Replies to post #13139 on Your Economy (No Politics) (YE1)

[Ace Hanlon]

No Relief For Bargain Hunters Yet
By Brady Willett

A sharp sell off in oil, a massive bond market rally, a Fed pause, or a plunge in the US dollar that, somehow-someway, neatly unifies global central bank interests. Yes, there are many events that could spark a massive relief rally in the stock markets. Yet for all of the potential rallying points, one point can not be easily dismissed: stocks are not cheap. To be sure, on a GAAP basis the Dow is trading at 20-times earnings, the average dividend yield on the S&P 500 is only 1.76%, and the average REIT is yielding less than the 10-year Treasury bond. As for the forward looking earnings estimates, they remain simply that: If you know what the GAAP earnings on the S&P 500 are going to be in the coming 12-months - or if you know what will constitute GAAP earnings 12-months from now for that matter - you know a great deal more than most.

What is known is that following one of the longest streaks of double digit profit increases in US history, and even after the most recent correction, the price to earnings multiple on the S&P 500 is 17.41 GAAP (or more than 18.5 at the core, est.). The long-term average since 1935 is 15.68.

Bargain: Something offered or acquired at a price advantageous to the buyer.

Unless you conclude the earnings party is set to continue or you are willing to gamble on expanding market multiples because you feel good, US stock prices are hardly a bargain at current levels.

How Overvaluation Spread It’s Wings

If you threw a dart at any quality REIT in 2000 and held it you made big money. If you selected any small cap stock trading near book value in 2001 and held it you made even bigger money. If you picked up anything that offered a reliable dividend/distribution in 2002/03 you made big (and safe) money. But as the easy money days faded away – yes, making money buying what was unpopular was easy during the 2000-2003 bear – value investors went into hibernation.

Although recent market turbulence has awakened many value investors, it has done little to promote widespread undervaluation. Rather, since March 2003 stocks have seen very few corrections as a steady influx of money has been dispersed into every possible crevice of the markets. This fanning of capital has tapped any hint of undervaluation, and convinced nearly everyone that a new bull market has been born (incidentally, it is difficult to agree that a sustainable bull is in the works with energy and precious metals two of the industries recently leading the charge).

Needless to say, for market bears and value investors the last three years have been exceptionally brutal on the mind, although not necessarily on returns. The lesson since 2003 has been that even during secular bear markets stock prices can rally strongly.

Plots Thicken

Lichtenstein has been joined by Pirate Capital and together they are pushing for change at Angelica. Although a little sloppy on the balance sheet side of things, if natural gas prices behave Angelica is worth monitoring on weakness leading into October. A weaker greenback helps make Hawaiian Macadamia nuts more competitive and Mauna Loa is making distribution advances. This could bode well for ML Macadamia Orchards LP in the long-term. Sturm, Ruger & Co., a potential turnaround candidate, may not necessarily be negatively impacted by slumping US economy. Rather, take away a few of the company’s smaller private competitors and rid the company of its casting business segment and RGR could perform well. Lack of growth doesn’t take away from the fact that TC Pipelines remains a yield target on weakness (be aware of the unconsolidated balance sheet).

Suffice to say, thanks to recent market weakness these and other potential undervaluation stories (from the Watch List) are cropping up on a daily basis. Similar hopes for falling stock prices have been dashed before, but, to borrow a Wall Street axiom, this time things really could be different. The US housing ATM machine is closing down, the threats of peak oil and peak earnings (especially in tech) are casting an ominous shadow, the US dollar is threatening to decline in a disorderly manner, and liquidity is getting tighter. If this coalescence of negative forces were not enough, the bond market is no longer paying attention to stock market weakness, precious metals are not convinced that inflation and/or a financial crisis can be avoided, and the biggest carry trade of all-time (Yen) is threatening to shut.

Decline Already!

Volatility in the global financial markets can oftentimes presage a financial crisis. And while another LTCM or Asian-style crisis would not be welcomed news to the majority of investors, it would serve to speed up the purging process in the markets and stimulate bargain hunters. It is always a good idea for the bargain hunter to be prepared for the possibility of a sharp decline.

Failing an unexpected financial crisis, it may be prudent to stay cash heavy until fund redemptions, economic recession, and/or more attractive valuations arrive. While you wait research and be ready to invest in companies you understand and believe will be successful in the long-term. Two big caps with a global reach worth consideration are Microsoft and Coca-Cola. Although not screaming undervaluation on any level, a lot of shareholders have watched MSFT and KO shares do absolutely nothing for six and nine years respectively. Prices could become attractive if these investors start throwing in the towel.



