He’a back, and growing a bit bearish!

My last post was quite awhile ago – January 14, 2014 to be exact.  Why the hiatus?  I’ve had nothing novel to write about.  My rationale for commentaries is to produce quality insights (if I can) rather that to push out as much prose as possible.

Back then, I took credit for predicting the fall in energy prices. If I don’t congratulate myself, who else will do it?  I also said the following worried me some:

Two problems I can identify.  Should the P/E on current earnings remain constant?  Part of the current valuation is biased by future earnings expectations.  Based on estimates I’ve seen the forecast for 2015 remains about $120.  Expectations are adjusting downward quickly, which in my experience influence valuations negatively.  It is also inevitable (human nature) that revisions will overshoot  due to our propensity to overweight recent events.  Put an 18X multiple on earnings of $99 takes us back to closer to an 1800 target on the S&P 500 – at least a 10% correction.

Although it didn’t get down to 1800, it got pretty close as you can see from the graph.

S&P 500 since oil shock

Once that was out of the way, I saw nothing to keep the market from moving toward my earlier target, on an estimated $120 of ‘peak’ earnings divided by a ‘normalized’ risk adjusted 5% discount rate = 2400.  And here we are today at 2185.  Do I see another (roughly) 10% upside from here?  It will depend (as others who write about these things are saying) on earnings and expectations. According to most research sources the estimated earnings for the next 12 months is pretty much the same as it once was for the current year. For example, the earnings corresponding an 18.57 PE would be about $118.  But since the trailing PE is nearly 25X earnings, we remain far short of that potential still.

S&P PE August 18, 2016

Some concerns that came from the July FED policy meeting minutes (just published) also worry me:

However, during the discussion, several participants commented on a few developments, including potential overvaluation in the market for CRE, the elevated level of equity values relative to expected earnings, and the incentives for investors to reach for yield in an environment of continued low interest rates.

Overvaluation in commercial real estate and high equity valuations are not as bad as the last item – not only are investors blindly reaching for yield (disregarding risk), many are also perfectly content to lock in current low yields for long time periods.  When things look too good to be true, they usually are in my lengthy experience.  The question isn’t what can go wrong, but rather what else can go right?

A strategist I respect (and have quoted frequently) has this to say today:

We estimate sequential earnings growth of 11.8% in Q2 on a quarter/quarter seasonally adjusted annualized basis. We expect Q3 will show positive year/year growth of about 2%, but this positive momentum will not be apparent until the earnings season begins in mid-October. (from the Wednesday, August 17, 2016 Investment Strategy by John Aitkens, of TD Securities )

In other words, there could be good news on the earnings front, but it won’t be evident for a few months. Do investors right now have more faith in corporate America that is warranted?

deer in headlightsWhat worries me (and clearly worries the FED also) is that the market has been resilient despite disappointing earnings thus far this year.  And why keep postponing the inevitable rate increase? All the economic news certainly justifies a rate hike – Europe now has inflation rather than deflation, and according to the US Bureau of Labor Statistics “Real average weekly earnings increased 0.6 percent over the month due to the increase in real average hourly earnings combined with a 0.3-percent increase in the average workweek.” They also reported:  “On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers was unchanged in July after increasing 0.2 percent in June.” Like a deer in the headlights, the FED is hesitating.  But the committee also knows that if it doesn’t move soon, things won’t be pretty.

If the FED waits too long, this (see graph, illustrating a disquieting trend since it was published in the Financial Times earlier this year) will only get worse and derail both financial markets and the economy.


Bottom line, we’re screwed if the FED does act sooner rather than later, and we’re really screwed if it doesn’t act.  Either way it’s hard to imagine interest expense not putting downward pressure on earnings.  Corporations used debt to buy back stock, make acquisitions aggressively and hike dividends.  Have they gone too far? Once laden with liquidity, the reverse may now be true. We’ve seen many companies announcing cost cuts already – even without higher interest rates.

