El-Erian: Bull Market Won't Last

[Parsad]

I don't always agree with Bill Gross, but I've come to appreciate the clarity with which Mohammed El-Erian, CEO of PIMCO, portrays the credit markets and economic environment.  I don't think I've heard an explanation as simple and clear as his in this CNBC interview.  Cheers!

 

Story:

 

http://www.cnbc.com/id/32334381

 

Interview:

 

http://www.cnbc.com/id/32200989/

 

 

[Parsad]

Actually Bill Gross' August Letter is quite good and expounds on El-Erian's comments.  This is pretty much what we talked about in our 2nd Q letter...low growth, modest prosperity, increased frictional costs, more efficient business, higher unemployment and several years of continued recovery.  He also has some wonderful shots at the money management business.  Cheers!

 

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Investment+Outlook+August+2009+Gross+Investment+Potion.htm

[TorontoRaptorsFan]

El-Erian's interviews on WealthTrack with Consuelo Mack are really good.

 

They're all available for download on ITunes.

[link01]

yea, the pimco august commentaries from gross & el-erian are extra intriguing, coming as the markets have been furiously clawing their way up that old slope of hope, where green shoots can be seen blooming over the other side of the valley.

 

but others see a recession thats unequivitably ending, citing a synchranized global surge just under the surface.

 

so cast your votes!

 

http://www.businesscycle.com/news/press/1481/

 

http://www.ritholtz.com/blog/2009/07/synchronized-surge-strengthens-since-april/

 

[Parsad]

Hi Kumar,

 

I think El-Erian had a very good answer for that as the interviewer said the same thing.  Any investor has to have some broad understanding of the capital markets.  Bonds finance corporate America, thus what happens there is directly correlated to equities.  Plus some of us do buy bonds!  ;D  Cheers!

[Zorrofan]

If we are going to vote - my vote is that it isn't over, not by a long shot! Many investors have forgotten a few things already......

 

Mortgages to refinance

 

http://www.bloomberg.com/apps/news?pid=20601109&sid=arb3xM3SHBVk

 

Unemployment still high

 

http://www.foxnews.com/opinion/2009/08/07/john-lott-unemployment/

 

We live in interesting times!

cheers

Zorro

[Guest Broxburnboy]

Most bearish prediction from a reliable, analytical source:

 

John Williams at shadowstats.com separates the sh*t from the shineola:

 

http://www.321gold.com/editorials/williams/williams080509.html

[scorpioncapital]

I don't care who this guy is, anybody who thinks they can confidently forecast the future of the stock market or the economy is philosophically flawed in his/her reasoning.

[20ppy]

This guy did some research and comes up with a probability of some future events in the markets and I don't think this much is flawed. However his data, perspective and the way he does it, would in reality simply imply a probability of accuracy. The second probability is not always zero.

 

[Guest Broxburnboy]

I don't care who this guy is, anybody who thinks they can confidently forecast the future of the stock market or the economy is philosophically flawed in his/her reasoning.

 

Every investor, particularly those who do proper due diligence, is forecasting the future of the stock market including those who use technical analysis. When we buy (or short) a stock, we are expressing confidence in our own analysis.

 

There is a school of thought (supply side economics/trickle down theorists) who believe that the markets predict the future and there are those who believe that markets will eventually reflect the realities of the underlying economy. We seem to be in a period where there is a huge disconnect between these opposing views and will shortly find out which point of view is correct... either the markets will recover  and drag the economy with it, or the economy will stagnate/deteriorate and the markets will go south. It looks like those who have been quoted on this thread are of the second opinion ... that the dog wags the tail and not the other way around.

[Parsad]

Excellent answer Broxburnboy!  Cheers!

[Parsad]

The other issue facing the economy, along with Alt-A and Opt-A refinancings, are the commercial property mortgages and decreasing values as commercial properties are sold over the next two years.  I had mentioned that one of our partners renewed leases on his commercial properties by offering an across the board 20% rent reduction.  He was probably smart to do that this year, as rents will probably decrease more than that in 2010 and into 2011.  Cheers!

