Research Watch

Dr Doom turns bullish, bears take a beating, but don’t get too excited, a greenback comeback, crash revisited, and the longevity factor.

Summary: This week’s Research Watch includes a range of investment snippets, including Dr Doom turns bullish, bears take a beating, but don’t get too excited, a greenback comeback, crash revisited, and the longevity factor.

Key take-out: Nouriel “Dr Doom” Roubini says the market cycle is very bullish, but that will create the biggest asset bubble in a decade. In the medium term, he predicts that bubble with burst.

Key beneficiaries: General investors. Category: Portfolio management.

Following weeks of warnings about the current rally coming to an end, Nouriel “Dr Doom” Roubini has apparently turned bullish—at least in the short term. What’s more, David Rosenberg’s favourite economic indicator has just turned positive. The bear camp sure is taking a beating. At times like these, though, Bill Gross calls for “rational temperance”, amid signs equity yields might not live up to growing expectations. Among the big investment firms, Bank of America Merrill Lynch thinks the US dollar is on the verge of a long-term rally, while Goldman Sachs reveals hedge funds have a new favourite stock. Mark Hulbert finds lessons in the upcoming anniversary of the bursting of the internet bubble, researchers promote a ‘buy high, sell higher’ strategy, and a new study declares 72 is the new 30. On video, Dennis Gartman, who exited all his bullish positions last week, explains what might bring him back into the market.

Roubini is bullish—for now...

“As with most financial issues these days, the NYU Professor and chairman of Roubini Global Economics says it all comes down to the aggressive policies of the Federal Reserve and other global central bankers, notably Japan. ‘The risk of the end game from QE is not going to be goods inflation, it’s not going to be a rout in the bond market,’ Roubini says. ‘The risk is like during the 2003-06 [cycle] - we’re exiting very slowly and we got an asset bubble.’ Actually, Roubini predicts the coming (arguably ongoing) asset bubble is going to be ‘bigger than the one we had in 2003-06,’ which is somewhat shocking given the massive excesses that occurred in that era, especially in housing and related finance.

Roubini’s rationale for ‘the mother of all asset bubbles,’ is that Federal Reserve is going to be even more reluctant to pull back now vs. the prior cycle, when they executed a steady stream of 25 basis point rate hikes in 2004-2006. That’s because unemployment is much higher today in most ‘developed’ economies and there’s more debt on both public and private balance sheets: ‘So if you exit very fast you’re going to kill the bond market [and] you’re going to kill the consumer in terms of debt servicing,’ he says. Roubini being Roubini, he doesn’t predict a happy ending to the Fed’s current experiment. ‘We could create an asset bubble worse than the previous one which could lead to another financial crisis not this year, not next year but two or three years down the line if we keep on doing these policies,’ he says. ‘You’re building the financial leverage that’s going to lead you to [another] bubble and eventual crash.’ … Roubini sums up his analysis of all this as ‘short-term bullish, long-term catastrophic.’” (Yahoo Finance, February 22)

And Rosenberg’s recession indicator just turned positive...

“In October, Gluskin Sheff economist David Rosenberg warned of a big red flag signalling a recession in the United States. The year-over-year change in the three-month moving average of nondefense capital goods orders excluding aircraft and parts (also referred to as “core capex”) had turned negative. Rosenberg considers this chart the purest look at what businesses are doing with their cash. … Now – lo and behold – Rosenberg’s recession indicator has finally moved into positive territory, albeit only slightly. (Money Game, February 27)

But please, temper your exuberance...

“On a scale of 1-10 measuring asset price ‘irrationality’, we are probably at a 6 and moving in an upward direction.... Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced. Spreads are tight, corporate profit margins are at record peaks with room to fall, and the economy is still fragile. Still that doesn’t mean you should vacate your portfolio of them. It just implies that recent double-digit returns are unlikely to be replicated and that when today’s 5-6% high yield interest rates are adjusted for future defaults and recovery values, that 3-4% realised returns are the likely outcome. … But I would step now into the forbidden territory of equity pricing by presenting additional historical correlations compiled by Jim Bianco of Bianco Research … [who] points out in a recent daily release that high yield and corporate bonds are really just low beta equivalents of stocks. It appears that they are.

… Narrow yield spreads in high yield credit markets appear to be accompanied by “narrow” equity risk premiums in the market for stocks, which is another way of saying that the course of future equity returns may not resemble its recent exuberant past. 3-4% high yield returns over the next few years? Why shouldn’t that logically lead to a generalised 5-6% return forecast for stocks? … PIMCO’s ‘rational temperance,’ in contrast to excessive historical bouts of ‘irrational exuberance,’ simply counsels to lower return expectations, not to abandon ship.” (Bill Gross of Pimco, March 2013)

Prepare for a greenback comeback...

