Value of Perfect Information

The latest data releases this week about the state of the residential real estate market confirm my belief that the threat of a double dip in the economy is triggering another down leg in home prices (click here for Residential Home Prices in Terms of Gold). June housing starts plunged 5%, and the National Housing Association of Home Builders Index is once again in free fall. Look at the stock chart for Pulte Homes (PHM) and it resembles my flight path just before I crashed a twin engine Cessna into the Australian Alps (my engine failed). Ditto for the home builders ETF (XHB). Anyone who believes that housing is on the rebound, and that now is the time to buy, should take a very hard look at the real numbers. There are 140 million personal residences in the US of which 19 million homes are either directly or indirectly for sale. According to a survey by Zillow.com, a real estate appraisal website, 5 million homeowners plan to sell on any improvement in prices. Add 4 million existing homes now on the market, 1 million new homes flogged by companies like Lennar (LEN) and Pulte Homes, and 1 million bank owned properties. Another 8 million mortgage owners are late on their payments and are on the verge of foreclosure, bringing the total overhang to 19 million homes. Now, let’s look at the buy side. There are 35 million who are underwater on their mortgages and aren’t buying homes anytime soon, nor are the 35 million unemployed and underemployed. That knocks out 50% of the potential buyers. Here is where it gets really interesting. There are 80 million baby boomers retiring at the rate of 10,000 a day. Assuming that they downsize over time from an average 2,500 sq ft. home to a 1,000 sq. ft. condo, and eventually to a 100 sq. ft. assisted living facility, the total shrinkage in demand is 4.3 billion sq.ft. per year, or 1.7 million average sized homes. That amounts to a shrinkage of aggregate demand for a city the size of San Francisco, every year. You can argue that the following Gen-Xer’s are going to take up the slack, but there are only 65 million of them with a much fewer assets and lower standards of living than their parents. Throw in the disappearance of state and federal first time buyer tax credit. You can count on a jump in long term capital gains taxes and state and local property taxes, further diminishing property’s appeal. If you are looking for a final stick to break the camel’s back, how about eliminating, or substantially reducing the home mortgage interest deduction? Add it all up, and there is a massive structural imbalance in residential real estate that will take at least a decade more to unwind. We could be looking at a replay of the same 26 year period from 1929 to 1955 when prices remained flat, and we are only 3 years into it! A second down leg in the real estate market seems a no brainer to me, as is the secondary banking crisis that follows. Perhaps that’s why hedge funds have been big sellers of the (XHB).What’s a poor homeowner to do? Don’t ask me. I sold everything in 2005 when my research threw up these numbers, and have been happily renting ever since. And, if the toilet blocks up, I just call the landlord.

I knew Jeff Bezos back in the eighties as this always cheerful quant in Morgan Stanley’s bond department who had this incredibly annoying laugh.  He blew us all away when he took off on his own, used innovative technology to discover the immense profits to be found in long tale markets, and built Amazon (AMZN) into the world’s largest book seller, practically overnight. Now I learn that the alpha male of internet distribution is selling more Kindle books than old fashioned hard copies, at a ratio of 1.8 to one. I expected this, but not for another five years. Once again, the rate of technological progress has caught me flat footed. This development is the result of a brilliant strategic move by Bezos to slash prices of his Kindle eReader from $259 to $189, thus, under-pricing Steve Jobs’ cheapest competing IPad by a stunning 62% (click here for Apple’s Next Stop: $1,000). Kindle books are vastly cheaper than hard copies that range from $20-$40, carry no shipping cost, and are delivered instantly. Some 81% of Amazon’s Kindle book offerings cost less than $9.99, and 1.8 million pre 1923 published books are free.  Kindle books are even price competitive with paperbacks. Some analysts believe that the 3 million new IPad owners are buying more ebooks from Amazon than Apple, whose offerings are pricier. I will miss the musty smell of an old, hand tooled, leather bound tome almost as much as my wooden slide rule, six track tapes, and manual adding machines. In order to get the new price for a Kindle at Amazon, please click here.

