About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Friday, February 27, 2009

Stock Market -- Earnings & Long Term

It appears that the 12 month operating earnings of the SP 500
could well fall 50% or more peak-to-trough in this cycle.
Specifically, net per share could fall from an all time high of more
than $91- to $45- or less by later this year. The post WW1 era and
Great Depression saw larger declines, but the present downtrend
is as bad as it gets short of economic catastrophe.

As you might imagine, steep declines of corporate profits are followed
by strong advances once the economy turns positive. Even so, with
a decline of 50% in net per share, experience shows it could take
5-6 years to recoup and see earnings move to new highs. This
observation suggests that the recent $91- peak might not be topped
until 2014-15.

I do keep a model of the SP 500 based on very long term net per
share growth of 6.45% and a p/e based on both a long view simple
average of this ratio plus one based off long run inflation. Trend
or "normalized" eps for 2009 is about $75- and the p/e ratio is
set at 16.0 - 16.5x. The model value thus has the "500" at 1200 -
1238. Thus the market, now in the mid-700s, is very reasonable
against the long term framework. But, to be realistic, it could well
take several years to see reported "500" eps back up to $75-. Thus,
you need to take the model's output as a measure of value and not
a shorter term price target. But, you also have to recognize that
development of a cyclical bull market in the wake of a very deep
decline of earnings can easily double the price low within 4-5 years.

Now I can use historical earnings and dividend data to construct
a more muted price recovery as well as one with even more punch
than that outlined just above. Much will depend on the power of
the economic recovery as well as how aggressively companies
manage their plowback of earnings and their balance sheets.

The long term model I discussed above is quite a bit more
conservative than the one that served me well from the 1985 -2007
period. I have taken the long run trend of earnings component
down from 8.5% back to the historic 6.45% in looking toward
the future. I also used a 70% earnings plowback rate with the
1985 - 2007 model and this could be high going forward. But we'll
have to see on that.

I use a long run "normalized" pattern model to try and envision
the future and as a diagnostic. The LT model of the SP 500 is
different from the Market Tracker, which relies on current 12
month earnings rather than points on a trend. If 12 month "500"
net per share drops to $45- this year as expected, the Tracker
would show a value of about 740. Grim indeed.

I plan to set the longer term stuff aside for awhile to focus more
on the shorter term environment. After all, the economy still
sits at the edge of far more serious trouble, and I need to check
in on whether my view that we can avoid catastrophe has some

Wednesday, February 25, 2009

Big Bank Nationalization -- No Thanks

First, a contrary view: The conventional wisdom is that the banks
need to be "fixed" to have an economic recovery. I see it the other
way around. We need to see an economic upturn start first to have
a good chance at straightening out the major banks. Recovery
implies an improvement in loan loss experience, an improvement
in bank operations cash flow and stronger investor interest. A
persistent economic decline implies all of the opposite: wider
losses, shrinking cash flows and the coup de grace for bank equities.

Overall, bank loan demand is more of a lagging indicator, since
businesses can cover early recovery working capital needs with
fast rising cash flows. In the meantime, banks can accomodate
early recovery mortgage needs straight out of the pot. Early
economic upturn provides business with a chance to reduce their
loans and for big companies to refinance short term credit with
bonds. Yes, eventually we will need the banks to finance advanced
expansion, but the early upturn comes first.

Banks follow a certain script with troublesome credits. They
increase loan loss reserves, charge off losses against those reserves
and post loan delinquencies to regulators. Banks are now being
stressed tested every day in the weak economy and will now
step up with 2 year estimates of unrecoverable loans and the hits
to capital such might involve. The US Treasury will then have a
projection of external primary capital each of the major banks
might need.

An economic upturn will bring better loan loss experience and lead
to an upward revaluation of toxic, securitized loans. It will also
greatly expand the market for selling these loans as monster bid /
ask spreads narrow.

At this point, banks would be foolish to sell those loans at large
discounts. If it wants, the Treasury can enlist private capital with
guarantees to, in effect, make a market for the junky stuff. But
an economic upturn will underwrite a far better market, as banks
can sell at reduced losses if need be and dilute equity less.

For my part, the most appropriate course for the Gov. is to
recapitalize the big banks as needed in the short run, close out
the smaller stinkers and wait for improving economic conditions.

The guys out there who are calling for an immediate takeover of
Citibank have no idea of what they are asking for. First, the Feds
would be on the hook for hundreds of billions of $ deposits. Then,
figure it will take the new top guys and directors 18 months to
figure well what they have inherited. In the meanwhile, top
divisional people will leave for better money elsewhere, leaving the
bank undermanned at a time when businesses may come a calling
to bank with a "risk free" house. Finally, there's an even darker
side: The guys at the seized bank may simply not prove very
helpful. So, taking on a big guy via a takeover should be an
absolute last resort.

