley c. Mitchell. The institute’s long leading index of the U.S. economy, along with supporting sub-indices, are making 26-year highs and point to the strongest bounce-back since 1983. A second nonconformist, the previously cited Mr. Darda, notes that the last time a recession ravaged the labor market as badly as this one has, the years were 1957-58 —after which, payrolls climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion. Which is not to say, he cautions, that growth this time will match that pace, only that growth is likely to surprise by its strength, not weakness.
And that is my case, too. The world is positioned for disappointment. But, in economic and financial matters, the world rarely gets what it expects. Pigou had humanity’s number. The “error of pessimism” is born the size of a full-grown man—the size of the average adult economist, for example.
Once again Doug Kass pens a Bearish take on the economy and markets. Once again, I must take exception to Kass’s assessment of the future. Where Kass and his brethren, such as Bill Gross, Mohamed El-Erian and David Rosenberg fail in their analysis, is in the idea of “this time it is different”. Every time I hear those five words, I know the opposite is true: “this time is the same as it ever was”.
Kass and the others contend that we will face “non-traditional headwinds” to the economy. This implies that most often the economy must deal with traditional headwinds, I guess. That premise is a fallacious idea from the beginning. No two economic crises are the same. Every event in my 50 plus year experience is different. And always, the economy recovers. Any so-called statistical “outliers”, or what are called by the Bears “black swans”, always mean-revert.
So too will it be this time. Housing prices which did dramatically diverge from long term price appreciation trends that roughly follow long term inflation, shot up in the early 2000’s. Then, as is normal for an overshoot, they have over-corrected to the downside. Now they will revert to the old pre-2000 trend line. Credit creation which was excessive in the past ten years will return to a path dictated in the early 1990s. The same is true for every economic series. All revert to a long term mean that is determined by human behavior and the governing economic system, not by short term policy mistakes and resultant excesses.
Kass’s (and El-Erian’s) assertion that many of the “headwinds” are non-traditional, is questionable in the first place. In his most recent post titled “Bearish Arguments Are Roaring in My Ears” Kass, as is his wont, gave readers ten such headwinds. I will challenge several of the points he makes, that are in fact, traditionally part of an economic recovery, not unusual as suggested by Kass:
That deep corporate cost cuts can’t be maintained to improve corporate bottom lines, and that top line revenue growth is required to continue profit growth; this is obvious and is a characteristic of every recovery, not just this one. To the degree that corporate managers have studied their history and have been much more aggressive and anticipatory in cost cutting in this cycle, it actually bodes very well for tremendous profit growth when revenue growth returns. Companies are very lean at this time and have very high operational leverage.
That cost cuts “pose an enduring threat to the labor force”; while this may be true, it is not new. This condition accompanies every business cycle since the Industrial Revolution. Productivity improvement is constant and recessions provide the cover for corporate managements to reduce labor made unnecessary by productivity improvements. The economy adjusts and new more meaningful jobs are created to replace mundane or dangerous jobs displaced by advances in technology.
That the consumer entered into this recession with credit badly damaged and with a need to save and invest to replace lost equity; this is also true, though again is true in every economic cycle. There is always a de-leveraging accompanying a recession. Over-leverage, either operational (too much new production capacity) or financial is most often the reason for the recession. The increased savings resulting from a natural defensive reaction to a recession will most likely end up in equity investments with interest rates currently near zero. So, a return to savings and investing is good for the equity markets and will be good for consumer markets with an eventual return of the wealth effect.
Kass’ fifth point was that Federal monetary efforts are “experimental”; this is simply not true. They have been used in the past and were mostly innovated in the Great Depression. What is somewhat different this time was the magnitude of the monetary policy; but such a response was needed due to the magnitude of the credit contraction;
In Kass’ eighth point, he declared that fiscal stimulus to compensate for the recession (unemployment benefits, for example) creates a negative multiplier effect; How So? That makes no sense at all; to the extent that money is put in the hands of a consumer, then that money will multiply as it always does; putting money to consumers would never cause less spending by others in the food chain, this is just common sense; it might be inflationary at some point if the Federal government runs a deficit to fund the transfer; but that is an entirely different set of problems and inflation normally accompanies too much monetary multiplication, not too little;
Kass declares that “Municipalities have historically provided economic stability during times of economic weakness “, but not this time; again I challenge this assertion; it makes no common sense; municipalities are always challenged by economic downturns; revenue (tax) sources of all types see contraction and expenses for social services always expand to cover economic hardship (housing services, etc); Orange County, CA and New York City both experienced near-death during economic crises (1994 coming off the Mexican economic collapse for OC and 1975 during the 1974-75 recession, to name two high-visibility incidents);
And to Kass’ last point regarding higher marginal tax rates and the deleterious effect on consumption, it is unclear to me that the recession has anything to do with the potential for higher tax rates; with a more Democratic, “big government” Congress and Presidency, higher national taxes would have a high probability regardless of the economic backdrop; and the current recession pushes that eventuality back in time, if anything;
So, once again Kass, who is an otherwise special and thoughtful, even poetic commentator on the economy and markets, twists data points to build a case to justify his own Bearish position, rather than allowing reality to dictate his strategy, as he did back In March when he called the market bottom. There is enough real evidence to build a case for a conservative or neutral market stance. On the other hand, it takes a lot of effort to trump up or distort facts to try to make the case for a Bearish market scenario going forward.
