Last Post

In the second half of last year I started thinking about potentially leaving my current employer and starting my own investment firm.  There were many reasons for this, not the least of which is complete disillusionment with company management.  For a number of months now I have been exploring this possibility, researching regulatory requirements, interviewing financial service providers, developing a business plan, etc.

I started this blog as part of this research.  The concept was to incorporate it into a more traditional business web site and use it as a way of effectively communicating updates to clients and prospective clients.

The blog has turned out to the the easy part.  Creating one and filling it with content has been simple compared to the other tasks.  And, after a very detailed examination of the alternatives, I have decided to shelve the idea of launching own firm for now.  The rate of change and amount of uncertainty in the financial services industry is at extreme levels, and I may end up elsewhere, but for now it will not be of my own volition.

So, this is the last entry for the Durable Investor.  I will turn my efforts back to concentrating solely on success in my current role.  Yes, management at my company remains questionable, and perhaps has even been borderline criminal in the past, but I have the ability to work independently to a very large extent and protect my clients from my own company as well as the overall markets.

To close, here’s a final thought: while the future does not look appealing right now, it does not look as bad as many think.  We may be in a “Great Recession”, but it remains highly unlikely that we are in Great Depression II.

Look at this entry from Calculated Risk.  CR was one of the very early voices warning about the bubble economy.  Behavioral investing is all about being aware of crowd dynamics and irrational actors.  We are currently in a pessimism bubble; try to keep things in perspective.

One Good Day in Perspective

Today was a good day in the markets.  For some perspective, take a look at this chart.  The markets are still tracking the course they set during the Great Depression.  Even if we start to see a rally, here’s some perspective from today’s Barron’s.

Recent volatility doesn’t even begin to compare to what it was like during the 1930s.

In fact, there were eight calendar months during the decade of the 1930s in which the Dow rose or fell by more than 20%. The month with the biggest Dow move was April 1933, when the Dow rose by 40.2%. In August 1932, furthermore, the Dow rose by 34.8%.

The biggest monthly losses during that decade were almost as big. The largest came in September 1931, when the Dow lost 30.7%.

A quick look at a Yahoo! chart of the Nikkei over the past 20+ years also shows up upswings followed by even bigger losses.

For the foreseeable future any time we see some upside from Mr. Market, the very tough question will continue to be, is this rally the real thing or a head fake?

“Reinvesting When Terrified”

That’s the title of Jeremy Grantham’s last posting on the GMO website.  Like most of his writings, this one is nuanced.  While he believes that the S&P is fairly valued at 900, and he is putting money to work, he also thinks that there is a 50% chance it drops to 600.

Clearly, this does not provide the clear guidance we all wish for.  His closing comment: “be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before.”

Here’s the entire one-page article:

The Future of Capitalism

Martin Wolf is the influential chief economics commentator at the Financial Times.  His most recent column, titled Seeds of its own destruction, is a lengthy contemplation of the future of modern capitalism in the face of what appears to be systemic weakness.  It begins, “Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.”

Wolf provides a brief history of key inflection points in capitalism over the past few decades, states that we are at another one, but admits that “it is impossible at such a turning point to know where we are going”.  That being said, according to Wolf the most likely outcomes are discouraging over the short term.  Wolf also reminds us that the way out of the Great Depression was via WWII.

Echoing my earlier post about the real roots of the current problem, Wolf asks “if the financial system has proved dysfunctional, how far can we rely on the maximisation of shareholder value as the way to guide business?”  A very interesting question coming from the pages of the Financial Times.

Ahead of Roubini?

I am just a simple financial consultant trying to do my best for my clients, but it looks like Nouriel Roubini is late to the game on this prediction.  Below is excerpt from the latest “alert” message from Dr. Roubini.  I’ve been talking about this for some time now.  (Emphasis in the original.)

Earnings per share (EPS) of S&P 500 firms will be in the $ 50 to 60 range, but they could fall to $40. The price earnings (P/E) ratio may fall in the 10 to 12 range in a U-shaped recession. If earnings are closer to 50 or the P/E ratio falls to 10 then the S&P could fall to 600 (12 x 50 or 10 x 60) or even to 500 (10 x 50). Equivalently the Dow (DJIA) would be at least as low as 7000 and possibly as low as 6000 or 5000.

Unemployment

You’ve seen the report that the unemployment rate is now officially 8.1%, the worst since 1983.  You may not have heard that the rate of job losses is the highest since 1949 and appears to be accelerating.  CalculatedRisk has a good chart showing how the current recession compares with prior ones since WWII.

