The Contrarian's View s published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. My own material in this publication may be freely quoted provided proper attribution is given to its source; quotes from other people are subject to fair-use copyright restrictions. Subscription rate: Selections are free on the Internet. Using your favorite Web-browsing program, open URL http://onashi.org. Mailed paper subscriptions are currently not being accepted (current paid subscribers will continue to receive their paper issues). Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! ISSN 1536-4429 Phone: (508) 757-2881
Let's start with the money manager's stuff. As I previously noted, by the time I got the stocks the money manager had buried most of his mistakes, as the great majority of stocks were bought on November 9, 2005; a few in December 2005; and a very few earlier than November. I was not privy to seeing what had been sold to free up cash for those November buys, and it's unlikely I'll ever find out.
But the money manager did fail to hide his mistake with Intel. As you can see in the decade-long graph below of Intel's stock price, this is a stock which has gone to sleep for the past four years. But the money manager had certainly gotten caught up in the turn of-the-century tech frenzy, as one small chunk of Intel shares I received had been bought on February 10, 2000 at a price of $52.92 per share. That was pretty close to the peak, as you can see from the graph.
By November 2000 Intel's stock price had fallen so much from its ultimate high that it obviously was a screaming buy from the money manager's point of view, so he tripled his investment by purchasing Intel shares at $41.53 each.
Well, six years later you can see the damage caused when the herd gets caught up in a mania, as Intel shares now trade at less than half the price of the money manager's second purchase.
The first pitiful few shares of Intel passed onto me were, I felt, worth much more as a tax loss (to offset the short-term gains I was generating with my stop losses), so I sold them.
But the second batch of 45 shares (normalized) of Intel I decided to keep in the Inheritance portfolio, without a stop-loss, just to see what would happen. The semiconductor industry is mature, and Intel faces fierce competition from AMD. Its main problem is that the prices of its products keep dropping, and it is difficult to increase unit sales enough to show an overall gain in revenue. Without good revenue growth, retaining key employees is difficult and research and development suffer. Intel, to its credit, is increasing its R&D budget every year in spite of its difficulties. Tech can be unpredictable, and that blockbuster chip that could shift the chip markets to Intel's favor might be just around the corner, so it doesn't hurt to wait awhile to see what develops.
On the other hand, as the year grinds on, that Intel holding looks more and more attractive as a tax-loss sale. I'm still undecided.
The other money-manager tech pick I decided to keep (in this case, with a stop) was Microsucks - er, sorry, that's the Mac lover in me breaking forth, I mean Microsoft. This was one of the money manager's November 9 buys, and since then the stock has done squat.... as I would expect, because I don't expect much action until Windows Vista is finally released to the general public, now scheduled for early 2007. As a dedicated Mac user, I have gone through essentially four major operating systems (MacOS 10.1, 10.2, 10.3 and 10.4 which, despite their fractional renumbering, are each major overhauls of the OS), so I have for some time been using all of the wonderful advantages of a modern operating system which so far have been only whispered promises to Windows users.
When the Windows population finally discovers the true joys of a modern operating system with the Vista release, they're going to be tickled pink. I expect Windows XP to be junked wholesale in favor of Vista, which should provide a boost not only for Microsoft's stock price, but for the PC market (hardware and software) in general.
I might add that while I would never bother with a Windows personal computer for myself, with its plague of viruses, adware, spyware and intrusions which I, as a Mac user, never have to worry about.... in my last few months at Assumption College, before I retired, I did have some exposure to Windows servers, particularly Active Directory and networking, and I was impressed with the high quality and attention to detail of Microsoft server software. Once you get beyond the Windows home/personal products, which everybody (rightly) likes to dump on, you will find that Microsoft churns out some really high-quality software.
Do high-quality products eventually translate to a rising stock price? I hope so.
As an aside, I have a suspicion Vista may be Microsoft's last release of a "proprietary" operating system (proprietary, in this case, being an MS-DOS-based design for the Intel-architecture chip). Future operating systems are more likely to be based on underlying "open" software such as UNIX or Linux because, frankly, they're easier and much cheaper to maintain, and they can be run on many different types of hardware.
