Where are we now?

First off, let’s get all the honesty out of the way.  I’ve been very cautious about this market and its ability to continue higher or even maintain these levels (I’m being polite to myself for how off the mark I’ve been).  The good thing is, if I keep saying I think the market will correct and go lower, eventually I will be right…

All kidding aside, please always remember, it’s never a good idea to be “all in” or “all out”.  It’s about being more exposed to markets you think will benefit from the current economic conditions and less exposed to markets you think will not benefit from the current economic environment.  Right now I happen to be less exposed to the stock market as I’ve indicated previously and more exposed to cold hard cash and some treasuries.

Let’s move on and review some of what I think are key points in my opinion, regarding the overall economic environment.

Starting with the S&P earnings.  If you go back to 1960, the average price of the S&P 500 to its underlying earnings (P/E ratio) ranged from 7 to 20.  In the boom times of the irrational 90’s (remember the technology stocks and when everything .com went public?), P/E ratios were anywhere from 17, all the way up to 45 in 2001 before the first big bust.  Today the P/E ratio, based on the earnings of the last three (3) quarters and the projected first quarter of 2012, is about 15.5.  If we take the longer term range of between 7 and 20, we see that the 15.5 is in the upper half of the range.  In addition, this is based on companies continuing to generate record earnings (by the way, Federal Express just recently guided their forecasted earnings for 2012 lower and stated the following, “The fourth quarter is still very good, we just don’t have as strong an economy as we would have hoped it would be a year ago.”).  Nothing really to write home to Mom about.

Now that we’ve talked about the underlying earnings of stocks, let’s look at how stocks as a whole have been performing.  The number of stocks making new 12 month highs is 324.  For comparative purposes, I reported a few weeks ago that at the end of January, there were over 400 stocks making new highs and back at the end of March in 2011, there were over 600 stocks making new highs.  Any reasonable person would think the market as a whole should have plenty of stocks participating by making new highs as the market itself makes new highs.  The fact that there aren’t more leaves me with reason for concern.  

Next we look at employment.  The unemployment rate recently held its level of 8.3%, which is down from its peak over 10% back in late 2009.  The calculation for the unemployment rate is the number of employed persons divided by the “available work force”.  The next interesting question is how does this available workforce number compare to the population of the United States.  In other words, are the same number of persons available for work as a percentage of the population as we’ve seen in the past.  The following is a long term chart of the “participation rate” published by the Bureau of Labor Statistics, which calculates what percentage of the population is available for work.

You can see how throughout the 70’s and 80’s, the participation rate increased dramatically as more of the population entered the labor force.  So what happened since 2001?  Do all of these people that have dropped out of the labor force belong to families that don’t need the additional income?  A small uptick in this participation rate to 65%, would leave us with an unemployment rate of 10%!  I wish I belonged to one of these families that doesn’t need the additional income.  I would be more than happy to become a statistic.
 

Even as each passing week goes by and I am wrong on where to put my hard earned money, I happily sit on the sidelines underinvested in stocks.  Until we see a nice correction where stocks get cheaper, I will remain an onlooker and enjoy reading how Apple will soon take over the world.

Joel Fink

Joel.fink@yahoo.com

Valuable Lesson

I don’t have the stomach this week to write about the trials and tribulations of the Greece bailouts (I’ll have more time to write about this in the future because there will be many more…), I don’t care to write about the non-stop meetings between Germany and France to talk about everyone else (I’m starting to think they don’t like to cook and just want free meals…), and I don’t feel like writing about how the stock market keeps going up even though only a few stocks are behind it (Apple should soon be worth all of Europe combined…).  What I do want to write about is what I believe to be one of life’s greatest lessons, which can actually be learned from our very own children.

Kids are hands down the best negotiators around.  You and I as parents might get frustrated by their actions sometimes, but if we take a minute to analyze what’s going on, we can all learn a valuable lesson.

Short story.  Just the other night when putting my daughter to bed, she requested I read her a book before going to sleep.  We were getting to bed a little later than normal that evening on a school night and so I had told her that not tonight, but we could certainly read a book the next night (this is all code for I just felt like heading back downstairs to start watching some of my favorite television shows).

Thinking ever so quickly on her feet, she immediately replied, “Can we just read part of a book?”  A seemingly meaningless question, but she was setting me up and I didn’t even realize it. My response to this was to simply try and reaffirm my earlier response by restating the fact that it was late and time to get to sleep.

Like water off a duck’s back, her next question was, “Well then what if we just read a few pages?”  Now she was just playing with me.  She was starting to ask me open ended questions as opposed to simple yes/no type questions.  My 6-year old professional negotiator was now toying with me.

So now I really had to dig me heels in and firmly stated that it was way past her bedtime and there was absolutely no time left to read a book.  Without hesitation (and I even think she chuckled under her breath as she laughed at my shear ignorance as to how she was manipulating me), she responded, “What if we just read one page?”

