The Coteau 1/13

The Coteau  

The View from Bannerstone Capital            By Biff Robillard

Thirteen, Pegs and Hem


Successful investing is having people agree with you later.   –Joe Robillard


Lucky 13? I happen to like the number 13. Here we are in 2013, year one of a presidential term and year, let’s see, five or six since the Great Financial Panic and Recession of 2008 (or was it 2009?). My, how time flies when you’re having fun, everybody! The number 13 is a defiant, enigmatic number. Much maligned, often avoided altogether, it just finds a way to stay in the number line anyway. It is, after all, a rational number. It is an integer, a so-called Fibonacci number (…5, 8,13…) and a prime number (yes, divisible only by itself and one). There is a lot to like in a number that just ignores the crowd, does its job and stoically remains utterly above superstition. What’s not to like?

I like the backdrop for 2013 if you are a stock investor: Bondmania and stockphobia make a contrarian smile. Forecastitis helps, too. Imagine watching the thermometer on your porch tomorrow to try to divine the temperature next, say, July 21— Earnest Hemingway’s 113th birthday (yep, there’s 13 again). Just last week it was well below zero on mine. This afternoon it is unseasonably warm at 35 degrees for the high school alpine ski race at Buck Hill (“unseasonably warm” is a local euphemism for “badly rutted race course”). Has the temperature forecast for Hemingway’s would-be 113th birthday changed? You tell me. Maybe a forecast of “a helluva lot warmer” would be sufficiently right to be useful whatever the temperature on my porch in January is. I think so. And so it is with certain markets: Some very general forecasts just might be good enough in 2013.

First, bondmania: Future bond prices? Probably lower. The data around investors’ continued affinity for bonds, after a 32-year bull market in bonds, is practically unbelievable. People do not change. That is a good thing in the hands of a sufficiently dedicated investor. Remember how you felt in the autumn of 2004, when house prices just kept going up? And again a year later, when they were up again in 2005? Remember how conflicted you felt: One part of you was the dumbest person in the world for not having nine houses with nothing down: the other you had an index finger in each ear, eyes closed, chin-against-your-sternum, waiting for the Big Noise? How about way back in 2000 and 2001? Remember that ticker tape? Boy, I do. I remember actually asking Scott in January of 2000, seriously, if the NASDAQ was going to double again. We thought the biggest risk was airliners falling out of the sky as computers tilted with an unmanageable date change. “A helluva lot warmer” is practical for a July forecast today and “lower” is close enough for a useful bond price forecast for the year.

The past isn’t really prologue, but Mark Twain cleverly pointed out it does often rhyme.

So with this in mind, I have pressed into service my rather worn out, marked up, one-owner copy of Sydney Homer’s A History of Interest Rates. This is, far and away, the best reference book of its kind I am aware of. Never a big seller, it is a cult classic among guys with few hobbies. So with the idea that history rhymes, let’s hear how Sidney Homer, on pages 368 and 369, describes a seminal turning point of a long, historic bond bull market in 1946. The war had just ended. Hemingway was 47. Homer describes precise events none of us can personally remember:


“During the first segment of the bear bond market, 1946-1948, the corporate bond average declined about 10% in price; the government bond average, reflecting the continued pegging policy of the Treasury and the Federal Reserve ( emphasis added by your editor), declined only about 7½%, while the prime municipal average declined 23%. Municipal yields more than doubled. Large new municipal issues over-taxed the limited resources of high-bracket investors and forced the market to seek a wider clientele.  After the surprise victory of the Democrats in November 1948 (recall “Dewey Wins!” and a beaming Truman—editor), and after signs of faltering in business, all bond prices recovered (more emphasis from your editor).”*


Homer’s description may prove invaluable when the turn comes this time. Most relevant is his reference to the residual influence of the Federal Reserve, and most importantly, the prominent mention of the War-time “peg”. It was still in effect and still working a little, but the interest rate market was taking matters into its own hands. Maybe we don’t wait until the end of QE to get nervous, in other words. I think this sequence is a classic Wave 1 in Elliot Wave Theory (tarot cards start next issue): The very first surge in rates came and went inside of two years, with a 100 percent retracement of the initial surge (or drop in price, whichever way you like to think about bonds). Can you imagine the blood on the floor with a doubling of municipal bond rates inside of a year? A 23 percent drop in a safe instrument is terrifying for anybody. At a 2 percent coupon, investor holdings, on average, would have dropped the value of an entire decade of interest … and then recovered all of it in an Elliott Wave 2, a classic corrective wave, where rates retested the lows of 1946. Calm was restored, if that’s what you want to call it. Until prices broke again in 1950, which was the beginning of what the Elliott Wave crowd might call a Wave 3. Third waves are the really powerful motive wave, which in this case confirmed a bear market which would run, capriciously and persistently, until 1981.

