Sunday, January 03, 2016

I predict the S&P 500 will end 2016 at 2,336, up about 14% from its year end 2015 figure of 2,044

Cliff notes

I predict that the S&P 500 will end 2016 at 2,336.  This represents a 14.3% increase above the year end 2015 figure of 2,044.  Barring a black swan event, I think the risks to this forecast are slightly to the upside; that is I think we could see the S&P above 2,400.  Note that the current all time high for the S&P 500 is 2,134, so I am predicting a series of fresh all time highs.

I would likely predict about the same 14% increase for the Dow Jones.  It closed 2015 at 17,425, so I would predict it ends 2015 at about 19,865.  Obviously 20,000 would be very much achievable if my forecast is right.

I note that I have been bullish on the market for a LONG time, and remain so.  More on that in an upcoming blog post.

I arrive at my prediction of 2,336 for the S&P 500 by assuming about a 14% increase in earnings for the 500 ish companies in the index, while keeping the price to earnings multiple the same. .

I expect the US economy to grow about 2.5%, just slightly above the very boring 2%+ range it has been in for much of the recovery.  (I must note here that I have been noticeably too optimistic about US GDP growth for years).  I expect interest rates to rise gently (perhaps 50 basis points on the 10-year treasury bond).  I expect inflation to pick up once oil bottoms, but not in a fashion that will scare the Fed or the market.  I expect the fed to raise interest rates only 2 or 3 times in 2016, as a still sluggish economy, and slightly slowing job growth mean that a real inflation scare is very unlikely.

I arrive at my 2016 Price Target by Estimating S&P 500 earnings and estimating a Price to Earnings Multiple

One way to value a stock or a market is by the age-old price to earnings ratio.  If a stock trades at $10/share, and earns $1/share, it has a Price to Earnings ratio (P/E) of 10 (and is often considered cheap).  The same valuation methods work for the S&P 500.  However, this is not a simple process.  First, you need to predict the earnings, or the E.  This is tricky enough, and estimates 12 months ahead are often well off the mark (typically too optimistic).  Next comes the harder part. You must assign a multiple.  Simplistically, if a market (or a stock) trades at a low multiple, say 10, that means the market is pessimistic on future earnings growth for that company.  Interest rates also play a large (and in my opinion hugely under appreciated) part in assigning an appropriate multiple.  Low interest rates should and typically do mean high P/E multiples, and high interest rates mean low multiples.

Thus in order to arrive at a price target for the S&P 500 by this methodology, I need to (a) estimate earnings for the S&P 500 in 2016; (b) estimate the Price to Earnings multiple at year end 2016; and (c) multiply the earnings by the multiple.  The result of that multiplication is my price target.  Is this a valid exercise?  Yes, I think so.  There are a series of assumptions that go into my estimate of the "appropriate" multiple, and disagreement with these can easily yield strong disagreement on the multiple I assign, and a wildly different price target.  I don't mean to make this sound scientific.  But I humbly submit there is some science involved.

S&P EPS 2015

Earnings per share for the S&P 500 for 2015 were about $105/share.  That is the number I am using.  (Its impossible to know exactly as final results are not in yet and I found significantly different numbers in a few places, some lower, some much higher.  

Raymond James said just a few weeks ago that 2015 earnings were $107.   

Standard & Poors' spreadsheet, with some extrapolation, yielded $105, so that's what I'm going with.   (additional Info, Index earnings).

I note that as for the obvious question what does S&P 500 earnings per share mean, the issue is quite complex. There is no one company, obviously. Instead, its a formula, based on the earnings of the constituents of the S&P 500, multiplied by the company's weight in the index.  Thus Apple's earnings count for more than General Electric, as Apple's market capitalization is nearly double GE's.  And so on, with smaller companies counting for less.  Honestly, I don't really understand the formula, except in broad outline.  Happily, I don't have to.  By relying upon published actual and estimated earnings per share and using the closing price of the index, I can easily compute the price to earnings multiple (as many do) and go from there.  I don't really need to understand precisely how it is computed.  

S&P 500 Price to Earnings Ratio for 2015.

The S&P ended 2015 at 2044 (rounded to the nearest whole point).  Thus the Price to Earnings ratio at year end 2015 was 19.47 (2044/105 = 19.47).  I use this P/E ratio to come up with my 2016 target for the S&P 500.  I assume no change in the multiple at all.  While this is obviously very unlikely to occur precisely, it does mean that I am not relying on any expansion of exuberance on Wall Street.  

S&P P/E recent history

19.47 is a fairly high P/E ratio historically, but not wildly so.  the ratio was MUCH higher during the wild bull market of the late 1990s, when I think nearly everyone agrees the market was significantly overvalued.

