Market View – January 2012

Happy New Year!  May 2012 bring you and your family good health and good fortune.

2011 was a tough year to make money in the markets.  It was not like 2008 when many investors dropped half their net worth, but with interest rates near zero and a variety of world events, 2011 was a volatile one.  Japan suffered an earthquake, tsunami and nuclear meltdown.  Greece reached the brink with other parts of the Eurozone slipping with it.  The United States Treasuries were downgraded – no longer rated AAA.  The Arab Spring brought six Arab countries into civil wars.  We entered a new war in Libya while leaving Iraq and we ended the year with Iran beating its war drums.  Even once dependable China spent the year purposely slowing their economy, wrestling with an over-built housing and office market.  After all, the S&P 500 ended the year, roughly flat, but 8% below its April 29^th high.  Even those numbers overstate the market performance since the 16% gain between October 4^th and October 28^th was one that few investors realized since most were heavily cash after a five month market decline, culminated by a September which saw the market drop by 10% in that month alone. Hardly a scenario that sounds good for investors?

The good news: Many of the storm clouds of 2011 may soon dissipate.  The week before Christmas, the ECB (European Central Bank) granted over $600 billion in three-year loans to European banks and loosened the collateral requirements that banks use to qualify for ECB loans (and to be considered solvent).  The plan is referred to as the Long-Term Repo Operation (LTRO) and indicates that the ECB has found a palatable (to Germans) plan for printing euros.  I believe the LTRO will actually help.  Very encouraging considering the ECB track record of talk, but no real action.  The LTRO allows banks to borrow at 1% and invest that money into their own nations’ treasury bonds.  It should help reduce the borrowing costs of their respective governments, while offering the banks a (no additional) risk way of making a 4% or more return on the borrowed funds.  I say there is “no additional” risk since the major banks of Italy, Portugal and Spain already have huge exposure to their government treasuries.  If their treasuries blow-up, the banks are toast, so helping to prevent such an occurrence while making an attractive return, seems to be a win-win.  The plan worked here, so the ECB has resigned itself to copy the U.S. plan of quantitative easing – allowing for the printing of euros on an “as needed” basis.

The LTRO indicates the ECB commitment to keeping the eurozone united, so it becomes less likely that even Greece will be eliminated.  It certainly bodes well for Italy, Spain and Portugal which until now, appeared in danger.  The investment opportunity will become clearer once we see a few treasury auctions in these same countries.  Lower rates will reflect the program’s success and that would bode well for all markets.

China

China spent the end of 2010 and most of 2011 stepping on the economic brakes, raising interest rates five times and bank reserve requirements eleven times.  But on December 5^th, the China Central Bank (PBOC or Peoples Bank of China) lowered the reserve requirements for the first time in over three years, indicating that they are satisfied with their inflation and property numbers and are now more concerned about stimulating their economy.  I expect another reduction this month, ahead of the Chinese New Year, and likely more to follow.  The PBOC favors reserve requirement reductions over interest rate reductions because they believe they are better able to direct the effects to business rather than residential real estate.  As China eases, it will stimulate their economy, likely keeping GDP growth above 8% for 2012.  This would be bullish for businesses selling to Chinese companies and consumers, regardless of their domicile.

U.S.A.

U.S. companies as a whole are in very good shape right now.  Though stock charts may not reflect it, most companies spent the last few years getting lean and profitable, while many are now trading their shares at very attractive valuations.  Once investors begin to wrap their beliefs around the ECB plan, these shares could takeoff.  Add a stimulus via China’s lowering of the bank reserve requirements and we may see a 20% or better rise in our portfolios, which are complete with the companies which should benefit most.

Possible Political Kicker

2012 might even bring a real jobs bill via an energy plan.  I never count on politicians (of any stripe) to do the right thing, but this is one that almost everyone would favor and it would help the lower incomes the most – not just here, but everywhere.  It might happen – election years have a way of getting politicians to get something done.

