We've been riding the bull against media sentiment for over a year now.
Stocks continue to out perform the S & P and the 10 year Treasury note
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Wednesday, May 31, 2006
We've been riding the bull against media sentiment for over a year now.
Posted by Jack Miller at 5/31/2006 02:28:00 PM
Tuesday, May 30, 2006
A member of the "Myrtle Beach Investor Group" forwarded a Barron's article an investor who has done well in gold for the past three years.
After any long move, the news media will find, and interview those who have made money off the move. Michael Millikan was a super hero after the long move in Junk Bonds. He was a hero right up to the date of the collapse that destroyed great wealth. Similarly, technology fund managers were the most popular people in the world in early 2000.
The truth about gold is that the story is more simple than is commonly presented. Gold is a store of value. Over the long run, folks who own gold will be disappointed. Ironically, they will not make much or lose much money. Over time, the value will increase by about 3% in nominal terms and 0% in real terms. In the short run the price can be very volatile.
The most recent cycle has behaved exactly as one would expect. From 1995 until 2001, gold declined in value because interest rates were high relative to inflation. After 9/11, the Central Bankers of the World, led by Chairman Greenspan, lowered short term interest rates well below the inflation rate in an attempt to prevent a world wide depression. We all should be thankful that the policy worked.
To lower rates, governments bought short term bonds from banks, giving the banks lots and lots of money. The Fed Funds rate dropped to 1%. At 1% interest, banks and speculators were able to buy "stuff", including gold, cheap. Gold was financed at below the inflation rate! If you can borrow money at 1% and invest it safely in Gold that is going to appreciate at 3% then why not borrow more and buy more?
Once the central bankers got the ball rolling, the public joined the game. In just a couple of years, the public has purchased 340 metric tonnes of gold by buying shares in the new gold ETF's. The US public now owns more Gold than the overwhelming majority of individual countries in the world!
The mess is about to hit the fan. Over the past 20 months or so, the US Central Bank has taken away the "automatic win". The FOMC has gradually raised short rates until the cost to hold gold has flipped from being negative 2% to positive 3%. Specifically, the Fed Funds rate is now 5% while the PCE price deflator (which is the best measure of inflation) is about 2%. Those who recently joined the party and borrowed money to buy gold at $730 an ounce are currently enduring pain.
In the same way that it took the FOMC and other bankers a while to get the ball rolling, it has taken a while to make the ball reverse course, slow down or even stop rolling. Japan continued to stimulate the purchase of gold until just a few weeks ago. The cyclical rotation of asset allocation has taken hold.
I do not claim to know the exact top. The psychology of millions of market participants is involved. There are lots of specious side issues that Gold Bugs can use to bolster their case at least temporarily. For example, the recent steep decline in the US Dollar is being used as a sign that all hell is about to break lose. The reality of the decline is a normal consequence of market correcting forces. Investors should count on the law of supply and demand rather than on a story about what is different about today's economy. The simple truth is that the decline in the US dollar is going to "bring billions of dollars home" and thus pull one of the legs out from under the fear monger's stool.
I just looked up some of the correlation coefficients of Hecla Mining (HL). As one might expect, Hecla Mining (HL) is highly correlated (.98) with under-developed country funds, such as the Malaysia Fund (MF) and the Thai Fund (TTF). However, we know that countries such as these tend to do extremely well in the years following a world wide recession and we know that they die a violent death as interest rates rise during a strong economic expansion. Hecla Mining (HL) carries a very negative correlation to big pharma, a stock group that tends to do well during the late phase of the cycle. The correlation of Hecla Mining (HL) to WYE, MRK, LLY and PFE is respectively -.88, -.87, -.86 and -.86. If you think this time is going to be different and Malaysia is going to continue to grow at the same pace as it grew for the past five years, then please do buy gold. However, if you believe in one of the laws of nature, which is that excesses revert to the mean, you might want to sell Malaysia Fund (MF), TTF and Hecla Mining (HL) and use the money to buy WYE, MRK, LLY and PFE.
I cannot call the bottom in big pharma any better than I can call the top in gold. However, I can say that an investor who buys big pharma now is buying near the bottom and that an investor who buys gold now is buying near the top. The pharma investor may need much patience. I could be off by two years or more. Besides, even when the "worm turns" pharma will not move quickly at first. Jumping in and out of gold right now could be tremendous fun. If you are lucky enough to be on the right side of the market, even though the current movements are not related highly with logic, then you will make a lot of money. If you buy and hold big pharma now, you will make a lot of money within 5 years. My estimate of your chances of success in gold are less than 50% and your chance in big pharma is more than 90%.
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Many thanks to the member who raised the issue!
