Research Watch

The bull market begins, the granny rally and yieldilocks, Paulson’s bullion gamble, a day in Roubini’s life, Soros’s engagement, and Australia’s sub-prime scandal.

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

Alan Kohler may not think the current rally or its next expected QE boost is sustainable, but bullishness reigns supreme on Wall Street. This week, Richard Burnstein compares the latest leg-up to the big rallies beginning in 1982, 1990 and 2002, cautioning investors not to wait for the days of wine and roses: “Bull markets are periods of fear.” At BMO, Brian Belski reckons we’re 18 months into a new 10-year cycle of gains, while JP Morgan’s Paul Bunker notices risks in what he calls the “granny rally,” with a warning for Australian investors in particular. Citigroup illustrates how returns have reduced since 2008 while risks have remained the same, and Bank of America points out that the Eurozone’s entire banking system is now worth less than Australia’s – is the sell-off overdone? Elsewhere, Jamie Dimon launches a fiery defence of big finance, George Soros shows off his engagement photos, and a day in the life of Nouriel Roubini. On video, a sub-prime mortgage scandal is unfolding in Australia.

This is what bull markets are all about... “Investors have the impression that bull markets are days of wine and roses. However, nothing could be farther from the truth. Bull markets are periods of fear. This becomes quite obvious when one examines the valuation and sentiment data associated with the 1982, 1990, 1995, and 2003 bull markets. … The bull market in US equities is now forty-one months old (March 2009 through July 2012), and the chart below compares the performance so far during the current bull market with the performance during previous bull markets’ first forty-one months. The current cycle’s performance fits well with history, and is in the middle of past cycles’ performances.

Bull markets typically end when valuations are extreme, the Fed is tightening monetary policy, and investors are over-enthusiastic about potential equity returns. Valuations are quite attractive given that the 10-year t-note yields roughly 1.5%. Investors are very leery of equities, and equities are no longer the asset class of choice. The Fed is considering easing further, and a tightening of monetary policy seems far into the future. The opportunity cost of fear has been very high. Both institutional and individual investors have largely missed out on a doubling of the US equity market. If this cycle continues to follow historical precedent, as it has done so far, then investors will eventually try to play catch-up, and fund flows will likely turn decidedly positive. The bull market seems to be a very typical one and, like past cycles, is based on fear. This bull run may still be in its early stages despite being forty-one months old.” (Richard Bernstein of Richard Burnstein Advisors, August 9)

And there might be might be a decade left to run…

“Stocks typically enter a very long period of expansion after emerging from a period of negative 10-year returns (10-year returns became positive in February 2011 in the current cycle). In addition, a closer inspection reveals that returns are not as volatile as some might suggest. In fact, based on all rolling monthly holding periods since WWII, the worst annualised return for any 10-year period was -5.1% (1999-2009). Furthermore, returns were negative less than 10% of the time. Thus, it can be inferred that extending one’s time horizon can greatly reduce the probability of investment loss. This leads us to another point: we continue to be surprised by those investors who argue that ‘it is different this time.’ To be sure, so some investment cycles are stronger or longer, while others are weaker or shorter. However, investment trends have remained remarkably consistent from one cycle to the next (with the exception of bubbles).” (Brian Belski, BMO chief investment strategist, via Money Game, August 12)

But there are risks in the ‘granny rally’ ... “Underpinning this ‘granny rally’ is a macro view which we call a ‘yieldilocks scenario’: growth will be weak enough to keep rates low for a long time, pushing investors to seek yield outside bonds and cash, but not so weak as to amount to a crisis that would hit everything except bonds and cash. This argument for mid-risk assets is attractive but it can be taken too far. It makes more sense for Europe and the US than for emerging economies or Australia; it runs the risk of over-emphasising yield as a proxy for certainty; and it can lead to risks being underestimated because they are not cyclical or simply because they are not immediately obvious. We think that Aussie bank stocks are a case of the latter. Investors who have been heavily skewed to high-yield defensives should in our view cut their exposure, particularly to stocks which lack a specific story. We favour underweighting the banks, which we see being valued as utilities with too little recognition of their cyclical properties. We recommend increasing exposure to ‘life goes on’ cyclicals, i.e. ones with reasonably clear industry economics; in this we include large-cap miners. We also see opportunities in lower-visibility situations which are not strictly cyclical, including the energy sector.” (Paul Bunker of JPMorgan, August 13)

Trouble in Macau...