I think 19.47 is slightly below where the P/E ratio should be, given that inflation is VERY low, interest rates on long term government treasuries (key competition for bonds) were VERY low compared to history, and earnings growth potential for the next few years was/is good.  Obviously, one can disagree with these key assumptions.

One way to look at this is what is called the earnings yield.  This is merely the inverse of the Price to earnings ratio.  If the P/E ratio is 20 (close enough to the actual 19.47 for this big picture point) that meanings the Earnings yield of the S&P 500 (earnings/price) is 5%.  Put another way, stocks are "earning" 5%.  $105/share in earnings is just under 5% of the 2,044 that the S&P ended the year.  That's a pretty good deal in comparison with the 10 year treasury bond, which closed the year at 2.27%.

Predictions for S&P 2016 Earnings Per Share 

I am "estimating" 2016 earnings to be $120/share, a number I believe to be slightly conservative.  When I say I am estimating, what I really mean is that that is the number I am ASSUMING.  I lack the capacity (by a long shot) to actually run bottom up estimates for what each of the 500 (ish) companies in the S&P 500 index will earn and then multiply each appropriately.  Instead, I am relying upon estimates by the big banks.

RBC (Royal Bank of Canada) predicts S&P earnings for 2016 of $124/share (recently cut from an earlier $128).

Raymond James predicts $126/share.

Goldman Sachs in late September predicted $120/share for 2016:

Barrons states that the mean average Wall Street estimates for 2016 are $123.50, with most estimates being higher.

I am assuming $120/share.  $120 represents about a 14% increase in earnings over 2015.  A 14% increase in earnings may seem very optimistic, but is in line with earnings estimates by Wall Street, above, (which I freely admit are almost always too high).  I think this time the estimates are slightly too LOW because I expect the consumer to finally spend more of the savings resulting from massively lower oil prices, while the negative effects of lower oil should be largely played out.  If it sounds like I am saying this time is different, that's because I am.

By coincidence, the $120 estimate I am using for 2016 is exactly the same as Goldman's estimate.  I think the risk is to the upside; that we could actually end up between 125 & 130, as the more optimistic seers on Wall Street are predicting.  However, I have been too optimistic on economic growth (which tends to yield higher earnings) for a long time now, and its time to make a different mistake!

S&P predicted 2016 P/E and thus target price for 12/31/16

2016 earnings per share of $120 X the projected P/E ratio of 19.47 = my target of 2,336.

The final item necessary for me to come up with a price target for year end 2016 is to estimate the Price to Earnings multiple at the end of 2016.  This depends on my view of interest rates (gentle rise), inflation (rise), and my prediction for overall optimism of the market in general (about where it is now, or slightly more optimistic).

As I said above, I am using the P/E ratio from year end 2015, which was 19.47.  I think that forces pulling it higher are evenly balanced with forces pulling it lower.

Forces pulling the P/E higher include slightly better economic growth, a predicted encouraging rebound in earnings, better numbers out of Europe and possibly Japan, China failing to implode and slightly less pessimism about the US recovery.

Forces pulling the P/E lower include slightly higher interest rates, continued sluggish growth, potentially a further rise in the dollar (this would surely effect earnings, whereas the effect on the P/E multiple is not clear), and, most importantly, a rise in inflation, as we lap the sharp declines in oil prices.

Crucially, I am betting that Janet Yellen does not panic in the event inflation rises slightly as she and others predict, and raise short term interest rates quickly.  That is absolutely mission critical to everything written here.  If the economy performs as I expect, and Yellen raises rates 5 or 6 times, the market should be about flat for 2016 even if we do earn the $120/share on the S&P 500 that I am assuming.  The reason is that the market will take down the P/E ratio in a world of rapidly rising short term interest rates and a sluggish economy.  In contrast, if we see 3%-3.25% GDP growth, the market would happily accept 5 or 6 interest rate hikes.  This is a very unlikely scenario.

A final word about inflation.  Inflation should FINALLY move towards or even above the Fed target of 2%.  With the recent sharp price DECREASES coming off the books, and a predicted somewhat higher oil price for the year, the inflation in the rest of the economy (health care, education, rent, housing) becomes a larger weight in the CPI. See Bob Johnson of Morningstar.

Tuesday, November 04, 2014

Senate Predictions:

I predict that the GOP will take the Senate tonight relatively easily, netting 8 seats.  Most of these elections will not be close, although runoffs are very possible which would, in my view, delay the inevitable.

First, the 3 currently GOP held seats which the democrats could conceivably win.  The GOP will hold Kentucky.  McConnell will not lose a red state seat where Obama's name is mud.  Not gonna happen. Second, Georgia.  Sam Nunn's daughter is putting up a real fight.  If it were 2008 she'd win.  2012 she might win.  Not in 2014, though it won't likely be a blowout.