When you bend over backwards to kiss the magical stone at Ireland’s Blarney castle, you can’t help but notice a sign assuring you that your won’t catch AIDS in your effort to obtain the gift of persuasion. However, the ancient stone is completely covered with lipstick. Investors in Ireland national debt certainly must feel like they contracted the dreaded disease this morning after rating agency Moody’s announced a downgrade of the country’s debt from Aa2 to Aa1. Ireland saw a real estate boom even more frenzied than our own, at the eventual price of $32 billion in bank bail outs. That has driven the country’s debt/GDP ratio from 25% to 64%, and Moody’s thinks it will eventually get to 100%. The bigger question is what all of this means for the Euro (FXE), which has spent that last two months getting talked down from a suicide leap (click here for my piece). Suddenly, the European currency has gone from being the leper with the least fingers to the most, thanks to the sudden economic slow down in the US. Credit default spreads for the PIIGS have been narrowing, traders are willing to give the European Central Bank’s rescue package some grace, triggering a speedy unwind of one of the largest short positions in history. The European bank stress tests are expected to deliver the same arbitrary seal of approval that the American ones did. Hedge fund managers are choosing to take extended vacations at the Hamptons, Cannes, and Newport Beach than re-establish their Euro shorts. All of this means that the Euro could remain muscular through the summer. We’ll get the first hint tomorrow when the troubled Irish tap the market for €1-1.5 billion in new debt, and we find out how powerful that Blarney Stone really is.

Jim Trippon, of the China Stock Digest, says that investors better start scaling into China now, or risk missing the biggest economic opportunity of our lifetime. Quality growth stocks can be bought for price earnings multiples under 11, and often for 4-5 times, compared to an average 13 multiple for the S&P 500. You are already investing indirectly in the Middle Kingdom whether you realize it or not. Just take a stroll through Wal-Mart (WMT).

Jim has been publishing his widely followed China Stock Digest for six years, running a full time group of analysts out of offices in Shanghai, Hong Kong, and Houston. Financial markets in China are still primitive, with no options or futures, short selling, international accounts, arbitrage, spotty disclosure, and tough currency restrictions. Individuals account for up to 70% of turnover, compared to only 10%-20% in the US, which can lead to higher highs and lower lows in share prices.

Jim overcomes many of these obstacles through buying US GAAP audited, Sarbanes-Oxley compliant, American listed ADR’s, or Hong Kong listed “H” shares. Although these shares correlate highly with the US equity markets, a stock picking strategy focused on undervalued names will outperform over time with reduced volatility. This eliminates the need to reach for returns by taking on inordinate risk. Jim won’t touch a company unless he sees a “3-5 bagger” in it.

Recent moves by Chinese authorities to remove restraints from the renminbi, or Yuan (CYB), give investors a potential double play. Rising share prices fueled by the steroids of an appreciating currency can create a “J” curve effect for profits, much like I saw in Japan during the eighties.

Trippon blithely dismisses claims by naysayers, like Jim Chanos of Kynikos Associates, that a real estate induced crash in China is imminent (click here for my piece). Buyers in the mainland cities are required to put down deposits of 30-40% which they are unlikely to walk away from. This enabled the Mandarins in Beijing to spend their $500 billion reflationary budget last year on infrastructure instead of bank bailouts. If only they’d thought of that in the US! A GDP growth rate of 9% last year compared to an American economy that shrank, also tends to bail out a multitude of sins. If you need more reasons to invest in the Middle Kingdom, please read “How China’s Economy is Already Bigger than the US by clicking here.

Jim posts a model Chinese portfolio on his website for subscribers, and revealed a few of his favorite names. China Mobile (CHL) has a domestic monopoly, with more cell phone customers than the entire US population, and is still clocking impressive growth. Huge swaths of the country are leapfrogging land lines and going straight to mobile. PetroChina (PTR) will make a killing from the upwardly mobile, exponentially growing car market. China Medical Technologies (CMED) and Mindray Medical International (MR) will benefit from the extension of health services into the country’s rural hinterlands.

Trippon admits to being an out of the closet scripophilist, and includes in his collection share certificates for the Titanic and the original Standard Oil Trust and bonds from the Revolutionary War. I confessed my own orientation in this direction, and admitted my holdings of shares in the Trans Siberian Railway, bonds for the construction of the Golden Gate Bridge, and a collection of Japanese wartime occupation currency from throughout Asia.

Jim started out his career as a CPA with Price Waterhouse, advising the pension programs of companies like Exxon and Shell Oil. He then struck out on his own to found one of the most widely read investment newsletter families in the US. They include the ETF Profit Report, the Dividend Genius, and the top rated China Stock Digest. Jim has published two books, Stay Rich Forever: Retirement Planning Secrets of Millionaires and How They Can Work for You, and Becoming Your Own China Stock Guru: The Ultimate Investor’s Guide to Profiting From China’s Economic Boom. To learn more about Jim, you can visit him at his website at http://www.chinastockdigest.com/ .