In short, another month like May and the stock stories and large cap losers could be worth pecking at. Then again, another month or two like May and some real bargains may finally arrive. Given that the US consumer has not had to tighten their pursestrings for 15-years, no one can be certain how ugly things will get for the US economy and financial markets. What can be said is that with no longer-term market worries as yet resolved, May 2006 is unlikely to mark any type of bottom for the markets.


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[Bullwinkle]

It's Not About Bernanke
Comstock Partners, Inc.
Thursday, June 8, 2006


Poor Ben Bernanke. He inherited a mess that was probably beyond the capacity of any Fed chairman to solve and now the stock market seemingly plummets every time he opens his mouth. Although this should have been foreseen at the time of his announced appointment, the Street became so enamored of its “one and done” thesis that it overlooked the serious problems that should have been obvious at the time. In fact, the comment we wrote back in October bears repeating today, and we quote portions of it in the following paragraphs.

“It is indeed ironic that Ben Bernanke, upon his appointment as the next Fed Chief, found it necessary to promise a continuation of the Greenspan policies that are likely to cause him a great deal of grief during his coming tenure. While Wall Street is narrowly focusing on Bernanke’s qualifications for the job and whether he is an inflation hawk or dove, the important point is that the new Chairman will be inheriting a mess that is probably beyond the capacity of any Fed chairman to solve without a damaging recess and financial crisis.

Yes, Bernanke has an excellent resume, and, yes, the Greenspan era was marked by low inflation, decent economic growth and only two mild recessions. This economic record, however, was achieved by the creation of a record stock market bubble that ultimately burst, followed by a huge housing bubble that mitigated the damage, but led to a fragile, unbalanced economic recovery fueled by the cash raised from soaring home prices. The result is record household debt, negative consumer savings rates, a huge trade deficit and a dangerous federal budget deficit. All of this is being exacerbated by record energy prices…”

“Judging by Fed actions, statements and speeches, the FOMC’s main current concern is to prevent the huge rise in energy prices from creeping into the core inflation rate, although we also sense that they have been extremely concerned about the housing bubble as well. This is evident in their moves to clamp down on the more speculative aspects of mortgage lending and in the emphasis given to housing prices in Greenspan’s speeches and testimony in recent months. Given these concerns, it seems that the Fed is signaling that they will continue to raise interest rates at the so-called “measured pace” for at least the next two meetings…”

“Since the late 1990s the Fed has continually faced the dilemma of moving interest rates either too much or too little and, until now, has succeeded in avoiding great damage to the macro economy, although the stock market obviously suffered a major blow from which it still hasn’t recovered. At this point, however, they seem to have painted themselves into a corner with no place to go. That Greenspan, himself, seems to recognize this is obvious from his August speech at Jackson Hole, where he said, ‘Thus this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent…But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of debt that supported higher asset prices. THIS IS THE REASON THAT HISTORY HAS NOT DEALT KINDLY WITH THE AFTERMATH OF PROTRACTED PERIODS OF LOW RISK PREMIUMS.’ (Caps are ours).”

“It seems that after 18 years of cheerleading, the Chairman, in his last days in office, is now acknowledging the potential negative consequences of his policies. He leaves, however, with the knowledge that cleaning up the mess will fall to his hapless successor, and not to him. Whether Bernanke, despite his acknowledged brilliance, knows what’s awaiting him is not known, but he will find out soon enough.”

If Bernake did not really know what was awaiting him, he is certainly in the process of finding out now. He first tried a balanced approach by bringing up the possibility of a pause, but also said he would go with the incoming data. When Wall Street took this to mean that he was soft on inflation, he unwisely told Maria Bartiromo that he was misinterpreted. To prove his anti-inflation credentials he took a more anti-inflationary stance in his Congressional testimony and followed up with a hawkish-sounding speech a while later. As a result the Street now fears he may hike rates too much and cause a recession.

Investors wanted transparency, and now they have it, but they don’t like it. They wanted a chairman who would fight against inflation, but would not cause a recession. Although investors have an exalted view of what the central bank can accomplish, the fact is that the Fed’s power is severely limited, and they don’t have the tools to get the economy they desire. Having engineered a stock market bubble, followed by a housing boom, they are out of options, and there are no more obvious bubbles to create. They can pursue policies leading to inflation or recession or a combination of both with little or no room in between. In the end Greenspan finally got it right—“history has not dealt kindly with the aftermath of protracted periods of low risk premiums”. You can’t get much clearer than that.

http://www.comstockfunds.com/index.cfm/act/newsletter.cfm/CFID/3100225/CFTOKEN/15616716/category/Mar...