The focus needs to be on re-starting the economy.

Monday, February 23, 2009

Stock Market -- Technical & Psychology

There are easier days for technical comments, but here goes. The
recent weakness in the market has brought it to a fairly deep short
term oversold, with the SP 500 about 10% below its 25 day m/a.

The "500" did close under the previous bear market low of 752
set in 11/08, but, with today's close of 743, the action was not
decisive enough to claim that a new dramatic breakaway downleg
is in force. Thus, the focus can be on whether the clear oversold is
deep enough to warrant a rebound. My 25 day price oscillator
broke down below an improving trend in force since last autumn.
That tells me not to simply proclaim a rally is imminent. My six
week adv / decline "flame" is deeply oversold and that tells me there
is a good bounce in store over the next 10 trading days.

My intermediate term indicators run out to 13 weeks. I rely heavily
on these to trade, and, they are in whipsaw mode and have been of
little help. So, I am stuck with the short run.

My weekly SP 500 chart has long term support at 800, so weekly
closes below that level would turn that chart bearish on a longer
run basis. I do note that my NYSE a/d line is a country mile above
levels seen when the SP 500 broke 800 back in 2002. Such has
been the interest in smaller cap stocks as well as the disastrous
performance of the major financials.

With so many years of looking at charts, I have developed trend
momentum trendlines that have proven helpful to me. The SP 500
did move out from under the crash line in 11/08, but has not yet
been able to clear a serious momentum downline in force since 9/08.
Recent failures to do so ratify the bear market. Chart here.

Market Psychology
The major issue in recent weeks concerns how well psychology
will hold up with corporate profits so very weak and with the
leading indicators not signaling recovery straight ahead. It is
difficult for many to summon the courage to buy stocks now even
if profits recovery is 6-7 months away because profits are so very

I do not use psychology as a primary indicator because it is not at all
easy to "read" and because it can turn on a dime. I am now looking
to see whether despair may be starting to creep into the environment.
Tough read now because we are so oversold.

Friday, February 20, 2009

Coincident Economic Indicators

My favorites are the changes to the real hourly wage, employment,
real retail sales and production. Measured yr/yr, the composite of the
four stands at -4.5% for Jan. Momentum is still to the downside, but
the window for economic recovery has opened a little further. The
yr/yr change in the wage stands at a strong 3.9%. The decline of
industrial production has tumbled to -10.0% yr/yr.but that brings it
below that of retail sales at -9.7%. This means weak production has
caught up with sales and that excess inventories are therefore being
worked off. Best now would be a period of stabilization of retail
sales, which did rise 1.0% in Jan.

The economic power index -- change in the real wage plus change of
employment -- stands at 1.7% yr/yr. Compare that to the 9.7% drop in
retail sales and you can see clearly how fiercely consumers have been
building savings and going light on the plastic.

The strength of the real wage gives the US a golden opportunity to
stabilize the economy with a better balance between spending and
saving. I hope we take it, because sooner or later, a weak economy
will bring the wage down.

Inflation (Deflation) Indicators

The 12 month CPI came in at 0.0% for Jan. '09. As often discussed,
the rapid deceleration of inflation measured yr/yr primarily reflects
the Half 2 '08 blowout in the commodities markets, especially fuels.
Worth noting is that the 12 month change for the CPI ex. fuels and
foods has dipped to 1.7%.

My inflation thrust gauge is now a deflation thrust measure and
continues to point to mild 12 month CPI deflation in 2009. Another
longer term measure I follow weighs commodities less heavily but
also seems to be pointing to mild deflation (ECRI).

The CPI has fallen about 4.0% from its all time peak set 7/08. Most
economists now know that the 12 month CPI will show deflation
unless the CPI accelerates up over the next 6 months. So, from
here, there will be more focus on the month-to-month change in
the CPI to determine whether the recent sharp decline was but a
shorter term phenomenon.

The hot button component for the increase in the CPI from Dec. ' 08
was the gasoline price, which has moved up from $1.62 a gallon to
$1.92. There will be little concern unless the gasoline measure
surges much further.

