HEAD QUOTES TO ASSIST PERSPECTIVE
In preparing for battle I have always found that plans are useless, but planning is indispensable.
Dwight D Eisenhower, circa 1942.
No one would remember the Good Samaritan if he’d only had good intentions, he had money as well.
Margaret Thatcher, 1986
I stopped believing in Santa Claus when I was six. Mother took me to see him in a department store and he asked for my autograph.
Shirley Temple. 1999.
People are nervous about the long-term outlook, and they should be.
Paul Volcker, 11 July 2010.
Long range plans engender the dangerous belief that the future is under control. Try to stay flexible, open minded and sceptical. Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. In a bull market focus on price & momentum, a bear market focus on valuation.
ECINYA investment rule #8.
Quotes above: The Core Messages (note old journalistic adage – ‘90% of the message is in the head-note’)
- Call it a ‘plan’, a ‘vision’, a ‘hunch’ whatever you wish, but have some idea of where you think you are going and why, and change your mind if circumstances change.
- Love of money is the root of all evil, but money thoughtfully invested is the cause of all progress.
- Alan Greenspan still thinks he is Santa Claus. We believe him to be the worst central banker of his age, but he still appears on television as a guru.
- We have much confidence in Mr Volcker, Head of the Federal Reserve 1979-1987, and currently Chairman of Obama’s Economic Recovery Advisory Board. We always take his remarks seriously.
- Be nimble, be alert, investment accumulation will test your patience, watch the earnings season unfold. Conviction and Flexibility are opposite sides of the investment penny.
OVERVIEW
This is an update of the papers we published at the beginning of this year: ‘2010: Our view of the year ahead’ and ‘Revisiting the 2010 overview’.
Essentially, our views remain unchanged. We are expecting one more market rally followed by a retracement over several months of the order of 15% which will end about late September. At this time the global financial crisis will be over and markets and economies will be moving towards normalising. Then the next bull-market begins, subject always to context, determined substantially by what happens between now and then. There are always stocks to buy, and stocks to hold, there are always takeovers and other corporate happenings. Our conclusions exclude event risk. As always "Exercise Caution IN Your Affairs".
SUMMARY CONCLUSIONS
Our market is likely to remain difficult and hostage to world markets and perspectives on the global economic outlook. Europe is not good and America is, in our view, relatively worse, because it should be better than it is, and providing leadership after having caused so much of the recent mess. The glass is mostly half empty, not half full. On 27 May we moved all of our ‘buy’ recommendations to ‘accumulate’ and we are maintaining that position. Watch for special situations, wait for value to emerge, trade around the edges. It is all very tricky.
The world is in recovery mode. The global recession is over and we should not have a double-dip recession. But the pace of recovery is muted as the sister ships of America and Europe are turning around very slowly and most of the turnaround is already priced into markets. Asia, which includes Australia, is carrying the world economy. Australia has exaggerated its perfections under a profligate and inept Rudd Labor government and our vulnerability to a global slowing in the second half of calendar 2010 will become apparent over the short-term. Fortunately, the Reserve Bank is aware of the Government’s exaggerated claims and dismal fiscal record and has moved to tighten monetary policy to the point where we have the highest official rates in the developed world. This provides some flexibility if the projected second-half slowdown becomes severe.
Our 2010 ‘view of the year ahead’ said: "Though we regard the primary trend for 2010 to be UP, volatility will be a feature as the recovery will be complex. Most of the forecasters will have their moment(s) of directional accuracy, but will not be right for the entire year. Distrust any forecaster who just gives you a year-end index figure, which is a simplistic and lazy forecast, and relatively worthless. 2010 will be a difficult year simply because we had a complex recession with misleading and deceptive behaviour from many institutional and market related sources. Political correctness, self-interest, and convenient informal conspiracies have combined over the past decade to induce complacency and to mute criticism of behaviours that were near to fraudulent at worst and criminally careless at best, in relation to this credit crisis and the last tech/ telco crash. These institutions include bankers and brokers, government ministers, long-term fund managers, hedge funds, companies, the accounting profession, ASIC, the ASX, the IMF, and central bankers. Thus the natural tendency of market participants and informed commentators towards scepticism has been in retreat, and, to varying degrees, we have been slapped in the wallet by yet another harsh dose of reality. The commentariat has polarised into rampant bulls on one side of the debate, and negative zealots on the other. The response of the thoughtful should be to develop a strategy around viable data, consonant with an effective review and monitoring process. Only the nimble can outperform the swirling mass of ‘noise’ that hits us on a daily basis."
