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.

For an ageing population, estate planning and the economics of inheritance is set to take on new importance in 2012 and beyond. In fact, researchers are forecasting one of the largest wealth transfers in history, which will have a big impact on the financial services industry – something to consider over the summer break. China receives some Christmas cheer from the Baltic Dry Index and Kim Jong-un offers a rare gift for a special kind of investor. Strategists finish the year on a bullish note – just like last year – but expect volatility to continue. Dennis Gartman dumps his gold holdings as others see a buying opportunity. Mark Hulbert explains how to use the Mayan calendar as an investment tool, and Rupert Murdoch shows how not to make a Christmas card. On video: Facebook's blue-chip ambitions.

The great wealth transfer '¦ “Women of Wealth, a study produced by the Family Wealth Advisors Council, a network of independent wealth management firms '¦ [shows] women control 51.3%, or $US14 trillion, of America’s 'personal wealth'; that 67% of women manage the 'family budget'; and that they collectively control $US20 trillion in consumer spending and are responsible for 83% 'of all consumer purchases' '¦ Because widows outlive their husbands by 14 years on average, the report instructs financial advisers to start early in pawing the hands of these would-be-widows in waiting. That’s because 'up to $US25 trillion will accrue to women through 2030 via generational and spousal transfer. By then, at least two-thirds of the nation's wealth will be in women’s hands.' That, apparently, is a big problem for today’s male-focused financial advisers. 'In many cases advisors have regarded the husband as the “primary” client and failed to see the woman as a client with her own concerns. It is no wonder that an estimated 70% of women who are widowed change advisers within one year.' '¦ [Women who have never worked outside the home] are far more inclined to pay for uncompromised financial advice from a trusted adviser, culled from a rigorous due diligence process, and then have this independent adviser help them execute their financial strategy by finding best-in-class financial products '¦ [More than retired women, stay-at-home women also] think it is 'critically important that their adviser help factor in desires for children and community into legacy plans.” (Barron's, December 19)

Is China pessimism overdone? '¦

“Economists and analysts like to watch the Baltic Dry Index because its pricing reflects demand for shipping stuff across the ocean '¦ It is not surprising to see a correlation between Chinese stock prices and some indicator of world economic activity. China is a mercantilist country that seeks to export a large amount of what it produces. So when there is a change in world demand for 'stuff’, that is going to affect the country producing the stuff. And because stock price movements can often precede changes in GDP, the big drop in Chinese stock prices during 2011 has people understandably concerned. But the Baltic Dry Index is not confirming that drop '¦ [the index] did not confirm the higher highs in the Shanghai B Index in late 2010 and early 2011. Now, as Chinese stocks are unwinding that big top, the index is saying that things are actually not as bad as the stock price decline seems to imply.” (McLellan Market Report, December 17)

The new normal for volatility '¦ “The five-year implied volatility on the S&P 500 is currently 29% '¦ this translates into a daily standard deviation of 1.82%. If we believe that the distribution of returns follows a normal distribution, this means that 33% of the trading days for the next five years will have returns that are greater than or less than /- 1.82%. This is a whole lot of movement over the next five years. To put this into perspective, we can look at the trailing 1 month, 1 year and 5 year realised volatilities since 1928 (see below) '¦ Take a look at the red line and find the periods where five-year realised volatility traded above 20%: during the Great Depression, a period after the internet bubble and the recent period since the global financial crisis. What about 29%? Great Depression exclusively.”

(Surly Trader, December 14)

Want to bet on Kim Jong-un? '¦ “The price of hard-to-find North Korean debt edged higher '¦ as some adventurous investors took a long-shot bet that the secretive country could open up after the death of Kim Jong-il. Obscure North Korean debt certificates, tied to long-defaulted syndicated loans from the 1970s, traded in the market [this week] with a bid/ask spread around 14/18 cents on the dollar in London, up from a range of 13/15 cents last week, according to London-based Exotix Ltd, a specialist frontier market brokerage firm '¦ 'If you buy, you are buying on the expectation of events moving the price because they have been in default for 20 to 30 years,’ said Stuart Culverhouse, chief economist at Exotix Ltd.” (Reuters, December 20)

Strategists expect a strong 2012 '¦ “The mean prediction of the 10 stockmarket strategists and investment managers surveyed by Barron's is that the Standard & Poor's 500 Index will end 2012 at about 1360, some 11.5% higher '¦ That sounds like a big gain, but a lot of things have to go right for the market to make such impressive headway. Even the most bullish of these Street seers fears stocks could be more wobbly in the next six months than in the six months past '¦ Although many European banks have loaded up on the sovereign debt of nations that can't repay it, even our most bearish prognosticators don't expect the Continent's financial problems to explode into a full-blown banking crisis on the order of 2008 '¦ Other issues also will shape the market's course: Chief among them are next November's US presidential and congressional elections '¦ Then there are questions about the growth of corporate profits. The top-down call, or that of Wall Street's market strategists, is that earnings per share will rise about 7% in 2012 '¦ The typically more optimistic bottom-up crowd of industry analysts calls for a 10% increase ... and both top-down and bottom-up projections for next year are lower than the 15% growth rate likely in 2011 '¦ The S&P 500 currently trades at a price/earnings (P/E) multiple of 12.5 times this year's expected earnings. Given the uncertain political and economic backdrop, none of our bullish experts sees any meaningful P/E expansion until the clouds start to part toward the end of next year. In other words, the S&P's advance to 1360 '¦ will be supported by 5–7% earnings growth, and modest P/E expansion, at best.” (Barron's, December 19)

