Tag: davidson

This rally has put me in a rather perverse situation. I’ve been on record several times saying I do not believe in it (the market rally) and it is due for a fall. I still believe I will be proven right sooner rather than later, yet at the same time, I am really enjoying the profits being made being wrong for now. It’s odd as no one like to be wrong, especially when you broadcast those opinions to the masses but having what you own and what you have purchased recently (oil (USO) & gas (UNG) options) rally huge along with the market really takes the sting out of it.

Additionally, since I do not “short”, and have not advised others to do so, there has not been monetary loss from being wrong (the most important point).

Because of all that I have made it a point to post thoughts contrary to mine here in order to give readers both side of the argument (suckers rally or bull market)and let them decide for themselves.

This morning I posted thoughts from “Davidson” contrary to mine.

Here are some supporting my thoughts.

From TechTicker:
Merrill’s economist David Rosenberg left the firm yesterday (planned for several months). And he went out swinging. David has maintained from the beginning that the recent rocket rally off the lows is just a suckers’ rally, and he reiterated that view as he walked through the doors.

Market likely to peak the end of the week [Friday]. Just as the clock is winding down on my tenure at Merrill Lynch, the equity market is winding up with an impressive near-40% rally in just nine weeks. For those that were still long the equity market back at the March 9 lows, a good ‘devil’s advocate’ exercise would be to ask yourself the question whether you would have taken the opportunity, if the offer had been presented, to have sold out your position with a 40% premium at the time. What do you think you would have said back then, as fears of financial Armageddon were setting in? We haven’t conducted a poll, but we are sure at least 90% of the longs at that point would have screamed “hit the bid!”

Are we at risk of missing the turn? Fast forward to today, and within two months optimism seems to have yet again replaced fear. Are we at risk of missing the turn? What if this is the real deal — a
new bull market? This is the question that economists, strategists and market analysts must answer.

Risk is much higher now than it was 18 weeks ago. The nine-week S&P 500 surge from 666 at the March lows to 920 as of yesterday has all but retraced the prior nine-week decline from the 2009 peak of 945 on January 6 to the lows on March 9. We believe it is appropriate to put the last nine weeks in the perspective of the previous nine weeks. To the casual observer, it really looks like nothing at all has happened this year, with the market relatively unchanged. But something very big has happened because the risk in the market, in our view, is much higher than it was the last time we were close to current market prices back in early January, for the simple reason that we believe professional investors have covered their shorts, lifted their hedges and lowered their cash positions in favor of being long the market.

Employment, output, income, sales still in a downtrend. Considering what transpired from an economic standpoint, the decline in the first nine weeks of the year was rather appropriate in the midst of the worst three-quarter performance the economy has turned in roughly 70 years. The rally of the past nine weeks appears to be rooted in green shoots. While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend.

Need to see an improvement in the first derivative. We have evidence that the consumer, after a first-quarter up-tick that was front- loaded into January, is relapsing in the current quarter despite the tax relief (didn’t we see this movie last year?). Not until improvement in the second derivative morphs into improvement in the first derivative with respect to the important economic data will it really be safe to declare what we are seeing as something more than a bear market rally, as impressive as it has been.

This is a bear market rally that may have run its course. The investing public is still holding tightly to their long-term resolve, but much of the buying power at the institutional level seems to have largely run its course, in our view. That leaves us with the opinion, as tenuous as it seems in the face of this market melt-up, that this is indeed a bear market rally and one that may well have run its course. We have “round-tripped” from the beginning of the year and there is real excitement in the air about how these last nine weeks represent evidence that the economy will begin expanding sometime in the second half of the year.

Growth pickup will likely prove transitory While it is likely that headline GDP will improve as inventory withdrawal subsides and fiscal policy stimulus kicks in, our view is that whatever growth pickup we will see will prove to be as transitory as it was in 2002, when under similar conditions the market ultimately succumbed to a very disappointing limping post-recession recovery. So yes, there may well be some improvement in the GDP data, but it is based largely on transitory factors. We strongly believe it is premature to totally rule out the end of the vicious cycle of real estate deflation – residential and now commercial – that we have been experiencing since 2007. Balance sheet compression in the household sector will continue to pressure the personal savings rate higher at the expense of discretionary consumer spending. This is a secular development, meaning that we expect it will last several more years.

Chances of a re-test of the March lows are non-trivial. To reiterate, it seems to us likely that the risk in the market is actually higher today than it was back at the same price points in early January, and we say that with all deference to the stress tests (which given the less-than-dire economic scenarios, along with the changes to mark-to-market accounting, were destined to reveal healthy results). While the consensus seems gripped with the burden of trying to decide if there is too much risk to be out of the market, we actually still believe that the chances of a re-test of the March lows are non-trivial, especially if the widely touted second-half economic rebound fails to materialize…

The data flow is less relevant this cycle than in the past. This was not a manufacturing inventory cycle, which makes the data flow less relevant than in the past. Real estate values are still deflating and the unemployment rate is still climbing; these are critical variables in determining the willingness of lenders to extend credit. And as we just saw in the Fed’s Senior Loan Officer Survey, while there may be a ‘thaw’ in the financial markets, banks are still maintaining tight guidelines. In fact, the weekly Fed data are now flagging the most intense declines in bank lending to households and businesses ever recorded.

