quarta-feira, 9 de julho de 2008

Bearish battalions

Global markets

Bearish battalions

Jul 3rd 2008
From The Economist print edition

Almost everything that could is going wrong for world stockmarkets

Illustration by Satoshi Kambayashi

THEY rarely ring a bell at the bottom of bear markets. Investors who thought they had heard a tinkling sound when Bear Stearns, a failing American investment bank, was bundled into JPMorgan Chase in March have been disappointed. The Dow Jones Industrial Average is now weaker than it was in the spring (see chart).

The American stockmarket had its worst month since 2002 in June and is now down more than 20% from its peak, the definition of a bear market. It is not alone. According to Standard & Poor’s, a rating agency, the value of global stockmarkets fell by $3 trillion during the month, thanks in particular to a 10% decline in emerging markets.

Share prices are suffering because of the outlook for four forces that impel stockmarkets: economic growth, profits growth, interest rates and inflation (see article). At the moment, the first two seem to be slowing while the last two are rising. That is the worst possible combination.

Soaring oil and food prices are stoking inflation. Oil closed at another peak of $144.14 a barrel on July 2nd, because of disappointing data on American crude reserves, and lingering fears that sabre-rattling between Israel and Iran might lead to conflict in the Persian Gulf. High commodity prices have also acted as a terms-of-trade shock for consuming countries—the things they buy from abroad cost more compared with the things they export. That has made them poorer.

The past six months could be seen as a dreary exercise in sharing out the pain. Will workers suffer by seeing their wages rise more slowly than inflation? Will companies have to compensate their workers by raising wages, sacrificing their profit margins? Will central banks treat high commodity prices as a blip, and leave real interest rates low, penalising savers? Or will they raise interest rates and risk pushing the economy into recession? None of these choices is palatable.

All this has been made worse by the credit crunch. True, the rescue of Bear Stearns seemed to avert the implosion of the financial system. Credit spreads, which measure the excess interest rate paid by riskier borrowers, have fallen from their March peaks, although they have recently been rising again.

However, the crunch continues to chew its way through the system. Its effects can be seen in the sharp falls in mortgage approvals in both America and Britain. And it can also be seen in data produced by the Federal Reserve which show that loans made by banks (their assets, in the jargon) have fallen over the past three months.

This tightening in credit has taken so long to show up in the numbers because of the way that banks were operating before the summer of 2007. First, they had pushed much of their lending business off-balance-sheet, so that loans were bought by specialist entities like structured-investment vehicles (SIVs) and conduits. When the market for subprime loans collapsed, a lot of these loans came back on to the banks’ balance-sheets. Second, banks had made back-up commitments to businesses to lend money if needed. With the collapse in other debt markets (such as asset-backed commercial paper), corporate borrowers cashed in those chips. Much as they would have wished otherwise, banks found their loan books expanding.

Now, chastened by the huge amounts of capital they have had to raise to strengthen their balance-sheets, banks are being more careful. According to Ian Harnett of Absolute Strategy Research, a consultancy, the availability of credit in Europe for both consumers and companies is now at its lowest level since 2003.

The problem for financial markets is that the virtuous circle which pushed asset prices higher in the middle of this decade may be turning vicious. Banks lend money against the collateral of assets, most notably in the form of housing. As house prices increase, the collateral rises in value and the banks are willing to lend more. That enables buyers to bid up prices even further.

But when banks stop lending, buyers are unable to purchase assets. Some investors are forced to sell to pay off loans. The value of collateral falls, making banks even more reluctant to lend. Markets freeze up, as neither buyers nor sellers have the confidence to do business.

As house prices fall in America, Britain, Ireland and Spain, the wealth effect kicks in. George Magnus, a strategist at UBS, cites the examples of Finland and Sweden in the early 1990s. As house prices fell, personal-savings rates jumped by 12-14 percentage points. A similar move in America or Britain would have a devastating effect on consumer demand, and thus on GDP growth over the next couple of years. As yet, there has been more of an effect on consumer sentiment than actual retail sales, although individual retailers (such as Britain’s Marks & Spencer) are suffering.

As for companies, with consumers depressed and banks unwilling to lend, why should they invest? They may still see exports as a source of economic growth, but that works only for some firms in individual countries, not for those in the world as a whole.

So the market’s sorrows have come in battalions, not single spies. Investors might have coped with the credit crunch if it were not for the high commodity prices, and vice versa. They do not know whether to fear inflation or recession more, but they know that both at once will be unpleasant.