Anecdotally, this announcement (there have been so many) came out today concerning CISCO:

The 5,500 job cuts would present 7% of its total workforce. That’s a much lower number than the 20% layoff some reports suggested Tuesday afternoon, but still one of the largest job cuts in Cisco’s history.

Cisco expects the next quarter to show -1% to 1% year-over-year revenue growth and EPS of $0.58-$0.60. Analysts are expecting actual revenue to decline 1.6% and EPS of $0.60.

Although the company actually reported better than expected earnings, the stock went down on this news – the cost cuts, despite good earnings, just might be a hint that the company is preparing for potholes on the road ahead.

If S&P 500 earnings at best will be only $100 over the next 12 months (still an improvement over where we are now) then even if my discount rate doesn’t change it means a target of 2000 – not appealing.  Of course, if rates are bumped or the economy gets hit with some negative surprise – then down we go again.  And did I mention that September/October cometh?  Seasonally ugly months at the best of times.  Cash looks like a good place to be to me.  Maybe Bill Gross (who mistakenly believed the FED would hike in June) will finally be right.  He’s due!  (watch the video).

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Who could have predicted these oil prices? I’ll tell you.

The following prescient quote is from February 2014:

shale gas rigThe economies of China and India have slowed, and the U.S. is trending towards energy self-sufficiency thanks to production growth nobody envisioned back then.  The question today is why oil prices haven’t fallen further?  The current price certainly can’t be explained by inflation.  Picking a random starting point, say 1994 – inflation should imply a current price of crude about 124.2% higher today.  But since the price of oil in 1994 was $14 that would mean today’s price should be $32.


Oil WTI graph January 2015

Yup.  I’m quoting myself, although I didn’t really expect to see $30 oil.  Nothing is impossible, and nowadays its possible for speculators to buy the stuff and store it, short it and all those actions that increase volatility.  Also in a blog I posted (here) I made the case that ultimately falling energy prices will prove to be the shot in the arm the world needs, but after a correction I expected and which did occur.  Once the market had some of the wind knocked out of it (March 2014) I said this:

If we believe that inflation can remain at 2% or less (rather than hitting levels of  3.5% to 4% like in 2005) then a 10-year yield hovering at around 3% to 3.5% would not be outrageous.    To me this means that the earnings yield on the S&P 500 still has room to continue to decline (i.e. stock prices can go even higher).

A couple of years ago I estimated that earnings growth (coming out of recession) would take the S&P 500 (there would be bumps, and there always will be) through the 2000 level.  But what next?  It is important to do what many experts are doing – trying to come to grips with the short term impact lower energy prices will have on the index earnings.  We’re seeing a plethora of opinions and statistics painting a rather dark outlook.  Since the energy industry accounts for 35% (according to Deutsche Bank AG) of all capital spending, and there are announcements daily of cap spending cuts by producers, the impact on stock market earnings will be substantial.  If oil stays below $50 a barrel then index earnings could be reduced by $6, suggest Bank of America analysts.

S&P PE January 2015If we assume that S&P 500 earnings are around $105 and in the short-term drop to say $99 (minus $6), why wouldn’t the index fall about 6% as well?  That would imply we’re almost there, down 4% (as I type this) from the 2070 peak, holding the P/E ratio constant.

Two problems I can identify.  Should the P/E on current earnings remain constant?  Part of the current valuation is biased by future earnings expectations.  Based on estimates I’ve seen (see WSJ exhibit) the forecast for 2015 remains about $120.  Expectations are adjusting downward quickly, which in my experience influence valuations negatively.  It is also inevitable (human nature) that revisions will overshoot  due to our propensity to overweight recent events.  Put an 18X multiple on earnings of $99 takes us back to closer to an 1800 target on the S&P 500 – at least a 10% correction.

Winners & Losers

starbucks coffeeIt’s pretty easy to determine who the losers are now and will be for this year.  My nephew (a bright portfolio manager in Latvia) asked if it might be a good time to short the US railways – since there’ll be fewer barrels of shale oil to deliver.  Tongue-in-cheek, I reminded him that railways also use fuel, so the net effect is hard to determine just yet.  On the other hand I feel it safe to predict that low gasoline prices will no doubt prompt more driving and more stops at the local Starbucks.  Determining those companies that will enjoy better profit margins due to falling energy prices, and overweighting them is a good defensive measure in equities.  As always, even when the broad market indices decline, there are winners.

