Friday, January 23, 2009

What Kind Of Change Will Obama Bring

What Kind Of Change Will Obama Bring To The Stock Market?

From A Usually Reliable Source…

The good news is that my data points to a very positive outcome for stocks over the next four years.

But, before we go any further, I want to issue my standard "political content" disclaimer: What I am about to report is in no way based on my personal beliefs about how our great country should be run. This report is 100% driven by empirical, 'unbiased' data (at least, insofar as humanly possible!). Sure, there are always ways to make numbers fit a particular worldview or bias. But that isn’t my intent with this newsletter. My only aim is helping you make smarter investment decisions. Period. I don’t recommend throwing your money away on the altar of your beliefs, but rather on going with what the odds favor.

Look at international trade as financing has disappeared from the banking industry:

Click Here, or on the image, to see a larger, undistorted image.

Now let’s look at the collapse in employment and incomes which come from private sector jobs:

This is a reflection of the Wolf Wave as private sector companies lay off workers in order to maintain profitability and solvency. These pictures are of the United States but similar pictures are are mirrored throughout the G7.

Look at the average peak-to-trough employment losses associated with the banking crisis:

Click Here, or on the image, to see a larger, undistorted image.

John Mauldin is reporting that recent reports of of 524,000 new unemployment claims masks the true number of 952,151 (he says it’s not a typo and I believe him). Think of it, almost a million jobs lost in one week and I believe this is just the beginning. He goes on to report that continuing claims rose to 5,832,746 and, if I recall correctly, that is double the number from a year ago. Unemployment is set to double again this year in the US and EUROPE.

Let’s now take a look at the outstanding borrowing and unfunded obligations which must be serviced by these declining incomes:

Wow, debt to GDP of 350%, almost 100% higher than when the Great Depression started. Now let’s look at the value of the assets by which this borrowing is underwritten in the United States (see left). As housing is set to decline another 20%, keep in mind my projections for the S&P 500. Keep in mind also that government debt is serviced through taxes and as incomes and asset values collapse so do government revenues.

Just for fun, let’s take a look at the UK, and see how it compares to US liabilities (from the ):
Future borrowing and ultimately money printing to finance these obligations, or to repair the lenders’ balance sheets (American and European Banks), is set to SKYROCKET! Cumulatively the sum as of January 1, 2009 is already almost 5 trillion dollars and rapidly rising as the bank bailouts are woefully underfunded, as was demonstrated in last week’s bailout of Royal Bank of Scotland, Bank of America and Citigroup. Unrealized losses are piling up at record rates (see below, Europe is worse), the US Bank rescue has consumed $350 billion and the next 'tranche' is being detoured into rescuing new sectors at a rapid rate such as autos, credit cards, mortgage holders, commercial real estate and the list keeps on growing. Lobbyists are lining up like pigs at the trough to get in on the giveaways.

Meanwhile, unrealized bank losses just keep on piling up as this chart illustrates:

In December alone over $320 billion was vaporized from the balance sheets of the nation’s biggest banks! Only we haven’t been told yet… After almost a year of de-leveraging, nothing has been accomplished, as income and book value have shrunk faster than the money can be shoveled in. Europe is in the same boat or worse, depending on the country.

BKX-PHLX/KBW Banking Index
Throughout the US and Europe the biggest banks are toast and will have to be nationalized. You can expect this to happen in all ways but name, merely because the public only understands rescue language. 'Bankrupt' and 'insolvent' will never be used in a headline. Look no further than the 'rescues' of Fannie, Freddie, AIG, Citigroup, Bank of America, Royal Bank of Scotland and more. Shares of all of these companies are headed to Fannie Mae and AIG territory near 1 Dollar. Want to know where the financial sectors (BKX-PHLX/KBW banking index) are headed? Take a look at the weekly charts which are on a sell signal as they sink to ever new lows and plunge through the downside of the downtrend channel established two years ago:

Brand new sell signals on the weekly charts and the "falling out of the bottom" of the trend channel signal the potential for a crash: RSI declining, slow stochastics on new sell signal, MACD on new sell signal and the ADX trend gauge at a healthy 37 (rarely do trends change when ADX is at this level.)

