WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
One fascinating characteristic of all financial bubbles, from the South Sea Bubble in 1720 to the Nasdaq in 2000 to real estate in 2005/2006 to crude oil today, is that the vast majority accept them as permanent just when they are on the verge of a powerful collapse. --Steven Jon Kaplan
BE CAREFUL WHAT YOU WISH FOR, AS IT MAY COME TRUE (June 26, 2008): Investors and just ordinary folks around the world alike are hoping against hope that the price of crude oil declines sharply in the near future. The good news is that the price of crude will soon rapidly plummet to $100 per barrel, and will eventually reach $60. The bad news is that the global economy will simultaneously contract.
Many investors naively assume that the economy would be in pretty good shape, if only the price of oil were to retreat. However, a decline in the price of crude oil will coincide with a steep pullback for stock markets around the world and a recession in many countries including the United States.
One important reason for crude's imminent collapse is that anticipation of future demand is significantly higher than what it actually will be. That is because projected double-digit growth rates for emerging markets are far too optimistic. As the world continues to struggle with declining real-estate prices and tighter lending standards, this will cause the formerly hottest economies to experience the most severe slowdowns. This is already clearly foreshadowed in the huge pullbacks in stock markets throughout the developing world. Those which had enjoyed the greatest increases have been plunging in recent months by more than one third for many countries including India and China and even more than 50% for some including Vietnam. Most observers have not yet adjusted to this reality, and keep talking about the so-called economic miracles in these places.
As a result of this global contraction, demand for crude oil is less than it was a year ago, while supply is greater. In spite of this, the price has doubled in the past year--which means that there is no fundamental basis for this increase, and thus the entire gain will be wiped out sooner or later.
As the crude oil price declines, it will likely do so in spectacularly erratic fashion, with sharp plunges toward $100 followed probably by a sharp rebound to around $120, then a choppy pullback to $90, back to $100, then to $80, and so on, until its price is eventually near $60 per barrel. These wild fluctuations, even though they will progressively lead to significantly lower prices for gasoline, will unsettle the markets. In addition, a contraction in equities historically has always been followed by a delayed pullback for commodities. Instead of being positive for the stock market, rapidly falling oil prices will signal that the global economy is contracting more rapidly than had been anticipated, and will therefore coincide with the greatest percentage pullback for equities since 2002.
As a result, in a few months, stock markets around the world will return close to their respective support levels from 2005 and 2006.
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U.S. TREASURIES REPRESENT A FANTASTIC BARGAIN (June 15, 2008): What do June 2006, June 2007, and June 2008 all have in common? I'm not talking about weddings, the summer solstice, or the start of the summer break for students, as important as all of those may be to some.
The answer is that in the month of June for each of the past three consecutive years, investors have become irrationally fearful of rising inflation and the risk of the U.S. Federal Reserve raising interest rates. This caused U.S. Treasuries to slump to multi-year lows one year ago, and also two years ago.
This time, concerns over Fed rate hikes are particularly misplaced. The U.S. economy is not only suffering from rising unemployment and falling housing prices, but also from an equity market which has been progressively declining since October 2007. And that's not even considering that this is a Presidential election year. The chance of the Fed raising rates under this combination of conditions is about the same as the likelihood that there will be a blizzard in Manhattan this summer.
As a result, U.S. Treasuries represent a terrific bargain across the yield curve. Of all of the possible Treasury investments that are available at this time, my favorite is TLT, which is an exchange-traded fund of U.S. Treasuries averaging 25 years to maturity.
As global equities continue their decline, while the commodity bubble bursts in spectacular fashion, U.S. Treasuries and other government-guaranteed bonds will be among the few asset classes which are rising in value. It is likely that TLT will gain roughly 10% in just three months, which represents an annualized yield well in excess of 40%.
The U.S. dollar index, which began a major one-year rally on March 16, 2008, will soon accelerate its uptrend. While most government bonds around the world will benefit from falling equities and commodities, the rising U.S. dollar will make U.S. Treasuries the superior choice for hedge-fund managers and other asset allocators.
GDX, a popular exchange-traded fund of gold mining shares, has slumped by more than 24% since it peaked on March 17. This confirms the equity and commodity downtrend, and is signaling clearly that inflation is an overblown concern. Federal-funds futures show that investors are anticipating not just one, but two rate hikes from the Fed by October 29. Don't believe it for a moment. While all of your friends are buying agricultural-commodity funds or Brazilian equities, purchase U.S. Treasuries instead and enjoy enormous annualized gains with limited downside risk.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, and then again on February 25, 2008 (page M14) and June 2, 2008, page 41.
CURRENT ASSET ALLOCATION (June 26, 2008): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 1.5%; municipal bonds, including MYJ, 2.5%; TLT, 1.2%; other U.S. Treasury funds, 3%; KRE, 1%; XRT, 0.5%; TOC, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 1.3%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX, GOOG, in that order), 38.5%; short EWM, 1%; short ILF, 1%; short GLD, 20%; short GDX, 3%; short USO, 5.5%; short SLV, 2%; short DBA, 8%; short BIK, 1%; short EWZ, 1%.
REMINISCENCE OF THE WEEK (June 26, 2008): When I was in high school, I had a friend named Ken whose father Sal loved to tell stories around the dinner table. Unlike myself and most of my friends who ate our biggest meal of the day around six or seven in the evening, my friend and his family dined at 3:30 sharp--which also made it convenient to watch "All in the Family" on TV. After school ended at 2:30 p.m., Ken and I would often walk over to his house, so I was invited to quite a few dinners through the years (my mother always wondered why I wasn't as hungry as I should be). Sal's favorite story was about the time when he was helping his oldest son load several heavy packages onto the train at Penn Station in downtown Baltimore. He was about to leave, but the doors had firmly shut and could not be opened even with several other people trying to assist. By the time he found a conductor, the train had left the station--on its way to the next stop more than 60 miles away in Wilmington, Delaware. In those days before cell phones, all Sal could do was to make an expensive long-distance call when he finally arrived in Delaware and tell his wife that he'd be quite late for dinner that day, as he was in Wilmington and would have to wait for the next train back. As the years went on, this tale accumulated numerous additional humorous embellishments which may not have been entirely true.
Sal pretended to forget that he had recounted one or another version of this story dozens of times earlier, so he would frequently retell it and improve upon his earlier attempts. One fine Saturday morning, my father drove his brother, who lived in New York, to the Baltimore train station and still had not returned after nearly two hours. Finally, the telephone rang and my mother answered it. "You'll never guess where your father is!" she screamed. "Wilmington, Delaware, no doubt," I calmly replied.