As a now worn down adversary I responded, “Ok, we’ll read a few pages and then it’s time to get to sleep.  What book do you want to read?”  She replied, “Hell if I care, you pick…”

In life, “No” simply means no to the specific question asked, but may not mean “No” to a slightly modified question (please don’t take this to extreme, there are certain situations where you should respect “No” as the final answer…).  Kids understand this point better than anyone; however, as adults many times we hear “No” and quickly think it’s the end of the conversation.  In life, don’t take “No” for an answer!

Next article, it’s time to start talking more about the economy and the impact it will have on your treasured savings.  There’s still a lot going on and a lot to discuss.  Till we meet again…

Joel Fink

Joel.fink@yahoo.com

Where do We Go From Here?

As you know if you’ve read any of my postings, I am a skeptic when it comes to the economy.  I can not connect the dots to understand how these improved earnings can be sustained.  With that being said, I will be the first to admit I have not participated to any great extent in the recent market rally.  My exposure to stocks is probably about 40% of my portfolio with the rest in cash and a little in government bonds (which helps me sleep at night because these things have been on a tear since Aug 11’). 

The great thing about markets is that they don’t care what you think.  Just because I think the market is too high and should be priced lower doesn’t mean the market will actually go down.  Many times markets will move to unreasonable levels in light of current dismal conditions before correcting lower.  Or worse, the market continues higher because economic conditions improve and you finally have to admit something you don’t want to admit… that you’re wrong!

I am not at the point yet of admitting my thesis is incorrect.  But I am getting close.  The Dow Jones Industrial average is just several points from its high (12,876 high back in May 11’ vs. 12,870 on Friday/Feb 3^rd) and the S&P 500 is not quite as close, but getting closer every day.  If these highs are taken out, the market could see an explosive rally as short traders (people like me betting against the market) come in to buy stocks, which is how they close out their positions.

This to me is still a big “IF”.  As we approach the highs set earlier last year, the number of stocks contributing to this rally is less than before.  At the peak in May 11’, there were 493 stocks making new highs (actually hit 636 in April), and on Friday there were only 442 stocks hitting new highs.  So the number of stocks driving the rally is less.  If we look at the Nasdaq (generally technology related stocks), there were 189 stocks hitting new highs during the peak last year (240 in April 11’) and this time there are 235 stocks hitting new highs.  So from my point of view, this is generally a technology driven rally with less involvement from other stocks such as industrial, retail, energy, etc.

Now that we see technology is a driving force, let’s look at Apple specifically.  The following is an article showing that before Apple reported earnings, S&P earnings growth was 2.7%.  After Apple reported earnings, the growth rate jumped to 11.6%.  This market is a one-trick pony!

http://blogs.wsj.com/marketbeat/2012/01/26/apple-earnings-give-facelift-to-entire-sp-500/

And let’s not forget, Europe still hasn’t figured out what to do next.  Rumor has it (strictly rumor) Greece may be announcing their exit from the Euro in early March. 

This will be an interesting week coming up to see how the stock market responds as it tests the highs from early last year.  I remain a stubborn skeptic till death do us part.  Have a good week!

Joel Fink

Joel.fink@yahoo.com

Talk is Cheap!

Here we go again.  Same topics in the headlines; can Greece renegotiate their debt, how can the European Union raise more funds to bailout bankrupt countries, can our own government agree to terms in order to raise the debt ceiling, blah blah blah…

Think what would happen in the business world if the only thing employees did was talk about what to do, but never actually come to a solution and/or executed any plans.  I’ll tell you what would happen, people would be fired!  In addition, how many times do I have to read about France and Germany having another meeting in an effort to find a solution?  I want to know what goes on at these meetings, because they’ve been having a lot of them over the past several months.

FR: “Well Germany, we really need to do something.  We lent a helluva lot of money to a bunch of countries who have no possible way of paying us back.”

GE: “I hear ya, you guys did lend a lot.  We’re still not sure why you did that.”

FR: “What if we print more money?”

GE: “Can’t do that, our people would not be happy paying for someone else’s ignorance.”

FR: “Yeah, I hear ya.  Oh, would you look at the time.  What do you say we finish up the statement we’ll make to the press and then get out of here?”

GE: “Sounds good.  Meet again next month? You’re place or mine?”

I’d like to circle back and tie in the current state of the stock market with the state of government demise.  The S&P 500 has risen about 24% since the beginning of October 2011.  One of the things I find interesting is the lack of volume or participation in the rally.  The following is a chart of SPY an ETF that tracks the movement of the S&P500 index.  Look at the lack of volume during this entire rally.

 

As you may know, I am not overly optimistic regarding the ability of the US economy or other global economies to continue on this path of good earnings without some significant impact from the European fallout.  Once they are forced to deal with the issues as opposed to just talking about them, earnings will be impacted and stocks will get cheaper.

Interesting Interest Rates

After some relaxing time visiting family and friends over the holidays, it’s time to get back to sorting through this mess of economics and investments.  I’ve mentioned previously about sharing what I believe will be one of the best investments of the next several years, but before I dive in I want to quickly review my general position on investing.
Great investments for me are areas such as markets that are so severely shunned by others that they are selling at crazy levels or stocks for example that are sold relentlessly, but really still have a sound financial structure and a relevant business model.  These are the types of situations, which get me excited about opening up my wallet and purchasing an investment.

