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.
TOO MANY NERVOUS BULLS ENSURE AN EQUITY PLUNGE JUST AHEAD (June 24, 2009): If you've been paying attention to the financial media in recent weeks, then I'm certain that you've noticed a sharply increasing number of analysts who are making remarks such as this: "The S&P 500 remains bullish as long as it remains above 875". Some analysts substitute similar support levels such as 860, 870, or 880 instead of 875, but their outlook is otherwise identical.
This line of reasoning has progressed to the point where it is a nearly unanimous consensus. Therefore, what must inevitably happen is that one fine day in late June or early July of 2009, the general equity market will break below the topmost of these popularly followed support levels. This will trigger sell stops from all of those investors who have decided that they will reduce or eliminate their equity exposure once such a target is broken to the downside. The resulting pullback will cause the next support level to be hit, thereby inducing more selling, and so on, until everyone with this viewpoint has turned bearish. This will probably cause the S&P 500 to complete a short-term bottom near 837. As a result of this retreat, there will likely be some fresh short selling by those who believe this event has ushered in a key downside breakout.
Since so many are positioned to unload rapidly when their pet support level is violated, the market will likely flush out all of these nervous bulls within just one or two trading days. Afterward, there will likely be a period of several trading days of above-average volatility in both directions, as investors become confused as to what will happen next. The following headline will become commonplace: "Will we retest the March lows? Analysts are divided in their opinions."
Following this period of indecision, some tentative buying will emerge. Hedge funds and pension funds worldwide are currently severely underinvested in equities as compared with their target allocations. Therefore, since hedge funds love to buy into any rebound which follows a sharp pullback, these funds will all be rushing back into the market at the same time. Those who sold short following the alleged downside breakout will simultaneously hurry to cover their short positions. This buying spree will be as intense and as brief as the previous rapid pullback had been.
Within a week or so thereafter, the S&P will likely regain the 900 level en route to the most powerful phase of its entire 2009 rally which began in early March. The quick bull market will likely end this autumn with the stock market returning to its levels of early September 2008. That could result in the S&P reaching 1300.
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TIME TO SWITCH GEARS TO THE MOST UNDERVALUED SECTORS TODAY (May 25, 2009): In my March 8 update, I gave a strongly bullish case for buying global equity funds. In my May 3 update, I pointed out why gold mining shares were irrationally undervalued.
Since then, both of these have rallied strongly, making them no longer compelling bargains for purchase (although it is far too early to sell either one). Therefore, I am presenting my two favorite contrarian investments for the present time.
My first and best pick is UNG, an exchange-traded fund of natural-gas futures. On Friday, May 22, 2009, natural gas traded at its lowest-ever ratio in history to the price of crude oil. Now that the winter and early spring heating season in the northern hemisphere is over, people are maximally bearish toward natural gas which is primarily used for that purpose. There is a global surplus which has forced prices down to their lowest absolute levels in nearly seven years.
The reality of supply and demand, combined with the restoration of historic patterns that have prevailed for decades, ensures that by January or February 2010, natural gas will have reached at least twice its current level--and probably considerably higher. Therefore, you can more than double your money by purchasing UNG, which will likely exceed 30 by next winter. This is my single favorite fund at this time for making money over the next eight or nine months.
If you are interested in turning a profit over a much shorter period of time, U.S. Treasuries have become among the most disliked sectors in recent weeks. Practically every financial media outlet has explained in graphic detail why they don't like U.S. Treasuries. Anything which is that thoroughly despised must be worth buying, and therefore I am recommending purchase of TLT, a fund of U.S. Treasuries averaging 25 years to maturity.
While this will not more then double in value like UNG, it also won't take eight or nine months to enjoy your gains. TLT will likely gain at least 10% in value just over the next month, and perhaps even sooner. This is not a long-term recommendation; I would sell TLT as soon as it reaches 102 or 103.
Most global equity indices are likely to decline moderately in value over the next few weeks in order to shake out late-arriving momentum players who missed out on the huge global equity rally from early March through early May. This was the biggest two-month percentage gain for most stock markets since the Great Depression. Too many people arrived late to the party; those tardy souls have to be forced out before global equities can resume their powerful uptrend this summer. As stocks retreat over the next few weeks, U.S. Treasuries and their funds such as TLT will be among the prime beneficiaries.
GOLD MINING SHARES REMAIN SUBSTANTIALLY UNDERVALUED, AND COULD TRIPLE BEFORE THE END OF 2009 (May 3, 2009): While most global equity indices have rebounded strongly since my very bullish update of March 8, 2009, while my recommended energy funds like KOL, RSX, and FCG have done astonishingly well, one sector has remained barely changed in price since December 2008. This sector is gold mining shares and their funds including GDX.
Investors are finally beginning to realize that absurd media hype about a "deflationary depression" made as much sense as more recent hysteria about a massive global "swine flu epidemic". As the worldwide recession has begun to moderate, this has led to a powerful recovery for stock markets around the world.