To listen to my interview with Jim Trippon on Hedge Fund Radio in full, please go to http://www.madhedgefundtrader.com/ and click on the “PLAY” arrow in the top right corner. Or, you can download it to your IPod.

Who to Believe? There is a ferocious debate underway among economists over which leading indicator to believe, the Baltic Dry Index, or international container shipping rates. The BDI, a measure of the cost of chartering bulk carriers for coal, iron ore, wheat, and other dry commodities, has just suffered one of its most dramatic sell offs in history, plunging some 60% since May. The downturn has been accelerated by the recent delivery of a glut of new ships that were ordered during the boom years 3-4 years ago, when getting cheap money was as easy as falling overboard. There is no doubt that this index is shouting loud and clear for a double dip in the world economy. On the other hand, and if you notice, most economists are two handed, the rates for standard 20 foot containers shipped to international destinations has gone absolutely through the roof. The Maersk Line has even gone to the extreme of diverting its fastest ships to return empty containers from the U.S. to China. The big driver here has been intra Asian trade, as well as rising imports by big US customers like Wal-Mart (WMT). This shortage has been exacerbated by the large scale cancellation of orders to build new containers during the 2008-09 crisis, and strikes at key manufacturers in China. The data points to a global economic recovery centered in Asia, and trickling down to the U.S. and Europe. Who to believe?  I’ll let American rail traffic cast the tie breaking vote, which you can see in the chart below. After crashing in 2008-09, it performed a “V” shaped recovery, and has been holding its gain’s ever since, although is only at 80% of full capacity. This is my “gull winged” chart, which you see for the prices of almost all financial assets these days. And the envelope, please! The conclusion is unequivocal. We are in for a slow, bumpy long term recovery that will deliver the long term U.S. growth rate of 2% that I have been predicting all year. Too bad the stock market doesn’t know this yet.

Yesterday, I was commiserating with my buddy, Charles Nenner, of the Charles Nenner Research Center in Amsterdam, about his team’s miserable performance in the World Cup, which lost 0-1 in overtime after a dreadfully pedestrian, foul plagued, uninspiring game. No wonder Holland and Spain lost their empires! I didn’t want to beat up the suffering Dutchman too much, as my hometown Los Angeles Lakers, had only recently clinched the National Basketball Association championship (whose center, ironically, is from Spain). All glory is fleeting, isn’t it?

Charles was so depressed, that he said his team’s feckless play reminded him of the Dow’s coming plunge to 5,000. What! Come Again!! The alarm bells and distress flares went off in my head. Would he care to expand on that view? Charles thinks that we are ten days into a summer rally that will run out of steam sometime in August. Then we will resume a 3-5 year bear market, with enough 40% rallies along the way to squeeze those without conviction out of their shorts. His best historical parallel was with Japan’s Nikkei, which for 20 years has seen gut wrenching sell offs followed by equally violent, and prolonged rallies. Each pop was optimistically heralded as a new bull market, only to end in tears.

So, are we supposed to sit on our hands for the next half decade until we reach the final, agonizing reckoning? Not at all. He gave me a list of ten names that had the long-term technical muscle to outperform on either a relative or an absolute basis, no matter how dire things get in the main market. The list follows below, along with my own fundamental comments:

Ing Groep NV ADR (ING) – Rigorous risk control, low leverage, a healthy balance sheet, and broad diversification will enable this financial giant to weather any storms headed its way. This company has been around, in some form, for centuries, for a reason.
Toyota Motors (TM) – Will recover from recent quality knocks to reclaim its lead position as the world’s largest and best car maker. It will leverage its nearly two decade head start and dominant market share in hybrids to generate record profits, the “BP” of the auto industry.

Lennar (LEN) – The residential real estate collapse continues and industry consolidation will accelerate, but this homebuilder will be one of the few survivors. Pick your entry points carefully through buying only on the melt downs.

Reuters/Jeffries CRB Index- The 9 month bear market in commodities ends, as investors flee paper assets in favor of the hard stuff.

Alcoa (AA) – Ditto for AA on the aluminum front.

Agrium (AGU) – The big rally in most agricultural commodities since June may mean that the long awaited bull market in food is at hand. China returns as a huge importer of fertilizer to address its own production shortfalls.

IBM (IBM) – One of the best companies, in one of the only US sectors that will prosper globally for decades to come. Their brilliant transmutation from a manufacturer to a service provider insured its prosperity as a world class competitor.