Assigning some probabilities to those generic conclusion we said:
- "Recovery with market retracements, subdued economic advance ……………. ……… 60% probability
- Double dip recession, more and/or new stimulus, secular bear overtakes…………..33% probability
- All other possibilities, new bull, depression, something we are unaware of…………..7% probability"
CONVERTING THOSE CONCLUSIONS INTO INDEX LEVELS (note the S&P 500 is our global proxy)
We are currently experiencing the first retracement from the intermediate high of the SP500 of 1217 reached on 23 April to a retracement low of 1022 on 2 July, a decline of 15.4%. In All Ordinaries terms (XAO) the decline is also 15.4% from 5024 to 4250 in the same period. Each of the markets should bounce around levels above 1050 and 4300 respectively for a little while yet.
The primary uptrend to the intermediate highs of 1217 and 5024 lasted 289 days and the current retracement period is 55 days. Our expectation is that it should exhaust itself after about 115 days i.e continuing to grind lower until about 30 September. For this ‘scenario/ thesis’ to unfold the current bounce should begin to falter later this month or early August, and the SP500 should go above 1100 and the XAO above 4500. Our September target levels are circa 975 for the SP500 and 4250 for the XAO.
How do we arrive at these technical levels? The March 2009 low for the SP500 was 676 and the intermediate high was 1217 in April 2010. The mid point is 947, and so 975 is near enough. The corresponding numbers were 3111 and 5024 for the XAO giving a mid point of 4068 but we expect Asia to be in better shape than Europe and the Americas so 4250 is near enough.
We also believe that the fundamental macro economic and market conditions will exist to support moves in these directions.
Our stock-market (and the developed markets generally) is not a true investment market, it is being dominated by quantitative and technical traders. Why? Because there is considerable uncertainty about the outlook and traders thrive on uncertainty. Remember, the laws that would make many trading activities transparent do not yet exist. Our market is thus a difficult market for the genuine investor who seeks to ‘buy and hold’.
CONTEXT
Short term – next month or so: the Gulf oil spill is capped and the relief rally continues. Australia remains in election mode and the Rudd government failures become prominent causing the consumer to hesitate. We do not really care who wins the election provided that Wayne Swan is replaced and Ken Henry learns something about business or is sacked by the new Gillard or Abbott government. At this point we are far from impressed with Ms Gillard as she seems to be a more personable version of Kevin, but no less vacuous. However, the Liberal front bench needs significant rejuvenation on the economics front and they need to find a seat for Arthur Sinodinos. We will have a major Insights issue after the election is called and policy positions can be evaluated.
Mid term – next 4 to 5 months: Global GDP numbers begin to be revised downwards, particularly for the USA, and unemployment remains persistently high. Retail numbers and housing starts continue to disappoint. America remains politically dysfunctional. The US mid -term elections will be a media nightmare, but we hope that Obama comes out in front and then shifts to the right and veers towards fiscal restraint. Obama and Geithner inherited a mess, and seemingly are not solving many of the problems. We always take great comfort in Winston Churchill’s: "You can always rely on America to do the right thing, once they’ve exhausted all of the alternatives".
BACKGROUND
The global recession of calendar 2009 resulted in a negative growth rate of 0.6% according to the IMF statistics.Over the 20 years to 2009 world GDP growth averaged 3.2% (at constant prices) and if we exclude the low growth years 1991 to 1993 inclusive, and the 2009 recession, then world GDP has averaged 4.2%. Further, over the 10 years to end 2008 growth averaged 4.0%. If the world is growing at 3.0% then world output doubles in approximately 24 years and at 4.0% per annum it doubles in 18 years, considerably faster. We know that growth is good.
At the end of 2008 world GDP was US$61.2 trillion and in 2009 it fell to US$57.9 trillion. Thus the shortfall was $3.3 trillion and the 3% growth we missed out on was about $1.8 trillion, giving a growth shortfall of US$5.1 trillion. Thus in 2009 the world lost about 5 Australia’s, or 1 China,or close to the combined GDP of France and Germany. That’s a lot to lose!!
Current estimates for 2010 are for world growth to rise by 4.2%, 2011 by 4.3%, and 2012 by 4.5%. These numbers look overly optimistic, but even if they are ‘wrong’ or the timing of the return to normalised world growth is delayed, the world will be in far better shape in 2011 than it was in 2009. We should also note that 2009 has been the only year of negative growth in the past 20 years.