Thursday, February 19, 2009

Financial System Liquidity

I start this comment looking on a global basis. The very sharp
contraction in the US trade deficit over the past six months means
a large decline in US dollars flowing overseas. Most economies,
now in deep recession, would welcome additional dollars to buttress
reserve holdings in a time of stress when their own currencies
may be under pressure. The contraction of US trade adds to
sovereign risk for economies in distress now, such as eastern
Europe and Taiwan. The Fed has provided about $600 bil. in
currency swap credit lines to foreign central banks as an offset.
The growing US budget deficit and a strengthening US dollar may
also work to syphon liquidity from abroad, as foreign investors
choose US Treasuries for safe haven status. As the yuan has
weakened in China, there is evidence of some capital flow from
there to the US. The US dollar in global context poses hazards
abroad in 2009. The Fed swap lines are not that popular here as
the Fed is taking credit risk abroad. Thus the Fed has to operate
with caution here.

Over the past 6 weeks or so, the Fed has drained nearly $400 bil.
from its balance sheet. January is often a "drain" month following
the holiday season, and given the current gargantuan size of the
Fed's balance sheet, well, we're now talking big numbers on the
add and drain sides. The drain resulted in substantial shrinkage of
the monetary base and the basic money supply. The liquidity here
is still strong and not a major worry at the moment. However, the
shrinkage may have bothered some stock players. By happenstance,
it might also serve as an important message to high inflation buffs
as the Fed showed it can shrink liquidity in size every bit as fast as
it pumped it up.

The broader measure of liquidity (in which I include financial co.
commercial paper) is recovering in growth. Realistically though, we
may be at a point where increased credit demand may be required to
sustain improvement over the next year or so.

There is large excess liquidity on hand relative to the current needs
of the real economy. And that excess reflects rising deposit balances
against a 10% yr /yr decline of US production and SP 500 company
sales. The much lower need for working capital could at some
point lead to a sharp run off of C&I loans and relieve stress on bank
system liquidity and capital. We'll see. The excess liquidity described
here is normally a powerful plus for stocks, although low investor
confidence has been holding players back.

Wednesday, February 18, 2009

Stock Market Comment

Much of what I read blames this new round of weakness in the
market on the failure of Treas. Sec. Geithner to present a fully
fleshed out plan to corral toxic bank debt and put the system on
a sounder footing. Such may be hogwash. The Street is out after
Geithner because he represents the leading edge of more regulation
of hedge funds and other managed products. They are not going
to love Timmy.

Rather market weakness reflects the ever more obvious: Really
awful sales and earnings. Yr/yr SP 500 sales are down by more than
10%, and operating earnings for the final quarter now look to come
in below $6.00. That has knocked the wind out of the long side of
the market. Most know that Q1 '09 net per share promises to be
quite low as well, so that there can be no BS-ing about the second
half of the year: Net per share needs to bounce big time to provide
12 month eps that can bridge into a much stronger 2010. You have
to go back to 1932 / 33 to find a shortfall of earnings comparable
to what we have now. Unsure of a Half 2 '09 sharp positive turn
of earnings, investors now struggle with how to stay long on such
low current net per share.

Every stock investment manager out there has faced the challenge
of deep down earnings or worse for a particular stock or industry
sector, but none have faced such depressed earnings for the entire
market. It's gazing into the abyss and players may need more time
to adjust.

Friday, February 13, 2009

Stock Market Psychology

Basically, a waiting game continues. The global market crash over
Sept. /Oct. ' 08 was the direct reflection of a plunge in global output
and profits. In the US, the leading economic data sets I follow have
leveled off over the past 2 months, and the SP 500 has notched 70%
of its daily closes between 800 - 900 since mid - Oct. ' 08.

The market has faded since year end primarily because operating
profits have come in well below expectations. In turn, players now
know the Obama stimulus package will phase in rather slowly.
Players have also re-discovered that settling the toxic debt issue
of the banks is going to have require some creative thought not now
in evidence.

We have G-7 this weekend, but beyond that the focus should be on
another round of poor earnings reports coming in April and whether
prospective additional economic rescue steps by the Obama admin.
and others in the interim might be enough to hold the markets up.

Wednesday, February 11, 2009

Stock Market -- Fundamentals -- Earning Power

Late last year, everyone knew that the earnings estimates for the
SP 500 based on individual company forecasts by analysts were too
high. So, S&P took it upon itself to put all of the estimates under
review. The regular weekly update was suspended to accomodate
said review. For Q4 '08, I was well under consensus with an
estimate of $10.00 for the quarter. On 2/2, S&P published $8.19
and then one week later, came $6.33 with about 80% of the reports
in the can. Sweet Jesus, that came as a surprise, especially since
peak net per share of $24.07 was notched in Q2 '07.