So with this fresh in our minds, let’s move on to discuss interest rates.  There are very few guarantees in life, but one guarantee is that people will not lend money (at least for very long) to others for less than 0%.  Why would anyone give someone else money to use and not get paid something in return for giving them the money.  So from my point of view, this puts a worst case scenario for interest rates at 0% (the downside risk).  I happen to think the actual worst case is something higher than 0%, but let’s stick with the zero.

The following is a historical chart of interest rates the US government has paid to borrow money for ten years going back to the late 1800’s.

In the past 100+ years, the interest rate for a 10 year bond has been at its lowest around 2%.  The current rate for a 10-year bond is 1.87%.  So, if we place odds on whether rates will be lower or higher over the next several years, my money is easily on higher.

Just to be clear, I couldn’t tell you exactly when interest rates will be higher because markets tend to stay at extreme levels for longer than anyone typically estimates (anyone who says they know is guessing and don’t let them convince you otherwise). But I am willing to bet (put my money into an investment) they will be higher in 5-10 years from now as opposed to lower. 

The big question now is how to take advantage of this as part of an overall portfolio.  TBF and TBT (leveraged – uses debt to juice the returns) are exchange traded funds (ETF), which purchase securities designed to allow an investor to position themselves for higher interest rates.  Since I still believe the economic environment is weak for at least a good part of 2012, I do not believe we see a whole lot of upside pressure on interest rates in the near term.  However, I will be looking to begin making purchases of these ETF’s throughout 2012.  From my point of view the odds are stacked in our favor here, low risk with high potential opportunity.

Should you find this interesting and intriguing, contact your financial advisor and ask them their recommendation for how to best take advantage of a long term, higher interest rate environment.  Let them earn their money in 2012.

I plan on keeping a close eye on the market over the next few months with everything that’s been going on.  Some pretty bearish positions have been executed in some different areas (actual investments made as opposed to someone simply talking about different investments on the news, but not really putting their own money behind it), so I’m not the only one who thinks 2012 could be a rather bumpy ride and willing to put their money behind it by buying some protection.

Happy New Year!

Joel Fink
Joel.fink@yahoo.com

Inflation vs. Deflation

In a continuous effort to try and understand what the world will look like in the next several months (and therefore our investments as well), the dynamic between inflation and deflation should be understood on at least a basic level.

 

First, let's understand what both of these really are.

 

Inflation – too much money chasing too few goods/services.  So if there’s lots of money in the economy and the individuals who have it are buying stuff (there’s that technical term again), there will be higher competition for the stuff, which results in higher prices.

Deflation – too much debt and difficulty making the interest payments.  Need to sell stuff to reduce debt exposure.

With the issues in Europe and even here in the US regarding the need to reduce debt, it appears to me deflation is in control, which would mean lower prices for stuff (stocks).

I would offer the more interesting question is how will we know when the economy switches from a deflationary stance to an inflationary stance as this will have a significant impact on the prices of food, gas, and other consumable items.  During a high inflationary period, you will see the prices you pay for goods and services go up and potentially faster than you see the value of your paycheck increase each year.

Inflation is made up of two parts.  The first is an increasing money supply.  This is how many dollars are in the economy.  The second is how fast each of theses dollars are turned over (or said a bit different, once someone spends a dollar, how quickly does the person receiving the dollar turn around and spend that same dollar).

Let’s look at a chart showing how many dollars are in the economy and see if it has been increasing:

Looks to me like we definitely have an increasing money supply.  It even looks as though it’s been increasing at a higher rate since 2000 (have to print money to fund these bailouts).

Next, let’s look at the velocity these dollars to see quickly they’re changing hands:

Looks to me as though anytime someone gets their hands on some money, they’re not doing anything with it.  Since we need both for inflation, as long as the velocity points down, deflation will be in control.

So, once velocity turns up (people start spending all of this money, which they will at some point), we will begin to see inflationary pressures.  The outcome of this will be the Federal Reserve raising interest rates (think in terms of the interest you can get for a mortgage, if you have a variable rate you will start to see your monthly payment rise as your rate adjusts) to slow down the pace of inflation by selling securities to collect some of the dollars you see in the first chart.  The simple way this works is the Federal Reserve sells securities and when someone buys these, it takes this money out of the system.  Also by “flooding” the market with securities, it will drive the prices down, which has an increasing affect on interest rates (ex. you own a bond, which you paid $1000 for and it pays $50/year, if someone paid you only $500 for this bond because there are a lot more of them in the market, they would still collect the $50 and so their interest rate received would be higher than what you were receiving; or $50/$1000 equals 5% whereas $50/$500 equals 10%).  If you recall from a previous post, interest rates are at historical lows with nowhere to ultimately go, but up.

Over the next several months, look for deflation to persist as countries and banks look to unload assets to clean up their finances.  Then watch the velocity of money for a signal when times may be changing.

I still get an eerie feeling the stock market is teetering on the edge of a cliff.  The euro has be accelerating its move lower, which I can’t help but think this means we will soon be hearing some negative news come from our friends across the pond.

Cheers,

Joel Fink
joel.fink@yahoo.com