Adopting an energy plan based on the incredible abundance of natural gas, would create hundreds of thousands of jobs, would decrease the cost of oil for Americans and all other nations.  Reduced costs for gasoline and heating would free-up money for reducing debt, saving, and for the purchase of discretionary products – a global stimulus plan that would vastly increase tax revenues without increasing tax rates.  The United States is the Only major nation without an energy plan.  We are the Saudi Arabia of natural gas – a clean burning fuel that costs less than 1/4 that of gasoline.  The program would almost eliminate the US trade deficit, would put much more than the $80/month that the payroll tax reduction provides American workers and instead of robbing Social Security, it would add to the Social Security funds.  The resulting drop in the use of oil would make the environment cleaner and make the world safer.  Oil would likely drop below $70 per barrel, making the funding of terrorist groups difficult if not almost non-existent as Arab countries dealt with a drop in net income by half or more.  That would reduce the costs of defense for us and our allies, allowing countries to reduce their deficits and debt from savings and the additional tax revenue.  A natural gas energy plan would spur the economy and the markets in many ways.  We will not count on this, but when this finally happens, portfolios will have an incredible bull run.

Frank

Ph.  512.345.6789

Double Dip Economy?

October 4, 2011

Finally, it appears that Europe may act – right or wrong, they appear ready to do something about the sovereign debt crisis’ of Greece, Italy and other PIGS nations. We have used cash and short positions to hedge against the markets over the past five months and they have helped considerably, but positive actions by Europe and China should put the wind at our back. With that in mind, we have removed all hedges and are now cash and long. The first and most in-your-face, is Europe’s sovereign debt. Germany has ratified the European equivalent of TARP and now only a couple of nations remain. Why did Europe ever put together a system of 17 nations which must vote unanimously for any change? The second event looks closer as of an hour ago (4:30 am CST). China announced stronger growth numbers than generally expected and said they expect their currency to continue its steady appreciation (much of our cash is in Chinese renminbi or renminbi). We will start adding renminbi denominated, short-term bonds as a safe parking spot. They average about 2.5% (net) and the renminbi has rather steadily climbed 6.5% against the dollar in the last twelve months. With China’s intentions well established, we can expect the same going forward. It is exactly as I have expected and previously discussed, since it is in China’s best interest. Since they are entirely in control of their currency, it is the one given in an unpredictable world.

There is still a third big issue that will put the wind at our economy’s back and would make market gains an easy proposition. It would go a long way towards solving the unemployment and housing problems. It would reduce, almost eliminate, our export deficit and reduce the threat of terrorism. I encourage you to let the President and Congress hear from you on the topic. It is simply an energy policy. Short-term, start drilling for our own oil. It will greatly reduce the cost of gasoline, putting extra money into the economy instead of sending it to OPEC. Just 2 ½ years ago the national average cost for a gallon of gasoline was $1.73 but the moratorium on drilling has reduced global supply, resulting in an increase in the cost of oil and putting more money in terrorists hands. Long-term, we should convert our trucks and cars to natural gas. We have more than a 100 year supply and it is clean burning. The number of jobs the two solutions would create would be in the millions, which would obviously spur the economy and spill over to housing.

Before I go forward and discuss the Fed, the economy and China, in more detail, I want to show you the following graph. It should put into perspective exactly what we have been dealing with. The following shows the relative performance of the various world indexes and gold. Even gold retreated in September (there were two margin requirement increase which caused much of the (temporary) retreat). Down months are never a good thing, but try to remember others, like the end of 2008, where we rebounded very quickly. I expect we will be able to do the same this time. All losses hurt, but we have actually dropped very little relative to the world indexes which are down an average of 24% since the end of April. We have a lot of cash that can be put to work when the big sovereign debt issues are resolved and when the emerging markets resume their more obvious growth. But as I stated earlier, we plan to tread water in the meantime and wait for these issues to be clearly solved.

The Fed

Whenever speaking before a Congressional committee, former Fed chief, “Easy” Al Greenspan was fond of saying, “I guess I should warn you. If I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” His protégé, Fed chief Ben “Bubbles” Bernanke borrowed the script from his mentor, and speaking in Jackson Hole, Wyoming on August 26th, – left most his audience wondering what he meant.

At the end of the day, it was generally understood that while the Fed hasn’t made a final decision so far, Bernanke was careful to keep the dream of QE-3 alive. “The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability,” Bernanke said. Adding a new twist, he said the September policy meeting will be extended to two days, instead of just one, to allow for a fuller discussion, suggesting a “pleasant” surprise (QE-3) could be in the offing next month. Since then, several Fed governors have indicated that they would back another round of QE should the economy show clear signs of sliding towards another recession. And just this week, Mr. Bernanke said the same.

