Dick Bove's Apology

On CNBC this Monday, Nov. 28th, analyst Dick Bove apologized for the failure of his foremost recommendation of the year: US bank stocks.

The official apology ran like this: “I failed to understand that the fears in the market concerning banking were so great that the fundamental improvements in the economy, the industry, and companies like Bank of American and Citigroup would simply be ignored.”

In other words, Bove's "apology" consisted of telling investors that they are foolishly selling excellent stocks that are a great value, simply out of fear.  He didn't quite call them idiots, but pretty close.

The reason I mention all this is because I agree with him.

Back in March (US Banks to Rumble), and again in August (Buffett and the Beautiful Banks) and I'm sure a few times in between, The Frost Report has recommended buying US bank stocks.  But after a short-lived pop, bank stocks kept dropping.  And dropping some more.  And a bit more yet.  So what have I been doing?

Why, buying more bank stocks, of course!  Instead of trying to guess which particular bank will fare the best, I have been purchasing the KBW and XLF bank index funds.  Every time the market has a 2-4% correction I buy more, since each "correction" misprices them just a little bit more.

The view that bank stocks are a great bargain is clearly an unpopular one.  Every time someone recommends bank stocks (like Dick Bove), their article is overwhelmed with comments calling them a loser/screwball/dope/idiot, or ranting about bank bailouts and world domination.  Fortunately, my goal is to make money, not to make popular decisions.

Bank stocks will recover because they are highly profitable, and an economic necessity for which there is no replacement (contary to popular sentiment, credit unions are not equipped to handle large-scale multi-national banking).

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See also:
Bill Miller vs Instant Gratification
Bank Debt is Near Record Low

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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Time Machine - 1111 and the US National Debt

INVESTOR PSYCHOLOGY

Recency Bias is the tendency for people to remember recent events more than past events, and to believe that the most recent situation has always been so.  Put another way, people tend to frame their memories based on recent events, and to remember what they want - and likewise, to forget what they want.

I mention all this because it seems like lifetimes ago that the US national debt was not only in control, but people were actually talking about paying it off.  That moment was 11 years, 1 month, and 1 day ago today.

Bill Clinton had just finished his term in the White House, stained by political scandal (ie. the Monika Lewinsky affair).  Many viewed Clinton as a very unpresidential, even embarassing president.  Yet, no one could deny the positive economics of his term.  At the end of the Clinton presidency, the National Debt stood at 5.73 trillion dollars - a relatively small sum for the massive US economy.  After three straight years of budget surpluses, economists were estimating how long it would take to pay off the National Debt completely.

Presidential hopeful Al Gore, for example, outlined an economic plan that would eliminate the National Debt by the year 2012.  When candidate George W. Bush was asked if he had a similar plan, he said that although he agreed with paying off the debt in principal, he would not commit to a specific date.

Soon thereafter, Bush was elected as President.  He immediately began a series of tax cuts for high-income families, which he (and his economic advisors) believed would stimulate the economy so much that the end result would be an overall increase in tax revenues (known as "trickle-down economics."); unfortunately, it didn't work .  Tax revenues declined drastically with each cut.

Bush ran a budget deficit (increasing the national debt) in 7 of his 8 years in office.  In 2003,  he set a record for the largest annual debt increase in US history.  Due to a combination of tax cuts and expensive foreign interventions, by the end of the Bush term the US National Debt had nearly doubled - from $5.73 to $10.69 trillion.

People now talk about the National Debt as if it was meant to be, always was, and always will be.  Many cannot remember the time - not so long ago - when there was talk of the United States of America having no debt at all.

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"I've abandoned free market principles to save the free market system."

George W. Bush, 2008

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Dear Workers of America

Actually, it IS your fault.

Barack Obama was raked over the coals this week (at least on Fox news) for suggesting that the US is not as competitive as it used to be, and that Americans are becoming complacent about their #1 position in the world.

What is interesting about Obama’s comment is that so many people agree that the US is not as competitive as it used to be, yet refuse to believe that they personally have anything to do with the situation.

I know many Chinese parents whose children are enrolled in soccer camp, take swimming lessons and piano lessons, have math tutoring, and yet still have time to meet their friends for several “playdates” per week – after finishing their homework, of course.  They have this much free time because they are only allowed to watch 2-3 hours of television per week, with another 1-2 hours per week to surf the Internet or play video games.  In contrast, I also know many American families whose children do almost nothing except watch television and play computer games.

The above is merely anecdotal evidence, of course, and doesn’t prove a thing.  But can we really call the average American family “motivated and driven to succeed?”

To find out if you are part of the problem or exempt from scorn, ask yourself the following questions:

1)      Do you watch 3 hours or more of television per day?  How about your children?

