Dear Diary,
Things are slowing down. This is Thanksgiving week. People are leaving work early, trying to beat the holiday traffic rush.
US stocks and gold were flat yesterday.
We’re still in New York, taking care of business. Tomorrow, we’ll get an early start and head back down to Maryland.
We have a lot of young men coming for the holiday – friends of our sons. Your correspondent does not like to see young men with idle hands.
A strong back is a terrible thing to waste! So, he has a project: to save an old tobacco barn, using the soft hands of these future lawyers and financial managers.
The trouble with most young people, we’ve observed, is they don’t know how to use their hands. They’ve spent their entire lives in school and on laptops and smartphones. Few have had any contact with tools or hard work.
Our plan – for the benefit of readers interested in tobacco barn preservation – is to turn an old-fashioned oak-frame barn into a pole barn.
The sill is rotten, as are many of the main supporting posts. We will dig holes, plant treated 12-inch poles in concrete and bolt them to the uprising posts above the rot. And we will hope that the barn doesn’t fall on our heads when we start banging on it.
“You’re gonna do this with a bunch of college boys?” asks Tommy, a much weathered local man who has spent his whole life “movin’ dirt.”
“You’re gonna put a hurtin’ on ’em.”
Yes. That’s the plan.
We’ll let you know how it works out.
Fantasy World
Meanwhile, as Chris pointed out yesterday, in politics and economics we live in a fantasy world.
The feds claim to improve our economy. We pretend to believe it.
Did a central bank ever add one single centime, one peseta, one zloty or one fraction of a mill to the world’s wealth?
Not that we are aware of.
But all over the world, central bankers pretend to sweat and toil on behalf of mankind – correcting… adjusting… nullifying the decisions of honest men and women going about their daily business.
Interest rates are too high! Inflation is too low! Not enough demand! Too much savings! They are omniscient as well as all-powerful.
In Japan – now back in recession – Prime Minister Shinzō Abe has taken off on a kamikaze mission. Victory or death! He will either revive the Nipponese economy… or he will kill it!
Abe may succeed. But we’re happy to bet he doesn’t.
Our new Trade of the Decade – buy Japanese stocks and sell Japanese government bonds – aims to capture the disaster in dollars and cents.
Abe and his delusional copilot at the Bank of Japan, Haruhiko Kuroda, have their flight jackets on. They’re about to take off… creating incredible amounts of new money and credit.
The Japanese economy expects it and depends on it. But when word gets around that there is no way the government can ever repay its debts, there is sure to be trouble.
Investors will dump Japanese government bonds, leaving the Bank of Japan as the only source of financing for the government’s deficits.
This will put Japan in roughly the same spot as Zimbabwe in the early 2000s… and Argentina in the 1980s. Stocks will soar, as investors seek safety in productive assets. Bonds and the yen will crash.
A Clear Message
And in Europe, Bloomberg reports:
Mario Draghi strengthened his stimulus pledge for the euro area by saying the European Central Bank can’t hold back in its fight to revive the economy.
“We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires,” the ECB president said at a conference in Frankfurt today. Some inflation expectations “have been declining to levels that I would deem excessively low,” he said.
“Draghi is sending a clear signal that more stimulus is coming,” said Lena Komileva, chief economist at G Plus Economics Ltd. in London. “If the ECB’s current measures prove underwhelming and inflation expectations fail to recover, the ECB will act to expand QE.”
In the Old World people expect stable prices.
What’s wrong with that? we hear you asking.
But it’s a problem, says its chief banker. “Excessively low” is how Draghi describes the public’s fear of inflation. He vows to do something about it.
What?
The same thing the Japanese are doing!
In the New World the real economy continues to deteriorate. But the stock market floats along like a hot-air balloon in a children’s cartoon.
The Fed has turned off the QE gas. But it has its hand on the valve, ready to turn on the jets as soon as prices sink.
More to come tomorrow….
Regards,
Bill
Keep an Eye on Starting Valuations
As we’ve been warning members of Bill’s family wealth advisory, Bonner & Partners Family Office, investors today are focused on the doctor, not the patient.
It has largely been the efforts of central banks and governments to revive a flagging economy that has moved markets, not real economic change.
This is certainly the case in Europe…
The Stoxx Europe 600 Index – which tracks large-, mid- and small-cap companies across the 18 countries in the euro zone – just hit a two-month high.
This comes hot on the heels of Mario Draghi’s promise that the ECB “must raise inflation” as soon as possible.
Draghi is telegraphing massive QE in Europe. Stock market investors there are responding by bidding up stocks.
It’s also the case in China…
Yesterday, Chinese stocks trading in Hong Kong rallied the most in a year after the People’s Bank of China governor Zhou Xiaochuan surprised the market by announcing the first interest rate cut since July 2012.
The cut – which lowers the one-year bank lending rate by 40 basis points to 5.6% – follows news that Chinese factory orders in October rose at their slowest pace since 2009… retail sales fell below expectations… and the economy is set to grow at its slowest pace since all the way back to 1990.
Zhou joins Draghi and Kuroda in the “stimulus or die” camp.
That doesn’t mean all markets are created equal. Although many of the major economies are the subject of central bank stimulus of one form or another, valuations vary hugely from market to market.
You can buy the Chinese stock market for less than seven times trailing 12-month earnings. It will cost you 20 times trailing 12-month earnings to buy the S&P 500. That’s a discount of 65%.
And on a Shiller P/E basis – which looks at the average of 10 years of inflation-adjusted earnings and is a better indicator of future returns – as of the end of last month, the Chinese market traded on a multiple of 17.2 versus a multiple of 27.2 for the S&P 500. That’s a discount of close to 37%.
That’s a big deal. As Mebane Faber of Cambria Investment Management points out, low starting Shiller P/Es produce MUCH stronger long-term returns than high starting Shiller P/Es.
According to Faber, adjusted for inflation, the US stock market has returned 5.8% a year going back to 1900. And starting Shiller P/Es ranged from 6 (1920) to 44 (1999).
If you group the roughly 11 decades into thirds, and average the best returning four decades, you see the effect of starting Shiller P/Es.
The best four decades saw 10.4% annualized GAINS and had an average starting Shiller P/E of 13.25.
The worst four decades saw 1.41% annualized LOSSES and had an average starting Shiller P/E of 24.5.
This looks at results of different starting valuations across time in the same market.
But a strategy of buying the stocks of the cheapest countries as ranked by the Shiller P/E, holding for a year and repeating would have returned between 15.9% and 17.6%, compounded annually, from 1980 to 2013.
The MSCI EAFE Index – which tracks the performance of 21 international developed markets outside the US and Canada – returned 9.6% over the same period.
Our advice: Make sure you diversify your stock market portfolio globally. Favor stock markets that are inexpensive relative to long-term earnings over stock markets that are expensive relative to long-term earnings.
If you have the discipline – and the stomach – to stick to this strategy, you’ll do well over time.