Regular readers know I lean towards Rosenberg’s analysis. For a while now I have been saying “not as bad” is not the same as “getting better”. Consider when GM (GM) sheds its dealer ranks this summer, conservative estimates say it will cost another 150K jobs just from dealership closing and almost 70k of last month’s unemployment report (the “getting better report”) was temporary census workers, not permanent jobs. Just these two alone must leave people wondering where to bottom in employment is…

Today we here the Administration raised its estimate for the federal budget for this fiscal year by $89 billion, 5%, to $1.84 trillion. The new, higher number is nearly the same as the one provided by the Congressional Budget Office. Remember that one? Early on is was criticized as being “overly pessimistic”.

On April Fool’s Day I covered the Budget issues here:

But, don’t worry, the Obama administration projected today that the U.S. economy will expand at a 3.5 percent annual rate by year-end, a rebound that would be almost twice as strong as private forecasters expect. I can’t even really comment on that. It is so devoid of any reality……..stunning.

They also expect “housing starts to reach bottom this year and to begin a robust recovery as relative housing prices stabilize,”. Right….we covered that last week here.

Finally the report also said “inflation is expected to remain subdued over the next few years.”

Call it the “Alice in Wonderland” report……

Disclosure (“none” means no position):Long Jan 11 $35 USO calls and UNG Oct. 2009 $15 & $16 calls.

so Davidson has a response and a take on the constant fretting about the “frothy” market and the upcoming sell-off they fear/predict. NOTE: I am one of those “fretters” although not shorting….just not buying

The genesis of this was a recent article in Barron’s that said in part:

HOW MUCH WOULD YOU PAY, IN ROUND NUMBERS of unmarked bills, for a quick 10% retreat in the Dow? For the kind of 10% correction that was a thing to be feared when we went a couple of years without one, but now would make it easier for an investor to buy stocks that are up 40% from their lows, stocks for which there seemed no rush to own just two months ago?

Most investors, especially those long-only pros who grapple a benchmark for a living, seem to wish for a fleeting drop of 10% or more to provide psychological cover for entry.

More staunchly bearish folks — among them those who, based on the latest exchange data, have been reloading short positions — want that 10% as a small down payment on the resumption of the bear’s dominance.

The rest of us just pray for the wisdom to know the difference should such a pullback arise.

Strategist Jason Trennert of Strategas Partners sums up a common stance: “Simple valuation analysis leads us to be skeptical about the potential of the market to rally from these levels. The problem, it seems, after spending the last week on the road and looking at recent short-interest data, is that we have a lot of company — very few of our clients believe the rally is real.”

John Roque, the technical strategist at Natixis Bleichroeder who has been in synch with the rally and the preceding collapse, detects an upside “breakout” on the chart of investor frustration, because they have doubted the rally and owned too little of the stuff that has run the most.

The blogger sentiment poll on Birinyi Associates’ Ticker Sense blog (http://www.tickersense.typepad.com) last week showed 50% bears to 33% bulls — almost as many bears as at the early-March lows. In late January, just as the market was ready to roll over hard, 65% of the bloggers were bullish.

Other sentiment indicators are leading Ned Davis Research to get behind the idea that “a monster rally could continue within this secular bear market.”

This remains a net positive for the market, the idea that investors (and financial columnists, it should be said) continue to “fight” this move. Sure, they (and we) have been fighting it with some plausible ammunition: the slipshod quality of the leading stocks, the massive speculative volumes in stock options, the spike in corporate-insider selling, the fatigued look last week of the recently indomitable Nasdaq index. These characteristics can, and would, accompany both a doomed head-fake rally and something larger, for sure.

Of this think, Davidson opines:

“This is the type of article that imparts a great deal of information without being definite. From this I get that there appears to be great concern amongst many noted investors, esp. technical types, that a correction is due and most have invested in anticipation of a correction to what appears to be obvious over zealousness by current market participants. I don’t invest trying to catch short-term dips. My time perspective is a business cycle with the goal of adding fresh capital during the down portion of a cycle and removing capital during the up portion.

Reading of the angst of traders not knowing what to over the short term leaves me in a positive frame of mind, knowing that their stance in the market will add additional buying pressure when there is additional recovery in the business cycle.

For business cycle investors this is a bullish environment.”

Disclosure (“none” means no position):

Todd,

The conflict in our society between the rightful owners of property thru legally executed contracts and those who do not understand the values behind legal obligations entered into freely and transferred freely to others has been basic to the development of the United States as a great economic power and is the basis of our democracy.

Jefferson after the Revolutionary War decried that soldiers had sold their pay vouchers to speculators seeking immediate cash when some years later Hamilton created the first Bank of the United States to issue debt to fund these obligations in full. Jefferson believed that the soldiers should get their pay in full even though they had sold the vouchers for immediate cash at substantial discounts to speculators before it was known if the vouchers would be made whole. Hamilton made good on the vouchers to whoever presented them as long as they could prove legal ownership. He paid them in full thus establishing the US as a sovereign and responsible nation that paid its obligations. More importantly, he affirmed the legal standing of contracts, freely entered and freely exchanged. Legal contracts cannot be abrogated by any other than the owners of those contracts as long as ownership has been legally obtained.

