Trade of the Decade Update, Value Investor Outlook, Small Business Oddity and More!

by Addison Wiggin & Ian Mathias

  • Trade of the Decade already paying off… forecasts and explanations below
  • Chris Mayer offers the best thing for a value investor to do with his cash, right now
  • Rob Parenteau highlights a strange phenomenon of this tepid recovery
  • Plus, international crises-yet-to-be: the yuan, Iran… and the U.S. military

 

  We didn’t plan it this way. After all, it is our Trade of the Decade.

We prefer being pointed to, laughed at and mocked. That’s certainly the way it was with our “sell U.S. stocks, buy gold” Trade of the Decade in 2000. Now we’re getting nervous because the new Trade of the Decade “sell Treasuries, buy Japanese stocks” looks like it could peak before we even release the details of the trade!

Today, after a big rally in March, the Nikkei 225 is at an 18-month high. Stocks almost everywhere are still popular, and a weak yen makes some Japanese stocks especially attractive at the moment.

“If the yen stays at this level, pretax earnings at Japanese companies will more likely increase by 50% next fiscal year,” Kazuhiro Takahashi of Daiwa Securities Capital Markets told the FT recently. “That’ll be positive for the stock market.”

Heh. A 50% increase in earnings usually is.

  Treasury bonds, the sell side of our Trade of the Decade, are at their lowest levels since June. Yields on the 10-year bond (the inverse of this trade) are just shy of 4% this morning.

“High fiscal deficits and higher outstanding debt lead to higher real interest rates and ultimately higher inflation,” notes famous bond investor Bill Gross in his latest monthly meandering, “both trends which are bond market unfriendly. In the U.S., in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don’t matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%.

“The trend promises to get worse, not better. The passage of health care reform represents a continuing litany of entitlement legislation that will add, not subtract, to future deficits and unfunded liabilities. No investment vigilante worth their salt or outrageous annual bonus would dare argue that current legislation is a deficit reducer, as asserted by Democrats and, in fact, the Congressional Budget Office…

“Long-term bondholders beware.”

Amen. Look this week for your second beta issue of Apogee, in which we provide details for the Trade of the Decade. If you’re not already enrolled in the beta program for Apogee, here’s how you can get the first three issues free and help build the top-down investment service of your dreams! Enroll, here.

  American stocks are popular lately, too. The Dow and S&P 500 finished at 18-month highs of their own on Thursday. And on Friday, when markets were closed, futures traders were treated to this next nugget.

  Christ may have died on Good Friday, but the American worker was born again, says the latest jobs report from the Labor Department. The U.S. economy added 162,000 jobs in March. CNN trumpeted, “Finally! Job Growth Returns.”

Ian Mathias, Intrepid researcher and co-conspirator here at The 5, took a closer look on Friday… for the critical investor, parsing these data is like shooting fish in a barrel. Here are the CliffsNotes:

  • Roughly half the monthly job creation was in temporary employment. 48,000 were new Census hires, another 40,000 in run-of-the-mill temp work
  • The headline unemployment rate stayed put at 9.7%
  • The underemployment rate actually increased 0.1% percentage points, to 16.9%
  • Average hourly earnings fell 0.1%, while average work weeks rose 0.1 hour
  • February snowstorms put an atypical skew on March job growth… essentially, the entire Mid-Atlantic bumped planned February hires into March.

And don’t forget all the usual footnotes… margin of error, birth/death model, seasonal adjusting, yada, blah, etc.

We wish the best for the American worker. And, he, the consumer, too. But to celebrate either of their resurrections now would be premature.

  Nevertheless, stocks are creeping up again today. The S&P was up a few tenths of a percent within the first hour of trading.

  “It’s true that investors at all times have had to deal with the distorting effects of government spending, currency manipulation and the like,” notes our value investor Chris Mayer. Financial statements during the best of times offer suggestions, but no certainties. But today, it seems particularly difficult.

“So how does one handle markets like this?

