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Happy Birthday, America!
July 2, 2009
It’s the weekend of July the Fourth where America celebrates its Declaration of Independence (7/4/1776) from Great Britain. In such a holiday-shortened week, with a very limited audience, we continue to think the path of least resistance remains up, so we thought we would spend this morning on this country’s national anthem. While most citizens know the first stanza of said anthem, few know the other three. Nor do they know the history leading up to the crafting of its words.
The year was 1812 and the United States was at war with England over freedom of the seas. It was a tumultuous time as Great Britain was struggling with Napoleon’s invasion of Russia. In 1814, however, Napoleon was beaten and England turned its attention to the United States. While many naval battles were fought, the fight eventually centered on the central part of the U.S. as the British attempted to split this country in half. Washington, D.C. was taken and then the Brits “marched” toward Baltimore, where a mere 1,000 patriots manned the cannons at Fort McHenry, whose guns controlled the harbor. If Baltimore was to “fall,” the British would have to take Fort McHenry.
The attack commenced on the morning of September 13, 1814, as 19 British ships began pounding the fort with rockets and mortar shells. After an initial exchange of fire, the Brits withdrew to just outside the range of Forth McHenry’s cannons and continued their bombardment for the next 25 hours. Surprisingly, on board one of the British ships was 35-year-old poet-lawyer Francis Scott Key, who was there arguing for the release of Dr. William Beanes, a prisoner of the British. Even though the captain agreed to the release, the two Americans were required to stay aboard until the attack on Baltimore was over. It was now the night of September 13th as the bombardment continued.
As twilight deepened, Key and Beanes saw the American flag flying over Fort McHenry. And, as reprised by famed author Isaac Asimov:
“Through the night, they heard bombs bursting and saw the red glare of rockets. They knew the fort was resisting and the American flag was still flying. But toward morning the bombardment ceased, and a dread silence fell. Either Fort McHenry had surrendered and the British flag flew above it, or the bombardment had failed and the American flag still flew.
As dawn began to brighten the eastern sky, Key and Beanes stared out at the fort, trying to see which flag flew over it. He and the physician must have asked each other over and over, ‘Can you see the flag?’
After it was all finished, Key wrote a four stanza poem telling the events of the night. Called ‘The Defense of Fort McHenry,’ it was published in newspapers and swept the nation. Someone noted that the words fit an old English tune called, ‘To Anacreon in Heaven’ – a difficult melody with an uncomfortably large vocal range. For obvious reasons, Key’s work became known as ‘The Star Spangled Banner,’ and in 1931 Congress declared it the official anthem of the United States.
Now that you know the story, here are the words. Presumably, the old doctor is speaking. This is what he asks Key:
Oh! say, can you see, by the dawn’s early light,
What so proudly we hailed at the twilight’s last gleaming?
Whose broad stripes and bright stars, through the perilous fight,
O’er the ramparts we watched were so gallantly streaming?
And the rocket’s red glare, the bombs bursting in air,
Gave proof thro’ the night that our flag was still there.
Oh! say, does that star-spangled banner yet wave,
O’er the land of the free and the home of the brave?
(‘Ramparts,’ in case you don’t know, are the protective walls or other elevations that surround a fort.) The first stanza asks a question. The second gives an answer:
On the shore, dimly seen thro’ the mist of the deep
Where the foe’s haughty host in dread silence reposes,
What is that which the breeze, o’er the towering steep.
As it fitfully blows, half conceals, half discloses?
Now it catches the gleam of the morning’s first beam,
In full glory reflected, now shines on the stream
’Tis the star-spangled banner. Oh! long may it wave
O’er the land of the free and the home of the brave!
‘The towering steep’ is again, the ramparts. The bombardment has failed, and the British can do nothing more but sail away, their mission a failure. In the third stanza I feel Key allows himself to gloat over the American triumph. In the aftermath of the bombardment, Key probably was in no mood to act otherwise? During World War I when the British were our staunchest allies, this third stanza was not sung. However, I know it, so here it is:
And where is that band who so vauntingly swore
That the havoc of war and the battle’s confusion
A home and a country should leave us no more?
Their blood has washed out their foul footstep’s pollution.
No refuge could save the hireling and slave
From the terror of flight, or the gloom of the grave,
And the star-spangled banner in triumph doth wave
O’er the land of the free and the home of the brave.
