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starbucks4ever (94.15)

The market is irrational as ever, but the kernel of truth can't be overlooked

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May 18, 2010 – Comments (15)

And so the contagion in Europe is finally reaching the American heartland. As I kept telling people this past year, the US market is the only game in town. True, the returns have been lackluster, but going from 1100 to 1200 and then back to 1100 is nothing to blush about. Compare that with the bloodbath taken by the grass-is-greener crowd in markets like China and now in Europe. China is down 25%, and the Euro is rapidly going down toward the purchasing power parity (around 1.20) and looks set to drop much further. Suddenly, my 90 cent target for the Euro looks within reach.

Only the goldbugs have been spared the carnage, but they too will pay the price for their stupidity one day when people realize that gold is not edible and not drinkable either. At $100 an ounce I will return to that issue once again and ask myself if it's worthwhile to purchase some gold for speculation purposes.

What are the reasons S&P is holding up so much better than Europe? First, it's holding up better because it was less overvalued. It was (and is still) in a mini-bubble but not in a dramatic bubble. In contrast, Europe was is a dramatic bubble, if only because the currency was selling for 30% more than it was worth. So we American supremacists (to borrow AndreyLikesMTL's definition) had a smaller height to fall from.

Second, it's holding up better because Europe and China are holding up worse. In warfare, you don't have to walk upright to collect the spoils from a dead enemy. It will be more than enough if your enemy is lying dead on the battlefield and you can still crawl on your knees; the army that's crawling on their knees after the battle will soon become more powerful than it ever was before the battle because they are now in control of the land. And economic warfare is not different. The crash of Europe is making America stronger despite the short-term pain from the lost exports. When the crisis reaches its bottom, American banks will buy Europe and the price will be extremely favorable to them.

The way the "victory factor" works is two-fold. Multiples expand because you want to pay a higher multiple to own a winner than to own some pathetic loser. And the capital that wants to pay this higher multiple also expands because the losers - Europeans, Asians, and I guess, some Americans foolish enough to invest abroad - see the butcher's knife over the heads, take their remaining money, and fly to safety. More money going to US treasuries means more money for the US government to re-inflate its bubbles and less money for foreign governments to re-inflate theirs. More money to re-inflate the US bubbles means more consumption in the US and less consumption abroad. More consumption in the US means more foreign investment going to the US because that's where the consumers are. A virtuous circle starts at home, that is also a very vicious circle for Europe. America becomes richer because it's rich. Everybody else becomes poorer because they are poor.

Third, it's holding up better because of the perception that it deserves to hold up better. The debt situation in Europe is on the agenda, thanks to the valuable insights of the three credit ratings agencies. In capital markets, appearance becomes the new reality. These credit ratings agencies won't ever mention that the debt situation at home is exactly the same as in Greece and since they won't mention it, the reality of the defaulting US government will not become the "real reality" while the reality of defaulting Greece will, because it's in the headlines. All of that explains why I became increasingly bearish on foreign markets last year and then went on record calling a purchase of these stocks one of the worst investing mistakes you can make in 2010. It was obvious that out of the two bubbles - the American and the European - the one that fails to control perceptions will also be the one that pops first, and the one that fails to control ratings agencies will be the one that fails to control perceptions. But that doesn't mean S&P will give you a smooth ride in the short term.

For one, much of the income of S&P companies is made abroad. Yes, the crisis will open up some fabulous opportunities for these companies, but the profit from these opportunities will materialize in five years, and the hits to the earnings will materialize next quarter. We need to go down first in order to up.

Then there will be some losses to the US banks like JPM that have exposure to foreign debt. Again, these banks will end up taking over Portugal, Italy, Greece and Spain, but that will be a little later while the losses or at least the fear of losses will have to be suffered here and now.

Then there will be emotional stress, there will be momentum, there will be Elliott Wave charts and all the thousand reasons why we should go down. Tea leaves reading will point to a bear market and bird entrails will indicate Wave 3 of Wave III of wave iii of wave 3) of wave iii) of wave Three, and all these waves will be peaking at 1100 and cascading down to 500. And all the mo-mo investors will be looking at these waves and hitting the sell button, getting rid of the ridiculous jokes like XOM but also of the reliable, profitable companies like WMT. 

All of that would not be sufficient to make a dent in the market if it were reasonably valued. But we are still in the stratosphere and extended valuations make us vulnerable to hysterical pullbacks. That's why I think we may have another 10-15% downside from here. But while we go down 15%, foreign markets will be absolutely decimated. To drive the point home, I will predict that at least 50% and possibly 100% of Chinese stocks trading on American exchanges will be bankrupt in the next 5 years.

It is irrational that we are going down on what (to us) is good news. But if we recall that it was also irrational that we got that high then the world will start looking rational again. 

And then by the end of the year the re-inflated US economy will begin to reward investors for this short-term inconvenience. In the nominal terms, at least. The real return is a different story, but for the next 6 months we'll have more important things to worry about. 

 

15 Comments – Post Your Own

#1) On May 18, 2010 at 9:11 PM, AbstractMotion (52.03) wrote:

Interesting read, I agree that trouble abroad is a net positive for the US.  There will be some pain as stock prices revert back to reasonable measure, but it will remain rather tepid compared to the losses abroad.  I don't think the US is necessarily still in as bad a boat as Greece -yet-.  A lot of our bills haven't come due yet and there's a lot more room in budget for expense paring and a population more open to doing so (Military, entitlements).