“You have to fall back on the basics as much as possible. As Seth Klarman, the great investor behind Baupost Group, writes in his last shareholder letter, ‘Where we can distinguish ourselves is… one investment at a time.’ That means rigorous analysis of each investment idea. That means buying only with a margin of safety. That means keeping a long-term focus and not getting lost in the day-to-day blips of the stock market…

“You have to learn to make good investment decisions and not worry about what the market might do. You have to have confidence in your process and in your research.

“It’s akin to playing poker. You can’t say whether any particular hand will work out. But you know that over time, playing good hands wisely will win the money. Same with stocks. You don’t know for sure whether any particular stock will work out. But if you have a good process and you follow that same process over and over again, collecting good stocks along the way, you’ll do well over time.

“Also, you can’t be afraid to hold onto cash when good ideas are scarce. I think we’re entering a period when good ideas are going to get really scarce… We need another correction to create some more opportunities.

“Otherwise, we’ll sit on our hands until we find something good.” If you’d like to sit on your own hands, you might as well do it with a friend. Subscribe to Chris Mayer’s Capital & Crisis, here.

  Also helping stocks today, the ISM’s service sector index rose from 53 to 55.4. That’s not only another month of service sector growth, but even better than Wall Street anticipated.

Couple this with last week’s ISM manufacturing index score, which blew expectations out of the water, and the current investment landscape is looking all the more like an aging movie actress with the soft glow lens meant to hide the blemishes and restore the admiration of the audience.

  “One of the major anomalies we have noticed in this U.S. economic recovery,” notes the Richebacher Society’s Rob Parenteau, “is that small businesses are not participating in the upswing very much at all. As displayed in the chart below, while supply managers in the most cyclical part of the U.S. economy, namely manufacturing, have reported a stronger rebound in economic activity than in the prior two recoveries, the National Federation of Independent Business small business optimism index has yet to regain even to the level of the 1990–1 recession trough.

“Yes, small businesses are clawing their way back, but the mood remains distressingly dour in this, the entrepreneurial heart of the American economy.

“We believe two culprits can be identified in the body slam experienced by small businesses during the recent recession. First, U.S. households adopted an unusual deficit spending habit for the decade extending beyond the fourth quarter of 1998. Under the influence of a sustained rise in equity prices during the New Economy bubble of the late ’90s, and an unprecedented housing boom 2001–06, U.S. consumers became very comfortable spending more than they were earning…

“We suspect many small businesses were, unknowingly, especially dependent upon perpetually increasing deficit spending by households. One can easily imagine all sorts of discretionary consumer service businesses that found niches to inhabit and grow under what, at its peak in the fourth quarter of 2005, was an annualized household deficit spending rate of $419 billion…

“The second major force crushing small business has been the scarcity of credit flowing to this business segment. Small businesses are the first clients that banks cut off when credit conditions tighten and economic uncertainty spreads. That has certainly been true in spades this time around. Only in the February reading on credit conditions for small businesses have we begun to see any kind of relief.

“If we are correct in our assessment that investors may next start to adopt a self-sustaining recovery view about the United States, then we would put on our stock picking hat and go hunting for financial firms with a history of small business lending that have clean enough balance sheets to either (a) drive a consolidation wave or (b) steal market share from their more conservative or cautious competitors…”

(Ed note: Mr. Parenteau was featured just this morning in a podcast by the independent Web site The Disciplined Investor. Check it out here. And if you’re inclined to listen to Rob’s mellifluous tones, you can catch him here on the Richebacher Society Round Table discussing his 2010 forecasts with yours truly.)

  Pending home sales lurched 8.2% in February, the National Association of Realtors reports. “We need a second surge [this spring] to meaningfully draw down inventory and definitively stabilize home values,” said Lawrence Yun, economist for the massive real estate lobby.

We’ll keep an eye out… especially later this month, when the homebuyer tax credit is set to expire. We’ve also got our eye on the shadow inventory for houses… those homeowners who are in default, more or less, but whose banks don’t want to begin the foreclosure process. Our source indicates there are about 100,000 “shadow properties” in Los Angeles County alone.

