The Intersection of Value & Contrarian Thought

Over the course of the last year, the most grizzly of bears have come down off the mountain, frolicked and pillaged in the market torrents and crossed the wild terrains in pursuit of the once in a generation pilgrimage to Pamplona. These grizzlies want to run with the bulls. Should we heed their transformations? By nature they are prudent beasts. Will they arrive early to the party just as they did with their warnings of an over-leveraged and frothy marketplace? Would they have been playing for the same team in 1873, 1874, 1875...1929, 1930, 1931? I realize these are moving targets, but do contrarians need to move even further out on the continuum of risk? These are some of the crosscurrents running through my brain these days.

Back in the summer of 2007 it was Richard Russell blaring the trumpets of a new bull market. The octogenarian investor/market pontificator was one of the few who picked to the day one of the great bear market bottoms of the 1970's. However, this time the usually bearish Russell seems to have been left flat footed and whipsawed by the market's bi-polar convulsions. Here he is in the summer of 2007:

"We are experiencing a global bull market of Titanic proportions. The central banks of the world now have the ability and the power to create fiat money at will." - August 30, 2007

The tragic irony of his untimely call was his continued bearish posture and skepticism throughout the 2003-2007 cyclical bull market. Even the great ones get it wrong from time to time. Today there is a bull market in the carcasses of former prescient investors and traders. To quote from Buffet once again, "It takes 20 years to build a reputation and five minutes to ruin it."

The list of financial luminaries below illustrates the depth and breath of typically conservative and tactically bearish investors that have begun buying this market.

Jeremy Grantham

"Most of the damage is behind us now and the US market is trading exactly at fair value." "We've probably stumbled into doing enough things right that the meltdown is finished," he says. "We're in for a bit of a recovery followed by a meat grinder." - November 1, 2008. http://www.boston.com/business/articles/2008/11/07/bear_turns_bullish/

Warren Buffet

"So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities."http://www.nytimes.com/2008/10/17/opinion/17buffett.html

John Neff

"His current portfolio contains about seven stocks. His on-again, off-again love affair with banking giant Citigroup Inc. is on again. He famously bought a big stake in that company for Windsor in the early 1990s when bad loans in real estate and in developing countries pummeled its shares.

He has been buying Citigroup again, believing that its stellar network of offices around the world will help it thrive when the global economy recovers. Citigroup now accounts for about 13 percent of his portfolio." October 15, 2008. http://www.philly.com/inquirer/business/homepage/20081015_Former_Vanguard_guru_is_buying_stocks.html

Marty Whitman

"TORONTO -- Marty Whitman, the octogenarian dean of deep-value investing, sees great bargains to be snapped up from the current stock market meltdown.

"It's a great time," enthused the 83-year-old founder of New York-based Third Avenue Management LLC before speaking yesterday at a conference organized by AIC Ltd.

"We can't try to pick the bottom, but it seems to me that there are great values out there now, just like in 1974," the firm's co-chief investment officer said in an interview.

The stock market crash of 1973-74, which affected all the major stock markets around the world, lasted 694 days before bottoming out.

"Everything went down every day, and if you bought, you hit a lot of 10-baggers," recalled Mr. Whitman. "I hope that we do it with a lot of what we are doing now." September 18, 2008. https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20080918/RAIC18

John Hussman

"As of last week, the Market Climate for stocks was characterized by favorable valuations and unfavorable market action. From the standpoint of the general approach described in the Strategic Growth Fund's Prospectus, this places us in the “moderate” yellow box. The appropriate investment strategy is to increase market exposure gradually on substantial price weakness, which is exactly what we are doing here." http://www.hussman.net/wmc/wmc081124.htm

Steven Leuthold

"People say we haven't seen anything like this before. They just haven't looked.""Today's stock market is quite undervalued, in the low 15 percent of our 60-year valuation history." http://www.businessweek.com/magazine/content/08_16/b4080067330758.htm?chan=top+news_top+news+index_investing
http://www.startribune.com/business/33615589.html?elr=KArksLckD8EQDUoaEyqyP4O:DW3ckUiD3aPc:_Yyc:aUUsX

I am sure Nassim Taleb would have thrown out these reflections as irrelevant and completely out of perspective to this markets character and danger. He may say, "This is not your grandfather's depression, keep going out on that continuum of risk". Of course value investors would be frothing at the mouth in this environment, they have been conditioned their entire lives for moments such as these. Where else in their lifetimes have the most high quality blue-chip companies been cut in half in one year? They are paid to work in these environments. I guess that is all the information we need...