But be careful who you trust '¦

(JP Morgan via Paul Kedrosky, December 14)

An apocalyptic buying opportunity '¦ “I know – this puts me directly at odds with the Mayan calendar followers who interpret it to be saying that the world will indeed come to an end next year. But '¦ I view the end-times obsession with the Mayan calendar through contrarian-coloured glasses. If enough investors start behaving as though the world is about to come to an end, a great buying opportunity will be created. Just take how investors reacted the last time there were calendar-based predictions of doom: Y2K '¦ [Back then] the market timers tracked by the Hulbert Financial Digest became incredibly bearish '¦ In the weeks leading up to the end of 1999, there were occasions when '¦ the average timer was suggesting that his clients allocate four-fifths of their equity portfolios to going shorting. That’s a breath-taking level of pessimism '¦ In true contrarian fashion, of course, the market soared following that late-1999 spasm of fear '¦ To be sure, the market timers’ mood today is nowhere near as dark as it was in late 1999. As measured by the Hulbert Stock Newsletter Sentiment Index (HSNSI), the average recommended stockmarket exposure today stands at plus 22.9% – a far cry from the extraordinary bearishness that prevailed when Y2K was the worry du jour '¦ Still, I get the sense that it wouldn’t take much for their mood to become very sour indeed. The December-January period historically has been one of the strongest two-month stretches of the year, and if it turns out to be a disappointing one for the market, or worse, then the HSNSI could very well plunge. If and when it does, then contrarians will be ready to buy.” (Mark Hulbert of Market Watch, December 20)

Gartman exits gold '¦ “Dennis Gartman warns that the incredible run-up in gold over more than a decade appears to be at an end. He noted that China has been buying gold aggressively over the past several weeks, which should have sent the price surging. 'Instead they plunged,' Mr Gartman wrote in his Gartman Letter. 'One of the oldest rules of trading is simply this: A market that cannot or does not respond to bullish news is a bearish market not a bullish one.' Mr Gartman, who '¦ correctly called the 2008 commodities slump, said that 'we are out of gold' '¦ 'Where then can gold go? '¦ Lower, we fear and perhaps decidedly so. So much damage has been done to the psychology of the market in the past week and so many late longs have been caught off-guard that we think wholesale liquidation '¦ and perhaps forced liquidation '¦ shall be the outcome. We can imagine gold trading back towards €1075–1125 an ounce and/or towards $US1475–1525. It really won’t take much to push it there. Panic liquidation would do so rather swiftly. We’ll simply stand aside from the gold market then, preferring to be long of gold and not wishing really to be short of it. The sidelines seem the cosier of the two’.” (Dennis Gartman via The Globe and Mail, December 14)

While others are upbeat about bullion '¦ “The attendant chart shows the history between the price of gold and the percentage deviation from the 13-week moving average on a monthly basis. The majority of the time when gold negatively deviates from the monthly price by 2.5% it has generally been a good buying opportunity. However, in recent years, as individuals have piled into gold, that volatility has become much greater and negative drawdowns of 6% or greater have become more common.

“How far could the current price decline be? If we go back and look at the monthly price chart on gold in early 2008 as the peak was achieved, the decline to the bottom was roughly 30% '¦ Today, a similar 30% decline would take the price of gold all the way back to – wait for it – the beginning of 2011 '¦ This hardly seems cause for alarm or claims that the secular 'bull' market in gold has come to its inevitable conclusion '¦ Don’t get me wrong – the bull market in gold WILL eventually end and the price WILL collapse back to extremely low levels '¦ However, that event is likely several years away and we will need to see a much stronger economic environment for that to begin to occur. Here is our take on gold in the coming months:

• We have entered an intermediate term correction in gold that will most likely last 3–6 more months.
• Any short-term rallies to the longer-term uptrend should be sold into for now. Take profits, limit losses and raise cash.
• If Europe fails to resolve itself and a financial crisis emerges gold prices will initially drop rapidly as risk assets are unwound indiscriminately.
• Any further decline in the Euro that forces funds into the US dollar will likewise keep a lid on gold prices.”

(Street Talk Advisors via Pragmatic Capitalism, December 16)

Merry Christmas from Rupert Murdoch '¦ “Courtesy of the NYT's Brian Stelter, who got one, here's FOX News's Christmas card. Those are the CBS, ABC, and NBC sleighs Fox is blowing past. And that's CNN hiding over in the snowbank, not even in the race.”

