A Vain Search for Yield

Dave Gonigam – January 31, 2012

  • Making sense of a “strange stock market”: Chris Mayer on what to do when investors flee equities in a vain search for yield
  • Jim Nelson on where to go as income investors step further out on the risk curve
  • Central bankers convene, hilarity ensues… until the proverbial punch bowl is drained: Two charts with stunning parallels
  • LSD pioneer has visions of a return to the gold standard… seriously
  • A reader’s excellent book tip… an inquiry into bank failures… a photo that explains a lot (or not)… and more!

   “This is a strange stock market we are dealing with,” observes Chris Mayer, writing from a 777 en route to Santiago, Chile, in search of investing opportunities far from home.

Not much is happening in the U.S. market today. The major indexes lurched up at the open, a move attributed to the latest misplaced hopes about a solution to the eurozone crisis. Then they settled back down. The S&P 500 is still about eight points above 1,300.

Indeed, the first month of 2012 has proven sedate by recent standards.

   “Last year,” says Chris, “there were 68 days in which the S&P moved up or down by 2%. This has been the pattern in the last four years — lots of big up and down days.”

“But in the years before the financial crisis started to gather steam in 2007, the market had, on average, only two or three such days in any given year.” Since 1928, the average daily move of the index has been about 0.75%. During the second half of last year, it was 1.44%.

   “It’s been a tough ride, more than most people can stomach, or make any sense out of,” Chris goes on. “So they pull out. In fact, they are pulling out in droves.”

“For most of the 1990s and 2000s, people put more in stocks than in bonds. That’s reversed in a big way since 2007.”

No kidding…

   “Whatever people love about bonds,” Chris says, “it can’t be the returns they’ll earn. On the plane ride, I read the latest issue of Grant’s Interest Rate Observer. Grant’s makes a note of the slim pickings in the bond world. A sampling:”

  • 12-month U.S. Treasury bills yield 0.10%
  • 12-month German bonds yield 0.13%
  • U.K. 4-year notes yield 0.893%
  • U.S. 2-year notes yields 0.25%.”

Bonds are the shelter the crowd seeks when it gets fearful. But the shelter could turn into a slaughterhouse, Chris warns: “The world’s central banks conspire to keep interest rates low, which is another reason for the slim pickings. Central banks have also opened up their taps, creating waves of money and credit. How long they can do both is the question.”

“The Federal Reserve’s balance sheet, for instance, grew nearly 18% over the last year. When the Fed grows, that means more money and credit pumped in the system. Certainly, the economy didn’t grow 18% last year. No. The Fed poured these drinks to help flagging banks — essentially subsidizing the banks that lost money.”

   “You don’t need to be an economist to understand what is going on here. An increase in money and credit without an increase in goods and services means more dollars chasing the same amount of goods and services. Might this mean that the cost of those goods and services go up in price? Put another way, the value of money falls.”

“Might this also mean that interest rates too adjust upward as investors demand more compensation to protect their purchasing power? I think it likely. And then the bond bulls get collectively slaughtered. (When rates rise, bond prices fall.).”

“Better to own real things — real estate, oil, gold and the like — that ought to hold their value in the face of central bank illusionists. (You can’t print real estate, oil or gold). Better to own shares in growing and adaptable enterprises — especially as the latter seem so unpopular.”

Chris has one idea worth your consideration here.

   “Investors are still piling into riskier and riskier income plays in search for extra yield,” says Jim Nelson, looking at the phenomenon from the vantage point of our income desk.

“After all, they can’t exactly turn to Treasuries with the 10-year generating less than 2% in annual income.” Thus, junk bond funds saw another week of big inflows last week, according to Barron’s.

And over the last year, income-producing ETFs were among the best performers — whether you were looking at indexes or sectors…

“The best performer in the top section,” notes Jim, “was the Dow Jones Dividend ETF — representing the top dividend payers in the Dow.”

“In the middle section, two standouts were consumer staples and utilities — both known for the safety of their dividends, which is why our portfolio is stuffed full of each.”

“And finally, look at the tremendous performance in U.S. debt securities at the bottom. TLT, which represents long-dated Treasuries, took off a whopping 29% last year. Treasuries do not typically move that much.”

So will this quest for yield continue? “We think it will for the next several months, at the very least,” says Jim.