“A longer term trade is to buy the USD which is no longer correlated with volatility and has benefitted from the recent increase in risk appetite. Our house view is that the USD may be embarking on a strong secular uptrend; the only risk being any unexpected derailment of the US house price recovery. A key element of the USD strengthening story is global rebalancing with Asia no longer deemed the world’s producer and the US the world’s consumer. As a result assets tied to the China production story are slowly derating – note the underperformance of materials stocks versus the global equity market in the past 12 months. However, some currencies also tied to the story such as the Australian dollar and the Canadian dollar are taking longer to derate and hence constitute good shorts against our long USD stance.” (Bank of America Merrill Lynch via Pragmatic Capitalism, February 23)

Hedge funds have a new favourite stock...

“Apple is no longer the most-loved stock among hedge funds. The Goldman Sachs equity strategy team is out with its new list of the most important stocks in the hedge fund world, and ‘after three consecutive years as the top hedge fund holding, AAPL has slipped to third place, with 67 funds (11%) holding the stock as a top-10 position versus 109 last quarter (19%).’ The new top stock: AIG. At the end of the fourth quarter, 117 funds were holding the stock, and it was a top-10 holding for 80 of those funds. AIG is up 22.5% since mid-November, almost double the S&P 500. Goldman analyst Michael Nannizzi has a $43 price target on the stock, 14.5% above today’s closing share price of $37.57.” (Business Insider, February 20)

An anniversary you shouldn’t forget...

“I’m referring to the 13th anniversary of the bursting of the Internet bubble — which will be ‘celebrated,’ ironically enough, on almost the same day as the bull market’s fourth birthday. So I will let everyone else break out the bubbly to celebrate the bull market’s longevity, and focus this column on the disaster that began 13 years ago. And I’m not being hyperbolic in saying that it was disastrous. Even though everyone else is preparing the celebrate the four-year-old bull, the Nasdaq Composite is still some 38% below its all-time high of 5,132.50, which was hit on March 10, 2000. In inflation-adjusted terms, this market average is more than 53% off its March 2000 high. … What lessons can we draw from the sobering picture painted by the Nasdaq Composite over the last 13 years?

  1. Diversification is crucial. Broadly diversified indexes recover far more quickly from bear markets than do narrowly defined subsets — whether that subset is the Dow, with just 30 stocks, or the Nasdaq Composite, which is dominated by a relatively small number of large-cap companies. Anyone who put all their money into the Nasdaq Composite in March 2000 was putting far too many eggs in the baskets of a few companies, like Cisco CSCO 1.37%  , which at the time dominated the index just as Apple AAPL -0.16%    does (or at least did) today.
  2. Dividends play a crucial role in stocks’ long-term returns — so don’t ignore them. Believe it or not, dividends accounted for about half of stocks’ total return over the last century.
  3. Inflation must be taken into account in any historical comparison. A focus on nominal prices during periods of inflation creates the false impression that we’re doing better than we really are — just as such a focus during periods of deflation makes it look like we’re doing worse. While the impact of this illusion can be quite small over shorter periods of time, it can be — and usually is — huge over longer periods.”

(Mark Hulbert via Market Watch, February 21)

Bullion loves Bernanke...

“While CPI may have been contained under Bernanke, the price of gold sure hasn’t.”

Bespoke Investment Group, February 26)

Buy high, sell higher...

“So we tested which strategy works better: Buying near 52-week lows… or buying at 52-week highs. We looked at nearly 100 years of weekly data on the S&P 500 Index, not counting dividends. You might be surprised at what we found. After the stock market hits a 52-week high, the compound annual gain over the next year is 9.6%. That is a phenomenal outperformance over the long-term ‘buy and hold’ return, which was 5.6% a year. On the flip side, buying when the stock market is at or near new lows leads to terrible performance over the next 12 months… Specifically, buying anytime stocks are within 6% of their 52-week lows leads to compound annual gain of 0%. That’s correct, no gain at all 12 months later. Using monthly data, our True Wealth Systems databases go back to 1791. The results are similar… Buying at a 12-month high and holding for 12 months beats the return of buy-and-hold. And buying at a 12-month low and holding for a year does worse than buy-and-hold.” (World Beta, February 26)

And good news for retirees...

“Human longevity has improved so rapidly over the past century that 72 is the new 30, scientists say. Researchers at the Max Planck Institute for Demographic Research in Rostock, Germany, said progress in lowering the odds of death at all ages has been so rapid since 1900 that life expectancy has risen faster than it did in the previous 200 millennia since modern man began to evolve from hominid species. The pace of increase in life expectancy has left industrialised economies unprepared for the cost of providing retirement income to so many for so long. The study, published in the Proceedings of the National Academy of Sciences of the United States, looked at Swedish and Japanese men – two countries with the longest life expectancy today. It concluded that their counterparts in 1800 would have had lifespans that were closer to those of the earliest hunter-gatherer humans than they would to adult men in both countries today. Those primitive hunter gatherers, at age 30, had the same odds of dying as a modern Swedish or Japanese man would face at 72.” (Financial Times, February 25)

Video of the Week: What would bring Gartman back to stocks...
Graph for Research Watch

(CNBC, February 26)

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