Third Kansas.  I have no idea who will win Kansas.  The GOP incumbent is VERY unpopular.  The state is VERY red.  Obama is VERY hated.

So I see the GOP has very likely holding two and don't know about Kansas.  Forced to predict, I would predict the challenger wins and chooses to caucus with the GOP!

The above predictions leave all currently GOP held seats in GOP hands.  There is certainly a chance the democrats snag Kansas, but even that won't save them if my predictions are right, as shown below.  Assuming the GOP does hold the above 3 seats, it needs to take 6 seats from democrats to gain control.

The GOP will definitely take West Virginia and Montana.  The democrats winning either of these would be a MONSTER upset, and won't happen.  I further predict the GOP will take South Dakota, though, amazingly, that isn't a sure thing.  But if the GOP takes these three seats, and holds the above mentioned seats, it needs 3 more seats to take control.

The possibilities are many: Alaska, Arkansas, Colorado, Iowa, Louisiana, New Hampshire, North Carolina.  That's 7.  Of these, I think the GOP wins all except for North Carolina and New Hampshire.  Thus I have the GOP taking 5 seats here, plus the three mentioned in the previous paragraph, for a total of 8.

In a massive wave, there are other democrats that could lose, but I don't think that's likely and I don't predict any further losses.

All in all a disastrous night for the democrats, though, as I will show in a future post, not at all a good predictor for the 2016 Senate elections.

Monday, November 05, 2012

Obama will win tomorrow, and receive 303 electoral votes

I know its VERY late for my election predictions, but I never got around to it before tonight.

Obama will win.  It won't be anything like the margin of 2008, obviously, and some states won't be called until after 11, but he will win.

Of the swing states:

Romney: wins Florida (by about .3%)and North Carolina by about 1.5% (some chance of Obama upsetting Romney in Florida)

Obama wins all of the rest of them: Minnesota (by 8), Pennsylvania (by 4), Michigan (by 10) (blue states won by Gore/Kerry), as well as the true swing states (New Hampshire (by 2), Nevada (by 4), Iowa (by 3), Colorado (by 1), Wisconsin (by 5!), Virginia (by 2), OHIO (by 3.3 or so).

This adds up to 303 electoral votes (270 is the magic number).

If all of my other predictions are correct, Obama could lose OHIO and still win (he would have 285, and could still spare 15).

If you see Virginia or Colorado called for Obama, he's all but a shoo in.  In contrast, if both North Carolina and Florida are called quickly, within 1 hour after their polls close, then it becomes reasonably like I am wrong, and Romney might even win.

In the end, its a highly similar election, really, to 2004, with the incumbent at about 50% job approval and a weak challenger from Mass.

The democrats will also hold the Senate.  I predict 53 Democratic Senators (counting the new Senator from Maine and Bernie Sanders of Vermont, the two independents (after King from Maine wins) who are politically liberal and will caucus with the democrats.

Put another way, 51 democrats, 2 independents, 47 Republicans.

There you have it.  Here's hoping my predictions are anything like as good as 2008 (very VERY good) as opposed to 2004 (predicted Kerry by 2.5) and Gore (predicted he'd win, let's leave Florida out of this).

Sunday, March 11, 2012

Further investment ideas.

I have been thinking a lot about the markets in recent weeks, and talking a lot about them, to anyone who would listen, and more than a few people who wished they didn't have to.

Two caveats.  First, nothing in this blog post is investment advice!  You must do your own homework!  Second, I own stock and/or option positions in every company mentioned in this post except JP Morgan, which I'm considering buying.

Here is what I've been thinking about.  I have a few GREAT investment ideas which I'll outline.  Cheat sheet-- BUY STOCKS.  Especially buy cyclical stocks and big banks.  I am especially bullish on Citigroup, GM, Ford and GE.  Not because I think they will triple quickly or anything (though both Citi and GM should double or come close in the next two years if most things go right) but because I'm super confident that each of these are seriously undervalued.  But more on that later.

The conditions I laid out as crucial parts of my investment thesis in my last post, hold.  Europe is successfully muddling through, and will VERY likely avoid the worst outcomes which involve contagion.  The manner in which they are doing it is very stupid, and harmful to Europe long term, but that's another post.  Suffice to say Merkel and company won't let Greece/Portugal take down the world economy a la Lehman, and new flyingpinkunicorn fave Mario Draghi, the new head of the ECB will not let banks take down the global financial system, a la Bernanke.