Close to half of the decline in Q4'08 eps compared to that of Q4 '07
reflected an acceleration of financial sector red ink, with the
remaining 9 sectors down 21% in toto. The lower band for the
trend of earnings since the latter 1980s was $15.00 per quarter,
so the dramatic decline for the recent quarter represents a major
blowout and certainly suggests a probable new epoch of more
restrained earnings growth and profitability.

The decline in earnings for the non-financial sector has so far been
mundane and not alarming. However, this broad sector could well
see significantly weaker earnings over much of the first half of ' 09
as the full brunt of a broader, deeper recession is felt. As well,
the accountants have let many non-financials take large
"nonrecurring" write downs which in effect inflates operating eps.
In fact, total earnings as reported for the 500 companies and
which includes the writeoffs, could well be in the red for Q4 ' 09 --
an historic first for any period.

There is a temptation for investors to "low ball" eventual recovery
earnings. However, the positive earnings leverage for non-financials
is enormous when a global economic recovery takes hold. The
financials, now mired in deep red ink, are holding net revenue, and
have extraordinary positive earnings leverage once loan / securities
losses peak and begin receding. That leverage will outweigh the
effects of dilution to be expected when market conditions improve
enough to allow this sector to re-capitalize.

So, we have extremely depressed corporate earnings currently,
with the potential for a large bounce up once economic recovery takes
hold. Clearly, investors are not treating quarterly eps of $6.00 - 8.00
as the new norm, but are pricing in a substantial recovery in
earnings over much of 2009 and going into 2010. And further,
players are assuming the banking sector will be repaired enough to
provide normal assistance in an economic expansion.

Right now, we are a ways from recovery. I say Half 2 '09. Plenty of
others see no economic recovery until 2010 or even later. Some have
us in a deflationary "death spiral" that could spell a long, perilous

Oops! I have to add another no-no to my list. The other week I
added the price of gold to my grandad's list of things not to argue
about ( He fingered politics and religion). I'll add the economic
forecast to that list. Thus I leave the reader at full liberty to
his or her own economic view. But, I do have a sobering point
here: Earnings are being badly mauled in the short run, and even
if you are more optimistic such as I, you have to have a strong
regard for how bad things did turn in recent months.

Tuesday, February 10, 2009

Stock Market -- Fundamental Note

In the latter part of last year, the SP 500 Market Tracker was
giving readings of 1000 -1050 or well below the actual level
until the crash came starting in Sept. Then, investors gave up
on consensus earnings and tanked the market. The Tracker
closed out the year at 925, and now looks to be around 875,
on the expectation that earnings in Q1 ' 09 will again come in
under forecast. 12 month earnings could now be down around
$53, compared to the record 12 month total of $91.47 through
mid-2007. More on this subject as the week progresses.

Friday, February 06, 2009

Economic Indicators

Weekly and monthly leading indicators have stabilized over the
past two months at very low levels. There was a little slippage
toward the end of the month as jobless claims rose sharply again.
We remain on the cusp of a downturn not seen since the depression
years, and further significant weakness in the leading indicators
would signal that we may enter into a far more serious downturn.

My economic power index is at a +2.2 through Jan., primarily
reflecting yr/yr real wage growth of 3.8%. That is a strong number
and would normally make a recovery call a slam dunk. But as we all
now know, consumers are building liquidity in heavy preference to
spending, and we need to have a better balance between the two to
see recovery develop. The clock is running because with such a weak
job market, the growth of the current dollar wage can be expected to
slow. I also continue to look forward to spring, when sharply higher
housing affordability will test consumer interest. The Fed quietly
shrunk its greatly enlarged balance sheet by 18% in Jan., resulting
in a significant decline in the basic money supply. If this condition
persists, I would not be surprised to see the Fed purchase $100
bil. of Treasuries across the spectrum to inject liquidty directly
into the sytem and put some downward pressure on the yield
curve. That would further help the mortgage market.

As you can imagine, profits forecasts continue to be slashed with
the financial sector taking the heaviest hit by far. My profit model
for this sector shows an extended period of flat net revenues, fees
and operating expenses. The damage is mostly coming from loan
losses with securites losses a small but rising drag. As a group, the
major banks are well in the red. Analysts have continually
underestimated the losses. However, remember my point of a
few weeks back, banks can still be under repair in the early phase
of a recovery.

Wednesday, February 04, 2009

Long Treasury Bond Profile

Reflecting a continuing financial crisis and the sudden, breathtaking
descent of the economy into deep recession, Treasury yields across
the spectrum plummeted over H2 '08. Over a several week period
late last year, the 30 yr. yield dropped from 4.40% to 2.56% in a
panic flight to quality by investors.

