A lot has happened since I last posted, but nothing to change my overall view. Stocks are still dangerously expensive, with the Fed successfully creating a one-way market with QE-2. In fact, Rosenberg’s 2/25 newsletter points out an 86% correlation between the S&P 500 and the Fed’s balance sheet since QE-1 started 2 years ago. Bernanke actually mentions performance in the Russell 2000 and other stock benchmarks in defense of the program which is disconcerting, but he is right in his view of a fragile economy with a weak labor market and low chances of a sustainable inflationary spiral developing.
Here are some graphs from the 3/1 Rosenberg newsletter that were interesting:
(Note on the 2/28 post, Rosenberg said that US equity funds attracted $19.1 billion in January 2011 which was the third major inflow in a row and the largest since February 2007)
(Note that the doubling of oil from the lows was actually back in December… it was $75/barrel in Aug 2010, $90 in December perhaps a good part as a reaction to QE-2, and only went up 10% from there since the recent turmoil in the middle east.)
Housing is still getting crushed and has a ways yet to correct – with a combination of high supply & foreclosures, tougher requirements to qualify for a loan, and higher mortgage interest rates. The government is still trying to figure out what to do with Fannie, Freddie & the FHA and how big a role they should be playing in the mortgage market. This is important because it is the asset class most held by the middle class, and thus has more to do with consumer spending than the equity market (except for luxury items).
As for the inflation risks, I liked these graphs from the 2/24 newsletter:
In the 1970’s the labor market was tighter and earnings went more quickly to labor… right now, real wages are still deflating. Higher food and oil prices won’t result in higher wages with so much slack in the labor market, they’ll merely shift money from other things and deepen the recession in other areas (avoid anything Vegas-related… don’t forget what the 2008 oil spike did there – and how much it restrained the weekend crowd from places like Los Angeles).
Anyway, I’d like to repeat that I’m not asking you to short the market… and also remember the heavy risks betting on volatility even though the VXZ is still cheap… you could make similar arguments for weakness in 1999 or late 2006 and being early is equivalent to being wrong with those bets. Just keep in mind that the bond market has priced in a good deal of inflation fears, and the municipal bonds have really been pushed too high. Municipals are more likely to tighten than default at this point – we know the State & Local governments have been cutting budgets, laying off, and raising taxes – and the higher taxes will make the tax-free side of municipal bonds more valuable. I really think that assorted Muni-bonds are the best return for the risk out there, and are likely to be pulled down by year end, and according to the WSJ big investors in places like Pimco agree.
One thing I’d like to finish with is Rosenberg’s predictions which I thought were interesting (2/22 newsletter, p.11):
• March: Irish elections. Default back on the table. Euro weakens. Flows into front end of the Treasury curve.
• April: Debt ceiling is hit. Political gridlock in vogue. Market volatility ensues. Gold and silver firm.
• June: End of QE2. Stock market wobbles like it did last year under similar conditions. Bonds and the U.S. dollar rally. High-beta stocks slip.
• July: Start of fiscal year for state and local governments. Big retrenchment begins and takes a bite out of economic activity.
• October: End of fiscal year for the federal government. Fiscal restraint replaces three years of radical fiscal expansion. Big rally in bonds. U.S. dollar should firm up too.
• December: The payroll tax cut and the bonus depreciation allowance both expire, creating a huge air pocket for first quarter growth in 2012. Talk of recession accelerates. Bull flattener in Treasuries likely to ensue. Equities will still be in corrective mode as double-dip risks re-enter the market mindset.
About me: I don’t mind if most of my information is from Rosenberg- I love his newsletters because of the technical information which is difficult to gather. I’m still keeping up with the WSJ and the Economist, but they aren’t as rigorous and lack the fancy graphs. Also, I’ve been spending most of my time lately applying for jobs, visiting friends, snowboarding, riding motorcycles, etc while I’m still in California. I graduated from Marshall in Dec 2010 and if I’m not working by June I’ll have to apply outside the state… I’m trying to enjoy as much time here as I can, and I’ll focus more on the blog, digging through technical graphs for correlations, etc if I end up moving.
Also 2 interesting books I just read.
This time is different: very technical, mainly shows that financial innovation leading to an investment bubble and a “this time is different” mentality leads up to many market crises – and that government defaults have been much more common than you’d think, especially in emerging markets.
Black Swan: very introspective with many personal stories & anecdotes… main theme is that the gaussian bell curve simply doesn’t work in predicting investments. While extremes can be ignored in deviations of average human heights or weights, they happen more often and have a large effect in complex systems such as social behavior and stock markets. An example of another type of distribution is fractal where say, half as many people have a net worth $200,000 as $100,000 and half again have $400,000 net worth … and in such a system a small percentange of people will have an outsized affect on overall wealth, while it wouldn’t in a gaussian because the extremes would be so rare they’d wash out. Interesting to think about – main thing is don’t blindly trust the risk-management software or the rating agencies. An approach I would suggest is to think on your own about what major events could make your investments tank (maybe write them down – civil war in Saudi Arabia or another Russian default) and make sure that all of your portfolio isn’t exposed to the same risk even if the event does seem unlikely.