Perhaps more important, when it comes to energy the have-not countries are now at a relative advantage.  As I have said over many years in print and on television – do the opposite.  The euro certainly has its issues, but the Eurozone stands to benefit LARGE with lower energy costs.  Foreign money is poised to abandon the U.S. and go back home where the action “will be.”  Perhaps even troubled Greece will see real tourism revenues again. Russia, Mexico, OPEC members, and even Canada will struggle some, but low crude prices will provide a needed boost to emerging markets.






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Trade sanctions will hurt global growth! And equity markets!

There’s no doubt that the impact of the former financial crisis on the global economy was grossly underestimated even in its early stages. The reason is that today’s global economy is extremely intricate – a massive matrix of interwoven relationships impossible to even partially comprehend. In economics we try our best to focus on small models that we hope can be used to understand the bigger forces at play, with admittedly limited success.

One critical by-product of the former financial crisis was damage done to global trade. Many of you may also have watched as financially solid (good cash flow, manageable debt) businesses were strangled simply by their inability to get letters of credit. After all, banks and other lenders had no idea whether they were in fact solvent, so when liquidity froze, so did trade.

Trade has become the lifeblood of the global economy. Business professors are quick to compare the stagnating isolated economy of North Korea versus the South Korean powerhouse fueled by international trade.

It is surprising that investors and forecasters alike seem oblivious to the potential harm that the sanctions already implemented will have on Russia and its trading partners.

One of the most fundamental lessons for young economics students is that trade between two countries makes both better off. The proof is usually derived arithmetically then illustrated graphically. It is possible with trade to expand total domestic production beyond one economy’s production possibilities frontier by introducing trade. Produce more of the good you have a comparative advantage producing, and trade with a country that has an advantage in some other good. The star in the diagram represents a point outside the productions possibility frontier.

For example, Russia supplies raw materials (minerals, oil and gas) to many European trading partners, and they supply food products. Everyone is better off because of trade.

Economists also agree that there is a multiplier effect – incomes in general improve, which of course boosts consumption and savings and so forth. Buoyant global growth in recent decades no doubt has been due to the multilateral and bilateral free or relaxed trade agreements that continue to be negotiated.

But turn the tables around and what will happen? Trade hostilities must also have a multiplier effect – but in reverse.

Russian export growth got off to a slow start this year even before the tougher second round of sanctions were introduced. Since exports account for 20.6% (WTEX) of total Russian economic output ($526.4 billion), things can get very ugly. Of these exports, I estimate $276.4 billion (converting from euros at 2013 rates) went to the European Union. Assuming a Keynesian foreign trade multiplier for Russia of something in the neighborhood of 1.5X*, then a reduction in exports of 15% this year due to sanctions could knock at least a half a percent off of Russian GDP. In my opinion, the Keynesian macro approach hugely underestimates the negative multiplier effect that a more in-depth microeconomic analysis would imply.

Piecemeal articles are beginning to grasp some of the potential damage to Russia:

From Forbes: According to a report from IHS Automotive, car sales in Russia were already falling in the first half year as the economy creaked, consumer confidence declined and the falling value of the rouble increased prices of imports and components. Car sales fell 7.6 per cent in the first half of the year, including a dive of 17.3 per cent in June. This raised concerns that car sales will fall sharply in the second half of the year, the report said.

The more difficult measure to contemplate is the impact of reduced imports from Russia on the European economy. Substitutes, if available in the short run at all, for the stuff Russia exports to Europe will suddenly be incredibly expensive. Imagine if the supply of energy in the U.S. (almost self-sufficient nowadays) from domestic production just wasn’t available suddenly. Take away the coal, lumber and minerals produced domestically as well. It seems unlikely that trade sanctions will escalate into a full scale embargo but despite this, markets do not seem to be discounting nearly enough of the risk that should be factored in – especially in equity markets.

