• Contango Isn’t A Dance In Argentina: It is a Shot at Windfall Profits

    Posted on January 22nd, 2009 Keith Fitz-Gerald 7 comments

    Contango Isn’t A Dance In Argentina: It is a Shot at Windfall Profits

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    Many investors have given up on oil, fearing that a fall from grace precludes a rise in price from the ashes. But it’s worth noting that the oil markets are right now in a rare state of  ’super contango,’ which suggests that the markets expect far higher prices by next year.

    Here’s what you need to know.

    In case you’re not familiar with the term, ‘contango‘ denotes a normal and very specific condition associated with futures contracts in which the price of oil for distant delivery months from now exceeds the price of oil being traded right now on the spot market. Typically, the price difference is related to the cost of storing and insuring the oil itself.

    An example might help. On Tuesday, oil traded at $38.81 a barrel on the New York Mercantile Exchange (NYMEX) spot market. So if we bought a barrel and put it into storage for the next five months, and assumed that would cost us 90 cents per barrel per month, under normal market conditions, we’d expect the June crude oil contracts to be priced roughly at $43.31 ($38.81+ the cost of storage for five months = $43.31).

    However, according to the New York Mercantile Exchange, June crude oil contracts settled at $52.14 on Tuesday, which represents a state of ’super contango’ – and an excess potential profit of $8.83 per barrel ($52.14 – $43.31 = Excess Potential Profit of $8.83). But only for traders who can buy oil now and store it until then.

    There are obviously wrinkles, of course, depending on where the oil is stored and how it is priced for delivery. But, in general, the spreads we’re seeing now are at, or near, their highest levels since April 2004, when the government started collecting Cushing data. Cushing is the delivery point for all NYMEX futures.

    Super contango is a rare situation that causes most traders to drool – myself included – because it signals an arbitrage opportunity that’s literally too good to pass up if you’ve got the means to capitalize on it.

    But, as usual, there are all sorts of unanticipated consequences – including a phenomenon we don’t see very often – hoarding at sea.

    Tanker rates are skyrocketing as companies literally top off very large crude carriers with the 2 million gallons they’re designed to carry – and then park them offshore until prices rise. In the meantime, they’re also selling the June futures and locking in profits above and beyond what it costs them to buy and store their stash of this ‘black gold.’

    Of course, with every tanker that’s stuffed to the gills as a storage container, there’s fewer of the big boats in circulation. And that’s caused benchmark supertanker rental rates to rise more than 56% since Jan. 1. But the perceived profit potential is so high right now, that even investment banks, which are hardly in the market for super tanker rentals under normal circumstances, are getting into the game.

    According to recent reports by Bloomberg News, Phibro LLC, the commodities trading arm for Citigroup Inc. (C), has booked two supertankers to hoard crude oil supplies. Phibro recently stationed the 1-million-barrel carrier ‘Ice Transporter’ off the coast of Scotland and the ‘Ashna’ waits patiently on the U.S. Gulf Coast. Assuming they capture the entire $8.83 a barrel in excess profits we cited in our example, that’s a cool $8.8 million in the bank, just from the Ice Transporter cargo alone.

    Based on my experience, traders tend to run in packs, so it’s highly likely that all the usual suspects are involved including most notably Morgan Stanley (MS), which owns half of tanker group operator Heidmar Inc. and Goldman Sachs Group Inc. (GS), which executes commodities trades and structures related deals through J. Aron & Co.

    As many as 80 million barrels of crude are being stored at sea around the globe, according to Frontline Ltd. (FRO), the world’s largest owner of supertankers. That’s nearly enough to supply the entire world’s demand for a day.

    As for what caused the super contango, the most common and widely accepted argument is that falling global demand has caused a current glut in supply that will be rectified by production cuts by the Organization of Petroleum Exporting Countries (OPEC) later this year. That’s certainly plausible and there is no shortage of data to support this contention.

    ‘That’s really what they’re betting on,’ said Opportunities in Options‘ Paul Forchione, a veteran trader with 30 years in the commodities markets. ‘A significantly higher price for the deferred contract month in excess of storage and insurance costs typically means traders expect demand to grow in the future.’

    In his experience, Forchione said that ‘this situation is hardly the panacea that everybody thinks it is because it’s hard to put a limit on how far out of whack prices can get.’

    However, there’s also another plausible explanation that seems entirely likely, based on conversations I’ve had with traders, officials and company officers in the oil business all around the world.

    Basically, the super contango we’re seeing now could suggest that future pricing is as much about the fear of supply interruption as it is about present demand dropping. And that’s entirely logical given the constant state of warfare in the Middle East, threatened production in Africa, an unsteady South America, and China, which is structuring oil-supply deals with rogue nations as fast as it can.

    I know from having addressed crowds of investors all over the world that this seems impossible, but at a time when China and India, for instance, are doing everything they can to stave off a global recession, it’s certainly not inconceivable. Moreover, if this is even remotely true, as a growing trail of evidence suggests, then the present super contango could also imply that traders believe oil will be increasingly hard to find, refine and transport in the months ahead. That, too, suggests higher prices to come

    Now for the million-dollar question: What can investors do about it?

    The most obvious choice for investors who think prices will indeed be higher come next June is to buy any of the half dozen oil-related ETFs. That includes The United States Oil Fund LP (USO) or iPath S&P GSCI Crude Oil Total Return ETF (OIL).

    The problem, of course, is that the spreads companies are counting on for profits could drop rapidly between now and then. This would force companies currently hoarding oil to begin dumping it, thereby reinforcing even lower prices going forward. There is also the possibility that OPEC production cuts never happen, or are ineffective, which would also point to lower prices.

    History suggests that far safer bets include mid-process transportation companies like TeeKay Corp. (TK) or land-based alternatives like Kinder Morgan Energy Partners LP (KMP). Both pay healthy dividends that can help stave off a personal recession no matter what happens with oil prices. That’s always important in rough markets.

    For futures-savvy investors, there’s an even more direct bet. Data shows that ‘mean reversions’ are particularly powerful phenomena when it comes to commodities, so the fact that spreads have risen to all-time highs suggests that it’s only a matter of time before they reverse. One way to potentially capture that would be to buy March futures while selling June futures.

    Risk management is paramount, regardless of which path investors choose. Super contango sounds to good to be true and we all know the old adage: If it sounds too good to be true …

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    Keith Fitz-Gerald, Time Trader Pro ,

  • Are U.S. Stocks Nearing the “Sweet Spot” for Double-Digit Gains?

    Posted on January 16th, 2009 Keith Fitz-Gerald No comments

    Are U.S. Stocks Nearing the “Sweet Spot” for Double-Digit Gains?

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    With the way stocks are being whipsawed, investors often ask me how to tell when the market is ready for a rebound. While there’s no way to ever be 100% certain, I usually just let history be my guide.

    And history has a very interesting story to tell right now.

    Just take a look at the following chart. Since 1927, the markets have shown beyond a shadow of a doubt that the worst of times for the U.S. economy have literally proven to be the best of times for stocks when it comes to choosing a time to buy.

    The best buying opportunities are typically found when the market is represented by points inside the box located in the lower left-hand corner of the chart. This is when valuations are most favorable, as they were in 1932, 1941 and 1982.

    When the markets are anywhere above and to the right of the box, they are statistically more at risk of falling than rising. There are naturally times when the markets rise from points above the box, but those are the historical exceptions.

    For instance, take a particular note of March 2000, represented by a point way up in the right-hand corner. Take a minute to drift back in time and recall just what everybody was saying then about U.S. President Bill Clinton’s “New Economy,” the Dow Jones Industrial Average heading to 15,000 (and beyond), the Internet-technology boom, etc.