It looks like a lengthy period of gloom is in store for the stockmarkets. Meanwhile, the best investors can do is hope, Micawber-like, that something will turn up. A collapse in oil prices would help.

segunda-feira, 7 de julho de 2008

10 Signs of a Recession

Happy Birthday, America!

The typical economic cycle consists of two main phases: Boom and Recession. The phase leading to a boom is called expansion and that leading to a recession is called contraction. Another way of looking at this is considering expansion the transition from recession-boom and contraction the transition from boom-recession.

click to enlarge

10 signs that an economy’s in recession:

  • Automobile companies are down (GM)
  • Package Carriers are hurt (UPS)
  • Real Estate companies are down (DHI)
  • Financial Sector is down (CS)
  • Aluminum and Steel companies are down (AA)

The trending in the first 5 sectors looks bleak. Are we really doomed?

Remember I said there are 10 signs. Let’s look at the next 5 signs and then discuss the recession for real:

  • The airlines industry is trending down (DAL)
  • Retailers such as Sears are down (SHLD)
  • Farm equipment manufacturers are down (CAT)
  • Mid-sized hotels are down (CHH)
  • Industrial real-estate developers are down (FWLT)

Looking at the chart above, it’s obvious that FWLT and CAT are trending down but are the only ones not in the red yet. This is semi-good news. There’s still some expansion going on in industrials and agriculture – this indicates that we are in the contraction mode of the cycle and are currently looking at imminent recession. However, I’m hoping that corrective measures are taken before this situation actually spirals out of control. What corrective measures, you may ask?

First and foremost, there should be an increase in the short term interest rates. This will help in 3 immediate ways:

  1. Higher interest rates strengthen the dollar by making it a lucrative investment for all. If the dollar has to be competitive with the Euro, this increase has to happen soon as the Euro banks hiked their interest rates this past week. A stronger dollar gets more bang for the buck and brings back a semblance of balance in the currently insanely skewed US trade deficit.
  2. It separates the wheat from the chaff. People who don’t deserve loans don’t get one as they can no longer afford to—the biggest problem with low interest rates is that it creates a low barrier to entry which forces business to compete for diminishing margins and mandates quantity versus quality of loanees. Therefore, our subprime crisis of today.
  3. It helps drives inflation down. In the early 1980s when inflation was severely high, the Fed tackled it by increasing interest rates. Rates were as high as 18% then versus the paltry 2.5% they are today.

I believe the Fed would have increased interest rates already had they not been pulled into salvaging and saving the banks caught in the quagmire of the subprime crisis.

The chart below shows whenever the economy’s been in a recession historically (see 1980 or 2000), an increase in interest rates has had an ameliorating and rejuvenating effect on the market. The Y2K downturn was converted into an upswing in 2003 through the increase in interest rates. It’s time we saw an increase in both interest rates and the market versus inflation, for a change.

Today’s economies are global and the US has a lot of things to go manage at the same time (fix the $, inflation, deficits, energy demands etc.). Just increasing the interest rates may not be the silver bullet anymore. It’ll require a series of steps besides that, such as the bursting of the energy bubble.

What do you think?

domingo, 6 de julho de 2008

20 Guidelines for the Individual Investor

Making money in the US and Canadian stock markets requires that an investor constantly buy and sell company stocks.

Below are my 20 guidelines an investor should consider when trading in the stock markets;

