This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, October 26, 2009

US Laggard in Global Recovery

Well, perhaps apologies are in order. Apparently I’ve underestimated readers’ interest in political satire. It seems that last week’s article was not read with the same enjoyment that I got in writing it.

I will be the first to admit that my article last week was a bit more political than most. However, while I chose to present my case as a political satire – not to mention fantasy – the real objective was to get readers thinking about current economic circumstances, and how the economy could be turned around – if that was really the goal.

This week we’ll stay away from politics, but keep discussion broad. So this week let’s consider the following question: Why is rest of world recovering and the US isn’t? In other words, why are we lagging rather than leading?

First, let’s be clear. I’m not talking about a stock market recovery. I’ve stated repeatedly that we believe this rally is totally unjustified in fundamental terms. What we’re talking about is REAL economic recovery – sales, jobs, revenue, PROFITS.

The example we’ve seen thrown around repeatedly in the last week is the London real estate market. According to one Bloomberg article some agents there are nearly sold out of inventory (London Agents ‘Sold Out’ as Home Asking Prices…, Svenja O’Donnell). Even though unemployment is still high, construction had slowed down so much during the downturn that now inventory is extremely low.

Of course, mortgages are much more available there than they are here, and that is spurring demand from foreign buyers. That includes demand from several big banks, including at least one that was the recipient of a hefty taxpayer bailout. Goldman Sachs employees have reportedly been major buyers in UK real estate (The barefaced greed of bankers and their bonuses…, Boris Johnson).

All this demand on the far side of the pond has sparked recent increases in asking prices, which are now topping previous highs set in late 2007 (London Agents ‘Sold Out’…). All this while US housing prices remain at their lowest levels since the start of this recession, amid growing foreclosure figures, even among modified mortgages (the so-called “refault rate”).

What’s more, things aren’t expected to improve in the near future as another wave of trouble is expected, this time in commercial real estate and Alt-A mortgages, which could very well lead to even more bank failures (Commercial real estate to drive U.S. bank failures, Elinor Comlay).

And London is hardly the exception to the global recovery. Australia has rebounded so fast that the central bank there recently began raising rates in order to ensure the economy doesn’t overheat and inflation doesn’t take off (RBA Says Low Australian Rates Imprudent…, Jacob Greber).

The million dollar question, it seems, is this: What’s makes the United States so much different from most other developed nations? Why does credit continue to contract here as consumers pay off debt rather than take out loans – not that banks want to lend anyway?

We’ve been saying for some time now – especially since government bailouts started – that inflation would be a problem down the road. But we’ll readily admit that isn’t the case right now. In fact, deflation is a much more serious threat as credit continues to shrink.

In fact, right now the US dollar buys more than it did a year ago, according to CPI figures from the Bureau of Labor Statistics (Consumer Price Index – All Urban Consumers, Department of Labor).

To add to this history lesson, let’s take a quick look at the Dow. At just over 10,000, the first time the Dow was at these levels was in 1999, and most recently crossed these levels (while in an upward trend) was in April of 2005.

Thinking back to 1999 and 2005, I certainly can’t speak for readers, but I can say that personally today feels absolutely nothing like 1999, much less 2005. Not in economic terms like sales or unemployment.

It’s historical comparisons like this that have led us to believe that this recent run in stocks, while beneficial for helping to rebuild portfolios, is not supported by economics. Even though some big business have started loosening their purse strings (Business Spending Looks Up, Timothy Aeppel), the US still has a long way to go before we see a true economic recovery, one that would justify the kind of rally we’ve seen in stocks.

Monday, October 19, 2009

How Obama Saved the Economy

The following is, or could be, a transcript from a high school history teacher’s lecture in the year 2030 on Obama’s first term.

Having entered office in July of 2009, newly elected President Obama was put in a very tough spot. Presented with an economy plagued by recession, financial crisis, the threat of inflation, and calls for vast social reform, the Obama Administration was forced to prioritize.

After conferring with economic advisors, new Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke, the administration had good reason to believe that the tools possessed in the vast arsenals of these agencies had been strategically deployed, and would slowly guide the economy away from further calamity.

So, having received his mandate for social reform from the American people in the election of 2008, Obama and his team went to work on reshaping social policy in America, particularly with regard to climate change and healthcare, with the hope of letting the economy take care of itself, under the close supervision of Geithner, Bernanke, and others.

However, by the fall of 2009, it was evident that would not happen, that the economy would not right itself, and that the administration would be forced to reevaluate, knowing that the economy is always goal number one, and that social reform cannot be achieved in the absence of stable economic activity.

