Tuesday, November 1, 2011

Monday Thoughts

Papandreou to EU: Drop Dead

The eurozone debt drama is far from being resolved.

At 2:01 p.m. EDT these headline came out on Bloomberg, suggesting the eurozone debt drama is far from being resolved:

* Papandreou says challenge to exploit window of opportunity
* Papandreou says new Greek plan must be put to referendum
* Venizelos supports Papandreou in referendum on new Greek loan
* Papanedreou says Greek elections to be held in 2013 as scheduled

Life insurance stocks are selling off under the pressure of profit-taking and another ratchet down in bond yields. I would add to the group only if they drop another 5% to 10%.

To be honest I continue to be surprised by the group's volatility, both up and down. It seems the sector moves by 3%-5% every day -- that sort of volatility is not what I expected when I began to do work on the group.

The MF Global bankruptcy filing shows that news commenters can also be advertisers.

There is a need for more disclosure regarding the financial role that contributors/"talking heads" employers' have in their relationship with the media (e.g., CNBC, Bloomberg, Fox etc.).

Case in point: MF Global Holdings, whose chairman, Jon Corzine, was a frequent guest host on CNBC's "Squawk Box." It turns out that MF is a large advertiser on CNBC. And in this morning's bankruptcy filing (hat tip Zero Hedge!), CNBC is owed $845,000 in advertising from MF!

The October Chicago PMI came in at 58.4, slightly below consensus expectations of 59. New orders and inventories dropped, backlogs rose (as did employment improve).

To summarize the previous regional reports, Chicago's weak report was in line with disappointing results in the New York and Richmond regions, Philadelphia was better and Kansas City in line. Dallas PMI comes out soon; tomorrow we get national ISM (consensus is at 52.0 vs. 51.6 in the prior month).

As I look at all these reports, I would conclude that a lot of the forward-looking business expenditure data are likely to slow in the quarters ahead:

* CEO Roundtable survey on capital spending is close to two-year lows.
* The Fed's Beige Book suggests continued weakness in hiring and spending.
* New orders in the ISMs suggest slowing capex.

Europe remains a destabilizing force on world economic growth despite the euphoria of last week.

Meanwhile, on a fundamental note, the September euro-zone unemployment rate rose to 10.2% -- that's the highest reading in over three years.

Placing further pressure on the European consumer and economy was the October CPI, which was over 3% for the second month in a row.

Europe remains a destabilizing force on world economic growth despite the euphoria of last week.

What we have learned from history is that we haven't learned from history.

"In sum, with both earnings and bond yields near historic lows as a result of a lack of real growth in developed economies, investors will need to find lots of pennies to produce asset returns much above 5% in bonds or equities. Pension funds, Washington politicians, and indeed Main Street investors are likely expecting much more. One of the big problems of an asset-based economy is that once interest rates inch close to zero and discounted future cash flows are elevated in price, it’s difficult to generate much more if economic growth doesn’t follow. Such appears to be the case today. Unlucky…very, very unlucky." -- Bill Gross, Pimco's November Investment Outlook

What we have learned from history is that we haven't learned from history. Case in point: MF Global Holdings, which is on its death bed this morning after having leveraged up its capital into the purchases of European sovereign debt.

CEO Jon Corzine tried to accelerate MF Global's growth strategy by utlizing more debt.

It hasn't worked out.

I think Europe, which is also attempting to solve its debt crisis with more debt, will face a similar problem/fate.

The Wednesday eurozone "solution," designed to put economies on a sounder footing is ambiguous in many ways. The region has likely already entered recession and it is far from certain that the contagion that has moved from one country to another over the last 24 months will continue to be troubling.

In "Pennies from Heaven," Pimco's Bill Gross covers the challenges of asset-based and driven economies in his November outlook.

Emotion is taking over the market. On any given day (or maybe any given hour!) the U.S. stock market can swing by several percent based on a rumor, a flimsy blog or by a statement by a central banker or world leader.

In one brief four-week period, the fear of return of capital has been replaced with the fear of an inadequate return on capital as fear of the downside has been replaced with fear of missing the upside.

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
-- Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

The Oracle of Omaha, Warren Buffett, has often written about the madness of investing crowds and why it often pays in the long run to be a contrarian:

* "You can't buy what is popular and do well."
* "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is."
* "You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right -- and that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else."
* "A public-opinion poll is no substitute for thought."
* "The most common cause of low prices is pessimism -- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer."
* "If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."

And above all, let's be attentive to Buffett's observation below that applies as much to today's market as it did when he wrote this quote several decades ago:

* "Remember that the stock market is manic-depressive."

