Research Watch

Tepper’s prediction on stocks, PIMCO on bonds, the dollar bull run, and more.

Summary: Tepper’s prediction on stocks, PIMCO on bonds, waiting for the snap, the dollar bull run, buy the peso, and Mad Money billionaires.
Key take-out: Hedge fund titan David Tepper says he’s still bullish on stocks, and investors shouldn’t worry about the Federal Reserve tapering its massive bond-buying program.
Key beneficiaries: General investors. Category: Portfolio management.

When David Tepper first expressed his extreme bullishness on stocks in September, 2010, he sparked what was dubbed “The Tepper Rally”: the Dow and S&P 500 have since risen 45% and Australian markets are up some 15%. In this week’s video, the hedge fund legend is back to argue reduced market intervention by the Federal Reserve could offer a new, more sustainable leg up. His comments come as the equity premium over bonds reaches historic new highs, and as Bill Gross suggests we may never see another bear market in fixed interest assets. John Hussman has also joined a chorus of support for bond investing, adding weight to Mark Faber’s warning about the growing disconnect between stocks and the economy. Meanwhile, UBS quantifies the effects of a 5 cent drop in the exchange rate — backing Tim Treadgold’s argument that the miners have the most to gain — while others are pairing Aussie dollar shorts with an accumulation of Mexican pesos. Elsewhere, Hugh Hendry is making new bets on the US and Japan, the BRICs are being overtaken by the so-called MIPS, and followers of Jim Cramer should be billionaires by now.

Video of the Week: Tepper offers an ‘overwhelming’ case for stocks...

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“Hedge fund titan David Tepper, founder and president of Appaloosa Management, told CNBC he’s still bullish on stocks, and investors shouldn’t worry about the Federal Reserve tapering its massive bond-buying program. ‘There better be a true [Fed] taper or else you might be back into the last half of 1999,’ Tepper said. ‘If the Fed doesn’t taper back, we’re going to get into this hyper-drive market,’ he explained. ‘It’s a backwards argument. To keep the markets going up at a steady pace the Fed has to taper back.’” (Click here to watch the video: CNBC, May 14)

And it’s partly built on bond yields...

“Stock investors may reap unusually high returns during the next five years thanks to record-low interest rates on government bonds, according to researchers at the Federal Reserve Bank of New York. A survey of 29 models for the equity risk premium -- the expected future return of stocks over the risk-free rate offered by Treasuries -- shows ‘we will enjoy historically high excess returns for the S&P 500 for the next five years,’ Fed economists Fernando Duarte and Carlo Rosa said in a paper released today... The premium rose to a record 5.4% in December, they said. ‘The equity risk premium is high mainly due to exceptionally low Treasury yields at all foreseeable horizons,’ they said.” (Bloomberg, May 9)

Which may never enter bear market territory again...

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“Bill Gross, the bond investing legend who runs the world’s biggest fixed income fund at PIMCO, last week declared … that the 30-year secular bull market in bonds ended on April 29, 2013. However, that doesn’t mean bonds are about to enter a bear market, says Gross today in another tweet – in fact, they may never enter a bear market. Typically, the beginning of a bear market is marked when an asset class falls 20% from its previous peak.” (Money Game, May 13)

Hussman backs fixed interest...

“I’ve often noted that even a run-of-the-mill bear market decline wipes out more than half of the preceding bull market advance. I doubt that the present instance will be different. … The perception that investors are ‘forced’ to hold stocks is driven by a growing inattention to risk. But Investors are not simply choosing between [an estimated] 3.2% prospective 10-year return in stocks versus a zero return on cash. They are also choosing between an exposure to 30-50% interim losses in stocks versus an exposure to zero loss in cash. … Think about that. One literally could have sat in Treasury bills through 1996, 1997, 1998, 1999, 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, and into early 2009, and have done better than the S&P 500 did over that entire span of time. Moderate losses are frustrating, but deep, major losses from rich valuations are the ones that matter, because it is difficult to recover from them in a durable way. The recent advance is a gift in that regard. Consider that carefully now, not later. …There will be opportunities to take constructive investment positions, certainly at the completion of the present market cycle, but most likely even in the event that the advancing portion of this cycle continues. Choosing those points, based on demonstrable evidence, is essential. Recklessness, crowd-following, euphoria, fear of missed gains, and monetary superstition has certainly been rewarded lately, in a way that seems indistinguishable from insight and genius. Retaining such windfalls will prove far more difficult.” (John Hussman of Hussman Funds, May 13)

As Faber waits for stocks to snap...