Operation “Twist” began last week with the Fed pledging to buy longer-term U.S. Treasuries. I guess Bernanke and friends believe that business is not borrowing to expand because the 10-year rate was 2.25%. Certainly, by driving that rate down to below 2%, …that will change? Hopefully, that is the precursor to a Refinance Bill that will allow qualified home-owners to quickly and easily refinance their homes at very low rates. That would create a huge stimulus to the economy, one which continues every month for years, and without taxpayer expense. Of course, it takes a President and a Congress to pass the bill or the Fed action is basically useless if not harmful. Again, if such a bill is enacted, we will respond, but not before it is passed by both houses and signed by the president.

The Economy – Double Dip?

Investing Rule 1 of 1 : The economy and the markets seldom reflect each other. As I discussed in a recent letter, one should not confuse a bad economy for a bad investment environment. That is true of most weak economies and even recessions, but this government has brought us to a meaningful chance of depression, thus the forced decision to hunker down our investments and wait.

Today, if you are looking for a job, the world may appear hopeless. With over 9% unemployment and around 17% of the workforce underemployed, America is less than vibrant. But when you look at corporate America, it is a different picture. Corporate America is in perhaps, its best shape since the 1980’s. Balance sheets are robust, earnings are growing and cash is at record levels. The disconnect is at the cross-section with government. Those with the capacity to hire are simply immobilized. How can you budget or manage to the unknown of fiscal and regulatory policy? In an environment where companies question the potential demand for their goods and services, there is good cause to be hesitant about hiring new employees.

Add a president and a congress who bombard the consumers with a constant tome of the sky is falling, why would anyone rush out to spend a dime of what might be the last dollars they should ever have? The leadership of our nation, along with a compliant media, convinced most of the world of an impending disaster called the debt ceiling and went on to target D-day as August 2nd. As the days and weeks passed with the president on television almost every day speaking of the coming financial disaster, and the Republicans and Democrats arguing as to who was at fault, why would anyone expect the consumer to do anything but hunker down?

With the European Central Bank and Euro Zone enacting the same play across the ocean, there is little surprise that the last couple of months have stripped the MSCI World Index of some 27% of its value. But again, this problem has been kicked down the road and one would hope that the real solution being voted upon now, will pass all 17 Eurozone countries and finally begin the cure.

Gold

Mark Twain once said, “If you don’t read the newspaper you are uninformed, if you do read the newspaper you are misinformed.” The constant barrage of barely informed reporters constructing stories to explain the stock market, interest rate moves, or the value of gold, are more likely to misguide the viewer than inform. The story about gold is a good example. According to most journalists (most of which have very little or no personal investments), gold is in a bubble about to pop. And it has been for years, so now it must be true. They compare it to its inflation adjusted value or discuss the 75-year average return (the first 35 of which it was pegged by the government at $35/ounce so there was no gain). Liam Denning of the Wall Street Journal declares that it cannot be a hedge against the falling dollar since “gold’s 22% gain since April has happened while the dollar has not really moved”. Mr. Denning appears to miss the fact that he compares the dollar only to the dollar index, comprised mostly of the euro, along with the pound and yen. Certainly, it helps his case if you ignore the fact that the euro, pound and yen are all devaluing along with the dollar. I always liken it to four men standing in quicksand and comparing their height. You may not be believe you are sinking if you only look at your three doomed friends, but it will become apparent that you have been, once the sand is at your nose. Mr. Denning goes on to say that “the past few decades suggest it (is not a store of value), but again he misses the point. Gold is a real currency and has been for thousands of years. The dollar was an acceptable currency and store of value until persistent government deficits and an insurmountable debt. It was only then that wise investors determined that a return to a real currency, gold, was a good insurance policy against governments that owned printing presses that can churn out fiat paper currency at any volume desired.

Gold will rise – sometimes too fast, and gold will fall, only to rise again. And finally, gold’s rise will end, but I can only think of three scenarios in which that will happen (none are here today). The first is one in which the U.S. and European governments actually pass budgets that they can afford – no more deficit spending – no more currency printing to pay for their overspending. The second scenario would include a world in which currencies, again, are backed by gold or some other hard asset or combination of assets. The third scenario would entail a single world currency which only increased in volume based on a formula which included population and world GDP. Make real progress towards any one of those three scenarios and you can be assured that we will no longer own gold.

China

We truly are living in a “flat earth” economy in which every part affects every other. In stock markets this flat-earth effect is magnified by many ETFs which move entire sectors in tandem, whether or not the companies they hold are good or bad.