But is it too late to get into the kind of income investments Jim follows? Not at all. Indeed, one sector stands to benefit big in the next several months. It’s one of the sectors Chris identified above, in which you can find a set of plays Jim has dubbed “10-86 plans.”

If it’s income you’re after, they’re worth a look.

   Oil is up marginally this morning, knocking on the door of $99 a barrel… as celebrity economist Nouriel Roubini projects a war with Iran could drive the price to $150 and set off a global recession.

“There are lots of sources of uncertainty from the eurozone, from the Middle East, from the fact that the U.S. is not tackling its own fiscal problem, from the fact that Chinese growth is unbalanced and unsustainable, relying too much on exports and fixed investments and high savings, and not enough on consumption,” he tells The Associated Press.

“So it’s a very delicate global economy.”

Mr. Roubini’s forecast lines up in a way with two of the big themes covered by our own Byron King: Iran’s role in the Sunni-Shia conflict that he sees driving oil north of $200… and the knock-on effect that would have for U.S. energy producers.

   We never knew central bankers could be such cutups.

With the release this month of 2006 transcripts from the Federal Reserve’s Open Market Committee meetings, a blogger has uncovered an eerie correlation between the expansion of the housing bubble and the number of times the Fed stenographer noted [laughter] in the transcripts.

As the housing bubble grew, the more hilarious the proceedings became.

“The number of recorded laughs,” according to The Daily Stag Hunt, “actually increased in frequency from 2000 to 2006. In 2001, the FOMC erupted into laughter 16.5 times per meeting on average. In 2003, it was over 19. In 2005, 27.

“And then in 2006, the FOMC burst into laughter nearly 44 times per meeting!”

We can’t wait until the release of the 2007 transcripts to see if the laughter stopped… because through 2006, the similarities to the Case-Shiller home price index are hard to miss.

   The Case-Shiller numbers, by the way, are updated through today’s release. The index fell 1.3% from October to November, and the year-over-year decline was 3.7%.

From the July 2006 peak, prices are down 32.9%. Among the 20 metro areas tracked by the index, the only ones showing improvement over the last year are Detroit (could it get any worse?) and Washington, D.C. (home to the only growth industry left).

   University endowments racked up a 19.2% return in the year ended June 30, 2011, according to a survey of 823 public and private institutions.

Wealthier endowments like Harvard and Yale did even better, with average gains of 20.1%, says the research from the National Association of College and University Business Officers.

Not noted in the study, or the Financial Times story about it, is that the time span coincides almost perfectly with QE2. Nor did they observe that an S&P index fund would have outperformed the endowments with a 25.7% gain. Heh…

   Gold is drifting up and down today, but the general trend is up. At last check, the spot price was $1,736. Silver’s holding steady at $33.55.

   “Can the gold standard be far off? I think not. (Far out, maybe, but not far off.)”

So concludes our friend Ralph Benko of the American Principles Project after seeing himself quoted on the blog of Ralph Metzner.

Metzner doesn’t have quite the cachet of his famous colleagues at Harvard in the early ’60s… but he pioneered research into psychedelics along with Timothy Leary and Richard Alpert (aka Ram Dass).

“As the world’s, especially the West’s, economies careen wildly between inflationary and deflationary trends,” Metzner writes this morning, “conservative hard-money proponents are predicting or announcing the demise of the dollar as the de facto reserve currency and pushing for the return of some kind of modified gold standard, or gold-silver standard, to stabilize economic fluctuations.”

That’s followed by a lengthy excerpt from a Benko Forbes column we excerpted ourselves a while back.

“It is an odd honor,” says Ralph, “yet a great honor, to find oneself in the blog of a major countercultural icon.”

Along with Michael Moore and Dennis Kucinich, we hasten to add. Hmmm….

   “Let us hope,” writes Mr. Benko’s colleague Lew Lehrman in The New York Sun, “that Gov. Romney and Sen. Santorum will join the alliance and help to incorporate a restoration of a sound dollar into the Republican Platform of 2012.”

Mr. Lehrman was one of only two dissenters on the U.S. Gold Commission in 1982 calling for a new gold standard. The other was Rep. Ron Paul.

Recently, former House Speaker Newt Gingrich called for the formation of a new Gold Commission. We write off the move as opportunism… but Mr. Lehrman sees it as two down, two to go among the Republican candidates for president.

