The followers of The Other Street probably wonder where I have been - my last article dates back to August 24, 2012. It was titled "S&P Target 1600 - Buy'em When They're Sleepin', and Don't Wake Me Up Until We Get There". Well, we're not there yet - but we're close. And a number of things need updating, or correcting.
First, my S&P target. Last August, I warned it would become 2000 at some point. Frankly, I expected to update it sooner, but now that we have had a few bad hair days, it's time to reassess.
For one, this is a correction - not just a 1% drop in the S&P. I can name a few stocks I own that are down 5 to 10% - Federal Agricultural Mortgage (AGM), Fiat (FIATY.PK), Headwaters (HW), St. Joe (JOE), Blue Nile (NILE), Toll Brothers (TOL), Wesco (WCC) - and a few more that I sold - Woodward (WWD), Valmont (VMI), United Rentals (URI). When my stocks, usually high beta and somewhat aggressive, start to decouple, I start to worry. Especially at an historical intraday high after the huge run-up we've had. Remember, stocks do not all top or bottom at the same time. That's why they are called round tops - personally, I prefer round bottoms.
Talk about a run-up. When I published my book in 2009, William P. Stewart was kind enough to say this: "Franck illustrates that the market's decline over the past decade was about as bad as it gets, but the following decade is usually spectacularly good. Schumpeter on steroids!". I was a bit outside the box then, hoping for a 10% annualized compound return over the 2009-2018 decade - we got 136% since the 666 intraday low of March 6, in just four years. I mention this because my book was about the crazy rides that characterized the "Worst Decade", which actually started in 1995: up 300%, down 50%, up 100%, down 50%. The question now becomes "Are we starting a new bear wave?".
Well, hell no - but that's debatable, short term. When a corrective process starts we need to gauge where the next equilibrium will be, so I wouldn't be in a rush to miss the boat. Let's see how far the tide recesses, and which stocks outperform - they should lead the next move. If I need to venture a guess, Fibonacci is as good as any. Intraday on April 5 at 10:00 am, we are testing 1542, the trend line from the November 2012 low of 1343. We will likely break it and go on to 1515, or 1485.
Longer term, however, and for second, don't believe anything the Fed says about ending QE, or worse, withdrawing Excess Reserves. As you know, one of my favorite charts is the Money Multiplier.
It remains dead. It actually went deader last month. Until it revives, no chance of inflation. Now, to be safe, the Fed is admittedly jawboning the markets - read "if inflation picks up, we'll take the punch bowl away". This should not come as a surprise, it's part of the tool box. The fact is, as long as the banking system fears for its balance sheet and keeps all the monetary "stimulus" in Excess Reserves at the Fed, it's all talk. Last I checked H.4.1, the amount of Total Reserves was $1.8 Trillion - and the amount of Excess Reserves was $1.6 Trillion, i.e. roughly half the $3 Trillion Monetary Base.
Which brings me to Japan, of which I know nothing. However, contrary to the many commentators I have heard over the past couple of days - except for Nouriel Roubini - I do have a long memory. This is not a "new, bold adventure for Japan". On March 19, 2001, the Finance Ministry adopted "Ryoteki Kinyu Kanwa", RKK for short, which stands for… Quantitative Easing. And sure enough, the Monetary Base expanded from Y80 Trillion to Y140 Trillion in twelve years - with a big down blip in 2006. What is true is that it failed to work - so far.
What is also true is that "Helicopter Ben", then Member of the Fed Board, gave a speech in November 21, 2002, entitled "Deflation: Making Sure It Doesn't Happen Here" - see page 111 of my book. And what is also true is that when both Henry Paulson and Dr. Ben asked for a Bazooka in 2008, they got it - and then some. From August 2008 to March 31, 2010, our Monetary Base went from $900 Billion to $2 Trillion - it is now $3 Trillion. In the meantime, Household Net Worth which troughed at $51.5 Trillion in Q4, 2008 crept back up to $56.8 Trillion by Q4, 2010, led by a huge rebound in Equities. As of Q1, 2013, it stood at $66.1 Trillion, surpassing its previous peak of $64.3 Trillion in Q3, 2007. Given the 10% move in Equities in Q1, 2013, and the pick-up in Housing, add another $3 Trillion. So what's the moral of the story? I don't know how you define "work", but to me, the Bazooka worked.