China was affected disproportionately in this latest blast of volatility, but the economy remains in a strong growth pattern. Infla­tion remains somewhat of a problem, but is overstated at this time. China has raised interest rates six times in the last year and bank reserve requirements some eleven, and are allowing their currency (renminbi) to appreciate, all of which bring real interest rates well above the inflation rate. The biggest threat to China remains external, not internal.

It is true that a slowdown in European imports from China would hamper the nation’s growth trajectory by a fraction of a percent according to the latest projections, but the market has re­sponded more dramatically, as if China’s entire economy could suffer a hard landing because of weak exports. The numbers do not bear this out. In fact this is a clear case of irrational markets at work.

Market valuations have now done much more than factor in a worst case scenario. They have priced in valuations of some companies well below book value. It is an absurd prospect to imagine that Chinese firms have been priced as if they will have no sales growth at all for years, but that’s what the market is saying right now and it is tough to argue with market volatility. The upside is that there will be buying opportunities as this phase of volatility passes. Stocks are very, very cheap. And, as the saying goes, it makes sense now to buy low and sell high later.

Investment Perspective

We are now beginning to move more cash back into the market. We will do this slowly in expectation of a positive European resolution and expecting Chinese monetary easing to take place in the next few months. We have been rotating our portfolio towards more companies that have high dividends, attractive valuations and are generating a large percentage of their revenue from non-US, non-European customers. Intel is a good example. It has a 3.9% dividend, a 10 P/E with an 8.9 forward P/E, a PEG of 0.83 and generates 75% of its revenues outside the U.S. and Europe. There are a number of technology companies, food companies (McDonalds & Yum Brands), and others who are growing their sales in China, which we own and will add to the positions where appropriate.

We are adding short-term bonds (Bernanke has given us a guarantee) and we are finding good bonds denominated in non-dollar currencies. Many large international companies issue bonds in a number of currencies where they do business. One might buy a General Electric bond in a number of currencies. They are (typically) backed by the same company and only the interest rate and currency exchange rate may differ. With most currencies appreciating against the dollar, a bond portfolio diversified among countries can offer the opportunity for higher yields and the possible appreciation due to currency appreciation. Hong Kong bonds denominated in the renminbi (yuan) are, in my estimation, some of the best since the Chinese will either continue to appreciate their currency or at worst, peg to the dollar.

Finally, in moderate to aggressive-risk portfolios, we will be adding more natural resource companies such as Freeport McMoran. Chinese copper inventories have been dropping – combine that with Chinese monetary easing and this beaten down sector is rotating back into favor. Other minerals and even oil and natural gas are attractive – natural gas will soon be exported to Asia and Europe in the form of LNG (liquefied), helping the exploration companies that have been beaten down by very low prices. Natural gas prices should rise to the $5 to $7 range in the next year or two as LNG is exported and the exploration companies exit remaining contracts that required them to drill to retain leases. They have met their requirements and the newer contracts contain pricing contingencies so they will no longer be required to drill when prices are too low.

享受好天氣和一個更好的股市 (Enjoy the good weather and a better stock market),

Frank

512.345.6789
2009 S. Capital of Texas Hwy. 2nd Floor
Austin, TX 78746

Beck Capital Management
Pro Player Investing

Beck Capital Management LLC, a Registered Investment Advisor, Frank Beck, Chief Investment Advisor. Fidelity Investments, custodian.

While Governments Fiddle, Debt Burns

With the heads of Germany and the European Central Bank getting along about as well as Obama and the Tea Party, the European Union is moving quickly towards total political failure. Weeks of disagreement by Europe’s political and financial leaders have let the crisis move far ahead of their discussions.Last week Italy was dragged into the morass when yields on Italian treasury bonds popped above 6%. According to Goldman Sachs analysis, Italy cannot service their debt should yields reach 7%, potentially escalating the European debt crisis to full meltdown.

Austerity packages aren’t going to fix that problem (they might even make it worse by slowing economic growth). Italy needs either a way to grow faster — by ditching the euro and devaluing a revived lira— or pay lower interest rates —by financing some of its debt through Eurozone bonds.

The steep climb in Italian yields is an indication that financial markets have begun to focus on the need for a more far-reaching restructuring of the euro system. Neither of those items appears to be on the agenda for Thursday’s “non-emergency” summit. European leaders still seem to believe that they can “solve” the crisis by kicking the Greek debt problem down the road into 2014, A more accurate metaphor would be rolling the Greek snowball down the mountain, as the problem continues to get bigger as they balk at a real solution.