Second, the US economy is improving, though recent data causes me to think the expansion has slowed a bit and may remain slow until about June when it should pick up again.  Although we do not yet have the Obama Boom I wrongly predicted a few years ago, all signs are indeed more positive, and auto sales are particularly strong, a sign of consumers having long term confidence (as well as beat up old cars).

As for specific investment ideas, the two that I mentioned prominently were TBT, an ETF which shorts interest rates, and IFN, a Closed End Fund which owns shares in Indian stocks.

On January 3, when I recommended TBT, it was at 18.60.  It closed Friday at 19.27.  That's a 3 % return in two months and change.  Not pathetic, but not great considering the market has beaten that by a mile.  I NO LONGER RECOMMEND TBT.  I have concluded that the fact that instrument (designed to vary by twice the inverse of a basket of long term bonds) does not do this accurately over periods longer than a single day renders it useless for a long term investment.  In addition, I appear to have been premature on my call that interest rates will rise.  They may not rise much until after the Fed's Operation Twist concludes in June, and maybe even a tad later.  I have instead bought put options on TLT which expire in January.  This ETF will, at least, accurately track long term interest rates (with a direct 1-1 relationship) over time.  So a put on TLT does indeed serve as a bet on longer interest rates.  I am not as excited about this call as I was in January.

IFN, an ETF which owns Indian stocks, turned out to be a brilliant short term call.  IFN was $19.68 when I recommended it on January 3rd, and closed this past Friday at $23.23.  That's a tidy 18% return in two and a half months!!!  A Monster return, obviously.  I did not advocate IFN because I thought the Indian market would soar overnight, but instead as a long term play.  My strong belief that India is the next China is intact.  It won't be as clean and neat an economic rise, but a rise it will be, and a stockpicker who can pick the right companies in India can make a glorious amount of money if my predictions come to pass.  The folks running IFN seem to know what they are doing, so there is no reason I can think of not to buy IFN if you are thinking long term.

As for my American stock plays:

GM/Ford-- their stock is ridiculously low compared to their profits last year.  Car sales are WAY up this year in the US, and both companies are going to make a metric boatload of money in the US this year.  Europe will be a big drag, and China may be a potential pitfall for GM (it currently makes a lot of money in China) but roaring success in the US should drown out international woes.  Both stocks have already run up nicely this year, but have a long LONG way to go.  In addition, the market is only trading at 13 times last year's earnings.  With interest rates this low, that is an absurd multiple.  That multiple should increase to a historically normal 15 or so sometime in the next 2 years.  That implies a big further rally in this already remarkable bull market, which turned 3 years old and 100% big just last week.

Citigroup (and JP Morgan, and probably Bank of America) are wildly undervalued.  The market still doesn't begin to trust these mega financials and their mega balance sheets.  With good reason.  But the market has gotten carried away.  They've already run up big this year (my Citi shares and all of my Citi options are in a lovely shade of green) but have MUCH more room to run.  Sometime this week, the Fed is HIGHLY likely to say that all financials have passed its (stressful) stress tests.  Citi has presumably already asked for permission to increase its dividends/institute a stock buyback.  I predict this permission will be granted.  Don't know when, sometime in 2012.  If/when that happens, I expect an immediate pop in the stock of at least a buck, and a whole lot more bucks in the stock price after that.

GE: As soon as the Federal Reserve approves it, GE Capital should resume paying a dividend to the parent, GE, as opposed to hanging onto all of its cash.  GE should then be able to increase its dividend and share buyback, as the CEO has repeatedly publicly stated he wants to.  That should cause some of the share price increase I seek.  Excellent quarters this year in most parts of the company should cause still more of it.  Finally, I think the market overall is undervalued.  Add all of that together, throw in a 3.57% yield, and I think GE is a clear buy (and hold!) for the long run, and a fine buy for the short run as well.

Tuesday, January 03, 2012

Two hot new investment ideas for 2012. 

Happy new year blog followers!  I know I don't post frequently anymore.  Happily, I've been very busy working, as well as with life, so I don't have the free time I used to to put together detailed long blog posts on the issue of the day.  But there are a few killer investment ideas that I just have to share.  Want to make 50% or more on your money in the next 12-18 months?  Read on.  Needless to say, these ideas are, for the most part, very very risky.  Not for the faint of heart.  And nothing herein constitutes investment advice, of any kind, whatsoever.  I mean it!  If you are interested, you need to do your own research, and a lot of it.

I know this post is long, but I think it is well worth reading through, as it could make you a lot of money.  By all means comment or email with any questions.

My investment ideas are based on my predictions that interest rates are highly likely to rise significantly in the coming year or two (and perhaps beyond) and that certain investment vehicles which buy Indian stocks on the Bombay Stock Exchange are reasonably likely to soar in the short run and VERY likely to rise in the long run.  I have put my money where my mouth is on both of these ideas, and expect to do very well and hope to make a killing.  If you have money which you can afford to invest in HIGHLY risky investments, you should join me..