  1. Stock Bell Curve. The rise and fall of stock prices over time resembles a bell curve for most companies. There is a price rise to a peak followed by a price decline over time. Indications of a stock price approaching its peak are smaller changes in price per trade. These curves can be extrapolated to predict the peak. When the curve height is 2/3 of the predicted peak you should sell the stock.
  2. Peak and Plateau Curve. Some stock prices rise to a peak and plateau over time. Crude Oil commodity stocks in 2008 resemble a peak and plateau curve. Examples include BP Petroleum (BP) and Suncor Energy (SU). When the stock price reaches the plateau and it holds the price value for a period of time, you should sell the stock if the commodity price does not rise further.
  3. Undervalued Stocks. Buy stocks with a P/E (price to earnings ratio) of <12,>5% and an annual dividend yield >2%. Typical stocks include Husky Energy [TSE: HSE], Wells Fargo (WFC) and Chevron (CVX).
  4. Quarterly Earnings Reports. Look for stocks in which the corresponding commodity price has been rising significantly during the quarter. For example, with high crude oil, gasoline and diesel prices there will be a significant impact on 2008 Q2 earnings of companies such as ExxonMobile (XOM) and ConocoPhilips (COP).
    Buy these stocks a few months before the company reports its quarterly earning results and sell them shortly after the earnings announcement, when the stock price has peaked.
  5. Commodity Contracts. Look for a stock in which the commodity contract between supplier and buyer is going to significantly increase the commodity price. In 2008, high contract prices have resulted in a significant stock price rise for companies such as Potash (POT), Consol Energy (CNX), Arch Coal (ACI), Fording Coal (FDG), Companhia Vale (RIO) and United States Steel (X).
    Buy these stocks 3-4 months in advance of the contract renewal date and sell them after the earnings announcement, when the stock price has peaked.
  6. Good News. Good breaking news will result in a price rise of the affected company stock. For example, recent news of discoveries of large deposits of shale oil, coal and crude oil made by Arc Energy (AET), Enerplus (ERF), Continental (CLR), Range (RRC), Talisman (TLM), Duverney [TSE: DDV], (Goldsource [CVE: GXS] and Petroleo Brasileiro (PBR) resulted in significant increases in stock price. Buy stock immediately upon the news announcement and sell them after the price peaks.
  7. Bad News. Bad breaking news such as an extended power shortage, mine flood and bad asset backed securities recently resulted in the value of company stocks of Anglogold Ashanti (AU), Cameco (CCO) and CIBC (CM) to drop significantly. If you owned these stocks at the time you should have sold them immediately. If you did not own them, you never buy on weakness. They will seldom fully recover from their lows regardless of the commodity.
  8. Acquisitions. Acquisition announcements immediately result in a rise in the stock price of the acquired company. Recent acquisitions and attempted acquisitions of companies such as Bell Canada (BCE), Yahoo (YHOO) and Cordero (COR) have resulted in a significant increase in share price. Buy stock immediately upon the acquisition announcement and sell them after the price peaks.
  9. Trends. New trends created by fashion and business companies such as Crocs (CROX), Lululemon (LULU) and Research in Motion (RIMM) created hype that resulted in share prices soaring beyond their intrinsic value. Buy trend stocks immediately upon the news announcement and sell them after the share price peaks.
  10. Technological Breakthroughs. Companies involved in technological breakthroughs usually see a significant rise in the stock price. Companies such as Petrobank (PBG), Ivanhoe Energy (IE), Quantum Fuels (QTWW), Timminco [WAR: TIM], Synthesis Energy (SYMX), Shlumberger (SLB), Rentech (RTK), Global Resources (GBRC.PK) and Dupont (DD) have seen increases in stock prices due to these types of recent announcements. Buy the stock when the technological breakthrough announcement is made and sell it after the price peaks.
  11. Value of the Dollar. Sometimes it is profitable to buy stocks in a foreign market knowing that the value of the domestic currency is going to drop. For example, it has been forecasted that as the US economy comes out of the recession in Q3 2008, the value of the US dollar will rise about 15% above the value of the CND dollar. Early in Q3 2008 Canadians should consider selling Canadian stock and buying US stock. When the value of the US dollar has stabilized, you should then sell your US stock.
  12. Stock Promotion. IPOs (Initial public offerings) are initially offered at a set asking price, then discounted over time to attract more buyers and finaly offered again at the higher price until the IPO is sold. Recent examples of companies issuing IPOs include VISA (V) and Sprott (SII). Buy these stocks when they have bottomed and sell them when they have peaked.
  13. Subsequent Stock Issues. Known as a BBP (Brokered Private Placement), companies often issue stocks to be used for additional exploration expenditures, working capital or general corporate expenses. A recent example of a company that issued a BPP for additional exploration expenditures was Goldsource (GSX). Generating additional cash in this manner is a positive indication of a highly potential asset and normally results in a stock price increase. You should buy these types of stocks immediately. If you own a stock in which the BPP is to be used to pay off debt, you should sell it immediately. Keeping it will result in diluting your stock value.
  14. Inside Trading. Certain company officials known as Inside Traders are required to disclose the purchase and sale of their company stock. When an insider buys stock you should consider buying it and when an insider sells stock you should consider selling it too.
  15. Stock Buy Backs. Occasionally companies feel the selling price of their stock is too low and buy back large quantities. A recent example was PetroCanada (PCA) buying back 5% of their outstanding shares. Known as an NCIB (Normal Course Issuer Bid), the announcement often leads to a stock price rise. Consider buying the stock following the NCIB announcement and selling the stock after it peaks.
  16. Stock Splits and Consolidations. Occasionally companies feel the selling price of their stock is too high or too low. If the stock is too high they tend to split the stock shares, for example 1:2. If the stock is too low they tend to consolidate the stock shares, for example 6:1. Companies involved in recent stock splits and consolidations include Suncor Energy (SU) and Pacific Rubialis (PEG). Buy stock well in advance of the company announced stock split or consolidation date and sell the stock immediately after it peaks.
  17. Seasonal Sector Cycles. Certain company stocks are priced higher during certain parts of the year when demand for the corresponding commodity is stronger. Agricultural and amusement stocks are at their lowest in the winter. Typical examples include Viterra (VT) and Cineplex (CGX). Buy stocks well in advance of the seasonal cycle beginning and sell off well in advance of the end.
  18. Non Compliant Resource Report. Occasionally there is a news flash about a huge resource discovery affecting one or more companies. These discoveries lack a compliant resource report, such as 43-101 or 51-101, to validate the resource size. Recently a Utica Shale natural gas discovery resulted stocks in area companies such as Gastem (GMR), Petrolia [CVE: PEA], Questerre [TSE: QEC], Junex [CVE: JNX], Petrolympic [CVE: PQC] and Epsilon (EPS) to skyrocket. Only buy into these types of stocks if there is a compliant resource report and the resource value is well in excess of the company market cap. In these situations, buy into the stock upswing and sell off immediately when the stock peaks. Do not buy back into the stock after a pull back unless there are further positive news announcements.
  19. Foreign Government Laws. New foreign government laws can have a major impact in the value of company stocks. For example, Canadian legislation requires that Income Trust companies become incorporated before 2011. Examples of Income Trust companies include Canadian Oil Sands [COS.UN], Superior Plus (SPF), True Trust [TUI.UN], ARC Energy (AET) and Enerplus (ERF). These companies hold valuable oil and natural gas resources. Their stock prices rise with commodity prices and the companies pay high dividend yields to shareholders. Normally new government laws negatively impact stock value and the stock should be sold immediately. In the examples above, the stocks should be purchased in anticipation of being acquired by incorporated companies between now and 2011.
  20. Cash. Always have on hand about 20% of your holdings in cash to buy stocks when positive news announcements are made.