2)      How many books have you read in the last month?

3)      Do you currently have 3-6 months of emergency savings in cash, in case of injury, unemployment, or other unforeseen disasters?  If not, why not?

4)      Do you have trouble saving money?  If so, what have you recently done to drastically reduce your spending or increase your income (or both).  Or, do you just complain that bills are hard to pay but do nothing about it?

5)      During the last few years, have you purchased items like recreation vehicles, sports equipment, home decorations, electronics etc. on credit that you did not pay back at the end of the month?  Why?

6)      Have you been with your company for five years or longer?  If so, have you recently upgraded your skills/taken training courses etc on your own time?  Have you expanded your skill set to improve your employability outside your currently industry?

7)      Do you hate your job?    If so, what have you done to change careers or companies?  Have you updated your resume and practiced your interview skills?  How many jobs have you applied for?

In street interviews, website comments, and in social media, it is apparent that many Americans believe things will never get better: that they will always be unemployed, never get out of debt etc.   The more healthy reaction, of course, would be to say, “Wow, I was really stupid to rack up all that debt on my credit cards and house.  Now I’m going to have to study and train and work three times as hard.”

Of course, self-analysis is a difficult process and most people avoid it.  So, just continue to believe you are unemployed because of the President of the United States.


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People who are unable to motivate themselves must be content with mediocrity, no matter how impressive their other talents."

Andrew Carnegie

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see also:

Market of Sad Pandas

Today’s front-page headlines:

Think the Economy's Bad? 'You Haven't Seen Anything': CNBC, US

Shares fall of Greek deficit fear: BBC News – Business, UK

Markets take a turn for the worse: Financial Post, Canada

Wall Street drops as Greece overshadows ISM data: Delhi Business Standard, India

Is it just me, or is this constant vacillation between panic and complacency getting a bit tedious? I mean, seriously, it's been going on for 3 years now.

Everyone who reads this blog knows that the Chinese market is overbuilt and due to crash. Everyone knows that Greece is in trouble, and that European countries supporting Eastern European countries will suffer contagion. Everyone knows that the US economy is still in the tank, and although holding its own (and I would argue, poised for a comeback) will nonetheless remain there for some time. None of this is news. And yet, people are“reacting” to this news by selling their stocks - again.

Not that I am complaining, exactly. I love it when people sell their stocks at low prices, because I like to buy them. Canadian resource companies are my current favorite, since the chart for virtually every one of them has the shape of an inverted ‘V.”

No, this does not mean that I am suddenly one of those chart-wielding soothsayers who use terms like “reverse head and shoulders formation” or other such nonsense. It just means that no entire sector of a profitable industry deserves to be priced so low. Of course, this was one of my predictions in a previous article (The Fortune Teller), and I am now taking full advantage.

As one wonderfully sarcastic writer commented on a financial site today: “I would recommend you panic.”

Panic and fear are an intelligent investor’s best friends, as long as you watch but do not partake.  Don’t be a sad panda.

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"One must not let oneself be overwhelmed by sadness."

Jackie Kennedy

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From www.urbandictionary.com

Sad Panda, noun:

An unhappy, disappointed person. The phrase can be traced back to an episode of the cartoon South Park, in which the "Sexual Harassment Panda" teaches the children what is and isn't sexual harassment.
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The Debt Ceiling Hurt Locker

and the triumph of founding fatherism




The debt ceiling was raised, the crisis averted.

So why did the stock market go down again? Wasn’t there supposed to be a rally?

You may recall the award-winning movie from 2008, The Hurt Locker, in which a US soldier disarms bombs in Iraq. For the enemy combatants, blowing up innocent civilians was acceptable so long as it furthered their goals. I mention all this because it seems eerily similar to what we all witnessed in Congress last week.

Tea party members actually said – publicly - that they were willing to let the US default on its debt if it led to reforms later. That is, they were perfectly willing to detonate an economic bomb in order to reach their long-term objective (which, ironically, was to save the economy). Sane members of congress, despite universally despising the bill, passed it only because self-destruction was worse.

Both Republicans and Democrats swallowed bitter amounts of compromise to get the job done over the weekend, which was admirable. Despite this, rightist media is still calling the President a “Marxist thug” and “Nation Destroyer,” along with the usual racial slurs (ex. “leader with swollen lips.”)

Some of the tea party's ideas are actually good, though most members probably don't realize why. For example, Keynesian spending (to improve the economy) doesn’t work if everyone is worried about the country spending too much and defaulting on its debt; in this case, fiscal conservatism is better. It’s not the tea party’s economic ideas as much as their methods which are concerning.

The stock market continues to drop because people around the world increasingly regard the US as fanatical. The nation’s cult religion, “founding fatherism,” is growing faster than Falun Gong.

