Bearish News

The latest sentiment reading by Investors Intelligence shows a disturbing trend. Only 15.6% of financial newsletters are currently bearish on equities.

Last time the bearish indicator was this low was April 1987. A few months later (Black Monday) the DJIA dropped 21% in a single day:

In other words – when everything seems peachy — watch out. Turns out that peaks and troughs in investor sentiment are pretty good contra-indicators. Bullish sentiment tends to peak as bubbles are near their top, and vice versa.

From the revamped and newly Bloombergesque Business Week:

Pessimism about U.S. stocks among newsletter writers fell to the lowest level since April 1987, six months before the equity market crash known as Black Monday, following the biggest rally in the Standard & Poor’s 500 Index in seven decades.

The proportion of bearish publications among about 140 tracked by Investors Intelligence fell to 15.6 percent yesterday from 16.7 percent a week earlier. Sentiment has improved since October 2008, when the financial crisis drove the figure to a 14-year high of 54.4 percent. After plunging 38 percent in 2008, the S&P 500 has risen 25 percent this year.

This is not to say markets wont’ run again in 2010. Irrational bull markets can last much longer than you’d think. The momentum they build up is impossible to fight. Gotta wait for that to break before getting seriously short. Example – After the bearish-sentiment index bottomed in 1987, the market rallied another 14% before crashing.

Smart investors like Bill Fleckenstein have been highlighting the credit bubble since the mid-1990′s. And today markets are more irrational than ever. Government intervention is preventing market cycles from proceeding like never before.

Industries like housing, banking, and commercial real estate have become completely dependent on government support. Their future (and that of our currency) depend on whether our leaders will extend or end this support. It’s a ludicrous, manipulated market.

So far America’s leaders have repeatedly demonstrated that they have zero tolerance for economic pain. Their support for the financial markets seems unlimited, no matter the long-term cost. I don’t see that changing without something drastic hapenning – another huge round of bailouts, a shift in the political landscape, or something else.

Earnings Distorted, Bloated

Earnings, as officially reported, are less and less reflective of a company’s real income.. Today’s earnings are nothing less than a rosy version of what they “should of been, had not X happened.” X represents the bad stuff that constantly happens to businesses, but currently they are treated as one-time events, no matter how many quarters-in-a-row they occur. One-time transactions that are profitable, however, are included in “headline” earning numbers, of course.

This is a different breed of bubble. On top of creative income interpretation, asset losses are being swept under the rug with an impressive array of accounting gimmicks. Changes to rules that govern loan valuation, and the continued allowance of off-balance-sheet vehicles are examples.

Related:

• More Bailouts and Inflation Loom
• David Tice Sees S&P at 400

Dubai’s man-made islands are stunning technological achievements. But they may end up as the poster-children for this era’s reckless real estate ventures. These projects are playing a big role in the ongoing debt crisis in Dubai.

Here’s “The World” island project:

And here’s one of the three palm tree islands, where you can see construction underway:

I remember being struck by the scale of the project while watching a Discovery Channel documentary. What a cool concept. Unfortunately, it looks like reality is catching up to this pipe dream.

Recent revelations show that the islands’ parent company, Nakheel PJSC, is in trouble. Their attempt to delay debt payments sparked a global selloff on 11/27. Fears of a debt crisis in Dubai spreading to other emerging markets (EM) roiled stocks.

Investors collectively paused the day after Thanksgiving, “Wait a sec… I thought emerging markets were going to be the engine driving us out of this mess… Now their bubbles are popping? Uhhh-Ohhh.”

Bloomberg provides a detailed example of island building gone-wrong:

Samsung C&T Corp., builder of the world’s tallest tower in Dubai, said it stopped work on a $350 million bridge in the city after a unit of Dubai World halted payments.

Construction of the half-finished bridge, to the man-made Palm Jebel Ali island, was suspended earlier this month after Nakheel PJSC made no payments for about two months, Cho Keun Ho, a spokesman for the Seoul-based builder, said today. Calls to Nakheel’s spokeswoman Anna McGovern went unanswered.

Not all emerging markets have the same debt issues Dubai does, of course. But there are tons of risky investments lurking out there, and they’re not just in EM (hint – many are hidden off US bank’s balance sheets).

Some are speculating that Dubai’s debt problems will be a catalyst, sparking major selloffs worldwide, particularly in EM. If so, I would think those countries with stronger balance sheets, like China, will fare better than those with high debt loads. That said, I am considering reducing my personal EM holdings, but haven’t done so yet.

China’s massive infrastructure rollout has been hailed by many as brilliant. Helping its case is the inevitable comparison to America’s dismal emergency spending, the majority of which is being spent propping up black hole zombie-banks.