Is New Jersey The Next Michigan?

If a rising tide lifts all boats, then naturally, as Warren Buffet says, "only when the tide goes out do you discover who's been swimming naked." It appears that New Jerseyans have been swimming completely bare and in the moonlight for quite some time. It was not always the case. Besides being the whipping boy and the low hanging fruit for comedians bent on exhausting the irony of the Garden State, New Jersey once had a dynamic and diverse economy.

New Jersey has successfully adjusted to changing economic climates in the past. Over 150 years ago, the agricultural-based economy matured and became an industrial and manufacturing-based economy. Paterson became "Silk City". Trenton was "Trenton Makes What the World Takes". Camden became "On Camden Supplies, the World Relies". You could say resourcefulness and salesmanship is in the DNA of New Jerseyans. However, the consistency of their financial success is most likely attributable to the geography and being within a stone's throw of New York City, Philadelphia, Washington D.C and Boston.

In the early 1980's New Jersey completed another transformation, this time to a post-industrial, knowledge-based, high business IQ economy. Businesses flourished in the upper echelons of the pay scale; telecom providers, pharmaceuticals, financial services and information services. Everything that was touted as the very best of America's new "finance driven economy" was within New Jersey's footprint. In 1990, New Jersey had 20% of the nations pharmaceutical jobs. Jobs that average $100,000 a year. Worries were cast aside that they no longer needed the manufacturing sector as ballast. Property values soared, running commensurate with New Jerseyans rank as first in household income and third in per capita income. Tony Soprano was flush. All was well...

The Gathering Storm

New Jersey's tax code use to be a friendly partner to business. Today it is ranked 49th out of 50 for state business tax climate. It's declining cost competitiveness is forcing those hands that once fed the coffers of the State and the people elsewhere. Whether it is the Sunbelt or friendlier international suitors, the depth and job diversity is thinning. For example, whereas in 1990 the State had 20% of the nations pharmaceutical jobs, today New Jersey has only 10% and it is declining rapidly. Comparatively, the State is one of the most expensive places to live, with an overall cost of living 32 percent above the national average. Real estate, rent, property taxes and insurance are high.

Similar to New York City, New Jersey is just arriving at the new great depression in real estate. Interestingly,

"New Jersey was one of just three states (besides Indiana and Alaska) where home sales actually increased from the year-ago period, rising 4 percent in the first quarter, the NAR said."

Just like the stock market was the last to unwind with the credit crisis (real estate peaked in June 2006, credit peaked in early 2007, the stock market in October 2007), New Jersey appears to be following a similar trajectory. It should be no coincidence, since 30% of the State's high paying jobs come from Wall Street or a street running parallel to it. Just look at Jersey City.

"Workers, Mayor Worry City's Giants May Lay Off Thousands

Tuesday, September 16, 2008
By CHARLES HACK
JOURNAL STAFF WRITER

With the grim financial news from AIG, Lehman Bros. and Merrill Lynch, much of the speculation in the Downtown Jersey City financial district has concerned how many employees will keep their jobs.

The Dow Jones Industrial Average plummeted 504 points yesterday after being slammed with the double-barrel news that Lehman Bros. was declaring bankruptcy and Bank of America would be buying investment banker Merrill Lynch for $50 billion - half the price it would have cost a year ago. News also came through that insurers American International Group reportedly asked the Federal Reserve for a $40 billion bailout.