Many believe that because of fringe groups, the United States simply can’t be trusted.

Can it?

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(about the civil war in Cuba)

Michael Corleone: "I saw a strange thing today. Some rebels were being arrested. One of them pulled the pin on a grenade. He took himself and the captain of the command with him. Now, soldiers are paid to fight; the rebels aren't."
Hyman Roth: "What does that tell you?"
Michael Corleone: "It means they could win."

From the movie, The Godfather, Part II

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Let’s just say what we really think about Barack Obama

An Open Letter from Donnie Drumpf to the American People


Dear Citizens of America,

In recent days, the media have played into my doubts about Barack Obama’s citizenship, his academic abilities, and more. But now I am thinking, “Why all this pussy-footing around? Why not just come out and say what we are all thinking?”

Barack Obama is a negro! Am I the only one who has noticed this? I referenced an anthropology textbook (just to be sure) and it is undeniable: he has big lips, a wide nose, and dark skin. He looks like a heterosexual version of Michael Jackson before he became white. Weren’t these people slaves just a while ago? How did we allow this to happen?

Obama has relatives in Africa, spent part of his life in Malaysia, and yet still speaks English more eloquently than I do. Do you know how annoying that is? Black people aren’t supposed to be good at English. They are supposed to say, “yassah, nossah,” and “You’s disrespectin’ me, Holmes.” Of course, there are other members of the blacks who sound like white people. I forgave Denzel Washington and Laurence Fishburne because they make good movies. But now a President? This is too much.

And that name: Barack Obama. What kind of name is that? “George Washington” is a good American name. “Abraham Lincoln” sounds a bit Jewish, but is still pretty good. “Barack Obama” sounds like the kind of person we look for in caves in Afghanistan.

We’ve tried labeling Obama as the anti-Christ, linking him to communists and racists, challenging his citizenship, and of course the general and sweeping comment that he doesn’t seem American. The whole time, he keeps smiling and saying, “We need to focus on the issues.” He talks about the economy, energy planning and health care - completely ignoring our requests for college transcripts. What is it going to take to get rid of this guy!?

Barack Obama is better educated than I am, obviously smarter, holds the highest position in the world, and even has a better beach body. What’s not to hate?

By the way, did I mention that I have the highest rated show on the Gonzo network? It’s a great show, with a great fan base. We have a great name. People would be impressed if they knew how much money I have. I’m important. Right?

Sincerely,

Donnie J. Drumpf®

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"Don't hate me because I'm beautiful."

Kelly LeBrock, 1980s shampoo commercial

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The Mortgage Foreclosure Mess

YET ANOTHER KICK AT THE CAN



US Bank stocks skidded downward this week, based on a moratorium on foreclosures. Major US banks, including Wells Fargo and Bank of America, are accused of (among other things) using “robo-signers”: employees who rubber stamp foreclosure documents without properly reviewing them.

The mass-producing and bulk-signing of documents has a disgusting and immoral aura to it, similar to the revulsion for traffic tickets issued by speed radar cameras.

Having an employee decide the fate of someone’s home without reading the documentation is cold-hearted, and people are understandably upset. Having said that, it isn’t like the banks haven’t been trying. Wells Fargo alone has 17 thousand employees working on foreclosure and mortgage modification paperwork: they are simply overwhelmed by the volume.

For the banks, any moratorium on foreclosures is definitely negative. Moving foreclosed homes into the stabilized marketplace has been an order of priority for months now.

As an investor, there is a series of questions that should be asked in any situation where the immediate outlook seems negative. 1) Is this going to reduce earnings, and therefore stock prices? 2) Will this cause the company to go bankrupt, resulting in a permanent loss of capital? 3) Will the reduction in earnings be permanent?

In this case, the answers are clear: yes, this is going to reduce earnings and stock prices (and already has); no, this is not going to cause the major banks to go bankrupt (since their balance sheets are already positioned to withstand major calamities); and no, the reduction in earnings will not be permanent.

As usual, where there is fear there is opportunity.

The big chance to load up on bank stocks was in Feb-Mar of 2009, but there have been several smaller opportunities since: this may be another one. While today’s drop in bank stocks was just a small bump in the 3-year chart, a few more days of declines will result in some real bargains.

Bank of America (BAC), Citigroup (C), Wells Fargo and Co. (WFC), and JP Morgan (JPM) have all dropped nicely. That is, four of the biggest banks in America - with the greatest profit potential - are on sale again. Depending on next week's hype, bank stocks could drop even further.

If you missed out on the biggest run (when banking index fund XLF went from $6 to $15 in about a year), this is looking like another fine opportunity.

Hope for fear!

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"If I owe you a Pound, I have a problem; but if I owe you a million (Pounds), the problem is yours."

