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 twice or thrice per month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence. Those who believe in this investment philosophy should consider subscribing to my daily update service which I began in February 2006.
WITH LITTLE FANFARE, MORE AND MORE ASSETS HAVE BEGUN BEAR MARKETS (January 5, 2011): The trading pattern during the past two months has been characterized by the increased eagerness for amateurs to purchase risk assets near their respective peaks, with top corporate insiders recording their highest-ever ratios of selling to buying in history for many subsectors during the fourth quarter of 2010. This is a classic case of distribution, and will lead to profoundly bearish consequences through 2012. In the first half of November 2010, many emerging markets and their funds including Colombia (GXG), Thailand (THD), Singapore (EWS), and most importantly, China (FXI), have begun downtrends which have been characterized by several lower highs, as is typical of a true bear market rather than merely a correction. Beginning in the first half of December 2010, many of the hottest speculative shares of 2010, including Netflix (NFLX), OpenTable (OPEN), and Salesforce (CRM), similarly began what appear to be bear markets with a sequence of lower highs. Even though January 2011 has just begun, we have already seen numerous commodities including silver, copper, and crude oil completing important multi-year or even multi-decade highs and thereafter initiating potentially significant downtrends; it appears that many global equity indices and funds may be joining them in reversing their primary direction.
Especially with numerous recent surveys showing multi-year extremes of high investor bullishness and low investor bearishness, and nearly unanimously bullish forecasts by most financial analysts and advisors, it is becoming increasingly likely that we are transitioning from a major global bull market for risk assets to a major bear market. Following a pattern of several lower highs, a confirmation of this transition would appear in the form of a rapidly accelerated downtrend especially for equities and commodities which is not anticipated by the vast majority of investors. The key to the current bear market is the fact that approximately 4-1/2 billion of the world's population are living with real-estate bubbles, versus only about 1-1/2 billion just before the last bear market. The pronounced weakness for equities during the past two months in countries like China may be an early warning that a severe slump for housing prices may be imminent. The current average annualized rental yield in most Chinese urban areas is only 2.5%, versus a historic average of 7.5%, indicating that urban Chinese real estate may be averaging three times fair value. Another loudly singing canary has been the U.S. dollar index, which has been in a little-heralded uptrend which began in the morning of November 4, 2010, less than 20 hours following the "QE2" announcement by the U.S. Federal Reserve. Nearly all major bear markets first begin with a strengthening of the U.S. dollar, so this is an omen which should not be ignored.
YEAR-END FINANCIAL GAMES GIVE INVESTORS PRIME OPPORTUNITIES (December 29, 2010): Many fund managers are intentionally selling the worst-performing assets of 2010 and purchasing the best-performing ones, so that their year-end portfolios will appear to own the top winners of 2010 and will be free of the worst losers. Many amateur investors, who know virtually nothing about taxes, are selling their losers for the alleged excuse of saving money on their 2010 taxes, although the real reason is that they want an emotional justification for unloading them near a major bottom. This has caused the most undervalued and oversold assets at the present time, including long-dated U.S. Treasuries and their funds such as TLT, to become even more compelling bargains than they otherwise would have been. Similarly, the most overvalued and overbought subsectors, including silver (SLV), the top-performing technology shares (QQQQ), and many emerging markets (EWY) have become prime candidates for selling short. Investors should therefore seize these opportunities, as the current global financial situation is at least as precarious as it had been in the summer of 2008.
Numerous measures of investor sentiment have demonstrated their greatest ratios of bulls to bears in several years, including both AAII and Investors' Intelligence. Luxury buying is once again the rage; talk of austerity and "recessionistas" has virtually disappeared from the financial and nonfinancial media alike after having been incredibly trendy just two years ago. The more things change, the more things stay the same. The best investments over the next two years will be virtually the same ones as had performed most strongly during the last bear market. For this reason, I have recently doubled my position in TLT, a fund of U.S. Treasuries averaging 28 years to maturity, and have also added to my short equity and short commodity positions. Just as the trigger in 2008 was the consequences of the collapse of real-estate bubbles for 1-1/2 billion of the world's population, the danger today is three times as great with 4-1/2 billion people living with real-estate bubbles. One loudly singing canary has been the U.S. dollar index, which has been in an uptrend since the morning of November 4, 2010--less than 20 hours following the Fed's "QE2" announcement. During any era of stagnation, a rising greenback is one of the clearest signals of an upcoming global economic contraction.
