Friday, August 29, 2008

Buy Baghdad, Sell Cleveland

Several weeks ago I mentioned how much advice was flying around usually unsolicited and often without basis. One of the items that had caught my ear was the advice to buy National City Bank stock. It hasn't done much in either direction since then, but the last time I saw an EKG that looked like the chart of NCC they were pulling the sheet over the patient's head.

Something today struck me as an interesting anecdotal side note. The bond market now values Iraqi bonds as safer than Nat City. The bond market measures the relative riskiness of bonds by the "spread" above US Treasuries. More risk, wider spread to reflect the market demand for a higher return on higher risk. Currently Iraqi debt trades to yield 4.84% more than treasuries. Conversely to Nat City bonds yield 9.59% over treasury bonds. In other words it takes a lot more to entice a bond investor to hold the debt of the bank in Cleveland than the one in the Green Zone.

It is of course the old story of wondering is one is chasing an ambulance or a hearse. In any event, I think I'd give such investment advice a wide berth unless its a replacement for a Powerball fix.

John Barnyak
Stonehouse Asset Management

Wednesday, August 20, 2008

Unlikely Guidance

In the interest of full disclosure, it must be said, I don't look to President Bush often for words to keep close and help in my musings. Having said that, the occasional out of context blurb can give one some wisdom. During Dubya's first presidential campaign, as he kissed hogs and admired babies in Iowa he was addressed by an elderly woman in the crowd for his thoughts on a subject of importance to her. After telling him what her view was, his response, which perhaps was the precursor of things to come? "Who cares what you think?" I doubt he got her vote, but there be a useful nugget in his snappy response.

The investment community is overwhelmed with the thoughts of literally thousands of bright, and disagreeing, analysts and their opinions. Whether it is Jim Cramer fairly screaming his latest sure thing, or Secretary Paulsen reassuring the world that all is well at Fannie Mae or the manager of the local bank branch telling us now is the time to buy NatCity shares, or the Florida real estate broker or me, sometimes it doesn't hurt to let the inner voice say, "who cares what you think?"

Successful stock investors have a mantra that comes in handy in a world of opinions clamoring for attention. Don't tell me what you think, tell me what you see.

I see a man who is very selective in reminding us of his successful investment calls. I see a government agency trying to figure out how to repay $223 Billion in bonds due at the end of September with lenders and investors very thin on the ground for Fannie Mae stock or bonds. I see a bank stock that the market valued at $39/share last year and less than $5 now. I see an advisor who kept clients out of Enron, but got smacked by Worldcom. If what someone thinks, does not match what we can see; who cares what you think?

John Barnyak

Friday, August 15, 2008

The Worst Except For Everywhere Else

Winston Churchill once opined that "democracy is the worst form of government except for all the others that have been tried." That was a man who knew many truths are relative. Likewise investment markets and economies are about options, their relative benefits and performance.

For all the wailing on Wall Street, the U.S. market has held up relatively well. Having said that, we can't eat relatives and absolute returns are what we are looking for ultimately. Drowning by inches is no better than drowning by feet. This is the time for capital preservation and opportunistic buying AND selling.

In the relative performance chart above there are clues to be found about the global economic currents and investment strategies. What do we see that creates the backdrop for our decisions? There is somewhat of a parallel to the US boom real estate markets in many of the performances. The trading cliche', "when in doubt zoom out," is a good one. Step back when strategizing.

In the government statistics for housing through the first quarter of this year, we see tremendous declines in average house prices in various markets. Naples, Florida decreased 18.67% over twelve months. Conversely in our corner of the world, Pittsburgh, PA, average prices were actually up 3.61%. Cause for celebration? It depends. Over the past five years, Naples housing prices are still up 60.55% while Pittsburgh has advanced 22.83%. Now that the euphoric bubble has burst painfully can we learn anything to apply in other areas?

Does the prospect of buying in Saginaw, Michigan,which fell only 3.38% in the past year look more attractive than the Florida Gulf Coast over the longer term? The catalysts that are moving populations southward and westward in the United States seem unlikely to reverse and drive migration to Saginaw.