John Maynard Keynes

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Disclosure
Do not buy stocks, sell short, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

American Economic Dictionary 2010

Knowing this list of terms will not help you make money in the stock market. It will, however, give you a few laughs at a cocktail party (or a few nods of agreement, depending on your crowd).
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Bankster – n. A banker, since bankers and gangsters have the same profession (stealing).

Bernanke Clown Confetti – n. Common stock certificates.

Big Casino (The) – n. The New York Stock Exchange.

Corporapists – n. Evil organizations (corporations) that no one can trust, despite the fact that most people who believe this belong to one.

Green Shoots – n. Any hint of economic recovery, no matter how small. Popularized by CNBC’s Larry Kudlow.

Helicopter Ben – n. Ben Bernanke, Chairman of the Federal Reserve Board. The nickname comes from a speech he gave in 2002, in which he referenced economist Milton Friedman's metaphor of a helicopter dropping money on the community as a way to rescue the economy.

Hummer – n. A heavy, unaffordable, and somewhat useless off-road vehicle. Also denotes buxom women who date only wealthy men (ie. “Watch out, she’s a hummer.”)

McGlobalization – n. The evil result of cultural export (ex. Hamburgers in France, or rap music at nightclubs in Mongolia).

Nuclear Banana Republic – n. The USA

Perceived Recession – n. An economic situation that makes life uncomfortable for an extended period of time. The technical definition of recession (two consecutive quarters of negative GDP) no longer applies, since by this definition the US is already out of recession.

Sheeple – n. Individuals who do not recognize that the world’s economy is under the control of big business/Jewish Zionists/communists/hedge funds/The Federal Reserve/ Literati/Right-Wing Christian Fundamentalists/The Freemasons, or any combination of the above.

Staycation – n. A vacation spent at home, since one can’t afford to go anywhere.

Toxic Waste – n. Income products composed of sub-prime loans. Named by the traders who sold them to unsuspecting clients.

Turbo-Tax Timmy – n. Timothy Geithner, United States Secretary of the Treasury. Named for an incident during his stint at the International Monetary Fund, where he blamed his late income tax filing on the popular tax preparation software “Turbo Tax."

Zero Interest - n. The basic rate of interest during the credit crisis. Also used to denote the lackadaisical attitude caused by the credit crisis (ie. "I'm not going to the party. Zero interest.")
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“Men can acquire knowledge, but not wisdom. Some of the greatest fools ever known were learned men.”

Spanish proverb

US Banks: What a Difference a Year Makes

Although recent financial news has a decidedly cataclysmic tone, evidence continues to mount that things are improving frustratingly slowly and steadily, exactly as expected.



Today, the FDIC announced that US banks earned, in aggregate, 21.6 billion dollars in the second quarter of this year (FDIC). Though this is still well below historical standards, what is striking is that most banks (80% of them) have returned to profitability.

Back in May, when I first publicly recommended bank stocks (US Banks), headlines warned that the government might force banks to be broken up and sold, that financial regulation could destroy them, and that a new debt crisis (ex. Greece) might soon cripple them. None of these things has materialized.

Since May the US financials index (XLF) has nonetheless dropped from $15.36 to $13.44, despite quantitative improvements in all areas of banking: decreased leverage, reduced loan loss provisions, increased profitability, improved credit market stability, and more.

The new worries for banks include a flattened yield curve (making credit spreads less profitable), a potential double-dip in housing, and that Barack Obama is secretly a communist Muslim and/or Biblical Anti-Christ whose intention is to destroy the US financial system.

If you truly believe that the US economy will never improve, and that US families will never again buy cars or houses, use credit cards or keep bank accounts, you should definitely stay away from bank stocks.

If you believe that banking has a future in America (and that America has a future at all), this year’s prices may well mark the single greatest buying opportunity we will see in our lifetimes.
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"After 1929, so many people had been traumatized by the stock market crash that there was a lost generation."

Ron Chernow
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Disclosure and Disclaimer

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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Related amusement:

Is the US Recovery in Danger?

This week saw low sales numbers in housing, lowered (but still rising) durable goods orders, and a generally pessimistic attitude all across the board.

In fact, “pessimistic” may be an understatement. One website effectively summarized the prevailing mood: “Things will never get better. We are all doomed.”

One of many problems with doom and gloom reporting is the resulting dialectical materialism (George Soros calls it “reflexivity”). When people believe something it can become a reality, even if it wasn’t a reality at the time people began to believe it. For example, if people believe there is an increasing chance they will lose their jobs or homes due to recession, they will curtail their spending, thereby causing the recession that they feared. Despite the reflexivity effect, however, I do not believe that this recovery is endangered.