If it rhymes, maybe it sounds a little like this: We see an initial sharp uptick in rates just before Bernanke and Co. stop “pegging” rates, whenever that is. Bond portfolios will be among the worst-performing assets, I would think. Open-end tax-free bond funds will be decimated in particular. You will see even more of Bill Gross on TV and the New Normal will be reiterated as Just Normal. Then, amidst all the howling and “I told you so,” rates may peak, bond prices trough, and then rates quietly decline back to lower, familiar levels, proving everyone both right and wrong. But beware the ensuing Wave 3: tsunami time. Think of the possible rate retracement after the initial rate surge as the water inexplicably retreating from a Polynesian beach. Run like hell. Will we see a “Jeb Bush Wins” headline? Who will be smiling nearby, a certain female former secretary of state?  Your call.

*Yet another Editor’s Note: I am reminded how Irish monks are credited with preserving and copying books and manuscripts, including the Bible, as the Dark Ages tore Europe asunder.  Long before the Fighting Irish of Notre Dame and before anyone had uttered “Roll Tide!” I should add these isolated, dedicated monks (I like to think some were my ancestors but reproductive rates for monks are usually extremely low) were avoiding the Black Death while busily copying original classic tomes from the past Roman Era. This would also seed the Renaissance with important texts otherwise lost to time forever and then eventually antagonize liberal arts undergraduates 700 years later. At least if you believe Tom Cahill’s wonderful How the Irish Saved Civilization, which I happen to, my own Irish ancestry notwithstanding. In any event, Sidney Homer is our interest-rate monk, carefully preserving facts otherwise lost to time. Thank you, Sidney, Irish or not.

Why does the inevitable end of the 32-year bond bull market matter? First, because it suggests there might be (emphasis on might), two chances to unload bonds near their decades-long bull market highs. If you get caught long and the turn comes, you may grit your teeth and get another shot—but it could be unnerving. Also, because the bond bull death may coincide exactly with a new bull market birth in stocks, just as it did in 1946. One must own stocks to benefit from a bull market. Which leads me to stockphobia.

This is almost a synonym for bondmania, but not quite. I think stockphobia means a meaningful bias toward stocks, of course, not away. Unlike bondmania, stockphobia doesn’t technically require frequent TV appearances by Mohamed El Erian, the Prophet of PIMCO, although he helps. Stockphobia is simply the unbelievable insistence of investors to fear imperfectly valued stocks to own perfectly valued bonds. There are many Mohameds these days and not all are truly prophets.

Don’t get me wrong. El Erian is okay. He seems wickedly smart.  But I’m frankly a little suspicious of his almost clearly self-serving “market perspective”: the New Normal. Like the Canadian fellow’s monogram, whatever it is, now headed for the Bank of England, PIMCO stands for “One Trick Pony, Insanely Lucky,” if you ask me, I don’t care what the letters actually stand for. The New Normal, as long as it persists, is very, very good for PIMCO’s owners. If the crowd hangs with New Normal for a few years after the aforementioned Wave 1, well, that’s more years of fat paychecks for PIMCO before the tide begins dropping for likely a very long time. It just can’t get much better for them, and my bet is it won’t.

Besides, there are sufficient calls for a market crash this year to establish that stockphobia exists independent of PIMCO’s tireless marketing of Doom.  None other than Harry Dent, Mr. Wrong-Way-but -I-Went-to-Harvard-Business-School and Merrill’s Mary Ann Bartels are nervous (the least interesting technical analyst to ever play that role at Merrill, if you ask me). I am comforted for the time being by these observers’ skepticism. A good uptrend is an unbelieved uptrend.

John Murphy’s excellent, if slightly repetitive, Intermarket Analysis reveals something I was utterly unaware of: the Nikkei Dow has had a very curious long-term positive correlation with the yield on the U.S. 10-year Treasury note. They go the same way much of the time. I was sufficiently impressed with his case to mention it here. It may have very practical implications for those of us awaiting the inevitable bond bear market alluded to moments ago. As the Nikkei goes, so goes the 10-year yield, says John Murphy. We have had one of the most remarkable 30 days in the Nikkei that I can recall. The venerable Asian average is up double digits in a few weeks. This could bear watching. Pun intended. A rising Nikkei will likely mean a rising coupon on the 10-year U.S. Treasury. And lower prices.