LONG-DATED U.S. TREASURIES BRIEFLY BECOME FABULOUS BARGAINS (December 19, 2010): As a rule, whenever global equities, corporate bonds, commodities, and real estate become as dangerously overvalued as they are today, U.S. Treasuries become a compelling bargain. This is exactly what occurred during the past week, as TLT, a fund of U.S. Treasuries averaging just over 28 years to maturity, slumped to its lowest point (90.47) since April 26, 2010. I recommended that subscribers begin to purchase TLT as soon as it touched 93 dollars per share, and to continue to purchase it each time it fell another 50 cents. From Thursday's intraday low to Friday's intraday high, TLT soared more than 3.6%, but additional pullbacks are certainly possible over the next several weeks. Should that occur, TLT should once again be bought into weakness. Investors throughout the world are convinced of the certainty of a continued economic recovery. However, all of the following signals are profoundly bearish for risk assets: 1) the rising U.S. dollar index since the morning of November 4, 2010; 2) the near-record level of insider selling to insider buying by top corporate executives throughout the fourth quarter of 2010, especially near all market peaks; 3) the recent intense amateur accumulation of the riskiest assets since late August 2010. Most analysts are busy debating whether stock markets will gain less than 10% or more than 10% in 2011. Since so few analysts are willing to stick their necks out and proclaim their bearishness, I'm doing precisely that. In addition to my recent purchases of TLT, I have been progressively selling short SLV, QQQQ, and EWY into strength, as all of the above assets have become substantially overvalued. Silver has been among the most overhyped commodities and rose nearly vertically in the early autumn; QQQQ consists of the most popular technology shares including AAPL which have become dangerously popular with mom-and-pop investors; emerging markets like South Korea have experienced unsustainable real-estate bubbles as housing prices there and in many other countries including China, India, Brazil, Indonesia, and Malaysia have soared to roughly three times fair value.
During every era of economic stagnation since the 1700s, U.S. largecap equities have at least briefly yielded average dividends exceeding 6%. With the dividend yield on the S&P 500 index currently standing at merely 1.89%, this will require the S&P 500 to slump to roughly 400. While this is derided as impossible by nearly all equity analysts, I think this is exactly what will occur. Because of the U.S. Presidential election two years from now, the most likely timing for such a deep equity nadir will occur during 2012. Just as had been the case exactly three years ago, since so few investors are currently prepared for a double-dip recession, we are likely to experience a severe pullback for risk assets which will be as devastating as or even worse than the 2007-2009 bear market.
FAR TOO MANY INVESTORS ARE UNDERESTIMATING THE IMPACT OF REAL-ESTATE BUBBLES (December 5, 2010): Three years ago, we had about 1-1/2 billion of the world's population living with real-estate bubbles. When those bubbles collapsed, as all bubbles inevitably do, they caused massive problems for all risk assets. Without the collapse of the U.S. real-estate bubble, for example, there would have been no bankruptcy for Lehman Brothers, and the bear market of 2007-2009 would have surely been far less severe instead of the S&P 500 losing 57.7% of its peak valuation. Fast forward to today, when 4-1/2 billion of the world's population is experiencing real-estate bubbles. This includes all of the most populous countries such as China, India, Brazil, and many other places such as Malaysia, Canada, Australia, Colombia, Peru, and Chile. In fact, there are more countries today with real-estate bubbles than without, which is the first time in history that such an event has occurred. What is even more amazing than the presence of these bubbles is their intensity; many countries have housing prices which are near three times fair value by historic norms, as compared with just over twice fair value in the United States at the 2005-2006 peak [as measured by the Case-Shiller index at 206]. This puts these bubbles on a par with where Ireland had been four years ago, and we know what has happened with Ireland since then. Many emerging-market countries which had nothing directly to do with the U.S. real-estate bubble lost 70% or more of their equity valuations during the last bear market; when their own real-estate bubbles pop, it isn't likely that the results will be less severe. Very few analysts have been discussing the potential negative impact of this massive overvaluation for global housing prices, thereby likely creating a true surprise when it occurs. As forecasts for double-digit growth in China and elsewhere have to be revised sharply lower, we are almost certain to experience an approximate repeat of the last bear market.