The financial sector shareholders will be left with nothing as management has failed to protect shareholders and their clients alike, and shareholders have not exercised the proper oversight and kicked the bums out. The losses this year by the biggest banks in the EU and US project to over 2 trillion, and either the government recapitalizes the banks or the financial systems will cease to exist. I predict that most of the top 50 banks in the world will be rescued to the tune of at least another 2 trillion dollars in the coming year.

About my data: It covers the S&P 500 and goes back to 1928. While the 2008 numbers weren’t finalized as this issue went to press, I still chose to include the year’s data, using December 9 as the cutoff. That way, I’m working with a complete eight-decade history, encompassing 20 full Presidential terms (41 years of Republican leadership; 40 years of Democrats).

Five of the most interesting things I uncovered:

1. The first year of a Presidential term is generally the worst for stocks. On average, the "500" rose just 3.1%. However, the first year of a Democratic candidate produced a much better 8.9% gain vs. a 2.78% loss under a Republican (the only negative number in the party averages).

2. The third year of a Presidential term is typically the strongest for stocks, with an average annual gain of 14.12%. In a Democratic third year, the gain is an even stronger 17.7%.

3. Overall, stocks have done much better under Democratic Presidents, with an average increase of 10.1% vs. 3.1% under a Republican White House. This clearly runs contrary to conventional wisdom.

4. In terms of Democratic leadership, the second year is typically the weakest for stocks, producing a gain of 4.29%. A Republican’s second year was good for 3.81%.

5. Of President G.W. Bush’s eight years in office, five saw a double-digit move exceeding 13 percentage points.

Strictly going by the past, 2011 would be expected to post the strongest gain (but, of course, with the usual caveat that "past performance is not predictive of the future"). I find that extremely interesting, especially in light of what top economists are forecasting right now— a deepening recession/depression through 2009, and a housing bottom as late as 2010. In other words, based also on fundamental analysis, 2011 would seem to be the light at the end of the tunnel for the U.S. economy.

Typically, stocks 'anticipate' the beginning of an economic recovery. But given the psychological damage that has been done by this severe downturn, perhaps many investors will fail to jump in until the market has already made a substantial jump forward. In other words, 2011 could be the year that stocks really surge from latecomers and momentum players piling back in.

What about the time between then and now?

Based strictly on the Presidential cycles, 2009 will produce a below-average, but positive, return for stocks. Ditto for 2010. On the other hand, the current climate is hardly typical— so, based on the data with which I introduced this report, I would expect down markets in 2009 and 2010. Much will depend on how swiftly and effectively the new Administration handles its massive challenges. And, Obama has already announced his intention to launch the largest infrastructure initiative since Eisenhower developed the U.S. highway system about 50 years ago.

There’s no question our nation could use a facelift— just take a look at the bridges in your immediate area and I’m sure you’ll agree. But as always, the question is whether this money will really flow to the places where it’s most needed. Since we’re talking about the government here, I’m going to say "probably not." Regardless, the investment should be a nearterm positive for the economy (and stocks).

I also expect another stimulus package geared toward putting money directly into taxpayers’ pockets. Frankly, I’m not a fan of such efforts. We’re simply borrowing from our future selves to buy big-screen TVs today. Investing in infrastructure at least creates jobs and improves our daily lives for decades to come.

I believe Obama’s direct effect on Wall Street will be more positive than many expect. He talked tough on the campaign trail, but his recent appointments are all centrists who have been around the block before. While they don’t represent real change, they’re already up to speed and provide a high level of continuity. Once the crisis has been calmed, look for sweeping changes to oversight and regulation.

If the market doesn’t take off immediately, don’t be shocked. As past Presidential cycles demonstrate, it often takes a few years for an Administration (and companies) to see and profit from the benefits of new initiatives. The key is positioning yourself now rather than waiting until everyone else else catches on.