Back to Japan. It seems they've got it now - it's about time, it reached its peak in 1989! When RKK first came out, twenty years into the deflation spiral, the Japanese Ministry kind of apologized for it, true to form. What they missed was the difference between inertia and shock. I am not going to go societal here, but twenty years is inertia. In the meantime, we saw the Tigers rise, and the BRICs. All underwent societal transformations. It is often the work of one man who, for some reason, is able to induce the shock. It was Ben Bernanke for the US, Mario Draghi for Europe, it is now Haruhiko Kuroda for Japan. Mark my words, he will be remembered, and Japan is back.
Which brings me to North Korea and Cyprus, the other two talking points of the day. I tend to look at the World a bit simply. First there is the US, the beacon, the New Continent. Then there is Europe, the Old Continent, led by Germany. The UK is somewhere in the middle. Russia clearly shares third place with China and India. Europe is still the same as it was centuries ago, a mix of powdered aristocrats, zealot bourgeois, aspiring revolutionaries, and former colonies immigrants. Russia is no longer the USSR, China has forgotten all about Mao, and India I can't really tell - but all three have more millionaires than any other countries, and a middle class to boot. So what's the "deal" with loony North Korea and Cyprus?
There is no "deal" - it's called media hype. From a geopolitical standpoint, and sticking to my "simplistic" view, we all have our "satellites". We have Israel. Europe has Luxembourg and Switzerland. Russia has Syria, Iran - and Cyprus. China has North Korea. Any satellite move engages its Big Brother. And no satellite will move without his Big Brother. So, unless you can tell me who of Russia or China has a skin in the game, all I see is media hype. I will change my mind if any player emerges as totally irrational but this is statistically improbable, and there is no such thing as a spontaneous generation - if anything, it takes time. I have not heard from Nassim Taleb in a while, for that matter. If there is a Black Swan, I don't see it and he doesn't either.
What are we left with? Valuation - absolute and relative. We are passed the absolute stage - when assets are priced below their replacement value. We are in the relative stage, and this is a tougher call. Historically, to use one benchmark, P/Es have hovered in two ranges since WWII - 8 to 14, and 14 to 26. We currently are around 13.6 on a forward 12-month basis of $120 for the S&P 500. My new target of 2000 calls for a simple regression to the mean, now that the World has started to stabilize. I will take 16.6 to start with, round number. This would still provide for an Earnings Yield of 6%. With the 10-Year T-Note under 2%, this leaves room for rates to creep up as the economy recovers. Contrary to popular belief, in the early stage of such recovery, an increase in rates parallels an increase in stock prices, as earnings become the driver. Now, to be sure, there is a difference between a liquidity and an earnings driven market. It's called Stock Selection. My own stocks are not a good example because of their low market correlation. However, even using the list of my August 2012 piece, you will get the general idea. It is up 25.5% on average, vs. 10.9% for the S&P 500. The median was 18%, but the standard deviation was a whopping 34%.
Now, take the more mundane Dow Jones Industrials (DIA). In the same period, it is up 11.3%. The average relative return of the thirty components is 0.45% - but the standard deviation is… 12.3%! Actually, in relative terms, there were seven stocks up more than 10% or so: Bank of America (BAC) + 32%, Home Depot (HD) + 12%, Hewlett Packard (HPQ) + 13%, Johnson & Johnson (JNJ) + 9%, JPMorgan (JPM) +15%, Pfizer (PFE) + 9%, and Travelers (TRV) + 17%. And there were five stocks down more than 10%: Alcoa (AA) - 17%, Caterpillar (CAT) - 16%, Dupont (DD) - 15%, Intel (INTC) - 27%, and Microsoft (MSFT) - 18%. So, for the time being - S&P 1542 on April 5 at 10:00 am EST, hold your fire. We should be done in the next couple of weeks, when we have a better read on Q1 Earnings. Then expect more of the same out of this buying opportunity.
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