LOOK FOR SAFETY, NOT VALUE (November 28, 2010): In the mainstream financial media, it has become extremely popular for analysts to talk about "looking for value" or "restricting your choices to real quality". This is exactly what happened three years ago, when analysts and financial advisors recommended buying high-dividend shares or seeking out earnings growth or anything but what they should have done--putting their money into the safest money-market funds and other guaranteed time deposits. Bear markets are like Rodney Dangerfield; they never get any respect. In a bear market, the winners are not those who lose "only" one quarter of their net worth instead of one half, but those who are content with very low rates of interest since they at least come out ahead instead of behind. Recently, municipal bonds have fallen sharply in value, thereby tempting many to chase after their higher yields. Real-estate investment trusts, high-yield corporate bonds, and other high-dividend assets have begun to decline from their recent peaks. Do not succumb to these dangerously popular temptations, since we have seen only the tip of a huge iceberg which will soon hit the Titanic in a dramatic head-on collision. When you're in a sinking ship, head for the lifeboats instead of trying to upgrade to a better cabin.
Looking back at the second half of 2008, far too many investors jumped back into the market far too soon. Enjoying a modest discount from a peak valuation is not sufficient justification for assuming a high level of risk. In late 2008 and early 2009, many high-quality sectors bottomed at dramatically undervalued levels, and it's not going to be different this time. In 2007, we had real-estate bubbles in some countries including the United States and Ireland; today, we have far more numerous real-estate bubbles in dozens of countries, including many with huge populations. These bubbles will pop with dramatic consequences from China to India to Australia to Canada--and to those countries which don't have real-estate bubbles but are firmly interconnected in a truly globalized world. Don't even think about purchasing your favorite equities until they have become as irrationally cheap as they had been in the fourth quarter of 2008 and the first quarter of 2009. In a bear market, assets don't simply retreat to fair value and then stabilize; they continue to plummet until they have become absurdly undervalued and oversold.
The biggest mistake is chasing yield. If you need income for your monthly expenses, then the worst investment you can make is to purchase a fund which generates an above-average dividend, since you are taking on above-average risk and will end up losing money as far too many pursue this strategy which has repeatedly failed during the past decade. Instead, buy equities whenever they are deeply undervalued as they had been two years ago, and sell them whenever they become overvalued as they are today. Keep some of the profit from this sale for your expenses. That's the proven formula for success which will continue to apply during the upcoming decade. It will likely not be until 2012 that we have true bargains which are worthwhile for consideration for nearly all risk assets. A 1% bank savings account may not sound very exciting, but it's a lot more exciting than losing 30% or 40% of your money from the current favorites which include high-yield corporate bonds, real-estate investment trusts, and similar assets which are certain to perform poorly since they have experienced enormous amateur buying during the past year; any investment which is that popular cannot possibly succeed. I'm amazed that people are willing to lose a huge percentage of their money for the second time since 2007, by not respecting the normal cyclical behavior of the global financial markets. The ratio of selling to buying by top corporate insiders reached an all-time record earlier this month for many sectors, which is not a coincidence. When the world's smartest investors are positioned for maximum safety and protection, it makes no sense to take the opposite side of their trades.
