Investment strategies for the near-term

Posted by Shyam Moondra


Emerging economic trends are very encouraging. While unemployment rate remains high and consumer confidence is still in the doldrums, there are many signs that suggest that the recession may be over. For example:
· In the second quarter of 2009, the GDP declined by only 1%.
· New and previously owned home sales in June increased, thanks to low mortgage interest rates and about 30% lower prices from the peak set in 2007. The latest housing report showed a small increase in the average home price, indicating that the long slide in home prices have finally come to an end.
· Leading indicators went up three months in a row, strongly suggesting that the economic recovery is underway.
· Inflation remains under check, enabling the FED to keep interest rates low for the foreseeable future. Low interest rates will fuel the economic growth.
· The banking system has stabilized, as is evident from better than expected profits reported by many banks and steadily improving credit markets. Some banks are still in poor condition (but less critical than six months ago) because of continuing foreclosures and losses in commercial real estate and consumer credit card markets.
· In general, in the first half of 2009, corporate profits far exceeded analyst estimates. The private sector has done an excellent job in controlling inventories and costs. The mean and lean private sector is well positioned to rapidly expand profit margins as demand perks up in the coming quarters.

Looking forward, the federal stimulus program will continue to boost the economy. The $787 billion stimulus package was to be spread over the 2009-2010 period; therefore, as much as 80% of the stimulus money still remains to be spent in the coming six quarters. A big part of the remaining stimulus program will be directed to infrastructure projects that will create new jobs. The Congress just added another $2 billions to the enormously successful "cash for clunkers" program, which gives as much as $4,500 to consumers if they trade-in their old gas guzzlers for new fuel-efficient cars. This program will give a much-needed boost to the auto industry. In spite of the encouraging economic trends, the unemployment rate will not decline any time soon. However, consumers, who have been lately saving more than spending, will loosen-up the strings of their purses and thus provide the fuel for the economic growth engine.

Given that we are on our way to recovery, the stock market is again attracting investors that have trillions of dollars sidelined in safe investment vehicles such as Treasury bills and notes. That money will steadily move into the equity markets. A Dow Jones Industrial Average of 12,000 by early 2010 does not seem far fetched.

Many stocks are currently priced very attractively for the long-term gain, starting with the companies in the consumer sector. Companies that have had the steepest decline in their stock prices over the last twelve months will likely appreciate the most. Investors should start nibbling at selected stocks every time the market dips. Following are some of the segments to focus on:

· Consumer non-durables and discretionary goods/services including fast food restaurants.
· Travel and leisure: Airlines, hotels, and casinos.
· Machinery: Stimulus spending for infrastructure projects will increase profits for heavy machinery companies.
· Industrial: Aluminum, chemical, aircraft manufacturers.
· Media: Television networks and Internet companies (ad revenues will gradually increase).
· Selected financials: Financial companies that were beaten down hard will provide the best returns, although they may still be somewhat risky.
· Transportation: As the economy improves, air frieght, railroad, shipping, and trucking companies will do well.

Future challenges remain just as daunting as they were six months ago. As the economy starts growing, consumer and industrial demand will steadily grow, increasing inflationary expectations. Starting next year, the FED will have to start raising interest rates; it will be a challenging job for the FED to not increase interest rates too fast or too early that might choke off the economic growth. That balancing act will require the brilliance of the FED Chairman, whoever that might be coming January of 2010. The Obama administration and the FED will have to wind down financial stabilization programs and stimulus expenditures, and start focusing on how to reduce the budget deficit. Increasing income taxes for the super rich and closing-down tax loopholes for the corporations (e.g., off-shore tax havens) will be necessary to balance the federal budget.

Obama's poor execution may sink his approval rating

Posted by Shyam Moondra

Since Barrack Obama became the president, he has been saying all the right things. However, Obama's mode of operation has become an obstacle in achieving the desired end-results of his policies. Consequently, Obama's popularity has declined somewhat and is about to crash down unless he improves his execution.