    Everyone was encouraged to buy in. One of the reasons why I refused to buy into that – pun absolutely intended – is because of this valuation chart. I could see that the markets were ludicrously overvalued at that time versus any other period going all the way back to 1927.

    The markets certainly aren’t that overvalued now.

    GDP Declines Bode Well for the Dow

    Interestingly enough, this data is supported from another angle using gross domestic product (GDP) data. Since 1947, of the 11 times the quarter-over-quarter change in GDP was a minus 4% or more, the Dow was higher by an average of 25% one year later and 35% two years later.

    What the data in this second chart tells us is that the latest projections suggest we’re right in line with historical norms, given that economists expect that the U.S. economy suffered a mind-numbing decline of 4.35% in the final quarter of last year. When everyone else believes the worst; that’s when you should be buying.

    Obviously, we have to take this kind of phenomenon with a grain of salt, but any time one data source corroborates another, it’s worth noting – particularly when there are companies out there that meet our very strict investment guidelines.

    One company in particular that I’m jazzed about is pretty phenomenal. Just today, in fact, I released a report on it to the online readers of The Money Map Report. Let me give you some specifics.

    I like this particular company because it operates in a “boring” section – and yet the numbers surrounding this company are about as exciting as they come.

    It’s got a $4.4 billion market cap, and it’s beaten five of the last six earnings estimates by an average of 32.35%, despite horrific market conditions

    In fact, anytime I consider a stock as an investment candidate, I want to see expanding year-over-year sales and earnings figures. More so than any other indicator, I find that what a business does for and with its customers is a solid indication of how management’s handling things.

    And by all accounts, this company’s score is “darned good.” Quarterly year-over-year revenue has expanded 33.6%, while earnings have increased 49.5%.

    The bottom line: The stock is undervalued. And it pays a steady dividend, so we’ll be rewarded even while we’re waiting for the rest of the market to recognize this company’s inherent worth.

    I’ve just released all my research on this company today (Friday) in our current issue of The Money Map Report, which is for subscribers only. But I’ll also be reporting on other opportunities like this in the weeks ahead. I’m hoping to see more of them.

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    Keith Fitz-Gerald, Time Trader Pro , , ,

  • If You Want a Forecast for China’s Economy, Ask a Hairy Crab

    Posted on January 8th, 2009 Keith Fitz-Gerald No comments

    If You Want a Forecast for China’s Economy, Ask a Hairy  Crab

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    This is the time of year in which many The Geiger Index - Keith Fitz-Gerald investors really start to study corporate earnings, jobless statistics and all sorts of other state data in an effort to divine what’s next for China.

    But I simply prefer to head for the Wan Chai Street Market in Hong Kong, or the Temple Street Night Market across the harbor in Kowloon, and check on hairy crab prices as we approach the Lunar New Year.

    These delectable little guys are usually served steamed, with a splash of soy sauce. When China’s booming like it was in recent years, shoppers are hard-pressed to find a store that can keep them on the shelves. And at 720RMB, or $420HK (about $60 U.S.), that’s no small feat for a palm-sized morsel. They’re expensive, and taste great.

    A hairy crab, if you’ve never seen one, is usually a bit smaller than the Dungeness crabs many Americans are more familiar with. These freshwater crustaceans start to fatten as soon as the autumn chill cools the Yangtze River Delta. That adds to their taste and desirability.

    When China’s feeling pinched, hairy crab sales drop and prices plummet. At the moment, hairy crab prices are off by more than 80%, which is a steeper drop than during the Asian Financial Crisis a decade ago, or during the SARS epidemic in 2003. After the best sales in history last year, that’s significant because of what falling hairy crab sales imply about the state of China’s economy at a time when it is struggling to stave off the effects of a global recession and growth may drop to the slowest pace China’s seen in nearly a decade.

    Since hairy crabs are a luxury both in the home and at restaurants, the falling prices suggest that people are “eating cheaper.” Rather than ordering up haute cuisine – including hairy crabs – at such restaurants as Cuisine Cuisine in the International Financial Centre (IFC) Tower, or the famous Jumbo Floating Restaurant in Hong Kong Harbor, most Chinese are eating “cheap” and seem to prefer smaller, more modest places these days.

    They’re also apparently “shopping cheap,” too. Call it a Chinese version of the “Wal-Mart Effect” (WM), but that’s what’s happening as savvy Chinese consumers downshift. They’re still spending – as reflected by Chinese retail sales figures, which suggest year-over-year growth of 21% in 2008 – but they’re spending differently.

    Nowhere is this change more evident than in those stores where luxury items are sold. Shanghai and Hong Kong store managers I’ve spoken with recently told me privately that such big-ticket brand names as Dior, Chanel, Hermes and others aren’t moving as fast as they were a year ago.

    Knock-offs, of course, are still flying off the shelves.

    On a related note, many Chinese merchants are actually refusing to take credit cards these days, at least from Chinese consumers. Don’t think for a minute this is limited to convenience store items, either. Big-ticket items like tours and holiday excursions that have long been paid for on credit are now cash or check only as many travel companies – like Hong Kong’s Sincere International Travel Service Co. Ltd. – look to avoid getting caught short.

    Many merchants say that banks are hoarding cash and delaying payments on personal credit cards. While no banks would comment officially in response to my inquiries, it’s clear that Chinese lenders are dumping riskier credit-card holders just like their Western banking brethren. Only faster.

    Unlike their Western cousins, for whom credit has been a bonanza, Chinese banks have only relatively recently gotten into the credit game after being so cash-centric that the rest of the world’s bankers viewed China’s lenders as antiquated. But now that generation of cautiousness is paying off.

    Chinese banks are apparently also going the extra mile to ensure they don’t get burned. Lenders are making credit-card transactions as unattractive as possible for the merchants who process the charge slips and they’re doing so by using the most effective tool of all – delayed payments.

    Only a year ago, most banks paid credit-card transactions in 14 days. But now, according to reports by CNN and other news outlets, it’s not uncommon for a merchant to have to wait 20, 40 or even 90 days to get paid. And that obviously affects cash flow at a time when luxury businesses in China are already under pressure.

    This all speaks to something we at Money Morning have talked about repeatedly over the past 12 months: Investing in China is not about luxury as so many investors have mistakenly thought. It’s about the basics. To be sure, luxury items and top-shelf brands have enjoyed a heyday in China that coincides with the dramatic growth spurt the country has experienced in recent years. But luxury brands are hardly the key to steady growth and profits over the long term.

    That mantle, instead, belongs to much more basic industries, such as power-generation, railway-and-infrastructure construction, water filtration, and pollution control. All will benefit substantially from China’s $583 billion stimulus package, which is designed to fuel growth that not only benefits the economy, but also staves off social unrest, which is what Beijing’s power elite fears the most. To China’s Politburo, running out of power is a far more significant risk than running out of Gucci.

    So for investors who are interested in grabbing the best that the Red Dragon offers while avoiding the risks there, hairy crabs are yet another harbinger of where and how to invest in China in 2009.

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    Keith Fitz-Gerald, New Rules, Time Trader Pro , , ,

  • Unprecedented Volatility Will Continue to Rock the Stock Market in Advance of a Possible Rebound in Mid-2009

    Posted on December 30th, 2008 Keith Fitz-Gerald 11 comments

    Unprecedented  Volatility Will Continue to Rock the Stock Market in Advance of a Possible  Rebound in Mid-2009

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    In the 20 years I’ve been creating stock-market forecasts, I’ve never seen such a contradictory set of forces at work in the markets all at one time. I could just as easily make the case that we’re finally nearing a bottom, as I could that we’re in for protracted downturn punctuated by sharp, quick drops.