 

http://www.bloomberg.com/apps/news?pid=20601109&sid=aFp6TE9kWkqk

[JAllen]

There's a huge difference between owning a handful of stocks and predicting that the entire S&P 500 is going to move in one direction or another.  It's barely comparable in my opinion.

[mpauls]

 

 

Forecasting the future of the stock market is very different from forecasting the future of your investment in a particular company.

 

There's a huge difference between owning a handful of stocks and predicting that the entire S&P 500 is going to move in one direction or another.  It's barely comparable in my opinion.

 

Huge difference. 

 

One is very general, the other specific.  So while they are similar in that your making some guess about the future, they are quite different in that one is a cross-section of a nations production of goods and services and the other is (generally) specific to one or more related/identifiable products.  It's not hard to conclude that the government will employ policies that promote at least some inflation, which will cause prices to go up.  If, as I think most do, investors are interested in income and earnings then if prices go up in equal proportion to the costs of labor (more or less) then values should rise in similar fashion for most businesses.  I think that is quite a different thing from saying, you expect xyz to increase production by such-and-such percent, which will lead to lower costs per unit production from scale of such-and-such amount, which will increase profits and per share earnings by such-and-such after the assumed net change in stock buy backs and therefore after discounting by some interest rate (or interest rates) it might be purchased for $x1y2z4 today such that you might expect some rate of return. 

 

But this ignores the main reason people invest.  If you conclude that some inflation is likely and you choose not to invest, you are essentially taxing yourself.  So the purpose for most people is to protect their savings (i.e. future purchasing power.)

 

To be fair to each argument, investing is in some ways forecasting.  But investing in the general stock market is a far cry from projecting a companies future earnings over the next 1-5 years and discounting it back to today.  But while it may appear that I am in favor of the former more so than the latter, this isn't necessarily the case.  It's the timing of the general market that gets people in trouble theoretically and in practice-largely due to (as someone mentioned) psychology.  Trying to guess what irrational and uninformed individuals will do on any given day or in any given year is, well, silly.  I mean just look at what happened to Berkshire Hathaway's stock today or over the last 8 months. Most people on this board are more sensible than "industry or investment experts" (most of which are either idiots or have been brainwashed).  Most people on this board are also more rational than average.  Why make life hard studying facts that may or may not be relevant and then trying forecast uncertainty?  Especially when you can make a really good living by identifying companies that are stupidly undervalued and following up this simple conclusion with the decision to make purchase? 

 

 

 

[locutusoftexas]

Forecasting the stock market is much more difficult than, say, the weather because we know the differential equations governing the weather but there is no such knowledge of markets.  There we have a very large number of degrees of freedom and relatively few numbers with which to characterize the system.  With our superior knowledge of the atmosphere and the huge number of data points with which to populate the models, we still do a very lousy job of forecasting the weather. Further, humans are linear thinkers. These interacting systems are most likely nonlinear. There is no reason to assume that we can forecast the markets with any accuracy.

 

Meanwhile, upon reviewing the stock market history of the 1920s, Ben Graham's frustration with attempts at valuing stocks (i.e., at developing formulas) became more understandable to me. The only value to an individual investor is the amount of cash that the investment generates, i.e., the dividend yield. Since the 1950s (and maybe earlier), the return has been gauged in terms of capital appreciation rather than dividends.  As we have seen over the last year, capital appreciation is ethereal. On the basis of dividend yields and bond yields, stocks have been overvalued for decades. This is more apparent with the lack of investor influence over company policy (vis a vis capital allocation and return to investors) and the fact that companies become bankrupt, resulting almost always in complete loss of value of the equity.

 

Given the present situation, the emphasis of the individual investor must be on risk management. The concept of a stupidly undervalued stock is itself an illusion as we cannot know what the managers are doing with the company from day to day and what decisions they are making.  For this reason, a selling strategy must be as important as what to buy.  Buying what we understand, if properly applied, would prevent our buying more than one or two stocks.  Large corporations, like pharmaceuticals, are vastly overvalued as the dividends do not compensate us sufficiently for risk and we cannot influence their policies at all.