Posted by Jack Miller at 5/30/2006 12:30:00 PM
Friday, May 26, 2006
May 2004, Continental Airlines saw a sharp increase in revenue passenger miles and flew with 74.4% of all available seats occupied. May 2005, Continental enjoyed a tremendous year over year increase and flew with a load factor of 79.1%. No one in the business today had ever seen such a high May occupancy rate. Yesterday, the day before the start of the Memorial Day Week-end, Continental's month to date load factor was 80.8%!
The important thing for investors to appreciate is the operating leverage involved. The concept is simple, at 74% occupancy consumers typically have more than one convenient flight available to get from point a to point b. At 80.8%, the choices become much more restrictive. Therefore, in the past year, airlines have raised the prices of almost all seats on all routes. The revenue on a particular flight might have gone from $100 times 225 seats to $110 times 240 seats or from $22,500 to $26,400. The percentage increase in passengers in this example was 6.7%, the percentage increase in the fare was 10% but the percentage increase in revenues was 17%! Even more important, the first flight might have produced only a $500 operating profit whereas the second flight might have produced a $4,000 profit or an increase of 800%. Total international revenues have increased by around 17% this year.
A reader asked me yesterday if airline success depends on declining oil prices. NO! Oil prices are high partly because demand for travel, international travel in particular, is very high. If demand for oil keeps continues to hold oil prices high, the airlines will continue to have a convenient excuse for increasing prices.
Take a look at the success of the railroads the past couple of years (our NSC and CSX positions have seen very nice gains). Higher fuel costs have been a major benefit to the rails. The cost of fuel per pound of freight moved by truck is very high relative to the cost of fuel per pound for freight moved by rail. To some extend, folks are choosing to fly because the price of gas has climbed. The fuel cost of flying an airline passenger is a small portion of the total cost.
Those of you who have not officially joined our investment group should do so as soon as possible. Only those who have "shown us the money" will be able to participate when it comes time to "make the big money" in real estate. Those who only wish to buy a share in a beach condo for personal use should also join.
By the way, we still have many empty 2006 dates available at Myrtle.
Dell Computer: I like the recent Dell Computer moves. The company will use AMD and INTC chips, the company will earn an ongoing fee for installing Google software and the company is opening a new plant in India. The company is the low cost producer. The cost of a basic computer has gone down a lot and I do not know how much Dell will make off the Google software deal, but I suspect that in a relatively short number of years, Dell will make more per PC for installing software than it will by selling the hardware. Now that the INTC, MSFT, Dell links have been compromised, can you imagine deals whereby Red Hat or others pay Dell to install software?
The economic impact of the Dell moves show the continuation of disinflation forces afoot; productivity and globalization. This economic cycle is being stretched. Let the good times roll!
Posted by Jack Miller at 5/26/2006 02:21:00 PM
The high price of oil is having an effect on supply and demand. China just raised its regulated price to all citizens. The government is still subsidizing the price to the consumers but the increase in price will lower that subsidy in two ways. The important point is that usage will decline on a relative basis.
The effect on production takes a little longer. In North America, the number of oil rigs drilling for oil this month is an increase of 78% over last May. The following information about OPEC Upstream Projects was obtained from James Williams at Energy Economist
Year New OPEC Production--Kilobarrels per day
While OPEC is producing a smaller and smaller share of world production, they are spending 10's of billions of dollars each year to increase their production. The cumulative total is more than 11,000 Kilo-barrels per day. That is a lot of oil.
Correction to last email on this topic: More jet fuel is being used this year than last. It was correct to say that the airlines have done a great job of cutting consumption per passenger but, because traffic growth has been very strong, the total usage has gone up by a small amount over last year.
SADLY: I believe that in three to five years, the US is going to be importing a larger and larger share of finished petroleum products, including gasoline and jet fuel, while our refineries see lower utilization, while our oil sits in the ground at ANWAR and off the east, west and gulf coasts. Numerous refineries are going to be built in the next few years, however, it makes no sense to build them in the US if we are not going to drill for oil here.
The earnings momentum of oil and oil service companies has already peaked. The time to buy oil stocks was in 1998. If you buy now, your relative performance will be weak at best.
Legacy airlines will continue to raise fairs to recoup the increase in the costs of fuel. Because other costs have been cut, a significant portion of the increase in revenues will show up as profits. The profits made will be very sweet because no taxes will be owed.
The high price of oil is working in conjunction with increases in short interest rates to slow down the growth of the world wide economy. I hope you have followed my advice and sold any mutual fund that buys "BRICKS" (stocks in Brazil, Russia, India, China, Korea and other developing countries). Small stocks, metals, mining and BRICKS have all been pounded during the recent correction. The pounding is not over relative to big growth stocks.
