Will the Fed cut rates?

The market certainly seems to think so.

Just look at interest rate futures and you’ll see investors are expecting a 25 to 50 basis point cut in the Fed Funds Rate.

Or, more meaningfully, look at the gold market. Gold prices spiked to over $785 an ounce, today.

That’s up 17% over the last month and 31% over the last year.

Why does the gold market indicate a cut in the Fed Funds Rate?

Because the Fed does not create growth–they do not possess some magical fairy dust that makes the economy run faster.

The Fed prints money to decrease interest rates. And, when the Fed prints money more quickly than the economy grows, they create inflation.

Gold prices are going up because gold investors believe the Fed will print money, also known as cutting the Fed Funds rate, thus creating inflation.

Gold is going up because investors are guessing the Fed will create inflation by cutting rates.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Comparing apples and oranges

What would you say if I told you the market was over-valued by 30%? Would you think I was full of it?

What if I told you that this over-valuation were based solely on market commentators comparing apples and oranges?

When someone says the market is fairly valued or over-valued, what do they mean by that? What standard are they comparing it to? This may seem like a pie-in-the-sky question, but it’s very important.

Why? Because market commentators are frequently saying the market is fairly valued by comparing apples and oranges! And, the two are off by 30%.

You see, many say the S&P 500 is fairly valued because they are comparing the S&P 500’s forecast, operating earnings to the S&P 500’s actual, reporting earnings. But that’s comparing apples and oranges.

This may seem like technical minutia, but it makes a big difference. In fact, operating earnings of the S&P 500 have been 20% higher than reported earnings over the last 5 years. And, forecast earnings for the S&P 500 have been 10% higher than actual earnings.

In other words, when commentators say that the S&P 500 is trading at its historical average, they are comparing apples (forecast, operating earnings) to oranges (actual, reported earnings). And, those apples are 30% overstated compared to the oranges.

Next time you hear someone say the market is fairly valued, ask them if they are comparing apples to oranges. Are they comparing forecast, operating earnings to the historical average of actual, reported earnings? If so, tell them to adjust their numbers and get back to you when their figures are fairly comparing apples to apples.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Did credit market turmoil rattle equity markets…again?!

I watched with fascination as short term government interest rates plunged on Wednesday and Thursday. But, to my surprise, equity markets barely reacted.

Then along came Friday.

I don’t think the anniversary of the 1987 stock market crash had a thing to do with it, but I do think interest rates had something to do with it–like they did in 1987.

When I see short term Treasuries surging in price and their yields plunging, that means that someone, somewhere is scared and they are running to the safest securities they can find–US Treasury securities of short duration.

Whenever this happens, like it did in August, it means risk is becoming more expensive. And, when that happens, equities will almost always dive.

Why did it take a couple of days to work out? I don’t really know.

Perhaps the same people running to safety were hoping things would cool off, but they didn’t. And when risk continued to be more expensive, then they started selling equities.

Perhaps some leveraged investors, like hedge funds, were squeezed by the people who lent them money as credit markets seized up again.

Who knows?

But, I do know you could see it coming, and it didn’t surprise me (except that it took so long).

Its amazing to watch this because it shows how integrated financial markets are.

Anyone watching short rates plunge on Wednesday and Thursday had to scratch their head and wonder why equities weren’t tanking. That is, until Friday–when they did.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

My latest client letter is available

For those of you interested, my latest client letter just came out today.

In it, I discuss client account performance, my projections for the market over the next 6 years and my opinion on the economy, Part III of my assembling portfolios segment dealing with investment probabilities, an investment spotlight on Microsoft, a segment on why the subprime mortgage market impacted equity markets, and my section on admirable business people covering Benjamin Graham–the father of value investing.

If you get a chance to read it, please tell me what you think and what could be improved.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Does everyone believe the market will continue to climb from here?

Not John Hussman. Hussman makes his case in his latest Weekly Market Comment.

Although Hussman gets very close to attempting market timing, which I don’t believe anyone can do successfully, he does make some very good points about why the market’s returns from here may not be very exciting.

Luckily, we don’t need to invest in the market per se, and it’s possible to get significantly better returns in the right investments.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stick to the fundamentals

Although I tend to write here about the economy and markets in general, I must admit such opinions affect my investment process very little.

I don’t buy and sell based on what the market is doing or might do. I don’t buy and sell based on my assessment of the overall economy.

I buy when I find businesses selling significantly below assessed value and sell when the businesses I’ve bought are selling significantly above assessed value.

I pay attention to secular trends, such as energy prices and the expansion of cable into phone and broadband Internet, but I don’t use such trends as a starting point in my investment process.

I spend my days researching individual companies. I look for businesses with good economics–with sustainable competitive advantages. I look for businesses with great management, who are competent and rational, act as trustees for shareholders, and hold a significant stake in their company. Then, and only then, do I assess business value.

When the market is tanking or roaring ahead, it’s important to keep this in mind.

The best way to succeed in investing is to buy good businesses below their assessed business value and sell only if price exceeds valuation. To do this, you must stick to the fundamentals–you must primarily focus on business economics, management and valuation.

When the market is diving, it may be an opportunity to buy, but only if prices go below assessed value. When the market is rising, it may be an opportunity to sell, but only if prices go above assessed value.

The focus is always on the business fundamentals primarily, and only secondarily on prices. What the market and economy are doing should take a distant, and almost completely unimportant, third.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

If the US economy slows, will the world economy slow, too?

Many market watchers believe that even if the US economy slows (as it looks like its doing), the global economy will stay in the growth lane because emerging markets like China, India, Brazil and Russia will more than make up for US slowing.

A look at historical information and the global yield curve seems to contradict this. William Hester, CFA of Hussman Funds wrote a great article addressing this subject.

The global yield curve is a way of looking at the yield offered by government bonds around the world at different maturities. By comparing short to long term bond yields, one accesses one of the most reliable predictors of economic growth.

You see, when short term rates are equal to or higher than long rates, this almost always signals economic slowing and, usually, a recession. When short rates are equal to long rates, that’s referred to as a flat yield curve. When short rates are higher than long rates, that’s called an inverted yield curve.

Using global bond yields, as Hester does, a flat or inverted yield curve usually precedes a recession by a year or two. As he shows, the global yield curve turned flat last July, perhaps signaling that global earnings growth may slow, too.

Although the yield curve is not a fool-proof method of determining future economic growth, it’s been reliable enough that it shouldn’t be ignored, either.

Although it looks like the world economy is currently humming right along and will easily weather the US slowdown, the yield curve is telling a different story.

As Hester suggest, this has historically been a bad time to be in industrial, consumer discretionary or energy stocks, and a good time to be in materials and consumer staple stocks.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.