Email – #311
The Sell-Off Will Give Us a Great Re-Entry Opportunity
Dear Reader,
Markets do not turn on Fridays. And this past Friday, we got more of the same downward drift that we have been seeing. Since we pretty much took all of our profits ahead of this, with the exception of two stocks, I am not concerned.
I have a roadmap for what’s coming…
We are mostly in cash, with our mouths watering at the dropping valuations of our targets. I have been through crises like this at least once every three years for the last 29 years. And we are where we want to be.
Let me explain…
We are in the midst of two seemingly confusing sets of major information: The Greek crisis and the jobs report.
The Greek sovereign crisis is hitting the European debt and equity markets and debilitating the euro against the U.S. dollar, especially. And the U.S. jobs report showed conflicting evidence: the payrolls number was down 20,000 jobs, but unemployment actually dropped. This jobs data confounded many analysts.
The negative payrolls number “ensures” in the mind of investors that the Fed’s liquidity withdrawal and interest rate tightening schedules will be moved back in time. Hence their conclusion is that the 5.7% GDP growth of the fourth quarter is mostly due to inventory rebuilding, which demand little hiring.
Thus, the U.S. Treasury yield curve is steepening, not pricing ANY TIGHTENING at all.
This is the WRONG conclusion. Because what analysts across the board have failed to see is that “this recession is different.” I venture to make this very risky assessment on the sound basis that there are huge structural changes this time that never took place in the past. While in the past we used to drop interest rates strongly and bail out, this time we have made two dramatic changes: 1) We have forced the entire banking system to DELEVERAGE; and 2) we are introducing legislation and other structural measures to CURB EXCESSIVE RISK TAKING.
These last two changes are limiting the potential economic bounce of the economy, with the intent of preventing bubble-making behavior down the road. And thus, with this new reality, we can expect that the recovery in the short term will be more drawn out and weaker than it would have normally been. So lower expected interest rates in the future should be a good thing for stocks, which was the initial reaction after the employment number.
But this longer and weaker recovery means that companies have also adapted. They, especially the large ones, are very reluctant to rehire workers, even though some might have gone overboard in their cost-cutting efforts to start with. So, instead, they are using temporary workers and consultants. Hence the discrepancy between payrolls and unemployment: The consultants and many temps do not show in payrolls, but when those households are asked about employment, many consultants say they are now employed.
Therefore, there is more traction than meets the eye in the U.S. economy.
Let’s go to Greece…
Whether or not you are reading the Greek newspapers in English, like I am (http://www.ekathimerini.com/), you are hearing that we have a crisis there. Yes, it is a crisis. But the Greek funding gap is equivalent to half of the German financial stimulus. The Greeks and the Europeans know that the gap is small, compared to Europe. And the Greeks are dragging their feet with the need to adjust.
Hence you have the traditional “negotiation” between both parts, played in a game of brinkmanship (“chicken”).
“Let’s see who throws the towel in first,” they each think. So the markets are castigating Greek spreads in order to convince the Greeks that they will become a well-submerged market if they do not adjust. And the Greeks are playing the dangerous moral hazard trade. That is, they think that the Europeans will have to save them in order to prevent contagion of the situation to other countries.
So the P.I.I.Gs are suffering: Portugal, Italy, Ireland, and Greece are seeing their debt sell-off and protection against default go up in price fast.
In the end, the IMF, the European Union and the European Central Bank will extract adjustment concessions and we will avert a Lehman II.
When this will happen and how deep this will go, I do not know. But my 29 years of emerging markets experience, the fact that the Europeans clearly pointed the finger at allowing Lehman’s demise as a mistake, their past behavior in bolstering weak countries for decades, including Iceland, all lead me to believe this. And we are betting small (only two stocks).
Eventually we will start buying before we see the light at the end of the tunnel in order to take advantage of all of my favorite picks that are “on sale” right now. So stay tuned for some fast buying and nice profits ahead.
Enjoy and profit,
Horacio Marquez