 

Regards,

Tex

[mpauls]

The only value to an individual investor is the amount of cash that the investment generates, i.e., the dividend yield. Since the 1950s (and maybe earlier), the return has been gauged in terms of capital appreciation rather than dividends.  As we have seen over the last year, capital appreciation is ethereal. On the basis of dividend yields and bond yields, stocks have been overvalued for decades. This is more apparent with the lack of investor influence over company policy (vis a vis capital allocation and return to investors) and the fact that companies become bankrupt, resulting almost always in complete loss of value of the equity.

 

Given the present situation, the emphasis of the individual investor must be on risk management. The concept of a stupidly undervalued stock is itself an illusion as we cannot know what the managers are doing with the company from day to day and what decisions they are making.  For this reason, a selling strategy must be as important as what to buy.  Buying what we understand, if properly applied, would prevent our buying more than one or two stocks.  Large corporations, like pharmaceuticals, are vastly overvalued as the dividends do not compensate us sufficiently for risk and we cannot influence their policies at all.

 

Regards,

Tex

 

"Tex"  The greater proportion of your points are valid.  The residual might warrant improvement.  

 

I would substitute, "i.e., the dividend yield" with e.g. the dividend yield.  Whether or not it was part of your point, to say that earnings are meaningless unless paid out as dividends is incorrect.  Dividend yield or increases in dividends as a measure of return is not much of an improvement from capital appreciation.  For years GM paid what appeared to be a meaningful dividend, but these payments, though cash in the investors pocket, turned out to be worthless in relation to the loss of principal they ultimately suffered.  

--

 

I love the term Risk Management.  It's a nifty little word that the industry just loves.  It's almost as amusing as Due Diligence.  Granted there are ways to mitigate risk (properly defined) but for the most part money managers who talk about Risk Management, offer little more than a false sense of security.  (If you jump the gun this will be taken out of context.)  

 

A comment on sell strategies as they relate to what must come first, buy strategies.  While they appear to be two things, they are effectively the same, because all you are really talking about is being able to rationally appraise underlying business value.  Meaning, if you can't identify companies that are stupidly undervalued, then good luck with your sell strategy-and good luck trying to justifying your fees. (exception: special situations, workouts, etc.) 

 

[mpauls]

p.s.

(i)  Not everyone lost money over the last year. 

(ii) Not everyone is subject to bankruptcy.

[locutusoftexas]

I hear you. Over much of my investing career, I bought the line that you are espousing and I made (for me) a lot of money. However, my point is that I was lucky.  Business value is a useful concept, if you are going to buy the business, lock, stock, and barrel, as Warren Buffet has always preferred to do, since the 1960s.  Then you become the owner and get the cash that the business generates.

 

However, I am speaking about a small investor, who can only hope either for the business value to be realized in the market price or for a return through dividends. The people running the company decide what to do with the earnings. I have concluded that they are not trustworthy in general, and they can easily make mistakes, misuse the earnings, and cause a disaster. The problem is that we do not know which ones will avoid disaster and work for shareholders (see below). Hence my belief that, on average, the only way a small investor should value a company is by actual cash return. Anything not realized can disappear, just as "receivables" often do.

 

As Ben Graham found, one can analyze the value of a large number of businesses and rely on statistics to achieve a good return. As you point out, not all companies go bankrupt or lose money. (Many "undervalued" businesses probably lost money last year however.) So investing in a considerable number of undervalued businesses and taking profits (sell strategy!) can work reliably.  However, in the end, I believe that the failure to remunerate shareholders with dividends is a very large negative in a small investor's method of assessing business value (to that investor).

 

Regards,

Tex

[mpauls]

Fair enough.  I'd comment further.

 

To whom thy secret thou dost tell, to him thy freedom thou dost sell.