Feb 18, 2008: Cues & Clues (for confusing times)
Market updates Pundit survey & the AUM clue More cues & clues A big clue-stick
Market UpdatesAfter an impressive rebound from the Jan 22-23 lows, the markets took a not very surprising breather, falling pretty sharply in the first week of February. The general advice: if you're bullish, wait for pullbacks for buys, and if you're bearish, wait for overbought conditions for sells, should always be kept in mind.
In the past week, markets have stabilized again and a new higher-low since the 22-23 of January bottom seems to have been established. The news overall has been mixed and utterly confusing. The markets seem to be so confusing to many observers, that one pundit seems to be saying the exact opposite of another, thus the title of this article: Cues & Clues. How can one remain "unconfused" in the midst of such mixed-signals and polarity.
First, let's try to go over the most important good and the bad news (for investors) of the past few weeks:
- Insider buys exceed sales, signaling market bottom [Source: bloomberg, Feb 4th]
- Investor sentiment hits record low in January. [One source among many]
- ECRI proclaims The consumer is screaming that they need help with regards to a economic cycle contraction. The WLI index as at its lowest since the 2001 recession.
- The New York Fed's Empire State manufacturing index is at its lowest since April 2003. Consumer sentiment index is at its lowest since February 1992. Check out these dates. They were both great entry points into stocks.
- Conforming-loan limits have been raised from $417,000 to $729,750. Great news for home-owners in expensive areas, such as California, whose ARMs are about to reset higher in 2008.
- The British government is planning to bail Northern Rock
- Bond and treasury yields vs stock yields are now at record lows. For example: the S&P500 trades at ~14 times earnings, while 2-year treasuries are now yielding 2% (the equivalent of 50 times earnings).
If you think something under good news is actually bad as an investor, think contrarian indicator.
- Credit downgrades are still overwhelming upgrades. A little secret: I have a daily script collecting this data.
- Municipal bond rates are sharply UP. And there are still no buyers.
- The credit crunch and lack of trust among banks continues.
- Inflation is picking up.
- Layoffs and unemployment are up (but note that this is usually a lagging indicator.)
- Technicals: market breadth is still very narrow. Also only about 22% of US stocks are now above their 200 day moving averages.
- No resolution yet to the monolines (bond insurers) debacle.
And with all this, it is no wonder that even those with excellent long-term records, don't agree, to use a bit of an understatement.
Pundit Survey & the AUM clueAt uncertain times like these, the biggest insight I get is from tuning out the perma-bulls and the perma-bears. There's no signal in reading them. That leaves those who are the most realistic and least emotional. Naturally, this also means, those with the best long-term records. So let's look at a small, and by no means representative, yet instructive, sample of those:
Of all the above, I like Andy Mayo the best. Why?
- Andy Mayo: a market technician. Focusing on identifying the primary trend. Very good reading. In his view the markets are now in limbo giving a pretty ambiguous signal-set. Breadth stinks, but the worst may be, just maybe, be over. This is typical pure-technical analysis. It is critically important to follow technicals, but also to be aware that following breadth and moving averages crossing each other, is a lagging method by definition.
- Ken Fisher: a mostly fundamental, value investor with about 4 billion under management, is very bullish. In his mind, it is 1998 all over again (may require free registration), and we are just before the last leg of a bull market. The recent Oct-Jan correction is, in his view, technically, only a big correction because it didn't exceed -20%. His recommendation is to invest in "mega caps" because that's what works best in the last leg of a bull market.
- Bill Miller: 15 year in-a-row beater of the S&P500 with his 20 billion Legg-Mason Value Trust. He hit a rough spot with the past two years underperforming the index. He is now very bullish, especially on Financials. In his view, it is now 1991 all over again. Funny how different pundits find different parallels to today's markets. His last letter to shareholders is extremely reassuring and makes great reading
- Jeremy Grantham: Chief Investment Strategist, GMO. 150B under management. Very bearish, calls the current credit-crunch The worst financial crisis we've had in the post-war era. and sees the current weakness as one leg in a secular bear.