“Who knows?” Lehrman writes. “Even a gold Democrat might emerge to pick up the mantle of President Grover Cleveland, a famous gold Democrat, who emphasized the centrality of a sound, stable, constitutional gold dollar.”

   “There is a new book out called Currency Wars, by James Rickards,” a reader tips us. “It is a must read for any of us who are trying to understand what the Federal Reserve, and our government, have done.”

“He has explained the goals of some policies that have been undertaken and why they never achieved their desired effect, plus his descriptions and explanations are in language that most people can understand, although I found myself going back to reread pages constantly.”

“I would think that fellow authors Bonner and Wiggin would enjoy this book, as it ties in to works they have written.”

The 5: “Fans of financial TV,” reads a review posted today by Doug French at the Mises Institute, “will recognize Rickards as a fast-talking, straight-shooting pundit on banking and the macro economy who actually talks seriously about the world returning to some form of gold standard…”

“Rickards gets the reader’s pulse surging with the warning of a complete collapse in the book’s preface, telling readers that Fed chair Ben Bernanke ‘is engaged in the greatest gamble in the history of finance.’”

Indeed, there’s much in Mr. Rickards’ outlook that lines up with our own.

   “So how many banks are left?” a reader inquires after our update on bank failures yesterday. “They normally merge or sell a closed bank’s assets to another bank.”

“You end up with fewer, but bigger banks. Do we get banks that are ‘too big to fail’ again? So I ask, how many banks are left to close?”

The 5: The number of FDIC-insured institutions is, indeed, falling, however gently. As of Sept. 30 last year, it was 7,436. Three years earlier, as the Panic of 2008 was reaching a crescendo, it was 8,384.

That’s an 11% decline from 2008-11 — double the pace of the previous three-year span from 2005-08.

Indeed, the number’s been in a steady decline since it peaked at 18,033 in 1985.

   “The CEO of the failed Knoxville, Tenn., bank BankEast was Fred Lawson, former state banking commissioner,” adds another. “Go figure!”

   “I observed four or five years ago that the time would come when Chinese costs would rise over time to the point that Chinese companies would follow the lead of those in Japan and one day begin building factories in the U.S. to reduce the cost of their products.”

“That hasn’t quite come to pass, but some of the U.S. companies that transferred their manufacturing to China are beginning to bring it back home to save on transportation and import duties, etc., as the cost of making things in China rises and makes them less competitive.”

“And who would ever think that an American company could make inroads in the market for throwaway chopsticks in China? But it has happened for a company in Georgia.”

The 5: We actually wrote about that one six months ago. More recently, we’ve seen accounts of blue chip companies like Ford, Caterpillar and GE adding to their factory capacity here at home. And the savings on transportation costs is one of the major factors… which spotlights a remarkable investment opportunity.

   “Being a new subscriber, I find your information on your government shows that our (Australian) government is not much different, just the scale.”

“Both systems are founded on the principal of INEPTOCRACY, meaning: a system of government where the least capable to lead are elected by the least capable of achieving, and where the members of society least likely to succeed, or even to sustain themselves, are abundantly rewarded with goods and services, paid for by the confiscated wealth of a diminishing number of producers.”

“The offshore solutions will work until a government troglodyte notices (they might even be subscribers) and then anything offshore will be lumped in with your onshore assets.”

“Keep up the good work until then.”

The 5: The trick is to stay one step ahead of the bastards… which is exactly why we’re convening a first-of-its-kind event.

If you’re eager to learn more about placing some of your assets offshore… but nervous about the legal and logistical hurdles… this is exactly the event you need.

We’re calling these The Rancho Santana Sessions. They’re an intimate, confidential series of briefings limited to only 30 people at the brand-new Rancho Santana Conference Center in Nicaragua.

The dates are March 21-25. To learn more and receive an invitation, read on and drop us your email address here.

   “It’s easy to poke fun at our vulnerable soon-to-be ex-Secretary of the Depleted Treasury,” a reader writes after seeing Friday’s issue, “but sometimes the story takes a bit more digging.”

“I took the trouble to do that, and found what I believe to be the reason why our lovable Timmy is so willing to risk it all with high-stakes gambles. The truth is, he’s a born risk taker.”

“Offered in only a slightly more disingenuous tone than what we’ve been subjected to during his tenure…”

The 5: Well, that would explain a lot now, wouldn’t it?

Cheers,

Dave Gonigam
The 5 Min. Forecast

rspertzel

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