At that point, Obama and his team were faced with a decision, their first option to continue pursuing a socialist agenda, holding onto the naïve belief that the economy would fix itself. Had Obama taken this course of action and the economy not improved, the Democrats would have lost Congress at the next midterm election in 2010, leaving Obama a neutered, lame-duck President for the final two years of his term, at which point the Democrats would have most certainly lost the White House.

Obama’s second option, and the one we know from history that he [correctly] pursued, was to redirect the focus of his first term toward bolstering the American economy.

Now, at that time energy was a very controversial issue, between speculation, regulation, and carbon footprints. Many people, mostly in the US, were pushing very hard for new regulations that would force energy companies to become more environmentally friendly.

And take it from me, because I was there and I lived through it, when I tell you that at that point in time, global warming, as it was called back then, was a religion, not a science. Up until then everything, the economy included, had taken a backseat to the environment – until the Obama Administration led the change.

At that point, what will certainly go down as a tipping point in American history, some key members of the administration, in a magnificent change of direction, decided to take a hard line with environmental lobbyists, much of their work having come into question (Gore dodges questions at environmental journalist conference, Michael Krebs).

Obama and his staff began independently reviewing research conducted on the environment and found that, while there was a time when evidence of global warming abounded, by 2009 the case had changed. The polar ice cap summer melt rates had been falling for several years (Polar icecap is melting at slower rate…, Mike Swain), the Pacific Ocean had begun to cool (Whatever happened to global warming…, Daily Mail), and arctic polar bear populations, which were at the time a key indicator used by environmentally-conscious Americans, had actually been expanding (Federal Polar Bear Research Critically Flawed…, Institute for Operations Research and the Management Sciences).

Aside from the obvious environmental implications, energy was a major issue for still other reasons. By 2009, many Americans were growing upset that their country had been exporting so much money to conflict-regions – including the Middle East and Venezuela – in exchange for oil and other forms of fuel over the preceding decades.

In the first nine months of 2009 alone there had been over 200 major oil finds worldwide including several in the Gulf of Mexico, one of which may have been the largest deposit ever (The Oil Industry Sets a Brisk Pace…, Jad Mouawad). Meanwhile, the price of natural gas was ready to fall through the floor, not just due to the numerous finds, but the advent of technology allowing companies to more efficiently extract gas deposits.

One single natural gas discovery in northern Louisiana alone revealed enough natural gas that, with the new technology available, was equivalent to 33 BILLION barrels of oil, which was about 18 years worth of all oil production in the United States at that time (U.S. Gas Fields Go from Bust to Boom, Ben Casselman). Of course, there were also major finds in Texas, Arkansas, and Pennsylvania, making the supply of natural gas on – or under – American soil sufficient to fulfill demand in the US for nearly a century.

Now, we must remember that at the time – remember we’re talking about the fall of 2009, Obama has only been in office for 9 months and already the country is viscously divided – the U.S. economy had slowed to a near standstill. Consumers, who had carried the burden of excess debt for decades, simply were not capable of rescuing the economy through spending. Around mid-2009 statistics had showed a halt to the flow of consumer credit, due in small part to banks’ hesitations about lending, but even more-so to Americans’ lack of demand for loans.

American corporations, despite sitting on $14 trillion in early 2009 – I know it doesn’t seem like much now, but at the time that was a year’s worth of GDP – simply could not be convinced to tap into those funds, even to invest in future growth (Where Consumers Fail, Can Businesses Lead?, Gongloff).

Obama knew that despite all odds, he had no reasonable alternative but to take the bull by the horns and attempt to rescue the economy himself, using one of his most powerful tools to do so – policy. By late 2009, it was clear to Obama and most other Americans that the environmentalist crowd, despite their good intentions, simply would never be won over by the more economically-minded. With their lobbyist, celebrity advocates, and protest crowds, and despite ignoring a good deal of facts that weakened their arguments, environmentalists at that time had a much louder, more resounding voice than the silent majority.

As a student of history, Obama of course recognized that he faced a predicament frighteningly similar to that faced by President Jimmy Carter just thirty years before. Obama remembered the gas lines under Carter’s terrible energy policy, and knew that he could not go the way of his predecessor as a one-term President who took his party out of power for the next twenty years, while his successor would be remembered for fixing the problem.

Obama could not have his own equivalent of Ronald Reagan, who was given credit for quickly cutting the price of gasoline in half. Obama knew he could fix the mess himself, even reducing the cost of energy in the long-term, which would ultimately return the United States to its place of prominence among the world’s manufacturing nations.