What most investors still fail to appreciate is that during any major recession, governments worldwide will create short-term stimulus packages as a popular political ploy. These packages are inherently inflationary. Even during relatively moderate past recessions such as 1973-1983, government stimulus packages led to double-digit inflation almost everywhere.
Now that we have both a much more severe global economic contraction than we ever experienced in the 1970s and 1980s, combined with government stimulus plans from practically every country that are enormously higher in inflation-adjusted terms than they have ever been in the past, the only question is when inflation will exceed 10% in developed markets including the United States. In my opinion, that day is not imminent, but will surely happen within the next decade--probably in about five or six years.
Meanwhile, in 2009, we will soon see the early signs of a major worldwide inflationary surge. 30-year fixed mortgage rates in the U.S. and Canada will likely exceed 8% later in 2009, as will bank CD rates. What is more important, very few people are anticipating such a rapid rise in these yields, which ensures that they will have a profound impact just as any "shocking, shocking" development always has on the financial markets.
From a psychological point of view, if anything has not occurred for about twenty years or longer, most people cannot emotionally envision that it could happen. In 2007-2008, even though we had obvious signs of a worldwide economic meltdown, people could not imagine a stock-market crash--since it had not occurred recently. Since we have not had massive worldwide inflation since the early 1980s, then even if people understand why inflation is likely to surge higher, they can't psychologically bring themselves to prepare for it. Many others have simply forgotten that we had double-digit inflation in the U.S. and 30-year fixed mortgage rates which exceeded 13% at least once each year every year from 1980 through 1985--and which moved above 18% briefly in 1981. As George Satayana wisely said, those who cannot remember the past are doomed to repeat it.
Gold mining shares are the single best performing equity sector when the anticipation of higher inflation is the most pressing concern of the average investor. TLT is a fund of U.S. Treasuries averaging 25 years to maturity, which has plummeted from a multi-decade U.S. Treasury peak on December 30, 2008. This is serving as a reliable indicator that the world's wealthiest investors have been progressively shifting their expectations from deflation to inflation for more than four months. The U.S. dollar index has been declining for two months after it had soared to a three-year zenith on March 4, 2009.
Now is a rare opportunity to take advantage of nearly the only sector in the equity market which has remained essentially unchanged in price since December 2008. This sector is also fundamentally undervalued: gold is currently at $887 spot while GDX closed Friday at 33.04. Last year, when gold was at exactly the same price, GDX averaged slightly more than 46 dollars per share. Because energy prices and other costs are generally lower now than they were then, this means that while profit margins have expanded, share prices have declined. This creates an unusual bargain opportunity for a sector which has seen more than its share of sharp vertical price increases in past decades--and even just since the year 2000.
Buying GDX is far superior to purchasing physical gold, since it will rise about three percent for each one-percent gain in the price of gold. Of course, there's no free lunch; the potential downside is similarly greater. However, since physical gold buying from India has emerged each time that gold has moved below $900 per troy ounce in 2009, this likely indicates that any remaining downside for precious metals in the near future is strictly limited. Once inflationary fears become paramount, gold mining shares will be among the top-performing sectors and GDX will be set to approximately triple by autumn.
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.
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 June 24, 2009): My own personal funds are currently allocated as follows: LONG POSITIONS: Gold mining funds GDX, ASA, BGEIX, INIVX, 39.8%; Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 8.2%; Global equity fund VIDMX, 7.9%; U.S. Treasury fund TLT, 7.7%; Coal mining fund KOL, 7.5%; Energy closed-end fund PEO, 6.3%; General-equity closed-end funds ADX, CET, 3.9%; Russian fund RSX, 3.8%; Natural-gas futures fund UNG, 2.2%; Natural-gas fund FCG, 1.8%; High-yield BB corporate bond fund VWEHX, 1.8%; Crude-oil futures fund USO, 0.9%; Municipal bond fund MYJ, 0.9%; VINIX, 0.2%; VIEIX, 0.2%; TRBCX, 0.2%; KRE, 0.2%; XRT, 0.2%; VZ, 0.2%; TRI, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 3.9%; other collectibles, 0.4%; Vanguard Municipal Money Market Fund VMSXX, 0.2%; 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 (May 25, 2009): In December 2008, my wife and I visited New Orleans. It was an unusual visit in many ways; on our first day there, they had their heaviest snowfall in eight years. Kids had a wonderful time building snowmen which they had previously only seen on television. We walked through a fascinating neighborhood called Bywater, which includes the street named Desire, and serendipitously found ourselves at the monthly Bywater Art Market. We purchased an unusual wooden sculpture of a cat made from a gourd--but the real highlight of the market was a fellow selling huge, rich chocolate truffles. We bought several, and then ran into him the next day at another outdoor fair in Washington Square Park where several remnants of snowmen could still be found, at which we purchased several more. He had some free time, so I spoke with him at length and discovered that the chocolate maker and I were born and raised in the same neighborhood in Baltimore. A month later, when our family was making plans for our parents' 50th wedding anniversary, I discovered that the chocolatier's grandfather was the rabbi who officiated at my parents' wedding.
· Best of Previous Reminiscences
(c) 1996-2009 Steven Jon Kaplan Your comments are always welcome.