THE NEXUS BETWEEN THE MARKETS AND THE ECONOMY
The market is a leading indicator, it goes up or down before the economic numbers are broadly known. Our current view is that the market got too far ahead of the economy around the first quarter of 2009 as a V shaped recovery was the prevailing wisdom. But the 2009 recession was caused by credit and liquidity problems, not the normal inflationary pressures that cause central bankers to put on the brakes. The way out of the global financial crisis was to ease monetary policy and expand fiscal policy to incredible extremes with the US taxpayer bailing out the major investment banks and other institutions (Fannie, Freddie, AIG) whose profligate behaviours caused the problem in the first place. It has been a bizarre recession and the response has been a frenzied form of Keynesian economics.
FUNDAMENTAL FEAR LIST FOR 2010 from our overview document dated 12/1/2010 with update notes in brackets
- America economic aggregates, and policy settings; negative trends in employment, current account and domestic deficits. (No change, in fact, things are a tad worse than envisaged)
- The aftermath of American foreign policy history and its implications for global resource allocation and growth. (Iraq, Afghanistan and the Middle East are still excessively troubled)
- The global economy and the possibility of growth rates disappointing as stimulus is withdrawn. (We consider the second half of 2010 will see this come to pass)
- The lead into various elections around the world that might encourage profligate fiscal behaviour (Australia, and US mid-terms are on the horizon, but there is little room for further profligacy)
- Higher global and local interest rates, particularly the latter, in context of rising inflation. (Has not happened, deflation now more of a problem, particularly in the USA)
- The unintended consequences of additional stimulation. (America politically dysfunctional, and Fed Reserve part of the political system, Congress needs to cut spending)
- Another major institutional failure in the USA. (Has not happened but BP certainly makes the list for other reasons)
- A downgrade of US debt. (Still on the agenda, but who is brave enough, or silly enough, to do it)
- China having a few problems which are currently overlooked such as slowing exports, failures in the small business sector, and non-performing bank loans. (Always hard to forecast or fully comprehend China problems, despotic governments can be more efficient in the short-term at least)
- Rising taxation levels. In Australia this will be euphemistically called ‘tax reform’. (Has been recently attempted with the resource rental tax, but has failed dismally, and was far from ‘reform’… The GST should have been extended to food)
- A break-out in local wages. (Will occur)
- Unemployment staying persistently high. (Australia OK if you ignore some of the definitional problems, but USA particularly vulnerable to entrenched unemployment problems)
- Commercial property values globally. (Still weak)
- Municipal and state failures in the USA . The 10 most troubled states in the USA are Arizona, California, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin. Other states, not far behind, are Colorado, Georgia, Kentucky, New York and Hawaii. (This is a big problem just bubbling beneath the surface)
- US local bank failures -144 banks have failed since December 2008 and more are said to be at risk. (Has fallen below the radar screen, probably OK)
SHORT TERM FEARS AND RIDDLES – 25 May, 2010 from Strategy section of that date.
- The IMF has said global growth has returned to circa 4%. They didn’t know about the GFC until it slapped the entire world in the wallet. Thus we should treat their pronouncements and actions with some scepticism. Currently, their solution for Greece seems to be fluid in context of rubbery Greek numbers on the depth of the ‘crisis’ and the political reality of potential solutions. (No change here)
- What has emerged with Goldman Sachs thus far looks like the the first cockroach, meaning that more are sure to exist. Michael Lewis’s book ‘The Big Short – Inside the Doomsday Machine’ throws up a lot of questions. (No change here, someone needs to be held accountable)
- The new GDP numbers for most of the developed world have been achieved via massive fiscal and monetary stimulus so that unqualified comparisons seem misleading. Australia has moved pre-emptively on interest rates and that seems good policy in context of sub-optimal fiscal policy outcome. (New securities laws in America having a trouble passage through Congress)
- US housing is still cum housing credit and better weather for construction.(Housing falling away as stimulus withdrawn)
- Can the US continue to borrow abroad at current interest rate levels? Watch 10 year bond yields. (America is a ‘safe haven’, perception is that Europe is worse, but we have always thought Europe was disinterested in growth and addicted to welfare anyway)
- The Henry Tax Review is likely to be substantial nonsense. (This has been shown to be true)
- The All Ordinaries index looks weak vis the SP500. (Still unfolding on the weak side despite the current rally)
- The SP500 looks stretched and vulnerable. (Still unfolding on the weak side despite the current rally)
- The Shanghai index looks to be rolling over. (Still unfolding on the weak side)
- The copper price looks like the Shanghai index. (Volatile to the downside, but not really falling over)
- British politics looks to be complicated leading into the election. (Conservative-liberal coalition going very well)
- America believes it is a capitalist country and wants to debate socialism under Obama and capitalism under anyone else. Congress seems to be fighting old wars on dogma and confusing and disappointing main-street.(America remains fragmented and dysfunctional)