This market is looking very strong. Every day there is another challenge by the bears, and every day, the bulls shake it off and drive the market further up.
Today, the challenge was to Intel (INTC). It reported good earnings (well above consensus) and also decent future prospects, which is a big change for people in the tech space. The future prospects, though, were less than what some analysts expected, so the stock was sold off on profit taking. But now it is bouncing back along with the tech sector and the whole market.
Same thing happened with the financials this week. Goldman reported great earnings on Monday, stock sold off from $140 to $115 by this morning, and has now bounced back to $120 as of noon. JPM reports tomorrow and we may see a big day after the knee-jerk sell-off.
I am positioned for all of this as I have bought more Proshare Ultra Financials (UYG) today at $3.33 (sold off 1000 shares on Monday at $3.58 to take some profit, after buying for $3.15 last Friday). I have another order in at $3.05, should it fall that far, but I don’t think it will. I also have an order in for INTC at $15.05 trying to catch a bounce down from a high of $16.40 yesterday leading up to earnings. To catch more of the tech rally, I also have another order in for both XLK (tech ETF) stock at $16.30 and XLK put options for the May 17 (XLKQQ) at $1 a contract.
I am still of the belief that we will trade up like this in sawtooth fashion with a bullish trend through April and into May. Then, we will bump into the 200 day EMA for SP500 at around 970. That will represent long term resistance coinciding with the typical summer selling season. We will then move down to around 760 through the summer selloff. But until then, we have another 15% to rally and good trading opptys.
Doug Kass has a terrific track record of predicting the tops and bottoms of recent markets. He has been known as a short seller the past several years as he thought the market over-valued. Now, however, he has picked March 5, 2009 as the bottom and has gone long. He was nearly alone in his convictions on that date, but has recently been joined by more and more investors, including yours truly. Why does Kass think we have reached the bottom of this Bear? Read on for more:
I continue to believe that the early March low represented a yearly and, quite possibly, a generational market bottom.
The mustard seeds for the economy and the U.S. stock market have begun to take root. The rate of change in 10 of 12 factors in my watch list are improving.
On Feb. 17, I presented a watch list of conditions that, if in an improving trend, would likely indicate that a sustainable up move is possible for equities.
It is time to review this checklist (and add one more factor) to determine the market’s standing. Our new grades and those of two weeks ago are in parentheses and will be updated in the weeks and months ahead.
Bank balance sheets must be recapitalized. Yesterday a comprehensive bank rescue package was introduced. It is obviously too early to consider its full impact, but the details of the program suggest to this observer that it will likely be effective in clearing toxic bank assets. (We grade the package a B+, up from a D+ only two weeks ago.)
Bank lending must be restored. While bank lending standards remain tight, my view is that yesterday’s announcement of ring-fencing toxic bank assets will almost unquestionably succeed in unclogging the transmission of credit. (Grade B, up from a c previously.)
Financial stocks’ performance must improve. Financial stocks have finally awakened from the dead, and the recent outsized move to the upside could foreshadow continued market strength. Historically strong relative performance in the shares of asset managers — such as Franklin Resources (BEN), T. Rowe Price (TROW) and AllianceBernstein (AB) — presage a better equity market, and Monday’s strong group action was conspicuous in its outperformance. (Grade B+, up from a D.)
Commodity prices must rise as a confirmation of worldwide economic growth. Beginning two weeks ago, commodities’ prices began to strengthen, and the Fed’s message last week accelerated that trend. Gold, copper (at the highest level since November) and crude oil (over $54 a barrel) continued to rise yesterday, reflecting a combination of continuing inflationary and currency debasement fears coupled with the possibility that worldwide economic growth might stabilize sooner than later. Finally, the TIPS market is forecasting some higher inflation, and a little inflation is better than a lot of deflation. (Grade B, up from a C+.)
Credit spreads and credit availability must improve. Spreads remain worrisome and the transmission of credit remains poor, but the economy should gain traction as public policy is implemented, money is made more available and lending terms are liberalized. (Grade D, flat from two weeks ago).