It is this rule of law that has made the US a great economic power and is vital to the US remaining so. The attempt to abrogate the contracts of the senior debtors of Chrysler by the US Treasury unfortunately misses this point. It is impossible for me to overstate how important a point this is to the underlying value of the not only the US economy but to the existence of the US as a political entity.

“Davidson”

Disclosure (“none” means no position):

“Davidson” Submits:

The Institute for Supply Management survey was released Friday morning at 10AM with the Purchasing Managers Index (PMI) at 40.1% vs. 36.3% last month. Turns in this series has a good history of predicting future improvements in US GDP and stocks but for (as you can see below) 2001 when we experienced 9/11.

Based on the historical relationship of the PMI bottoming 2mos after the SP500 this supports the contention of a number of analysts that the “Internal Bottom” (defined as the number of SP500 stocks making what proved to be the low for the next 12mos) was made in October of 2008. Many bullish analysts said this at the time, but when the SP500 continued to hit new lows due to the large cap stock dominance in the index, the importance of “Internal Bottom” vs Index Bottom was lost in the cacophony of bearish forecasts on CNBC.

The relationship of the SP500 at ISM PMI bottoms is reproduced below the ISM Index vs. GDP chart.

My conversations with insightful individuals assure me that they consider this relationship important with the caveat that unforeseen events can trip up expectations. I recommend a balanced approach that is allocated for each investor’s risk tolerance.

Disclosure (“none” means no position):

Well, we must give credit where it is due here. “Davidson” was ahead of the curve on this one. Read his prior criticism of Shiller here and here

From the WSJ:

Now another economist, Thomas Lawler, says Prof. Shiller’s chart is “bogus.” Mr. Lawler says Mr. Shiller cobbled together data that are inconsistent and sometimes unreliable. Mr. Shiller defends his work and accuses Mr. Lawler of making “wild allegations.”

The clash is more than just a spat between two of America’s most prominent housing mavens. It could affect the debate about exactly where the U.S. is in its housing cycle. The squabble also illustrates the paucity of reliable information on house prices.

If they rely too heavily on house-price gauges, politicians may get a distorted view of the severity of the slump and support overly drastic measures, says Kenneth Rosen, a housing economist at the University of California, Berkeley. Mr. Lawler says the Shiller chart also appears to understate the long-run rate of increase in home prices.

No one has found a precise way to measure changes in house prices. Because no two homes are exactly alike, changes in the price of one won’t necessarily be matched even by apparently similar homes nearby, much less those hundreds of miles away. Though some indexes track price changes in the same set of houses over time, those can be distorted by major improvements in some of the houses and deterioration in others. The publicly recorded transaction prices, used to create indexes, often are distorted by incentives given to buyers that aren’t tallied in the price.

It continues:

For 1890 to 1934, Mr. Shiller used data from a trio of economists led by Leo Grebler. Because he found no index for 1934 through 1953, Mr. Shiller wrote, “I had my research assistants fill that gap by tabulating prices in for-sale-by-owner ads in old newspapers,” covering just five cities. For 1953 through 1975, Mr. Shiller used an index compiled by the U.S. Bureau of Labor Statistics, or BLS. An index from the regulator of Fannie Mae and Freddie Mac covers the period through 1986, after which Mr. Shiller uses the S&P/Case-Shiller index he created with another economist, Karl Case.

“In other words,” Mr. Lawler wrote in a recent edition of his daily housing-market newsletter, “the long-term chart is based on a concatenation of different time series of home prices which use different methodologies, have different samples, measure different things, and all in all are, well, different.”

Mr. Lawler, a former Fannie Mae economist who now is an independent consultant in Leesburg, Va., says the BLS data used by Mr. Shiller was based on a “very small sample” and so isn’t reliable. Mr. Shiller’s chart shows that home prices from 1940 through 2000 rose at an annual real, or inflation-adjusted, rate of 0.7%. Data from the Census Bureau, however, puts the real rate at 2.3% for that period. Part of the difference may be due to improvements in the quality of homes, Mr. Lawler says, but he doubts that accounts for the whole gap.

Youtube plotting of housing prices on a roller coaster:

What to think?

I’m not sure how much confidence we can have in the Shiller data since the inputs it uses are not from the same series. It is sort of like trying to draw historical conclusions on stock prices by using different indexes for different periods. It doesn’t work.

Because of that, drawing conclusions on Shiller because of events that happened in the 1940’s based in his data I think is flawed and prone to massive error. Now it may also be part truth that Case-Shiller is a self fulfilling prophecy. If the index is treated as gospel, and it says home prices must fall “x”, then they may actually do so as potential buyers sit on the sidelines waiting to catch the low. The death of buyers then causes sellers to lower prices to move inventory.

If that is true then the problem is two fold. Incomplete data being used to make predictions and a publics blind acceptance of those outcome sin part causing them.

I think a healthy debate on the accuracy of the historical price points used in necessary.

Disclosure (“none” means no position):

A book, Jeans, Davidson Speaks

– The Forgotten Man

– Folks need clothes

– From an email from my friend “Davidson”
“I view the recent Conservative deregulation of the financial markets one of the most destructive attacks on our free market system and the concept of capitalism since Hoover’s gross loose monetary policy and price support activity of the 1920’s. This has opened the world to viewing Capitalism as a crass process of money gathering by the few to the detriment of the many, when in fact true Capitalism empowers individual initiative and productivity by insuring that each person has fair access to the tools necessary to fulfill his/her vision.