    The only question in my mind is what shape an eventual recovery will take, for I see three possibilities:

    • A “U,” with a slow, methodical reversal that gradually transitions into a market rebound.
    • A “V,” with a quick, sharp reversal that marks the start of a powerful rebound.
    • Or a sideways “hockey stick,” in which the downward trend ends sharply – but without the immediate upward surge in stock prices that would constitute a strong rebound.

    My proprietary analysis and historical precedents both suggest the “hockey stick” is the most probable scenario. At a time when earnings are slowing and all sorts of red flags are flying, there are still too many unknowns to predict a U-shaped or V-shaped rebound.
    Therefore, we believe investors will be best served filling their sails with the winds from the world’s most-powerful trends than they will be by trying to catch the intermittent gales. This is a market that will be dominated by large global trends – and the blue chips that follow them – particularly at a time when the so-called “economic cycle” doesn’t matter much.

    Position Yourself to Profit

    A properly structured and globally diversified portfolio using the 50-40-10 allocation model (50% “base-builder” foundation investments, 40% global growth and income plays and 10% “rocket rider” speculative investments that will perform well in a recovery) we recommend in The Money Map Report – our affiliated monthly investing newsletter – will prove to be an investor’s best friend. And the reasons for that are as simple as they are compelling:

    • First, a properly structured portfolio has built in safety brakes that keep us from making overly risky decisions.
    • And second, while this allocation model was constructed to minimize our downside in markets such as the one we’re navigating right now, it also positions us to benefit when the rebound eventually gets under way.

    During the past year, we’ve repeatedly urged our readers to make sure two other elements are part of their portfolio: Dividend-paying stocks and specialized “inverse funds” that gain when the markets decline.

    While dividends are important in any market, they’re downright crucial now because they add to returns during market rallies and help offset losses during market declines. And our commitment to inverse funds was rewarded during the whipsaw month of October: During a month in which the Standard & Poor’s 500 Index lost 16.8%, the Nasdaq Composite Index shed 16.3% and the Dow Jones Industrial Average dropped 13.9%, all 10 of the best-performing exchange-traded funds (ETFs) were inverse funds, which boasted one-month returns ranging from 36.4% to 66.6%, Thestreet.com reported last week.

    Now those are admittedly highly remarkable returns – and clearly aren’t the norm. But it does demonstrate the point we’ve been making: It pays to protect y our downside even as you position yourself for gains. And not only do such investments as inverse funds hedge our downside, they smooth out our overall portfolio volatility and help calm roiled waters.

    On a more positive note, we’re now getting to the point where true value is finally being revealed, after years of “irrational exuberance.”
    But the reality is – and this is hardly new information for most investors – that global markets in general (and the U.S. stock market in particular) remain fragile, and we expect them to remain that way as long as policymakers continue to interfere with their ability to function freely.

    Some readers will no doubt take issue with this, believing that the responses of the U.S. Federal Reserve and other central banks have been necessary. While we respect that opinion, we must also point out that the markets have a remarkable history of sorting out problems on their own – if left to their own devices. However, that’s a largely academic discussion that we’ll leave for another time because the government has already charted a course it believes is prudent.

    Even if the world’s central bankers get their act together, the damage has largely been done. What’s more, the various bailout packages – especially the $700 billion U.S. banking bailout – while well intentioned, are almost certain to have more than a few unanticipated consequences.

    Topics to Watch

    The reality is that these bailout programs remain with us, meaning we must factor them into our efforts to scout out profit opportunities. And on that point, we see five primary areas of change and opportunity:   

    • The U.S. Dollar: By pumping an estimated $3 trillion into the global financial system, the U.S. government is setting the stage for the mother of inflationary conflagrations. According to classic economic theory, the greenback should be in an actual freefall right now – especially in the current low-interest-rate environment, where there’s the potential for still more rate cuts and for additional capital outlays by the U.S. government. And that’s just with the current administration. President-elect Barack Obama has made it clear that if an additional stimulus isn’t announced before he takes office, he’ll make that one of his first official acts. What’s saving the dollar, at least for now, is that there’s so much global uncertainty that the dollar is retaining its reputation as a “safe-haven” currency. And, for now, at least, a safe U.S. dollar trumps inflationary concerns. However, should global investors regain confidence for whatever reason, expect the dollar to decline sharply.
    • Oil: Many people are focused on declining oil prices as a function of a perceived slowdown in global demand. We think that’s an erroneous analysis for three key reasons. First, oil is still largely priced and traded in U.S. dollars. That means that as the dollar has risen, oil has become correspondingly cheaper. In other words, much of the price decline we’ve seen can simply be attributed to a rise in purchasing power associated with a stronger dollar. Second, China, India and other newly capitalist (and still-reasonably robust) economies are still increasing their oil consumption at a rate that more than offsets the decline in consumption we’re seeing here in the United States and in other developed markets. And third, Brazil aside, there hasn’t been a major new discovery capable of offset global demand on anything more than a temporary basis for more than 30 years, and most major oil fields are in decline or soon will be. Increasing demand and diminishing supply are clearly bullish influences over the longer term. More immediately, however, a stronger dollar negates this and may well keep oil under $100 a barrel for much of 2009. Obviously a terrorist attack would change the ballgame significantly, meaning we could see a spike to levels exceeding our multi-year target price of $225 a barrel. A year ago at this time, we called for oil to spike well up over $100 a barrel, and touch $150, which it essentially did. Even with recent price declines, some energy-industry insiders are starting to subscribe to our bullish outlook: The Paris-based International Energy Agency (IEA) last week projected that long-term oil prices would reach $200 a barrel (although we think that will happen much sooner than the IEA does).
    • Commodities: The story is much the same for commodities, in general, and we expect that longer-term investors will be amply rewarded. More immediately, the popular – though erroneous – assumption that a global slowdown will negate demand is driving prices lower, and may continue to do so for the next six months. Gold will be the most obvious casualty in this arena, as hedge-fund-redemption requests and margin calls continue to mount, which is why we expect the price of the yellow metal to remain lower far longer than most people expect (We’ll focus specifically on gold in an upcoming installment of the “Outlook 2009” series). When it does rebound, however, the returns will be high.
    • Global Markets: There’s no doubt that the global markets have taken their share of lumps along with their U.S. counterpart in recent months. But we don’t expect them to suffer forever. Countries with high cash reserves as a percentage of gross domestic product (GDP) – such as China, India and Brazil – are becoming less dependent on the fractured U.S. consumer almost daily, and the economic decoupling we’ve seen developing for several years may really take hold in the New Year. This stands in direct contrast to the situation a decade ago, when the Asian Rim and South America were economic train wrecks and the United States and Europe held all the cash. Companies with significant global exposure to the Asian Region, Latin America and Europe – in that order – remain the best bets for relative safety and growth in 2009.
    • Stocks in General: Many investors are questioning the wisdom of being in stocks at all. While we certainly understand the pain that sentiment is based upon – and are hurting, too – it’s important to remember that the last time stocks really performed this badly was during the 1930s. Investors who decided to “get out” entirely then missed the investment opportunity of their lifetime. Don’t make the same mistake. Data shows, unequivocally, that investors who buy when the world is going to hell in a hand basket –think 1932, 1942, 1982 and 2003 – enjoy the largest returns. That’s even true if you’re “early,” and buy ahead of the specific market bottom. However, history also demonstrates that investors who pile in at the market’s peaks – such as 1928, 1969, 1999 and 2007 — tend to incur the worst returns.
    • Global Stocks in Particular: Led by cash-rich China, we expect global blue chips to remain the best relative bets for safety, income and appreciation potential in the New Year. We are especially focused on companies involved with infrastructure projects and with firms that derive substantial portions of their revenues from Asian consumers. The first is a no-brainer. According to the latest studies from a variety of sources, planned global infrastructure expenditures in this area exceed $40 trillion by 2030. There is not a bigger, more unstoppable trend on the planet today. If you want proof, notice that a big portion of China’s just-announced half-trillion-dollar stimulus package is devoted to infrastructure projects. Infrastructure companies there will certainly benefit. So will consumer-products firms that are positioned to benefit from the rise of an increasingly Asian consumer base, which boasts significant savings and pent-up demand. Many of the best companies are beaten down to the point that they now feature single-digital Price/Earnings (P/E) ratios – lower than we’ve seen in decades. Some are actually trading for less than cash value, despite a strong history of growth. And the companies we’re studying have solid cash flow – and excellent prospects of maintaining it.