“What was the trigger of the ‘87 crash when markets fell 21% in one day? What was the trigger of the Nasdaq crash in 2000? What was the trigger of Japanese crash of 1989? What was trigger of 2007 crash that brought global stocks down 50%? We don’t know these things ahead of time, but something will always move markets up and something will always move them down. I would guess at the present time, given markets from the 2009 lows have in many cases increased by as much as 100%, that they are no longer very cheap. .... Something could come along, geopolitically or otherwise. I would be very careful being overweight equities. I still have 25% in equities and 25% in corporate bonds. … In the 40 years I’ve been working as an economist and investor, I have never seen such a disconnect between the asset market and the economic reality ... Asset markets are in the sky and the economy of the ordinary people is in the dumps, where their real incomes adjusted for inflation are going down and asset markets are going up. Something will break very bad.” (Mark Faber via The Globe and Mail, May 8)

And Hendry shifts from contrarian to consensus...

“Hugh Hendry has backed Japanese equities to continue their stellar start to 2013, but is also boosting exposure to sovereign bonds [from issuers in Australia, Korea, Switzerland and the US] on concerns Japan’s recovery will have harmful effects elsewhere. … In equity markets, Hendry has been buying US blue chips, favouring those with the least debt on their balance sheets. … ‘An unresolved but pertinent question is whether this price action might mark the start of the next asset bubble?’ he said. ‘Consider the plight of the conservative investor: concerned about the risks to the global economy and hence cyclical equities; fearful of financial repression in treasuries; trapped (possibly unfairly) by the prejudice of the ten-year bear market in US dollars; scared that governments may have to haircut his savings account in the bank; and now terrified by the sudden price collapse in gold,’ Hendry said. ‘It could be argued that for such an investor, all roads lead to the safest, least volatile, most liquid consumer non-discretionary blue chips on Wall Street, which provide a 3% dividend income payable in dollars.’ A long trade on the dollar has also been a major play for the Eclectica fund, with Hendry highlighting the relative strength of the US economy as a major investment theme in the portfolio. … Hendry added the dollar has become less negatively correlated to the performance of the stock market, in a break from recent tradition. ‘It is too early to draw anything firm from this, but the sight of the stock market and the dollar rising in tandem looks more like the regime which accompanied the last two dollar bull markets of 1980-1985 and 1995-2001,’ he said.” (Investment Week, May 13)

When the Australian dollar falls, miners benefit...

“The greatest change in earnings is displayed by WSA, AWC and PEM, with a 100% change in EPS for a US5¢ change in the A$. Albeit these companies have little to no earnings, which amplifies the sensitivity. Interestingly, BHP is slightly more sensitive to the A$ than Rio Tinto. A weaker A$ would drive upgrades to consensus earnings for the miners, as consensus A$ for CY 13/14 is US$1.04/US$1.00. Therefore we should expect that resource equities to outperform in an EPS upgrade environment. However, we also need to consider the reason for A$ weakness; that being the possible winding back of QE and weaker commodity prices. Both may weigh on equity performance.” (UBS, May 13)

While others are cashing in by buying pesos...

“Investors bracing for slower growth in China are turning to a formerly little-used currency trade: selling Australian dollars and buying Mexican pesos. The bet is that Australia’s economy, and its currency, will suffer as Chinese demand cools for raw materials like iron and coal. Mexico, with closer ties to the resurgent US economy, is seen as more insulated if commodities prices fall. … So far, the bet has paid off: An investor who made the trade at the start of the year would have profited from a 9% drop in the Aussie against the peso, compared with a 4% decline against the US dollar, a far more common bet.” (Wall Street Journal, May 13)

And don’t overlook the MIPS...

“One group of countries that looks particularly attractive from an investment standpoint is the MIPS, which includes Malaysia, Indonesia, the Philippines, and Singapore. These countries have favourable demographics, and with the exception of Singapore, which is more mature, their respective stages of development, infrastructure needs, and low labour costs bode well for the prospects for growth in the coming years. Singapore is uniquely positioned as a financial hub with a favourable political climate, and will continue to benefit from Asia’s growth. If the trajectory these nations take is comparable to the rate at which the BRICs have grown over the past decade, their equity market returns are likely to be extremely robust, possibly in the order of several hundred per cent between now and the middle of the next decade.” (Guggenheim Investments, May 9)

Everyone who started watching ‘Mad Money’ in 2005 now billionaires…

“According to a report released this week by Forbes magazine, every person who has regularly watched CNBC’s financial program Mad Money since its 2005 premiere is now a multibillionaire. ‘[Host] Jim Cramer turned out to be 100% accurate with every stock he said to buy, sell, or hold; I started out by investing $600, and now I have a net worth of $4.1 billion,’ said former dishwasher Paul Welling from the plush 100-seat TV room aboard his custom luxury yacht. ‘All I had to do was follow Jim’s investment instructions and then sit back as the millions upon millions rolled in every day for the past eight years. And actually, I myself watched no more than three times weekly, and today I own a media conglomerate.’ The findings reportedly came as welcome news for the cable channel following recent reports that over half the regular viewers of the morning show Squawk Box had died of exposure after winding up penniless and destitute on the street.” (The Onion, May 8).