I think this all means that any relief rally from a new Greek debt package is likely to be short-lived and we will be living this deja vu once again. With Greece able to finance its debts through late August, thanks to a $17 billion payment from the first rescue package, the stalemate could extend into September. Sound a bit familiar? With the U.S. facing a debt ceiling deadline of August 2 it appears the dollar and the euro may take turns as the weakest currency on the planet for at least the next couple of months.

How to invest the meltdown

The question most investors are asking though has little to do with the best solution (i.e. the ECB issuing Eurozone bonds backed by the EU so there is common debt to go along with a common currency). Most investors are wondering how to protect their life savings or perhaps even make a little money while the politicians manufacture solutions to the problems they created.

Beyond what should be obvious by now, gold and silver will most likely be profitable safe havens during the currency turmoil. Shorting large banks is working and will likely continue until such day that real solutions to sovereign debt are found. At that point we can go back to worrying about the banks “assets,” especially those burdensome mortgage loans that just won’t go away. In the meantime, I believe the TIPS of non-Euro and non-US governments might be profitable as even controlled inflation produces reasonable yields in appreciating currencies.

But the crisis promises to ebb and flow as politicians on each side of the Atlantic prove more inept than their counterparts in handling their respective debts. European ineptness causes some dollar strengthening, hurting most stocks and commodities, while America’s politicians seem only capable of tactics, but no strategy, leaving the markets to daily, decide who is most inept.

Here at home most investors are trying to find a place to hideout or at least add some protection to their current portfolio. Should you hold dollars knowing that they buy a little less each day or will the stock market or US treasuries be a better place?

Though I don’t believe you should completely sell out of this market, I would encourage most investors to keep some cash ready for buying opportunities created by a delayed agreement in Washington. It is the type of cash that matters right now. It makes sense to own some dollars, maybe 25% of your cash, but then consider a mix of Chinese renminbi, Swedish krona, Swiss francs, Brazilian reals, and Australian dollars for the rest of your cash position.

Consider the fact that the euro and the dollar are losing value and the faith in each is diminishing, making gold the real currency. As such, I think it is appropriate to own gold in your investment accounts and to own some gold and silver coins as insurance against a currency meltdown. I do not believe we will get to that point but I carry fire insurance on my house and the odds are heavily weighted against a fire. Personally, I buy and recommend owning some one ounce gold eagles and silver eagles. These are not the collectible coins, but are widely recognized as containing one ounce of the respective metal. Should we ever experience a currency meltdown, you can use gold and silver coins to buy food and other necessities.

Once you have your precious metals and cash as anchors for your portfolio, you may consider adding some floating rate notes of major corporations or some TIPS from emerging markets. An easy way to get exposure to these is through the iShares ETF (ticker symbol is FLOT) and the WisdomTree ETF (RRF & WDTI).

I expect all of these can add some stability to your portfolio during this government induced mayhem without costing you once the clouds disappear. Remember, most multinational companies are very profitable and are flush with cash. Once agreement is made in Washington, we are likely to see a very strong and positive reaction in the markets.

Looking forward to analyzing companies and markets again,

Frank

May 2011 Market View: The Long-Term and the Short

The Long-Term and the Short

I always emphasize the macro economy and its importance in making sound investment decisions and at this unique time it may warrant added consideration. With the developed economies’ governments and central banks having overspent, overpromised, and overprinted, the environment is unlike that which we have ever seen on a world-wide basis. While the developed countries central bankers print money to pay for spendthrift governments, the developing world’s central bankers are trying to slow their economies and deal with inflationary pressures. In the past, it was always developing economies or those of war-defeated countries that printed their way into hyperinflation – this time it is the developed countries who are nearing the tipping point.

The ending of QE2 (Fed’s 2nd phase of Quantitative Easing or money-printing in layman) has brought a significant, although I believe it will prove brief, contraction in commodity prices. The end of QE2 was made more significant with Greece, again, front and center. Then there was the repeated increase in margin requirements that forced significant selling in the silver market, which briefly spilled over to other commodities. After weathering a trifecta of investment challenges, one must consider where the market goes from here. Are these priced in or does Greece cause the euro to further devalue against the dollar? Has China finished raising interest rates and bank reserve requirements for now? Will interest rates move higher or even spike if the Fed does as they say, and end QE?

[Continue reading May 2011 Market View: The Long-Term and the Short]