Bill Clinton's presidential campaign strategy was based on "it's the economy, stupid" that led to his astounding victory over George H. W. Bush. After the election, Clinton exclusively focused on economy and he especially avoided making foreign trips. He even resisted getting involved in Kosovo as long as he could. His hands-on approach in formulating and executing economic policies paid off handsomely - he turned the budget deficit into a surplus and the American people enjoyed the longest period of prosperity in the modern history. Now we have a much more serious economic crisis but Obama has been spending way too much time traveling around the globe. When people are losing their jobs and homes at the fastest rate since the depression of the 1930's, it's hard to justify Obama's extensive travel plans. Surely, Obama has improved the image of the U.S. that was battered during the Bush years, but, at the moment, that's not what the American people want him to focus on - they want him to stop the bleeding of our economy.

One of the other operational problems Obama has is his desire to be in front of the cameras at all times. He suffers from overexposure because of his constant interviews, press conferences, speeches, video blogs, etc. The American people would rather see him working at his desk in the oval office and be focused on execution of his economic policies. Obama likes to tell Congress that he wants this or that by so and so date, and then becomes somewhat aloof from the process. The Congress then writes the legislation with the help of lobbyists, who are likely to insert all kinds of loopholes, diluting the reforms that were expected from the legislation. The case in point, the health care legislation - we keep hearing that Obama's original vision has been riddled with all kinds of concessions sought by the lobbyists that raise the question if the proposed legislation will achieve its originally stated goal of significantly reducing costs (in fact, the Congress is talking about imposing new taxes worth $1 trillion to pay for this proposed plan!). During the campaign, Obama promised he would reduce the role of lobbyists in the government, but right now just the opposite is happening. Why not Obama roll up his sleeves and sit down with the Congressional leaders and hammer out legislation rather than let the lobbyists write the laws? The American people want a more hands-on approach from Obama in lieu of his non-stop TV appearances and pronouncements.

Obama has been busy proposing a million different things but in the absence of focus and hands-on approach, nothing much is being accomplished – his emphasis is on quantity of things he proposes as opposed to getting things done right in a timely manner. Congress is not used to working on multiple things that fast, so what will come out would be half-baked goods that will not achieve the reforms that were originally envisioned. May be Obama could get done more by focusing on a fewer things at a time so that he can devote more time in executing things as opposed to proposing things.

Here are some examples of how Obama's poor execution is becoming an obstacle in achieving the desired results:

· In spite of huge stimulus spending, the economy continues to lose jobs and the unemployment rate continues to rise. The loss of jobs means more and more homeowners are joining the ranks of who can't keep up with their mortgage payments. That leads to more foreclosures and lower home prices. The American people would like to know why economy is not getting a lift from increased government expenditures – is it because the stimulus money is not being spent fast enough or the stimulus package was flawed? The proposed budget will sharply increase the national debt, so it is important to properly analyze why increased expenditures are not generating more jobs. Shouldn't Obama be focusing on analyzing the stimulus package and deciding what to do next?

· Foreclosures continue to be at near record levels. Shouldn't Obama take another look at homeowner assistance programs and come up with changes in the approach? Mortgage rates went up in recent weeks shutting down the refinance market - shouldn't Obama do something to bring down the mortgage rates to stimulate the demand for the houses? Economic turn around is contingent upon stabilizing the housing industry first.

· Oil prices have doubled in the last few months. Congress had a lot of hoopla when oil hit $150-a-barrel and it talked about reforming CFTC, limiting investment by speculators in oil and other commodities, eliminating the "Enron loophole" etc but nothing has happened. Why is Obama not doing anything about this? When commodity prices on the futures market go up and down by 100% or more in short periods without any change in the underlying fundamentals, then clearly something is very wrong with the way the markets operate.

· The outlandish executive compensation was a major issue during the campaign, but Goldman Sachs and Morgan Stanley just announced that they would put aside tens of billions of dollars for 2009 bonuses that is 50% more than the amount set aside for 2008 bonuses. Why has Obama not done anything on this issue? We need a law to limit CEO compensation at all publicly held companies, not just TARP companies.

