Archive for July, 2011

Same Stuff Different Day

As Europeans prepare to decamp to the beaches for their August holidays, the newsflow on the festering Greek Sovereign Crisis has taken a temporary, slightly positive spin. However, just like a band aid applied on the beach before one goes swimming in the ocean, don’t expect the latest “fix” to last for very long. Greece is in an untenable position and it will remain so until one of two things happen soon: either they are allowed to write off a significant portion of their debt and remain in the Euro or they are allowed to leave the Euro and write off a significant portion of their debt. The first solution will require the EU to backstop the Greek, German and French banks that hold the bulk of the Greek Government Debt. The latter will also require a backstop of banks (French and German) but will leave the Greeks with a newly devalued drachma with which to rebuild their shattered economy. Given the risk of contagion, the French and Germans would like to keep Greece in the Euro simply to reduce the damage of a cascade of sovereign debt crises that wait in the wings.

On the US side, the faux debt crisis is coming to a head as political strategists on both sides try to divine whom the voters will blame more next November for a government shutdown. The last time, Newt Gingrich ended up with the most egg on his face but that was during a relatively buoyant economic backdrop. Although the New York Times and other feel that there is a natural “out” in the form of the 14th Amendment (click here for a quick read), this political “chicken race” will come right down to the deadline of August 2nd. As those of us old enough to remember the aftermath of the Clinton/Gingrich Government Shutdown of late 1995, the long term impact will probably be negligible even if the government has to furlough workers in the first week or two of August.

While the debt crisis continues to unfurl across the developed markets, listed companies are quietly racking up decent profits as the benefits of globalization accrue to those companies who were able to take advantage of emerging market demand. A quick glance at the P/E ratios across the globe shows most markets trading in the low to mid teens. Although “low to mid teens” is hardly a screaming bargain, it is a respectable level to support an autumn rally if the Europeans can keep from scaring investors too badly. Adherents of the Fed Model might get a bit more excited but since the interest rates are being artificially held down, the validity of the Fed Model at this stage is at best qualified. Should the 10 year treasury trade at the S&P 500’s current 7.45% earnings yield (from current 3%) to bring the two into line or should the S&P 500 more than double to make up the difference? The answer is somewhere in between but it does suggest that valuations of US Treasuries vs. US Blue Chip stocks are a bit out of line. A return to the mean is not out of the question and should prove profitable for those willing and able to move with the markets.

What should investors do now?

For now, the Fund King System is signaling a risk-off, wait on the sidelines approach. Biotech (XBI) and Pharmaceuticals (XPH) are still at the top of the Global ETF portfolio with Eurocrat suspicious Gold (GLD) rounding out the top three. But none of the readings are particularly strong at the moment, signalling a lack of conviction amongst institutional investors.

Still Waiting for the End of the GFC

A number of subscribers have asked why I have been slack about writing the newsletter this summer.

The answer is simple, there really isn’t much new and fresh to talk about. The problems that stand before us are unchanged from the beginning of the year. That realization hit home when I watched a good presentation on the web which was recommended to me recently. The presentation was done in late January but could have just as easily aired yesterday.

While I try to be an optimist and remember that recessions are very good times for innovation and new leading companies to emerge, I cannot help but pay attention to the doomsayers who are correct in pointing out that the developed world is still in a long term, debt-laden situation that will only deteriorate as the demographics continue to shift toward older voters who expect to be taken care of in their old age.

Perhaps that is why two of the bright spots in the Global ETF Portfolio are the Biotech ETF – XBI and the Pharmaceuticals ETF – XPH.

So, as a result, the Fund King System is throwing up some perfectly dreary numbers and telling us that there is nothing terribly compelling for your risk capital at the moment.

If you want to see a market snapshot, we have broken down the Fund King rankings of the ETF market by market capitalization on this page. The 100th largest ETF this week, for example, is ACWI at $1.9bn. The 250th largest is PDP at $523m and the 500th largest is HHH at $131m. As you can see, the only ETFs showing any decent ratings are the leveraged ones. Overall, that does not fill us with tremendous confidence for the medium term outlook.

For me, the only bright spot is that the market is starting to pay close attention to unemployment. Not only is this a perennial lagging indicator but it is a very poorly constructed data series at the best of times and almost always wrong at turning points. Therefore, I find it highly amusing that investors are trying to catch a turnaround in underlying economic growth using a statistic which has failed so spectacularly in the very recent past.

Why is that a bright spot? Because it means that a large number of “smart money investors” are once again focused on the wrong thing. The current high level of reported (and underreported) unemployment is unfortunate but it is the wagging tail of the economic dog. A more sensible leading indicator to follow would be retail sales in the US. And on that score, it looks like some of the negative numbers could turn a bit more positive if you look at the work being done by the Consumer Metrics Institute. Nothing to “bet the farm” on this week but it is encouraging to see the line of their main indicator making a move for the Growth side of the chart.

What should an investor do?

Sometimes it is hard to do nothing but that is what the Fund King ratings suggest (as they have since April). There should be opportunities in the autumn and perhaps one of the catalysts to kick start a fresh round of investment will be the end of the faux crisis gripping Washington DC with regards to the debt ceiling.
The Euro Crisis should quiet down as Europeans take the traditional August holiday. The crisis will still be there when everyone gets back in September.

Continue to build up cash and wait for opportunities to emerge in the coming months.