Author: Joshua Brown

Here a Swan, there a Swan, everywhere a Black Swan…

Newsletter writers, hedge fund managers, journalists, bloggers, technicians, fundamental analysts, economists and strategists are joining the crash camp left and right.  Not the bear camp…the crash camp.

I’ve been running around Manhattan all day taking care of business, meeting clients etc.  After scanning today’s articles and blog posts, I can honestly say that I’ve never heard more chatter about an imminent market crash, all at once, in my life.  It’s like the May 6th Flash Crash got everyone in the mood to talk cataclysm all of a sudden.

I’m not one of those guys who takes everything as a contrarian signal.  I abhor knee-jerk contrarianism.  Samuel Lord once said “Do not choose to be wrong for the sake of being different,” and I think that’s kind of apropos here.

As avowed contrarian Dougie Kass likes to remind us, the crowd usually outsmarts the remnant when herd mentality takes over.  So what is the herd hearing/ seeing?

* First of all, the macro guys are disturbed by the Euro Zone’s crisis and its ripple effect/ contagion risk.  This isn’t new but it is more pervasive.  And the possibility of a China collapse scares the hell out of almost everyone.

* The technicians and Dow Theorists are grossed out and have dusted off all the 1937 charts again.  Specifically, they are looking at the highly distinct pattern of a big drop (May 6th) followed by a failed rally (euro bailout day’s 4% gap open) followed by another fast sell-off.  Richard Russell‘s latest missive, in which he tells us that we won’t recognize America by year’s end, will make you want to kill yourself.

* Equity analysts are all pointing to year-over-year comps which will start getting harder now.  They may feel OK about the “E” but they’re shaky about the “P” – will the tax hikes and regulatory headwinds we now face really allow for a high-teens multiple on whatever the earnings turn out to be?

* Bond guys are freaking out about sovereign stuff, obviously.  We’ve transferred corporate risks onto government balance sheets with bailouts, the Piper still awaits his payment in many cases.

* Eddie Elfenbein posted the results of a CNBC poll yesterday in which 40% of respondents predicted a 50% haircut for the Dow.  Seriously, almost half the respondents predicted Dow 5000 by the end of this year.

* The hedgies are vocally bearish again as well.  Seth Klarman‘s got some cautious commentary out today and Jeremy Grantham‘s “sell everything” stuff is being quoted everywhere.  Raoul Pal put out a newsletter this week with a 2 day-to-2 week crash prediction.

We’re not talking garden variety bearishness here.  We’re talking about ubiquitous crash predictions.  My comment is that I’ve never seen so much certainty in so many places of a coming crash.  Will it be self-fulfilling or are we talking major contrarian signal?

Worth noting no matter what.

This guest post previously appeared at the author’s blog, The Reformed Broker >

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(This is a guest post from the author’s blog.)

Compared to virtually all commodities of late, natural gas has been an absolute dog.  Holders of a certain nat gas ETF  have been forced to ask themselves whether or not a stock can trade in negative integers.

The reason for nat gas’s lackluster price action?  The conventional wisdom goes that because of our ability to horizontally drill for shale gas, the supply picture may be damn near unlimited. 

Out of left field comes a major-league contrarian call from Henry Groppe, an 80-something year old Texas-based petroleum industry analyst with a long track record of making big calls.  According to a story at The Globe and Mail, Groppe argues that shale wells are rapidly depleted and that there is, in fact, a major shortage of gas which will become apparent this summer in dramatic fashion.

David Parkinson reports on The Globe Investor site:

No, his analysis (and more than 50 years of experience) tells him that gas inventories are about to get a lot tighter, that new supplies are overstated, and that prices are headed north of $8 by the end of summer.

Why is he so sure he’s got it right and most everyone else has it wrong?

Because, he contends, shale gas – the previously unattainable source of vast gas supplies that has been unlocked by new high-tech horizontal drilling advancements – is not the holy grail it’s been cracked up to be. Not even close.