(The fourth stanza, a pious hope for the future, should be sung more slowly than the other three and with even deeper feeling):
Oh! thus be it ever, when freemen shall stand
Between their loved homes and the war’s desolation,
Blest with victory and peace, may the Heaven – rescued land
Praise the Power that hath made and preserved us a nation.
Then conquer we must, for our cause is just,
And this be our motto – "In God is our trust."
And the star-spangled banner in triumph doth wave
O’er the land of the free and the home of the brave.
I hope you will look at the national anthem with new eyes. Listen to it, the next time you have a chance, with new ears. Pay attention to the words. And don’t let them ever take it away ... not even one.”
“GaveKal”
June 29, 2009
I finally returned to Florida last Friday after eight days in New York City, and three days before that in Pittsburgh, seeing institutional accounts and doing numerous media “hits.” The plane from Pittsburgh to New York was late due to weather. As I sloshed down the gangway into the terminal I got the feeling I was traveling back in time since La Guardia is in serious need of a “refresh.” Proceeding to the taxi stand was likewise anachronistic as certain parts of my taxi were being held together by duct tape. Nevertheless, the trek into “the city” began. During the course of my rush hour journey I preceded over potholed streets, decaying bridges, a tunnel that reminded me of my youth, and dead-zones that dropped numerous phone calls. All in all, I felt like I was in a third world country, not the greatest city in the world!
Contrast that experience with Singapore Changi Airport, which has become the gateway to emerging and frontier countries. One arrives at one of the best airports in the world, with more than 80 airlines serving more than 180 cities. Despite the fact that the airport has been open since 1981, it remains a benchmark for service excellence, having won more than 280 awards, 19 of which were achieved in 2007. Travel to and from the airport is modern and efficient, both by road and rail. Indeed, there are no potholed roads, no old taxis, no decrepit trains, no “dropped” phone calls . . . well, you get the idea.
I begin this morning’s comments with the aforementioned diatribe because as readers/listeners of these comments know, I think that IF the markets have embarked on a new worldwide bull market the “new leaders” are likely to be emerging and frontier markets. That view was reinforced by our friends at the astute GaveKal organization, whose seminar I attended last Thursday. I love the GaveKal folks because they are truly “out of the box” thinkers; and, it is just such thinking that produces net-worth changing ideas. Louis Gave opened the presentation by noting, “Things are feeling better because they are better; largely because of Asia.” With that, Louis turned the podium over to Arthur Kroeber, who is an expert on China/Asia, and author of Dragonomics, which is GaveKal’s sister publication. Arthur began by stating (as paraphrased by me so this will be generally correct and precisely wrong) that China’s economy has grown by roughly 10% per year for the past 30 years. A large portion of that growth has been driven by exports. Arthur made the point that export growth is really a “technology transfer,” as foreign companies share their knowhow (manufacturing, warehousing, distribution, etc.), allowing China to leapfrog up the learning curve much faster than it could have on its own. Clearly, such a technology transfer causes a huge improvement in labor productivity. More recently, however, the western world’s recessions have caused China’s export growth to slow.
To counteract this slowdown, the Chinese government has “thrown” a lot of money at the situation. Official figures show that in 2009 that stimulus was four trillion renminbi ($580 billion), but Arthur thinks the figure is closer to five trillion renminbi, or roughly 15% of GDP. This monetary stimulus should permit China to grow at 7% - 8% per year for the next couple of years. However, by 2011 the stimulus will be gone and probably not renewed. It is also doubtful exports will reassert themselves to former levels. Therefore, the government is working toward transitioning the economy from a story of labor productivity to one of capital productivity. This transition was the MAJOR takeaway I got from GaveKal’s seminar. Manifestly, if accomplished, it would have extremely positive implications not only for China, but the rest of the world. Forcing reform in the financial markets is a major thrust of that transition. Accelerating reform in the financial markets should create more “efficiency of capital.” While the nascent reforms currently appear scattered, over time they should become more impactful, permitting capital productivity to replace the decline in labor productivity caused by diminished exports. For signs this is beginning to work look for more IPOs, more bond issuance, large banks lending to smaller banks, and more diversified financial channels. As a sidebar, if this works, there should be a boom in Hong Kong real estate; but that is a topic for another time.
