Thursday, July 30, 2009

Capitulation

The latest Newsweek cover says it all:





Rosie turns grudgingly bullish?
In addition, perennial economic bear David Rosenberg allowed in his latest missive that the economy might be turning around [emphasis mine]:

[T]here is no doubt that after the sharpest downturn in housing, production and employment since the 1930s, that the laws of gravity themselves prevent the economy from any further deterioration. Nothing is going to zero, and there is always the chance that housing sales edge back up towards their demographic levels, auto sales recover to their replacement demand levels (plus GM getting back into the leasing game), and inventories get rebuilt in line with spending levels. The government has its hands in 40% of the economy and when public sector officials can influence how banks can value their assets, how mortgage servicers should be doing their business, who shall fail in the financial industry and who shall not; and when we have a central bank that is not just the lender but the market of last resort, even for RVs, and a government willing to run up its deficit to levels that would have made FDR blush, then perhaps we can end up seeing a recovery occur sooner than we had thought.

You can almost hear the agony in his voice as he penned those last few words.

On top of that, Mark Hulbert reported about a week ago that newsletter market timers were getting too bullish.

As the S&P 500 rally tests the magic 1,000 level, it’s worthwhile to think about these sentiment data points.

Wednesday, July 29, 2009

Naked girls and gold demand

Some interesting headlines came across my desk in the last few days and something doesn’t add up. The first headline was entitled Naked girls plough fields for rain:

Farmers in an eastern Indian state have asked their unmarried daughters to plow parched fields naked in a bid to embarrass the weather gods to bring some badly needed monsoon rain, officials said on Thursday.

Witnesses said the naked girls in Bihar state plowed the fields and chanted ancient hymns after sunset to invoke the gods. They said elderly village women helped the girls drag the plows.

The Wall Street Journal also reports that the Indian monsoon season has been very uneven this year [emphasis mine]:
After India's driest June in 83 years, four of 28 provinces have declared drought, and many farmers don't have enough water to grow a full crop. More than half of Uttar Pradesh, the most populous state and a key rice and sugar cane-growing area, is suffering from drought.

A poor crop yield could push up food prices, straining the government's budget and complicating the central bank's efforts to revive the economy without letting inflation get out of hand.

Something doesn’t add up here. India has an economy that is still very agriculturally dependent. How can the Reserve Bank of India forecast deflation to end this year?

In its review of macroeconomic and monetary developments in the first quarter to the end of June, the Reserve Bank of India said on Monday: “There are indications of inflation firming up by the end of the year” because of rising commodity prices, high food prices and the government’s fiscal stimulus measures.

I would remind you that India accounts for a large part of the world’s physical gold demand. Much of that manifests itself during the wedding season after the monsoons and demand is dependent on how the crops come in.

In a year where the monsoons are below average and uneven, what is that going to do to Indian gold demand?

Just wondering…

Tuesday, July 28, 2009

Comparing US and Canadian health care

They say that you should never talk about sensitive topics like sex and religion in polite company, the topic of health care is also one of those topics. Nevertheless, I am going to wade into this touchy topic.

I lived in Canada from 1967-94. I moved to the US in 1994 and I returned to Canada a couple of years ago. Given the extensive debate on the Obama health care proposals, I feel compelled to speak up about the differences between the Canadian and American health care systems.

Much of these experiences are personal and your own mileage will vary.


Canada: The grass isn’t necessarily greener
The overriding feature of the Canadian health care system is universal access. Canada is a giant HMO, with health being managed by the provinces.

Fist, some words about access and waiting times. For essential procedures, waiting times are excellent. During the early 1990s, I went into a retail eyeglass store for new glasses and an eye exam. The optometrist saw something that he didn’t like and referred me to an ophthalmologist at the local hospital, who discovered that I had a retinal detachment and scheduled me for surgery. The total time from the day I walked into the optometrist to the day of the scheduled surgery was two days. You can’t ask for anything better than that.

Yet the waiting times for non-emergency routine exams can be maddening. Waiting times to see a specialist, like a dermatologist, can be two or three months. This is the point at which many Americans get upset. If we examine outcomes, life expectancy is higher in Canada than the US. The CIA Handbook shows US life expectancy at 78.11 years, behind Canada at 81.23 and many other developed countries (Australia 81.63, France 80.98, Sweden 80.86, Israel 80.73, Italy 80.20, etc.)