Groppe explains that horizontally-drilled wells face a huge amount of rapid depletion once tapped, and so the supply that we are all counting on to be there is ephemeral at best.

A double in nat gas prices by summer’s end?  Now that’s a variant, outlying view that grabs my attention.  Especially in light of the fact that Nat Gas E&P stocks have sat out most of this rally.  Hmmm.

Source:

A Contrarian Makes Another Call – This Time Natural Gas (GlobeAndMail)

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(This guest post previously appeared at the author’s blog, The Reformed Broker)

The natural gas sector has been hot this week on the heels of several upgrades and bottoming calls on The Street.  I’ll take this opportunity to disabuse the investing public of a horrible bit of faux-wisdom about the commodity…

One of the biggest money-losing maxims of the past 5 years is the old “Oil Historically Trades at an 8 to 1 Ratio to Natural Gas” chestnut.  I’ve also heard that it’s more like 10 to 1.  Whatever.

Time to forget this ratio for good.

‘Cause the word “Historically” is meaningless in the face of our newfound limitless supply of natural gas.  My clients who work in the oil and gas patch in Oklahoma and Texas know this ratio to be false in today’s reality.  They know that the availability and methods for procurement of natural gas are much improved…

We can drill everywhere for nat gas now – from Pennsylvania to the Rocky Mountains, from the swamps to the shales.  Geographically speaking, America is like a hot tub cover sitting atop a steamy jacuzzi of nat gas.

We can drill for it sideways, diagonally, upside-down, in our underwear and from half-court.   We can pull it from the well heads as a byproduct of oil drilling or we can frak it from the side of a cliff formation. 

There is so much natural gas in this country that we’ve run out of places to store it.  A recent estimate from the EIA postulates that we are currently looking at working nat gas storage in excess of 54 days worth of usage.  The same study concluded that we may end up testing “the brim”, meaning the maximum amount of storage capacity that we can handle in the lower 48 states.  This brim is estimated at 4 trillion cubic feet, but no one is really sure because it has never gotten close before.

This is a great thing from an energy-sourcing standpoint and many of the technological breakthroughs that have made this bountiful supply a reality have come along in the last decade or so.  With significantly better equipment comes higher supply, regardless of what used to be the norm.

What does this mean to those looking for a quantitative answer to an old school relative-value question?  It means that your historical 8 to 1 ratio has been rendered impotent.  Throw your models away.  The below chart of Oil-To-Gas from Bespoke demonstrates exactly how volatile this relationship truly is:

“Historically” is a dangerous term, it justifies all kinds of cocksure assumptions.  When I hear Wall Street guys talking with certainty about the crude to natty ratio, I chuckle to myself.  Historically, it was a good idea to have 8 year old boys working in coal mines.  Historically, it was acceptable for food packaging companies to add poisonous trans fats to apple sauce in order to extend shelf life by an extra week or so.  Historically, the earth was flat, Tiger was a model citizen and guaranteeing pensions to autoworkers for life was a safe bet as most of ’em would barely live past 60 years old.

Historically.

Enough with the ratio, the earth has turned and things don’t work that way anymore.

Chart Source:

Oil To Natural Gas Ratio (Bespoke)

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(This post originally appeared on the author’s blog)

Boston Scientific ($BSX)  is like that shady diner on the edge of town that’s been around forever, the one that used to be packed 3 meals a day but now just kind of opens its doors for no reason.  Nobody goes there anymore, but every once in a while, you decide to give it another chance and try the food again.

And you are rewarded with a wicked case of indigestion the next day while howing “Why, oh why did I just eat there?”

Anyway, as of this posting, Boston Scientific is getting snork-hammered, down about 18% on the day as news of a major setback with the FDA drove over 150 million shares in volume so far, much of it to the downside.

The upshot here is that this particular shady diner is loaded with hedge fund managers, many of them newly-disclosed shareholders – especially of the value-oriented variety.