· Everybody knows that investment banks and hedge funds manipulate the stock markets. There have been a lot of talk about twenty-first century regulatory reforms but nothing concrete has yet come out and market volatility continues to be an obstacle in getting the economic house in order. We need to clamp down on computerized day trading by investment banks and hedge funds that are destroying our markets.

· With the huge increase in government spending, the budget deficit is ballooning rapidly that almost guarantees that interest rates will go up in the coming months. Why has Obama not announced concrete plans on how the budget deficit and national debt would be brought down?

If Obama doesn't change his mode of operation and exclusively focus on deteriorating economy, his approval rating will crash in coming weeks and months. Obama has a real opportunity to be a great president but he is blowing it away by not being on the top of things in seeing that the economy rebounds quickly.

The Obama bull market is here!

Posted by Shyam Moondra

The stock market has gone up over 20% since it hit the bottom in early March. As a rule of thumb, that's considered the beginning of a bull market and not a bear-market rally as some analysts suggest. While 20% gain in less than a month may seem excessive, this up move should be viewed in conjunction with the excessive market decline of over 55% from the peak set in October of 2007. During most of 2008, the market behaved as if the sky was going to fall and we will have a repeat of the depression of the 1930's, which never materialized. In essence, during 2008, the market was besieged with fear and it simply overreacted.

It's hard to not stipulate a bullish scenario for the stocks in coming weeks and months, given the following government actions and market trends:

1. The monetary policy is the most expansive we have witnessed in decades. The money supply is growing at a rapid clip and interest rates are the lowest we have seen in recent history. The bountiful money will unquestionably expand the economy.
2. The Obama administration's aggressive policies on the fiscal front are also positive for the economy. The stimulus package and the proposed budget plan include lower taxes for the middle class and significant increases in government expenditures. These actions will create new jobs, revitalize the sagging construction industry, and increase consumer confidence. Because of the provisions in the stimulus package and the budget, we can expect a reduced rate of home foreclosures and increased rate of home buying, made possible by tax credits for home purchases, attractive home prices and the lowest mortgage rates ever (stimulating refinance market which puts more money in the pockets of homeowners). The latest monthly housing report showed an increase in the home sales for the first time in months, which confirms that we may have hit the bottom in the housing sector.
3. The credit market is stabilizing and we will see a continued improvement in that area in the coming weeks and months. The TARP, FED's credit-window facilities, and the proposed $1 trillion plan to remove the toxic assets from the books of the banks will steadily bring normalcy to the financial markets. The fear of systemic failure of the financial system, which sunk the markets by 55%, is behind us, and, therefore, it's natural for the market to recover a big chunk of that loss in the short-run. The recent signs of stabilization in the housing sector bodes well for these toxic mortgage-based securities to start appreciating in value and thus help speed up the process of normalization in the credit market.
4. Consumer confidence seems to be gaining, as is evident from the recent data on retail sales. The consumers are already seeing a slight increase in their paychecks, thanks to the stimulus package; more money in consumers' pocket will boost their confidence in coming months and they will start spending again.

President Obama deserves credit for providing strong leadership on all fronts; his plans are intellectually well thought out and he is attacking the problems through a multi-pronged approach that will bear the fruits sooner than many critics think. For the first time since the Clinton presidency, it is becoming clear that a smart and a strong leader can indeed make a big difference.

Of course, things are not going to go up in a straight line. We will have some hiccups along the way, but the die is cast and we are on our way to renewed prosperity again. The biggest issue in my mind is the rekindling of inflation. As the economy becomes stronger, we will see a spike in commodity prices. Easy money and sharply increased government expenditures will set the stage for inflationary spiral. Therefore, the next challenge for the FED will be to manage interest rates in a way so as to ensure continued economic expansion while keeping inflationary expectations in check. That means the interest rates will have to start going up gradually beginning in 2010. The Obama administration will also have to come up with a plan to address the bulging budget deficits and ballooning national debt. Decreasing government expenditures (e.g., eliminating waste and contracting abuses in the defense department) and increasing taxes on the super rich and closing down corporate tax loopholes (when companies like Goldman Sachs that use their offshore subsidiaries in tax-haven territories to escape taxes and pay only 10% in taxes, they unfairly put the tax burden on the American people).