I bought Yahoo on a couple of accounts in the past few days and was pleased by the EBAY-Yahoo deal announced this morning. Google is still my favorite internet stock and I think ETrade will continue to do well but the combinations being formed by EBAY and Yahoo make for a powerful growth engine. The inevitable big question with big high priced growth stocks is, will the company become very large or will a new "invention" take market share. My take is that the market continues to underestimate the future earnings power of Google in particular. So far, Google is so far ahead of everyone else that it is going to take combinations like the one announced today to level the playing field. MSFT is going to spend billions in its attempt to catch up. MSFT can no longer force the game to be played by its rules.
In several accounts, I took a few tax swaps in the past few days. There is no point in letting a good tax loss go long term. The trick is not to sell your long term winners as tax losses right at the bottom of the correction.
The 15 day moving average of the total PUT-CAll ratio, hit a 10 year high yesterday. A strong sign that the correction has scared the pants off the weak and impatient investor. The good news for us is that this increases the probability that the one year returns from here will be very nice.
Posted by Jack Miller at 5/26/2006 08:52:00 AM
Thursday, May 25, 2006
An investor sent the following:"Airline stocks seem to be leaking a lot of oil. I know the market has been soft and I guess there is fear among investors over inflation. Do you think this is a short term weakness in the airlines? Is there any news out there that we have missed or is this just a knee jerk reaction to oil and gas prices?" Yes, there is news. Both the house and the senate have passed pension reform legislation. The two bills have been stalled in the house-senate conference committee for several months. A couple of days ago, Trent Lott tried to break the long jam by threatening to attach the airline portion of the bill to another bill. The house will not go along. The house and "big business" knows pension reform is necessary, however, passing the bill is as tough as taking a dose of Castor oil. The various folks who are against it are holding out for a lot of "sweeteners". The bill as written in the senate would give the legacy airlines an enormous cash flow break. They will ultimately have to set aside all the money required for all pensions but they will have extra years to do so.
The irony is that CAL and AMR are meeting their funding requirements and building up extra cash. With the price of oil dropping off a little, the conference needs to act before it becomes obvious that the big carriers no longer need an extra helping hand. Today's IEA numbers showed that gasoline usage in the US is flat year over year! Usage normally grows by 2 or 3% per year. Airlines have done an even better job of reducing usage than has the public. Airlines are flying 7 to 10% more passengers and using less fuel. One of the things in which I have great confidence is the law of supply and demand. Sometimes it is easy to slip up and say that supply and demand are out of balance. The reality is that supply is always exactly equal to demand at a certain price. Inventories of fuel stored in America are as great as they have ever been. Speculators are hoarding fuel or selling it forward to those who are hedging their costs. Many speculators are refusing to sell what they have in storage at today's price because they have sold it at a higher price in the future or because they think they will sell it at a higher price in the future. The IEA numbers showed again today that the current price is high enough to destroy demand. The countries of the Persian Gulf have cut back production in recent weeks because no one wants to buy all the oil they can produce. When the price finally breaks, oil will be back below $50 in a heartbeat or two.
As far as the over all stock market is concerned, the public is piling into bonds driving up the price while the big increases in stock earnings have made the market all the more relatively cheap. Last week, the smart money confidence indicator jumped from 47% to 58% and the dumb money indicator dropped from around 52% to 47%. I am not a great believer in trying to time the market over the short run but all kinds of indicators show that the market is now over sold. The fearful are running for cover; bargains are available. Aggressive investors will do well if they hang on until the worm turns again. I suspect there will be more rough days ahead in the airline business but who among us can say when the price of oil will break, or who can say what day the house-senate will strike a deal, or who can say when a major gusher will be hit or who can say when Iran will make a deal? On the other hand, who among us was even alive in 1946 which was the last time airlines had such tremendous pricing power?!!
Posted by Jack Miller at 5/25/2006 11:39:00 AM
Tuesday, May 23, 2006
I spent several hours Saturday and early this morning studying the markets. I want to share my two basic conclusions:
1) Fundamentally most big stocks are still cheap relative to other investments;
2) The reactions of investors to recent sharp declines shows that the current correction is not going to become much worse.
Sentiment has made a rapid turn. There was a lot of greed built into the market just a few weeks ago but now fear is taking over as the predominant motivator.
I have personally been very concerned about the flat yield curve, the sharp decline in housing prices, the decline in car sales and the sharp decline in consumer confidence. However, this morning, I reviewed charts of the weighted average world yield curve and was pleased to see positive prospects for a strong world wide economy.