As of the latest 13F filings, BSX stock has been purchased in size by:

David Einhorn (Greenlight Capital) – he’s made BSX a 10.5% position in the fund.

John Paulson (Paulson & Co) – 5th largest stock holding, 4.5% of holdings (over 99 million shares held).

John Burbank (Passport Capital) –  BSX is a brand new position as of the 4th quarter.

David Gallo (Valinor Management) – BSX is a brand new position as of the 4th quarter.

One caveat here is that 13F filings come out 45 days after the close of a quarter and plenty could have changed between now and December 31st.  That said, this truism cuts both ways and these hedgies could just as easily have added to their BSX holdings as they could have subtracted.

And then we must also consider that to value-oriented investors, 20% one-day sell-offs ar almost always looked at as “opportunities”.

Guess we’ll see.

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See Also:

• Health Insurance Companies Get Rocked As White House Aims To End Anti-Trust Exemption
• MARKETS IN FREEFALL
• Tenet Healthcare Plummets After Missing Expectations

(This guest post originally appeared at the author’s blog)

In last week’s Barron’s, I read the following quote from a fairly prominent hedge fund manager:

*Redacted* “favors emerging stock markets, Brazil and Turkey in particular, over developed markets, but he is bearish on China, citing what he views as ‘extraordinary economic imbalances and the mismanagement of its economy’.”

Let me help you out with that notion, homeboy… Liking Brazil while disliking China is like favoring the Indianapolis Colts in the Super Bowl but betting that Peyton Manning will have a bad game.

I’m hearing this “Brazil is great but watch out for China” thing a lot lately.  It just doesn’t work that way.

China and Brazil are quite possibly the most symbiotic investment story going right now.

It’s completely understandable if you don’t like what’s happening in China, including the crane-filled skylines, the widening gap between those who can and cannot afford city real estate, the ghost cities and the infrastructure being built just for the sake of building.  But if you are a disbeliever in the Chinese boom or its ability to continue, how could you possibly want to invest in an economy like Brazil that is completely beholden to China’s appetite for building materials, finished goods and food?

Brazil’s burgeoning middle class and the rise of their own internal consumer culture are highly appealing to investors, especially when you look at the progress they’ve made in beating back inflation.  But don’t for a minute think that the Brazilian consumer isn’t flourishing as a result of the world’s insatiable appetite for the country’s mineral and agricultural wealth.

Companies like Vale (VALE) and Petrobras (PBR) have been coining money by selling to the Chinese Dragon and that same money is precisely what has trickled into the Brazilian population’s purse.

China displaced the US as Brazil’s number one trading partner in 2008; the annual trade balance between the two nations has grown exponentially over the last decade and is now in the range of $36 billion.  In May of 2009, they also signed a $10 billion oil agreement.

Many of China’s steel plants have been running in overdrive since before the 2008 Summer Games.  What made this possible was the metallurgical coal they imported in huge quantities from Brazil (400 million tons last year).  This is in addition to the Brazilian metals and petroleum products shipped to China to facilitate the building of several metropolises and the highways to connect them.  And then there is the agricultural export business, in some ways even more crucial for Brazil, which includes the shipping of soybeans and cellulose products.

The revenues from this relationship have been extremely beneficial to the 90 million or so Brazilians who are now considered middle class (aka Class C).  They buy cell phones, visit dentists and decorate their homes with the dividends from the export business.

And as the US and Japanese economies have retreated over the last two years, Brazil has specifically targeted China as a market to sell into and has become increasingly reliant on it.

What my friend the hedge fund manager doesn’t seem able to connect is the fact that should China’s internal issues cause a blow-up or a slowdown of any consequence, Brazil’s export industry will be perhaps the hardest hit, followed soon after by its consumer class.

And frankly, in the absence of Chinese demand, who could possibly pick up the slack for Brazil’s export industry to keep chugging along?  The US?  LOL.  Europe?  Yeah, ok.