After Arthur’s conclusions, Charles Gave shared some very interesting stock/economic points, followed by Steven Vannelli (portfolio manager and head of U.S. research), who discussed why corporate/household balance sheets are not as bad as widely believed. As followers of our work know, we too believe balance sheets are not as bad as many fear. However, the surprise of the session came when Louis Gave concluded the seminar with a “call” to consider investing in Japan. Hereto, followers of our work know we have eschewed Japan for decades due to fertility and demographic reasons. Yet, Louis’ reasoning was sound and insightful. To wit, while it’s true Japan’s demographics and corporate governance are terrible, a case can be made that Japan’s “freefall” is ending. It is also true that Japanese companies only restructure when there is a “gun” being held to their collective heads; and currently that “gun” is too much capacity. A quick perusal of corporate Japan shows the restructuring has already begun. Accordingly, the question then becomes, “Is this restructuring only going to foster another six- to nine-month rally in the Nikkei Index, or is this the start of a new bull market?”
As Louis opined, bull markets begin from cheap valuation. To be sure, Japan’s P/E mutliple is high, but think of it like a cyclical stock that you want to buy when the P/E multiple is high, and the price to book is low, like Japan is priced. Secondly, it takes excess liquidity to drive stock prices higher. In Japan’s case foreign investors, and commercial/central banks, are/should provide that liquidity. Indeed, Japan’s money multiplier is positive for the first time in two decades! Further, the Bank of Japan is engaged in quantitative easing, so liquidity should be ample. Thirdly, it appears with more detente between China and Taiwan there is also more integration between China and Japan. Interestingly, Japan does more business with China than it does with the U.S. Thus, if China’s transformation toward “capital productivity” is successful, it could be hugely positive for Japan. Just think of the bull markets fostered by NAFTA (North American Free Trade Agreement) and the European Union (The Treaty of Maastricht). Finally, there are increasing signs the Democratic Party of Japan (DJP) is gaining traction over the long dominant Liberal Democratic Party (LDP), which could/should have positive ramifications for Japanese equities. Clearly, these views are “out of the box,” but as stated that is where net worth changing ideas begin. For further clarity we suggest contacting GaveKal.
As for our markets, we have not really changed that much since early May’s momentum peak at 930 on the S&P 500 (SPX/918.90). Since then, our indicators have flopped/chopped between positive and negative, indicative of a trendless stock market, which is why most of the indices we traded off of the March “lows” are no higher now than they were back in May. Moreover, last Monday (6/22/09) was a 90% Downside Day (volume and points were skewed more than 90% to the downside). It was the second 90% Downside Day in the past two weeks and therefore counsels for caution. That said, we still think it’s a mistake to get too bearish. As Charles Gave stated in his presentation – this recession is an anomaly because productivity actually rose. That implies companies cut costs dramatically; and, if demand picks up it would suggest corporate profits could explode, causing one old Wall Street wag to exclaim, “Maybe that’s what the rally has been all about!”
The call for this week: We have now experienced two consecutive down weeks in the SPX, the first such occurrence since the March “lows.” Worryingly, both weeks contained a 90% Downside Day, which is why we remain cautious, but not bearish. Indeed, according to Bespoke Investment Group, July has historically been a strong month for equities, with an average gain of 1.17%, and a 70% positive monthly track record over the last 20 years. However, late last week the Russell Rebalance (Russell Investment Group rebalanced its 25 U.S. indices) created some “noise” that is unlikely to abate until quarter’s end. And speaking of noise, this morning we find out that even Greenpeace is against the Cap and Trade Bill as things remain curiouser and curiouser . . .
“I’m confused?!”
June 22, 2009
His email read:
“Jeff, I’m confused, which way are you leaning more heavily?
6/18/2009 9:26:50 AM
byJeff Saut
Caution is the word warranted here. This week’s market movements suggest we could see a deep downside correction, or at best a sideways market action for the remainder of the summer, similar to what the markets experienced in the summer of ’03.
6/15/2009 10:18:35 AM
byJeff Saut
We believe there are a plethora of reasons that suggest it’s a mistake to get too bearish on equities at current levels. Moreover, Dow Theory would confirm the start of a new bull market if the DJ Industrial Average and the DJ Transportation Average can better their respective January 6, 2009 closing highs of 9015.10 and 3717.26.”