In regard to my favorite group, a report from San Francisco shows that airfares will be up an average of $30 in June, $40 in July and $50 in August; very strong. The August number is extremely strong because in most years fares trail off by the end of summer. To reach an average increase of $40, with the $400 tickets up only about $25, the $59 seats have had to double. There are still bargain seats around but fewer and fewer of them. One of the ways the airlines can hide a price increase is by leaving a $59 special on the books but reducing the number of seats that are available at that price. This practice encourages passengers to book early which allows the airline to adjust to the market and attain higher yields.
Some of the other areas that have become attractively priced includes bio tech, internet, commercial real estate and selected telecommunications and technology stocks. The super conservative investor could buy AT&T and get a yield of better than 5%. Not bad but because I see free or almost free internet phone services around the corner, I will invest in areas with higher growth potential.
Posted by Jack Miller at 5/23/2006 01:18:00 PM
The "rotation" out of what was working is well under way. Some sectors, such as metal and oil stocks have taken a huge hit. The excuse most folks use for the declines is the jump in the core inflation rate. OLD NEWS!
"Headline inflation" normally takes about 7 months before some portion of it creeps into the core rate. The latest blip was right on schedule. It was last September when oil prices spiked up to $70.50 per barrel. A few days ago, the market made a big deal out of a small jump in the core rate of inflation. The market has moved as if it believes that the Fed will have to raise rates much higher to suppress inflation; a poor reading of the tea leaves.
Look at it this way, oil hit $70.50 per barrel in September of 2005 and today it is trading at $68.45 per barrel. For the past seven months oil has not contributed to inflation but instead has declined about 3%. The new global work force simply does not permit wages to get out of hand and wages account for the bulk of the cost of most products.
Please do not get too excited about the current decline. Remember that the current churning out of stocks is a way to provide cover for the market to set up for the next BIG BULL RUN! The next big run will be "second stage stocks". Now is the time to add to your account if you can. Now is the time to get ready to make good money as more and more of the billions and billions of dollars held by foreigners begin to flow into US products. Also, remember that the US tends to sell high dollar products. We cannot compete with China in labor intensive industries. However, when China spends its dollars, it will buy expensive capital goods; goods that require lots of money, talent and research to make. The range of products include everything from movies, drugs, airplanes and computer software. The other thing to keep in mind is that big companies with steady earnings will grow more and more attractive as the cycle matures.
In the short run, it is good to know that many technical indicators have already gotten over extended. Value investors are already pecking away at stocks that have declined too far too fast. I believe the value of the big S&P sized stocks relative to expensive bonds and real estate, should give investors a lot of comfort. We are not likely to see a major decline with earnings yields so high.
Posted by Jack Miller at 5/23/2006 01:04:00 PM
At current prices, big cap US stocks are much cheaper than bonds and bonds are much cheaper than real estate. Obviously the last sentence is the one that is subject to debate. If one estimates that big company earnings are going to decline and that rents at the beach are going to rise, then one can say real estate is cheaper than stocks. However, the US economy has clearly moved from the "recovery from recession" phase to the "business expansion" phase. During times like these, history says that big companies do well while bonds and residential real estate do less well. History also tells us that at the end of the "business expansion" phase, a tough recession normally follows.
Posted by Jack Miller at 5/23/2006 12:54:00 PM
I have repeatedly pushed the idea that now is the time to get out of "little stocks", residential rental real estate and expense loaded mutual funds. The basic reason is that you do not need a mutual fund to buy big cap stocks and big stocks out perform small stocks in the second half of the business cycle. The same is basically true for technology stocks.
After a deep recession, there is more than enough capacity in most industries. The businesses in each industry can more than satisfy demand. The price of goods produced tends to fall during relative to general infation during this "slack time" all the way down to the break even price of the marginal producers. The pressure builds on all producers to cut costs; as the only way to make a profit is to lower costs.
NOW the WORM HAS TURNED! About half way through the cycle the world changes. Industry after industry discovers that they can raise prices because demand exceeds supply. The business that can make the most goods is now going to be the most profitable. How does a business make more goods? At first, it recalls laid off workers or expands work hours. However, more help only works for a while and the cost of that route increases as wages start to rise. At some point, the business realizes that it must spend on technology. This is the classic case of substituting capital for labor. Companies such as Oracle, have suffered for the past 6 years. There has been little need to buy expensive new software. How the worm does turn! Oracle has not been sitting in idle. With lots of software companies hurting from lack of business, Oracle has bought company after company after company. Oracle now "owns" market segments that it only entered after the down-turn. In several big markets where the company already had a presence, it is now the big dude on the block. The company is not without strong competitors but all of these providers are going to see much higher demand as this economy matures.
One should take the two ideas and combine them. That is; if one avoids small stocks (in general) and if one is willing to buy big caps and technology then why not add a big cap technology stock to your portfolio?
Posted by Jack Miller at 5/23/2006 12:02:00 PM