    Now for the $64,000 question – when could we see a rebound?

    We don’t know for sure. Nobody does. History demonstrates that the first and second years of any newly elected U.S. president’s term are almost always problematic. When taken in isolation, we could see a scenario where this is countermanded by President-elect Obama’s planned stimulus, but given the potent combination of flagging earnings and slowing U.S. growth, we’re leery of doing so. [For a story that outlines what an Obama stimulus package could look like, check out this related story on the outlook for the U.S. economy elsewhere in today’s issue of Money Morning.]

    On the other hand, for a variety of reasons, history also suggests that if we are to see a rebound, however nascent, the probability is highest for a resurgence starting in the middle of next year. First, since the 1970s, the time between the first and last market lows in any given bear market is an average of seven to eight months. If historical trends hold true, this suggests we could see a bottoming out by the middle of next year. That’s consistent and plausible, especially since other data shows U.S. recessions, on average, last 14.6 months – which also points to a bottoming out in late spring or early summer.

    But the biggest indicator of all that we may see a bullish rebound in late spring or early summer – however slight – is admittedly based on emotion. Literally. Small investors have fled the stock markets in droves, and so far they’ve yanked more than $175 billion from the markets, with nearly 50% of that coming out during October alone. Granted, this is a mere 3.2% of the $5.5 trillion invested in stock market funds, according to Forbes, but it’s the first year that net equity flows have been negative since … a drum roll please … 2002.

    History shows that small investors may be the most telling of all Contrarian indicators. According to TrimTabs, the Investment Company Institute and our own proprietary research, individual investors have a remarkable habit of rushing in near market tops and fleeing near market bottoms.

    That means that long-term investors seeking the best wealth-building opportunities should find the immediate price declines we see ahead to be some of the most compelling buying opportunities of their investing lifetimes.

    Now for the caveats – and you knew this was coming – we see three wildcards in 2009, and any one of them could prove to be a joker:

    • The continued de-leveraging of hedge funds and other financial institutions.
    • More credit-default-swap valuation problems.
    • And unknowns associated with the ongoing U.S. and global-economic-system bailouts.

    There are still huge questions regarding who owes what to whom, how large the debts are, and exactly who’s going to get what help and when. History shows that the most effective bailouts are those that recapitalize institutions and that allow the weak to fail, which is why we are especially leery of the U.S. government’s plan to acquire bad debt while rewarding weaker institutions that should be put out of their misery.

    What’s more, as a Money Morning investigative story demonstrated, many banks are using the government bailout money as takeover capital, and not to boost their lending, which at least would have had an expansionary benefit for the U.S. economy. With most of the bailout programs, and through no fault of their own, U.S. taxpayers and investors have been caught in the middle – or left on the sidelines altogether.

    The Outlook 2009 Action Plan

    For investors who want to get a head start, it’s important to bear in mind that the markets tend to begin their rebound in earnest anywhere from two months to six months before an actual economic bottom. While that doesn’t suggest going “whole hog” into stocks, it does speak to the need to take some steps now to get ready. Here are the top moves to make now:

    • Rebalance Now: As markets have declined, many portfolios have done out of kilter, too – not only in terms of value, but in terms of balance. And that lack of balance can seriously dampen returns, even as we await the market recovery – and even more so once the market begins to rally. It’s far harder to catch a moving train than most investors think.
    • Think Safety First: There’s no need to rush into the markets. It’s not clear we’ve hit bottom yet. Keep your powder dry for the better days and easier trades we see developing ahead, while bargain-hunting for those stocks with true upside, and that are positioned to capitalize on the strongest global trends.
    • Spread your buys over several days: When you’ve found something to buy, wait for a particularly bad day, then place your order in the last half an hour of trading. Leverage the lower prices (and maximize your returns) by spreading your purchases over several days or weeks. That way you won’t get tripped up by committing your entire nest egg when the market looks cheap and will probably get cheaper.
    • Go Global: China is still on track for 9.6% growth this year and may, in fact, slow to a “mere” 8.0% next year. Even that reduced growth rate will probably be about eight times the growth rate of the U.S. economy – if we’re lucky. Consider adding exposure to the Asian Rim as part of the rebalancing process, or as a primary focus once the recovery begins in earnest.
    • Get Inverted: Continue to use specialized inverse funds to hedge downside risk. We’re not out of the woods by a long shot.
    • Stop Your Losses – with Stop Losses: By all means include trailing stops to control small losses before they become catastrophic ones. This market could easily fall further before it gives way to the rally that history suggests is in the making.

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    Keith Fitz-Gerald, Outlook 2009, Time Trader Pro , , , ,

  • U.S. CEOs Could Learn From Their Asian Counterparts

    Posted on December 23rd, 2008 Keith Fitz-Gerald 21 comments

    U.S. CEOs Could Learn From Their Asian Counterparts

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    Judging from recent reports that JP Morgan Chase & Co. (JPM) Chief Executive Jamie Dimon and Citigroup Inc. (C) board member Robert W. Rubin will forgo bonuses this year, it appears that at least some U.S. executives are starting to change their habits, as we’ve long suggested they should.

    Just yesterday (Monday), in fact, U.S. heavy-equipment giant Caterpillar Inc. (CAT) announced it was cutting executive compensation by as much as 50%, because of weakening global demand.

    But let’s be very clear: U.S. corporate leaders still have a long way to go, and many lessons to learn.

    In fact, American executives could learn a thing or two from some of their counterparts abroad. Just look at Haruka Nishimatsu, CEO of Japan Airlines Corp for example (OTC ADR: JALSY).

    Each morning, Nishimatsu gets down to business immediately after his morning commute to the office – on a city bus.

    His desk – like those of all the other Japan Airlines employees – sits in the middle of an “open office.” I know this from personal experience, having sat at a desk just like that when I’ve worked in Japan over the years. He eats lunch in the company cafeteria and hopes – like all Japanese employees – that he’ll have time to eat his meal before it gets cold as he stands in line waiting to pay, says CNN’s Kyung Lah.

    This hardly sounds like the life of a corporate CEO, especially when you consider that JAL is one of the world’s top airlines. Nor does the fact that when JAL cut back and asked many of its employees to take early retirement, Nishimatsu first eliminated every one of his own corporate perks, including his own pay – which, at a mere $90,000 (U.S.), is below what JAL’s pilots get paid.

    Nishimatsu noted in the CNN interview that many of the affected employees were about his age, 60, so he “thought he should share the pain with them.”

    Obviously, that’s very different than in the United States, where top executives regularly make tens of millions of dollars a year, and where some compensation packages actually eclipse the hundred-million-dollar threshold. And some of the top earners are the very same executives who “managed” their companies into financial oblivion – and who took their trusting shareholders along for the ride.