I note that I have been consistently WRONG about my predictions about the US economy, consistently being way too optimistic.  I do think we're about to break out somewhat, and grow about 3-3.5% in 2012, but it would be entirely sensible for you not to pay too too much attention to my prediction.  Hey, what can I say, predicting the future is hard, especially when it hasn't happened yet.  I also note that I am nowhere near expert in what I am discussing here.  But the big picture I think I do understand, and I think that is enough to make a lot of money.  With those caveats in mind, here are my 2 hot investment ideas for 2012.

1) Interest rates on long term US treasuries are highly likely to rise.  Hoped for return 1year from today?  50-75%.  120% wouldn't surprise me much.

As many or most of you know, interest rates on long term US bonds tend to rise when investors are optimistic about the economy (for several reasons, especially including expected increases in inflation down the road) and tend to fall when investors are pessimistic (for the inverse reasons).

First, some brief background, experienced investors can skip.  Long term interest have been very low for a few years now because of severe economic weakness as a result of the Great Recession, as well as a flight to quality and safety in turbulent times.  When investors think the sky is falling, or might fall shortly, they often are eager to buy US Treasuries because these provide a safe haven.  Accordingly, they bid up the prices of the Treasuries, and the yields move in the opposite direction of prices (google as to why if you like).  The reverse happens when investors are more optimistic about the economy and less fearful about the world in general.  The low yield of a US Treasury seems paltry compared to much more exciting and potentially lucrative investment ideas.  At this time, investors are relatively eager to SELL US treasuries, driving the price down and the yield up.  I note parenthetically that mortgage rates on houses are tied directly to the 10-year Treasury Bond-- they move in virtual lockstep with 10-year Treasury Bond rates.  My predictions mean that if you are thinking of refinancing, hurry.  Rates are VERY unlikely to go down significantly, and could well go up significantly.  Quickly.

A year ago, in January 2011 the economy was in many ways quite similar to where it is now.  Unemployment was a little higher, but there was optimism that stronger growth was right around the corner.  Accordingly, the interest rate on the benchmark 10-year Treasury Bond rose from 2.54% on October 1, 2010 to 3.36% on January 3, 2011, a year ago.  In contrast, the interest rate on this bond closed 2011 at 1.89%!  Thus interest rates on the 10-year bond plummeted by 1.4 points last year, a very significant move.  (I note that rates are already up to 1.95 in early trading today)

There is nothing especially surprising about the interest rates from October 2010 and January 2011.  However, the current interest rate, 1.89%, is very surprising indeed, and makes no sense based solely on the fundamentals of the economy.  Why did interest rates drop so much in 2011, from a low level of 3.36% to a VERY low level of 1.89%?  In a word, Europe.  As the fundamentals in Europe deteriorated, and investors became more and more fearful of events in Europe, they fled the risks there (what market commentators call a flight to quality.  (In fact, investors by and large fled risks everywhere, at least for a time).  On July 1, 2011, before the worst of the Europe news began to hit the front page and dominate the business section (and before the huge market volatility of last Summer), the 10-year bond was at 3.22%, very close to the 3.36% where it started the year.  On August 1, it was 2.77%, and by August 15th it was 2.29%!  People became convinced the sky was falling, avoided almost anything risky like the plague, and ran to the safety and security of US treasuries.  This trend continued right through to the end of the year.

I expect the 10-year bond interest rate to reverse course and head back towards about the 3.36% it was at at the start of 2011.  I expect this for four  reasons, the first three of which are by far more important than the 4th: 

A) First, as noted, I predict that the economy will improve.  Not an Obama Boom, perhaps, but an improvement.  That should move interest rates up some.  I note that I would make this investment even if I were certain the economy would be as in 2011 (but I would, admittedly, be less enthusiastic).

B) Second, I expect Europe to successfully muddle through, avoiding the worst (for example, an Italian default, which would be absolutely calamitous for Europe and very painful for the entire world).  This is the key reason for my being so excited about this investment.  If I knew for certain that Europe would (i) get significantly worse; and (ii) not improve noticeably by the end of the year, I would NOT make this investment at this time.