A New Yorker article also indicates that more and faster health care isn’t necessarily better:

Americans like to believe that, with most things, more is better. But research suggests that where medicine is concerned it may actually be worse.

In a 2003 study, another Dartmouth team, led by the internist Elliott Fisher, examined the treatment received by a million elderly Americans diagnosed with colon or rectal cancer, a hip fracture, or a heart attack. They found that patients in higher-spending regions received sixty per cent more care than elsewhere. They got more frequent tests and procedures, more visits with specialists, and more frequent admission to hospitals. Yet they did no better than other patients, whether this was measured in terms of survival, their ability to function, or satisfaction with the care they received. If anything, they seemed to do worse.

The issue here is coordination. Remember the original idea of the HMO (before it became a dirty word)? In an ideal world, an HMO assesses the patient’s health and risk factors and then puts resources into preventative care, which is a lot cheaper, rather than being reactive with treatment, which can be enormously expensive. Under the current system, many doctors are siloed in their own specialties and there is little coordination and consideration of overall care.

Ironically, I found that I received better care and better insight for a chronic condition from a Canadian organization which can be best described as a wellness clinic, to which I pay a fee, than I did in the US. My American physicians included doctors from world class hospitals such as Mass General Hospital in Boston, which was part of Harvard Medical School, and people listed in the Who’s Who for my condition. I have no complaint about any of these individuals. All of them were knowledgeable and dedicated to their jobs, but coordination was lacking.


Problems on both sides of the border
Opponents of the Canadian system cite horror stories. Yet there are horror stories on both sides of the border. People drop the ball everywhere and it doesn't necessarily have to an indictment of the system. Here are two stories to which I have first or second hand knowledge. One occurred in a world class US hospital, to which people come from all over the world, the other occurred in a regional hospital in Canada.

Case 1: A expectant mother is rushed to hospital because her water broke and there is risk of infection if the baby isn’t born soon. She is told that they need to induce labor right away. After she is admitted, hospital staff put her in a room and forgot about her.

Case 2: A woman visits her terminally ill father in the hospital. When she arrives, he appears to be asleep so she sits down and reads a book. After about half an hour, she tries to wake him and discovers that he seems to be dead. She goes to the nursing station and is informed that the patient had passed away about two hours ago, but no one bothered to call and notify the next of kin.

Anecdotes make good headlines and they make good stories, but they don’t tell what’s wrong with the system. The Canadian health care system’s problems aren’t necessarily the waiting times, which can be frustrating, but extra and unexpected costs that were not part of the initial design. The system was conceived and financed in a day when the practice of medicine consisted mainly of doctors and nurses, either in a standalone practice or in a hospital. Fast forward a few decades, we now have a huge array of medical equipment and drugs that are available to the practitioner.

When I returned to Canada, I found the system glaringly short of medical diagnostic equipment (like MRIs). Given the structure built into the system of nurses’ unions, medical associations (which are in effect doctors’ unions), there is little left in the budget for equipment and drugs.

This state of affairs has resulted in a two-tiered system, much like the British NHS. You are entitled to a basic level of care, but if you don’t want to wait for an MRI, then you need to cough up money. Several months ago, my wife broke her foot and went to the hospital. She was offered a plaster cast for free. If she wanted a removal walking cast, she had to pay.


The American system: Great access, but…
When I lived in Boston, I was fortunate to have worked for a company that took care of its employees well with a gold-plated health plan. You had access to any doctor in the Boston area and the co-pays were extremely low.

The lack of waiting times was great and so the lack of requirement for a referral to see a specialist, but I wasn’t sure if the care because I wasn’t necessarily qualified to make decisions. Here is the perspective from the New Yorker:

Providing health care is like building a house. The task requires experts, expensive equipment and materials, and a huge amount of co√∂rdination. Imagine that, instead of paying a contractor to pull a team together and keep them on track, you paid an electrician for every outlet he recommends, a plumber for every faucet, and a carpenter for every cabinet. Would you be surprised if you got a house with a thousand outlets, faucets, and cabinets, at three times the cost you expected, and the whole thing fell apart a couple of years later? Getting the country’s best electrician on the job (he trained at Harvard, somebody tells you) isn’t going to solve this problem. Nor will changing the person who writes him the check.