    If you want to see the latest example, just watch the parade of corporate-jet-riding, custom-suit-wearing corporate “beggars” that have been appearing (hat in hand) before the House Financial Services committee lately and you’ll see what I mean.

    The pay gap between the boardroom and the factory floor – already a longtime topic of controversy here in the United States – has widened to the point that it’s become absolutely staggering. According to a survey conducted by the non-profit group, United for a Fair Economy, CEOs of large corporations made an average of $10.5 million in 2007, which is 344 times the wages of the average U.S. worker. The Economic Policy Institute puts it at only 275 times higher, which is still outrageous when you consider that the average working stiff won’t see in his lifetime what these guys have made in a year lately [To see how that disparity has grown over the past four decades, look at the accompanying chart, “Leaders vs. Workers”].

    Capital One Financial Corp. (COF) CEO Richard D. Fairbank took home a cool $73.1 million last year, which is 1,456 times the median household income of $50,233 for taxpayers footing Capital One’s $3.55 billion bailout, according to The Corporate Library.

    In Japan – and throughout much of Asia, for that matter – there’s a much more balanced approach, with CEOs more commonly making only 10 times to 15 times more than their base level employees.
    “Businesses that pursue money first fail,” Yoshichika Terasawa, a Singapore-based managing director for the Japan External Trade Organization (JETRO) told me when we spoke at his home in that Southeast Asia city-state earlier this year. “Companies that have their employees in mind tend to do better longer and recover faster. We learned that in Japan during our own bubble economy.”

    The numbers seem to bear out Terasawa’s assertion. According to a USA Today study, the 10 best-paid CEOs made more than half a billion dollars collectively. Yet, half the members of this stratospheric club were actually heading companies whose profits shrank dramatically.
    The poster boy for this club could well be General Motors Corp. (GM) CEO G. Richard “Rick” Wagoner Jr., who closed four plants and posted a $39 billion loss in 2007, a period in which his company’s stock cratered 19%. But in the face of this financial mess, Wagoner’s compensation jumped 64% to reach $15.7 million.And GM apparently had a little something set aside; after all, Wagoner was able to take a corporate jet to Washington to plead for a taxpayer-funded bailout [For a breakdown on the top-earning CEOs of 2007, take a look at the accompanying graphic, “Top of the Charts.”]
    .

    The numbers, when they’re in for 2008 will probably be more egregious.
    JAL’s Nishimatsu clearly understands what his U.S. corporate brethren do not. As the global economy has worsened in recent months, the Japanese executive recounted how he’s dug into his savings like the rest of us have had to, in order to deal with life’s challenges.
    “The air conditioner broke, the water heater … and my car,” Nishimatsu said. “My wife is still telling me this is all your fault.”
    We can certainly sympathize with him. But clearly, he can sympathize with us. Making the effort to relate to what employees and customers are feeling during such a difficult stretch is very important: It fosters pride in the work force, loyalty from customers and in long long-run, will also win over investors. My guess is that we’ll all be the most sympathetic and supportive of companies led by CEOs like Nishimatsu.
    And that might be just what’s needed to get out of this mess. [For additional coverage of the executive compensation controversy, check out this related story in today’s issue of Money Morning that details how the 116 banks that are receiving billions in taxpayer-provided bailout money this year actually paid out $1.6 billion in compensation and benefits to their top executives last year].

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    Keith Fitz-Gerald, Time Trader Pro , ,

  • Stocks May Not be Cheap Enough, Yet; And Here’s Why

    Posted on December 19th, 2008 Keith Fitz-Gerald No comments

    Stocks May Not be Cheap Enough, Yet; And Here’s Why

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    For many investors, a low Price/Earnings (P/E) ratio is a sign of value.

    But don’t you bet on it – at least, not yet.

    According to Michael T. Darda, chief economist for MKM Partners LLC, analysts have overestimated earnings by an average of 30% to 35% in the last three recessions. For millions of investors who use low P/E ratios as a litmus test for selecting their investments, that’s going to be a rather unpleasant shock.

    If Darda is right, and our research seems to suggest he is, so-called “cheap stocks” may not be all that cheap. For proof, we can turn to some plain-old high school math. P/E ratios are calculated by taking the price of a stock (the numerator, or the “P”) and dividing it by earnings per share (the denominator, or the “E”). The higher the denominator, the lower the P/E ratio and, by implication, the cheaper a stock appears.

    However, if higher denominators can make stocks appear “cheap,” then the opposite is true, too, and that suggests that stock prices may have a lot farther to fall – despite the fact that they’ve already tumbled 40% or more.

    Just how much farther is anybody’s guess, but the outlook is not good.

    For instance, according to Forbes writer James Clash, “more than a year into the market downturn that threatened Morgan Stanley’s (MS) survival, the 17 analysts covering the company cut their 2009 mean earnings estimates by 36% to $3.63 per share.” Given Darda’s observations, there may be another 35% to go, which would put total expected earnings cuts at 71%.

    That sounds harsh, but it may not be out of line. Thompson IBES reports that the analyst community as a whole has cut 2009 earnings expectations by only 7.5% for the Standard & Poor’s 500 Index. If they are to be believed, that means that the analyst community expects the average S&P 500 company will have to grow earnings by 15% next year to $91, according to Clash.

    We don’t know about you, but a time when recessionary flags are flying, we have a hard time buying that (pun absolutely intended).

    That’s why – at the risk of igniting an e-mail firestorm – we point out that analysts are paid to have opinions and a huge body of evidence suggests that they’re strongly encouraged to make them bullish. Not only is this a cozy relationship for investment bankers in general, but it has historically helped Wall Street generate huge commissions from an anxious retail investing public that is desperately seeking good news. This bullish predisposition may be especially true at a time when investors are not inclined to buy – and with good reason.

    Compounding the problem is the fact that many analysts focused on specific industries or companies tend to become quite myopic. Far too many don’t think outside the box and, as a result, are all too frequently surprised when macro-level events come crashing in on their little world and down on the companies they follow.

    Investors who rely heavily on Wall Street analyst estimates are, in effect, driving down the highway using only their rearview mirror. The results are all too predictable.

    Among the more infamous examples of these errant estimates was the group of analysts who, back in 2001, continued to recommend Enron Corp. stock all the way into bankruptcy and congressional hearings, based solely on their own “optimism.” Only when Enron shares were trading at less than $1 did the majority of analysts change their recommendations to a “hold.”

    When it comes to Wall Street, the fox clearly does guard the financial hen house, so to speak.

    In the interest of fairness, we should mention that there were “accounting irregularities” in the Enron case. But that really shouldn’t let anybody off the hook.

    What’s happening now – and why we’re leery that things may not be as they seem – is that overall business and economic conditions are deteriorating faster than management is willing to publicly acknowledge (although we’re now watching these same management teams slash work forces and shutter plants at a rate we haven’t seen in years). And since management “guidance” (the sarcasm you detect is intended) is what drives and shapes Wall Street earnings estimates, this is why things are probably going to get worse before they get better. The earnings figures used in most P/E calculations haven’t yet been reduced.

    As for the ratings agencies such as Standard & Poor’s, Moody’s Investors Corp. (MCO) and A.M. Best Co., these, too, are problematic when it comes to the earnings and the ratings that help drive them. Supposedly independent, it’s been common knowledge for years on Wall Street that firms wanting higher ratings need only coddle the agencies using a combination of fees and information. Of course the agencies will deny this but history suggests that’s like the pot calling the kettle black.  Historically, for example, Moody’s, S&P and Fitch Ratings Inc., have each earned huge amounts of income from fees being paid by the issuers whose credit they’re supposedly rating. That’s changing, of course, but as the credit crisis has highlighted so aptly, probably not fast enough.

    So what does work?