I believe the stock market is slated to recover at least half of the losses incurred in 2008 rather quickly, which will bring the Dow Jones Industrial Average to around 10,000 by the end of this year. Further gains in 2010 and beyond will depend on how skillfully the FED manages the interest rates and money supply and how successful President Obama is in bringing down the budget deficit. By the end of President Obama's second term, it's not inconceivable to see Dow Jones Industrial Average of 18,000.

For the rest of the year, there are plenty of attractive investment opportunities. The technology sector has been lagging and thus could do well in the coming months (HP, GOOG, AMZN, AAPL, RIMM, BIDU, IBM, MSFT, CSCO, etc.). The financial sector has been beaten down sharply, so it will recover just as fast (JPM, WFC, BAC, C, etc.). Some of the other industrial companies that look very attractive are MON, CAT, CMI, FDX, UPS, AA, CE, DOW, BA, HON, GE, MMM, VFC, TJX, etc. (Disclosure: The blogger owns most of these stocks).

Economic recovery may be erratic but it's on right track

Posted by Shyam Moondra

President Barack Obama has been in the oval office for only a few weeks but he has moved at a lightning speed on several fronts simultaneously. While his actions may not be perfect, he seems to have a good intellectual grasp of how the various pieces of the puzzle fit together. Undoubtedly, some critics on the other side of the political divide would say that he is on a wrong track. However, given the awful results of the George Bush presidency, it's hard to support the Republican ideological viewpoint that doing anything differently from what President George Bush did automatically puts you on a wrong track.

Never before, economic fortunes crumbled worldwide in such a short period. Low interest rates of the 1990s fueled the housing market prompted by innovative products such as sub-prime mortgages, mortgage-based securities, and credit default-swaps. The business was so lucrative that financial institutions around the world jumped on the bandwagon without ever bothering to fully assess the enormous risks involved and made a fortune. But when the FED started increasing interest rates to tame the fears of inflation, the house of cards began to crumble. Reduced demand for housing led to rapid decline in home prices that, in turn, led to the floodgate of defaults and foreclosures. The financial institutions that grabbed the mortgage-securities began to see the values of those securities evaporate and they were forced to report huge losses bringing them closure to bankruptcy.

The Obama administration moved swiftly to address the issues in a top-down as well as bottom-up fashion (as I suggested in "Combine top-down and bottom-up approaches to deal with the credit crunch," The Moondra Post, September 30, 2008) by offering assistance to the financial institutions through TARP and FED credit facilities as well as providing help to the homeowners to stay in their homes. The stimulus package, recently passed by Congress, includes tax credits for home buyers that should help reinvigorate the housing market. The Obama's proposed budget includes income-tax reductions for 95% of the taxpayers that will induce them to spend more, thereby boosting the economy. The budget also includes massive spending for infrastructure projects that would instantly create new construction jobs. In addition, the proposed budget includes long-term investments in alternative energy technologies (that will create new high-paying jobs and reduce our dependence on imported oil), health care (that will reduce health care costs), and education (that will increase our competitiveness in the world), The Obama administration's multi-pronged approach to the economic collapse is well thought out and it will yield positive results over time. While it's true that the budget proposal has many pork-barrel wasteful spending appropriations, overall, it has many more positive elements that are necessary under the present dire circumstances.