Note, for example, how easily Apple was able to introduce the Intel chip into its hardware line (to eventually replace IBM chips) because the MacOS is essentially a graphical overlay on the UNIX operating system, which runs on most anything. Could you see Microsoft easily migrating Windows XP from Intel/AMD chips to Motorola/IBM chip-based PCs? Not in a thousand lifetimes.
Of the five remaining stocks in the portfolio which were selected by the money manager, I am riding iShares Emerging Markets and Wells Fargo with stop-losses until the next bearish jag stops them out. I consider BP (energy stock) and FPL Group (electric utility with a good dividend) to be long-term additions to the portfolio, though with stops. L-3 Communications (defense industry) also seems to me to be a good long-term holding and, because its price has almost doubled since the money manager bought it in May 2003, I may sell half to recoup the original investment, and let the rest ride.
Now, for the stocks I bought. These all have dividend yields in excess of 6% while I wait for their corporate strategies to pan out (or not pan out, as the case may be).
The telecoms I discussed in the last issue, particularly Citizens Communications. These depressed rural telecoms basically have two ways to grow: By expanding the services offered to its existing customers, or by acquisition. Iowa Telecom has taken the first approach (DSL/Internet), and Valor Communications has elected the second, by acquiring the landline business of Alltel and quintupling its size. As far as I can tell, these telecoms' cash flows can all support their current generous dividend payouts until growth kicks in again.
Also added to the portfolio is Deswell Industries, a Chinese injection-molded plastic parts company. As you know by now, I am not keen on investing in fascist countries, where property rights (to say nothing of human freedoms) are regularly abrogated. But manufacturing in the U.S. is dying, while in China it's growing so, if you want a long-term investment in a manufacturing enterprise, China seems to be the place to go. The stock is also somewhat a dollar play; its price should rise as the dollar weakens. So far my Deswell investment's performance is subpar, so perhaps God is punishing me for playing footsie with the fascists.
The most recent addition to the portfolio is Chicago-area Peoples Energy, a (primarily) natural-gas distribution utility company. This corporation had the misfortune of getting caught up in the Enron scandal. According to Illinois regulators, Peoples conspired with Enron to sell natural gas to its customers at above-market prices, splitting the excess revenues with Enron. PGL is now complying with a $100 million settlement (about $100 to each retail gas customer) and has agreed to make good efforts to reconnect 12,000 former customers whom it cut off for nonpayment during its Enron-connected heyday. Enron (still in the news) = kiss of death. No wonder this stock (and company) is unloved by everybody. A management change is also in the works - the CEO is retiring within a year. I suspect the new management will clean house.
I continue to look for more value plays. Stocks are,
for the most part, still grossly overpriced, and a bear
market lurks in the wings, so I'm not finding much.
At this juncture, cash is definitely not trash.
Perhaps I am missing something but in my naive view of the world, peak earnings deserve discount multiples. Yet investors seem to be willing to pay pretty much top dollar for cyclically high earnings. This amounts to a display of faith in a new era. The one thing that history teaches us is that such faith has never been appropriate. Both the US and European markets are significantly overvalued. - James Montier [global equity strategist, Dresdner, Kleinwort, Wasserstein]
Today more than ever your portfolio should be targeting absolute return strategies. In a world with fingers of instability that may be connected in ways we have not seen in the past, caution is the order of the day. If we do see a slowing US economy later this year, the average complacent investor is not going to be happy as [each component of] his diversified portfolio.... seems to be going south at the same time. - John Mauldin
The hard, ugly fact is that there is no way to amass a fortune quickly with very little money, except by pure luck, because if there were a way, it would be just as easy to amass a bigger fortune with a lot of money, and the world is full of guys who have learned that (and you might want to write this down) there is no way to amass a fortune quickly, except by luck. They took their chances, trusting in luck, and the dice came up craps, as it usually does after awhile. And if you want to get rich, it will not be by mindlessly buying and holding stocks, bonds, houses, insurance policies, collectibles, or anything else, as it is mathematically impossible for everyone to get back more than they put into these things. In the long term, it's a zero-sum game, and to have winners, you must have losers. If you let Wall Street or Congress tell you any different, then you deserve the misery you are going to get, because you are really, really, really stupid. - Richard Daughty
