Traderbill's Financial Markets Weblog

Bloomberg Quote of the Day: “The beginning of knowledge is the discovery of something we do not understand.” – Frank Herbert…a wise man indeed, TB

…it is getting ridiculous listening to CNBC (as if it wasn’t bad enough they have now individualized their reporters who give their biographies ending with “I am CNBC”, if that isn’t the height of hubris!), as we are constantly told how cheap stocks are here. The comment du jour is that the dividend yield on stocks is higher than the 10 year t-note. DUH! Do you think there just might be a reason for it? Take a look at the headlines in the overnight summary as the BOE and ECB battle each other to see who can cut rates faster (ECB wins hands down as they cut a full 1% overnight to 2% while the inflation-wary ECB cut 75 bp’s to 2.5%), meanwhile Bernanke is sounding scared and we only have another 100 bp’s to go to ZERO! Does that imply that stocks are cheap? Anyway, the dividend yield on the S&P 500 is 3.37% vs 2.60% on the 10 year treasury…wow, sounds great but before you back up the truck, how many of those dividends will remain in place? Once again, preferred stock could be a much better and safer bet, not just on income but on potential capital gains of 200% or more on some of the weaker names (be careful of the good ones though as they approach $25 par, or even exceed it). Plunging commodities prices are telling us something…aren’t they?

Take Freeport-McMoran (FCX) for instance. TB had noted that the dividend yield was 10% for this miner of gold, silver, and copper which is down 80% over the past year. Furthermore, they increased the dividend from .4375 to .50 just last quarter. Yesterday, before the close they announced a suspension of the dividend due to plunging prices of copper which is at the lowest level since July 2005 and they might have a significant ‘impairment’. The dividend suspension was the first since 1998 and they didn’t reinstate it until 2003! Shortly after TB started following it Jimbo Cramer endorsed it for the same reason in a show on dividend stocks. After the announcement the stock fell 17%, yet Cramer restated his recommendation as if the dividend didn’t matter because China will increase demand and thus the stock will rally…yes, Jim…but when? Talking from position!

Occasionally, someone calls in and asks about bonds and he has been very favorable on them of late…but says he doesn’t comment on them because “this is a stock show.” Now think about that: isn’t that why you are down 35% or more on your investments because so many investment managers have tunnel vision on stocks?

Historically speaking, you can’t fault them…nor can you fault them for saying stocks are CHEAP! But that is on a relative basis since 1945…thus the data is skewed. Note also that these “studies” to not adjust for changes in the composition of the S&P 500 nor do they include the depression years. Remember Fidelity’s Peter Lynch whose mantra was “over any 20 year period you can’t lose money in stocks?” First, you can when you adjust for taxes and inflation and if you doubt this go to www.crestmontresearch.com for a thorough understanding of returns and some beautiful color charts that can be downloaded (best to print them at Kinko’s on 18” paper as they are suitable for framing and much easier to read in the format). You can look at returns over any period since 1900 three ways: nominal returns, after-tax returns, and inflation adjusted returns, free!

Well, assuming Lynch, and Peter Bernstein are right, we better get going as the returns for the past decade are now negative. Of course, we could come out of this tomorrow, right? Stocks would rally, since housing would rally and it would be off to the races, but if you believe that you better ask what were the drivers of the past decade?

It began with a technology revolution, computers becoming affordable, the development of the internet and accompanying dotcom businesses…until it busted but only after surviving Y2k, there was a slight retrenchment in the wake of the Asian/Russian crisis and the collapse of LTCM but that caused Greenspan to ease when he had been ready to tighten. Stocks were seen attractive then too…even though priced at lofty levels and with IPO’s coming out and routinely doubling or more on the first day of trading. It was in this environment that hedge funds began to blossom. Then we had the double top in broad stocks, first in March and then the coup d’etat in September which took out both tech and dotcoms…along with analyst scandals that they were writing what their firms expected and their clients wanted (much as the rating agencies still do). Then we went down and rapidly and it was capped off by 9/11 when the bottom fell out again (contrary to popular belief which tries to make it appear as though this was the cause…we had been going down again since early August…it just exacerbated the decline).

From then until 2003 it was down and downer, then after treasury’s hit then-record low yields, the economy began to bounce back and along with it stocks. Much of this was due to the tax cuts of 2002, but mainly a housing boom which was more accurately a home equity withdrawal boom, that reached insanity in 2005 when a monkey could qualify for a subprime loan. Then there was an even more rapid growth of hedge funds which was aided by development of exotic derivatives that we are now paying for. But a major driver of stock prices was the companies themselves…not so much through performance as through five years of record stock buybacks rather than pay dividends…much of this due to activist hedge funds and CEO’s hoping to boost their bonuses the easy way.