Disclosure: I have stocks in COS, SPF, TUI, AET, ERF, TIM, PEG/, PQC, PBR, GMR, PEA, QEC, CCO, CLR, DDV

In today’s world, the stock markets are too volatile for the traditional investor to buy a stock and leave it in a portfolio until retirement. Without constant monitoring, there is a risk of losing the entire investment.

Barron's Trader Column Quote

Barron's Trader Column Quote

I forgot to mention yesterday that some recent comments were picked up in Barron's The Trader column this week:

"While the bear market could persist (as this week's cover story warns), the stock market's worst June in 78 years -- and its worst first half since 1970 -- have encouraged bargain hunters looking for at least a short-term bounce.

They were egged on by a few signs: Large-cap indexes have fallen decisively to fresh 2008 lows. Energy and material stocks, the last bastion of strength, have begun to crack, and even the high-flying Market Vectors Coal exchange-traded fund (ticker: KOL) has plunged more than 15% over the past three trading days. NYSE volume reached 5.8 billion Tuesday, almost matching the decisive 6.1 billion seen at the mid-March bottom. The crop of NYSE and Nasdaq stocks scraping year lows swelled above 1100 midweek, approaching mid-March's 1236 tally.

A pronounced spike in investor fear, matching levels seen in January or March, is no guarantee of an enduring rally, as recent selling wiped out the year's gains. But traders hoping for the kind of climactic purge that marks a stock-market bottom remain disappointed by the almost-but-not-quite-there cues. Option-market sentiment gauges also remain unruffled. "I would have thought the most recent drop might have frightened investors just a tad," notes Barry Ritholtz, director of research at Fusion IQ. "Instead, the bottom callers were out in full force. There is still a whole lot more greed than fear."

Always cool to get in The Trader column . . .


The Bear Arrives -- With Bargain Hunters
BARRON'S, JULY 7, 2008

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