China, meanwhile, is pouring resources into projects some think could catapult them into superpower status. It will take decades if it works. And there are plenty of skeptics of China’s infrastructure-based recovery plan. There is also a growing chorus of China bears warning of a bubble in equities and real estate.

The Good

It’s hard to ignore some of the projects going on in China. One of the more impressive is a $200b high-speed rail network.

Efficient public transportation is a no-brainer for China. Combine rising energy costs with 1.3 billion citizens in need of transportation, and you have a socialist’s dream-project. If well-executed, it will provide superior transportation options and a lower cost of living for hundreds of millions.

The alternative, a highway-based system, is not feasible. Currently only 3% of Chinese own a car. Boosting that number to anywhere close to America’s 44% would be disastrous. Energy prices and pollution would skyrocket.

Here’s a map of the rail project, scheduled to be complete within 10 years:

U.S. legislators have made noises about a high-speed rail plan of their own, but only $8b of a $787b package was earmarked for it. I suppose projects like tunnels-for-turtles need funding too.

AIG vs. Rail

I can’t resist noting that America has spent nearly the same amount bailing out AIG ($170b), as China will on this huge rail project.

America’s $170b “investment” in AIG allowed us to dodge some of the pain that would have resulted if (god forbid) banks were treated like real businesses, and forced to eat losses on deals with insolvent counterparties.

It also allowed bonuses to keep flowing on Wall Street, and bought some breathing room for near-death firms. The moral-hazard implications are immeasurable. It’s safe to say that our economy will never see its true potential with shenanigans like this going on.

When you reward failure and punish responsible parties, the consequences will be predictably bad.

Said and done

At the end of the day, America will still have our horribly inefficient and only quasi-solvent banking system. Chances for meaningful reform are still bleak, crony-capitalism alive and well.

China, meanwhile, will end up with 16,000 miles of energy-efficient railway connecting their major cities. Plus, they get to brag about badass 236-mph trains. If the U.S. insists on throwing piles of money at something, shouldn’t it be for something cool like really fast trains?

Some would counter that the U.S. strategy has worked. After all, the Dow is above 10,000 again. So everything must be preachy. I would reply that while America’s response has provided a temporary boost, it also sowed the seeds for another disaster. It will feature many of the same players, and involve even more debt.

This is the key difference between Chinese and American stimuli. Neither is perfect, but America’s fails to address fundamental problems – too much debt and banks who only exist thanks to taxpayers and accounting gimmicks. It’s a patch to buy time until the next bubble pops. Nothing more.

The Bad

China’s plan is not perfect by any means. It will be fraught with waste and inefficiency. That’s the nature of government projects, and China is a proudly socialist country. Bureaucrats generally make awful businessmen. With little stake in the outcome of their actions, workers inevitably get careless and make bad decisions. Corruption also tends to creep in.

Exhibit A – China’s Ghost City (skip to 1:15)

This project should serve as a cautionary tale for China. Big missteps like this will be costly. If leaders aren’t more judicious in the future, they could end up with a thousand bridges to nowhere.

American Bear in China

At Buttonwood last month, head of Morgan Stanley Asia Stephen Roach took many of us by surprise with his bearish comments on China. He noted that he moved to Asia because he was bearish on America, but now he’s starting to get bearish on China. He was critical of their infrastructure spending, hinting that much of it may be going to waste.

Roach is still long-term bullish on Asia, but we should listen to his warning. He’s certainly not alone. China-bashing is becoming quite the rage among contrarians these days. China bears are probably onto something, but I think fears of massive bubble are overdone.

I liked Chinese stocks earlier this year, when their valuations weren’t quite so lofty. In January I started buying PGJ (my favorite China ETF) around $13-$14. Since then it’s risen to $24, and like most Asian indexes, looks toppy. The 12-month trailing P/E for Shanghai stocks is currently around 30x. That’s not cheap.

So I recently sold some Chinese stocks from my portfolio. That said, I’m not giving up on emerging markets (including China).  Three reasons for this. Number one – it’s where the growth is. Number two – A falling dollar should benefit American owners of foreign stocks. Number three – it’s still working.

Disclosure: Long PGJ

Chart via The Transport Politic

Schiff calls out the Fed, recommends buying foreign stocks.

They don’t wanna face the pain, they don’t want to deal with reality. If they can’t deal with it now, what makes us think they can deal with twice the pain in the future?

I love the Economist for pieces like this: Please do feed the bears: The financial world needs its pessimists. I’ll post a few excerpts and commentary, but the whole thing is a must-read.