Fed rate hike cycles are great destroyers of wealth. Remember the last one which began in 1999? The financial markets talked about a soft landing. Instead we experienced a major bear market in stocks with the Nasdaq losing 75% of its value and the US economy went into a recession.... The only soft landing I've seen in my 30-year career in the business was in 1994. The rate hike cycle that year didn't create a recession, but it caused an incredible amount of damage to the bond and derivative markets.... So what are the chances the "Gang that can't shoot straight" will get it right this time? The probable course of action is that the Fed will raise rates and it will end up being a quarter point too far. The economy could very well go into a recession although distorted economic statistics will hide that fact. We could very well get a 10-15% correction in the stock and commodity markets, and even worse, a major financial accident in the form of a major player (hedge fund or bank) going bankrupt. This looks more likely if the Fed moves beyond 5%. What will follow in the aftermath? Probably quantitative easing in the form of helicopter money and an ocean of money. - Jim Puplava
The Bureau of Labor Statistics.... the U.S. Labor Department's agency that calculates the price index, estimates housing costs by figuring `"owners' equivalent rent", or a proxy of what homeowners would pay in average rent increases. As the largest component of the CPI at 23 percent, housing represents a huge portion of the overall cost of living. Yet the Labor Department's indirect measure vastly underestimates actual housing costs since it doesn't reflect home-purchase prices, financing, maintenance or property taxes. Done any roofing, remodeling or painting lately? Have you noticed how much your property-tax bill has climbed to match higher home values? - John Wasik
Our world has faced inflation and nothing but inflation since the Great Depression of 1929 as the money supply has increased constantly. However, what concerns me is the fact that the rate of inflation (money supply growth) is likely to skyrocket over the coming years... over the past year, a significant amount of money has been introduced into the system. The thesis is that the surging money supply will cause the value of money to drop and make it easier to repay the mountains of debt. "But what about my savings?" you may ask. Frankly, the establishment does not care about your savings. In order to remain popular, the officials almost always cater to the needs of the majority. Today, the majority of the population is heavily in debt and with its back against the proverbial wall! Therefore, you can bet your bottom dollar that the rate of inflation will continue to surge and hyperinflation may not be far away. - Puru Saxena
The US is already on its third or fourth currency since the American Revolution - and the banksters own the money through the Fed. We're a land of paper, not industry. Try to restrain that much greed and I'm betting the outcome is ugly. But, y'all have fun. - George Ure
As the refinancing game ends and borrowing costs increase, a significant rise in foreclosures could put a few million more homes back on the already-saturated market! When these foreclosures come, many of the homes for sale will have no equity and the seller will want a quick sale. Buyers will still be choosey, unless there is a real deal and the prices are marked down big time. The entire structure of housing prices will move lower with these forced sales. With mortgage foreclosures mounting up, it could get unbearably hot in Housing Hell. Our estimate is it will take about six months for sellers - particularly speculators who never intended to live in their properties but whose sole intention was to "flip" them for a profit - to realize they are toast. - Richard Benson
It is indeed the financial institutions that are most at risk in the real-estate market (which is not to say that consumers and speculators won't get hurt). The lenders will bear the brunt of the pain because, in many cases, they loaned the entire purchase prices of many homes. As I have said often, the housing bubble has been more a lending bubble. It will be the impairment of the financial institutions that will stop the flow of credit to the real-estate market. In turn, that will accelerate the collapse in house prices somewhere along the way.... Ladies and gentlemen, unfortunately, a lot of people around the country are going to be badly hurt as this bubble unwinds. And, after they have taken their losses, the financial institutions that were the engine behind this folly will take their own hits. 'Easy Al' Greenspan at the Fed tried to bail out one bubble with another bubble. While it bought some time, it will end in far-worse pain. - Bill Fleckenstein