Crowds usually outsmart the remnants, but in today's emotionally charged and volatile market (which demonstrates no memory from day to day) confusion reigns and the crowds seem to bend with the emotion (and news) of the day.

What's causing these rapid changes in sentiment, and how should the average investor respond?

Arguably this manic crowd behavior (manifested in the ups, downs and insane volatility that follow) is reflected in the mood swings from depression to euphoria that have been goosed and exacerbated by the media, by performance-chasing investment managers and by high-frequency trading, momentum-based strategies and levered ETFs. We must try to stay (and invest) above the hype, avoid the pressure to "get in" during vertical moves (and to sell during deep swoons) and continue to try to take advantage of the volatility served up by the robots (rather than having it sap our confidence).

A little-discussed secret is that representatives of significant media advertisers (print, radio and television) often appear with greater regularity than other "guests." This helps to explain, in part, the media's sometimes limited criticism of glib, formerly wrong-footed bulls (names are excluded to protect the guilty!) -- many of whom failed to see the drop into the debt and equity abyss in 2008-09 -- compared to the relative quickness in criticizing recently wrong-footed bears like David Rosenberg, Nouriel Roubini and Meredith Whitney.

Back in 1973 the first health warning appeared on cigarette packaging -- "Warning - Smoking is a Health Hazard." Perhaps in 2011 it should be legally mandated that guests/talking heads in the business media disclose that their employers are important advertisers on the platform on which they are appearing. For example, BlackRock Vice Chairman Bob Doll's appearances on Bloomberg might disclose BlackRock's significant business/advertising relationship with Bloomberg. And, as another example, Jim Paulsen's frequent appearances on CNBC might disclose that Wells Capital Management is a significant advertiser on the network.

The hedge fund community has become the dominant investor over the past two decades. The rewards of differentiated performance, especially in a successful hedge fund, is huge. As a result, the performance pressures are intense. The fear of missing meaningful moves -- especially to the upside -- make for hedge fund catch-up buying (sometimes oblivious to overall macroeconomic strategy or individual company analysis) like we might have seen last week. History shows that hedge fund managers can get even more emotional than retail investors (though there is less emotion, it seems, when markets drop).

"It's not a market, It's an HFT 'crop circle' crime scene."
-- Tyler Durden, Zero Hedge

We live in an investment backdrop that is tortured by insane volatility.

The disproportionate influence of electronic trading, high-frequency strategies (based on price momentum) and leveraged ETFs (operating in a vacuum of de-risked and inactive individual and institutional investors) corrupt the markets by exacerbating price trends (both up and down). These exaggerated moves tend to obscure any sense of fair market value at any given point in time and too often influence unduly our own investment behavior.

"Obviously the thing to do was to be bullish in a bull market and bearish in a bear market."
-- Edwin Lefèvre (Jesse Livermore), Reminiscences of A Stock Market Operator

The game does not change and neither does human nature. So, how should the average investor respond to the manic markets?

Books to read -

* Howard Marks' The Most Important Thing
* Jim Cramer's Getting Back to Even, Stay Mad for Life: Get Rich, Stay Rich (Make Your Kids Even Richer), Mad Money: Watch TV, Get Rich, Real Money: Sane Investing in an Insane World, Confessions of a Street Addict, You Got Screwed! Why Wall Street Tanked and How You Can Prosper
* Barry Ritholtz's Bailout Nation
* Michael Lewis' The Big Short
* Andrew Ross Sorkin's Too Big To Fail
* Richard Bernstein's Navigate the Noise
* Michael Lewitt's The Death of Capital
* Gregory Zukerman's The Greatest Trade Ever
* Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds
* Edwin Lefevre's Reminiscences of a Stock Operator
* Jeff Matthews' Pilgrimage to Omaha
* Jeff Hirsch's Super Boom
* Walt Deemer's Deemer on Technical Analysis (2012)
* Jack Schwager's Market Wizards (all versions)
* Adam Smith's The Money Game
* George Soros' The Alchemy of Finance
* Leon Levy's The Mind of Wall Street
* Martin Shubik's The Uses and Methods of Gaming
* Graham and Dodd's Security Analysis
* Charles Raw's Do You Sincerely Want to Be Rich?
* James Grant's Minding Mr. Market
* Hewitt Heiserman Jr.'s It's Earnings That Count
* Martin Mayer's The Fed
* James Altucher's Trade Like a Hedge Fund
* Marty Schwartz's Pit Bull
* Robert Shiller's Irrational Exuberance