    P/E ratios are a start. But that longstanding indicator should be regarded as a relative measure of potential price and performance rather than the do-all stock-screen selector so many investors utilize them as.

    When we analyze a company, we prefer to see expanding sales, advancing earnings and plenty of cold hard free cash flow. There’s an old saying on Wall Street that “nobody ever went broke on accrual accounting,” but clearly plenty of companies have figured out lately that they can go broke without cash. The best example may well be Detroit’s Big Three, which are grappling with this seemingly new reality even though we, as individuals, deal with it every day. As my six-year old son recently stated: “No cash … no dinner.”

    One other excellent indicator is a so-called “PEG” ratio (the P/E divided by the growth rate) of less than 1.0. While it’s more commonly viewed using 12 month trailing earnings, we find it much more stable when viewed against a historical stream of data that’s a decade or more in length. Not only does this help screen out the volatility associated with much shorter time periods, but we find that companies with low PEG ratios calculated in this manner seem represent good value over the longer term.

    Especially when compared to a deflated “E” – earnings.

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    Keith Fitz-Gerald, Time Trader Pro , , ,

  • Pledge to Hedge: Three Ways to Lock in Low Gas Prices Right Now

    Posted on December 17th, 2008 Keith Fitz-Gerald 8 comments

    Pledge to Hedge: Three Ways to Lock in Low Gas Prices  Right Now

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    Many of my neighbors here in Oregon are enjoying the big decline in gasoline prices, particularly those who still own SUVs, pickup trucks or any of the other fire-breathing, piston-clanking monstrosities I’ve seen on the road recently.

    And no wonder. Gasoline prices in our neck of the woods have fallen between 60% and 70% since July, when oil closed at a peak price of $145.29 a barrel. Here in Oregon, that means that my wife and I don’t feel like we’ve been mugged every time we fill up.

    But what happens when the prices start going up again? Global demand for oil will fall this year for the first time since 1983 as the world financial crisis saps demand, the International Energy Agency said a week ago. That has some people believing that prices will remain low.
    But I wouldn’t bet on it – at least not for long.

    The Organization of Petroleum Exporting Countries (OPEC) is making loud noises that it wants to see $75 a barrel again soon, which would represent a 70% increase from the $43.60 a barrel where oil closed yesterday (Tuesday). OPEC, supplier of more than 40% of the world’s oil, is ready to make a “big” cut in supplies when it meets in Oran, Algeria, today (Wednesday), Venezuelan Oil Minister Rafael Ramirez told journalists.

    How much of a production cut we’ll see is anybody’s guess, depending on who does the cutting and who actually abides by the agreement over time. But we’ll know very shortly.

    Russia recently announced, after years of going it alone, that it wants to actually join OPEC. Now OPEC has asked Russia to cut oil output by between 200,000 and 300,000 barrels a day to help revive prices, OAO Lukoil Chief Executive Officer Vagit Alekperov said in Moscow on Monday. And Russia may well do just that.

    A price of $60 to $80 a barrel would be consistent with a global production cut of about 2.5 million barrels, and that’s a figure apparently supported by OPEC representatives we spoke to.   Leonid Fedun, OAO Lukoil’s deputy chief executive officer, noted in a recent Bloomberg News report that “there is a consensus [among members] to reduce production.”

    This highlights something that’s often missed in the Western media, where the price of oil is typically associated with the price of gasoline and how that price impacts driving habits. According to CNN, MSNBC and a whole host of others, evidently that’s what matters to us.

    But in OPEC-producing countries, it’s a different story. There the price of oil is more typically associated with external trade relationships and hard currency requirements that are policy level decisions often made at the expense of individual concerns. And I don’t have to remind you that most OPEC member countries don’t exactly specialize in freedom of choice, so the odds are high that what the energy ministers want, the energy ministers will get … but that’s a story for another time.

    Here’s one other point to consider: With all the media’s focus on OPEC, there’s been little mention of China, India and the whole host of emerging markets that are still experiencing double-digit growth in oil demand. That’s not going away.

    The bottom line here is that it would behoove interested investors (and people who like to drive less fuel efficient cars) to hedge any potential future rise in gasoline prices sooner rather than later. Here’s one quick and dirty way to do it.

    If you drive 20,000 miles a year and your car gets 30 miles to the gallon at a time when fuel costs $1.75 a gallon, you are looking at an annual fuel bill of $1,166.67. If OPEC gets its wish and oil rises by 70%, gas prices may rise in tandem. Therefore, buying the equivalent share value of your projected annual fuel expenditure in such exchange-traded funds (ETFs) as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL) or the United States Gasoline Fund LP  (UGA) could be just the ticket.

    As prices rise, so, too, will the value of your investments. If prices fall further, you’ll obviously lose money, but you’ll be paying less at the pump at the same time.

    Granted, what I am proposing is not a perfect hedge. Among other things, there are potential capital gains to contend with when you sell 12 months from now – taxes, transaction costs and a whole host of other variables that could come into play. At the same time, you could simply alter your driving habits, which, of course, would change the value of your calculations midstream.

    None of that really is material, though. Hedges are never perfect.

    But they do offer you a chance of “being in the neighborhood” when it comes to protecting your wallet from what could be vastly higher oil prices to come.

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    Keith Fitz-Gerald, Pledge to Hedge, Time Trader Pro , , ,

  • The Big Three Need a Shakeout, Not a Bailout

    Posted on December 9th, 2008 Keith Fitz-Gerald 29 comments

    The Big Three Need a Shakeout, Not a Bailout

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    I don’t know about you, but my jaw literally hit the floor when the chief executives of Detroit’s “Big Three” begged for a taxpayer-funded bailout.   Never mind that General Motors Corp (GM), Ford Motor Co. (F) and Chrysler LLC are now seeking an aggregate $34 billion – which is up 36% from the $25 billion the Big Three was seeking just two weeks ago – or that they “drove” to Capitol Hill in a caravan of new hybrids so shiny they could’ve made the Keystone Cops green with envy.

    And now that negotiations are under way to “advance” the three U.S. automakers $15 billion from an existing loan program, I don’t know whether to laugh … or to cry, since the total amount actually needed may be north of $150 billion. [Click here for an update on the Big Three Bailout].

    The bottom line: Detroit doesn’t need a bailout.

    It needs a shakeout.

    How to Really Assess the Big Three’s Health

    Nothing drove that point home more than when Ford CEO Alan R. Mulally who, after admitting “big mistakes,” attempted to sway Congressional members by saying that “we’re really focused now.”

    I may not be the brightest bulb in the bunch here, but it seems to me I’ve heard this same mea culpa before – several times. Indeed, wasn’t that what the Big Three said:

    • Back in the 70s, after Japanese-made cars that were better made and more economical started grabbing huge swaths of U.S. market share.
    • Back in the 80s when U.S. quality began to suffer badly.
    • And again back in the 90s when they tossed their lot in with SUVs and trucks.

    But I really have to question whether GM, Ford and Chrysler were “really focused” after supposedly beating back each of these challenges, since the Big Three has seen its market share drop from more than 70% then to less than 50% today.

    They’re so “focused” I can’t stand it. And I can only wonder what they’ll say when Chinese automakers hit our shores in the next few years, rolling out cars that sell for 30% less than it costs Detroit to make cars for.

    Even at their new salaries of $1 a year, the Big Three’s top leaders are overpaid in my book – but I digress.

    The so-called Big Three are nowhere near the anchor of American industry that Detroit would have us believe. And the arguments they’re using are superficial – at best. Maybe that’s good enough to bamboozle some people, but I believe that the American public is smarter than that. I can’t speak for our elected leaders who seem hell bent for leather on sticking band-aids on all our serious problems, but that, too, is another story for another time.