Why am I (somewhat) optimistic about Europe?  Merkel in Germany is sensible.  She's walking an incredibly difficult political tightrope, as if she is seen in Germany to be spending German money to bail out profligate countries on the Med, like Greece and Italy, she will end up voted out of office, if not on the business end of a pitchfork.  In any event, she knows that whatever the consequences for her, she can't let the Euro area go to hell.  And she won't.  In addition, I really like what I've seen out of the new head of the European Central Bank, Mario Draghi.  He has cut interest rates, and significantly increased liquidity for the European banks, which badly needed it.  In other words, he's acting more and more like Time's 2009 Person of the Year, Ben Bernanke.  Thank heavens!  Sarkozy in France is also entirely sensible, and the new Italian government has already taken significant steps, as has the previous Spanish government.  The European Central Bank is really the key, and Draghi is WAY better than his mediocre predecessor, Jean Claude Trichet (search my posts for my true feelings on that fellow).

Accordingly, I think it is highly likely Europe will avoid disaster.  If you disagree with this prediction, you should almost certainly not make the investment I suggest. 

Why is Europe so vital to American interest rates?  Europe avoiding disaster will have a clear impact on the US 10-year Treasury, because as investors become more and more convinced that the sky is NOT in fact falling, they will want to take on more risk.  A 1.89% return on paper issued by a profligate and politically dysfunctional US will look more and more ridiculous.  So investors will want to sell, and drive the price up.  This is exactly what I expect.  I don't have any clue when in 2012 this should occur.  Interest rates could well 

C) Reversion to the mean: Interest rates have come down so far that I expect that in the absence of even more really bad news (for example, REALLY scary news out of Europe, a double-dip recession in the US, a localized shooting war between Iran and the US that temporarily drives oil to $180/barrel) interest rates should rise a decent bit from here even if I am wrong about the US recovery.  If you told me that on 12/31/12 Europe will have muddled through without real disaster, and the US economy performed like it did in 2011, with unemployment about where it is now (8.6%) and no other especially bad news, I would GUESS that the long term rate would move up to about 2.5-2.8%, making me a tidy (but not unbelievable) return on my investment. 

D) The US budget picture is gloomy in the medium and long run (as well as the short run) and our politics are dysfunctional enough that we may not fix it.  That should, all else being equal, put upward pressure on long term interest rates, as investors expect that the temptation for the US to "inflate its way" out of the huge debt burden will become all but irresistible.  

As stated above, reason D is far less important to me.  Although potentially powerful in itself, the risks of the US becoming overly debt burdened is more of a long term play, and need not play out over the next few years (not to say it couldn't).
A key reason I LOVE this investment idea is my conviction that even if I'm wrong and Europe DOES blow up, I still think I will either lose a little or make a little.  I just can't see the US going the way of Japan, with 1% interest rates for an extended period.  We're too dynamic an economy for that.  And we're not aging anything remotely like as fast as Japan.  So I see this investment as heads I tie (or lose a little) and tails I win a LOT.  That's a fantastically good deal, when you can find it.

How am I going about making this wager on interest rates falling?  I am using an Exchange Traded Fund ("ETF") to make this market wager.  

The ETF I chose is ticker symbol TBT.  It is an ETF designed to produce daily investment returns "before fees and expenses and interest income earned on cash and financial instruments, which correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index."  *Sigh*  I barely know that that means, but there is a strong, strong correlation between this index and the interest rate on the 10-year bond (which I am using as a proxy).  So this ETF is NOT a pure bet on the movement of interest rates on the 10-year Treasury Bond, not by a longshot!

Indeed, the biggest risk to this investment, other than Europe or something else going calamitously wrong, is the ETF itself, and its a close second.  There is no guarantee (to say the least!) that it will in fact perform as it is intended to.  If rates go up significantly, it is VERY likely to go up as well, but not certain, and the amount is far from certain.  I feel so strongly about interest rates going higher in the next 12-18 months that I am willing to take on this additional layer of risk.

For reference (and as you always hear, past performance is no guarantee of future performance (!), on January 3, 2011, exactly a year ago, this ETF closed at $37.51.  I bought this on December 21, 2011 at 18.59.  So if rates on the 10-year were to move back to where they were a year ago, and this ETF performed exactly the same on the way up as it did on the way down (HIGHLY unlikely) I would do a tiny bit better than doubling my money.  In a year.  In the real world, if interest rates do go back to 3.36% I estimate that I could expect a return of anything between 70 and 110%.  That's a crude estimate, and could prove wrong.

As a cheaper (but even riskier) alternative, you could buy out of the money call options on TBT, and REALLY clean up if I'm right.  Of course, you lose a lot, perhaps even 100%, if you're wrong.

2) India.  Mutual Funds and Exchange Traded Funds which invest in India got absolutely clobbered last year.  The ETF I have recently purchased (IFN) collapsed by 42.81% last year!!!!!  That counts the payouts that were made (equivalent to dividends on a stock).  A 42% loss!!!  Why?  Two main reasons: (i) India had its own serious problems (huge corruption scandals, a plummeting currency, the Rupee, and an economic slowdown); and (ii) Europe.  As of July 2011, (when Europe began to completely dominate business and investment news) it was down "only" 13% or so for the year.  The second half of 2012, however, was a complete wipeout.