Now that the Conservatives have so maligned the concept of Capitalism by permitting the few to ‘game the system”, it has thrown open the doors to Democratic self interested wish lists carrying extraordinary power to throw this country into socialism and the destruction of individual rights. We will not know how this will end for several years, but it is my hope that the recent Tea Parties although a media event is truly a sign of individual unrest and as individuals we will take this period as an opportunity to reinstall the rules of fairness to our financial system and rethink where we are going with everything else.”

Disclosure (“none” means no position):

There is an investment thesis here. We just need the backround first.

“Davidson” submits:

You may wonder why I have sent you something about sunspots.

I do so because with my background, BA Geology, PhD Physical Organic Chemistry and MBA Finance, I am always looking for those threads of information that will help us make better decisions. Even something that looks off the beaten path can be eye opening such as this piece I found in Don Coxe’s recent commentary. Don’s full commentary is attached.

Don is a macro thinker and provides his views on the appropriate investments. I do not do this, but prefer to use the best investment managers I can locate and let the managers handle the details on individual security selection. My goal is to balance them in an allocated portfolio and then monitor and rebalance the portfolio vs. the asset class Return/Risk relationships.

I think Don is right to consider this information as part of the investment discussion even though its impact on our future is not clear. What may be an obvious play on energy could easily be translated into discoveries yet unknowable and result in new investment directions. Julian Simon discussed the power of human intellect in his “The Ultimate Resource 2” in solving seemingly insurmountable problems.

What is clear to me is that the current mania regarding global warming does not have science on its side and that any massive climate initiative should be approached with greater study. Having a scientific background leads me to look for cause and effect. I do this in investing and providing direction to clients. Often I find that stepping back a few more feet to view the wider picture proves illuminating. I think Coxe’s focus on sunspots and the known connection to global temperature cycles is well worth reading.

The source for all charts is the web site: http://www.swpc.noaa.gov/index.html I added the chart for sunspot activity history from 1845-Present to provide you with perspective.

Don Coxe’s Section on Global Cooling:

Since we last published, the sunspots have been scarce and small, and the most respected measures of global climate show a strong cooling trend in this decade.

(The projections for future sunspot activity are from the two best-known sunspot research centres. For two years, they have been moving them forward as the sunspots disappoint the astronomers by failing to return.)

As clients know, we use our study of history to compare popular views about economics, finance, geopolitics with evidence of what has happened in previous eras.

As all scientific studies have shown, since the early 19th Century, the world has warmed up. Previously, the world went through roughly two centuries of serious global cooling. Whether by coincidence or not, sunspot activity during those centuries was extremely low.

Outside the Tropics, the world was cold. Example: Scotland suffered six straight crop failures during the 1690s because of late Springs and early frosts. Some historians believe this was the major reason why the Scots gave up their dreams of independence and joined England. There were skating parties on the Thames each winter. Polar ice caps expanded dramatically.

Then, in the early 19th Century, the sunspots returned. The pattern: ten years of sunspot activity, a year of rest, then a new cycle.

The last sunspot cycle ended on schedule in 2006. Also on schedule, there was minimal or no sunspot activity in 2007. Not to worry, said the global warmists: they’ll be back next year.

They didn’t come back in 2008. They haven’t returned so far this year. In retrospect, the record-breaking day-long super-spectacular series of 174 sunspot explosions on Bastille Day in July 2001 was the equivalent of Gandalf’s fi reworks display for Bilbo Baggins’s 111th birthday, which ended Bilbo’s ownership of the Ring. Astronomers still speak with awe of the sunspots that day. Satellite and radio communications across the world were devastated, and the Aurora Borealis was seen as far south as Texas. Almost immediately, sunspot activity began to dwindle, and then the spots completely disappeared in 2007. Periods of high sunspot activity didn’t reach the levels seen in the 1980s and 1990s. Minimums were lower. Then the sunspots virtually disappeared.

They haven’t come back, which means we are experiencing the longest sunspot drought in more than two centuries. As NASA notes, solar wind activity is at a fifty-year low. As other astronomers have noted, that decline in solar wind could be the factor that has dramatically reduced the depth of our atmosphere. Earth has had, for most of the time that we could measure such things, 400 miles of atmosphere between ground level and the Absolute Zero temperatures of outer space. We’re down to 250 miles.

As the science writer of the Telegraph put it, we are 150 miles closer to outer space than we were at the dawn of the Space Age.

As clients are well aware, we are infl uenced by the work of astronomers dating back to the Astronomer Royal, William Herschel, who two centuries ago demonstrated a correlation between the price of corn (wheat), and changes in sunspot activity. So we have watched with growing interest as astronomers report surprise at the failure of the sunspots to return.

The Victorian scientists would have swiftly said that the two cold winters we have been experiencing were inevitable, given the collapse in sunspot activity. There hasn’t been such sustained spotlessness on the sun for so long that it seems that the global warmists came to believe that those earlier Minimums were freakish occurrences.

Historians learn to take history as it is reported, and not to impose their own prejudices on it. We believe it highly likely that the temperate zones of the world—where most people and most grains come from—will experience notably cooler weather this year, which could imperil key crops.