My response read:
“I am flat on a trading basis and 80% invested in the investment account. Still, even though history suggests we could/should get a decent correction following the 40% straight-up rally, I continue to think it is a mistake to become too bearish right here. Sticking with the 2003 stock market pattern, after bottoming in March 2003, at around 800, the S&P 500 (SPX/921.23) sprinted into its June high of roughly 1000. From there it flopped and chopped into late August, but never gave back more than 6% (although certain stocks gave back considerably more). Then, in September 2003, the SPX broke out above those June “highs” and leaped another 150 points into January of 2004. While history doesn’t necessarily repeat itself, it does sometimes rhyme.”
We think it might just “rhyme” this summer as the equity markets trade sideways as investors contemplate whether the improving economic numbers are ephemeral or for real. Our guess is this won’t be figured out by the markets until the late summer. Admittedly, it is difficult to envision a “V”-shaped recovery, even though the history of recessions is that the sharper the downturn the more vigorous the upturn. In the current instance, following the recent rally, stocks are now priced such that they need a solid economic expansion to extend their gains. The problem is that economic expansions are driven by rebounds in housing and autos, which causes companies to increase capital expenditures and actually hire some folks. Such outlays are pretty dependent on debt financing. Unfortunately, given the country’s debt deleveraging mindset, it is difficult to embrace the thought of a sharp economic recovery.
That said, I still believe the economic numbers are going to look better than most people think into year-end. That view is spurred by various governmental programs/incentives, as well as the HUGE amount of money being thrown at our problems. As UniCredit’s strategist stated in Friday’s Financial Times, “The phase of a reality check we had anticipated on the equity market is now underway. [However] We think an abrupt and lasting deterioration in the equity market environment for 2009 is improbable. Instead, the trend of the 12-month forward earnings estimates should stabilize or recover in the second half because of the improvement in economic indicators.”
So the question this week is, “Was last week’s ‘wilt’ the start of the anticipated correction?” Interestingly, while the “cap weighted” S&P 500 was only down 2.6% for the week, the “equal weighted” S&P 500 was down 4.1%. The implication is that the decline was broader than the much-watched indices suggest. In fact, of all the things we monitor only aluminum and natural gas (Henry Hub, spot month) rose on the week, by 0.06% and 11.51%, respectively. As readers of these comments know, while we think crude is pretty extended in the short-term, we have become increasingly constructive on natural gas over the past number of weeks even though that goes against the opinion of our energy analysts. Coincidentally, our friend and Director of Research for Investment Management Associates, Inc., Vitaliy Katsenelson, sent me this email on Friday:
“Six reasons why natural gas is a better investment than oil:
- Reserves deplete faster than oil (in general).
- Oil/natural gas ratio: the price of oil divided by the price of natural gas is at an all-time high (or close). This ratio stands at 17 (historically it has been at about an 8 or so). Natural gas prices will go up, oil will decline, or both. Also, natural gas is not a good hedge against the declining dollar (it is for the most part a domestic commodity) and storage capacity is more limited, thus not as admired by speculators as oil. This explains in part why it lagged the spectacular performance of oil of late.
- At $4 natural gas, it is uneconomical to develop and look for new reserves.
- No OPEC competition, LNG (liquefied natural gas) imports are uneconomical at these prices.
- Politically more favorable than coal.
- After emission caps are implemented natural gas will become a cheaper alternative than politically and environmentally unfriendly coal.”
Obviously we agree. Favorably rated names from Raymond James’ research coverage include Apache (APA/$75.34/Outperform) and Occidental Petroleum (OXY/$64.52/Outperform).
The call for this week: To repeat the question du jour, “Was last week’s ‘wilt’ the start of the long anticipated correction?” Like our emailer, we too are somewhat confused. Indeed, over the weekend George Soros said that the “worst of the global crisis is behind us.” Yet, this morning the World Bank is stating that the prospects for the global economy remain “unusually uncertain” and lowered its world growth assumption from -1.7% to -2.9%. Then there is an independent research organization that opinioned last month’s economic figures showed the strongest rebound in five years. Typically, the first stage of a rally is driven by liquidity. Then markets tend to “rest” for a period of time until improvement in the economy/corporation becomes evident, sparking another rally. That’s why we have been embracing the stock market’s 2003 pattern, as well as why we think it’s a mistake to get too bearish. Nevertheless, since the March “lows” we have often repeated that we can find NO instance where after making a generational oversold reading the equity markets become vulnerable in less than three months. Regrettably, we are now more than three months from those “lows” and we remain cautious.
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