To back up a bit, I think two of the very biggest macro trends of the next few decades are HIGHLY likely to be strong economic growth in India and China.  China you all know about.  India has also experienced rapid GDP growth in recent years, a far cry from its chronic economic under performance from its independence in 1947 through the reforms of then Finance Minister Singh in the early 1990s.  This lousy economic performance was often called the License Raj, and the low growth rate (when India was dirt poor, and thus should have been growing far more rapidly) was derided as the Hindu rate of growth.  No longer.  In recent years, its economy has grown around 7.5%, and a tad higher in 2010.  Not quite Chinese rates of growth, but still very strong.  Enough to create tens upon tens of millions of new consumers, who are buying things like tvs, cell phones, refrigerators, etc.  And cars.  And a lot of other things.  

Although investments in funds that invest in India are very risky, and highly likely to experience wild swings, a reasonably well run fund should do VERY well in the medium and long run, as India's economy continued to grow strongly.  For all of its massive problems, India is a huge growth story.  Invest a piece of your portfolio in it, for the long run.  You'll thank me profusely 10, 20, 30 years from now.

In the short run, as stated above, India investments got absolutely clobbered by internal problems there and by Europe.  I know zilch about India's progress towards solving its internal problems.  I err on the side of pessimism knowing a little about the Indian government.  However, investments in India were hammered by global fear arising out of Europe.  Anything and everything risky scared people.  There was and is great fear of risk,as discussed above.  As this fades, there is no reason in the world for funds invested in India to do VERY well.

The investment vehicle that I have chosen is a Closed End Fund called "India Fund."  Ticker symbol IFN.  A closed-end fund is like the mutual funds you know about (commonly called open-ended funds) with the key exceptions that they trade like shares of stock, and do not generally issue more shares after an IPO.  The simple version is that the managers raise money on the open market and invest in whatever it is they are going to invest in, in this case shares listed in India.  The shares thus issues trade as any stock does, with supply and demand setting the price investors pay for shares in the fund.

The managers of the fund choose what shares (or other investment vehicles) the fund is to own.  These change as the managers see fit.  The market value of all of the shares (and other securities) owned by the fund, is called the Net Asset Value ("NAV") of the fund.  It is the amount that the fund would presumably raise if it sold all of the securities it owned and liquidate and close up shop.  The price you pay on the open market is NOT the NAV.  It is a share price, just like the price of a share of GE or Exxon.

Accordingly, there are two key indices you have to pay attention to, the share price of the closed-end fund, and its NAV.  It is possible for a closed-end fund to trade at a significant discount (or sometimes premium) to its NAV.  That is, the total market value of the shares of the fund that you can buy or sell can be significantly less than the value of the shares it owns.  Now and then this creates what I and many others believe is a monster buying opportunity.  Such a monster buying opportunity currently exists for IFN, my closed end India Fund.

IFN had a closing share price of $35.33 on January 3, 2011, a year ago.  I bought it at the very end of December at 18.82.  In addition, I bought it at a large discount to its NAV, 12.8%. According to Morningstar, its 6 month avg. discount to NAV was 7.97% and its 3 year average discount was 3.46%, so it is currently trading at a significantly larger discount to NAV than it typically does!  I don't know why this is the case.  If I had to guess, and its only a guess, investing in India is VERY risky.  As investors sought to avoid risk, this fund, and others like it, were shunned.  In addition, India was a VERY unattractive place to invest last year.  

The unusually large discount to NAV represents real value for me.  Even if the value of the shares in the fund (the NAV) stays the same, if the fund merely reverts to its 6 month average discount to NAV of 8% (for simplicity), it would increase in price to $19.86, a tidy 5.5% return without any increase in the value of the shares it contains.  Additionally, because the share price is beaten down so badly, it currently has a very attractive dividend yield of 6.3%.  (Monies returned by a closed-end fund are not exactly like dividends of shares, but they are close enough for my purposes).  

So there are 4 amazingly powerful reasons to buy IFN now:

1) The share price plummeted last year.  If Europe doesn't self-destruct, the price should rebound, probably sharply.

2) It has a tidy yield of 6.3%, at its current share price.  Needless to say, there is absolutely no guarantee this will continue.  On the upside, it could grow and grow significantly.

3) It is trading at a 12% discount to its NAV, as against a 6 month average of 8.06% and a 3 year average of 3.48%

4) India is a slam dunk long term growth opportunity.

For all of these reasons, as of the moment I think IFN is a MONSTER buying opportunity.  I wouldn't be at all surprised if my $18.82/share investment is worth $50 or $60 in several years, and a huge dividend yield thrown in at no extra charge.

