Research Watch

PORTFOLIO POINT: This is a sampling of the week's best research notes. In a world of too much information, we hope our selection helps you spot the market's key signals.

This week, the argument over the direction of markets takes a historic turn. For the bears, John Hussman (yes, him again, he’s very good) argues that the rally has gone too far – so far, in fact, that we have reached a rare point in market history that almost always precedes a major pullback. But the bulls are adamant that after five bad years we are at a point in the stock cycle that suggests markets have another 15% upside – at least. In Australia, Roy Morgan adds a few more gears to the two-speed economy, suggesting there are more bright spots than you might think, as Forbes magazine questions whether China is hoarding commodities. Meanwhile, you won't believe Apple's growth, and the economic power of the new industries it has created. On video, a rare insider tour of Berkshire Hathaway, from the Oracle of Omaha himself. But first Greece '¦

Greece is about to make history '¦ "The Greek economy shrank nearly 7% in 2011, the fifth straight year the country has been in a recession. GDP has shrivelled by a sixth since 2006, and unemployment has tripled over that period to 20%. With new rounds of austerity just announced, and a default yet to come, the nightmare isn't even close to being over. Will Greece be the deepest recession of the past 30 years? It's getting there. Argentina's output plummeted 20% peak-to-trough when it defaulted in 2001, and Latvia's economy has shrunk by a fifth since 2008. Uri Dadush, an economist with the Carnegie Endowment in Washington, told Reuters that 'on the current path, which is not sustainable in my view, we may very well see Greek GDP go down 25–30%, which would be historically unprecedented’. '¦ (Russia's GDP fell a spectacular 44% in the 1990s, but the dissolution of the Soviet Union is categorically different from a recession within a single country, so some analysts exclude it.)" (The Atlantic, February 15)

Could this be why? '¦ The chart below depicts the correlation between 5-year CDS (a form of insurance to protect against a credit event) of eurozone countries and the percentage of men between the ages of 25 to 34 still living at home with their parents. It's pretty obvious what the pattern is '¦

(Money Game, February 14)

Overbought, overvalued and over-bullish '¦ “If you spend any time at all with historical data, you'll find a multitude of nearly equivalent ways to define an exhausted advance, and the average outcomes are almost always uncomfortable '¦ As one of many ways to define 'overvalued, overbought, overbullish, rising yield' conditions, consider the points in history when the S&P 500 was at a 'Shiller' multiple of over 19 times 10-year inflation-adjusted earnings, the index was at least 8% over its 89-week moving average, within 2% of a three-year high, with Investors Intelligence sentiment over 45% bulls, less than 30% bears, or both, and with at least one yield measure above its level of 26-weeks earlier (corporate, Treasury bond, or T-bill). This set of conditions produces a cluster restricted to about 8% of market history, and also self-selects for many of the worst times an investor could have chosen to buy stocks, based on the depth of the market's decline within the following 18 months. While the criteria above are loose enough to include several false signals, the periods also include late-1961 (–25%), early-1966 (–20%), late-1968 (–30%), late-1972 (–30%, and a nearly –50% loss extending beyond that 18 month window), mid-1987 (–33%), mid-1998 (–12% over the next 13 weeks), mid-2000 (–35%, and a loss of more than 50% beyond that 18-month window), and mid-2007 (–55%) '¦ My argument is certainly not that stocks will decline immediately, nor that they cannot advance further from present levels. Rather, the point is that even if such an advance emerges, the likelihood of those gains being retained by investors over the course of the full market cycle is exceedingly small.” (John Hussman of Hussman Funds, February 13)

Enter the bull '¦ “Based on cyclical patterns of market history, the odds are better than two chances in three that the Dow Jones Industrial Average, [currently around 12,780], will reach 15,000 or higher over the next two years. Based on the same cyclical patterns, there's about a 50-50 chance that the Dow could hit 17,000 or more. Also, the broad fundamentals '¦ are fairly clear. The stockmarket enjoyed double-digit earnings growth in 2011, yet barely rose in response, mainly because of fears over the health of the domestic economy and contagion from Europe. Now that those fears have begun to subside, the market's upside potential can be unleashed '¦ [Based] on 141 years of equity performance '¦ a fairly straightforward cyclical pattern can be discerned: a strong tendency for periods of worse-than-average returns to be followed by periods of better-than-average, and vice versa. Since the past five years have been squarely in the worse-than-average category, better-than-average returns in the two-year period just begun are now likely. The cycles, then, are based on simple arithmetic: two-year intervals following intervals of five years. Also, five-year intervals that are worse-than-than average are objectively defined as belonging to the lowest quartile of all five-year periods in the 141 years tracked. Two-thirds of the time, after a five-year period like the one we've just seen, the market rises fast enough to lift the Dow to 15,000 or higher from present levels over the following two years. The same pattern applies to Dow 17,000 or higher, except that happens just half the time.”