NOBODY loves a party-pooper. When asset prices are going up, most people are inclined to celebrate. The bears who argue that asset prices are about to fall tend to get dismissed as out of touch (dotcom sceptics supposedly “just didn’t get it”) or are likened to stopped clocks: occasionally right, but mostly wrong…

Over the past 20 years it has been the repeated interventions of central banks to rescue bulls, not bears, that have contributed to the current mess by encouraging too much risk-taking. Those interventions, by shoring up stockmarkets with cheap money, have made life even more difficult for the bears.

So when the bears say, as they do now (see article), that the stockmarket rally is built on sand, they are worth listening to. On historical measures, Wall Street looked cheap only briefly, earlier this year, and now looks expensive again. The rally has once more been driven by interest-rate cuts.

Perma-bulls do love their broken-clock analogy. Whenever a realist/bear is proved correct, the “bulltards”, as Denninger calls them, snidely remark that even broken clocks are right twice a day. They never bother to think about why the bear’s analysis was right. They only care about the ticker and their paycheck which depends on it. Inflation, accounting manipulation, bailouts – none of these matter (except as they will affect markets).

Most never stop to think about the root of the problem. Bears do. When the dust settles after a bust, it’s amazing how quickly the focus shifts to getting in on the next bubble. So-called pessimists are the only ones trying to figure out what went wrong, and how it can be avoided in the future. I truly appreciate that The Economist recognizes this fact.

Bearish commentators provide a valuable (and largely thankless) public service.  Think Peter Schiff highlighting the moral hazards of bank bailouts, Bill Black and Nassim Taleb railing against corruption and systemic risk, or Ron Paul fighting against inflationary policies. Such efforts are critical for any meaningful economic reform.

Bearing Ain’t Easy

Most bears don’t set out to profit from gloom and doom. After all, being a bull is infinitely more profitable. Consider Wall St. analysts and execs: 99% perma-bulls, constantly pumping stocks with questionable motives and limited insight. The few critical-thinkers, like ex-Merrill Lynch top economist David Rosenberg, inevitably end up elsewhere.

There is no place for realists on Wall Street. They talk a lot about corruption, transparency, and the stealth-tax of inflation. Where’s the profit in that? As The Economist states, “NOBODY loves a party-pooper”. That applies doubly for Wall Street.

It’s certainly no fun being a bear at dinner parties (as my wife constantly reminds me). Nothing dampens a mood quicker than saying fair-value for the S&P 500 may be around 400, and the only thing propping it up is taxpayer cash and changes to accounting rules, both of which are utterly unsustainable. I also advise against informing the masses that inflation is inevitable, and explaining how it benefits precisely the wrong economic players. Or that the alternative to an inflation-based recovery is a severe (but necessary) economic contraction, which would result in a lower standard of living while the economy adjusts.

Nope. Lately I just steer clear when stocks come up. I change the subject to something safer; abortion, war, maybe affirmative action. Kidding, only kidding… Fantasy Football works like a charm in my circles, and I’m happy to talk shop since all 3 of my teams are on a tear this year. Here’s to hoping Frank Gore gets healthy soon!

David Rosenberg discusses ugly September data, and why this recovery is not sustainable:

THUD, DUD AND CRUD

There’s no other way to describe the U.S. employment report that was just released for September. And guess what? The rose-colored glass donning set of economists who have been talking about sequential improvement in the data and how “less negative” the employment numbers have become can’t say that after today (thank the good lord). That’s because at -263,000 on nonfarm payrolls, instead of the -175,000 print that was widely expected, we actually saw sequential deterioration for the first time since May as the August decline was -201,000 (though revised from -216,000; July was revised lower to -304,000 from -276,000). If you think that is bad, consider that the Household Survey showed a massive 785,000 plunge in September which again was sequential deterioration because the decline the month before was 392,000…

These numbers far from validate the overwhelming consensus view that the recession has come to an end just because of one positive stimulus-crazed GDP print (didn’t we have that in 2008 too?); not to mention the fact that the last time we came off such a two-month falloff in Household employment was back in March when the stock market was testing fresh 12-year highs.

Sustainability is the key and there can be no durable recovery without net job creation and organic wage growth. Both were lacking in today’s report – in fact, the combination of the workweek edging back down to retest the all-time low of 33.0 hours and the near-stagnation in hourly wages dragged the proxy for personal income down 0.2% (reads: in nominal terms) and the year-over-year trend is getting perilously close to deflation terrain at +0.7% from +0.8% in August and +1.2% in July.

Great commentary, as always. The big question is: When harsh reality sets in, what will the policy response be? If leadership believes they can spend more, they will. America’s lenders have started making noise about fiscal responsibility and inflation. Will they balk next go-round?

The near-term deflationary data will likely embolden the Fed with their monetary decisions. That much seems certain.