Consumer “entrenchment mentality” is already in full force, and has been for some time. As noted earlier in The Frost Report (The Spending Zone), Americans have been paying off their debts and increasing their savings for seven months straight, and are almost at the point where their free cash flow will increase substantially. As a result of these debt repayments and savings, consumer credit scores are already the highest they have been since 1998.

The corporate world largely reflects the personal one: businesses have vast amounts of emergency cash, have paid down and/or refinanced debts, and have streamlined staff and operations. Corporate America is mean and hungry. With solid balance sheets and low stock prices, M&A activity should rise soon and remain high for months.

The combination of high cash flow, lower debts, higher savings, and excellent credit ratings simply does not match the “we are all doomed” mentality. Similar to cult members who wait for the mother ship, at some point people will realize that the economic apocalypse they are preparing for is simply not going to occur.

Based on the numbers, I suspect that this revelation will strike the US consumer within the next 3 quarters. Regular (if not exceptional) spending will resume shortly thereafter, and corporate America will follow suit with mergers, expansions and hiring.

Though the international picture is deteriorating, it will not be enough to derail the US turnaround.
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“Hysteria has now disappeared from Wall Street.”

The Times of London, November 2, 1929
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FOR and "The Spending Zone"

AND ITS IMPORTANCE TO THE US ECONOMIC RECOVERY





The FOR, or “Financial Obligations Ratio,” is a surprisingly overlooked indicator of a nations economic health; specifically, an indicator of the financial health of its citizens. If the US is to truly experience an economic turnaround, the FOR is the number to watch.

The Financial Obligations Ratio is a ratio of the amount of debt that citizens of the US pay in comparison to income. For example, an individual with an income of $4000 per month (before tax) that makes monthly payments (rent, car, credit card, and other payments) of $2000 has a FOR of 50% ($2000 / $4000). The “safe zone,” where living is easy and spending is comfortable, is a FOR or 40% or less, with 32-35% being optimal. The higher the FOR, the more difficult it will be for a person to save for emergencies, spend, or invest.

As we well know, during the boom ending in 2007 many US citizens overextended themselves. In some cases, people were running at debt levels of 50% of more – a completely unsustainable level. Sometimes this was to “get rich quick” by investing in real estate. In other cases it was merely to keep up appearances.

In 2008 - with the collapse of housing and the markets in general - people finally woke up to the dangers of borrowing and started paying off their debts. In some cases, credit was cancelled and they were forced to start paying off debts.

The FOR statistic, as reported by the Fed, is somewhat deceptive. Retired people who tend to have almost no debt whatsoever skew the reported numbers downward. Most people in the U.S. do not actually have a FOR as low as 16%, for example. In reality, the average working person runs at 30% - 45% (even though 40% is the maximum recommended).

The most important thing to know is that free cash flow (spending money) becomes vastly more available as FOR declines. Say, for example, that someone has an income of about $50K, or $4167 per month. If they have a FOR of 45%, they will have approx. $1000 spending money available per month after paying bills and taxes. That's $1000 for groceries, evenings out, vacations, clothes - everything. However, if they pay down their debts to get a FOR of 40%, they will have approx $1210 per month. That's a 21% increase in spending money from a FOR only 5% lower!

Economists - ignoring reality, as usual - refer to the process of people paying off their debts and saving money as “consumer weakness.” The media often laments the currently high US savings rate, saying that it is “bad” for the economy. I could not disagree more. In order to have a long-term, sustainable economic advantage, the US needs to be a creditor nation, whose people use debt wisely and sparingly.

After people started paying off their debts in 2007, dramatic things happened. The national FOR rate for homeowners has dropped from 17.64 to 15.93 – the lowest level since 2002.

Since debts have been paid down and savings increased, credit ratings have consequently improved. The media routinely tells us about the thousands of consumers whose credit has been ruined since the crisis, but they ignore the millions of consumers whose credit has vastly improved. Equifax Inc. (commonly known as “the credit bureau”) reported that as of July 2010, the average credit score of the US consumer rose to 704 – the highest level since 1998.

Once people pay off enough debt to get into the spending zone (15.5% average), they will have enough cash flow to simultaneously spend freely and save. In addition, they will have better credit ratings than at any point in the last decade. It is a pivotal point that will cause the economy to turn around faster than anyone expects.

If current trends continue, this magic 15.5% cash flow level will be reached by the end of 2010.

For additional information, see
The Federal Reserve - household debt
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"Never keep up with the Joneses. Drag them down to your level. It's cheaper."

Quentin Crisp, Raconteur

US Foreclosures – The “Las Vegas Index”

In the past few months, foreclosure rates have climbed.



Under any normal circumstances, an increasing rate of foreclosures would indicate that the housing market and economy are declining/struggling/suffering. But, these are not normal circumstances.

