502 Bank Street Decatur, AL 35601 T/F (256) 850-4161
By Paul Lamont
August 31, 2011
We are glad the Summer is finally over. In March, we reported that investors were willing to “buy everything” even though stocks were wildly overpriced. In addition, investors were doing so with leverage. For a short period of time, the investment herd feels right (1999, 2007, early 2011) but the chart below shows how wrong they turn out to be.
Each peak in the market has corresponded with a special reason why stocks could not possibly fall. This Spring it was exceptionally tough to avoid joining the investment herd because of the Federal Reserve. They are aware of the deflationary Depression and will use any means necessary to prevent it. But as the following chart of the S&P500 shows, they cannot repeal the natural law of supply and demand. When there are more sellers of stocks than buyers, prices fall.
The market has almost completely retraced the QE2 rally. And it did so in dramatic fashion; with two days registering in the top ten largest point declines ever.
“Prolonging the day of reckoning only makes things worse when the pressure finally breaks through.” - Jim Rogers Investment Biker. 1994.
Even with all the stimulus, Federal Reserve money printing and U.S. Treasury public-private guarantees over the last two years; stocks have not breached levels of 4 years ago. Instead, they have reversed and have broken the uptrend of the last two years. With consumer confidence already back to April 2009 levels, we will continue to urge investors to “use this time to reduce risk, get liquid and secure your investment portfolio.”
“During this period, I began to consciously articulate the virtue of using variant perception as an analytical tool. I defined variant perception as holding a well-founded view that was meaningfully different from market consensus... We took exactly that approach during the early 1970’s, when most of our success resulted from our implementations of perceptions that were meaningfully at variance with consensus wisdom. We shorted near the top, in the face of great bullishness, and we got long at the bottom, in the face of keen pessimism.” Michael Steinhardt. No Bull: My Life In and Out of Markets. 2001. ($1 invested with Steinhardt in 1967 was worth $481 in 1995 when he retired, compared to $19 for the S&P500.)
Why We Aren’t Buying Like Buffett
Last month we cited an article written by Benjamin Graham, Warren Buffett’s mentor, that described the high cash levels held by public companies in 1932. The hope of investors at that time was that cash balances would be used for dividends or stock repurchases. That never happened, instead investors fell into a value trap as stocks reached extreme undervaluation.
Last week, Warren Buffett put $5B to work in Bank of America. However we would strongly caution investors against following his lead. In 2008, Mr. Buffett himself purchased warrants in GE (presently underwater) and in Goldman Sachs (a little over break even). The value strategy did not fare too well in the 1930’s either. As Benjamin Graham describes his performance before the Committee on Banking and Currency in 1955:
“We did pretty well in 1929 alone, but the real difficulty we experienced in 1930 and 1931 when the market went much further downward than we had anticipated... it was not until 1936 that a person who had been with us in 1929 and had held on would find himself even, but by 1936 he was even in our business.”
Meet the New Boss, Same As the Old Boss
Bloomberg reports there are 14,000 securitized bonds that are still rated AAA by S&P even though market prices suggest investors “does not believe the ratings anymore.” These bonds are “backed by everything from houses and malls to auto-dealer loans and farm-equipment leases.” So once again, Boudreaux’s Louisiana Crab Shack is the finest loan in the global financial system (yes, sarcasm). Especially since S&P just downgraded the ability of the U.S. Treasury, the printer of the global reserve currency, to pay its debt to AA+. In addition, “S&P is poised to provide AAA grades to 59 percent of Springleaf Mortgage Loan Trust 2011-1, a set of bonds tied to $497 million lent to homeowners with below-average credit scores and almost no equity in their properties.” We need no reminder that in 2008 “S&P contributed to more than $2 trillion in losses and writedowns at the world’s largest financial institutions and the collapse of Lehman Brothers Holdings Inc. three years ago, causing credit markets to seize up and leading to the global recession.”
We expect stocks to fall until the September Federal Reserve meeting. With investors trained to buy on the announcement of QE3, stocks could then rally and recover some of their losses into the Spring of 2012. If at any time the Fed fails to meet the expectations of the market, we should be prepared for another full blown financial crisis.
At Lamont Trading Advisors, we provide wealth preservation strategies for our clients. For more information, feel free to contact us. Our monthly Investment Analysis Report requires a subscription fee of $40 a month. Current subscribers are allowed to freely distribute this report with proper attribution.
***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.
Copyright ©2011 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at email@example.com, or call (256) 850-4161.