True, the US does not deal much with Russia directly.

These numbers are hardly big enough to seriously hurt the Goliath US economy. But if Europe hurts, and it certainly will, then everyone doing business with the EU will hurt some as well. The US in 2013 traded $650 billion with Europe. If trade makes countries better off, then stifling international trade makes them worse off.

What makes the current situation so perilous is that the stuff Europe imports (raw materials, especially fuel) is a critical low-value input into Europe’s higher value-added exports. Copper wiring might not seem to be such a huge component of an automobile, but without the copper it’s pretty hard to finish building the car. The outlay for the copper as a percent of the price of the vehicle might not seem large, but the revenue forgone by not being able to complete and sell the automobile sure is big enough.

(click to enlarge)

Manufactured products comprise nearly 80% or the lion’s share of the value of European exports – additional value (read higher production and income) that has been created from the fuels and mining products that have been imported. President Obama in the US and Stephen Harper in Canada are pressuring Europe into shouldering what will be a very heavy economic burden of punishing Russia for its unwanted aggression.

The strength in the bond markets could be signaling that a storm is brewing, but will it be a thunderstorm or a tornado? That is impossible to discern ahead of time, just as nobody had an inkling of just how much liquidity had to be pumped back into the global banking system to offset the negative multiplier effects ignited by that financial crisis – effects that continue to linger.

On the other hand, equity markets seem ill-prepared for the pending surprise. Private sector earnings will certainly be impacted on a global scale. Recall how investors underestimated the extent of the economic damage (again, trade-related) by the 2011 Tohoku earthquake. Although the quake and tsunami occurred in March, it wasn’t until July that stocks suffered. The S&P 500 on July 18th was at 1345.02 and by August 15th had declined to 1123.53 (a 16.5% hit).

Earlier this year, the European Commission’s published forecast for EU growth in 2014 was an optimistic 1.5%. Clearly expectations have since then been adjusted downward, but not nearly enough given the wrench just thrown into the machinery of international trade. If European economic ‘growth’ turns out to be a negative number, remember it was I that coined the phrase to describe Europe’s next recession – since it will be caused by trade sanctions against Russia I’ll name it the……”Russession.”

*Studies have tried to empirically estimate the marginal propensity to consume and the marginal propensity to import for many countries. My own back-of-the-envelope FT multiplier assumes a Russian MPC of .53, tax rate of 20% and MPM of .21 yielding 1.587 but who in their right mind would take this number seriously?

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Since when is the weather an economic barometer? Absurd!

Snow in TorontoMost of the economic data we’ve been seeing (don’t forget it’s historical data) belies the common thinking that the weather has been dampening economic growth.  The just reported U.S. GDP revision for the 4th quarter (up from 2.4% to 2.6%) suggests things might not have been so bad after all.  Was it reasonable to expect a carbon copy of the 4.1% GDP growth experienced in the 3rdQ of last year?  Of course not.

It seems bad weather didn’t stop consumers from having their strongest shopping spree in three years.

I find the current consensus disturbing, namely that inclement weather is responsible for the slowing of the economy, and when the weather improves there will be a huge resurgence in economic activity.

Behavioral scientists have published a great deal of research suggesting that we people have certain flaws in our thinking.  One that seems to impact the financial markets is our tendency to accept simple explanations readily, because we’re too lazy to delve into causes and effects that are complex.  Monetary stimulus has been easy, employment has been improving – judging by the recent decline in jobless claims – and industrial production has improved.  So why is there so much worry concerning stock markets?  It must be the weather.

Mortgage Rates USThere are more fundamental forces at work.  The softness in the housing market is being shrugged off (it’s the weather!) but in the U.S. housing and related services account for a significant percent of GDP growth.  Tapering is beginning to take its toll.  The leap in mortgage rates is a more rational explanation for the slowdown.  Despite the deluge of fairly positive data releases telling us it’s been pretty good, it’s developments like we’re seeing in housing that normally would suggest things will be not-so-good very soon.