Last year, according to some preliminary climatological surveys, the world temperature fell one degree Fahrenheit, the biggest one-drop for which we have authoritative records apart from the short-term cooling after Mount Pinatubo erupted in 1991.

That temperature decline seems to have continued through winter, which has been severe in many regions. It is, as of now, the 10th coldest in Chicago’s history.

Snow has been reported as far south as Malibu. The Pacific Northwest—including Seattle, Vancouver and Victoria—has suffered the kind of snow and ice storms that more resemble New England than the balmy Pacific Coast. London had one of its biggest snowstorms in decades. Louisiana had a severe snowstorm in December that closed the major bridge across the Mississippi, backing up traffic for miles in either direction.

The University of Illinois Climate Research Centre, which researches ice caps and sea ice in the polar regions (“The Chryosphere”), has for years been reporting on the shrinkage of sea ice. When they took their annual year-end portraits of the poles, they were amazed: In just four months, the sea ice had expanded dramatically, and the total ice was now back to the average level of the past thirty years.

But, (you may say), I’ve read the reports on the Arctic ice cap shrinkage and I know that we face a crisis. One of the best-known reports is published by the US National Snow and Ice Data Center, whose work was influential in the move to declare polar bears an endangered species. The Institute kept reporting this year that the ice was still disappearing, and its reports kept getting printed.

The Page 16 story came in mid-February when the Institute had to confess that “sensor problems” had given some misleading readings. In fact, they had managed to miss 193,000 square miles of sea ice, an area 18% larger than California.

Our take on all this is that the global warmists have such control over the universities, politics and media, that discussion of the possibility of a new period of global cooling is treated as something between hysteria and voodoo. Therefore, farmers and agricultural planners are making no provision for the possibility that this growing season could be far more challenging than last year. And, based on the historical evidence, cooling is cumulative: if the spots don’t return, next year is likely to be more problematic for farmers than this year.

’Twas ever thus. Our knowledge of sunspots dates back to Galileo and the records of sunspots have been kept since his time. He wasn’t permitted by the Elites of his time to say publicly that the earth revolved around the sun. The Vatican no longer claims that kind of authority, but the Scientific Left (if that is not an oxymoron) does.

One of Galileo’s contemporaries, Montaigne, expressed his exasperation about the way science was treated. “We parrot whatever opinions are commonly held, accepting them as truths, with all the paraphernalia of supporting arguments and proofs, as thought they were something firm and solid…Thus the world is pickled in stupidity and brimming over with lies.” That could describe today’s situation whenever the subject of global warming is discussed publicly.

This could be the ultimate Page 16 story.

On the other hand, it may be, as Henry Ford so vociferously maintained, that

“History is bunk.”

Full Report:
Donald Coxe BMO Basic Points 3 2009

Investment recommendations on page 41 of report…

Disclosure (“none” means no position):

Now, every reader here knows I am bearish on housing for 2009/2010. But, a new ETF out there has my contrarian indicator on high alert.

From the WSJ:

MacroShares’ Major Metro Housing product, brainchild of economist Robert Shiller, will offer investors a way of betting on rising house prices by buying “Up” shares, or expressing pessimism via “Down” shares. Unusually, these won’t be backed with the underlying physical housing assets.

Instead, MacroShares will be tied to the Standard & Poor’s/Case-Shiller Composite 10 Home Price index. When the Up and Down shares float, proceeds will be invested in U.S. government bills to ensure liquidity. If the index moves up, the trust behind the Down shares will shift a corresponding portion of its assets to the Up shares trust, raising the net asset value underlying the Up shares. The prices should follow.

This seesaw structure dictates there always being an equal number of Up and Down shares. So if, for example, there is high demand for new issues of Down stock, not an unlikely scenario in today’s climate, an equal amount of Up stock will have to be created and sold into the market. In this scenario, Down shares ought to trade at a premium to NAV because of high demand, while Up shares would tempt buyers with a discount.

First, readers also know how we at ValuePlays feel about Case-Shiller and its flawed methodology.

The ETF also seems at first blush to be a way to increase the relevance of the index the ETF’s creators have it tied to (they are the same people)

BUT, now that the average Joe has an easy way to bet against housing, are we looking at the “last fools in” on the downside? Please note, under no circumstances do I think there is any “rally” happening in housing. In all actuality just price stagnation would be stunningly good news. Past real estate busts have taken the better part of a decade to come out of and this was worse than any of them, there is no price rally in store.

Could the “RE ETF” to the downside be the “Lair Loans” from the bubble? Time will tell.

Now, when you couple that with this little piece of news also from the WSJ:

Jumbo mortgages became more expensive and harder to come by as the nation’s credit crisis deepened. That might be starting to change.

“Jumbo” refers to mortgages that are too large to be bought by Freddie Mac or Fannie Mae. The “conforming loan limit” for those government-backed entities is $417,000 in many parts of the country, but goes up to $729,750 in high-cost areas of the continental United States.

Bank of America recently began trumpeting its jumbo program, offering 30-year fixed-rate jumbo mortgages with rates in the high-5% range. “We decided it was time to really go after that market,” says Vijay Lala, a product management executive for the bank.

Also:

The rates on 30-year fixed-rate jumbo mortgages averaged 6.5% for the week ended March 27 — the lowest since May 2007, according to HSH Associates, a publisher of consumer loan information. On Oct. 31, a recent high point, the average rate on a 30-year fixed-rate jumbo mortgage was 7.9%, according to HSH data.