Gold bulls continue to be confounded. About time. I reiterate a point I have made before: As long as the gold miners’ shares are acting badly, stay away from the bullion. This apparent divorce began in April of 2011.  I think of it this way: The spot price for an ounce of gold, either in New York, London or at your favorite jewelry store is, by definition, the current price of gold. Mining shares, it seems to me, are really investors net appraisal of the likely future profitability of digging the stuff up still in the ground and selling it at future prices. Even allowing for the costs of other inputs, like labor and energy, the shares are a proxy for gold metal prices later. The shares have underperformed the bullion persistently and markedly. If mining shares assume an uptrend, gold bulls can take heart. But a 12-year-old bull market in gold is an octogenarian in people years. 2012 was the first down year in many and bullion underperformed the S&P 500. See Figure 1, which is the GLD gold bullion ETF alongside the GDX, the so-called Gold Miners Vector, a basket of gold producers’ shares. See what I mean?



FIG. 1                       GLD vs. GDX Daily since March 2011    Why Are Shares Falling?

A 2013 macro-economic trend which I think matters a lot is the potential future energy independence of the United States. This could be real, and if it is, well, that old rabbit’s foot Uncle Sam seems to have in his pocket just did it again. It could change everything.

We still like our big European banks like SocGen and BNP Paribas. We like our big American banks Citigroup, JP Morgan, Goldman Sachs (the recent video of the Giant Squid I am taking as a sign) and the UK’s Barclays. We are long Facebook in the teens and are feeling lucky. We like the usually sleepy loan servicing biz as loan creation awakens: We own NelNet, Inc. (NNI) and Elli Mae (ELLI). Another in the general group, but we don’t currently own, is Nationstar Mortgage (NSM) which bought a bunch of paper from Bank of America recently. Cheap U.S. energy looks like it is igniting (I can’t resist) another leg in the chemicals business. Thanks to Scott Larson, we have been long Ashland Chemical (ASH) for years. Eastman Chem (EMN), the spinoff that is just more tragic evidence Eastman Kodak lost its way in a very big way, intrigues me as a way to catch the improving economics of cheaper natgas sourced feedstocks, especially ethylene for plastics. We are doing some work on the name.

I am still struggling under one long position in particular: the dreaded Westport Technology (WPRT). Why I don’t know. I keep thinking WPRT will catch on as a natgas play, but it insists on trading like an engine manufacturer. I should know better. The tape has not been especially kind to any of the engine manufacturers for a year. I prefer Cheniere Energy LP (LNG), I think. Now that’s a natgas play. I may swap the positions. The chart is better and with their export facility completion years away, hope could be an important propellant, as it often is. Earnings will remain prospective and subject to imagination.

Our most antagonizing holding remains Leucadia Holdings (LUK), long a workhorse for us. It has lagged and now it seems to be lagging a strong financial sector. The recent merger with Jeffries (JEF) seems to have helped initially, but I remain very restless with this one-time juggernaut. Experience has taught me to sell reluctantly under such circumstances. I have let long-consolidating positions go only to watch them recover mightily to my perpetual dismay.  I need to get this one right in 2013. With Ian Cummings hanging up his spurs and my inexplicable aversion to Jeffries, my mind is open to change. The opportunity cost has been frustratingly high when we are finding fresh winners.

Ah, the 113th birthday of Earnest Hemingway this July, that Lucky 13 thing again.

Auspicious for the year don’t you think?  Remain long stocks. Beware bonds of any real duration. The coming supply of abundant affordable domestic energy could result in the U.S. having some things go right for a change, including lower inflation than otherwise might occur. This could be beneficial in a reflating world, the world the central bankers are trying so hard to create. This, in turn, could strengthen the dollar. Rising interest rates could also strengthen the dollar. A stronger dollar tends to be a headwind for many commodities. While demand and volume should be pretty good in an improving global economy, prices for commodities could be frustrating for commodity bulls, who have become accustomed to feeling the wind at their backs.

The first five days of January were up. Big. This is sufficiently correlated to an up January to keep it interesting for the bulls. Up Januarys have a pretty respectable record for calling up years. First presidential years, however, are typically crummy, as theory goes at least, as fiscal medicine is administered for the prior election-year hangover. Maybe. Something tells me the first half might be a lot of fun for the bulls. But they don’t ring bells at tops or bottoms. Speaking of bells, yes, I too, turned that last page in For Whom the Bell Tolls.

“…never send to know for whom the bell tolls. It tolls for thee.”  Yikes. Make every day count.




Craig Cox edits this for me. Thank you, Craig. None of the ideas mentioned constitute investment advice. You have to be kidding. Past performance doesn’t guarantee future results, either.

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