A question of incentives
In Canada, much of the practice of medicine is just that, the practice of medicine. Most doctors are engaged in well-paid piecework ($X for an examination, $Y for an operation, etc.) The government takes care of much of the practice management by functioning like a giant HMO. In the US, physicians take on much more of the burden of practice management themselves.

Economists know that people respond to incentives.

During my time in the US, I met many doctors who were dedicated to their profession. The US has built a health care system where doctors become salesmen. In a number of cases where the diagnosis or the solution is not so clear-cut, I encountered numerous situations where the doctor was subtly, or in one case not so subtly, selling the patient on a procedure.


About the same cost
Overall, I found that my out of pocket costs under the US system were roughly the same under the Canadian system. Under the US system, the main cost was health insurance. Under the Canadian system, the main costs were drugs and medical equipment and tests, which were discretionary.

The difference is universal access. There is something wrong when a former supreme court justice (a Reagan appointee no less!) worries about health care availability for her own family [emphasis mine]:

BIG NUMBERS, like 45 million uninsured Americans, are hard to grasp. But that number came home to me at a recent conference. The keynote speaker was former Supreme Court justice Sandra Day O'Connor. Her topic was our healthcare system, and her message was personal and anguished.

The gist was that even she lives in constant fear of major uninsured health bills. Not her own -- those of her son. He can't afford insurance because his son -- her grandchild -- has a preexisting condition.
I know that this post won’t win me many friends. For Democrats who look north for a model health care system, the Canadian system has many warts – and they are major ones. Cost pressures are relentless and the Canadian solution doesn’t address all the problems.

To the Republicans who say that they don’t want a government bureaucrat to make health care decisions for individual, I have two answers. Is having an accountant with green eyeshades make decisions, which is what is happening now, any better? Moreover, we have a legion of government bureaucrats in uniforms (that you most likely support) making decisions for you in faraway places like Iraq and Afghanistan. If you truly embraced free market principles, would the likes of Eisenhower, Westmoreland, Schwarzkopf and Petraeus performed any better if they had been given option based incentives to pursue their wars?

I have written before that the difference between the entrepreneurial spirits in America and Europe young engineers in the US want to grow up to be Bill Gates, where young engineers in Europe want a job with Siemens. If we were to transpose that analysis to health care, should young medical researchers aspire to discovering the cure for cancer or to commercialize the cure for cancer?

How you answer that question frames your response to the health care conundrum.

Monday, July 27, 2009

Some deep value stocks

Given the medium term risks for the stock market, I thought that I would highlight a few deep value stocks that may provide some downside protection from the cushion of fundamental value.


Stocks trading below net cash
I screened my database of US listed stocks for companies that trade below net cash (cash less all debt) and are showing positive earnings. The positive earnings test is a second check for the viability of the enterprise, as a deteriorating income statement could easily wipe out any value shown on a balance sheet. Not surprisingly, the pickings were rather slim given the market's extended nature:

Health Net Inc (HNT) and Pain Therapeutics Inc (PTIE)


Stocks trading below net net working capital
This is a classic Ben Graham screen. I looked for stocks trading below net-net working capital (current assets – all liabilities) and are showing positive earnings:

Cynosure Inc (CYNO) and Volt Information Sciences Inc (VOL)

I would not blindly buy these names but take this small list as a starting point for further analysis. I know nothing about the outlook or fundamentals of these companies. In particular, I would be cautious about Pain Therapeutics as it had shown a spate of insider selling.

Friday, July 24, 2009

A sanity check for bulls

As the S&P 500 roared past resistance at 950 and the calls that the recovery is here increase, a friend of mine suggested a thought experiment for bulls and bears alike.


A thought experiment
In the area that you live (if you don’t live in the US, use the United States as the area under consideration), what is your forecast for the following a year from now?

  1. Tax rate, including state, local, property and sales taxes (Up, down or flat)
  2. Short term interest rates (Up, down or flat)
  3. Employment (Up, down or flat)
  4. Savings rate, remember the new frugality (Up, down or flat)
  5. Consumer spending and confidence (Up, down or flat)

Do your answers add up to a bullish outlook for the economy? I didn’t think so.

