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Capitulation


Uccmal
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Only God knows if we are there yet but I have been noticing:

- the markets get a slew of bad news, drop for the day, and then rebound - they seem to be range bound for the moment.

- the bad news no longer seems as bad.  Once you have Madoff somehow losing 50 B, the other reports of 3 B, 8B seem to have no effect.  In contrast when Bear Stearns announced the losses at the BASM funds the markets took a shit kicking and yet the numbers were comparatively small.  It almost seems like it will take someone announcing a 9 Trillion loss to do further damage.

- the bad news is so pervasive that I am numb to it.

- Long practicing value investors are all screaming buy

- EVeryone else is on the sidelines saying the time is not yet right

- Roubini and Taleb have rockstar status - Reminds me of the Canadian Y2K Guru (Peter something).  In Roubinin, Taleb and Krugmans case it is make hay while the sun shines.

- governments worldwide are all on the bandwagon now.  Isn't government the last to figure something out, and then manages to actually do something when things are on the mend (conjecture)

 

- credit markets are slowly recovering - The TED spread (interbank lending rate) for example is trending lower each week.

- housing is well - maybe - stabilizing....

- the US consumer found alot to buy in January

 

I dont know, I am not much for technical analysis, but things do seem to be slowly turning.

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It doesn't seem as if the people in power are willing to accept the scope of this situation, we've had 20 trillion depletion in wealth, 50 trillion world wide, how is throwing 2-3 trillion dollars at the problem going to stop the bleeding?  How about this, California could save 4 billion a year fighting fires by switching to garden hoses!

 

These people move so slowly, why hasn't there been a payroll tax cut implemented across the board, wasn't Obama supposed to give tax cuts to 95% of workers? Speaking of which, where the hell is the universal health care?  Do we really want people going to the emergency room every time they get a cold?

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The one thing I've learned is that you will never have any idea where the "bottom" or "capitulation" is.  If we all went back to the beginning of 2008, most of us that follow Prem would have agreed that we would probably see dramatic corrections in equities, commodities, real estate, art, etc. 

 

What I don't think anyone really expected, and probably not even Prem, was just the sheer collapse in the credit markets.  I think Prem expected spreads to widen dramatically and significant tightening to occur.  But the seizing of the markets the way they did...I don't think anyone expected that.  After that, I think pessimism took a stranglehold to the planet, and fear became rampant. 

 

The one thing we do know is that once fear becomes rampant, usually the least likely scenario, in this case optimism, is probably more likely the correct assumption.  But it takes time to prove this theory correct.  It doesn't happen overnight.  Just like it took Prem a couple of years to be correct on the downside, it will take a couple of years for Buffett to be correct on the upside.  Cheers!

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I agree.  I don't think anyone understands or notices when capitulation happens, it's all hindsight.  One of those loosely used words that makes the investing public try to sound smarter than they really are to support their decision. 

 

Here's what I'm seeing:

 

-Historically investment grade bonds "bottom" before equities.  I use LQD as a proxy for that, it made the low back in October.

-Equities made their "bottom" in November.

-Most commodities have rebounded sharply after their December "bottoms"

 

The bond market offered equity-like returns back in October, and as long as that was the case (because money moves to the best risk-adjusted offered return), it didn't make too much sense for equities to go up.  Now, since October, if you look at the chart: http://finance.yahoo.com/q/ta?s=LQD&t=3m&l=on&z=m&q=l&p=&a=&c=%5EGSPC

 

You will see that investment grade bonds have outperformed the S&P by a wide margin the last three months.  I personally don't know if corporate debt still offers equity-like returns, but the last three months have been music to my ears as far as equity returns for the long term. 

 

What is happening has to be good news, over-leveraged with bad-practices are moving out of business.  I don't own Berkshire, but he's investing in the market leaders (HOG, GS, GE, USG, and now Vulcan).  When he says "Buy American," he means it!  and when the number 2, 3, and 4 in a certain sector are finished, he will have put together a phenomenal collection of assets in the Berkshire trophy case.

 

All in all, you can argue emotions and opinions which are a by-product of supposed "capitulations," but I'm putting my fingers in my ears because what I'm seeing (Investment grade bonds outperforming equities which bottomed in November, and Commodities in December) and what I'm hearing ("I haven't seen capitulation yet so I'm not buying") are not parallel.

