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JakilaTheHun (99.93)

The Return of the Bear Market

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May 17, 2010 – Comments (29) | RELATED TICKERS: LLY , PFE , BP

It's beginning to look a lot like a bear market.  I'm not that surprised given the negative headwinds of late.  Ironically, this is actually proving much of the perma gloom-and-doomer crowd wrong, as most of them have been suggesting that the US is in the worst shape.  Au contraire --- both China and the Eurozone face significantly greater problems right now.  The US, relatively speaking, is the best of a bad bunch.

The Eurozone

The Eurozone situation in particular frightens me --- but maybe for reasons different than those of most people.

Perhaps I am a bit of a contrarian right now in belieivng that the Euro will survive.  It seems an overwhelming number of commentators are predicting its demise.  It's a distinct possibility, but I believe it will be avoided.  The Eurozone is sort of like the US in 1783 under the Articles of Confederation --- a work in progress.   All the same, the Euro experiment is very beneficial to all of Europe and I think that there will be extreme relunctance to end it.  Instead, we will see major reforms over the next decade.  (But don't bet the bank of either outcome --- I give the Euro 65-35 odds of survival.) 

Germany and France might be nudging the Eurozone members to adopt strict deficit spending requirements.   This news is floating under the radar, but may be the biggest news of the past month.  From a policy perspective, this sort of move might be essential.  From an economic perspective, it probably means a ton of pain for the Eurozone over the next few years (if not longer).  This move could create very strong deflationary pressures in Europe, which will exacerabate the economic problems there.  

In fact, you could argue that Europe is now facing a similar set of circumstances that helped created the Long Depression (that resulted after the Panic of 1873).   Will it fare as poorly as that depression?  I hope not; but I'm not confident of that.  In spite of all the hyperinflation talk, the bigger fear should be sustained deflation and a severe depression that could be in the cards.  

Some of you might think I'm advocating the alternative to deficit-slashing --- but not so much.  Keynes was right about monetary policy and credit contraction, but the dynamics right now are different than they were in the 1930s.  Deficit spending is alright in limited quantities, but much of the world has been on a debt binge.  It was unsustainable and there is no realistic alternative to major spending cuts, unfortunately.

But there are major strucutral differences between the US and the Eurozone and the Eurozone will be unable to bear this without significant changes to its structure. 

 

The Great Wall of Fraud?

The other dynamic right now is that the Chinese markets appear to be crashing.  Is this possibly a sign that the housing bubble has finally burst?  Given the heavy hand of the Chinese government, it's very difficult to predict how this will play out.  But I'm not here to talk about that --- instead I want to focus on something else. 

At the most recent Value Investing Congress, Chinese's largest hedge fund manger, Lei Zhang, casually noted that about '200 of the 350 Chinese companies traded in the US are frauds or have significant problems.'  This quotation really stuck in my head.

A week later, I noticed a lot of top CAPS players jump aboard on NIVS IntelliMedia (NIV).  I started looking at it and saw why people were so excited.  It looked very cheap by the numbers.  Except, I noticed that they had used a relatively unknown auditor.  This isn't that big of a deal, but I always like to look into auditors I know very little about.  One of the first results I found in a Google search --- a PCAOB inspection report citing a number of non-conformities in the firm's inspection. 

As I dug into NIV's financial statements more, I noticed that their operating cash flows seemed to routinely lag their earnings.  This was almost entirely due to their rising Accounts Receivable balances, which were specifically cited as an area of concern in that PCAOB inspection. 

I've not had time to dig into NIV very much and it may indeed be a great value, but I would have a great deal of skepticism towards it.  After looking at a few other Chinese small caps traded on American exchanges, I see a lot of similar potentially negative signs.   They might look cheap, but I'd be very afraid of some of these Chinese microcaps right now.  I'm not saying there aren't great values out there --- but I'd be particularly diligent about doing due diligence first. 

 

What Am I Buying? 