As everyone knows, US banks are sitting on large numbers of properties where the owners have not paid in months. Previously, the banks wanted to foreclose on these properties but could not, since any increase in foreclosures would have only added to the already large glut. The fact that foreclosures are climbing means that banks are actually able to foreclose. Put another way, foreclosure rates are climbing because the economy is improving, and banks are able to sell their foreclosed properties faster than they were several months ago.

To illustrate, I give you The Frost Report’s “Las Vegas Index.” I chose Las Vegas to measure the nation’s real estate health because it is, officially, the worst housing market in America - with the highest percentage of foreclosures and the largest peak-to-trough drop in prices. The Las Vegas Index is simple: it measures the number of detached foreclosures and listed properties available for sale between 0-$1 million USD, with 1 bed and 1 bath or more.



There are two things that are clearly evident by studying this chart. First, non-foreclosed properties are simply not selling. Therefore, many of the existing home sales statistics are, at this point in the economic recovery, essentially meaningless. Foreclosures will have to clear before regular home sales will make any meaningful recovery. Secondly, the number of foreclosures on the market has not increased in recent months, despite a larger number of properties being foreclosed upon: this means they are selling.

The increasing rate of foreclosures is a positive sign, not a negative one, for the US economic recovery. The sooner bad mortgages and loans clear out, the sooner bankers (and citizens) can get on with their lives. The US real estate market, though it has a long way to go, is improving steadily.

PS - If you were ever considering purchasing real estate in Las Vegas, now would be a very, very good time.
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"...the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated."

The Federal Reserve, Aug 10th 2010

Are U.S. Stocks “Cheap?”

Reading the news, one could easily be duped into believing that stock prices accurately reflect the business potential and economic health of a nation. Of course, this is false.



Although stocks do, over the long run, tend to reflect underlying profitability and growth, in the short term stock prices and reality are not even necessarily related.

In the short term, stock prices are largely dependent upon the mood of investors. During times of pessimism, a company's earnings of $1.00 per share may give the stock a value of approx $10-14, or a P/E of 10-14. During times of optimism, the exact same stock with the exact same earnings may be valued at between $17-20, with a P/E of 17-20 or higher.

At present, the DOW 30 Index (thirty of the largest corporations in the US) has a collective P/E ratio of approx 18. Is this cheap? No. Is this expensive? It depends on your expectations.

A P/E ratio of 18 indicates that investors expect the profitability of the companies in the DOW to improve. That is, investors are willing to pay a slight premium over current earnings, with the understanding that earnings in in the near future will be greater.

Yesterday’s selloff was thousands of investors second-guessing their expectation that the US and world economies will improve. If the US economy declines, today’s stock prices are indeed slightly overpriced. If the US economy improves – even modestly – today’s stock prices are perfectly in line: neither overpriced nor underpriced.

Many world markets are set to slow down or even decline, including mainland China, Hong Kong, Taiwan, Canada, Australia, Israel and others – all of which has been well-documented in this blog. Yet, the US market will continue to improve, albeit slowly, because of various factors that I will be covering in detail in the days and weeks to come. The US economy was hit by the crisis first, and it will also be the first to emerge from the crisis, potentially stronger and more competitive that it has been in decades.

The US recovery may stall temporarily, but it is not in jeopardy. But of course I must add this caveat – in the short term, psychology trumps intrinsic value every time. That is, being fairly valued does not mean that prices cannot fall. Since I have no crystal ball, I unfortunately cannot tell you what stocks will do tomorrow.

My advice, as usual, is to buy the stocks of solid companies that are valued as if the present gloom will last forever.

PS – Don’t go looking for bargains in the Nasdaq. Thank you.
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"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions..."

Benjamin Graham
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Truth or Dare - The Fed vs CNBC

In past articles I have emphasized the importance – no, the necessity – of getting the facts and then forming your own opinions, rather than having your opinions formed for you.

In a hilarious exchange (to me), the Federal Reserve on Wednesday released the minutes of their June 22-23rd meeting, while CNBC simultaneously released a series of articles and commentaries on the same topics as seen in the Fed’s report.

The Frost Report today contrasts the differences between fact and opinion, or, more specifically, the impressions created by a non-emotional source versus the impressions created by a source that is necessarily dependent upon ratings.
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The Fed
“The rise in consumer spending slowed in recent months after a brisk increase in the first quarter….The moderation in spending appeared, on balance, to be aligning the pace of consumption with recent trends in income, wealth, and consumer sentiment. Real disposable personal income moved up at a solid rate in March and April, reflecting increases in employment and hours worked as well as slightly higher real wages, but home values declined in recent months and equity prices moved down since the April meeting. Measures of consumer sentiment improved in May and early June but were still at relatively low levels."