Let's make a list of Florida attractions: 1. Hurricanes. check; 2. Sinkholes. check; 3. Condo Mania. check; 4. Unsustainable Appreciation. check; 5. Clueless Snowbirds. check; 6. Wells Running Dry. check; 7. Earthquakes. no; 8. Unbearable Heat and Humidity. check; 9. Insurance Problems. check; 10. Mudslides. no; 11. Termite Problems. check; 12. Severe Affordability Issues. check. Florida is ground zero for housing bubble fallout, but rest assured the problem will spread. Trapped buyers have not yet begun to panic. They will. - Mike Shedlock
This week [March 27-31], as statistics revealed that China has surpassed Japan as the world's largest holder of foreign reserves, the U.S. Congress continues to threaten China with 27% tariffs on their exports to the U.S. The move, which is akin to a cornered gunman turning the pistol on himself and threatening to pull the trigger, reveals the extent to which American politicians fail to comprehend the true nature of the current Sino-U.S relationship. In desperate need of capital, America is hardly in a position to insult those providing it, or dictate the terms by which they do so. - Peter Schiff
It is.... wrong to think of contemporary China as an intensely unstable system, riven by the democratic impulses of capitalism on the one hand, and the repressive instincts of communism on the other. Fascism may well have been a potentially stable system, despite the frenzied energies of Hitler's Germany and Mussolini's Italy. After all, fascism did not fall as the result of internal crisis; it was destroyed by superior force of arms. Fascism was alarmingly popular; Hitler and Mussolini swept to power atop genuine mass movements, and neither Italians nor Germans produced more than token resistance until the war began to be lost. - Michael A. Ledeen [February 23, 2002]
This effect - to convince the world that Iraq is a hopeless and violent wasteland, heartbreaking evidence, even, of a trigger-happy cowboy's hubris - is compounded and reaffirmed day after day, as biased and exaggerated reports reverberate through and within thousands of local and syndicated media outlets.... I was there. I was in some miserable places, but I saw a miracle every day. I saw a lot of smiles, a lot of hope, and a lot of pride in that traumatized country. I saw a remarkably fraternal affection between Iraqi and coalition soldiers. I saw bustling markets, busy streets, and peaceful demonstrations. I believe I may have witnessed a pivotal time in the infancy of a vibrant, freedom-loving ally in the Middle East. I did not see a civil war. I did not see the beginnings of a civil war. But I did learn a thing or two about the "roots" of this civil war: Iraq's civil war has been engineered, in no small part, [by "news" reporters] from the comfort of a Baghdad hotel room. It is catalyzed by minor exaggerations, partial facts, and propagandistic suppressions. It will escalate, over time and across media, as minor mistruths beget outright lies, until the truth itself begins to change. As our new Iraqi allies become discouraged by what they see in the world news, and as they start losing hope, they may abandon their dreams once and for all. Our media's dark prophecies will then have fulfilled themselves. Then, and tragically, Iraqi and coalition pleas for "truth" may finally be silenced. - Franklin Raff
The ultimate asymmetry is that militants need only defend ideas whereas the West needs to defend real infrastructure like oil wells and mines. The reason we're in for a long and lop-sided fight which ultimately may not be winnable by throwing money at the problem, is that ideas are hard to kill. The only way to disarm ideas is through negotiation - or in great American style, with a demonstrably Better Idea. While George Bush says "failure is not an option," a thinking person has to ask whether the only way to kill some ideas is to kill all the humans that hold to them. Sorry to put it so bluntly. - George Ure
If you pay $10,000 a year in federal income taxes, your entire contribution amounts to just 1 percent of this
year's subsidy for the Waterfree Urinal Conservation Initiative and 0.07 percent of the money allotted to the
International Fund for Ireland, sponsor of the World Toilet Summit. Now you know you were literally correct
when you speculated about where your tax dollars were going. - Jacob Sullum
So OK, Nick, you say, then why is your "Inheritance" portfolio 70% in cash? The reason, I say, is that program trading currently accounts for almost 60% of trading volume on the NYSE (with presumably similar ratios prevailing in other domestic markets). This is the result of the popularity of hedge funds, which trade stocks for minuscule but frequent arbitrage advantages in the their pricing (and probably at your expense). This constant trading not only distorts formerly-reliable indicators such as the advance/decline line, but also measures such as volatility, which is at historic lows, and it creates a long period of a correctionless (less than 10%) market.