Not to forget the last piece of the puzzle, the regulatory reforms. Lack of regulations and oversight led to the collapse of the financial system. So it's not surprising that the Obama administration is aggressively moving to bring the regulatory regime to the twenty-first century. We need to regulate investment banks and hedge funds, monitor and regulate computerized trading to eliminate market manipulation (ban naked short selling, limit short selling to 1% of outstanding shares, require institutions to hold stocks they buy for a certain minimum period before they can sell those stocks, and limit trading in derivatives such as options), and impose strict capital requirements on all financial institutions (no more 40:1 leverage used by many investment banks and hedge funds).

The increased spending to jump-start the economy will certainly add to our budget deficit and national debt in the near-term. That's why President Obama is already looking beyond the near-term and he has proposed to reduce government expenditures (e.g., changes in defense contract procedures and health care reforms will save billions of dollars) and increase taxes on the richest (who prospered handsomely during the Bush years and now must give up some of those gains). It took President Bush eight years to turn a budget surplus into a huge deficit, so it's reasonable to expect that it will take a concerted effort by the Obama administration over the next several years before we see a budget surplus again.

In spite of the above dramatic initiatives, we are continuing to see unemployment on the rise and corporate profits on the decline, but the actions taken by the governments around the world create just the right conditions for an economic recovery. Lower interest rates, increased government expenditures, lower taxes for the middle-class, and regulatory reforms will boost the global economy soon. These conditions are ideal for the financial markets, so President Obama was right in his recent observation that long-term investors should start buying dirt-cheap stocks. The current average PE ratio of S&P 500 index of 12, while not as low as 6 of July 1932 and 7 of July 1982, is much lower than the latest 25-year average of 21 and 50-year average of 18. The decline in the average PE ratio from the recent peak of 44 set in 2002 is the worst since the depression of the 1930's. The conditions today are, however, very different than those in the 1980's when we had double-digit inflation and double-digit interest rates. Today, we have annual inflation rate of about 2% and fed funds rate of 0.5%. Therefore, the stocks are indeed very cheap with a huge upside potential.

Aside from the differences in policy directions, there is a stark difference in mostly reactive mode of operation of the Bush Administration and a pro-active comprehensive approach of the Obama administration. President Bush had no long-term vision and he never believed in a deep governmental involvement in free-market economy. President Obama works off a well-thought out strategic vision bringing in the full weight of the government to make his initiatives yield the results quickly. If President Obama continues to show vigor and remains a hands-on chief executive as he has been so far, chances are we will begin to see the results of his stimulus package and the proposed budget plan as early as in the second-half of 2009 and by 2010 we should be well on our way to recovery and renewed prosperity.

Obama should rethink the stimulus package

Posted by Shyam Moondra

The government has terribly failed the American people. First, former Treasury Secretary Henry Paulson and FED Chairman Ben Bernanke were saying that sub-prime mortgages were not a problem. Then they wanted the bailout money to buy these so called toxic mortgage-based securities from banks to strengthen their balance sheets. But once they got the bailout money, they changed their minds and ended up buying banks' preferred stocks instead. Now the new Treasury Secretary Geithner and Bernanke want more bailout money to buy those toxic securities they were supposed to buy in the first place. I bet even if they buy the current toxic securities, next quarter there will be more new toxic securities on the books of these banks and the FED/Treasury will ask for even more money to buy more of these securities. I don't think the government officials have really understood the problem or thought through what really needed to be done; they are just throwing money and trying different things thinking that something will work. Well, so far it's not working and tax-payers are out of $700 billion, adding to our already very high national debt.

Now comes this monster stimulus package (full of all kinds of pork barrel projects that candidate Obama said he will not allow) worth almost a trillion dollars that will guarantee that our federal debt will be so big that it will take at least ten years to bring it down to a more reasonable level and it will almost guarantee that we will have higher interest rates in the future. The mismanagement of our economy will ensure that American people will have to accept declining living standard for years to come.

Before we talk about the possible solutions, let us take a quick look at what brought us here:

1. Lack of leadership by President Bush and lack of oversight by Congress.
2. Incompetence of FED Chairman Bernanke and former Treasury Secretary Paulson.
3. Greed. Excessive compensation of the CEOs and market manipulation by hedge funds and investment banks.
4. Lack of regulations that led to these toxic mortgage-based securities and credit-default swaps.
5. Lack of enforcement by the SEC under Chairman Cox.