The WSJ’s Real Time Economics blog reports that the U-6, the broader measure of unemployment (it counts people who have stopped looking as well), is now at 14.8%.  Think of it as 1 out of 7 Americans out of work.  Some economists believe that this measure will get to 20%, 1 out of 5, before this recession is over.  Ouch. Peak unemployment in the Great Depression was around 25%.

Positive Sign in the Gloom?

Obama has described his plan for economic recovery as a stool with 3 legs.  One of those legs is the banking system.  And as we all know, the banking system will not be healthy until the “toxic assets” are purged from the system.  Geithner’s plan for doing this was intentionally vague at first, but details are emerging.

More clarity came today, although the plan is far from complete.  The crux of the plan is an embryonic “private-public partnership” that will buy the questionable mortgages (the “toxic assets”) from the bank.

Many commentators have been taking potshots at the plan, for good reason.  Until the details are known and some reasonable consensus for success forms, Geithner is just whistling in the dark.

But, this story in the NY Times is hopeful.  A group of investors have formed specifically to buy toxic assets.

(This group has) been buying up delinquent home mortgages that the government took over from other failed banks, sometimes for pennies on the dollar. They get a piece of what they can collect.

“It has been very successful – very strong…In fact, it’s off-the-charts good,” … even as the financial markets in New York were plunging.

So, the good news is that private entities are forming to do exactly what Geithner said they would, even without government assistance.

But, part of this story makes me somewhat ill.  It turns out that this group has been formed by execs from Countrywide Financial.  So, the same “entrepreneurs” who made themselves rich by getting us all into this mess are now figuring out how to make another fortune off our collective misfortune.

Who says crime does not pay?

How Low Will We Go?

I’m not sure what to make of the market today.  On the one hand, the S&P dropped 2.36% to set a new cycle low, closing at 735.09, with an intraday low of 734.52.  Clearly, closing at the lowest level in 12 years is not good news.

But, the economic news today was horrible.  Q4 GDP numbers were massively revised down, GE slashed its dividend by 68%, Citi had another massive infusion of taxpayer dollars, GM is truly on the precipice of bankruptcy, etc.  The S&P could easily have dropped more.  And 735 is just 2% below my approximate “fair value” number of 750.  Signs of resilience?

On the other hand I’m reminded of this quote that I posted earlier:

The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to ensure that as few as possible escaped the common misfortune.

- John Kenneth Galbraith, “The Great Crash”

And, it’s time to look at the Four Bad Bears chart again.  It looks a lot like 1929.

Long Road Back

After the Crash, Stocks May Face Long Road Back, that’s the title of an article in the WSJ’s personal finance section.  It refers to research from professor Elroy Dimson at the London Business School.  Based on analysis of 17 markets around the world looking back to 1900, Dimson “estimates that we’ll have to wait nine more years before the Dow average, including dividends, has a 50% chance of hitting its 2007 highs.”

Another View

I was sent some commentary from a strategist at another firm.  Here are some highlights:

By the time this is over, we could be slapping a classic recession trough multiple of 12x on an earnings stream that is closer to $50 than the current consensus $70 EPS estimate (as an aside, the multiple has troughed in single digit terrain half the time, in both deflation and inflation times).

(It) goes without saying that there is likely no bottom in the overall market until the (financials) group finds a trough – which means that not only are we talking about a “6-handle” on the S&P 500, but that we probably have at least another six months of this bear phase. We have said time and again that investors should stop timing the end of the bear market, but for those who simply cannot resist the temptation, here is our view:

• The market will bottom six months after the financials find their trough.
• The market will find a confirming bottom once it crosses above both the 50- and 200-day moving averages. [DI: the S&P 50-day is now about 840 and the 200-day is about 1000. So we need a big rally or a lot more sideways action to cross both of these moving averages.]
• The market bottoms 4 months before the recession ends (this is the average and median lag going back through 100 years of data), which we do not expect to see before the first quarter of 2010.
• Bottoms form when fear overwhelms long-term resolve. Fear has yet to set in, beyond say a few days. So what has to happen is what happened in June 2002, when the Sept/01 intermediate low was not just broken but it was punctured and continued to slide each day until we did get that fundamental bottom in Oct/02 – which was 20% below what was perceived to be the end of the market more than a year earlier (i.e. call us at 600 on the S&P 500 – that may be the level to start putting cash to work). [DI: I have mentioned repeatedly of late how we could get to 600, but I have to strongly disagree that fear has not set in. I think we've been seeing panic for months.]

Net: the final market bottom is Q4 of this year and we have another 22% to drop in the S&P.  Ouch.  I’m not endorsing this analysis, but it is plausible.