Exxon Mobile (XOM) – Obama can’t bring enough alternative energy supplies online in time to avoid another oil spike, possibly to $200 a barrel. The BP oil spill has suddenly revalued all onshore and foreign crude reserves. A rare chance to buy this gem at a single digit multiple, while BP is dragging down valuations for the entire sector.

Conoco Phillips (COP)- Ditto above for COP.

Best Buy (BBY)- The ultimate predator retailer, with a great service business in the “Geek Squad” to carry the whole enchilada.

If this all sounds like it is from another planet and you need to be convinced that Charles is not just making it all up, please visit his website at http://www.charlesnenner.com/ . And how far will the Dow plunge in the next down leg? Charles said he would fire up his computer and get me a number after more data came in. I guess you’ll just have to keep reading this letter to find out what it is.

following this post, i want to give an update on my eurusd count.

Well, the ending diagonal count worked so far, missing my target of 1,2492 for about 30 ticks… but after a 200 tick move.
i have to be honest, i profited by this move being but went stopped out on my last portion of position (i added during flags formation you can see in the picture). It is always a matter of greed (and fear)

What i really wasn’t expecting was a new high, so i went stopped out when I shorted the 61.8% retracement of the move from 1.2725 to 1.2522. Not only that move looked impulsive, but I was assuming ending diagonal could be a “terminal” pattern, and the larger euro downtrend will have to resume after the breakdown. But i was wrong.

So I came back to analyze the graph today, and i saw that 1.2522, the last low, was almost exactly the 38.2 retracement of a possible W3, if the ending diagonal was simply w5 of W3 of what i called a C wave (see previous post). What i see today is a complete impulsive pattern to the upside, that could have topped at 1.2779.

Following a complete impulsive pattern, i expect at least a 50-61.8% retracement of the impulse in a zigzag or other corrective pattern. So i entered short around 1.275, with stop above today’s high, looking for a target between 1.2622-1.2652… but i’ll adjust it looking how next waves develop. I don’t exlcude larger euro downtrend has resumed but… i’ll be cautious

have a nice trading
mdm

In my last article Bear’s Beware I warned that shorts were running the risk of getting caught in an explosive rally as the intermediate cycle was due to bottom. Well, it did bottom and bears have watched their profits quickly evaporate as the market has surged out of the intermediate cycle low.

The initial thrust out of one of these major cycle bottoms will usually gain 6-10% in the first 8-13 days. We are now 5 days in and up 6.6% so far. I expect we will see a test of the 200 day moving average before we see any significant pull back. These initial moves out of intermediate bottoms don’t tend to wait around as smart money smelling blood in the street pile in quickly.

It’s only the little guy, who doesn’t understand what has just happened, that continues to fight the trend change. This is usually about the time that I see the technicians start calling for this or that resistance level or trend line to put a halt to the rally. They are, of course, assuming this is a bear market rally and it will soon be over.

First off, let me say I’m not convinced yet that the cyclical bull is dead. I would need to see the market come back down and break the recent lows first. If both the transports and industrials do that then yes, we will have a Dow Theory sell signal and at that point I would have to assume that the market has begun the third leg down in the secular bear market that started in March of 2000.

Now let me say this, bear markets don’t begin because of lines on a chart. They begin because something fundamental is broken in the economy or financial system. Now we certainly do have a broken financial system, no doubt about it, but then again this cyclical bull was never built on the foundation that we had fixed anything in the financial sector. We certainly haven’t fixed anything in the economy with unemployment remaining above 15% if one counts everyone out of work. No this cyclical bull was built on a foundation of massive liquidity. I’m not convinced yet that that fundamental base is broken. Only time will tell.

But even if this is a bear market rally let me assure you that bear market rallies don’t end because of lines on a chart. If you think you are going to spot a top in a bear market rally by drawing a few trend lines or some meaningless resistance level you are just kidding yourself. It ain’t gonna happen. It never has and it never will. Lines on a chart don’t halt bear market rallies anymore than they initiate bear markets.

I’ll tell you exactly what halts a bear market rally. Sentiment! Sentiment, at every single one of those rallies during the `07-`09 market, reached bullish extremes. Not one single rally was halted by a pivot point or resistance level prior to sentiment reaching extreme bullish levels.

Even after the recent surge, sentiment is still so depressed that it’s at levels lower than most of the intermediate bottoms during the last bear market. So let me tell you, if you think the market is going to turn tail and run because it hits the pivot at 1130 or the 200 day moving average, or because you think earnings aren’t going to be rosy, you are going to be sorely disappointed.