CNBC
Economic Recovery Is Faltering As Shoppers Head to Sidelines
"Even Federal Reserve officials have rolled back their economic outlook for the first time in more than year, saying Wednesday that continued weakness in the job market is hampering growth."
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The Fed
“The anticipated expiration of the homebuyer tax credit appeared to have pulled home sales forward, boosting their level in recent months. Sales of existing single-family homes rose strongly in April, and, although they moved down in May, these sales were still above their level earlier in the year. Purchases of new single-family homes also jumped in April, but then fell steeply in May.”

CNBC
Home Sellers Slashing Prices, While Banks Mow the Lawn
"That heady buzz from the home buyer tax credit is now turning into a grinding headache, as home sellers realize their very temporary, government-induced catbird seat has now fallen back to earth."
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The Fed
"The staff's forecasts for headline and core inflation were also reduced slightly. The changes were a response to the lower prices of oil and other commodities, the appreciation of the dollar, and the greater amount of economic slack in the forecast. Despite these developments, inflation expectations had remained stable, likely limiting movements in inflation."

CNBC
White House Economic Adviser Sees Deflation Risk
"'Yes, it is a risk,' Romer replied when asked during a congressional hearing whether deflation was a risk. Romer also said she did not expect the economy to slip back into recession."
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The Fed
"In sum, the changes to the outlook were viewed as relatively modest and as not warranting policy accommodation beyond that already in place. However, members noted that in addition to continuing to develop and test instruments to exit from the period of unusually accommodative monetary policy, the Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably."

CNBC
Fed Discussed Steps to Bolster Sputtering Recovery
"Federal Reserve officials cut their forecasts for growth this year and signaled they stood ready to take new steps to keep the recovery alive if the economy takes a turn for the worst."
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Great investors read annual reports (at least the financial sections) before purchasing a stock. They read complex Federal Reserve statements firsthand. They know that in order to be ahead of the game, they need to do the things that average investors do not. When it comes to information, they never take the easy way out. Great investors know that second-hand information results in second-rate decisions.
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Sources used in this article:
Minutes of the Federal Open Market Committee, June 22-23, 2010
Economic Recovery Is Faltering As Shoppers Head to Sidelines
Home Sellers Slashing Prices, While Banks Mow the Lawn
White House Economic Adviser Sees Deflation Risk
Fed Discussed Steps to Bolster Sputtering Recovery
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"I am suspicious of the idea of a new paradigm, to use that word, an entirely new structure of the economy."

Paul Volcker, former chairman of the Federal Reserve

The US Economy - Headed in the Right Direction?

Today, Barack Obama announced that the US economy is "still headed in the right direction," a comment that induced a great deal of ridicule, especially after this week's dismal employment figures. Yet, Barack Obama is right - the economy is headed in the right direction, though it has little to do with his great leadership, or his lack of it.

Interest rates are low & housing prices are low, together creating the best affordability rates since the 1950s. At the same time, many stocks are trading at below book value (net asset value). These are prime conditions for economic recovery. No matter what other government programs or policies are in place (or not), the economy will be in far better condition two years from now than it is today.

The economic cycle is playing itself out, textbook style. If Bill Clinton, George Bush, Ronald Reagan (also a chronic spender) or anyone else were still in office, we would be at exactly the same point.

The tendency for people to overemphasize the significance of an individual's actions is known as "fundamental attribution bias." As an example, the Vice-President of a bank recently told me that he became Vice-President at the "worst possible time" – just before the recession hit - thereby making his sales and leadership abilities look terrible. The economy is still bad and people are frustrated, so they are blaming Obama for everything except breathing.

Now that the major requirements for recovery are in place, the actual pace of the recovery is not within Obama’s – or anyone else’s – locus of control. Just as Bush was unable to prevent the crash, Obama is unable to speed up the recovery.

This time of maximum pessimism is, as I have stated on previous occasions, a buyer’s dream. Take advantage of it by purchasing the stocks of great companies at low prices. That is, buy low and sell high – unless you really believe that the world is ending.
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"Until people feel better about their own lives, they're not going to feel better about the president."

Bill Clinton, regarding Barack Obama, 2010
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Barack Obama - Enemy of Business?

The same people who were clamouring for financial reform during the height of the crisis now appear to be taking a "if it's not broken don’t fix it" approach. Having seen their stocks go up since the lows of 2008, fear of change has taken hold. How can we be considering financial reform when talk of it makes markets drop? Don't the markets "know everything?"