Another flaw in our thinking is assigning too much weight to recent experience.  This is why most folks are demonstrably bad when it comes to managing their investments.  Because the stock market has done well, there are many who believe that it should continue to do well.  They believe this even though there’s no rational reason to believe it.  It is this flaw that causes humans to continue to make the same mistakes – such as buying at market tops and refusing to buy during slumps – over and over again.

An even better indication that the market (perhaps because the economy really is under pressure, and not because of the weather) is about to suffer a setback is the high level of consumer confidence.  I’ve indicated in the past that consumer confidence is a contrarian indicator.  Note in the following chart how markets perennially peak in springtime (usually in April or May).  Consumer confidence seems to peak about the same time.  What almost always follows is commonly expressed as “sell in May and go away!”

Consumer Confidence 2 March 2014

Someone might argue that this is too short a time period to be reliable, but rest assured I’ve been a money manager for decades and the pattern just won’t quit.  The recent strong consumer confidence measure bodes ill for the stock market, just as the slump in housing is not good news for the economy near-term.  The weather is sure to improve, but don’t expect much sunshine from the economy or financial markets over the coming months.





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Are markets in denial? Recent history in one chart!

Are we and the stock market in denial?  Talk of a ‘double-dip’ recession seemed to grow quieter once the correction I predicted back in January ran its course and the market headed to new highs.  I still adhere to my expectation for a strong year, but needless to say decades of experience has taught me the ride will always be a bumpy one.

This chart sums up what where we’ve been and what we still have to contend with for the next several months.

Yield Curves 2005 - 2014YellenIt is quite probable that post-Bernanke, Janet Yellen believes her real “job” is to orchestrate a return to normality.  This necessarily will mean some pain for gain.  The yield curve shift from upward sloping in 2005 (more or less normal) to the ugly line corresponding to 2007 (see chart) was a sign of imminent doom – we could all agree at the time.  Downward sloping yield curves imply deflation and ultimately worse.  Quantitative easing and the ‘twist’ managed to massage down rates into the somewhat deformed 2012 yield curve depicted above – a scenario we’ve since grown too accustomed to.  The current dilemma is that today’s yield curve is looking even more bizarre. Mid to long rates have been rising while the short end remains ridiculously low.

Risky Assets March - 2014Stepping back for a moment, I used this chart (courtesy of TD Securities) quite a long time ago to illustrate what had to happen in due course. Somehow the 10-year Treasury yield had to rise or the forward earnings yield on the S&P fall so the relationship stabilized – and I suggested both would happen.

Since then the earnings yield indeed declined as stock prices rallied (hence my bullish view of equities at that juncture) and long rates did rise if not dramatically (hence my bearish stance on bonds back then).

Back to NOW!  There still is a surplus of liquidity at the short end out there by almost every measure I’ve seen.  Although consumers did ‘bite’ and borrow large as they were supposed to – to get the economy rolling – in response to lower rates; the banking and corporate sectors did not.  As tapering continues, the issue is whether liquidity will shift into the longer end (higher margins for lenders) which would be ideal, or will a slowing of the economy serve to stifle lending; forcing longer rates down again.  In other words, will the few dollars actively investing out there just switch from stocks back to bonds while the cash horde continues to sit on the sidelines and constrain growth?

One day doesn’t make a trend, but this quote today from Bloomberg.com may provide a hint:

“The Treasury’s $21 billion 10-year note auction attracted the highest demand in a year as bonds rallied for a third day.”

All signs point to a global slowdown:  China’s sudden decline in exports and a downward revision to their economy’s growth rate, coupled with a stalling of Europe’s recovery creating anxiety.  Could it be simply that the path to normalization has begun in earnest?  What might ‘normal’ look like?

inflationOne of my favourite quotes from Clint Eastwood in The Dead Pool is:  “Opinions are like assholes. Everybody’s got one and everyone thinks everyone else’s stinks.” There are many opinions about the inflation outlook, but ‘normal’ critically depends on this parameter.  If we believe that inflation can remain at 2% or less (rather than hitting levels of  3.5% to 4% like in 2005) then a 10-year yield hovering at around 3% to 3.5% would not be outrageous.    To me this means that the earnings yield on the S&P 500 still has room to continue to decline (i.e. stock prices can go even higher).