All three companies have offices at 101 Hudson St., while Lehman Bros. has an office on Hudson Street and Merrill Lynch has one on Greene Street. Lehman Bros. employs 1,700 in Jersey City while Merrill Lynch has 1,500 jobs in the city. AIG refused to say how many employees it has in Jersey City, but one estimate puts it at around 200.

Jersey City Mayor Jerramiah T. Healy fears that between Lehman Bros. and Merrill Lynch, thousands of jobs could be lost in the city with a deep effect on Downtown restaurants, bars and stores. "It is bad enough that 2,000 people may lose their jobs," Healy said. "But it's made even worse by all those satellite businesses that rely on the foot traffic." Gov. Jon Corzine said yesterday that between one-quarter and one-third of New Jersey's economy depends on Wall Street, either directly or indirectly."

Just The Tip of The Iceberg

For those New Jerseyans who thought there may be a silver lining somewhere... guess again. To truly be horrified as to what is coming down the pike fiscally, look no further than the ever prescient, Mike Shedlock at http://globaleconomicanalysis.blogspot.com/.

"The state of New Jersey is insolvent. Bankrupt might be a better word. New Jersey is $60 billion in the hole on pension funding and the Governor is planning on skipping payments in a "pension payment holiday" until 2012 so as to not increase property taxes.

The Star Ledger is reporting New Jersey pension funds lost $23B so far this year.

New Jersey's pension fund has lost more than $23 billion this year, dropping to its lowest level since 2003 as a collapsing financial market battered its investments, a new state report shows.

The latest losses -- nearly $9 billion in October, and another $3 billion so far this month -- mean the fund is now worth $57.8 billion, or less than half the $118 billion in benefits it is due to pay out over time.

What Happens Now?

New Jersey is burning $5.2 billion a year. If the market is flat over the next 5 years, New Jersey will have a minimum of $118 billion in obligations and will be sitting on $31.8 billion. But what happens if the S&P falls to 450 or 600?

S&P 500 at 600 would be a drop of 24% from here. Assuming the pension plan assets dropped the same, plan assets would fall to $44 billion. On a drop to 450 on the S&P, plan assets would fall 43% from here to approximately $33 billion.

At $5.2 billion a year, New Jersey's pension plan would be completely out of cash in about 6 years in my worst-case scenario of a drop to 450 on the S&P.

However, even on a drop to 600 or 700 on the S&P (highly likely in my estimation), New Jersey, would run out of cash rather quickly putting in $1 billion a year and taking out $5.2 billion a year while assuming growth rates of 8.5% that are totally unrealistic." - Mike Shedlock

In many ways New Jersey is an amplified microcosm of the broader problems we face as a nation. Too much debt, too many entitlement promises, too much consumption, too high taxes, not enough savings and an economy much too dependent on creative finance. It is up to our leaders now globally, nationally and locally to make the hard decisions and to put us on sounder financial footings.

It only seems appropriate to end with a quote from New Jersey's own Tony,

"She was part of that generation who grew up during the Depression. But the Depression to her was like a trip to Six Flags." Tony Soprano

Barbarian's At The Gate

Watch the Prince rationalize why he's made a round trip with his position in Citigroup:

http://www.youtube.com/watch?v=JX9k6gFX_TQ

Then watch the Prince shoot his AK-47:

http://www.youtube.com/watch?v=CeSDAgTCD2Q

Do you think Vikrim and the other "Prince" sleep well at night?

If this is where we are looking for liquidity, we are screwed. If this is our Rockefeller or our J.P Morgan, the Dark Ages Part Deux may be coming round the mountain.

Which is the Best Analog- 1929 or 1873?

I was first introduced to perhaps the more appropriate historic analog of the 1870's by Bob Hoye, CEO of the market research firm, Institutional Advisors. Mr. Hoye's research has always attempted to place the current market environment inside a broader historical context. The belief being that the market forces that are currently present have been operating since the advent of the civilized marketplace. You could argue it is just another example of nature in the nature verses nurture argument. If you really want to wax philosophical, you could say there is very little free-will to the collective marketplace, since it is evident throughout history that we recreate the same market conditions associated with fear and greed. The stock chart is just our double-helix to that psychology. I have free-will to individually guide myself through the collective, but standing from space I am lost in the crowd.