But now that the recession is official, anyways, let’s revisit the sectors. December, 2007 marked pretty much the top of the U.S. economy. As investors, the question we must ask is this— "What areas are best positioned to ride out the tough times ahead and all the other changes likely to happen in the new year?"

Let’s start with where we’ve been. In past recessions, consumer staples, healthcare, and utilities stocks typically outperformed. And they were predicted to be the strongest sectors in 2008. Three specific industries— all in the staples sector— that have outperformed in past recessions are tobacco, alcohol, and household products.

Based on data through the end of November, here’s how the sectors actually performed:

Consumer staples stocks were the top performers in 2008 by a wide margin. In fact, they did twice as well (relative term, I know) as the overall market. Health care and utilities were also up substantially better than the market. All of that is exactly in line with historical data. That’s good news since it means that past performance is still likely to provide a basis for what to expect going forward.

I continue to believe that staples and utilities should make up the bulk of your income portfolio for 2009. As recessionary conditions continue, the companies that provide necessary services will hold up best. Healthcare should play a slightly smaller role until it becomes clearer just how far the new Administration wants to shake things up. My preferred healthcare industry remains pharma.

On the other end of the spectrum is the financial sector. It was the worst place to be in 2008. While the credit crunch and all its challenges were already clear at the beginning of the year, hardly anyone thought we’d see as much additional downside and collapse as we did. In fact, I felt that the group had already been beaten pretty severely.

That didn’t stop the bad news from pouring in from Bear Stearns, Freddie, Fannie, AIG, Lehman and many more of the world’s biggest names in finance. The mounting failures and bailouts came with a swiftness that shocked the entire globe. Still, I maintain my belief that this is not the end of the U.S. financial system as we know it.

But the dividend cuts have been so bad, and the near-term uncertainty is so strong, that I don’t think financial names should play a large role in your portfolio for 2009. That doesn’t mean I won’t recommend the odd bargain or adding to existing positions. One sector that really interests me going into the New Year is another one of the underperformers from 2008— technology.

The best tech stocks are not only paying nice dividends but (so far) are also increasing their payments throughout this downturn. I think that’s a trend worth following, and it is why one of my new recommendations in this issue comes from the tech sector. Yes, I recognize that technology firms tend to get hammered during tough times— as businesses and consumers alike put off upgrades— but the cash-rich companies will come through the weakness just fine.

And Based On Recent Dividend Announcements, This Group Is Emerging As A New Area Of Leadership.
What about the other underperformers— materials and industrials? I think it’s too early to jump in aggressively. As global economies remain in a slump, these firms will likely experience severe business pressure and weak demand. That leaves three sectors uncovered— energy, telecom, and consumer discretionary.

Of the three, energy is far and away my favorite for 2009.

Reason: Lower oil and gas prices do not necessarily hurt major integrated oil & energy companies. Nor do they negatively affect pipeline operators or refiners. Plus, some companies— such as drillers— have been pushed down into value territory. That’s why the portfolio already contains two MLPs that give you strong income-producing positions in the sector. And that’s why I’m recommending you scoop up a solid, well positioned drilling company or two.

I am not ready to get bullish on consumer discretionary stocks. Because their products aren’t necessities, these companies will continue to suffer from tight credit and low consumer confidence. However, as I’ve argued before, some companies, like McDonald’s— despite being considered discretionary firms— do represent good values in this market. Expect select recommendations in this sector for 2009.

That leaves telecom. Competition is fierce in this space, and business prospects are extremely uncertain in this environment. I would continue avoiding this sector, with the exception of high-yield rural local exchange carriers. So, there you have it. While I will not refrain from recommending an attractive dividend stock from any sector, my general outlook for 2009 is as follows:

First, I recommend you overweight staples, utilities, and energy.

Second, I like select companies in healthcare, IT and consumer discretionary for diversification.

Third, I would underweight financials, telecom, materials, and industrials.