    Essentially, the carmakers’ case boils down to this: Each of the Big Three – GM, Ford and Chrysler – contribute billions of dollars to the U.S. economy, and directly or indirectly employ three million Americans. Thus, by allowing any or all of the automakers to fail, lawmakers would be making a major economic misstep.

    That might be true, but not for the reasons the automakers have stated.

    The Big Three are manufacturers. You don’t measure their success or failure by how much they purchase. You measure it by how much they sell, whether their market share is rising or falling, and what customers are saying about the quality and functionality of the finished product.

    Economics 101

    That brings us to the basics of supply and demand. If you recall your freshman-level Economics 101 course, “supply” is the total amount of goods and services  (in this case cars and related support services) available for purchase. Demand is the amount of a particular good or services that a consumer or consumers will want to purchase at a given price.

    Demand curves are normally downward sloping because consumers typically buy less of an item as its price increases. Similarly, supply curves are upward sloping because producers are willing to supply increasing amounts of their wares at increasingly higher prices. A bit of an oversimplification, perhaps, but it makes the general point.

    In their rush to portray their industry as an economic linchpin and supplier of key future technologies – not to mention as a “victim” of the worst financial crisis since The Great Depression – the U.S. automakers are forgetting that their failure will not bring about a total destruction of demand. History is literally littered with failed companies. Demand for cars won’t fall off because the Big Three go under anymore than folks would stop buying beer if Annheuser-Busch Cos. Inc. (the maker of Budweiser that’s now Annheuser-Busch InBev NV) were to collapse and disappear.

    What’s far more likely to happen is that Japan’s Honda Motor Co. (ADR: HMC) and Toyota Motor Co. (ADR: TM), India’s Tata Motors Ltd. (ADR: TTM), Germany’s Daimler AG (DAI) and Bayerische Motoren Werke AG (BMW), China’s Chery Automobile Co. Ltd. and Geely Automobile Holdings Ltd., and other companies from around the world will happily fill the void.

    In fact, I’m certain that these companies will not only absorb key elements of the purchasing chain, but the workers, too. History shows that industry consolidation is actually a positive influence for the remaining companies and their workers. History also demonstrates that during periods of industry consolidation, there really isn’t anything other than short-term loss in business activity.


    In short, if the demand is there, other firms will move in.

    What Detroit is actually seeking is a bailout that preserves the status quo, and that implicitly rewards 40 years of inept management, bad decisions and poor quality. But to my way thinking, it makes no sense whatsoever to throw $34 billion at businesses that are losing $6 billion a month.

    Like the other federal bailouts that I’ve opposed (as a proponent of free markets and the Austrian school of economics, I believe that bailouts are fundamentally wrong), a taxpayer-funded bailout of the U.S. auto sector would do nothing to improve Detroit’s competitive position. Instead, the capital would serve as little more than a punitive tax on such successful companies as Toyota and Honda, just to name two of the most obvious that would suffer. It would also allow Detroit to come back for more money after they blow through whatever we give them now. In the end, that will hurt both the consumer and the taxpayer – in most cases, one and the same.

    Congressional sources are saying that that before the Big Three gets a cent, they would each have to make concessions similar to those extracted from the U.S. financial-services sector. Not only would the automakers have to eradicate their dividends and guarantee repayment, they’d also have to willingly submit to government control, just in case things didn’t play out as planned.

    Maybe I’m the only one who sees a problem with this but such a change would mean that the same people who have been running the U.S. Postal Service would now be in charge of both Wall Street and one of our major manufacturing industries.

    No thank you.

    There are still plenty of strong automobile companies operating in the U.S. market that are able to offer of successful products that range from ultra-plain utilitarian models to all sorts of luxury vehicles, with to large-scale trucks in between.

    And if the Big Three were to fail, still more auto firms will come to the United States, as their many foreign predecessors did in the years before.

    So here’s to the natural order of things and, hopefully, a levelheaded Congress that will let the markets take their natural course and force a shakeout – and not a bailout.

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    Keith Fitz-Gerald, Time Trader Pro , , , , , , , , ,

  • Inflation “not Deflation” is the Threat, Now Here’s What to do About it

    Posted on December 8th, 2008 Keith Fitz-Gerald No comments

    Inflation “not Deflation” is the Threat, Now Here’s What  to do About it

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    We’re “officially” in a recession and the panicky markets are bracing for deflation. But what most investors don’t realize is that inflation – not deflation – is the real threat that they face.

    For more than a year now, I’ve been telling readers and attendees at financial conferences around the world that the United States has been in a recession since last November.

    I was wrong.

    But only by a month: According to the National Bureau of Economic Research (NBER) announcement last Monday, we “officially” entered into a recession last December.

    Now, I realize that stocks have taken a drubbing in the past few months. And the odds are good that share prices will get beaten down further in the weeks ahead. But that’s actually good news – and for three reasons:

    • The NBER, which called the recession — apparently from its suite in the “Better Late Than Never” Department — is not known for being timely. In fact, its timing is so consistently bad that this latest recession pronouncement might actually be viewed as the light near the end of the tunnel. Indeed, of the four recessions since 1980, the NBER announced that we were in a recession in a (somewhat) timely fashion only once. That was in 1981, a full six months after the recession actually started.  But in each of the other three recessions – 1981-1982, 1991 and 2000 – the NBER didn’t officially label the deteriorating economic conditions a “recession” until the downturn was nearly over.
    • In three of the past four recessions – 1980, 1991 and 2001 – the Standard & Poor’s 500 Index had already reached its recessionary lows at the time the announcements were made.
    • Since 1900, the average length of a U.S. recession is 14.4 months. Assuming that historical relationships hold true, the NBER data, despite the fact that it’s a year late, falls in line with our suggestions of a few weeks ago that a late springtime rally may be in the works.

    (Whether we believe that last point is another point entirely for reasons we’ve written extensively about in recent months. So we won’t rehash those today.)

    But we will point out something that’s vitally important right now: There has not been a recession in history that wasn’t followed by inflationary pressure. And that, in turn, suggests that investors would be wise to shore up their defenses now while everybody is looking the other way … at deflation.

    Why?

    The U.S. Federal Reserve is expanding our monetary base by more than $11 billion a day since September to nearly $1.5 trillion, which represents an increase of 79.02% since October 2007.

    What they are doing is unprecedented in recorded history.

    On an annualized basis, the run rate in just the last few months alone works out to more than 369.92% per year – which means the monetary base is accelerating dramatically (See accompanying chart).

    According to the Federal Reserve’s latest H.3 report, dated Nov. 28, bank non-borrowed reserves fell to -$362 billion, more than doubling the -$158 billion reported in September. Meanwhile, the preliminary Nov. 19 two-week figures reflect total borrowings are now $652 billion, up 11.85% over the same time period.

    At the same time, total borrowings (TOTBORR) of depository institutions from the Federal Reserve have spiked dramatically, which signals still more money is working its way into the system. Note how smooth the TOTBORR chart has been historically for the last 22 years and how dramatically it’s spiked as a result of the financial crisis. When I say unprecedented, this is the kind of chart I’m referring to.

    And we’re not done yet. In addition to all the infusions we’ve already mentioned, Club Fed is poised to inject another trillion dollars to bail out banks, insurance companies, Wall Street, possibly Detroit’s “Big Three” automakers and just about anybody else who “needs” a handout to overcome years of inept management, financial malfeasance – and plain old greed.

    That’s why – more than any other single reason – deflationary pressures that might exist in the next six months or so aren’t really the enemy.