My inner investor tells me to be very cautious at these levels. On the other hand, when short-term traders like Tim Knight, who is bearish, start posting on the theme of “why I am right and the market is wrong” and with investor sentiment still leaning bearish, my inner trader tells me that this rally may have a bit further to run in the short-term.




Fear the bear, but respect the bull.

Wednesday, July 22, 2009

Replace Bernanke?

Ben Bernanke’s Op-Ed in the Wall Street Journal about how the Fed could remove accommodation has ignited a firestorm in the blogosphere. Most of the response has been less than complimentary (here is one of the milder ones). In connection with this article and his recent testimony, the cries to replace Bernanke in January 2010 have also been getting louder.

Yes, Dr. Bernanke, we know that the Fed has many tools to tighten its very easy stance of quantitative easing. The question is, is there the political will to do so? Today, we have a Fed Chairman spent his academic life studying the Great Depression he appears to be determined to avoid a repeat of that episode.


Tighten? Are you out of your mind?
On the other hand, we have a yield curve that is steeply upward sloping, with the spread between the 3-month and the 10-year well over 300 basis points. The textbook monetary policy response is to tighten now.




In response to the Op-Ed, there have also been calls to replace Bernanke as Fed Chairman when his term expires in January 2010. This may be a case of being careful about what you wish for.


Who are the alternatives?
Who have the political guts to tighten now? Would even Paul Volcker, who has largely gone silent, tighten in the face of a fragile recovery?

Over at intrade, Bernanke remains to be the front-runner to be re-appointed Fed Chair.


After Bernanke, the next leading contender is Janet Yellen, president of the San Francisco Fed. She recently gave a speech indicating that she wants the Fed to err on the side of accommodation:

I’ll put my cards on the table right away. I think the predominant risk is that inflation will be too low, not too high, over the next several years. I take 2 percent as a reasonable benchmark for the rate of inflation that is most compatible with the Fed’s dual mandate of price stability and maximum employment.

If you don’t like Yellen, how would you feel about Larry Summers, who is the third favorite?

If Bernanke, Yellen and Summers are the top three leading contenders to be the next Fed Chair, what does that say about the future of U.S. monetary policy?

For those who are interested, I have a free e-newletter for inflation and commodity bulls. You can sign up here.

Monday, July 20, 2009

The important of an investment process

John Hussman has a superb article this week on the importance of having an investment process, though he doesn’t quite call it that. Hussman says that that there are reactive investors and responsive investors:

[A] reactive investor tends to reverse existing investment positions only when provoked by pain. Investment positions are sold when they have declined enough to trigger fear or panic. Investment positions are purchased in a rush to “catch” or “ride” them. My impression is that the single best mark of a reactive investor is the tendency to measure investment success by the amount gained or lost on any particular day.

Then there are the ones with an investment process and disciplines:

In contrast, the investor who responds puts much more emphasis on daily actions than on daily outcomes. That doesn't mean ignoring outcomes, but it means following a specific, well-studied discipline with the expectation that the results will emerge through repeated application. As usual, those results are best measured in terms of long-term return and risk over the complete market cycle.

In other words, a responsive investor has a discipline. He responds to the changes in his models and indicators and adjusts his portfolio according to a discipline.

Good investors need to understand the importance of having a process and discpline. Life isn’t just about price momentum and stop losses.

Phoenix for Canadians

Further to my recent post on Phoenix stocks, I was asked by my Canadian friends for a Phoenix list for Canadian stocks (as I am living in Canada).

The problem is that the Canadian stock market is full of low-priced stocks, a key criteria of the Phoenix screen. Consider the members of S&P/TSX Composite Index, 29.8% of its members are priced below $10 a share, compared to 10.6% for the S&P 500. Even if we lowered the cutoff to $5, 8.7% of the S&P/TSX Composite trade below $5, compared to 3.2% for the S&P 500.

Moreover, the Canadian market is full of low-price mining stocks that you could take a punt with, here is an example (which is not a suggestion to buy or sell the stock).