Some Great Quotes:

"It's time to start again. I know what's about to happen. I know what Wall Street is up to. I know what they're going to do," he said. "Everyone is way too leveraged. Dozens of the largest and best companies are going broke. The banks will need someone to take the assets off their hands. They'll give me fixed-rate convertible financing— and then inflation will soar. This is what always happens. But this time it will be five or 10 times bigger than the last time. Time for distressed asset funds? It's time to be incredibly cautious about any business that's leveraged— especially real estate investment trusts (REITs). One should list every large American REIT, organized by debt to equity ratio."

Commercial real estate fundamentals are breaking down rapidly. Major retailers are killing open deals. In commercial real estate, expect to see 'blood in the streets' by late this year if not sooner. That is good news for anyone with funds to purchase quality commercial properties at depressed prices. Over the past year, many commercial real estate investors have been trying to figure out how to purchase and profit from the glut of land, developed lots, fractured condo conversions, etc., but the banks have been unwilling to take a hit on these properties and have refused to deal. Now that the commercial market is breaking down, the interest in the former has waned and by the time that the banks are ready to deal, the losses for them will be far, far greater.

Nearly 16 million square feet is currently listed as available in large blocks (generally 100,000 square feet or more) in 68 office buildings in Manhattan, according to Colliers ABR, a commercial brokerage firm. That is almost twice the number of blocks and total square footage listed as available a year ago. And Colliers says those numbers are headed up.

Subleases represented the biggest increase. At least 16 large Manhattan blocks are being marketed for subleasing, up from only three a year ago. In addition to higher vacancies, rents are also falling... in the neighborhood of 20% to 30% to around $80 a square foot in Midtown. Higher vacancies, lower rents, more problems in the future... may be time to short REITs.

Trying to avoid the vulture investors, a group of companies including American Electric Power (AEP), Textron, Home Depot, Honda, Dow Chemical, and Nissan is pushing the Fed to buy their paper, i.e. 'bail them out'. The coalition wants the Fed to go beyond top-rated paper and buy debt with the second-highest grade. AEP CEO Holly Koeppel said the group is looking to add more members.

Every time the government bails out another name business, the stock market craters. And more and more companies line up to be bailed out. Where will it end? Nothing scares me worse than this trend. It's what prolonged the Great Depression [[and the interminable Japanese deflation: normxxx]]propping up 'zombie' corporations, "for the good of society". And we seem hell-bent on repeating all of those mistakes.

"It doesn't add up that they are letting GE and American Express become banks to get aid, but they won't save the car industry." Maybe everyone should become a bank. The Big Three auto companies haven't been truly profitable or competitive in two decades, or more. They have failed.

If we give them more money, they'll still fail. It will only take longer and cost more money and remain a constant drag on any economic restructuring. Meanwhile, if you don't allow the automakers to fail, you'll end up crowding out the better companies, who make better products and bring them to the public at a better price. If you never weed the garden, how can your flowers survive?


"You’ve heard of mental depression; this is a mental recession. We have sort of become a nation of whiners...We’ve never been more dominant; we’ve never had more natural advantages than we have today....Misery sells newspapers. Thank God the economy is not as bad as you read in the newspaper every day."Phil Gramm.

The Parting Shot

The swindling of billions of investors’ capital by Bernard Madoff is sad. But the investors who lost everything with him were fools. They ignored the most basic rules of investing that would have protected them. Some thirty centuries ago King Solomon of Israel, one of history’s wisest men, warned
"Cast your bread upon the waters, for after many days you will find it again. Give portions to seven, yes to eight, for you do not know what disaster may come upon the land."

Always divide your capital by 7 or 8 ways! Never have all of your investment capital in one asset class, at a single brokerage company, or managed by a single fund, or in a single geopolitical region. As the Bible warned, this is just plain foolish because none of us knows what the future holds. Diversification is essential to protect you if one allocation fails totally for any reason. The Bible goes on to say,
"Plans fail for lack of counsel, but with many advisers they succeed."

Always seek multiple, independent wise counselors for any advice.



The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

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