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 once or twice each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
THE FINANCIAL MARKETS WILL CONTINUE TO PUNISH THE MAXIMUM NUMBER OF INVESTORS (October 11, 2009): The financial markets will always act in the manner which will cause the most harm to the greatest possible percentage of investors. Two years ago, when the greatest number of people worldwide had their money in equity bourses while hedge funds were maximally long using the greatest quantity of borrowed money on record, the financial markets suffered their worst one-year collapse since the Great Depression. Then, after investors made their largest-ever withdrawals from equity funds ever recorded by http://www.ici.org/ , while hedge funds liquidated at their most rapid rate on record during the past autumn and winter, we naturally experienced the greatest stock-market rally in more than seven decades. Therefore, if you want to know what the financial markets will do, all you have to do is to find out what the vast majority of investors have been doing, and bet that the exact opposite will occur.
In recent months, both investors and hedge funds have been increasing their risk exposure to both equities and corporate bonds. It is likely that we will eventually experience a nearly vertical rise for several equity and commodity sectors, as often occurs near the end of any extended rally. However, if such a surge higher were to occur now, it would reward most investors rather than punishing them. Therefore, the financial markets first have to experience a meaningful correction of probably about one sixth for general equity indices such as the S&P 500 index. That should be sufficient to encourage the media to speculate endlessly about "whether or not we will retest the March lows", which should encourage many amateurs to once again sell their equity funds. Meanwhile, hedge funds will be induced to switch from being heavily net long to being less heavily net long--with many of them probably establishing new short positions near the upcoming equity bottom.
At that point, when far fewer people will benefit from a rise for stocks and commodities, we will likely experience the strongest upward phase of the entire bull market which began roughly a year ago. This rally should be sufficiently intense to coax many who got out of the stock market from October 2008 through April 2009 to once again get back in. Once the maximum possible number of investors are once again heavily committed to the stock market, we will naturally experience yet another crushing equity bear market. It is likely that such a retreat will begin in the first half of 2010, will continue for about two years, and will result in a total percentage decline which will be even greater than last year's total cumulative pullback.
One important key to the performance of global equity indices will be the behavior of the U.S. dollar index. On March 4, 2009, the U.S. dollar index completed a three-year high. Just two days later, on March 6, 2009, the S&P 500 completed a 12-1/2-year nadir at 666.79 and began its dramatic rally. It is possible that the U.S. dollar index, which touched its lowest level in more than a year on October 8, 2009, is on the verge of a strong short-term rebound. If that is the case, then given their powerful inverse correlation, it will strengthen the argument for a meaningful worldwide stock-market correction over the next several weeks.
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 October 11, 2009):
My own personal funds are currently allocated as follows:
Gold mining funds GDX, ASA, BGEIX, INIVX, 39.1%;
Volatility fund VXX, 9.3%;
Claymore natural gas futures fund CYMGF/GAS-T (Toronto), 7.9%;
U.S. Treasury fund TLT, 7.8%;
Coal mining fund KOL, 7.7%;
Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 6.9%;
Energy closed-end fund PEO, 4.8%;
Russian fund RSX, 4.0%;
Gold and silver coins and related metals collectibles, 3.3%;
General equity closed-end funds ADX, CET, 2.8%;
Natural gas producers' fund FCG, 1.8%;
High-yield BB corporate bond fund VWEHX, 1.7%;
Thomson-Reuters TRI, 1.5% (bought at a 15% discount);
Crude-oil futures fund USO, 0.6%;
Miscellaneous collectibles, 0.3%;
Vanguard Municipal Money Market Fund VMSXX, 0.3%;
Putnam Stable Value Fund (retirement fund with stable principal paying variable interest), 0.2%;
Global equity fund VIDMX, 0.0% (recently sold);
Natural-gas futures fund UNG, 0.0% (sold when it had sported a 19% premium to its net asset value in late August);
VINIX, 0.0% (recently sold); VIEIX, 0.0% (recently sold); TRBCX, 0.0% (recently sold);
KRE, 0.0% (recently sold); XRT, 0.0% (recently sold); VZ, 0.0% (recently sold);
None; covered ALL of them in October 2008 which had amounted to just over half of my entire net worth.
REMINISCENCE OF THE WEEK (October 11, 2009): When I was attending college in Baltimore three decades ago, there was the Charles Theater, which showed the latest popular art films and which is still operating today--and then there was another cut-rate theater which showed more obscure art films, and which has long since gone out of business. In those pre-multiplex days, this cut-rate joint had only a single screen with a single film, which would be shown twice each evening. My best friend at school usually accompanied me to these events. General admission was $2.00, while the cost was just $1.00 for students and senior citizens; this disparity inevitably caused some arguments about exactly who qualified in both categories. One early winter evening's scheduled feature was "Promised Land" by Andrzej Wajda, the famous Polish film director. After the lights went down, the film began with a tank rolling across the desert; some murmurs of discontent began to be heard in the audience. After about one minute, the dialog began; while the subtitles were in English, the language being spoken was clearly Hebrew rather than Polish. There were louder mumblings from those watching the film; then the title was clearly displayed: "Promised Lands" by Susan Sontag. Pandemonium broke out as nearly everyone rushed simultaneously to receive a refund; with the confusion over how much each person had originally paid, it rapidly became nearly a mob scene. Some were shouting about the theater's incompetence in not even realizing that they had the wrong movie. I have not seen either film since then, but I will never forget every moment of the opening scene and especially the incredible emotional transformation of the audience.
(c) 1996-2009 Steven Jon Kaplan Your comments are always welcome.