Not much, to be honest.  But I wouldn't go heavily short the market, either.  Rather, I'm still mostly long, with only a few minor short positions (for hedging purposes more than anything).  I have sold off some stuff to increase my cash position.

While many might say I'm crazy, I still believe REITs are undervalued.  There are few deep value plays in the sector now, but they are still undervalued in the aggregate.  I will also continue to hold onto a basket of small commercial banks.

Aside from that, the only sectors I like are energy and defensive stocks.  I like big pharma stocks right now --- particularly PFE and LLY.  As far as energy goes, I do believe BP has been beaten down further it probably should be.  More importantly, I think nuclear and natural gas are the near-term future.  I like natural gas, in particular, right now. 

 

There is a Sunny Side

While down markets are bad, they also create opportunities.  If indeed, we are seeing a renewed bear market, it will be painful for a while, but there will be great values to be had somewhere down the line.  

29 Comments – Post Your Own

#1) On May 17, 2010 at 3:35 PM, bigcat1969 (92.41) wrote:

You are right about the US being the best of the bunch and the Euro has certainly helped the dollar.  A question I've been pondering though is if it was Europe that caused the second and greatest downleg of the Great Depression, couldn't the same thing happen again?  Will the upswing to the dollar and the ability of the US to borrow at virtually no interest be overwhelmed by Europe's bank problems and cause the next down leg of that long awaited W?

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#2) On May 17, 2010 at 3:41 PM, portefeuille (99.66) wrote:

From an economic perspective, it probably means a ton of pain for the Eurozone over the next few years (if not longer).  This move could create very strong deflationary pressures in Europe, which will exacerabate the economic problems there.

I do not think that will be a major problem if the euro remains somehat "weak" (which of course would also be great for Eurozone exports ...).

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#3) On May 17, 2010 at 3:46 PM, Momentum21 (96.14) wrote:

Oh no...they converted Jakila... : )

 

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#4) On May 17, 2010 at 3:48 PM, portefeuille (99.66) wrote:

The other dynamic right now is that the Chinese markets appear to be crashing.

Only if you look at A-shares or some of the obscure small capitalisation companies listed on U.S. exchanges. The Hang Seng China Enterprises Index, the FTSE/Xinhua China 25 Index and the Bank of New York Mellon China ADR Index are still doing alright.

The A-share indices are somewhat irrelevant (for the non-Chinese) ...

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#5) On May 17, 2010 at 3:50 PM, portefeuille (99.66) wrote:

You are right about the US being the best of the bunch

I think the "best of the bunch" are currently European equities (see this post).

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#6) On May 17, 2010 at 3:57 PM, portefeuille (99.66) wrote:

But there are major strucutral differences between the US and the Eurozone and the Eurozone will be unable to bear this without significant changes to its structure.

Not sure which "zone" has to change more. And talking about currency and government debt issues might be en vogue currently but I am not so sure they will really play such a major role for European equities ... 

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#7) On May 17, 2010 at 4:40 PM, Entrepreneur58 (36.01) wrote:

Rich countries lend money.  They can do that because they spend less than they make and they have a surplus.

Poor countries borrow money.  They spend more than they make and they become addicted to debt to maintain their inflated standard of living.

US and Euro are the largest borrowers in the world.

China is the largest lender.

Thus, US is not in the best shape of the bunch by a long shot.

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#8) On May 17, 2010 at 4:59 PM, portefeuille (99.66) wrote:

US and Euro are the largest borrowers in the world.

(from here)

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#9) On May 17, 2010 at 5:00 PM, portefeuille (99.66) wrote:

the U.S. almost beat Greece. almost, hehe ...