(Jefferies, August 9)

Paulson makes a big bet on gold ... “Billionaire John Paulson raised his stake in an exchange-traded fund tracking the price of gold while selling other stocks during the second quarter, leaving his $21 billion hedge fund with more than 44% of its US traded equities tied to bullion. Paulson & Co. purchased an additional 4.53 million shares of the SPDR Gold Trust, the firm’s largest position, and bought more shares of NovaGold Resources Inc, according to a Form 13F filed yesterday with the US Securities and Exchange Commission. Gold prices posted their biggest declines since 2008 last quarter. While Paulson trimmed his stake in AngloGold Ashanti Ltd. and Gold Fields Ltd, sales of energy, financial and auto-parts stocks boosted the relative weighting of gold-related securities in his US stock portfolio to the highest in three years. That’s making the fund more vulnerable to declines in the price of bullion as the hedge-fund manager struggles to reverse record losses last year.” (Bloomberg, August 15)

But QE3 may not boost bullion ... “In the latest Bloomberg survey, [gold] bulls still outnumbered bears two-to-one, and QE by the ECB and the Fed is currently held up as the next catalyst for rising prices. Indeed, evidence of falling inflation in the global economy, for instance the ebbing price pressures in China, is seen as positive for gold as it removes a barrier to easier monetary policy. So, gold bulls must be mildly frustrated at policymakers’ reluctance to move so far. However, very few dwell on the reasons for this caution, namely the fear QE might do more harm than good for the economy. Mightn’t it do more harm than good for gold prices too? For instance, due to the still diminished risk appetite, QE (in the way it has been conducted up to now) simply adds to the tightness in the safe-haven bond markets. Some money market investors are already facing negative yields and are being made poorer as a result of QE. It is difficult to see how this could be good for gold prices.” (Deutsche Bank, August 10)

Risk without reward...

(Matt King of Citigroup, August 2012)

A day in the life of Nouriel Roubini... “I travel about two-thirds to three-quarters of my time, mostly abroad. When I travel I meet, first, clients of RGE [Roubini Global Economics]. Second, prospects and people who may be interested in our work. Wherever I go, I tend to talk to policymakers in that particular country. I find time to think, to read, to write. I meet people in the financial and business sector. I talk with other intellectuals and economists. I do media wherever I go. Starting with a business breakfast or a business lunch or business dinner, I work nonstop. And often when I come back to the hotel, I have hundreds of e-mails to go through, and I write reports – you you name it. But you know, I also try to make time to see friends. I love the visual and the performing arts, so museums, galleries, theater, music. … If I arrive in a country, the first thing I do is ask the cab driver how the economy is doing or what he thinks about their government. When I’m in the hotel, I ask the same questions, or I walk around and go to the local shopping center. You know, I try to get a sense. And when I’m in a country I also try to talk to people who are not necessarily purely the elite.” (Nouriel Roubini via Businessweek, August 10)

Australian banks are worth more than the Eurozone’s...

(Bank of America Merrill Lynch via Pragmatic Capitalism, August 13)

‘It’s a free. F***ing. Country’ ... “‘Everyone is talking about the culture, the culture, and all that, and it’s just not true,’ [JPMorgan CEO Jamie Dimon] says. ‘Most bankers are decent, honorable people. We’re wrapped up in all this crap right now. We made a mistake. We’re sorry. It doesn’t detract from all the good things we’ve done. I am not responsible for the financial crisis’ he adds. ‘I hate to tell you. We were a port of safety in the storm. I find it unbelievable that that is the general theme–that you have to walk in a room and act like you are responsible for things you are not responsible for.’ He’s staring into the middle distance as he says all of this, as if addressing an invisible, unpersuadable audience. But when I ask if this episode has made him regret being such an outspoken defender of the banking industry, he looks at me point blank. ‘I’m an outspoken defender of the truth,’ he corrects me. ‘Everyone is afraid of retaliation and retribution. We recently had an event with a hundred small bankers here, and 85% of them said they can’t challenge the regulation because of the potential retribution. That’s a terrible thing. Okay? This is not the Soviet Union. This is the United States of America. That’s what I remember. Guess what,’ he says, almost shouting now. ‘It’s a free. F***ing. Country.’” (New York Magazine, August 15)

Fiscal cliff complacency...

(Client survey by Tobias Levkovich of Citigroup, August 14)

George Soros is getting hitched... Billionaire hedge fund titan George Soros, 82, is engaged to his 40-year-old girlfriend Tamiko Bolton. Check out their engagement pictures below taken by Myrna Suarez this weekend in Southampton.

Graph for Research Watch

Graph for Research Watch

(Clusterstock, August 13)

Video of the Week: Australia’s sub-prime mortgage scandal ... The ABC examines the low doc loan scandal developing here.

Graph for Research Watch

(ABC, August 13)>

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