Similarly, the emerging markets are among the markets that have fallen hard this year. But does the global shift in wealth toward these markets, the high population growth and youthful demographics seem at risk. Will China and India slow? Probably. Will the inexorable power of the underlying thesis of globalization reverse? Unlikely.

We have stepped back from the emerging markets somewhat, believing that there exist some persistent valuation issues as a result of a "crowded trade" not unlike the home prices in Florida and Las Vegas. But stepping back is not stepping away.

For the coming year, I expect the difficult conditions felt in the U.S. economy will move more steadily overseas. The US still represents a safer haven in times of turmoil and the capital inflows indicate a reversal back toward the US. Does that mean US market prices will climb steadily, not necessarily, but for now, it looks like the US is the worst except for everywhere else.

John Barnyak
Stonehouse Asset Management

Friday, August 8, 2008

Neighborly Recession

Everyone knows when your neighbor is out of work it's a recession, when you are, it's a depression. The Bloomberg chart of continuing jobless claims looks rather depressing I'd say.
The economy will turn around before the unemployment figures and we have to stay ahead of the curve, not behind it. That being said, it looks like we have further to go and more pain ahead.

What makes this picture so troubling from a public policy position is that consumers, the primary engine of the US economy, are not in good shape to weather a recession other than their neighbors'. Individual balance sheets are in tatters for many. The principal asset, their home, is losing equity value and in many cases already gone. With the largest number of mortgages in trouble ever, extremely low savings and high consumer debt, the loss of a job can mean disaster. Without a savings reserve in place, the home equity loan atm machine closed the prospect of foreclosure for many will only get worse.

This economy has some tough work ahead

Trees Don't Grow To Heaven

Long ago I learned in an earlier commodity boom that excess breeds its own demise. My boss, a quite brilliant trader, had bought huge amounts of silicon metal back in the early days of the first energy crisis. OPEC was flexing its new found muscles and the world was about to get its first taste of pain at the pump. Silicon metal is referred to as "solid energy" because of the massive energy consumption needed to produce it. He nailed it.

Eventually everyone else in the metals trading industry was pounding on that same nail, but by that time, Jean-Pierre had already decided to convert his strategy into a new eighty foot sailboat. The man knows how to live. Years later when he had taken me under his wing and another product was climbing with no end in sight I learned about crowded trades and falling trees. A boat with all the passengers on the same side is apt to capsize. There are times when you need everyone on the same side, but be ready to move quickly when conditions change.

The US Dollar has been whipped on mightily for the past few years, and rightly so. Our fiscal and trade deficits, our negative savings rate as a nation, and negative real interest rates have not been very attractive to the world at large. Only the dollar's role as the global reserve currency has kept it from getting worse. However now I think it's time to get ready to move back to the middle of the boat.

The economic conditions that have been on every front page for the past year relative to the credit crisis have spread globally. The European Central Bank has long had as its primary mandate the management of inflation. Conversely the Federal Reserve Bank has a dual mandate of managing economic growth and inflation. However, this past week Jean-Claude Trichet, the ECB president gave a press conference in Frankfurt in which he went out of his way to comment that while inflation is still a threat, risks to economic growth are materializing. In a world of supreme nuance this is a statement worth hearing more loudly than the soft words.

One of the primary reasons for the Euro's strength against the US Dollar has been the steady decline of US interest rates while the europeans have held relatively steady. As (or if) that gap diminishes the dollar may undergo a substantial retracement upward against the Euro. I believer the Euro tree is about to fall.

So how does one approach this potential inflection point? We began to underweight commodities earlier in the summer, have kept precious metals allocations low and begun looking more favorably at US domestic equities versus international. This does not mean everyone rushing to the opposite side of the boat, but edging slightly away from our long held preference for foreign equities.

Over the long term, the United States problems look engrained and exacerbated by continuing globalization pressures, the demographics and emerging economies and the shift of wealth away from the US, but there may be a few too many folks on one side for safe sailing at the moment.

John Barnyak
Stonehouse Asset Management