With all this in mind, Obama – always the consummate politician – undertook a major shift in policy; one which ultimately saved the US economy, his administration, and his party. After some impeccably executed and carefully choreographed political maneuvering, Obama was able to make American energy independence goal number one for his administration, which they resolved to do using all means necessary, including so-called green energy, mostly wind and solar, as well as the not-so-green like oil, natural gas, coal, nuclear, and offshore drilling.

As an added bonus, Obama’s administration was able to shape numerous programs to incentivize technology innovations in the energy sector. Most noticeably, there were many tax breaks offered to companies that invested significant assets in lowering the environmental impact of their respective fuels, with particular focus going towards cleaner-burning coal.

Obama’s focus on energy was simply brilliant, as was his ability to work out an acceptable solution for everyone. He knew that if he could loosen restrictions on the energy sector – even for just a few years – to give companies and individuals the leeway and incentives to expand the industry and achieve energy independence that more money would follow, flowing into investments designed to improve technology and curtail carbon emissions.

Under Obama’s supervening plan of action, job number one was the economy, since without a strong economy there simply would be no money – much less incentive – to invest in green technology. By holding off on social reform, the administration knew they could save the economy, which would give them time to garner support and credibility to be used later on to achieve their objectives of shaping social policy.

Furthermore, Obama and his administration realized just how many peripheral industries would be helped by a massive expansion in the energy sector. Resolving to build five new nuclear plants across the country, encouraging offshore drilling, and loosening restrictions on coal, natural gas, and oil refineries – temporarily – all combined with the already burgeoning areas of wind and solar power, had an immediate impact.

As a result, due solely to a temporary loosening of the leash, Obama and his team created a sudden and incredible demand for raw materials that would be needed for construction, engineers to design new facilities, construction crews to build them, not to mention ancillary companies required to feed and house those construction crews.

Once facilities started opening there was still more job demand to staff new plants, and all these new employees needed food, homes, and health insurance. As plants got up and running successfully those same employees found themselves with disposable income, which meant new demand for major purchases like flat-screen TV’s and new cars.

Of course, we can’t forget that now transportation companies were needed to help move and manage these fuels around the country, whether it was oil that needed to be moved cross-country by truck or rail, new pipelines that needed building to handle increased flow of natural gas, or companies managing the flow of electricity generated by nuclear plants, solar panels, and wind farms placed strategically across the country.

And so it went that through the single action of temporarily loosening environmental restrictions that President Obama was able to manufacture a massive trickle-down effect, by which he single-handedly saved the US and perhaps the global economy. Obama later went on to mold social reform later with new support and added credibility, earning the Nobel Peace Prize that was bestowed on him somewhat prematurely and shaking off his haunting image as a glorified community organizer and reserve his place among the greatest presidents in U.S. history.

OK, class, that’s all for today.

Monday, October 12, 2009

Traders put cart before horse

In our business, timing is absolutely everything. And while there is a big, big difference between being wrong and being early, waiting is rarely fun. But such is life for a contrarian.

Most readers will undoubtedly understand my frustration, as I have been calling for a downturn in the stock market for about a month now. So for the last month life around the office has been characterized by the old adage “Patience is a virtue.”

After all, we know that a market correction WILL come. There’s simply no doubt about it. Markets always – ALWAYS – correct, sooner or later. The only questions are (1) when, (2) how long it will last, and (3) how severe it will be. And once it starts, everyone who has been calling for a correction – us included – will look like geniuses.

Until then we must endure our current status as nitwits who obviously do not understand the dynamics of a bull market such as this (pardon my sarcasm).

In 2006, Euro Pacific President Peter Schiff stood up at a mortgage brokers’ conference and told all in attendance that the real estate market was going to crash. At that point, people laughed, having firmly grasped the belief that property values never went down. However, by early 2008, no one was laughing anymore. Many were looking for new jobs.

When we first started buying gold back in 1999, we did so in light of booming dot-com’s and tech stocks. For years people thought us cooks for ignoring such an obvious opportunity for easy money. Once the bubble burst and the market crashed, people wondered why we didn’t warn them sooner.

Last year crude oil ran to $140 per barrel, and even then analyst reports projected advances to $200 and beyond. We argued that the fundamentals didn’t support $140/barrel, much less $200. We argued then that oil and been pushed up to $140 by individuals speculating in the market, and that those the market would crash when there was no more money to push it higher – in other words, when everyone got on one side of the trade, the long side.