GMAC also has been pricing its jumbos aggressively, says Paola A. Kielblock, national product specialist for Fairway Independent Mortgage, a mortgage broker and banker based in Madison, Wis.

She recently has seen rates in the high-5% to the low-6% range for 30-year fixed-rate jumbo mortgages, and the low-5% range for five-year adjustable-rate jumbos.

Bill Higgins, chief lending officer for ING Direct, says his firm has been offering jumbos in the 5% range for several months — even back when average rates were higher

I have claimed here for what seems an eternity that helping over-levered people 6 months behind on their mortgage was a waste of taxpayer money. Why? There is no economic impact to saving the home. John and Mary’s loan has reset and they are hopelessly underwater and cannot afford the loan. Forcing the bank to refi it only enables them to barely afford the loan. That is it. There is no discretionary income freed for other economic uses. Results from FDIC programs that show near 60% of these folks re-defaulting 6 months later would prove that point.

The argument is that saving the foreclosed homes saves property values. Bull, once the first home on the block (or near area) goes into foreclosure, homes 2 and up have no effect on pricing until #1 sells as that is now the low price. Since we know we cannot save every home because some people cannot afford their homes under any circumstances, saving the others in the area is wasting money and resources.

Fording them to foreclose and rent would actually free up more money for them to recycle back into the economy.

Jumbo loans. Today these are folks with high credit scores (>720), at least 20% equity in the home and higher incomes. Lowering their payment adds to their discretionary income that then gets recycled. I have argued that refinancing current loans at 4% to credit worthy borrowers would have more beneficial impact for the overall economy than just allowing someone to squat in a home.

Will this “save housing”? No. We could not build another house for a year and still have new home inventory unsold next April. Until that is fixed, prices cannot climb. It will though help the overall economy.

So, what does it all mean? The ETF? A piece of garbage. It will take at least a decade to recoup housing values in the hardest hit areas. Housing has collapsed and the easy money has been made for those who think further falls are in store. Not that is matters as the ETF isn’t even backed by actual home prices (unlike commodity ETF’s) but by the “feelings” of investors. Housing could rally or fall 20% but if investors do not rush to buy or sell shares in the ETF, the value of the investment remains flat. Contrarily, prices could remain flat but a rush of sellers could cause a long position to crater totally unrelated to housing prices. Nice…

Also, the folks at Macroshares have lousy timing with this type of investment:

When MacroShares first tried the structure tracking oil prices, the results were mixed. In its first outing, in 2007, the sudden rise in oil prices from $60 a barrel to triple digits caused it to automatically liquidate in the summer of 2008. In a seesaw structure, if prices move 100% either way, the net asset value of either the Up or Down shares must go to zero. This is by design, but some investors may be put off by the idea that returns are capped.

Final thoughts:

•  Ignore the ETF
•  Housing will not rally
•  Giving current mortgage holders more discretionary income by lowering rates helps the economy
•  Stable housing would be very good news…

“Davidson” takes Robert Shiller to task again. A month ago Davidson submitted this post showing Case Shiller methodology flawed.

Robert Shiller’s home pricing analysis has created panic in the hearts of every home owner, every bank lender, home builder, the managements at home furnishing suppliers, lumber companies, cement companies and etc. Lending businesses of every type and description are in shear panic of a highly uncertain and dire future. I believe that Shiller’s widely disseminated forecast needs perspective.

FIRST:

The March 2009 data for NAREIT was released this morning and the index history from 1987-Present is presented below. I use 1987 as a starting point because Congress changed the tax laws to make “tax shelters” uneconomical in 1986 and the tax regime has been the same since. The point I make here is that when we invest in REITs as an allocation, we do so using the common stock and not by buying the actual asset. The NAREIT Index has fallen 67% from Jan 2007 to Feb 2009. The current valuation is well below the historical pace and as long as the tax law does not change, I fully expect the pricing of REITs to return to the historical performance level.

An important factor (but not the only factor) in my thinking is William Isaccs’ Testimony to the House Financial Services Comm on March 12, 2009 which I have attached to this email and I encourage you to read carefully. In his testimony he indicates that Mark-to-Market is today’s worst problem and

“I was Chairman of the FDIC during the banking crisis of the 1980s. The problems in the U.S. financial system in the 1980s, despite what we are hearing from some government leaders and the media, were more serious than we are facing thus far today.”

I urge you to look at the 1990 decline in the NAREIT Index (Chart 1) which Isaccs calls worse than what we see today. The NAREIT Index tells me that the current market has overstated the current situation. (Click on the chart to expand the corners to more easily view the details) Remember when we buy REITs we are buying stocks that represent the market’s perception of the value of the underlying assets. Real estate has never in the history of the NAREIT Index fallen 67%

Chart 1(click to enlarge):

SECOND:

I have reproduced below Shiller’s Unadjusted for Inflation Housing Price Data 1890-2008(Chart 2) taken from Shiller’s http://www.irrationalexuberance.com/ and the comparison of the Shiller late1980’s-early 1990’s (Chart 3) real estate decline vs. the current real estate decline as published at http://paper-money.blogspot.com/