RESPECT THE APPARENTLY IRRATIONAL DELAY (November 18, 2010): There were some wonderful cartoons I watched as a kid, where "Wile E. Coyote" chased after "Road Runner" around the top of a deep canyon. Road Runner hid behind a bush, but Wile E. Coyote didn't notice and kept running--right off a cliff. However, Wile E. Coyote didn't immediately fall; he continued in a straight horizontal line into thin air. Only when he looked down, and noticed that there was nothing holding him up, did he plummet to the bottom of the canyon. This is exactly how the financial markets behaved following the U.S. Federal Reserve's quantitative-easing announcement on November 3, 2010. The U.S. dollar began a strong rally less than 20 hours later, and continued to gain until it achieved its highest level since September 28--but the financial markets continued merrily along as though nothing had happened. Assets like silver and the Nasdaq 100 Trust (QQQQ) accelerated even more sharply higher when the U.S. dollar started rallying, than they had done while the greenback was slumping. Finally, equities and commodities and other risk assets looked down and noticed that it was just thin air below, and began to rapidly decline. Interestingly, when this process was occurring, most analysts either ignored the rising U.S. dollar index, or else said something ridiculous like "the fact that gold and silver can continue to rally in the face of a stronger U.S. dollar shows how incredibly powerful its bull market truly is". It always surprises me how few investors recognize that the financial markets repeatedly behave like Wile E. Coyote, following proven correlations over and over again--but usually only after an apparently irrational delay. It is the rare investor who respects and learns how to maximize the value of this delay. My personal strategy is as follows: the greater the number of divergences which indicate an impending reversal, the more aggressively I will add to my positions. I usually do this by placing the rungs in my ladders of orders closer together than they had been before the reversals had been so pronounced.
DO AS TOP CORPORATE INSIDERS DO, ESPECIALLY AT EXTREMES (November 8, 2010): Top corporate insiders worldwide have been selling shares at their fastest pace relative to insider buying since the second half of 2007 in many countries including the United States, and at an all-time record pace in many countries including India. Numerous subsectors, in the U.S. and elsewhere, have also seen record ratios of insider selling to insider buying. Those insiders who have the best track records with their trading have been among the most aggressive sellers. Regardless of the reasons, which are unimportant anyhow, they know that QE2 and all other government attempts to manipulate the economy will come to naught. More importantly, they recognize the dangerous overvaluations not only for equities around the globe, but also for real-estate prices.
While the housing bubble in the United States received some attention in 2005-2006, it was peanuts compared with today's real-estate bubbles around the world. U.S. housing prices reached just over twice fair value before they began a plunge which will surely continue for at least a few more years. At that time, the total value of U.S. residential real estate to GDP was at 1.8. Today, this ratio is 3.5 times GDP in China, 3.3 times GDP in Australia, 3.2 times GDP in New Zealand, 3.1 times GDP in the United Kingdom, and at similarly dangerous levels in numerous other countries including India, Canada, Indonesia, Brazil, Malaysia, Singapore, Colombia, Peru, Chile, and in other nations far too numerous to list here. If you rent out the average house in China today, your annualized rent will be equal to only 2.5% of the price of the house, versus a historic average of 7.5% in China and elsewhere for centuries (or millennia). This means that Chinese prices are at three times fair value. If you want to see what happens when a housing bubble at three times fair value collapses, as it inevitably must, then all you have to do is take a trip to Dublin, Ireland and look around.
Especially since the global real-estate and equity bubbles have been ignored or even cheered as allegedly bullish for the stock market, for commodities, and practically everything else, the opposite must inevitably occur. Just as we saw in the United States when the housing bubble burst especially in areas including Florida, Arizona, and Nevada in recent years, a surge in foreclosures will lead to all sorts of economic ills. The recent extreme bullishness toward equities and commodities must therefore lead to a dramatic pullback for these and virtually all other risk assets over the next two years, as we begin a global bear market which will rival and perhaps surpass the 2007-2009 bear market in terms of intensity and magnitude.
The problems in the global economy have not gone away during the powerful bull-market surge which began near the end of August 2010; it's just that you don't hear about bad news whenever risk assets are rising in price. Europe has a worse debt crisis than ever. Unemployment around the world has begun a multi-year increase which will persist for several more years. In every past era of stagnation dating back to the late 1700s, the dividend yield on any major basket of U.S. largecap equities has exceeded 6.0%; it reached only 3.5% at its highest point in early March 2009. While the last decade has been a very poor one for equity performance around the world, the next decade will likely be even worse as numerous pricing excesses have to be unwound and massive new borrowing has to be deleveraged.