Adjustments in expectations occur creating short term blips – but the fundamentals usually carry the day.  The only real uncertainty is whether China’s newfound fiscal discipline and Europe’s struggles will impact corporate profitability on a global scale.  Hard to imagine but that’s just ‘my’ opinion.

But, nothing remains static.  I opened with the question “Are we and the stock market in denial?” Yes and no!  Short rates will rise and create stress.  Some of the excess liquidity has found its way into parts of the market desperately trying to get some sort of return – reflected in the mini-bubble (not my expression but I read it somewhere and it fits) of technology-related growth situations and real estate.  Evidence?  Takeovers at high premiums with abundant cash (a bearish sign) in a small segment of the market and margin debt at frightening levels.

What do I mean by denial?  This (from Business Insider) quote from Morgan Stanley:

“Most of the highly priced stocks are not the mega caps that dominated the expensive spectrum during the internet bubble,” he wrote.

“This is not to say there aren’t overpriced tech stocks that could crash. Rather, they just don’t account for as big a share of the market as they did in the past.”

He may be right that they don’t account for as big a ‘share’ of the market as they did in 2000, but then again a few crashes would surely dampen investor enthusiasm and materially impact the overall market – even if it’s just temporary.

auto lineThe good news is that operating income on Main Street U.S.A. seems to be holding its own.   Less sensational acquisitions in many ‘other’ sectors abound at reasonable takeover multiples – usually a good indicator that the broader economy still has legs.  Therefore I remain convinced that the stickiness of liquidity in the short end of the yield curve will begin to slowly but surely find a home in longer maturities and that the new Federal Reserve chair will be able to get things back on course in due course. For those who wish to avoid being caught in the mini-bubble, it’s time to switch horses is all.

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TESLA will bring us World Peace? At this price it better!

tesla logoBased on the stock price performance, we should expect Tesla to bring about world peace.  Exciting growth situations, and I’ve seen many of them in various industries over my long career, seem to defy gravity for extended periods of time.

It wasn’t long ago that I warned about APPL becoming ridiculously popular (as a stock – we all know the devices had a huge following).  When it seems impossible to justify the price of the stock in the first place, and then it just keeps going higher – we’ve abandoned ‘financial’ reasoning and moved into the realm of imagination.  Nobody saw android coming….the blinders were on!

APPL March-14I’m the first to admit the vehicle is a beauty.  My first encounter with a live Model S was when I was touring on my Harley.  On route to Memphis, I stopped for a night in Indianapolis and there was this car parked in front of the hotel lobby.  I couldn’t help but gaze at the thing – a work of art on wheels to be sure.

The following quote is from USA Today, March 2, 2014

“Tesla Motors, which has seen its shares soar 619% in a year, has become the fastest growing automotive stock in at least two decades, a new analysis says.

As if that isn’t impressive enough, the analysis by Bloomberg News also finds that the electric car maker’s 15-fold increase in the value of its stock since its June, 2010, initial public offering is the biggest of any U.S. stock since 2006.” 

Rather than dwell on the fact that the automotive industry is hardly ‘tech’ (its extremely capital intensive and industry competition deeply rooted), let’s have some fun and try to come up with some sort of valuation metric.  Of course P/E isn’t much of a benchmark considering that most services (Yahoo Finance, Bloomberg) correctly provide a value of N/A (not applicable) or simply “-“.  Can we use the PEG ratio?

TSLA_egrConsidering what analysts are expecting in terms of earnings growth (see graph) the first difficulty is trying to pin down an earnings growth rate.  With the current price of the stock in the neighborhood of $250 we could pick the one year ‘estimated’ number and our PEG is like .36 and significantly less than 1X – a bargain?  Peter Lynch, who espoused the PEG ratio might say yes; since a ‘fairly’ priced stock should have a 1.0X PEG ratio.  It’s surprising the stock isn’t trading above $600 if you buy this sort of thinking.