Chart 2: Shiller’s Unadjusted Housing Price Data 1890-2008(click to enlarge)

Chart 3: (click to enlarge)

My first observation is that Robert Shiller makes a broad forecast using the complete period from 1890-2008. When I view his data it is apparent that crucial events in 1933 enabled the Federal Reserve to not only provide economic stabilization during times of distress but to set national baking regulation. My interpretation is that by lessening the downturns in our economy caused by a pre-1933 unregulated financial industry, the Federal Reserve lessened the capital destruction and the US economy and housing stock grew out of post-1933 economic declines from serially higher lows. The effect in home valuations and the gradual willingness to use borrowed funds has provided fulfillment to many American dreams. I have drawn valuation channels for these two very different economic periods and added rates of return that came from this analysis in the chart below. Robert Shiller treats the 1890-2008 price series as having a continuous economic environment.

I had puzzled over Shiller’s forecasts for some time as they appeared so dire, yet the history in the NAREIT above and the Nominal Housing Prices below did not fit the oft repeated forecasts.

The Shiller House Pricing Data is Inflation Adjusted, BUT we think in terms of the Nominal Price and banks lend against the Nominal Price.

Shiller’s forecast is an inflation adjusted forecast, but the media does not present it this way. We think in Nominal Prices, the price we see every day. When Shiller compares price declines during the last home price decline period to those of the current period as is presented in Chart 3 from paper-money.blogspot, these are inflation adjusted prices and not those that we actually experienced in the decline of the late 1980’s-early 1990’s. We experienced a 3% Nominal Price decline from 1990 to 1991.(See the Shiller Unadj Housing Price Data 1987-1997 Chart 4 below) Importantly, banks lend against the Nominal Price not the Inflation Adjusted Price.

Chart 4 (click to enlarge):

Our national panic over falling prices and owners being underwater vs. Inflation Adjusted Cost Basis is not how we or the banks think. It seems that we have suddenly come to accept a pricing methodology that we have never before considered valid.

In my view the current panic heavily promoted by the media needs to step back a bit and not take Robert Shiller’s price decline forecast as a Nominal Price decline forecast which is what I think we are doing.

Disclosure (“none” means no position):

“Davidson” submits……

It is useful for value investors to see how this may be applied when investing in common stock as it reveals that the markets do indeed arbitrage with the principle of Relative Returns. For the many who have attempted the use of simple relationships, i.e. P/BV, Market Cap/GDP, P/E this will appear overly complicated, but I do not apologize. I only observe that the world of capital requires adjustments to valuation so that a competitive return can be had.

The basic formula is the long term Real GDP + adjustment for inflation = Wicksell Rate(proposed by Knut Wicksell in 1898).

In reality this comes down to using the Dallas Fed 12mo trimmed mean PCE as the measure of core inflation and for US investors the Real US GDP long term trend which today sits at 3.16% and over the next 10yrs will fall to 3.15% based on 80yrs of history. Based on the Feb 2009 Dallas Fed PCE release of 2.2%, the Wicksell Rate at the moment is ~5.4%. This is the moving Wicksell Rate(Capital Return Benchmark) that essentially rises and falls with core inflation while Real US GDP does not vary very much for 5yr forecasting purposes. This approach is not for next quarter’s GDP or even next year’s GDP as we all know that no one has ever forecasted these levels with precision. However, IF WE KNOW WHEN THE MARKET IS OVER VALUED OR UNDERVALUED VS. THE WICKSELL RATE, WE CAN KNOW WHEN TO COMMIT FUNDS AND WHEN TO REMOVE FUNDS BASED ON RELATIVE RATE OF RETURN.

In using this approach one needs to be cognizant that psychology plays a significant role in market valuations for periods as long as several years. I call attention to the sell signal given when the SP500 return fell below that of the Wicksell Rate in 1997 and did not provide a buy signal till August of 2002. In general this valuation approach would have sold during periods of excess valuation and bought only after corrections had mostly run their course. The fact that it resulted in a buy signal just prior to the Fall 2008 collapse demonstrates that when market valuation rules change so does the ability of the market players to know where the values are in the market place. They just sell out and wait for the dust to settle. This was the stark effect of imposing an artificial price-based Mark-to-Market valuation methodology to securities known to be of much higher quality than those prices reflected.

The other half of the process, i.e. developing a reliable forward return for the SP500, requires the knowledge that 1) SP500 ROE has been surprisingly steady at ~14%, 2) SP500 BV has had surprisingly growth of ~6% since 1978 and the SP500 represents ~90%+ of US market capitalization. Together, these facts let us assume that the next few years will run along the same trend. This method is to divide the 2yr forward SP500 Book Value into the current SP500 Index Price and multiply this by the ROE to get a measure of how much of this ROE the investor receives at the current SP500 Price level. The 2yr number is based on the rational that Value investors look at least 2yrs into the future.(Value investors are not traders) The calculation looks like this:

(SP500 Price)*(SP500 ROE Trend of 14.2%)/(2yr Forward SP500 Book Value) = 2yr Forward Return at the Current SP500 Price Level

This proves that the market does have a rational Relative Return process at work. It also proves just as simply that regulations and psychology can tamper with the relationship over shorter periods such as the one we find ourselves in today.

The current market is an extraordinary buying opportunity!!

Disclosure (“none” means no position):

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“Davidson” makes the case that it is indeed flawed analysis….