One of the few beneficiaries of the global bear market for risk assets through 2012 will be a powerful surge in the value of the U.S. dollar. While almost everyone has been incredibly negative toward the greenback, the U.S. dollar index has completed yet another higher low in a bullish pattern dating back more than 2-1/2 years. On March 16, 2008, the U.S. dollar index bottomed at 70.698. Since then, it made a higher low on July 15, 2008 at 71.314; another higher low on November 25, 2009 at 74.170, and perhaps yet another higher low on November 4, 2010 at 75.631. As the greenback likely accelerates its uptrend and probably eventually achieves a nine-year peak, this will put substantial downward pressure not only on obvious assets which correlate negatively with the U.S. dollar, such as gold and silver, but also on high-yield corporate bonds, emerging-market equities, and virtually all of the favorite amateur investment choices of the past year. While everyone is looking up and asking when we're going to reach the sky, look down toward the solid ground.
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). Most recently, Barron's featured my letter to the editor about investing in Africa in their Mailbag of August 14, 2010, which you can read at the link below:
CURRENT ASSET ALLOCATION (marked to market at the close on January 4, 2011):
My own personal funds are currently allocated as follows:
Local checking accounts averaging 1.00%, brokerage accounts averaging 0.50%, and other cash equivalents, 25.6%;
TIAA/CREF Traditional Annuity Fund and Putnam Stable Value Fund (retirement funds with stable principal paying variable interest averaging 3.25%, no ticker symbols), 32.5%;
Coins and related collectibles purchased in 1997-2005, 7.0%;
28-year U.S. Treasuries fund TLT, 4.7%;
Claymore natural gas futures fund CYMGF/GAS-T (Toronto), a losing position, 3.5%;
Volatility futures fund VXX, another losing position, 2.9%;
22-year U.S. Treasuries fund VUSTX, 1.4%;
QQQQ synthetic short fund PSQ, 0.9%;
Thomson-Reuters TRI, purchased at a 15% discount, 0.3%.
Gold mining funds GDX, ASA, BGEIX, INIVX, 0.0% (GDX mostly sold at 50.12-50.17 on January 11, 2010, some sold at the open at 49.48 on January 12, 2010, average gain 81%; ASA sold at 80.00 on January 12, 2010, average gain 100%);
Coal mining fund KOL, 0.0% (sold near 40 on January 6, 2010; 8th-best mutual fund in 2009, average gain 212%);
Russian fund RSX, 0.0% (sold near 33.25 on January 6, 2010; 11th-best mutual fund in 2009, average gain 202%);
Natural gas producers' fund FCG, 0.0% (sold slightly below 19 on January 6, 2010, average gain 81%);
High-yield BB corporate bond fund VWEHX, 0.0% (sold on January 6, 2010, average gain 48%);
Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 0.0% (sold on January 6, 2010, with JOF at 7.58, average gain 28%);
Silver bullion fund SLV, 10.4%.
Nasdaq 100 Trust QQQQ, 7.7%.
South Korean equity fund EWY, 3.1%.
REMINISCENCE OF THE WEEK (December 19, 2010): About a decade ago, I purchased so many shirts that I ended up with a large surplus, so I stopped buying them altogether. Earlier this month, I visited Florida, and due to a mysterious cause my suitcase literally burned sometime between check-in in Philadelphia and pick-up at Tampa's baggage claim. Since every single one of my shirts and pants had been destroyed, I knew I'd have to go shopping for new clothes. I went to a well-known store with several brands of men's clothing. The new pants fit exactly as they have always done, but I was frustrated when I discovered that all of the size large shirts were far too spacious to even remotely fit. I hadn't worn anything of size medium since I was a sophomore in high school, but needing something to wear I decided to try one of them as a last resort. Amazingly, every single brand I tried fit perfectly, so I ended up buying six new medium shirts. Not being in the clothing industry, my theory is that as Americans have become increasingly obese in recent years, manufacturers are adjusting by making more generous shirts for each size. As people who wear large gain weight, they continue to buy bigger large shirts; those who are medium keep buying bigger medium shirts. Everyone stays happy, fooling themselves into believing that they're just as slim as ever. Either that, or I've actually been shrinking rapidly, and will soon be able to audition as a munchkin in a sequel to the Wizard of Oz.
(c) 1996-2011 Steven Jon Kaplan Your comments are always welcome.