 

 

 

 

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Guest kawikaho

I didn't expect the events to turn out so badly as they have, but I've read of a few hedge funds who have. 

 

By the way, haha, I remember the same thread from the old board:

 

http://groups.msn.com/berkshirehathawayshareholders/general.msnw?action=get_message&mview=0&ID_Message=50279&LastModified=4675699487936911039

 

It's not catipulation until people stop asking if it's catipulation. 

 

The one thing I've learned is that you will never have any idea where the "bottom" or "capitulation" is.  If we all went back to the beginning of 2008, most of us that follow Prem would have agreed that we would probably see dramatic corrections in equities, commodities, real estate, art, etc. 

 

What I don't think anyone really expected, and probably not even Prem, was just the sheer collapse in the credit markets.  I think Prem expected spreads to widen dramatically and significant tightening to occur.  But the seizing of the markets the way they did...I don't think anyone expected that.  After that, I think pessimism took a stranglehold to the planet, and fear became rampant. 

 

The one thing we do know is that once fear becomes rampant, usually the least likely scenario, in this case optimism, is probably more likely the correct assumption.  But it takes time to prove this theory correct.  It doesn't happen overnight.  Just like it took Prem a couple of years to be correct on the downside, it will take a couple of years for Buffett to be correct on the upside.  Cheers!

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What is going on is the US and others have overconsumed via debt and the productive capacity of goods and services have to adjust to this fact.  Debt has pulled future consumption to the present.  Wages and prices must adjust to this fact.  No one seems to admit this (most of all the gov'ts).  Most if not all of the policies that are being followed by governments are trying to deny and/or fight this.  They are increasing demand by spending (trying to reduce declines in prices that the market says should decline by spending) which is not sustainable.  It did not work in the 1930s, the 1970's and it will not work today. 

 

I think the reason the market is having a hard time going up is that with the gov't intervention fighting against the market forces, the rules of the game are unclear.  In addition with the gov't taking a larger role in demand and consumption, the rules are not based upon economics (which are known) but by politics which are unknown.  This increases this risk premium required so until the gov't intervention declines (i.e., an exit plan), the market will not rally like it did in the 1980's and 1990's.  I think the market did not expect the non-productive spending (which is what the stimulus turned-out to be).   

 

Most of the large market gains occurred when the country has moved from a more Keynesian spending approach to a more private investment approach.  I guess the current bill puts us back to a Keynesian approach, so when we convert back to a private investment approach we will get a pick-up.  I guess what I am pointing out is that with this change in philosophy (more gov't intervention in the markets), the period is probably more similar to the 1930's and the 1970's than the recent period of time where recessions were allowed to run there course without massive spending and recovery periods were quicker than in the 1930's and 1970's.

 

That being said there are many cheap stocks like SGA, SSP, GCI, JRN, BLC, CBS, TWX, CX, DELL and DINE.  I guess this is like the 1970's.  Buy cheap stocks and wait for more pro-market gov't actions.   

 

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Guest Broxburnboy

Before there will be a recovery in general business activity, it seems to me that the following have to happen:

 

Enough monetary stimulus has to be thrown at the financial system and governments to stabilise the credit implosion (this will have inflationary consequences when the recovery begins). This may be happening now, as credit is becoming more available, although there seems to be a lack of credit worthy borrowers.

 

Existing inventory has to be sold.. in houses, automobiles, debt instruments, consumer goods... these inventories are the result of too much money available at too low interest rates for too long. The current inventory will be sold at discounts to book value and these losses will also have to be accounted for (more government money?). This is the current deflationary period we are in now. It looks like it has a ways to run.

 

Recovery... will begin when current inventories are depleted and will be driven by consumer demand and financed by real savings. It may take a while to gather steam, but when it does inflation is sure to be a component.

 

There is room for individual companies and whole sectors to prosper in these environments, but overall business activity will remain in recession for the foreseeable future. Meanwhile growth is negative, volume of international trade is way off, government deficits are increasing... we are still going down. Any talk of capitulation seems to be premature.

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I agree and the artificial stimulation only delays the required reduction in capacity to reduce the inventories, but no one in gov't seems to get this so there policies are just making the problem worse (i.e. subsidizing excess capacity with gov't spending).