On the other hand, even Peter Lynch might think it foolish to base your analysis on a one year estimate.  If we skip along to the three year estimate, then the PEG is far above 3X making the stock over-the-top valued.  If you’ve lots of experience working with earnings estimates like me, then you might expect all the growth rates projected will be wrong.  Now what?

STRIKE ONE:  A warning sign that’s worked for me over the years (helped me call the plunge in AAPL shares last year) is when research analysts begin looking for non-financial reasons to recommend stocks when they stubbornly keep going higher.  This from Morgan Stanley’s research analyst:

“Tesla’s quest to disrupt a trillion $ car industry offers an adjacent opportunity to disrupt a trillion $ electric utility industry,” he wrote in a new note to clients. “If it can be a leader in commercializing battery packs, investors may never look at Tesla the same way again.”

Jonas raised his target on Tesla to $320 from $153. The stock closed at $217 Monday, and it’s up 6% in pre-market trading.”

Analysts, who can fall in love with their ideas just like the rest of us, have a tendency to reach for reasons to keep the momentum going. Historically this has been one of the best red flags for an imminent short.  No mention of the costs associated with trying to keep up with demand (constrained by resources and time) on the one hand, and then messing with a completely new (even if related) battery operation.

STRIKE TWO:  Even the company sends me confusing messages.  The company’s CEO mentioned in the most recent quarterly earnings release:

“Operating expenses and capital expenditures will increase significantly in 2014, as we plan to invest in the long term growth of Tesla,” management said in the press release. “We plan to expand production capacity for Model S and Model X, invest in our store, service and Supercharger infrastructure, complete the development of Model X and start early design work on our third generation car.

Tesla also said that it will soon share more information about a Tesla Gigafactory that will lower battery costs.”

Call me crazy, but increasing costs and huge capital expenditures (to maybe someday lower operating costs) do not normally contribute to earnings growth and valuation.

Tesla on fireSTRIKE THREE:  How is it that Audi suffered years of reduced sales because it was accused of making automobiles that randomly accelerated on their own.  Audi’s U.S. sales plummeted from 74,061 in 1985 to 12,283 in 1991.  Toyota had similar issues twenty years later. In both instances, DOT studies discovered that ill-fitting floor mats or drivers pressing the wrong pedal caused the acceleration.   Another indication that hype trumps rational when it comes to Tesla?  It was not okay for a car to accelerate unexpectedly, but apparently it’s okay for a vehicle to burn up.

TSLA StockPrice

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Canadian Stock Market earning a gold medal also?

Canada Gold MedalOne rule of thumb that works is ‘follow the smart money.’  Based on the most recent data I’ve seen:

In the three months to November, $20.4 bln flowed into equities, the fifth largest 3-month total on record, lifting year-to-date total net foreign buying to a solid $16.6 bln. While we look for commodity prices to remain relatively contained, there appears to be renewed interest in Canadian equities of late, perhaps taking advantage the weaker loonie and overly negative sentiment present through much of 2013. (BMO ‘econoFACTS’ Feb 16th, 2014 issue.)

Why in the world would money be moving into Canadian equities?  The $C has been falling and big Canadian financial institutions have aggressively been introducing new “US” equity funds based on the purported better returns had and to be had in American stocks?

In my post that called for a correction (which we’ve had) I suggested that: “Because it’s likely that ‘some’ monetary easiness  (now that it is considered good ‘political’ medicine) will continue to prevail – commodity prices will bounce and present some inflationary threat.”  A number of opportunities present themselves in this sort of environment.

As always, the better returns almost always come from places nobody is looking.  I’ve suggested in the past that China’s extremely responsible economic policies of late would not destroy its economy.  Yes growth has slowed, but it is ‘growth’ nevertheless.  While observers remain overly concerned about China, they’re missing the big picture.  Consider this quote that I found in an article about Australia’s strong shipments of raw materials to China:

IMG_0064While growth may be slowing, China’s economy is many times larger than it was a few years back and it still needs massive quantities of raw materials to construct houses and fuel urbanization.