A macro call on commodities and recovery
The essence of the Phoenix strategy is the combination of a macro call for a recovery by buying highly levered “fallen angel” stocks. To capitalize on that theme of a recovery, secular commodity bull (my theme) and fallen angels, I offer the following.

The chart below shows the relative returns of the Energy Select Sector SPDR (XLE) compared to the S&P 500. The XLE remains in a secular relative uptrend, indicating that it remains in a secular bull phase.



Oil prices, having retreated from a high of $147, are now trading at about $64 and showing some signs of stabilization. One way of playing the recovery in energy prices is through property developers focused on Alberta, such as Genesis Land Development (GDC.TO)



…and Melcor Development (MRD.TO)



These certainly qualify as fallen angels, as their stock prices were clobbered in the Crash (down 90% peak-to-trough for GDC and 80% for MRD).

In addition to the recovery in oil prices…



…recent statistics for the Calgary residential property market, as an indicator for Alberta overall, shows signs of a mild recovery. Not only have prices begun a modest upturn, but market internals such as inventory and the sales-to-list ratio have improved.

Needless to say, these stocks have moved off their bottoms and remain highly speculative. They represent high risk/high reward calls on oil prices and the economic recovery.

Buy them at your own peril.

Friday, July 17, 2009

Early clues from Earnings Season: No all-clear yet for Main Street

Sometimes investors can glean some clues as to the direction of the US markets and economy based on the market’s perception of Earning Season.

Firstly, Bespoke reported last week that the market was entering Earning Season with high expectations (a headwind for the bulls). Drilling down further, Starmine, which has a relatively good record of forecasting earning surprises, gave the following list of five North American stocks that were likely to beat 2Q Street estimates:

Electronic Arts (ERTS), Tyson Foods (TSN), Discover Financial Services (DFS), RadioShack (RSH) and Apple (AAPL).

The list of five forecasted earnings misses are:

Melco Crown Entertainment (MPEL), D R Horton (DHI), TransAlta Corp (TA CN), Royal Caribbean Cruises (RCL) and Canadian Pacific Railways (CP CN).

Admittedly ten stocks is a very limited sample but it can be instructive to analyze the tails of the distributions for clues to the market and economy. Based these obseravations, Tech is likely to be stronger than expected, while Consumer Cyclicals are likely to be weaker (Gaming, Homebuilding, Travel and Transportation), though the appearance of RSH in the positive surprise group is an exception.

Given the high level of expectations going into earnings reporting season, weakness in the cyclicals, combined with the systemic risks posed by a CIT failure (see commentary here and here), are not good signs for the near-term outlook for the market or economy.

Tuesday, July 14, 2009

A Phoenix (mini) report card

I have often written about the Phoenix effect. On February 24, I posted that speculators could take a punt on Phoenix because the market was so oversold:

While I wouldn’t recommend it, speculators could try to get long a basket of Phoenix stocks for a punt. If you do, then I would suggest that you manage risk with some tight stops in place so that the trade doesn’t totally fall apart on you.

I then gave a list of names that were Phoenix candidates.


When do you sell?
Subsequent to that post, the S&P 500 then fell to its 666 low on March 9. It then saw a rally, powered mainly by the “junk” stocks, or Phoenix names, that peaked in early May. The S&P 500 further rallied to a new high on June 11, but then fell through its moving average on June 22.



What would the returns of an equal-dollar-weighted basket of those stocks have been?

The answer depends on your exit price. While there are certain conditions for putting on a Phoenix trade, there are no specific selling rules. However, looking over the performance of that basket, results have been spectacular, with stocks like Fifth Third Bancorp turning in returns north of 300%.



The most conservative estimate of this portfolio would have postulated that a trader bought the basket on February 22 and sold on June 22, the day the S&P 500 fell through its 50-day moving average. The returns would have come to 118%.


High profit potential
Although I didn’t personally put on the trade, I did hear from some readers who selectively bought from the list and reported some very good returns. If you had perfect foresight, here is a range of possible returns:

Sold on June 22 (S&P 500 high): 164%
Sold on May 8 (Junk stock high): 169%
Bought on March 9 and sold May 8: 236%

In short, a trader buying a Phoenix portfolio would have seen somewhere between a double and triple in his capital in roughly three months.

This example illustrates the awesome power of Phoenix.