If this truly is a bear market then before you even begin to look for a technical turning point you first have to wait until sentiment does a 180 degree turnaround. That just doesn’t happen quickly after the kind of beating we just got.

Trust me, it’s going to take a while for investors to forget a 17% correction and dare to become bullish again. If I had to guess I would say at least 8 to 11 weeks. Even longer if the next half cycle (due around day 15-20 of the rally) and full daily cycle correction (due around day 35-45 of the rally) are strong enough to scare investors again.

The problem with the move out of February bottom was that we got no corrections and it quickly turned into a runaway move. Those kind of rallies tend to end with some kind of mini-crash. I started telling subscribers there was a high possibility of that back in late March and early April. It happened in Feb. of ’07 with the China crash and sure enough, it happened again in May with the flash crash.

Traders become extremely complacent during one of these runaway moves. At the April top sentiment had reached levels more bullish than at the top of the last bull market. As usual, we paid a heavy price for that complacency. But now we’ve swung 180 degrees back in the other direction, with sentiment so depressed it even makes the `09 bottom look positively giddy. That my friends is the base for another powerful rally.

Actually I won’t be at all surprised if the market rallies back to new highs … even if we have begun the initial topping process of this cyclical bull. Remember the bear market had already begun in the summer of `07 but that didn’t stop it from rallying back up to marginal new highs in Oct. before finally rolling over into the second worst bear market in history.

This idea that the markets can somehow magically look into the future is just ludicrous. I can assure you no one can see the future, and that includes the millions and millions of investors that make up the global markets.

Now let me say this – we already know where the cancer is. Does that mean the stock market will now start to discount the next bear market? In the summer of `07 we knew the cancer was in the credit markets, initially beginning in the subprime mortgage market. Did the market look into the future and discount the unraveling of the global credit markets at that time? No it did not. The stock market rallied to new highs.

Well, we already know what will eventually bring this house of cards down, it’s already started just like it had already started in the summer of `07. We are going to have one sovereign debt implosion after another and that is going to lead to the cancer spreading through the global currency markets eventually infecting the world’s reserve currency.

But don’t expect the market to look ahead and begin discounting the unraveling of the global currency markets. Markets don’t do that. What they do is slowly recognize the fact that the fundamentals are broken. Once enough traders realize that, the markets begin to roll over, usually in an extended process taking many months.

I doubt this time will be any different, especially since the central banks of the world are going to fight the bear with a blizzard of paper. Don’t make the mistake of thinking the markets have to act rationally. They don’t and won’t. If the Fed prints enough money markets are going to rise even though the global economy is crumbling all around us.

If you are bearish and determined to pit your stash against Ben’s printing press I’m afraid you are signing up for one very difficult time ahead. I seriously doubt we are going to see another credit market implosion like we saw in `08. Without a severe dislocation like that there will be no market crash this time. When the bear does return (and he will eventually) the next leg down is going to be a long drawn out process with multiple violent bear market rallies. Selling short in that kind of market isn’t going to be easy. As a matter of fact I doubt 1 bear in 10 will even manage to make money in that kind of environment.

Bear’s should be careful what they wish for. I suspect the next leg of the secular bear will manage to destroy both bulls and bears alike.

If you would like to be added to the email list that receives notice of new posts to GoldScents, or have questions, email Toby.

I have done many things in my life: hedge fund manager, pilot, cowboy, journalist, stock broker, mountain climber, translator, guide, etc, etc. etc. Now add technical consultant to Hollywood to the list. According to the New York Times, Simon Baker, star of the TV show “The Mentalist”, is using the Diary of a Mad Hedge Fund Trader as a resource to humanize Wall Street traders in the upcoming film entitled “Margin Call” (click here for the link). This is not an easy task, as the public generally considers denizens of the pit as greedy, soulless, money grubbing monsters, difficult to empathize with in any setting. The star studded thriller includes Kevin Spacey, Demi Moore, and Jeremy Irons, and will focus on a 24 hour period during the height of the financial crisis at a fictional Wall Street bank. No doubt, the producers are hoping to cash in on the imminent release of Oliver Stone’s sequel to the classic film, Wall Street. As with the last film, the great industry guessing game will be identifying who and which institutions in real life are being portrayed. I bet the troubled bank starts with the letter “L”. Watch for film crews framing those dark, foreboding shots in the canyons of downtown Manhattan this summer. Release is expected next year. This, I must see. Hey Kevin, baby, have your people call my people and let’s do lunch!