Rio Tinto, the world’s second-largest iron-ore producer, will report its 2013 annual results Thursday, and is expected to post a rise in earnings after last month unveiling record iron-ore shipments for 2013. A poll of seven analysts estimated an average net profit of $7.59 billion. That compares to a loss of $2.99 billion in 2012 due to write-downs on investment. (WSJ Feb 13, 2014)

Two things that benefit countries like Australia and Canada when they do occur.  Weaker currencies relative to the $US are good – costs of production are in the domestic currency but commodity prices and revenues are based in the stronger $US.  And improving demand following a period of constrained supply.  The crazy weather patterns not only affect agriculture:

coffee beansCoffee jumped the most in a decade, soybeans reached the highest since December and sugar rallied as drought scorches fields in Brazil, the world’s biggest exporter of the crops. (Bloomberg News February 18, 2014)

Unusually cold weather also hits other industries – particularly steel and mining.
As mining companies of all varieties watched their bottom line deteriorate over the past few years, cost-cutting and the postponement (or cancellation altogether) of major projects was bound to stall the longer term supply of raw materials.  And all this was happening just as the U.S. and European economies were picking up some momentum.

Despite bumps along the way my expectation expressed back in August of 2013 wasn’t too far of the mark:

As I’ve published previously (see China will be the next big surprise!) stronger demand in China (as well as North America and Europe) will drive growth, and the FED & ECB won’t have to fuel it….the heavy lifting has already been done.

The Canadian stock market, despite its heavy weight in resource sectors has managed to climbed considerably  since then.   Most of what I see suggests that this trend has only just begun.  Our hockey team beat the U.S. and Europe, and don’t be surprised if our stock market beats them in 2014 as well.

SP versus TSE


One thing that worries me a bit is when experts kind of agree.  Goldman Sachs’ David Kostin believes capital spending (a good cause of stronger raw materials demand) will be robust this year:

“S&P 500 companies that provided guidance plan to boost capex by 7% in 2014, [are] slightly below our forecast,” added Kostin. “171 S&P 500 companies provided capex guidance during recent quarterly earnings conference calls. These firms account for 50% of aggregate capex spending by the S&P 500. All sectors plan to increase capex in 2014 with the exception of Telecom Services, which guided flat.”

I can only hope that they’ll be wrong (they always are) because they’re too low (not too high) in their forecast for cap spending growth.  After all, there’s plenty of cash in corporate coffers and in lending institutions that should soon be put to work in the real economy.

On the other hand, news that the G20 believes they need to encourage growth is a welcome indication – since as usual governments decide to do something that really no longer needs to be done.  Growth will happen anyway, and they’ll be jumping up and down taking credit for this growth – having really actually done nothing at all.

The world’s largest economies, including Canada, have agreed to a soft target of boosting global economic growth by 2 per cent over the next five years at the Group of 20 summit in Australia amid concerns about a sluggish world economy and high unemployment. (Globe & Mail, Feb. 24 2014)

Meadowbank_OperationsWhat makes me worry less is expressed well in this quote from the Globe & Mail (Feb. 24) concerning Agnico-Eagle Mines’ (I’m a big fan of the company) Meadowbank project way up in Nunavut.

This open-pit mine west of Canada’s Hudson Bay has had such steep construction and operating costs—flying workers in and out, stocking a year’s worth of food, employee turnover and battling snow drifts that can reach eight feet—that the project is unlikely to break even over the long haul, executives now concede. (WSJ Feb 23, 2014)

I financed a fair share of Meadowbanks’ exploration via mining flow-through funds I managed – when the project was owned by Cumberland Resources. I visited once and even spotted some of the visible gold in a drill core sample I found in their core shack.   When management is at the point that they’re willing to say “the project will never make money” even if they don’t believe it (I don’t think the CEO Sean Boyd believes it) then not only will the mine make money, the price of gold and the company’s stock have bottomed out and should probably be bought – in my humble opinion.  And if gold is on the rise again, then so is the Canadian stock market.

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