Wait for the re-test: China can’t hold up the world
The equity rally of the last few months has been mainly been powered by signs of stabilization, or “green shoots”. Today, the market has now priced in stabilization and will only see a significant advance if the economy recovers – a much more difficult hurdle.

Globally, much of the expectations of recovery have been based upon the perception that China is growing, driven mainly by rising commodity prices and shipping rates. Commodity prices, however, were rallying because of Chinese inventory accumulation, not consumption. With stories that Chinese inventory accumulation largely over, commodity prices have corrected and so has the Baltic Dry Index.



I fully expect that we will hear “China is slowing” fears circulating among the trading desks in the near future. This would knock the last underpinnings of the current market rally and a decline in the equity indices. It would also mean that the USD and bond market would tactically catch a bid. The S&P 500 could well test the old lows, either made last November or last March.

That will be the time to buy Phoenix. Be patient.

Friday, July 10, 2009

The Grand Experiment

The long term outlook for the USD continues to look dire. As the story broke that the G8 failed to reach a consensus on policy, but believed that the world economy is too weak to withdraw stimulus, and the developing economies rose to challenge the G8, the BoE surprised by halting the expansion of its quantitative easing program.

As I have written before, Britain is the canary in the coal mine for the US. The UK, unlike the US, has a very similar range of problems as the US but does not have the luxury of being the issuer of a major reserve currency.

As Macro Man commented yesterday (before the BoE announcement):

[I]t's worth noting that today sees an announcement from one of the few CBs in a tighter spot than the Fed....the Bank of England. Inflation has consistently exceeded expectations, and a prior raft of better-than-expected activity data has recently receded into sharp declines. Oh, and the fiscal situation is worse than that in the US, and adminsitered by a government that's now utterly bereft of credibility.

The BoE is embarking on a grand experiment with its QE policy.

Watch this space for what may follow if the Fed follows this path.

Monday, July 6, 2009

Summer holidays

There will be light posting I will be on vacation this week and internet access will be sporadic.

Saturday, July 4, 2009

America: Decline or Revival?

As my American friends fire up the barbeque on this Independence Day weekend, I invite them (and my other readers) to ponder the long-term fate of America.


The end of Pax Americana?
The past few weeks has seen more bad news for American standing and influence. The Chinese are questioning the long-term supremacy of the US Dollar as reserve currency again:

Top officials, including Premier Wen Jiabao, have openly expressed concern about Chinese investment in the US. The country has also actively mooted the idea of a super sovereign reserve currency to replace the dollar.

Besides, it has also sought to promote the use of the yuan for foreign trade and investment; a first step, some think, toward challenging the dollar's status as the preferred currency of international trade and capital flow.

Meanwhile, Econbrowser reports that the US continues to go into debt, as it moved from a net debtor in the 1980s to a deeply indebted position today.


Or revival?
On the other hand, John Mauldin recently posted a remarkably optimistic view of American revival, based on the work of Neil Howe [emphasis mine]:

The potentially good news…is that the Crisis we're now entering will change pretty much everything. While this change will entail a great deal of pain and a reduced standard of living for a large number of people, by the time the Crisis subsides, society will have pretty much remade itself in ways that no one can predict at this point…

Neil Howe turns to his generational profiles and points out that the rising societal power today belongs to the generation he calls the Millennials, individuals born between 1982 and 2004. They are a "Hero" generation, just like the G.I. Generation that coped so well with the turmoil of the Great Depression and World War II -- the last Fourth Turning. Coddled as children, the G.I.s were ultimately called upon to help society through a dark and dangerous period and rose to the occasion…

[These] periods have always resulted in the nation redefining who we are in some essential way. That was certainly the case during the American Revolution, when we transitioned from a British colony into a collection of independent states -- and the Civil War, when those states were hammered into a single nation. And, again, after World War II, when the U.S. went from being a relatively isolated nation to a global empire. A wild card, for instance a terrorist nuke going off in a city anywhere on the planet, could similarly take the country, and the world, into unforeseeable new directions.

Of course, this optimistic view is highly dependent on America getting through the crisis intact.


A Singularity in history
Does America decline or will we see a new Renaissance?

I believe that we are approaching a Singularity, or a discontinuity, in history. All that we know is that we are approaching a Singularity but we cannot forecast what happens afterwards (that’s why it’s called a Singularity).