 

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Things may get a lot cheaper yet. The trailing 12-months earnings on the S & P are under $30 or expected to be under $30 IIRC, multiply that $30 by 15 and you get 450 for the S & P. Even if you are optomistic and feel $40 is fair for 2009, 15 x $40 = 600. And I am being generous with the p/e. Interesting to note that WEB & Prem are buying bonds (high yield) with warrents for future equity purchases. We will have hit bottom when BusinessWeek puts out a cover that equities are dead or WEB is wrong.....

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Guest ericopoly

450? 

 

Here is what Grantham had to say in October (and I guess that would put his idea of an overcorrection at about 800, which is close to where it was when I felt like we'd finally seen capitulation):

 

"So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging."

 

http://online.barrons.com/article/SB122367853796824483.html?mod=googlenews_barrons&page=1

 

 

 

 

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Keep in mind what a recovery initially looks like - a very small (sub)sector starts demonstrating optimism in a sea of pessimism. Look at WEB, FFH, etc & the senior companies in the industries (insurance, etc) they are asociated with. Spreading optimism ?

 

It should take a good 9-15 months for the major indices to start rising, if only because year-end hasn't hit yet & the zombie banks are still operating (bad news swamping the good). Change the metric ?

 

 

 

 

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I posted this chart on the old board a few months ago, and thought I would put it up again:

 

http://maxcapitalcorp.com/images/PriceValue.gif

 

I hate to act like a market prognosticator, but I don't think we've seen capitulation yet. People talk about how pessimistic everyone is. But compared to what? Compared to the attitude 2 years or 10 years ago market participants are very pessimistic. But compared to what it was like in the late 70's or early 30's, nowhere near as pessimistic.

 

450 on the S&P sounds low to me (you never know), but I can certainly see 600. Using 10-year normalized earnings, 600 would be about a 10x multiple. Certainly not out of the ordinary with current economic issues -- it got down to the 6-8x range in 1932 and 1980. And if you think earnings could be low for an extended period of time (2-3 years), the 10-year earnings figure, and hence price, would be lower.

 

I don't think that means one should be trying to "time" the market, but at least you should be expecting high odds of lower prices down the road.

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My concern is the uncertainty in and counter-productive policy.  Historically, the US has followed free market policies and let the chips fall where they may and the rules were well understood.  However, the new administration seems to be following Keynesian policy (it seems to be their economic policy - based upon Obama's recent comments and policy) and this will decrease the value of all investments as politics is added to the mix of rules because of the govt's investments/spending.  I was disappointed as I thought the U of C folks he had in his economic team would temper this but this has no happened to date. 

 

The downfall of Keynesian economics is that it says that if you do x, y will be the result.  As though the economy is a machine that you can fine tune.  The statement that the plan will produce or save TBD jobs is an example.  This sounds good for a rationale but how verifiable is this?  It is a non-provable result and how it was used with fear to increase spending in a rushed fashion with no debate reminds me of collectivist countries (like the former USSR).  The result - increased gov't spending (not just spending that would have occurred in the future anyway) - that wouldn't have been acceptable in normal situations. 

 

The gov't is doing what consumers did that caused this situation in the first place.  The market is now disciplining the consumers for their mistakes.  Historically, the gov't always has had a margin of safety in its spending plans.  I think by rolling out the stimulus first without knowing what the banking fix is going to cost (plus a margin of error) is going to be a mistake.  At this point, the market will lend to the US but once the total plan is on the table, the market may not be so generous.  It may be especially painful if the US needs more money than planned and the markets will not provide it as we have spent up our margin of safety.

 

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Guest ericopoly

"it got down to the 6-8x range in 1932 and 1980"

 

Yes, of course it can happen.  MSFT was (a couple of weeks ago) at a P/E of 8x (if you subtract cash off the market cap).  I have not been a big fan of that approach though, but it does explain what the business traded for.  In recent years it has traded close to the P/E of the overall market.

 

Then again, maybe earnings will implode and thus the stock will follow.

 

Prem Watsa recently (a few weeks ago) said that GE has NEVER been this cheap.  I figure it will be in his portfolio now.