The hot money flowing into the hedge funds has thus created a potentially explosive (sensitive to systemic risk) situation, with widespread investor complacency because the traditional health-of-the market indicators on which investors rely have been diluted into uselessness. Trash them.
The market will probably continue to deliver its modest and mediocre returns (for awhile) until something breaks and the hot hedge-fund money slithers away elsewhere. Then, watch out below!
In the meantime, I would be wary of most technical indicators of market health and of the various cyclical indicators such as Elliott Wave analysis, Hindenburg omens, sunspots, Kitchen and Juglar cycles, the four-year Presidential cycle, and six-month, 17 month and other supposedly-periodic cycles which purport to tell you which way the stock market is heading. In hindsight one or more of these will "prove" to be correct, but predictive value? Forget it.
Instead, use your common sense. Rising short-term interest rates.... worldwide, not just in the U.S.... are not bullish for stock prices. A popping housing bubble is not bullish for stocks. (War is bullish for stocks.... for awhile.... for the winner.) From a fundamental point of view ill winds are blowing for the stock markets, but this does not tell you when the next bearish jag will start. Sometimes stocks will ignore their icy breath for many months.... as they did in 1987.... but eventually the fundamentals win out.
Then there is systemic risk, which can lead to an abrupt rupture rather than a traditional bear market and which, in my opinion, is rapidly rising and is currently about 40%. We can see systemic "cracks" appearing, as in the recent collapses of the stock markets in Dubai, Saudi Arabia and Iceland. Iceland, you say, with population less than double that of Worcester, the financial backwater of America? Who cares? Well, Iceland became part of the "bond carry trade" because of its high interest rates (up to 11%) and the stability of its currency. The money thus sucked into the country created a big consumer consumption, asset and real-estate bubble, until the distortions sent down the value of its currency on world markets. The hot hedge-fund money then fled Iceland, and the local markets collapsed. This should sound vaguely reminiscent of a country we all know and love, except that Iceland does not run the world's reserve currency. I cite it as an example of how quickly a situation can change when an arbitrage profit dries up.
Our Federal Reserve has made plain its intention to deflate the housing bubble, and it is clearly succeeding. Mortgage rates, especially adjustable-rate, are rising (now about 6.5%) and the housing ATM is no more. The government has also insisted on tighter mortgage-lending standards, so you can kiss those no-equity, no-doc and neg-am mortgages goodbye. Of course, the Fed hopes that the bubble will let out air slowly. If it doesn't the Fed clearly is ready to print tons of money and aggressively lower the interest rates it controls, as it did following the popping of the tech bubble in 2000, to ameliorate the fallout from the popping of the housing bubble.
This is a dangerous (and inflationary) game. Recall that the Fed did lose control for awhile in 2002, and the stock market did not immediately respond to its ministrations. Real-estate market turnarounds move much more slowly, and there is plenty of opportunity for consumers (with their ATM machines unplugged) to severely retrench and send the economy into a deeper recession before the social mood improves.
Do I know when the stock markets will finally tank? No, but my guess is that after another peaking in early to mid-May, the trajectory of stocks will be mostly down for the rest of the year, and possibly into 2007. This is even a better bet if Congress fails to fend off the return of the more confiscatory levels of the alternative minimum tax, or to extend the 15% tax rate on dividends.
In 2008 the demographic worm turns.... the leading edge of the baby-boomers retire, and they will be converting financial assets to cash for living expenses. (Well, I suppose they could keep on borrowing, but I don't think the times will support that.) So the spring 2006 highs we've been seeing for stocks could be the highest levels we'll see for quite a few years. (Or until the Dow reaches 36,000, but an apple costs $5 and gas is $15 a gallon, heh, heh.)
So, I'm not saying that stock prices won't or can't
work their way higher, bucking the strong forces
now being arrayed against them. I only say that such
gains come with very high risk, and the longer
investors ignore these pressures for lower prices, the
more violent the eventual adjustment is likely to be. I
am quite comfortable with my high-cash position.