We need evidence of a bottom in the economy, housing markets and housing prices. As I have written, the retail industry has exhibited evidence of sequential improvement in the January through March period. Other economic signs are somewhat more ambiguous but, nevertheless, are showing some life. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in the affordability indices and a better relationship between home ownership and rental costs. Nevertheless, yesterday’s strong existing homes sales release raises the specter of a better spring selling season than most anticipate. I contend that housing could surprise to the upside and might lead most other economic indicators higher. (Grade C+, up from a C-.)
We need evidence of more favorable reactions to disappointing earnings and weak guidance. I am encouraged by the better price action in the face of poor earnings results and guidance in a wide range of companies, including Freeport-McMoRan Copper & Gold (FCX), FedEx (FDX), Airgas (ARG) and General Electric (GE). (Grade B+, up from a C+.)
Emerging markets must improve. China’s economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive, but other emerging markets remain moribund. (Grade B up from a C.)
Market volatility must decline. The world’s stock markets remain more volatile than a Mexican jumping bean. (Grade C+, flat with two weeks ago.)
Hedge fund and mutual fund redemptions must ease. I am comfortable writing that the worst of the redemptions are behind the asset management industry. Nevertheless, the disintermediation and disarray in the hedge fund and fund of fund industries still have a ways to go. And while brokerage account liquidations appeared to have decelerated last week (coincident with rising share prices), my high net worth brokerage contacts (such as Baron Von Broker) continue to experience account closures and a panicked constituency. (Grade C, up from a D).
Marginal buyers must emerge. Low invested positions at hedge funds and by individual investors no doubt fueled March’s market rise as the fear of being out has begun to replace the fear of being in. These two classes could continue to be the near-term marginal buyers fueling stocks. Corporate acquirers could also emerge as important marginal buyers, and the recent step up in merger and acquisition activity — for example, Genentech (DNA), Petro-Canada (PCZ), Schering-Plough (SGP) and Daimler (DAI) — is a concrete indicator that another important marginal buyer has surfaced. As the year progresses, a meaningful upside move awaits a broad asset allocation move of pension funds out of fixed income and into equities. (Grade B, up from a C.) To the above factors, I am adding a 12 factor in my watch list:
The market’s internals must improve. I am comforted by a number of improving technical conditions that have emerged since the March low and that have continued in force over the past two weeks since the market has made program off that nadir. Indeed, the conditions of the recent low were different than others — in sentiment, volume, number of new lows and in intensity. The move from the October lows to the March lows indicated growing fear and gave way to rising cash positions and the loss of hope, but the market’s internals were improving. November’s DJIA low of 7,552 was nearly 11% below the October low of 8,451, and the March low of 6,547 was 22.5% under October’s low. While each new low was more frightening than the prior one, however, there were improving technical and sentiment signals. For example, NYSE volume at the October low expanded to 2.85 billion shares; at the November low, volume dropped to 2.23 billion shares; and at the March low, volume was only 1.56 billion shares. As well, new lows traced decreasing levels: At the October low, there were 2,900 new lows; at the November low, there were 1,515 lows; and at the March low, there were only 855 new lows on the NYSE. Moreover, the combination of last Tuesday’s 12:1 ratio of advancing stocks over declining stocks coupled with that day’s 27:1 up-to-down volume ratio has not occurred in almost 65 years. Remarkably, yesterday was the fifth 90% upside day in March, which is evidence of a broadening market.
In summary, 10 out of 12 factors (including our newest, market internals) on my watch list are in an improving mode. Though many variables are currently accorded relatively low grades and the outlook remains debatable, the delta (rate of change) in almost my entire watch list is improving and flashing a green light for the U.S. stock market.
A classical wall of worry is being reinforced by an overwhelming consensus that the recent advance was a bear market rally. Moreover, the negative “chatter,” as Jim “El Capitan” Cramer describes it, appears loosely constructed and fails to credibly argue against the salutary effect that $4 trillion of stimulus will have on the domestic economy.
Based on the 12 considerations comprising my watch list, I respectfully disagree with the prevailing negative consensus, most of whose members failed to properly analyze the cracks in the foundation of credit, in the economy and in equities two years ago. Indeed, it remains my view that the fear of further investment losses and possible investor redemptions are clouding many managers’ objectivity in assessing the markets.
In the fullness of time, public policy aimed at stimulating the economy (in general) and in housing (in particular) should bear fruit, as will the ring-fencing of toxic bank assets serve to unclog the transmission of credit.
While it is unrealistic to expect a straight up move, I am growing increasingly confident in my variant and optimistic view that the early March low was not only a yearly low but, quite possibly, a generational low.
Coming Monday, March 30: Jeremy Grantham 1st Quarter Commentary