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#10) On May 17, 2010 at 5:10 PM, portefeuille (99.66) wrote:

a pretty map to see some economic forecasts for some EU member countries (also might be helpful for those not quite sure which countries are in the EU and which are in the Eurozone ...).

http://ec.europa.eu/economy_finance/eu/forecasts/2010_spring_forecast_en.htm

 

UK budget deficit 'to surpass Greece's as worst in EU'

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#11) On May 17, 2010 at 5:11 PM, TigerPack1 (96.86) wrote:

I covered your MEE, FCX and WLT short positions in the WSS player in the middle of the day, at 20%-30% gains... Nice going!  We miss your smarts!!!  You have proven yourself over and over again... Keep up the great work.

Per portefeuille's chart above, showing that the U.S. is actually borrowing the same or more money as a percent of GDP than the feared bankruptcy rate of the PIIGS in Europe... don't bore U.S. with the facts... we cannot handle the truth in America!

Portefeuille - we don't have a problem over here until we get the Treasury credit downgrades in the fall of 2010... at which point everyone will care, and the market will be trading 15%-25% lower than today!!!  Ben's fiction writing is much better than the truth...ZERO percent forever is creating monster imbalances in the global economy and "enabling" out of control sovereign deficit spending everywhere you look.

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#12) On May 17, 2010 at 5:17 PM, portefeuille (99.66) wrote:

this also does not look all that bad ...



enlarge

(from here)

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#13) On May 17, 2010 at 5:29 PM, JakilaTheHun (99.93) wrote:

Port,

Germany is in good shape.  Not too many people deny that.  It's the PIIGS that are in trouble; dragging down all of Europe. Even France, you could say, has its share of problems. 

Speaking of which, interesting article I read in the Telegraph today:

Forget the Wolfpack:  Ongoing Crisis Caused by EMU

Not sure that I agree with the author, but I do find the article interesting all the same.  In many ways, the currency union he hypothesizes (Germany, Austria, Benelux, Finland, & Czech Republic) makes more sense than the Eurozone. 

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#14) On May 17, 2010 at 5:37 PM, topsecret09 (36.64) wrote:

   March 10, 2010 .....      http://caps.fool.com/Blogs/ViewPost.aspx?bpid=351989&t=01009917921919779399    

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#15) On May 17, 2010 at 5:41 PM, JakilaTheHun (99.93) wrote:

I like natural gas, in particular, right now. 

I should probaby note that by "I like natural gas", I mean that I like certain companies involved in natural gas production and/or distribution --- not that I would want to bet on natural gas prices rising. I would keep far, far away from a lot of the natural gas ETFs, which have an extremely poor performance record.

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#16) On May 17, 2010 at 5:46 PM, portefeuille (99.66) wrote:

#13

The German nation is moving on. I was struck by a piece in the Frankfurter Allgemeine proposing a new “hard currency” made up of Germany, Austria, Benelux, Finland, the Czech Republic, and Poland, but without France. The piece entitled The Alternative says deflation policies may push Greece to the brink of “civil war” and concludes that Europe would better off if it abandoned the attempt to hold together two incompatible halves. “It can be done,” the piece says.

Ein Blick zurück aus dem Jahr 2013: Die Alternative

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#17) On May 17, 2010 at 5:48 PM, topsecret09 (36.64) wrote:

If you like energy stocks,check out (SDRL)  Seadrill....   9% dividend that looks very safe.....  When there's blood In the water .....    TS

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#18) On May 17, 2010 at 5:49 PM, AbstractMotion (53.76) wrote:

If anyone hasn't seen the 60 minutes interview about the BP disaster I highly recommend reading/watching it here.  Given some of the claims here and the fact that the well hasn't been plugged, coupled with a weak market and rising volatility I think there's enough pressure for the stock to still drop significantly in the near term.  Regardless of the interview is a great watch, one thing I found to be particularly interesting is that this disaster does in fact appear to be more the result of safety precautions being ignored due to pressures on drillers to get work done an quickly as possible.  It appears that the technology underlying deep water drilling is not to blame (assuming proper maintenance).  It's negative news for BP and possibly Transocean, but overall good for the industry and probably Halliburton as well.