A. "Inheritance" - real (normalized) "dividend distribution" portfolio::
SUMMARY - "Inheritance":
Original cost: $100,000.00 (normalized)
Present value: $109,435.26 (see below)
Increase: $9,435.26 [+ 9.44%]
COMMENT on "Inheritance": Another one of the money manager's good November picks, Accenture, was stopped out on a disappointing earnings report. I elected to sell the iShares MSCI EMU, which tracks a composite of the European stock markets, after it formed a "spike" short-term top. In the past these spikes in EZU have signalled that at least a short-term correction is at hand, and sometimes worse. I have a nice profit in this ETF; I didn't see any reason to push my luck. Moody's was another good pick by the money manager; it has been on a persistent and even (almost linear) climb for the past several months. But when its trailing P/E reached 39, that was too rich for me. I didn't see much room for disappointment there, so I captured a nice profit in that holding also. (In hindsight, a wise choice; the stock later cratered on a disappointing earnings report.)
Added to the portfolio since the last issue is 100 shares of Peoples Energy, as previously described.
Adjusting for the stocks sold, the portfolio cost (normalized) is $106,431.24 with $71,210.26 currently in cash or near-cash. I should add that "cash" is not such a bad thing to have in one's portfolio right now. The yields on my near-cash holdings vary from about 4.2% (SHY) to 4.8% (6-month T-bills).
B. "Professors' Investment Group (PIG)" - investment club portfolio.
SUMMARY - "PIG":
Original cost: $10,699.00
Present value: $21,524.37
Increase: $10,825.37 [+101.18%]
COMMENT on "PIG": I continue to "roll over" 3-monthT-bills, one per month.
C. Roth IRAs - real portfolio:
SUMMARY - Roth IRAs:
Original cost: $28,776.19
Present value: $ 34,379.09
Increase: $ 5,602.90 [+19.47%]
COMMENT on Roth IRAs: Returning to The Contrarian's View is an old friend - my IRA, begun in 1982. Real old-timers will recall that the original 1982-86 cost of the traditional IRA was $8,326.19. When Roth IRAs came into existence I converted this to a Roth (at $13,121), spreading the tax bite over 4 years. Since then there have been more Roth IRA contributions, including a separate bank CD which is included above in the cash total. The brokerage IRA has moved around quite a bit. The original traditional IRA was opened at Commerce Bank in Worcester, the financial backwater of America, with 10% CDs. (Does anybody remember when bank CDs yielded 10%?) When their brokerage commissions became exorbitant I moved it to Fidelity, then to Waterhouse (as a Roth), then to TIAA-CREF during my efforts to consolidate everything with one company, then back to Fidelity. Currently I am implementing a "6-month T-bill purchase every week" strategy with the funds that aren't in the bank CD. For the surplus cash I am looking at publicly-traded limited partnerships and Canadian energy royalty trusts, as in an IRA I don't have to worry about the tax paperwork that comes with limited partnerships.
D. TIAA/CREF 403(b) and IRA retirement plans; I switch between indexed stock/bond/money funds:
Gain for the period January 1, 1988 through March 31, 2002 (14.25 years): 223.43%. Compound annual rate of return for this period: 8.59%. (Gain excludes the impact of additional monthly cash contributions.)
A portion of my TIAA-CREF funds are currently in the process of being transferred to Fidelity Investments. Once this is complete, I will try to "pick up" the reporting of the performance of my TIAA-CREF retirement plans.
TIAA-CREF values, 26Apr2006: stock, 222.72; equity-index, 87.52; MM, 22.96; bond, 75.46; inflation-indexed bond, 44.89; real estate, 248.77; TIAA current yield in SRA, about 4.92%. Current money-market yield is 4.61%. COMMENT on NYSE "Timer's Trend": We are currently on a BUY signal of April 19, 2006.
COMMENT on NASDAQ "Timer's Trend": We're on a SELL signal given April 25, 2006.
NEXT ISSUE - will appear near the end of May 2006.