- Just as a little tip for the bulls, this weekend, Barron's is finding some extreme value plays among the rubble:
I like him because he is not managing billions and he has nothing but the truth, and his own insights to promote. He sounds the most ego-less and admits the situation is confusing, and his truth seeking leads him to follow the charts. He's thorough and is looking at many indicators. Note to self: add to bookmarks, and keep revisiting.
Here's perhaps the most significant thought: Big guys who manage billions can not turn on a dime. They must voice strong opinions to try and support their positions. But there's a huge difference between 4 billion and a 150 billion "under-management". The latter, more than the former, should be assumed to be already committed and already "priced in" the markets. This is true especially when that humongous position is in agreement with ECRI, the financial rags gloomy covers, and the prevailing investor sentiment. In other words, the biggest (note, I didn't say just 'big', but 'biggest') Assets Under Management (AUM) positions should be used by perceptive investors (big or small), as the the most contrarian.
These huge positions are yesterday's market.
This leads me to bet on Grantham as the least reliable indicator of all the above. In all humility, this is a true eureka moment for me. For many years I have been "programmed" to listed to the big players (if they're big, they must know something I don't), and treat the small ones as contrarians, I now find that, paradoxically, the biggest whales in the ocean, should be treated as contrarian, just like the smallest "odd lots" are treated! Pay attention to that AUM number.
But this doesn't mean that the 4 billion AUM are golden either. The bullish pundits are far from perfect. Independent data-driven views are IMHO the most precious. Fisher was hit hard by the recent correction, same for Miller, both have lost some of their "magic touch". While the defensive, sitting in cash, precious metals, and commodities were making a killing. So if both defensive and bullish may be wrong, who is right?
I tend to be a big believer in reversions to the mean and this gives some advantage to the bulls. I notice that Gold is up over 10% in the past 3 months, and down 2% in the past 5 days.
Since Fisher and Miller have great long term records and pretty dismal recent records, maybe that means that their better days are coming back. When the Granthams start moving into stocks, Fisher's and Miller's best bull days predictions become reality.
Cues & CluesLet's assume for a moment that Fisher and Miller are right and we are in the last up-leg of a secular bull. Even if the outlook is less bright and we're just in an intermediate leg up from a big drop, there seems to be a value opportunity here.
But what about that bullish mega cap recommendation above? It was based on the fact that during those times where credit is scarce, small caps tend to under-perform. Also: it sounds like a classical anchoring-effect. Since Fisher thinks it is 1998 redux, and since mega cap outperformed then, they must outperform now. He may be right, but this seems (to me) a bit premature given that:
- Companies today, unlike in 1998-2000, seem to be under-leveraged with pretty strong balance sheets. so I'm not so certain small-caps are under such pressure, from lack of credit. Especially the strong among them.
- The charts, at least since the last bottom, tell a different story. For now. Let's look at them.
Based on this chart, large caps have been underperforming, mega-caps have been even worse, and mid-caps have been the best place to be. We'll keep watching this chart in the coming months. If Fisher turn out to be right, there will be plenty of time to switch to mega caps.
In the mid-caps group, value and growth are neck to neck with value slightly under performing.
In the small-caps group, value seems to be gaining ground over growth.
A big clue stickA reader (you know who you are) has sent a wonderful link to a humorous video clip where British satirist John Fortune is interviewed as "George Parr the Investment Banker" by fellow satirist John Bird. In the clip the two are explaining the subprime crisis. This is British humour at its best. Now that it's official that the British tax payer will be bailing out Northern Rock (see the Daily Mirror link above), this seems to be timely again. It also means that governments will do whatever it takes to avert a 1930's style collapse. Enjoy.
As always, every investor should make up their own decisions. The above is an approximate description of my thinking and my own actions, and is not a solicitation to buy or sell anything. Any feedback, question, request, criticism, or "still confused" note, is very welcome.