Now this is what we need to do:

1. Have new leaders in Congress and replace Bernanke immediately.
2. Reform regulations. Regulate hedge funds (they must pay their fair share of taxes and report their trading activities), pass stronger laws to prevent stock/commodity market manipulation by big players (revisit short selling/option trading rules, reduce computerized trading by imposing a simple rule that hedge funds/investment banks must hold a stock they buy for at least five business days before they can sell that stock), and monitor risky financial products offered by financial institutions more closely.
3. Impose strict limits on executive compensations for all publicly held companies, small or big and whether or not they receive federal bailout money. The whole system has become corrupt where the Board of Directors (comprised mainly of other active/retired CEOs) grant outlandish compensation packages (cash, stock, perks). No one, even if she/he works 24 hours a day, deserves to make so much money; it's nothing short of looting of shareholders money by a handful of bandits who have become super rich. Why should these CEOs get to make so much more than President Obama, who has the toughest and the most stressful job in the whole world?
4. Change tax laws as they apply to businesses. When Goldman Sachs, using its web of foreign subsidiaries, pays only 10% in taxes, it's so unfair to the rest of the tax-payers. We need to close these tax loop holes and eliminate tax-exempt status of some of the territories.
5. Suspend TARP - it will never solve the bank solvency problem. The banks made so many mistakes (and they still continue to make mistakes, e,g., buying corporate jets and remodeling their offices) that the government will need several trillion dollars to clean-up their balance sheets. The best thing to do now is to let the bad apples fall from the tree. An overwhelming majority of the American people think that the TARP is a huge mistake and it is an unnecessary wasteful spending of taxpayers' money. Nationalization of banks is not a solution - it will create more failed enterprises such as Amtrak and United States Postal Service.
6. Aggressively and vigorously enforce the laws and protect the shareholders. Strengthen the SEC and mandate them to prosecute the wrongdoers mercilessly. Can you imagine what will be the crime rate on the Main Street if the police was not cruising the street? Believe or not, there are more crooks on the Wall Street than on the Main Street. We need to have an environment where these white-collar crooks think twice before they commit any fraud.
7. Solve the fundamental problem of housing which precipitated the economic meltdown in the first place. Find ways to freeze foreclosures and stabilize the housing market (may be the government should buy the houses overhanging the market, as was done during the 1930's depression). Force the lenders to lower the mortgage rates to 4.5% immediately. Come up with a plan which will reduce forced selling of houses and at the same time provide incentives to the people to buy houses, which will, in turn, help stabilize the housing prices. Once the housing prices start to increase again, everything else will fall in place (mortgage securities will become more attractive and it will become easier for banks to sell those securities).
8. We need a stimulus package but not the one passed by the House, which has a lot of wasteful pork barrel spending that Obama said he will stop. The package should include the following elements: Reduce taxes for the middle-class and increase taxes for the super-rich who make more than $500,000 a year; provide a safety net for those who need immediate help such as extended unemployment benefits, help with COBRA heath insurance premiums, and help to elderly people who live on fixed income; infrastructure spending (satisfies an urgent need to repair crumbling roads and bridges and also creates jobs), education spending targeted to improve our students' performance and make college education more affordable (that means better equipping labs etc. but not re-building our school structures; anything that has only a marginal value in improving students' scores is wasteful spending; also need new tax laws to force schools with huge endowments to roll back their tuition fees and increase student aid, or else the government should seize those endowment funds), set-up a program to help the housing industry, as explained above, and finally, spend on some long-term projects in the area of green technology, energy conservation/alternative energy sources, etc.

The stimulus package passed by the House has a lot of wasteful spending pushed by the liberal wing of the Democratic Party, which will hurt them in the next election. I support the efforts of some of the moderate Republican senators who are now trying to clean-up the bill just passed by the House.