 I do fear that this environment will likely embolden our politicians and executives to further overextend their budgets, which will cause tremendous problems whenever interest rates start to rise again.  I suppose the most positive aspect of this is that people are actually buying longer dated treasuries again, which should at least allow for a bit more flexible debt structuring.  We might get a few good years out of this, but ultimately if we don't see some budget restructuring at the public level we'll end up in the same boat down the line.  Likewise if the private sector squanders this influx of capital on misguided LBOs and unrealistic dividends then they'll likewise end up squandering this opportunity.

 

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#2) On May 18, 2010 at 10:54 PM, starbucks4ever (94.15) wrote:

In the long run we are all dead. But in the short run, we'll do much better than all foreign markets. I'm still making an exception for Airstrip One, but it's the only exception I will make.

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#3) On May 18, 2010 at 11:35 PM, simplemts (< 20) wrote:

zloj, why are you so oppossed to chinese stocks on american listings?  Many are very cash rish, are not shy to dilute further, and should be able to run 2-3 years without going bankrupt assuming NO new sales.  Are you simply exaggerating to make your point or do you actually believe 50+% will go bankrupt?  What is your reasoning behind this?  Why do you feel the US economy is more self sustaining than a Chinese economy (They lend, we borrow, they export, we consume, etc.)  I'm not trying to sound critical, just curious as to your reasoning.  While I believe their stocks will get crushed, I do not think the same of the companies behind the stocks.

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#4) On May 18, 2010 at 11:40 PM, starbucks4ever (94.15) wrote:

#3,

I doubt that China will exist 10 years from now. When the underlying country dissolves, its companies become almost worthless. 

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#5) On May 19, 2010 at 12:52 AM, RonChapmanJr (39.12) wrote:

"Only the goldbugs have been spared the carnage, but they too will pay the price for their stupidity one day when people realize that gold is not edible and not drinkable either. At $100 an ounce I will return to that issue once again and ask myself if it's worthwhile to purchase some gold for speculation purposes."

That's cute.  I don't know that much about gold, but $100 an ounce will never happen again.

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#6) On May 19, 2010 at 5:50 AM, stockdatamaster (99.15) wrote:

I doubt that China will exist 10 years from now. When the underlying country dissolves, its companies become almost worthless.

This is an utterly ridiculous statement.  How can you justify such baseless fear mongering?

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#7) On May 19, 2010 at 6:44 AM, portefeuille (99.61) wrote:

you want to pay a higher multiple to own a winner than to own some pathetic loser

some winner candidates.

Volkswagen, Toyota, Daimler, BMW, Roche, Samsung, Telefónica, Banco Santander, HSBC, Deutsche Bank, BNP Paribas, Barclays, UniCredit, Nomura, ICICI Bank, Nestlé, BASF, LVMH, Inditex, H&M, BHP Billiton, Rio Tinto, Vale, Petrobras, Gazprom, Mechel, Arcelor Mittal, Siemens, Reliance Industries, ABB, EADS, Infosys.  

 

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#8) On May 19, 2010 at 6:55 AM, portefeuille (99.61) wrote:

American banks will buy Europe and the price will be extremely favorable to them.

Again, these banks will end up taking over Portugal, Italy, Greece and Spain

Just like the Japanese were supposed to "take over the U.S." at the time of Wall Street I?

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#9) On May 19, 2010 at 7:00 AM, portefeuille (99.61) wrote:

making fun of chartists and gold bugs is of course always a good idea and your posts are really amusing as of late!

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#10) On May 19, 2010 at 8:24 AM, MoneyWorksforMe (< 20) wrote:

So if China and Europe were and still are inflated bubbles, the U.S. is still inflated, but to a much lesser degree, interest rates are zilch, and gold is artificially through the roof, where do we place our hard earned cash?

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#11) On May 19, 2010 at 11:57 AM, starbucks4ever (94.15) wrote:

#5,

Never say never. I am pretty sure that my chance to buy gold for speculation purposes for $100 an ounce sometime in this decade is at least 30%. 

#6,

I just tell things as I see them.

#7,

Your list looks to me very much like a list of losers. HSBC and Siemens look a little better than the rest of them. Gazprom - you will have to kick me with boots to make me buy even one share.

#10,

Should be obvious enough. I won't insult your intelligence by stating the obvious. 

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#12) On May 19, 2010 at 6:37 PM, bert111 (82.38) wrote:

Zloj, the value in your blog is not whether I agree, but, rather, whether it provides a perspective I haven't yet considered and that perspective is defensible and viable.  On both accounts, it is, and I am the beneficiary.  Keep thinking and writing. 

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#13) On May 19, 2010 at 7:22 PM, starbucks4ever (94.15) wrote:

#12,

I'll do my best, thanks :) 

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#14) On May 21, 2010 at 1:25 PM, RonChapmanJr (39.12) wrote:

"Never say never. I am pretty sure that my chance to buy gold for speculation purposes for $100 an ounce sometime in this decade is at least 30%." 

I don't know that much about gold, but $100 an ounce will never happen again.

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#15) On May 22, 2010 at 10:30 PM, starbucks4ever (94.15) wrote:

"I don't know that much about gold, but $100 an ounce will never happen again."

Like the Berlin Wall will never be destroyed, Lehman will never collapse, condos in Florida will never get any cheaper... 

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