  Despite the positive data today, the dollar index is at 81, right where we left it last week. Gold is just a tad higher, at $1,125 an ounce. Perhaps in light of this news:

  The U.S. Treasury announced it is “delaying” the release of a report that will label China a “currency manipulator.” The move is entirely political, as China is on the verge of some high-level agreements with the U.S. government.

“The delay is wise,” wrote Clive Crook in yesterday’s Financial Times. “Long may it continue. Hu Jintao, China’s president, has just announced he will attend a summit on nuclear security in Washington this month. The U.S. continues to hope that Beijing will sign up to sanctions against Iran. Sacrificing agreements in these and other areas to make an empty gesture on the renminbi, or, worse, to launch a series of escalating trade disputes, would be mad.”

The Treasury hasn’t yet decided when to issue the postponed report. Politics are fun, aren’t they?

  Last today, the latest victim of the credit crisis: American sardine canning.

Two weeks from now, April 18, Bumble Bee Foods will shut down its Stinson plant in Prospect Harbor, Maine. On April 19, not a single sardine cannery will be operating in the U.S. We’re under the impression sardines are getting popular again, but not enough, evidently.

The plant closure will be a tough pill to swallow for Hancock County, where the unemployment rate is already over 12%, officially.

  “I think you should draw the line at missives that are insulting and incoherent,” a reader wrote of Thursday’s incendiary inbox. “The reader whose bile you included in Thursday’s 5 falls into both of those categories — he insults the ‘Air Force brat’ who eloquently defended her father’s service, and then went on to spew, ‘If I remember correctly, the government shot people because of free speech at Kent State, tried to ruin a senator’s career and outed his CIA wife because of his free speech.’

“Huh? No, the Kent State shootings were not about free speech so much as a tragic result of having poorly trained National Guard soldiers respond to what was basically a riot.”

The 5: Cheers.

  “Over the years, you have helped me keep my eyes open, and have led me to excellent investments,” another writes. “And now you open my eyes wider, by permitting such as your anti-military contributors to comment. Indeed, thank you for reminding us ‘they’ are not only out there… way out there, but they believe what they believe! Wow — and keep up the fair and open forum. Well done!”

  “The U.S. military are enforcers for the economically powerful and privileged. That’s it!” a Canadian reader chimes in.

  “Doesn’t having over 200 bases make the point about the U.S. having switched from a republic to an empire?” our last reader asks. “The lessons of history are that empires expand until the cost of the military outweighs the economic benefit. Given that the U.S. did not invade Iraq for oil, did not invade Afghanistan for opium and presumably is not in Japan for the sushi, it detracts considerably from the economy.

“Imagine a world in which the U.S. closes all military bases, retreats to the U.S. mainland and reduces the army to a size consistent with self-defense. That may upset a few ‘friendly’ regimes, cheer a few ‘axis of evil’ regimes, but would the U.S. really be worse off?”

The 5: Unfortunately, as we pointed out, empires have a logic all their own. We’ve been passing around this essay this morning regarding the political run-up to an invasion of Iran. Who really wants to expand the war in the Middle East? And yet… here we go again

Try as we might to keep our attention focused on economics and finance, a broader war in the region would upset markets all over the place. And you can imagine what would happen to the price of oil. Some 40% of the world’s shipped oil slips through the Strait of Hormuz every day. If you can’t imagine, we’ve done the math for you, right here. Even if you’re already a subscriber to Outstanding Investments, we can’t urge you any more strongly to read it…

Iran “needs” a bomb to defend itself from the angry mob growing in the West. And to protect your portfolio.

Warm regards,

Addison Wiggin

The 5 Min. Forecast

P.S. On a lighter note, we love it when we get mail like this: “I want to thank Patrick Cox for his recommendations of XXXX and YYYY. They have made me over a half million dollars! — Kevin S.” Read on

 

rspertzel

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