“I’m flat and I’m nervous.”
November 19, 2007
. . . A European portfolio manager
“I’m flat and I’m nervous,” is what one portfolio manager (PM) said to us as we wound our way through 11 European cities over the past 19 days. The reference was clearly to illustrate that while he was “delta neutral” on stocks, he was still nervous. And that, ladies and gentlemen, was our observation of the investment position du jour of roughly 300 PMs we interfaced with over nearly three weeks. Other observations included: why are there NO American cars in Europe?; why don’t Europeans wear sunglasses?; where are the joggers?; why are the airport bathrooms so clean in Europe?; and the list goes on. The other near ubiquitous observations were that every taxi driver was listening to American/British music, a unanimous opinion that the U.S. dollar is going lower, a reluctance to invest in U.S. stocks, and despisement of the Bush Administration and the situation in Iraq. Even the British are disgusted with Iraq, but it is not America and Americans that are despised. Indeed, a party was given for us in Paris with roughly 30 Parisians that we knew when they were living in America. To a one, they would move back to the U.S. tomorrow!
While I should probably not comment on the Iraq situation, I would suggest that thanks to the internet, and TV, the under 30 crowd has become extremely savvy as to what’s going on in the world. Manifestly, the younger generation is quite aware of the “popular culture” and they want to be part of it. The only thing standing in their way (in certain countries) is their governments. Consequently, anything that stifles their radical leaders, and allows the young people to gain political traction, should (over time) permit the “Iraqs of the world” to modernize and subsequently join the world’s society. We can already see hints of this dynamic in the underreported riots of Iranian twenty year olds against President Ahmadinejad.
Speaking to the U.S. dollar, we have been bearish on the dollar versus most of the world’s currencies since 2001. That was the view we carried to Europe six years ago along with the recognition that China was joining the World Trade Organization (WTO), which was likely to “kick off” a secular bull market in “stuff” (energy, timber, cement, agriculture, water, electricity, infrastructure, base/precious metals, etc.). We had remained steadfastly bearish on the dollar, and bullish on “stuff,” until a few weeks ago. Indeed, short the dollar, long “stuff,” has gained such popularity that it has become an “overcrowded trade.” And, that’s why we told accounts we were reducing our anti-U.S. dollar “bets” and rebalancing most of our stuff-stock positions (read: selling partial positions and holding those funds in cash for the moment). Most of the European accounts were shocked about this reversal of opinion, just as shocked as they were when we first voiced the aforementioned anti-dollar strategy six years ago.
Nevertheless, we stood our ground when asked for a fundamental reason for turning bullish on the dollar, and while we don’t really have a fundamental reason, save the improvement in the trade balance, our mantra was, “It’s just too crowded a trade to be short the dollar right here. I don’t know if I will be bullish on the greenback for three months, or three years, but I do know I no longer want to be short.” Concurrently, we have been bullish on the Japanese Yen since the low 80s (FXY/90.11), and while I didn’t make any money on this trade, many of our accounts did. Interestingly, year-to-date there is an amazing 93% correlation between the ups and downs in the world’s stock markets and the spread between yen and the euro. To wit, when the euro rallies against the yen, the world’s stock markets rally. The quid pro quo is that when the yen rallies versus the euro, stocks decline. In past missives we have written extensively about this tendency driven by the famed yen “carry trade,” but that is a discussion for another time.
Other talking points from our European presentation included the U.S. consumer, the housing debacle, the subprime contagion, and the political situation; all of which should become much clearer over the next few months. Regarding the consumer, for decades our mantra has been, “never underestimate the American consumer’s ability to spend money even if they don’t have it.” Said mantra has served us well. However, recently there have been some “tells” that the under-saved, overspent American consumer may finally be sated with debt. If the U.S. consumer has become unwilling to take on any more debt, it spells trouble for the Federal Reserve and suggests the Fed may be “pushing on a string.”