Since then, the yield on the 30 yr. has backtracked up to 3.67%.
The short lead economic indicators have stabilized for the time
being, including sensitive materials prices, which bond traders
watch carefully. In addition there is the prospect of a large and
still growing stimulus program before the congress. Now at a cool
$900 bil., the program will surely add to Treasury new issue

At 3.67%, the 30 year carries a fat, roughly 350 bp premium to
the 3 mo. Bill, and a 366 bp premium to the 12 month inflation
rate. These are reasonable levels in the very short run as
confirmed by my long term regression pricing models.

Short term, the US economy has stabilized at a very low level.
My longer range economic indicators, which includes the now
steeply positive yield curve, suggest to me the US economy
should begin recovery by mid-year, fiscal plan notwithstanding.
At a minimum, I see a 5 month period of uncertainty ahead,
wherein the lead indicators could turn even lower, or morph
from stabilization into a more positive mode. Evidence that the
downturn in the economy will deepen further could easily send
the 30 yr Treas. yield back down toward the 2.50% level. But,
if indicators like sensitive material prices do not plunge and
begin to show signs of recovery as spring dawns, the yield on
the 30 yr will rise, perhaps to the 4.50 - 5.00% level. And that's
about the limit of my knowledge on the subject, at least for the
months ahead.

I have dwelled on the issue because the economy has invariably
responded positively to the kind of monetary stimulus that has
been applied. Ideas such as "liquidity trap" and "pushing on a
string" have proven chimerical when it comes to the US
economy. But, since short term indicators have yet to point to
recovery, I am stuck. Moreover, I just do not now know whether
liquidity preference, which been very strong, will continue in
unabated fashion or slacken some, allowing for recovery.

Two further points are worthy of note. Watch industrial
commodities prices over the price of oil. The bond market sees
a rising oil price as a tax on consumption and is more concerned
with a broad rise of sensitive materials prices. Secondly, if a large
stimulus plan is enacted, the market may begin pricing into yield
a premium for a bigger new issue calendar going forward. In
times past, that premium has been as much as 100 bp.

Back on Dec. 2, '08, I argued that the bond market, then 3.20%,
was strongly overbought and that advisory sentiment was too
bullish. In the next few weeks, sentiment grew to 91% bullish
and the market got even more overbought. We have had the
backlash in recent weeks as the 30 yr yield has shot up. The
overbought has been greatly reduced and sentiment (70 %
bullish) although high is not now acute. I have traded the
long bond for about 30 years. My suggestion is to watch the
sentiment indicators like MarketVane carefully and observe the
yield vs its 40 wk m/a. When it strays well away from the 40 wk.,
it does not do so for long. Yield chart here.

Monday, February 02, 2009

Short Term Interest Rate Profile

The 91-day T-Bill or "risk free rate" now trades between 0.00 -
0.25%. Money market funds have recently settled down at 1.75%
but yields have been in a downtrend. Despite the Fed's ZIRP
regimen, money markets have returned 5 - 6% over the past
6 months in real terms, as the CPI has experienced 4.5% deflation.
So, holders of short term quality debt have yet to be suckered.

Low short rates are warranted by the weakest economic conditions
in the post WW2 era. For example, the ISM index for manufact-
uring stands at 35.6, nearly 20 full ponts below the 55 level when
the Fed normally raises rates.

My long term regression (100 +yrs) model for the T-Bill yield
has an alpha of 1.7%, meaning that the bill should yield 1.7% at
zero 12 month inflation. The Fed, worried as it is about the
economy, has zeroed out the yield. Indeed, the real yield for
the past 6 mos. is over 4.5%.

Under normal circumstances of economic expansion and a
moderate 3% inflation rate, the Bill should yield about 4.7 - 5.0%.
This gives you a good quantitative benchmark to see how far the
Bill is below the long term capital market line. Once an
economic recovery begins, the Fed will move short rates up
much closer to the "normal" level.

So long as there is deflation in the system, many players will not feel
that pressured to pick up yield, as the Bill enhances the purchasing
power of their funds without credit risk.

In a deflationary environment, a meaningful real yield will tend to
suppress consumption and business investment as time wears on.
For now, consumers, facing bad housing, stock and job markets are
struggling to regain liquidity and build a cushion in a difficult
environment. As we head into the seasonally strong period for
housing this spring, it will be interesting to see whether liquidity
hoarding psychology will prevail in a market where affordability
has made a dramatic comeback.

More broadly, I do not know of a satisfactory rule to forecast
liquid savings, but I think it is ok to assume that when the
purchasing power of savings is rising, the personal savings rate
will tend to move back up to a longer term norm.