(Fox News via Business Insider, December 20)

Hussman calls a US recession '¦ “The chart below presents data (through October) from the Organisation for Economic Cooperation and Development, an international quasi-governmental agency that sets international standards on a wide range of economic policy issues. The OECD publishes its own set of leading economic indicators on developed and developing countries. Notably, we’ve never observed deterioration to the extent that we presently observe, except when the US was in or entering a recession.”

(John Hussman of Hussman Funds, December 19)

But don't be too fussed '¦ “Since 1855 the US economy has been in recession a full 30% of the time. In the post-war era since 1945, the US economy has been in recession 16.2% of the time. Since 1980, we have been in recession 14.6% of the time. Since the year 2000 we have been in recession 18.3% of the time. The flip-side of course is that the economy has been in expansion 83.8% of the time since 1945, 85.4% of the time since 1980 and 81.7% since 2000. What this shows is that, despite incredible turmoil in the global economy currently, the US economy has undergone a remarkable transformation, which has made it a rather tranquil place in which to reside.” (Pragmatic Capitalism, December 21)

When all the experts agree '¦ “Exactly a year ago, the USA Today ran with a big bold article titled: 'In 2011, It’s All About Stocks: 5 Top Experts Agree: New Year’s Looking Great For Stocks, Not So Great For Bonds' (nice call!). Indeed, it sure was 'all about stocks', but not the way the consensus was forecasting. While the US was a relative outperformer, even with the very recent Santa rally, the S&P 500 is still down 1.3% so far this year (if it holds it will be the first time since 1939 that the market was down in the third year of the presidential election cycle), and with tremendous volatility. Strip out Utilities, Healthcare and Staples – the stuff you want to own when the economy is in trouble – the S&P 500 is down 5% so far this year (by the way some people talk, down 5% today is considered a good year). And what do we see today? The same paper runs with 'Strategists Predict a Glowing 2012: Stocks Forecast to Finish the Year Up By More than 10%.’ Oy vey.” (Dave Rosenberg of Gluskin Sheff, December 21)

Is potash the answer? '¦ “The changes to the ways in which gold can be purchased [via ETFs] and the much broader investor base has dramatically changed gold's nature as a 'safe haven'. So, are there any 'safe' commodities left in which to invest? If you listen to the economists, probably not. Forecasts of a slowdown in global growth next year are common; that will wreak havoc on demand for everything from copper to crude oil and, not surprisingly, their prices have come under siege. But there is one intriguing option: potash. True, potash is one of those commodities that never really glitters like gold; rather, it lurks in the shadows. It’s not traded on the futures markets – you would have to invest indirectly, via stocks of producers like Potash Corp. of Saskatchewan [and, once its Jansen project is up and running, BHP Billiton]. But the absence of a futures contract also means potash prices haven’t been the focus of speculation '¦ The long-term fundamentals remain relatively upbeat. Demand for agricultural productivity isn’t going to abate, particularly in emerging markets like China, India and Brazil. Global demand was expected to climb 11% this year, and even if the rate of growth in demand from China ebbs, Indian needs are likely to more than compensate as that country tries to become self-sufficient in foodstuffs, especially grains. (India’s fertiliser budget is bigger than its military budget.)” (The Fiscal Times, December 19)

Investors flee the BRICs '¦

(Citigroup via Money Game, December 20)

Inside the mind of a gold-bug '¦ “Warning: this is a very scary place to be. Presenting the latest Thunder Road report from former resource analyst Paul Mylchreest: ''¦ The majority of people probably won’t agree (yet) with much of this paragraph, but we are in a chain of events where the direction of travel is: INFLATIONISM – INTERVENTIONISM – SOCIALISM – REDUCED LIVING STANDARDS – TOTALITARIANISM. Elements of all of them are already present to a greater or lesser extent, as I’ll discuss. Of course, the earlier ones, inflationism and interventionism (which Ludwig Von Mises described as “socialism by instalments”), are the most obvious. What we are experiencing was prophesied in fictional form by Ayn Rand in her masterpiece Atlas Shrugged when it was published in 1957. I’m reading it and it’s amazing '¦ The source of this whole chain of events is inflationism and the debasement of currencies. As it unfolds, gold and silver increasingly become the critical assets to hold in order to safeguard capital. Currently, prices are being held down to hide the wreckage of the financial system and enable TPTB (The Powers That Be) to load up. Market prices and demand for physical metal are temporarily disconnected. Going forward, essential items, like food and energy (especially crude oil) will account for a larger share of the 'economic pie' as living standards decline and inflation increases. In contrast, items like luxury goods and diamonds (not a store of wealth) will suffer.'” (Paul Mylchreest via FT Alphaville, December 20)

Video of the week: Facebook's market makeover '¦ The social network wants to be a blue-chip.

(Wall Street Journal, December 21)