As for housing, our real estate research team made a great “call” a few years ago by stating that the housing cycle was peaking and that before the downturn was over the homebuilding stocks would be trading at 80% of their book value. Before I left for Europe I had a discussion with that team’s leader (Paul Puryear), who told me with the homebuilders now trading at 80% of book value he would like to become more constructive on the group, but the numbers keep getting worse. Hereto, we think the next few months will provide more clarity as we enter the spring selling season and the mortgage resets expand at higher interest rates.
“The subprime situation is contained,” is what we heard earlier this year when the word “subprime” crept into America’s lexicon. At the time we were skeptical and suggested the fallout from the subprime contagion was unknowable and it would likely take more time than most believed to sort things out. We still feel this way and would note that even the prowess of Citigroup (C/$34.00) can’t seem to ascertain the extent of the contagion, or value the opaque assets (CDOs, RMBS, etc.) in its own portfolio. What we find ironic is that all of this is occurring as the new FASB #157 accounting rules are being implemented (more stringent marking to the market of assets), while it looks to us as if the Structure Investment Vehicles (SIVs and SPIVs) are going to be moved from “off” balance sheet items to “on” the balance sheet items for many financial institutions. Even more ironic is that the more stringent Basel II banking standards are slated to “kick in” this January as things continue to get curiouser and curiouser.
On politics, Mark Twain remarked, “The political and commercial morals of the United States are not merely food for laughter, they are an entire banquet,” . . . except in this case we are not laughing. To be sure, one of the things that continues to bother us is the movement by politicians toward protectionism, intervention, and regulation. This political rhetoric is going to torque-up as we enter the New Year. What you are going to hear regards increasing taxes on the rich. History suggests that when you hear this the middle class had best grab their wallets. Further, there is going to be more talk about raising the capital gains tax and eliminating the favorable tax treatment on dividends. How this plays out longer term is anyone’s guess, but we think it is a headwind.
As stated, we think there will be more clarity on the aforementioned points over the next few months, which is why we have been opining since mid/late-September, “the time to be aggressively bullish was in mid-August (we were), not following a 1500-point Dow Wow!” As written in our strategy report dated 9/17/07 (“Head I win, tails you lose!”):
“Consistent with these thoughts, we are on ‘hold’ in the trading account, as well as the investment account, on a short-term basis. While bullish since the August lows, we have always maintained that bottoms tend to be a process involving both price and time. Potentially we have met the ‘price’ requirement given the 20-session, 10% correction, ‘selling stampede’ that culminated on August 16th. That is why we are treating the August lows as an ‘internal low’ until proven wrong. It is now the ‘time’ component that we are contemplating. As previously noted, the 1990 and 1998 correction-sequences saw prices peaking in July, declining into August, and then rallying sharply before retesting those August lows in the September/October timeframe. Whether it plays that way this time remains to be seen, but we are cautious following the initial throwback rally we have experienced into this week’s FOMC meeting.”
The call for this week: Well we’re back. And we find it interesting that despite three interest rate reductions, the major averages are below where they were on the last rate cut of 10/31/07 (this is almost unheard of). Also of interest is the fact that crude oil has declined, yet the D-J Transportation Average has also declined and actually broken below its August 16, 2007 closing low, rendering either one-half of a potential Dow Theory “sell signal,” or a huge downside non-confirmation. Plainly, since the October “peak” things have gotten pretty confusing, leaving the four strongest sectors since that point: utilities, consumer staples, energy, and healthcare. Meanwhile, the over-crowded negative dollar “bet” has changed the export-import equation, making America just plain “cheap!” The effects can be seen along the Canadian border, in New City retail stores (read: foreigners), cruise lines, Disneyworld, etc., and the result has made us reduce our anti-dollar “bets” of the past six years. Indeed, things are currently confusing; and we are cautious, totally exhausted, and anxious to catch up, so these will be the last strategy comments for this holiday-shortened week. Happy Thanksgiving everyone . . .
ma ammazzati junker