At the time we had been forecasting a major spike in inflation, a spike that has not yet materialized, but certainly will once the real recovery in the economy begins. However, we still took a negative opinion of oil, taking a step back from the sector and later watching crude fall to $33/barrel.

You can’t argue with facts, folks. And the simple facts are that the market is overdone. Right now inflation numbers are lower than they were in March of last year when Gold was setting new highs. And yet Gold is again moving to new all-time highs, propelled mostly by excited buying from individuals who know somewhere between very little and nothing about gold and how it is traded.

One argument that has come up repeatedly is that the US dollar is crashing and that investors should be buying gold and other commodities as a hedge. This argument doesn’t exactly hold water, since the dollar is currently higher than it was last March when gold peaked, as measured against a basket of global currencies (NYBOT:DX). In fact, based on global exchange rates, it has been projected that Gold should actually be just shy of $800/ounce (Nadler, Buy the Rumour, Buy the Fact).

The facts are that the stock market is currently at levels seen around 2002, a time which was NOT characterized by rampant unemployment and a recession that economists have claimed is over, but is starting to feel more like a depression, unlike today.

The picture being painted by the markets is that the economy has bottomed and the U.S. is back on the road to prosperity. But the facts are that this economy has NOT recovered as the market suggests, and that it probably won’t anytime soon with the current policies coming out of Washington.

Successful investors must make decisions based on facts rather than emotions. Lately one report after another encourages buying of gold. With gold hitting new highs, analysts argue that it has risen above any kind of resistance, so there’s no reason NOT to buy. In reality, at this point gold feels eerily similar to dot-com’s near their peak in 1999 and 2000.

Unfortunately, gold hitting new highs does not have any affect whatsoever on the fundamentals. Instead, this event is the consequence of emotion in the markets, and it’s extremely important that investors not get caught up in that emotion. Instead, take a step back and separate emotion from truth and fact from fiction.

Monday, October 5, 2009

Earnings estimates fill markets with hot air

With this week marking the end of the quarter, it isn’t unreasonable to expect some screwy market activity. Between investors’ profit-taking and advisors’ window-dressing, the market can get so confused it forgets which way is up.

All-in-all, this past week has been relatively calm, considering the forces at work. After a brief pop to the upside, stocks seem to be settling back at last week’s levels. Fundamentals, however, rarely change from week to week.

The fact is that when we look at recent moves in the stock market, volume and sentiment numbers, and price-to-earnings ratio (considering our own estimates for realistic earnings), the stock market remains extremely overbought.

Of course, this is based on our opinion that the economy simply has not significantly improved, and that more likely than not, earnings reports are going to disappoint investors. At this point the market is fundamentally overbought, but other indicators suggest that many investors simply have a hard time taking a position against the current trend.

Our contention at this point is that stocks appear to be running out of steam on the upside. Trading volume around the peaks has been declining recently, indicating that a good deal of demand has been absorbed. Even with the window-dressing typical in the last week of a quarter, this market has made no substantial move to the upside.

Instead, Treasury yields have continued their decline that started back in August. This could mean that we aren’t alone in thinking this is a pretty good time for investors to be taking profits. It seems there are others who are content to book their gains on the year and take a breather on the sidelines.

Most financial advisors are content to hold until the market shows some sign of weakness, while our argument is that this market, lacking any fundamental support, is being driven higher each day by unrealistically hopeful investors. Once they run out of buying power – and they WILL run out of buying power – the market will descend back to reasonable levels, and there will be few buyers as everyone rushes for the exit at once.

This concept couldn’t be more evident than in the gold market. Recent market activity reflects sporadic buying likely to be central banks building positions. Why, do you ask? Well, quite simply, this buying is likely to be central bankers because they aren’t getting a good price.

Any investor who has bet against central bankers would likely have pretty astounding returns over the past several decades. Remember when Gordon Brown sold over half of Britain’s gold nearly a decade ago, right around $300/oz?

At this point there’s just way to much excitement surrounding gold for it to be a good buy. Being the contrarians that we are, we expect the demand seen lately buy uneducated investors will soon dry up. From there we see a forthcoming correction in commodities that will represent a great buying opportunity.

After its correction, commodities are likely to move higher to levels never before seen as the Federal Reserve is forced to inflate away debt accumulated by the U.S. government. We listen when representatives of the Fed claim they have the ability to inject enough liquidity to avoid a depression, but without causing runaway inflation. But we don’t believe a word.

One day in the near future, probably when election season draws near and campaigns kick into high gear, we believe that the Treasury and the Fed will be forced to make the difficult decision between a double-dip recession and inflation, and we all know which they’ll choose.