Or it could all go to heck and I could lose 20-50% on my investment.  Balanced against the above rosy scenario is that the problems in India which caused a good chunk of last years 42% decline are very real; are not going away anytime soon, and could easily get much, much worse before they get better.  And of course Europe could go kaboom.  Finally, a sharp rise in oil prices would hit India.  It imports about 3 million barrels of oil/day, or over a billion a year.  If oil jumps $20/barrel, a very normal increase, that's $20 billion out of India's economy.  That's slightly more than 1% of India's GDP.  And the effect would be worse than that, just as it is here when gas prices increase.  If oil jumped $80/barrel, India's economy would go to hell in a hand basket.  As would ours.  As would my portfolio.

Here are investment ideas that didn't quite make the cut.

I think gold is overpriced.  Look at a chart of the price of gold, its a classic bubble.  I bought GLL, an ETF designed to move twice the inverse of the price of gold.  I've done well thus far, up about 10.7% in 6 months.  GLL is at 19.81 now.  I'll probably sell some or all of it at around 22.

For a few more sedate, safer investment ideas, try GE and oil companies.  I really like the idea of a good dividend.  GE is currently yielding 3.8%.  Assuming they slowly increase their dividend, that # goes up (slowly) even if the share price remains constant.  You're wildly unlikely to quickly triple your money, and pretty unlikely to rapidly double it, but I see GE, counting dividends, beating the market for years to come.

In closing, remember Warren Buffet's famous investment credo: Be fearful when others are greedy, be greedy when others are fearful.  Right now, investors are quite fearful in much of the world.  So be greedy!

Tuesday, November 15, 2011

Romney will be the nominee.

I've been meaning to put up a post about how certain I am that Romney will be the nominee for a while, but life has interfered.  I'll keep it short.  Its done, over.  Has been for a few months.  Sure he's only polling around 30%, but he'll be the last man standing, just like McCain was in 2008.  And as in 2008, the base will rally around him, this time out of blind hatred for Obama who, to many base Republicans, is pretty much a Kenyan Muslim socialist radical.  One searches in vain to find any of these influences in his policies as president, but never mind.

Anyway, Romney is a done deal.  The huge favorite for his VP choice is Marco Rubio, first term Senator from Florida.  He's Cuban, so there's some hope (mostly vain imo) that he can help secure Hispanic votes.  But he won't hurt with them either.  He will sew up Florida, which leans away from Obama anyway, and that's not a minor detail.  He's young, VERY attractive physically, gives a very good speech and will boost the ticket despite a few drawbacks.

I'll try and post in the coming few weeks about how I see the 2012 general election going.  Cliff notes: Obama a clear but not overwhelming favorite.   An economic lift (oft predicted by yours truly, still AWOL) would be a huge boost, obviously.  As of now I see Obama winning the popular vote by about 3 or 4.  That prediction could change based on economic data, and assumes an economy gathering strength into 2012.  If we go into recession again before election day, however "minor" the recession (which I consider quite unlikely), Romney will win.  But if we are adding 200k-250k jobs/month next year Obama will beat my 3-4 point prediction.

Wednesday, September 07, 2011

Obama's big speech

Here's what's going to happen tomorrow, when Obama is going to give his jobs speech.

According to tentative leaks today, Obama will call for about $300 billion in "stimulus" spending, much or all of it to be paid for by cuts outlined soon.  Many of these measures, particularly FAST (Fix America's Schools Today) make sense.  And the dollar amount, if all of his proposals were enacted in full (snowball's chance in hell of that!) are enough to matter.

So I'm happy, right?  Not at all.  America has HUGE problems, and HUGE unmet infrastructure needs, as Paul Krugman and others have been saying for years.  America has a HUGE problem with a lack of consumer demand.  These two HUGE problems (coupled with other big problems I don't have time to post about right now) call for huge solutions.  Big stimulus now, reduction of health care spending, and some trims in other spending years from now.  But the current massive budget deficit we are running is not a problem.  In fact, its a godsend.  If the GOP had its way, we'd slide closer to a Great Depression.

Anyway, here's what I expect will happen after the speech.  The markets will not react much because much of his program will not pass, and because any effect is priced in.  The mainstream media will be very impressed with his "bold" plan.  The GOP will deem some of it dead on arrival, but promise a careful consideration of the rest.  And the Paul Krugman wing of the democratic party (the left, which is yearning for far bolder action) will be mostly disappointed.  Krugman himself will probably spin it as a glass half full speech, but I expect much of the rest of the liberal blogosphere will be disappointed.  Again.  If anyone cares.

I'll post my reactions in the days after the speech.