In any case, here is a piece by Paul Kedrosky at the Infectious Greed blog. http://paul.kedrosky.com

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Get Your Banking Crises Correct: 1872/73 vs. 1929

I've been saying this privately for some time, but only now finally getting around to saying it here: In many ways, the banking crisis of 1872/73, less so the bank failures around the Great Depression, is the right mental model in which to think about the current crisis.

The context: A banking crisis in Europe took hold in 1872 after a mortgage lending boom, one in which house prices climbed endlessly, houses became loan collateral, and all sorts of dubious banking and lending behavior went on, much of it pushed by return-seeking banks. Everything came unglued in late 1873 as the European economy unwound and housing prices began falling, thus causing European banks to fail in a cascade, and interbank lending rates to soar as no bank knew which other bank would fail next. The problems spread to the U.S. in 1873, where debt-needy railroads began failing as European banks withdrew funding, this after a long boom had produced an over-levered mess, and then large numbers of U.S. banks followed afterward.

The whole thing took around four years to unwind in the U.S., and slightly longer in Europe. Admittedly, there was little done at the federal level to ameliorate things in any meaningful way, and there were widespread labor troubles at the same time, both of which helped cause the economy to stay down for the count, adding to the woes.

Nevertheless, people need to focus on the right things. And to my mind that is the banking crisis of 1873, and less so the causes and fixes of 1929.

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What history provides us with is a mirror to realize that however unique and different we appear to be, we are just another version of our parents, grandparents, great-grandparents and so on down the line. As the saying goes, "the apple doesn't fall far from the tree".

Additional References:

http://chronicle.com/temp/reprint.php?id=477k3d8mh2wmtpc4b6h07p4hy9z83x18
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=761964

Where To Now?

Is the 2008 Bear Market Over? Is it the low or just a low? Technically speaking, the market performance last week satisfied both the bulls and the bears alike. That should provide some information in of itself. You will notice that I frequently view the market through a technician's lens. I believe it is absolutely necessary to do so in a bear market since the previous price performance is the only structure establishing reference points for traders. The charts do not lie and the charts provide guideposts. They also give you a visual map as to where the program trading desks will likely take the market. A majority of the markets liquidity is provided by program trading (i.e. hedge funds). These are algorithmic based systems that buy and sell the market on autopilot over and over again. The reference information that they trade off of are visually presented in charts. Bull markets create new buying and selling data as they go up. They are in fact building the infrastructure for the next bear market. In bull markets, charts are much less meaningful since the information has very little context. People just buy high and sell higher.

Getting back to technician speak. The bears point to the violation of the 2002 bear market low (closing below 768) as indication we are in for substantial weakness over a considerable length of time. Some very respected technicians are now calling for the market to fall to the 600's on the S&P in the short term and 400's over the course of this recession/depression. Here is arguably one of the best, Louise Yamada.

http://www.youtube.com/watch?v=M2HIM3HFXXI

However, those lows were quickly recaptured Friday afternoon and seem to be continuing this morning. Market technicians could now point to a potential long term double bottom or something called a Wyckoff Spring as illustrated on The Big Picture's site.

"A Wyckoff Spring occurs when a market average (or stock) falls below its trading range, and makes a new “panic low” — and then “springs” back into its previous range.Its a relatively rare situation, one that is usaully associated with a sell off. That is a rather apt description of the entire week’s action."

http://www.ritholtz.com/blog/2008/11/revisiting-the-wyckoff-spring/

This could very well be just another oversold bounce that we have seen again and again throughout the course of this crash. Market emotions tend to be binary and incapable of evaluating grey areas. I would argue, the only way this market get's a foothold, is to have a substantial rally over the short term with consolidation in a much tighter range. If the market languishes down in the 800's for too long or jumps up and down in a 200 point range (S&P) it will be very hard to recover from technically and therefore fundamentally.