A true contrarian look at investing and at life in general.
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.
INVESTORS ARE IGNORING NUMEROUS POSITIVE EQUITY DIVERGENCES (March 8, 2009): There are numerous positive divergences in the global equity markets which are pointing the way toward the strongest short-term stock-market rally since the Great Depression. Let's examine each of them to more fully understand their profound significance.
The first and most important divergence is the recent collapse in government bonds worldwide, including U.S. Treasuries. Long-dated U.S. Treasuries, such as the fund TLT, have been collapsing since they completed a historic peak on December 30, 2008. Very few individuals trade Treasuries; this sector is primarily the domain of major institutions and pension funds. The flight out of Treasuries represents a decisive shift away from safety toward risk and signifies a clear rejection of the "deflationary depression" hypothesis. If the global economy were really set for a major contraction, money would be flowing into government bonds instead of out of them. Therefore, the global economy is set for a major expansion.
Another important divergence is the U.S. dollar index recently forming a pattern of several lower daily highs after having reached a three-year zenith. During times of economic stagnation, the greenback is a nearly perfect inverse indicator: when the U.S. dollar is rising, this indicates that the global economy is contracting, and vice versa. The fact that the U.S. dollar index has been starting to move tentatively lower shows that the most knowledgeable global traders are beginning to position themselves in favor of economic expansion--thus confirming the message of global government bonds.
Yet another divergence can be seen in the strong performance of global commodity-producing shares since October/November 2008. Gold mining shares have more than doubled in value since October 24, 2008, as can be seen in a chart of GDX and similar gold mining funds. As the most reliable harbinger of upcoming inflation and growth, this doubling indicates that increased global growth and rising inflation will be the major themes of 2009. Other commodity-share funds have been forming bullish patterns of higher lows, including KOL (coal mining) and more recently RSX (Russian shares). Russia's economy is very heavily based upon commodity production, and therefore the recent relative strength in RSX is similarly signifying that both inflation and growth will be important global themes in 2009.
High-yield corporate bonds have been forming a bullish pattern of higher lows since the first half of December 2008. While obtaining credit is still far from easy, lenders are much more willing and able to supply capital today than had been the case three months ago. Nearly all corporate-bond sectors have been choppily improving over this period of time, as have municipal bonds. As with government bonds, these are primarily traded by institutions and pension funds; the most knowledgeable investors are signaling that the most distressed period has already passed for obtaining borrowed money.
Implied volatility indices including VXO and VIX remain near 50, which is historically more than twice its average level, but which is far below the extreme readings of 80-90 that were seen in October 2008. Investors are becoming so accustomed to falling stock prices that an increasing number of surveys are showing more investors anticipating an additional 25% decline in the stock market than are expecting a 25% increase. This is among the most negative survey results ever recorded, and is in sharp contrast to the outlook in 1999-2000 when investors routinely anticipated annualized gains of 30% lasting for a decade or more. When so many average participants are gloomy, the only possible resolution is a powerful worldwide equity rally.
As a result of these and similar positive divergences, I am anticipating that the next half year will experience the most dramatic short-term global equity rally since the Great Depression.
WHEN THE FINANCIAL MARKETS ARE MOST VOLATILE, GREAT TIMING IS NOT NECESSARY, BUT COMMON SENSE IS (February 16, 2009): During the 2007-2008 bear market, even if you had terrible timing and decided to sell short or to buy U.S. Treasuries many months after the turning point, you still enjoyed substantial profits. For example, those who didn't sell short until the late summer of 2008 still enjoyed double-digit gains when global equities subsequently collapsed. Those who sold short closer to the highs in 2007 or who covered their positions near the exact lows in the fourth quarter of course profited the most, but as long as you realized that too many complacent investors inevitably implied a major plunge, even poor timing was sufficient to gain 20% or 30% by the end of 2008.
The exact same principle is true in 2009, but in exact reverse. With so many amateur investors choosing to reduce risk AFTER a collapse, which is completely ridiculous, the financial markets are certain to surge sharply higher to punish their ill-advised decisions. Even if you are months off with your buying and selling, you will gain at least 20% or 30% this year as we experience the strongest short-term bull market in decades. If you buy commodity-related funds such as GDX, KOL, FCG, PEO, and RSX, which will likely more than double before the end of 2009, then you will enjoy even more substantial gains. That is because rising inflation will be an even more compelling story in 2009 than increasing growth.