 

 

 

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Guest ericopoly

Actually, he said it was the cheapest in 50 years, not "EVER" as I remembered incorrectly.  Note that when he said that it was before it dropped yet another 20% recently:

 

 

"General Electric has never been valued this cheaply in 50 years. GE at $15-16, represents seven times earnings, over 8% yield -- which takes you right back to the 50s. This is a AAA-rated company. It has a tremendous record and today you can buy it at these very low prices."

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Guest kawikaho

I think the biggest problem with GE is its financing arm.  That is going to weigh heavily on them.  GE may be the cheapest it has been in 50 years, but it's never had the kind of problems as it does now.  The financing arm supposedly makes up for over 50% of their profits.  That's all going to go kaput.  Not even kaput, but I believe it will drag down GE's other profitable divisions.  If they could spin that off, that would be great. 

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The problem with the SPY - PE chart is that it is really intended to look at Price only, not E.  The earnings on the S&P 500 during the 70s grew at a much greater clip (roughly 9% per year from 72 to 82), than the S&P (about 4%).  So there was alot of multiple compression. 

 

As companies put 2008 with all of its writedowns behind them, earnings will stabilize, and then grow relative to the low reached in 2008/ early 2009. 

 

Using Starbucks as a simple example.  They took 1 B in writedowns in the 4th Q of 2008, and will perhaps take another few hundred million in the 1st Q of 2009.  After that the cash coming in will be free cash.  The same should apply to GE, MSFT, and others that represent the largest pieces of the S&P.  Even a modest recovery in bank earnings would go a long way to raising the E.  I am thinking of all of those smaller banks that took non-lethal hits to their balance sheets and still have a healthy active small commercial and retail business. 

 

 

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2008 was the year of the financial crisis.

2009 will be the year the recession hits.

- The bad news has not yet hit mainstreet. Unemployment will likely hit double digits.

- Company earnings will likely get worse going forward (not just financials).

 

Talking to my friends and financial advisor it appears to me that most people are very fearful but still 'invested for the long term'.

 

Most research pieces I read bank on a 2H 2009 recovery (as all the stimulus takes hold).

 

The scenario most think unlikely is another 30% drop in the markets.

I was reading somewhere that investors in the Great Depression did not get wiped out with the '29 crash in the markets as they bounced back somewhat in '30. It was the 30 to 32 fall that really cleaned people out.

 

My read is the risk of a further material drop is quite high. I do not see enough upside opportunity in the next 12 months to want to risk my capital. I will invest a small part of my portfolio to take advantage of some opportunities. However, capital preservation is my new mantra.

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Hi Viking, Not intending to pick on you:

 

Why should company earnings get worse going forward?

 

Your friends and financial advisor do not represent the general markets which are down 45% on massive volume - obviously the majority were selling

 

The crash in 1929 wiped nearly everyone out.  Those who went back in such as Ben Graham later got wiped out on much lower volumes

 

....However, capital preservation is my new mantra. - Exactly why I believe we are at capitulation

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Uccmal, don't worry, I have thick skin.

 

"Why should company earnings get worse going forward?" Regarding earnings, yes, the financials have taken some very large write offs. However, many of the commodity companies posted very high earnings in 2008. As well, as the economy slows in 2009 and unemployment increases I would expect the sectors of the economy that rely on consumer spending to also post year over year declines in earnings. What sector (ex gold companies) do you think will post growing earnings in 2009?

 

"Your friends and financial advisor do not represent the general markets which are down 45% on massive volume - obviously the majority were selling" True. However, my guess is much of the was driven by institutionals (i.e. Caisse).  

 

"According to Buffet, we are supposed to greedy when others are fearful.

Are you guys still waiting for the more fearful moment to come?

Last Nov was pretty scary." Yes it was. But most people are still COMPLACENT. They fully expect the good old days to start up again. Everyone has had a scare, but my guess is most have not changed their outlook or more importantly portfolio weightings (to any great degree).

 

From my perspective, to be fully invested right now one has to have some sort of strong view of what will be happening in the economy over the next 12-18 months. I think the stock market expects the government to figure this thing out and a recovery to be on the way in 2H 2008. I am not so sure. As I have said before, if I am wrong I forgo some return. If I am right I am positioned very well.

 

I missed the downdraft last year but got roughed up in Dec. Early Jan bailed me out. What I learned last year is that the current environment is VERY trecherous. I just don't think we have seen the worst of it.

 

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