Consider the words of blogger Fabius Maximus, who wrote the following in February 2007, well before the onset of the current financial crisis, about the Singularity and the challenges that Americans face:

This transition will be like a singularity in astrophysics, a point where the rules breakdown – and beyond which we cannot see.

Such trials appear throughout history. Consider Russia in 1942. Ruled by a madman. Their government had betrayed the hopes of the revolution, killed tens of millions, and reduced the nation to poverty. Most of their generals were dead, their armies were in full retreat, and vast areas were controlled by a ruthless invader.

The mark of a great people is the ability to carry on when all is lost, including hope. We can learn much from the Russian people’s behavior in WWII.
For investors, such a scenario involves a high degree of market volatility and fat-tailed returns. Be prepared.

Thursday, July 2, 2009

A sanity check for bulls

As the S&P 500 roared past resistance at 950 and the cries that recovery is here intensify, a friend of mine suggested a thought experiment for equity bulls and bears alike.


A thought experiment
In the area that you live (if you don’t live in the US, use the United States as the area under consideration), what is your forecast for the following a year from now?

  1. Tax rate, including state, local, property and sales taxes (Up, down or flat)
  2. Short term interest rates (Up, down or flat)
  3. Employment (Up, down or flat)
  4. Savings rate, remember the new frugality (Up, down or flat)
  5. Consumer confidence (Up, down or flat)

Do your answers add up to a bullish outlook for the economy? I didn’t think so.

My inner investor tells me to be very cautious at these levels. My inner trader tells me that with investor sentiment still leaning bearish, this rally may have a bit further to run in the short-term.




Fear the bear, but respect the bull.

Wednesday, July 1, 2009

A cleantech revival? Or bubble?

Recently Bill Luby at VIX and More highlighted the revival of the cleantech group, at least relative to oil & gas energy stocks. Paul Kedrosky also pointed out that a United Nations Energy Programme report indicated that renewable energy investment (at $140 billion ) had surpassed fossil fuel investment (at $110 billion) in 2008.

Are these signs of a cleantech revival? Or bubble?


Algae as a case study
To answer that question, I would like to tell you the story of an email I received from a friend, who is an enthusiastic supporter of algae as a readily available alternative to petroleum-based energy sources.

To be sure, algae oil does have promise as an alternative fuel source. It can be grown relatively easily. Scalability and resource utilization is less of an issue when compared other biofuels. It can be relatively energy efficient.

Anyway, my friend emailed me this announcement and he breathlessly added that this may be the antidote to any potential Peak Oil problems. In part, the announcement read that a company called Algenol Biofuels was announcing a algae to ethanol solution, using sunlight and seawater. The company also stated:


[It] will produce ethanol at a rate of over 6,000 gallons per acre per year.

Doing some back of the envelope calculations, this comes to 16.4 gallons per acre per day. Assuming that they put together a 10,000 acre facility, this amounts to 164K gallons per day. There are 42 gallons in a barrel, but a barrel of oil produces about 23 gallons of gasoline. Using the 23 gal/bbl equivalent, a 10,000 acre facility produces about 7K barrel gasoline-equivalent from this technology.


Epsilon production
7,000 barrels a day of production wouldn’t even show up on the map of oil production. It’s what quants call epsilon, the miniscule error term that appears at the end of many equations.

Even if the company was to put together a very large parcel of land of 500,000 acres, which is roughly the size of the State of Maine, and they had sufficient access to seawater, this would amount to about 360K of barrel equivalent of oil production per day. While that represents a very large find (let’s remember that we are taking up Maine), it is still a blip in oil production. Saudi Arabia, by contrast, can produce about 10-11 million barrels a day.

In other words, even if we assumed that the infrastructure, power, transportation and technology problems were solved, you need to use this technology on an area 30 times the size of Maine to replace Saudi Arabia.

Correction: If you devoted an area the state of Maine to this technology, you would produce about 15 million barrels a day.

Cleantech breakthrough, revival, or bubble? You tell me.

If it were to be a bubble, recognize it as such and understand that bubbles depend on the Greater Fool theory. By all means play the bubble if you want, but don't wind up being the greater fool.