If you need "proof" that this rally will occur, consider the 18-year high in the ratio of insider buying to insider selling since October. Or look at how U.S. Treasuries and other government bonds worldwide have collapsed in recent weeks: the trillions of dollars which have come out of these safe-haven assets don't have many places to go. With money-market funds and other time deposits paying less than the inflation rate in virtually every country, the stock market will be the investment of choice if only by default.
It has always been true in the financial markets that you should sell when prospects are brightest, and buy when the outlook is gloomiest. In late 2007 and early 2008, one constantly heard about the Goldilocks economy, without many reminding you that in the children's tale, Goldilocks is always followed by the three bears! Now that Baby Bear, Mama Bear, and Papa Bear have had their respective turns on the financial stage, with GDP growth projections more negative than at any time in several decades, this represents an incredible buying opportunity for equities around the world.
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), as well as August 25, 2008 (page 32).
CURRENT ASSET ALLOCATION (fully marked to market on March 8, 2009): My own personal funds are currently allocated as follows: LONG POSITIONS: Gold mining funds GDX, ASA, BGEIX, INIVX, 43.0%; Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 10.0%; Global equity fund VIDMX, 10.0%; Coal mining fund KOL, 7.7%; Energy closed-end fund PEO, 6.6%; General-equity closed-end funds ADX, CET, 4.7%; Russian fund RSX, 3.0%; High-yield BB corporate bond fund VWEHX, 1.7%; Municipal bond fund MYJ, 1.2%; Natural-gas fund FCG, 1.0%; USO, 1.0%; VINIX, 0.4%; VIEIX, 0.4%; TRBCX, 0.4%; VZ, 0.5%; TBT, 0.5%; KRE, 0.3%; XRT, 0.3%; UNG, 0.4%; TRI, 1.6% (bought at a 15% discount); gold and silver coins and related metals collectibles, 4.7%; other collectibles, 0.4%; Vanguard Municipal Money Market Fund VMSXX, 0.1%; Putnam Stable Value Fund (retirement fund with stable principal paying variable interest), 0.1%; SHORT POSITIONS: None; covered ALL of them in October 2008 which had amounted to just over half of my entire net worth.
REMINISCENCE OF THE WEEK (February 16, 2009): In August 2003, my wife and I were traveling through one of our favorite U.S. states--which name I will intentionally not mention here. We were in transit from one bed-and-breakfast inn to another, and decided to stop in a local pizza place for supper. The front door was closed, but we heard lots of voices near the back, so we walked around and found a massive pizza-making operation in full swing. The setup was completely informal, as though they weren't expecting any customers. We spoke with one of the workers who was taking a break, and discovered that this establishment had built up quite a nationwide reputation; they mail-ordered thousands of their brand-name pizzas all over the country each week. We watched as the dozen or so workers, all in their late teens and early 20s, formed an elaborate assembly line: throwing the dough into the air; forming the pizzas; putting sauces and other goodies on them; running to put the pizzas into their boxes for shipping; and other highly kinetic activities. Everyone was generally laughing, sometimes cursing, and otherwise appearing to enjoy a wonderful time. I was astonished that with their being constantly in motion, they did not tire out more easily.
I walked over toward the lively assembly line, and commented to someone that they seemed to get along amazingly well with each other. This statement was followed at first by complete silence, and then by hilarious laughter which seemed far out of proportion to my remark. A short while later, they huddled in the corner for what looked like a brief private conference, after which they gradually became as animated as they had been at the beginning. Our meal was delicious, and I made sure to thank them profusely before we left.
When we arrived at our inn, the proprietress asked us where we had eaten dinner. We told her, and her eyes opened wide. "You mean they're still serving over there?" she exclaimed, rather surprised. "Sure," I responded. "We had to go around back to get in. They didn't have any formal tables set up, but when they saw us, they found a couple of chairs and an old bench, and brought us a pizza with tap water on the side." "I guess you don't know the story," she sighed. "Last summer, one of the young workers was shot and killed in back of the place, a couple of hundred yards away from the building. They never figured out who did it, but they lost their license to operate as a local restaurant. They only do mail orders these days; the internet has really helped them stay in business. You must have been the first people to eat a sit-down meal there since last year. The local newspapers still mention the incident every now and then, but everyone figures it's just one of those cases which will probably always remain unsolved."