FMX | Connect – www.fmxconnect.com - (Reported 8/4/2010)
Below are Excerpts from Bert Dohmen’s Wellington Letter: A Fundamental and Technical Analysis of the Economy and Investment Markets.
EVENTS LAST MONTH
There were 3 important events, all occurring on the same day in July:
1. BP plugged the well
2. FinReg was passed
3. Goldman Sachs settled with the SEC for a pittance
The stock market plunged the next day, but that was a fake out. Thereafter, a low-volume rally started. We call this the typical “summer rally.” Right now, it looks like that last attempt to turn money managers more bullish. There are a lot of shorts, so it’s easy to promote a rally by squeezing those shorts.
The FinReg bill, which is now law, is another monstrosity. Peter Wallison, a member of the president’s Financial Crisis Inquiry Commission, said the new regulations will be “disastrous” for the U.S. economy and will permanently slow economic growth. Furthermore, he said that it does nothing to prevent another similar crisis.
THE STOCK MARKET
The chief financial officer of a very large, well-known private equity firm gave a bullish forecast for the markets on national TV in late July. I always like to check track records. Here is what the same person predicted in early 2008, before the global meltdown later that year:
“Stocks (will) achieve a new all-time high in 2008 as price/earnings ratios improve.”
At the time, our forecast was that the stock market would tumble in 2008. As you know now, the bull market top in the stock market was made in October of 2007. However, just because he was wrong in 2008 doesn’t mean he can’t be right now.
This time of year usually brings a summer rally, and we have had a rally since early July. In 2008, the market also had a rally from July to August, before the crash that started in early September. Trading volume is now very low. That makes it easy for the handful of large trading operations to push stocks higher.
We will not get too impressed. There is a high probability of a meaningful reversal in September.
ILLIQUIDITY:
The very low volume in the stock market confirms that liquidity has been reduced significantly. Lack of liquidity is scary, as we saw on May 6 when the DJI plunged almost 1,000 points in less than an hour. When the high-frequency-trading (HFT) computers shot their sell orders into the market, there were no buyers.
To all subscribers who may be day traders, we advise you to lengthen your time horizon. From everything we see, the HFTs are programmed for very short-term trading. If you use 1-5-10 minute charts, you will be cleaned out. Delete those short-term charts from your computer! In our opinion, the HFTs don’t really ad liquidity; rather, they discourage normal traders.
Illiquidity is also seen in fixed income and Treasury securities. The amount of Treasuries outstanding has increased about 75% in the past 3 years. However, average daily trading volume of Treasuries among the primary dealers has declined 12%.
TECHNOLOGY:
Technology is often disruptive. It can forever change industries that have existed for many years, even centuries. The electronic readers such as the Kindle and the iPad will eventually put many bookstores out of business, and publishers will have to drastically change their business model.
Amazon just reported that in the latest quarter it sold more e-books than print books. The convenience is wonderful. I have an iPad. When I read or hear about a good book, I just connect to Amazon, click on the “1-Click Ordering,” and a few seconds later, the entire book is on my iPad. I can then read it at my convenience. Apparently, the iPad can store up to 2,000 books.
Now look at the convenience for authors. It usually takes a major publisher 9 to 12 months to get a book into the stores. That’s much too long, especially for financial books. And the author gets a very small piece of the retail price. With electronic publishing, Amazon and others become, in effect, the publishers, and the author keeps a bigger slice of the sale.
THE BIGGEST OBSTACLE TO GROWTH:
Entrepreneurs always do what they do best: innovate, create business, and create jobs, in order to provide for their families. The only impediment to this natural drive throughout the world, no matter when in history or where geographically, is government. Hernando de Soto discusses this in his book, MYSTERY OF CAPITAL. It’s a must read! His research concludes that poor nations stay poor because the governments make the mobilization of capital impossible.
The U.S. became the greatest economic power on earth due to minimal interference by government. But that has changed over the past 18 months. The entrepreneur sees what is coming out of Washington on a weekly basis and stands aside.
Investors have to inform themselves about what is happening in Washington. This is our future. The hidden obstacles in the health care law and the new financial regulations are now starting to surface. It is the greatest growth in governmental power and bureaucracy since at least the Roosevelt years, perhaps in history. There are thousands of pages dedicated to forming new committees, administrators, and regulations to stifle business. Those will be a huge hurdle to any economic growth.
INVESTMENT MINEFIELDS:
Investors are still being lured into municipal bonds, being told about the very low historical default rates, the tax free aspect of the interest, etc. But the fact is that the huge city salaries and retirement benefits cannot be paid in the long-term. Cities never asked how a city can pay tens of thousands of retired workers 90% of the prior salaries and pay for all their health care costs. Money doesn’t come from heaven. It means that as the number of retired city employees grows, each resident has to support perhaps 10 times as many people as when the program was initiated. That’s impossible.
Who is most vulnerable to muni debt defaults? The insurance companies and regional banks who have much of their reserves parked in them. Bloomberg Businessweek quotes Allstate Chief Executive Officer Thomas Wilson: “Nobody has the intestinal fortitude to actually move forward to try to change anything. They’re just sort of sitting there waiting for disaster to happen.
Businessweek pointed out that Allstate, New York-based Travelers, Chubb in Warren, N.J., Progressive Corp., and Hartford Financial Services Group Inc. held about $95 billion of municipal debt as of March 31, according to FBR
Source: Dohmen Capital
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