 

China is a tough call, I do think that a lot of people are overestimating the economy, but their markets have historically been very volatile.  One could easily view the drop in the market as a repricing of risk vs reward which had gone out the window recently.  The elephant in the room for China is the possibility of a weaker Euro and overall lower consumption in both Europe and the US going forward.  I don't know that we'll see the economy unwind, but as long as uncertainty hangs around the Eurozone economy I'd wager we'll see the Chinese markets hurting.

Europe is a tough call, there's going to have to be some belt tightening and that will probably mean some adjustments to a lot of the social programs people are depending on currently.  The real question is how much leverage do France and Germany have over things in the Eurozone.  I like the Articles of Confederation analogy as it suits things almost perfectly.  It will need significant reforms to survive, but the real question is if the leadership is in place to make that happen.  I honestly don't know enough of European politics to comment on that though.

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#19) On May 17, 2010 at 8:53 PM, megalong (< 20) wrote:

JakilaTheHun (99.97) wrote:

'200 of the 350 Chinese companies traded in the US are frauds or have significant problems.'

But the majority are not making up their financial statements, but are just crappy companies being pumped, just like homegrown US microcaps.  I don't think you have to do a lot of work to avoid 98-99% of terrible investments in any market.

Anyways if the main problem with the Chinese market is fraud, that would suggest to me that non-fraudulent small companies would have elevated returns as the market realizes they are non-fraudulent over the next few years.

In my opinion the Chinese housing bubble (which the government is trying to guide into a soft landing) is not that important.  Chinese people are vastly less leveraged than Westerners and the average down payment is way over 20%.  And the Chinese government has shown it is willing to spend its foreign reserves liberally to keep income rising. 

Agree with you on healthcare, energy and defensive stocks being more attractive in the US. Also South America, Australia and Asia ex-Japan are relatively healthy.

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#20) On May 18, 2010 at 2:19 AM, TMFUltraLong (99.95) wrote:

See I don't feel Germany is as pristine as everyone thinks. They have a larger amount of external debt obligations than Italy and have a debt to GDP of nearly 80%. I'm not in any way saying Germany is in trouble, because as of right now they're just fine, but they are nowhere near as pristine as everyone keeps making them out to be.

UltraLong

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#21) On May 18, 2010 at 2:58 AM, ttboydxb (28.69) wrote:

I think Germany has been doing so well since the euro started due to the PIIGS being able to finally afford the items Germany produces.

Example:

Your average worker in Portugal would never think of owning a BMW or Mercedes before Portugal joined the euro.  The conversion of Escudos to Deutch Marks made german product very expensive.  Once the euro was adopted, suddenly a BMW or a Mercedes became MUCH cheaper in terms of what your monthly salary was in Portugal.  Germany was a direct beneficiary of club med joining the euro, and now that the PIIGs have gotten too fat, I think germany will suffer alongside with them, as there will be less little PIIGS to buy their well made, but over priced goods. 

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#22) On May 18, 2010 at 7:40 AM, cthomas1017 (83.90) wrote:

Jak,

Your posts are consistently thought provoking, and this one is probably no exception.  I had to stop reading when you related the Eurozone to the individual states under the Articles of Confederation.  In fact, 1783 pre-US was the antithesis of the Eurozone.  There was not a common currency.  The reason the US came to being as successfully as it did was because the cultural & bonds drove the economic unification, not the other way around.

The greatest threat to the Union was the economic advantage that the north sought over the south (through tariffs on unfinished goods like cotton, sugar, & tobacco).  The economic disparities between the industrial/financial north and the agrarian south of 1862 are more akin to the Eurozone today than the formation of the US.

Perhaps someone else has already pointed this out.  If I am redundant, I apologize. 

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#23) On May 18, 2010 at 8:23 AM, JakilaTheHun (99.93) wrote:

In fact, 1783 pre-US was the antithesis of the Eurozone.  There was not a common currency.  The reason the US came to being as successfully as it did was because the cultural & bonds drove the economic unification, not the other way around.