Many conservatives have branded financial reform or regulation as "socialist" or "communist," making the ridiculous conclusion that since the highly-regulated communist structure didn't work, a complete lack of regulation must be best. Such short-term and narrow minded thinking is bad for the nation. Financial reform is necessary - and has been a long time coming:
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"If we bail out this one (Penn Square Bank)...then the markets will know that, no matter what risks they take, the government will bail them out. Eventually, its going to lead down the road to nationalization of the banking system."

William Isaac, FDIC chairman, 1982
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"If this sounds like a warning, it is."

Gerald Corrigan, President of the Federal Reserve Bank of New York, telling bankers that the over-the-counter (OTC) market seemed to be expanding without adequate controls, 1992
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"Improved 'transparency' - a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won't cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives."

Warren Buffet, Berkshire Hathaway 2008 Annual Report
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"A key question: Should we opt for even more pain now to gain a better future? For instance, should we create new controls to stamp out much sin and folly and thus dampen future booms? The answer is yes. Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct."

Charles T. Munger, 2009, in the Washington Post
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"A clear lesson of this crisis is that any strategy that relies on market discipline to compensate for weak regulation and then leaves it to the government to clean up the mess is a strategy for disaster."

Timothy Geithner, Secretary of the Treasury, 2010 in the Washington Post
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"It is simply unacceptable to walk away from this recession without fixing the system's basic flaws that helped to create it."

Timothy Geithner, Secretary of the Treasury, 2010, in the Washington Post
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"A clear lesson from the events of the past few years--and a recommendation in the report with which we strongly agree--is that the government must not be forced to choose between the unattractive alternatives of bailing out a systemically important firm or having it fail in a disorderly and disruptive manner. The government instead must have the tools to resolve a failing firm in a manner that preserves market discipline--by ensuring that shareholders and creditors incur losses and that culpable managers are replaced--while at the same time cushioning the broader financial system from the possibly destabilizing effects of the firm's collapse… The financial reform legislation in both the House and the Senate would provide for such a resolution regime."

Ben Bernanke, Chairman of the Federal Reserve, 2010, Fed Speech
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In my estimation, one of the reasons people hate Obama is because he is forward thinking and logical, and therefore does things that voters hate (a rare combination in politics). In doing what's necessary, he successfully manages to piss off every possible segment of his support base. He makes poor people get health insurance coverage, even if they don't want it. He institutes financial reform at a time when the market is recovering and when each word from his mouth causes the market to drop. His logic, rather than his strict adherence to political philosophy, makes him "difficult" and "impossible to predict." Personally, I like the fact that Obama ignores popular opinion and just gets things done. No doubt he will be a one-term president.

Enemy of Business: no.
Enemy of dangerous, unregulated, pre-1929 style business: yes.
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"Issues are never simple. One thing I'm proud of is that very rarely will you hear me simplify the issues."
Barack Obama

Reflexivity and the Decline in Home Sales

Recent headlines confidently announced that the 33% reduction in U.S. new home sales for May 2010 was due to the expiration of the new-home buyer’s tax credit at the end of April.

In other words, we are supposed to believe that home sales were robust due to an $8000 tax credit, and now that this credit is over the housing market is bust. Nonsense.

In fact, the reversal in new home sales was primarily caused by an equally large decline in psychological wealth that occurred at the beginning of May - which had nothing to do with tax credits.

Rapid declines in consumer spending are caused by rapid declines in asset values, such as stocks or real estate. While there is much talk about how a drop in stock prices can “predict” an economic downturn, there is little notice that a drop in stock prices, rather than predicting a downturn, may actually be the cause of one.

When people see their net worth decline, they compensate by saving. That is, they decrease their spending and increase their margin of safety, further exacerbating the symptoms of the decline.



The “flash crash” of May 6th 2010 punched the confidence out of retail investors, psychologically forcing them to transfer billions of dollars out of equity investments. So, while April saw inflows to equity mutual funds of $13.89 billion, May saw outflows of $29.94 billion (www.ici.org). Negative headlines caused retail investors to run for the hills - and they haven’t stopped running. These days, the market fluctuates wildly from the trades of hedge funds and volume traders, while those working with retail clients (such as Financial Planners and Brokers) sit at their desks, bored.

Stocks are reasonably priced, with little room for a disastrous collapse like the one from the peak. Home prices are low. Interest rates are low. Despite problems in Europe and Asia, the U.S. economy has all the logical conditions which make it ready to rise from the ashes. However, retail investors and consumers are anything but logical.

Until the chat-room anger and gloom subsides, both stock and housing markets will linger - and the buying opportunities for rational long-term investors will be sublime.
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“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
The Federal Reserve, Press Release, June 23 2010

“Housing cannot lift the United States from its new state of Marxist depression, you bunch of morons. The American Dream is just that. Rest in Peace, USA.”
Anonymous comment on a financial news website, June 24 2010
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See also: Reverse Attribution