(Barron's, February 11)

Australia's multi-speed economy '¦

(Roy Morgan, February 14)

Is China hoarding commodities? '¦ “Beijing racked up the outsized surplus because imports plummeted in January. They were off 15.3% year-to-year and 22.4% month-to-month. Analysts are continuing to argue over the primary cause, but it is indisputable that the big trade surplus comes at the wrong moment for Xi Jinping. China's vice-president, expected to be named the country's supreme leader this fall [is in Washington discussing trade issues with the Obama administration]. Those discussions would be more troublesome for Xi if it were not for China's large copper purchases, [up 47.7% and 13.6% in December and January, respectively], because then its trade surplus would have been even more off-the-charts. And so it's no surprise that, at the moment, Chinese enterprises are on buying sprees for other commodities, especially crude oil. So what does Beijing's politically motivated copper purchases mean for future demand? On the one hand, they suggest that Chinese enterprises will continue buying the metal to dress up trade numbers in succeeding months. At some point, however, Beijing will put an end to the years of stockpiling. My guess is that will happen in the middle of this year [once China's economy slows and Chinese enterprises run out of money to buy unneeded commodities] Soon, China, which accounts for about 40% of global demand for copper, will not be able to support world prices by adding to its hoard.” (Gordon G Chang, Forbes, February 12)

Prepare for 'peak people' '¦ “The world's supply of working-age people will soon be shrinking, causing a shift from surplus to scarcity. As with 'peak oil' theories, which hold that declining petroleum supplies will trigger global economic instability, the claims of the doomsayers are too hyperbolic and hysterical. These are not existential threats but rather policy challenges. That said, they're very big policy challenges. About 11% of the world’s people are over 60 at the moment. In the next 25 years, that will double, to almost a fifth, and one in six of those people will be over 80. While this is affecting every country and region – even sub-Saharan Africa is now seeing a very fast rise in its proportion of seniors – some countries are being hit very hard. While 12% of Chinese are now over 60, in two decades, there will be more than 28%. Peak people will be an age when jobs compete for workers rather than vice versa. The cheapest labour will vanish. We're already seeing this: Because China is ageing very fast, its dwindling working-age population is turning down the lowest-paid jobs and pushing up the minimum wage sharply, as well as the once-minimal costs of social services: Stuff from China will stop being cheap, because the Chinese aren’t young. Peak people will also be an age when countries will be competing for immigrants rather than trying to limit them. It will require nimble and clever policies to prevent us from becoming old and lonely.” (Globe and Mail, February 11)

Apple's only getting sweeter '¦ “Apple now represents about a fifth of all technology sales in the US, new NPD data shows. By the end of 2011, 19% of revenue in the US was related to an Apple product. The company was now the top company selling technology in the US, topping HP, Samsung, Sony, and Dell even when the others could include their sales from all categories. The iPhone designer was also the only one of out of the top five to be gaining in 2011 and, throughout the whole year, saw its revenue jump 36%. HP and Samsung saw single-digit declines, but Sony and Dell were falling fast with 21- and 17-point respective drops. Apple had almost twice as much the sales as HP, researchers said. Industry analysis VP Stephen Baker pinned the shift to Apple's capturing new categories while others were clinging to old ones.” (Electronista, February 13)

The world's newest economy is booming '¦ “The App Economy now is responsible for roughly 466,000 jobs in the United States, up from zero in 2007 when the iPhone was introduced. This total includes jobs at 'pure’ app makers such as Zynga, a San Francisco-based maker of Facebook game apps that went public in December 2011. App Economy employment also includes app-related jobs at large companies such as Electronic Arts, Amazon, and AT&T, as well as app 'infrastructure’ jobs at core makers such as Google, Apple, and Facebook '¦ The industries that are the job leaders during a recession tend to be the big drivers of the expansion that follows. So during the recession of 1990-91, the job leaders were infotech services such as software, computer systems design and data processing services, all of which turned out to be big job creators in the tech boom of the 1990s. Similarly, the job leaders in the recession of 2001 were finance, real estate, and residential construction, signalling the housing and financial job growth from 2001-2007. Today, the App Economy is clearly a job leader. It managed to create jobs during the worst recession since the Great Depression, suggesting that the App Economy will be a major driver of job growth during the coming expansion.” (Dr Mike Mandel of South Mountain Economics, February 7)

And the oldest economy is evolving '¦ “Struck by a recent report about how the Italian Mafia was now Italy’s largest 'bank’, Nicholas Colas, chief market strategist at ConvergEx Group, has decided to take a closer look at what one might call 'off the grid' indicators for the economy [based on Google Trends]:

'Gold Coin' searches are stagnant, likely due to high prices. Sales of silver coins '¦ are still growing at a healthy clip, averaging over three million units a month. They were less than one million units a month just a few years ago.

'Consignment' as a search term peaked during last summer but is still much higher than a year ago.

For 'I want to buy', the results are similar to our November review of the data. Houses, cars, dogs and guns all feature prominently. 'Stock' now appears as a popular answer in all three search engines for the first time in years, a positive sign for equities even if retail investors aren’t yet acting on this impulse.

For 'I want to sell' the lists are also similar to past results. Popular choices are cars and houses, but 'Hair' and 'Eggs' still appear on several lists.” (FT Alphaville, February 2)

Video of the Week: Inside Berkshire '¦ An inside look at the Warren Buffett’s 'headquarters’ in Omaha, Nebraska.

(CBS, February 8)