My intention was not to compare the currency situations of the EU and the US, circa 1783.  Rather, it was to compare the fragile and instable alliance of interests.  

The US under the Articles of Confederation, was arguably not a "state" in any real sense of the word.  It was (as the word "confederation" implies), somewhat of an economic/military/political alliance between a number of states (13 to be exact). Compared to most of the nations of Europe, it was quite bizarre.

The Constitution of 1789 solidified the bonds between the various states, created a stronger central government, and made them one unified entity.   Of course, the early US still had numerous problems at that point, and it would eventually have a Civil War, but the point is that it started as a weak and instable coalition of interests.

The Eurozone is very similar in that regard.  It's not really a state; though, it does have some characteristics of a state (like the US under the Articles).  There is a common currency, but no common fiscal policy.  There is nothing that would qualify as a "central governance mechanism", which is somewhat similar to the early US (maybe even weaker).  

In essence, the Eurozone (like the US circa 1783) is sort of a rough outline of a state.  Its too weak to survive in its present form, so it will either evolve into a stronger entity or it will dissolve. 

A lot of people probably doubted the US's survival in the 1780's, as well, as "the union" didn't make a whole lot of sense on some levels.  Yet, it seemed necessary in order to protect the collective interests --- otherwise, each individual state would be too weak to stand up to any continental European powers that threatened them.  

 

Even if the Eurozone fails, I do believe that many of the nations will look to replace it with a similar union.  There are too many advantages to go it alone --- just as was the case with the early United States. 

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#24) On May 18, 2010 at 8:36 AM, portefeuille (99.66) wrote:

The Eurozone is very similar in that regard.  It's not really a state; though, it does have some characteristics of a state (like the US under the Articles).  There is a common currency, but no common fiscal policy.  There is nothing that would qualify as a "central governance mechanism", which is somewhat similar to the early US (maybe even weaker). 

As usual I think it is a good idea to differentiate between the EU and the Eurozone. The EU does of course have some "central governance mechanisms" ...

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#25) On May 18, 2010 at 8:40 AM, portefeuille (99.66) wrote:

The exchange rates between some European currencies were rather stable "long before" the introduction of the euro, by the way. see for example here.

http://en.wikipedia.org/wiki/European_Exchange_Rate_Mechanism

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#26) On May 19, 2010 at 2:09 AM, BigFatBEAR (29.09) wrote:

Good article. I've added LLY and BP to my IRA in the last month, so good to see they get your timely vote of confidence here. :)

Keep up the awesome, Jakila!

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#27) On May 19, 2010 at 3:08 AM, bigcat1969 (92.41) wrote:

Good point about the Euro nations either getting a stronger central government or falling apart.  It is interesting to watch the weaker members being forced into line by the strong ones as the price of bailout.  I would suggest that Greece has less absolute power over its own affairs now than it did several months ago.  Germany and France seem to be the powers, though in somewhat odd ways, behind the Eurozone and I expect that to continue.  Watching the Central bank over there is a bit like watching the Feds rise to power over here that now might equal the other branches of our government and be considered the fourth arm of government.  There is a bit the reverse with the bank leading the charge to be followed by more power for the other branches of the Eurozone government.  Also having both the Eurozone and the EU seems a bit odd.  Presuming the Eurozone survives and continues to add members it wouldn't surprise me if the two merge with possibly an exception for the UK.

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#28) On May 19, 2010 at 3:19 AM, portefeuille (99.66) wrote:

Also having both the Eurozone and the EU seems a bit odd.

Not sure what is odd about that. I think people should at least skip through the wikipedia entry for EU (especially the "history section") or some other sources to see that the introduction of the euro does not have all that much to do with the EU ...

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#29) On May 19, 2010 at 3:32 AM, portefeuille (99.66) wrote:

also see this.

http://en.wikipedia.org/wiki/Maastricht_Treaty

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