Have you thought about what would have happened without that rapid increase in housing prices which was 25% or more a year in hot areas? First, the mortgage equity withdrawals (MEWS), alone added as much as 3% to GDP, meaning we would have been in recession much longer, and then the insatiable demand from speculators for mortgage paper along with ridiculous incentives to produce…er crap…get the bonus and who cares what happens after that. TB has also talked about the complicity of Congress (BOTH parites, so stop blaming it on Frank and Dodd, while Phil Gramm goes unscathed), the laxity of the SEC (even before Cox although he took it to an entire new level of incompetence).

What about instead if housing prices had risen by 6% a year…accompanied by wage increases for the rank and file instead of being flat for the past 10 years? Perhaps we wouldn’t have had all of that borrowing which was merely a continuation of what started 25 years ago. The point though is without incentives to produce bad investments we might still have five major brokers, now we have none with one bankrupt, two taken over by banks and two converting to bank status.

Instead, we have destroyed the global economy, despite the rapid growth in China, India and other developing countries who learning from the last crisis did it right this time, not knowing that by manipulating the commodities markets to sate the demand from commodities index funds we had some of the best and brightest assuring us that those price increases were REAL! What a bad joke that was…why could TB see it but they couldn’t? Was it because their noses were buried in data and charts that were misleading?

The history books are not going to be kind to the U.S. Not to the Bush Administration, capitalism that went unfettered until it required a bailout, or to the financial markets

Now with the above as a backdrop do you still feel stocks are attractive? How do we explain the lack of a true capitulation trade? The humongous daily, and intraday swings on low volume? The fact that about 80% of the market movers are the same hedge fund loved stocks day in and day out? The total neglect of economic data that is progressively weaker?

Yet we have had allegedly intelligent investors laud the NBER declaration that we are in recession and have been since last December! What possible value is there to something that took 11 months to prove and when we should have known we were going into recession in August 2007 when the crisis began? The reason they welcome it is it means that we are 11 months into recession and that means, historically speaking, we will be coming out of it by mid year…if you believe that you, like they are not paying attention to the global proportions of this beast and the draconian measures that have been taken, yet have shown no progress yet. Yesterday, TB heard of a study that showed that the average home price is undervalued by 23%…where does one come up with that drivel? Isn’t housing a function of supply and demand?..not only matching buyers and sellers, but borrowers and lenders…and what about those higher credit standards: strong credit rating plus 20% to 25% down? Income becomes critical here.

So we come to bonds. TB was a lover of TIPS, particularly the TIP ETF (TIP) for taxable accounts since you don’t have to do all the phantom income caluculations yet the ETF which had been steady for months began to plunge on September 30 on DEFLATION concerns after peaking on July 15 at 109.17. On September 30, it closed at 101.30 (-8.2%) and hit 84.14 on Oct 10 (-23%) on deflationary fears. Since then it came back to 95 but fell to 90.73 on 11/24 and is up 7.1% since then…even as over the past two days we have become even more concerned about deflation.

Now look at the TIP bonds. Whereas the ETF is a blend of all TIPS outstanding from 2009 to 2032, the individual TIPS have rallied incredibly (although not replacing the long bond as the best performer). On 11/24 you could have bought the 30 yr TIP at 3.23%, which if you recall TB said was too cheap. Today it yields 2.38% (which is probably way too rich) for a gain of about 15%. The 5 yr has rallied in price about 7.4% from 3.20% to 1.47% while the 10 yr is up 8% from 3.13% to 2.03%! Too rich! …but that can remain for a long time. As for regular treasurys the 5 yr is up 3% for the same period, 10 yr +5.4%; and the 30 yr +10.5% (ytd the 20 yr is up 29%!). There is one freak remaining in TIPS: the January 15, 2009 maturity which is yielding 16.6% (annualized) and priced at about 98-5/8. Note that is the raw yield…we won’t know the real yield until 12/22 after November CPI is released…it declined in October, even assuming a huge decline the expected return is probably around 11% and the worst case about 6% (remember this is only for one month but would you prefer 1 month or 2 month T-Bills at 0.10%?). The reason for this anomaly is the accounting which shouldn’t be important at this point but a lot of investors don’t understand it. More significantly, those who own it have losses and in addition will have to pay tax on the ‘phantom’ income which over the course of the full year could be substantial…it is all about liquidity…as a buyer now would have negative phantom income.

Yesterday, TB mentioned bank paper with treasury loan guarantees (TLG). These are yielding about 3.05% or 85bp over 3 month LIBOR and there are 11 issues with more on the way. There are also fixed issues at about 3%…all are due on 2010-2011. That yield is about 1.90% higher than a comparable treasury or about 0.75% more than an agency. True corporates are yielding much more but these are Aaa/AAA and risk free (how can any issuer with unlimited issuance be rated Aaa? Only to the whacky rating agencies).

Lastly, TB was perhaps too harsh on the auto makers…after all what concessions did Citigroup management or even the rank and file as is being asked of the labor unions make? Not one exec was asked to resign or even a director (all should have been forced out…especially Robert Rubin whose motives since he was at treasury are now questionable)…and don’t get TB started on Sandy Weill who did a stock swap of Travellers for Citi without prior approval and before Glass-Steagall was repealed. One has to be suspicious of why no action was taken.

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