    Carnegie Mellon University economist Allan H. Meltzer was much more in a recent interview with Forbes, stating that “people who say deflation is a threat are either rumormongers or ignorant.”

    Added Meltzer:  “They need to take a refresher course in economics.”

    As much as we’d like to dismiss Meltzer’s comments, we can’t. At least not entirely, because interest rate swaps are currently pricing in deflationary expectations.  And that speaks to something I’ve pointed out repeatedly: Any time the Fed squares off against the markets, the Fed loses. And it’s clearly fighting a losing battle now.

    That’s why the bond markets are indicating deflationary expectations of 1.5% over the next two years and inflation of just over 0.0% over the next five years. Over the next 10- and 20-year periods, the markets are pricing in inflationary expectations below 2.0% respectively.

    With an expanding monetary base already screaming inflation, this connotes opportunity.

    The best way to capitalize on this in the long term is through Treasury Inflated Protected Securities, or TIPS. Right now they’re comparatively cheap because investors have fled to straight Treasuries, preferring their immediate liquidity. But TIPs are rising nicely and are likely to rise much
    further and faster with the first whiff of inflation. 

    Speaking of which, we think there is a 50-50 chance of so-called “core inflation,” which excludes food and energy prices, rising to 4.0%. That doesn’t sound all too bad, but that’s 2.3% more than the recent 1.71% yield on five-year U.S. Treasuries, which means TIPS are a better bet today.

    Our favorite, the iShares Lehman TIP (TIP), sports an attractive 8.21% yield and plenty of upside. So it’s not only the good defense we’ve mentioned in the past, but one with plenty of inflation protection built in.

    It’s up 14.35% from the low of $84.14 set Oct. 10. That’s something most investors are not focused on right now, but they should be.

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    Keith Fitz-Gerald, Time Trader Pro , , ,

  • Three Ways to Know When the Credit Crisis Hits Bottom

    Posted on December 7th, 2008 Keith Fitz-Gerald 5 comments

    Three Ways to  Know When the Credit Crisis Hits Bottom

    By Keith Fitz-Gerald
    Editor, Time Trader Pro
    Investment Director, Money Morning

    “Have we seen the worst from the financial sector?”

    The question – a very good one – came from an audience member following my global investing presentation at the Agora Wealth Symposium in Vancouver, British Columbia.

    During my entire time there, the interest in the ongoing credit crisis was intense.

    I took a deep breath and launched into my three-point response. First, I’m encouraged by what I see lately but still believe there is a fair distance to travel before all the skeletons are cleaned out of the financial sector’s closet.

    There is a growing body of data that suggests banks have recognized only a fraction of the overall potential losses – approximately $50 billion to $75 billion so far on subprime debt alone.

    And a variety of estimates suggest that total subprime losses may be more than $300 billion before we’re through.

    And that figure, incidentally, doesn’t include the additional losses from secondary-prime mortgage loans, auto loans, credit card balances, student loans and the other credit-related flotsam and jetsam floating around in the debt markets.

    That suggests that the hundreds of billions of dollars in emergency capital infusions from the world’s central bankers we’ve seen to date may only be a fraction of what’s ultimately needed by the time fully leveraged figures are thrown into the mix.

    Second, liquidity conditions now may actually be worse than when the entire credit-crisis mess began to unravel this time last year. For example, the benchmark London Interbank Offered Rate (LIBOR) remains higher than so-called “policy rates” and U.S. Treasuries of comparable maturities.

    This suggests that banks still don’t trust each other and therefore are keeping so-called “Interbank” borrowing rates high in order to reflect what they perceive to be the added risk of doing business. We’ve been warning investors to watch out for this since as far back as April, and have generally been preaching caution since the credit crisis began last year.

    In other words, the fact that Libor-Treasury spreads are wider today than they were a year ago suggests that the banks really don’t know who continues to hold the toxic debt instruments the entire world has come to fear – despite a recent earnings parade of CEOs making claims to the contrary.

    The upshot: Many institutions are hoarding cash – something you’d hardly expect to see if the credit crisis were really on the mend.

    Third, judging from recent reports, it’s beginning to dawn on financial regulators that this crisis was never about a lack of liquidity in the first place, which is something I suggested in an open letter to U.S. Federal Reserve Chairman Ben S. Bernanke some time ago.

    Instead, this crisis is about three things:

    • Too much liquidity.
    • Fundamental structural problems in the credit industry, including the almost-total lack of regulation.
    • And the lack of transparency of complex financial instruments for which there is no public market, making them tough to value and nearly impossible to trade.

    It is becoming clearer by the day that – partly because of these three factors – a good deal of money has been made fraudulently, if not illegally.

    Granted recent changes surrounding the “mark-to-market” accounting of so-called “Level 3″ assets are a step in the right direction. But what few people realize is that, in the short-term, these new requirements could involve the immediate recognition of even larger losses than we’ve seen to date.

    The reason is that many of the firms involved – think Merrill Lynch & Co. Inc. (MER), Lehman Brothers Holdings Inc. (LEH) and Citigroup Inc. (C), for example – will no longer be able to hide their losses in Level 3 assets, as they have in the past.

    As you might expect, there’s a counterargument to this, and it’s a highly popular one on Wall Street – especially inside the CEO set, whose members desperately want to stop the financial hemorrhaging their firms are enduring. They claim they’re “selling” risky assets and “de-leveraging” their balance sheets.

    But here’s what they are not telling you.

    Even though these folks are technically “selling” assets – particularly the distressed “Level 3″ assets I mentioned a bit earlier – what they are really doing is assigning the upside to hedge funds, private equity firms, and sovereign wealth funds in exchange for cash.

    And here’s the kicker: The banks actually are holding onto the downside liability in the event the underlying securities go bad. That brings us back to the start of this commentary, when I said that I expect more securities to go bad.

    No matter how you look at it, these financial institutions are playing a vicious shell game, hoping all the while that they’re not the loser who is taken to the cleaners when he picks up the wrong shell.

    Where this goes from bad to worse is that at the same time they’re playing more fancy accounting tricks, these firms continue to pony up to the Fed’s private backdoor lending window for sweetheart financing. After all, they can’t get the financing anywhere else.

    That means that every taxpayer in this country is involuntarily being put in the bailout business.

    As for whether or not we’re near the end of the credit crisis as a whole, it depends on whom you ask.

    When this crisis started a year ago, I was asked a similar question and answered it by saying that we would not even begin to approach the end of the line until the total losses exceeded $1 trillion.

    My audience chuckled politely.

    Fast-forward 12 months, and nobody’s laughing anymore – especially when I say that I’m now raising my industry loss estimate to nearly $2 trillion.

    Increasingly, other analysts are embracing a similar viewpoint. UBS AG (UBS) raised its estimate of the total cost of the credit crisis to $600 billion, while noted hedge fund manager John Paulson suggested $1.3 trillion is not unthinkable. Meanwhile, in a report issued last May, the International Monetary Fund (IMF) projected the bailout costs at $1 trillion.

    All of this leads us to a single conclusion: At least for now, this is a “recovery” in name only.

    Keith Fitz-Gerald, Time Trader Pro , , , ,
  • « Older Entries


I’ll give you all the details of the trade recommendation: where to get in, what price, how to structure it, and exactly what to tell your broker. You’ll also know what the maximum gain will be … the precise chances of success (from 75-89%)… and where our adjustment points will be, just in case (remember… these adjustment points are your built in safety nets for the trade).

And if you can’t be on the call every month, no problem. I’ll send a confirmation email to each “Time Trader,” spelling out in exact detail the recommendation we covered on the call.

- Keith Fitz-Gerald
Editor, Time Trader Pro


“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors…”

- Warren Buffett in The New York Times, October 17, 2008

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