Robert Shiller has made quite an impact with his various appearances in the media and his active financial consulting business heavily promoting his negative market views. I downloaded his spreadsheets with the goal of understanding his views better, but was surprised to discover serious errors in his approach. I start with his analysis of the housing data and then follow with his view of the SP500.

This is an analysis of Robert Shiller’s data downloaded from his site with out modification. His chart is inflation adjusted Housing Prices in arithmetic format. My chart below is of his Nominal Housing Price Index in semi-log format.

Price/time series of this type require semi-log analysis and clearly reveal that conditions over the series are non-uniform. The point to make with this comparison is that Prof. Shiller draws conclusions regarding housing trends from 1890-Present (Chart 1) treating the period as if the conditions affecting housing prices had been uniform. My chart below Chart 2) provides a clear indication that this is an erroneous supposition as the pre-1933 environment greatly differed from the post-1933 environment. Namely, the Banking Act of 1933 and the Glass-Steagall Act provided improved financial stability which led to a ~300% growth rate in the housing index post-1933 vs. pre-1933. No analytical method can make a valid combination of pre-1933 data and post-1933 data and hope to come to conclusions with any validity.

Prof. Shiller’s housing forecasts are simply meaningless based on the data he presents.

Chart 1: Shiller’s Inflation Adjusted Housing Index Chart arithmetic scale

Chart 2: “Davidson’s Chart of Shiller’s Nominal Housing Index in semi-log format.

Next I turned to Prof. Shiller’s analysis of the Inflation Adjusted SP500 Index and again compared his chart (Chart 3)analysis vs. the proper semi-log format unadjusted SP500 Index(Chart 4). Prof. Shiller draws conclusions and makes forecasts based on the SP500 Inflation Adjusted chart below. He assumes that uniform conditions applied throughout the period. This is shown to be a very simplistic and incorrect assumption by observation of my semi-log non-inflation adjusted plot of the SP500 below. Pre-1933 and post-1933 environments are readily observed. Again one cannot combine the pre-1933 period with the post-1933 period as he has and make any intelligible analysis much less a valid forecast.

Note that the SP500 grew ~400% faster post-1933 when compared to the pre-1933 pace.

The greatest difference in both instances of Shiller’s analyses is that the laws enacted in 1933 to protect the US financial system, greatly reduced the rate of bank failure post-1933 and the subsequent capital destruction. Prof. Shiller has failed to recognize this in his assumptions that conditions remained uniform throughout the period of his analyses. He needs to reassess his approach.

Chart 3: Shiller’s Inflation Adjusted SP500 Index

Chart 4: “Davidson’s SP500 Index unadj. From Shiller’s Data in semi-log format.

I believe Prof. Shiller’s work by this simple analysis is revealed to be considerably flawed.

Humbly submitted,

“Davidson”

Disclosure (“none” means no position):

Visit the ValuePlays Bookstore for Great Investing Books

An interesting point on how investor sentiment has always overshot to the downside.

“Davidson” comments on the following chart”

Here is the SP500 from Dec ’27 to Dec ’49. The P/E and EPS are included. The change in psychology from Sept 1929 to June 1931 was much greater than the $1.60 per share to ~$0.50 per share earnings drop. Psychology has always had an enormous effect on market prices and true Value Investors utilize this knowledge to their advantage. Most available data bases do not go back beyond the 1960’s as the data reliability is not guaranteed.

(This chart is constructed from data extracted from older SP500 sources and likely does not conform to modern accounting standards. The relative perspective is useful just the same.)

From 1929 to 1931, the S&P Earnings dropped 37% yet the value of the S&P dropped 85%. Simply said this means investors were over twice as pessimistic about US business then what the reality of them actually was.

Another interesting point is the 1931-36 recovery. Note the PE skyrocket up ahead of the market. It is clear investor sentiment turned positive BEFORE the actual earnings of the S&P did. Notice from the chart earnings stays flat until essentially 1934 while the market has a massive rally. So, great you say, what does it all mean?

It means the market bottoms before earnings do and then rallies before they rebound due to sentiment. So, then, where are we now with sentiment? I am using modern numbers because to the best of my knowledge there are no “sentiment” readings from the 1930’s other than market results (if anyone knows that there are, please let educate me).

Link to chart data

We are now more negative than the last two recessions (with reason). Those low readings eventually gave way to the 1990’s and 2002-2008 bull markets.

We can go back to a post I did last week regarding cash vs. the S&P. It shows just how pessimistic people are. Money sitting in the bank right now in Treasuries in earning essentially nothing. This, for the majority of people is preferable to the “expected” losses they assume in the market. It also is tremendous fuel for the fire once that sentiment changes and, yes it will. The current situation is not even as bad as 1980-81 much less 1929-31. The US economy and the market both came back from those periods and will again.

Now, the trillion dollar question is “when?” Again, I do not make “bottom” calls but I feel there is a large swath of the market trading at “eventual destruction” valuations. I also know people are of the mindset the world, while not quite ending is racing towards depression. With the ammunition sitting there to buy equities present, when the depression does not occur people will tired rather rapidly of earning nothing on cash in the bank or in US Treasuries and will want a higher return in the market from equities again.

When they do, the floodgates will open..

Disclosure (“none” means no position):

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