Agora Financial’s Rude Awakening

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Laguna Beach, California

• Markets break into positive ground for the year!
• A brief round up of the bear market bounce story so far,
• The “Millionaires’ Market,” a full BRIC funds wrap and plenty more…

Eric Fry, reporting from Laguna Beach, California…

Thank goodness THAT’s over!…The bear market of 2009 is finally over and done with. Now we can get on with the joys of celebrating year-to-date gains, rather than the misery of lamenting year-to-date losses.

For those folks who may have been too busy watching video clips of Warren Buffett’s remarks from last weekend’s Berkshire Hathaway meeting to pay attention to yesterday’s big rally on Wall Street, allow us to point out that the S&P 500 index has now produced a gain for 2009. That’s right, a gain – up 0.44%! Sure, the S&P is still down more than 40% from its October 2007 record high, but that’s old news.

Monday’s rally received no small boost from Warren Buffet’s self-serving observation over the weekend that Wells Fargo is a “fabulous” bank. We would not quarrel with the Oracle of Omaha’s assessment. But we would point out that Buffet’s Berkshire Hathaway holds a fabulously large position in Wells Fargo. In fact, Buffett’s company is the single largest shareholder of Wells Fargo.

Seasoned investors would immediately recognize Buffett’s effusive praise for Wells as little more than “talking your book.” Even so, most folks seemed to receive the Oracle’s remarks as gospel truth. The shares rocketed nearly 24% in yesterday’s trading.

The stock market also received a little boost from a couple of “less bad” data points – namely pending home sales bounced 3.2% in March and construction spending rose 0.3%. If we may ignore the fact that a “pending home sale” is hardly a sale (especially when credit is tight) or the fact that the rise in construction spending was mostly the result of municipal projects, these news items were bullish. But in the context of real-world dynamics, these new items barely warranted an honorable mention.

So is it time to pop corks to Timothy Geithner and Barak Obama for a job well done? Or is it time to call a cab and leave the party? If we may rephrase the metaphor, is it time to act like a hermit crab, investment-wise, and crawl into one of the many empty bunkers that America’s formerly fear-ridden investors have vacated?

Remember, we only provide the questions, not the answers. But even though we have no answers, we have entertained enough guesses and observations to keep our minds occupied. So take a gander at this observation: The preference for risk vs. caution has completely inverted since early March. Risk is now the “crowded” trade; caution the unpopular trade.

From the middle of September 2008 through March 9, 2009, safe havens like gold and 10-year Treasury securities became as popular as the Jonas Brothers (among 10-to-12-year old girls). Both assets appreciated about 9% in this timeframe, while the S&P crumbled 44%. In other words, gold and Treasuries both outperformed stocks by about 53 percentage points (i.e. 9 plus 44)!

Since March 9th, however, the spread between these assets has reversed completely. Gold and 10-year Treasury securities have become as unpopular as the Jonas Brothers (with anyone who is NOT a 10-to-12-year-old girl). Caution is out. Risk-taking is back in…WAY back in. The S&P 500 is up a stunning 34% since March 9, while gold has slipped 2% and 10-year Treasuries have dropped 6%. Thus, the S&P has produced a POSITIVE spread of 36 percentage points against gold and 40 percentage points against Treasuries.

The higher and longer that the stock market advances, the more the investing public convinces itself that a genuine recovery is at hand. Markets make opinions. It’s as simple as that. But of course, no genuine recovery is at hand…unless you consider “less bad” to be good. I dunno, maybe less bad is actually good. But your editors have never been tempted by a plate of less bad oysters or been enticed by a glass of less bad wine. So neither are we thrilled by the prospect of investing in the fortunes of a less bad economy.

But before you hit the delete button on today’s Rude Awakening, please don’t assume that your editors are skeptical of ALL investments everywhere. We are not – not by a long shot. We are merely fearful of the notion that “all’s well.” All is NOT well – not by a long shot.

So we suspect that the forward-looking investor will want to continue shunning risk, as least the risks that he can imagine. (Because those that he can’t imagine are certainly hiding in the grass somewhere). The forward-looking investor will also want to invest in the companies that can prosper, even if economic conditions should become unimaginably bad.

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What to Buy…or Not Buy
By Marc Faber

From the tidal wave of e-mails and comments I have received from numerous different sources I am under the impression that most investors view the recent rally in the world’s stock markets as a bear market rally. I suppose we would need to define a bear market rally as a rally that fails to make a new all-time high (for the S&P 500, above the 1576 reached in October 2007) and is also followed by a new low for this cycle (below 666 for the S&P 500 reached in early March 2009).

The problem I have with this dogmatic definition of a bear market rally is the following: Assuming (and this isn’t a forecast, since I really haven’t the foggiest idea where stock markets will be in six or 12 months’ time) the S&P 500 moved up to 1350 and then declined to 500, as an investor should you care if the move to 1350 — a 100% gain! — was a bear market rally?

My impression is that investors’ fixation on the recent rally being a bear market rally has actually kept most investors on the sidelines and hoarding cash. Now, put yourself in the shoes of a fund manager who, in the last 18 months, has lost 50% of his clients’ money and missed the recent rally (34% for the S&P 500). What is he likely to do? I would think that he would be inclined to purchase equities as they correct the sharp advance since early March, especially as the economic news in the near term becomes less negative.

Based on our conversations with numerous managers in recent weeks, we believe that most quantitative managers’ portfolios were not positioned in expectation of a rally. Of the nearly 80 managers we have talked to, only one manager said they were up since March 9th and the clear majority admitted to being notably down or stopped out on their positions. These managers were both long-only and long-short quant managers using market neutral and non-market neutral strategies, sector neutral and non-sector neutral strategies, longer term and intermediate-term holding periods. It is fair to say that just about everyone is bewildered and trying to understand when this rally will end.

Another factor to consider is that there has been a significant improvement in the technical position of world stock markets. In the US the largest number of new 12-month lows was reached in October. At the November 21 low at 741 for the S&P 500, the number of new lows had already contracted, and even more so at the index’s March 6 low at 666. Also, market breadth and the number of stocks moving above their 200-day moving averages have taken a decisive turn for the better, indicating that the stock market advance is broadening and that the number of stocks that have bottomed out (at least in the intermediate turn) is expanding.

I have explained repeatedly in the past that if a government is really determined to try and postpone an inevitable collapse by “printing money” in order to lift or support asset prices, it can be done. However, the result of such a monetary policy is to lower the purchasing power of its paper currency, with catastrophic long-term consequences for its economic and financial volatility.

It forces individuals and institutions with cash to buy something…anything. So, this cash is channeled into gold and/or different paper currencies, commodities, equities, bonds, real estate, and consumer goods and services, but obviously with different intensities and at different times. For instance, at some times, such as in 2008, more money will be allocated to gold; while at other times, such as since early March, more money will flow into equities and industrial commodities. It is well understood that these money flows are driven largely by speculative activity (and more than a little dose of manipulation). The result in all asset markets is very high volatility and price fluctuations that don’t appear to make any sense to most market participants and observers who don’t understand the new rules of the investment game that were brought about by “money printing”.

This is where we are today, irrespective of whether or not you and I like policies of “quantitative easing, massive bailouts, and frightening fiscal deficits” and their long-term consequences! Another positive factor for stock markets is that a large number of Asian stock markets and individual stocks in the region had already bottomed out in October and November of 2008 and didn’t confirm the new low in the S&P in early March.

In Asia, the Taiwan and Shanghai indexes, and Korea’s Kospi Index, are all up by more than 50% from their late October 2008 lows. (The Shenzhen Index is up 90%.) But it is not only the Asian equity markets that have outperformed the US and Western European markets over the last few months; since late January 2009, the RTS Russian Index is up 66% and the MSCI Emerging Market ETF is up by 55% from its early November 2008 low.

This is not to say that the global economy is about to embark on a strong and sustainable growth phase. It also doesn’t mean that a new bull market in global equities à la 1982– 2000 has begun. But I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively. Therefore, in the case of resource and mining stocks, as well as Asian equities (and, for that matter, most emerging and other stock markets around the globe), the lows thatwere reached between October and March of this year are likely to hold — that is, for now.

The markets that have the highest probability of having made major longer-term lows are resource-related equities, emerging markets, and Japan. Conversely, the asset market that has the highest probability of having made a secular high (such as Japan in 1989, or the Nasdaq in March 2000) is the US long-term government bond market.

Despite a still-weakening economy and massive quantitative easing, long-term bond yields appear to be on the verge of breaking out on the upside. I have listed again below all the equity recommendations I have made since December 2008. Some of these equities have already moved up substantially (resource and mining companies, in particular) and, therefore, I would only buy most of these recommendations on a correction.

In addition, a number of BRIC and other (mostly emerging market) closed-end country funds and ETS were recommended, such as Brazil ETF (EWZ), the Templeton Russia Fund (TRF), the Greater China Fund (GCH), the Asia Pacific Fund (APB), Taiwan iShares (EWT), the Japanese ETF (EWJ), the Japan Smaller Capitalization Fund (JOF), the Morgan Stanley India Fund (IIF), the Turkish Fund (TKF), and the MSCI Emerging Market ETF (EEM).

In the US, late last year we recommended buying the iShares iBox Investment Grade Corporate Bond (LQD) and Nicholas Applegate Convertible & Income Fund (NCV), while earlier this year we recommended the accumulation of stocks of high-tech companies such as Cisco (CSCO), Intel (INTL), Oracle (ORCL), and Yahoo (YHOO). More recently, we recommended beaten-down insurance companies and financials as rebound candidates, including Leucadia National (LUK) and CNA Financial (CNA), Citigroup (C), the BKX, the Financial Bull 3x Shares (FAS), and the Financials Select Sector SPDR.

The market’s advance had been broadening and that more and more groups such as airlines (AMR), homebuilders (TOL, CTX, HOV), and cyclicals such as Dow Chemical (DOW), International Paper (IP), and Alcoa (AA) are showing signs of having bottomed out. Among commodities, I am particularly intrigued by natural gas. There are natural gas ETFs (UNG, GAZ), but costs are high. A better way is probably just to buy future contracts, or Pioneer Natural Resources (PXD) or the First Trust ISE Revere Natural Gas Index Fund (FCG).

Joel’s Note: Dr Faber publishes a widely read monthly investment newsletter “The Gloom Boom & Doom Report” report which highlights unusual investment opportunities, and is the author of several books. To learn more about Dr. Faber’s work, click here.

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[Rude Endnote: As Eric mentioned above, Wall Street bounded into positive territory for the year with yesterday’s spectacular rally. The S&P 500 stacked on 3.4% by the close of trading while the Dow and Nasdaq managed a healthy 2.6% gain each.

As you might expect, markets around the rest of the world took their cue from the good ol’ U.S. of A. and rallied overnight.

Here in Asia, Hong Kong’s Hang Seng and the Aussie All Ordinaries inched up 0.2 and 0.3% respectively while Japan’s Nikkei 225 managed to muster 1. 7% gains. China’s CSI 30 index finished higher by half a percent while Taiwan’s Taiex measure continued its epic climb, adding another 0.8% by the day’s end.

London’s FTSE was the big winner in Europe. The poms advanced just over 3% while France managed 0.3% gains and Germany’s DAX finished about where it started.

Over in the commodities pits, oil hovers just below the $55 mark, and gold, sweet, sweet gold, sprinted back up to $910 per ounce after teetering on the brink of $900 earlier in the day.

We’ll be back with more tomorrow but, for now, we’re out.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com