The codependent relationship between China and Brazil is as fundamental as that of the shark and the remora fish.  Any investor who believes otherwise is bound to be heartbroken.

As Old Blue Eyes sang: “This I tell ya brother – ya can’t have one without the … other!”

Read more market commentary at The Reformed Broker >

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See Also:

• The 10 States About To Get Murdered By The Coming Chinese Import Slowdown
• With New Muscle, Blackrock Is Betting Big On Brazil
• Geithner: We’re All Good Because China Will Save Us And Let The Yuan Strengthen

(This post originally appeared at the author’s blog)

The good news?  No more mindless dollar carry trade.  The bad news?  The fundamentals matter again.

Remember this?

I believe that last year’s overriding theme of the dollar carry trade along with the reverse correlation between the US Dollar and the S&P 500 ended the first week of December.  This occurred exactly when the BLS released its first strong(ish) jobs number.  That week, US stocks exploded higher and the US Dollar Index (USDX) was well in the green, too.

Some of this had to do with the fact that right around that time, Europe started to produce headlines uglier than Madonna’s bare arms.  Keep in mind that the Euro makes up around 2/3rds of the US Dollar Index.

Now that the seesaw trade of up dollar/down stocks and vice versa has stopped working like a Swiss watch, you may feel a temporary relief from that monotony.

You shouldn’t.

With the carry trade no longer in the driver’s seat, the market has begun to focus on actual fundamentals again…you know, those pesky numbers that describe the conditions of the corporations themselves.

Unfortunately, if fundamentals are back in focus, then so is the fact that we are still in the Costcut-covery.  Top line sales are coming in relentlessly weak, even as profits are hitting the targets.  These reports, even the beats, do not excite anyone who reads past the first line of the press releases.

I run a fairly sizable brokerage and advisory business.  I could fire my staff and cut off the research products I subscribe to and only commute to work 4 days a week instead of 5 and stop wining and dining prospective clients and drop the amount of states I do business in to lower registration fees.  And yes, my take home pay would look much improved at first.  But then what?  How can I grow my book of business if I’ve gutted it of the raw materials and resources it needs to get bigger?

The answer is I cannot, and as my revenues decline, my juicy margins from all that expense trimming are sure to fade along with it.  And then no one is happy, especially not the wife.

The meeting of temporary profitability targets may earn execs their bonus and make for good headlines, but at some point, you aren’t aren’t just cutting fat – you’re chopping into the muscle itself that you need to walk the next mile.

So yes, the carry trade got too easy and had run its course, but now we have to actually examine the fundamentals again.  In the Costcut-covery, that’s not necessarily such a good thing.

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Terms & Conditions page for a full disclaimer.

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See Also:

• David Rosenberg: The Market Is Becoming Discriminating, A Rising Tide Will Not Lift All Boats
• Goldman: Fears Of Chinese Tightening Are Overwhelming Positive Earnings
• The Dollar Carry Trade Is Collapsing

(This guest post originally appeared at the author’s blog)

Yes, I’m about to give props to Goldman.  Deal with it.

The single biggest, most profitable market call of the last decade was made in 2001 by economist Jim O’Neill, then working at none other than Goldman Sachs.  The call was made in Global Economics Paper #66 aka “Building Better Global Economic BRICs” and it marked the original usage of the term “BRIC” to describe Brazil, Russia, India and China as a group.

The coining of the term is secondary to the trillions in wealth and world-changing shifts that this paper predicted.  Had you heeded O’Neill’s work and gotten invested in the stock markets of those four nations, you’d have made more money this past decade than by doing virtually anything else conceivable.

O’Neill and his fellow researchers concluded way ahead of everyone else that:

• Over the next 50 years, Brazil, Russia, India and China—the BRICs economies — could become a much larger force in the world economy. Using the latest demographic projections and a model of capital accumulation and productivity growth, we map out GDP growth, income per capita and currency movements in the BRICs economies until 2050.

• The results are startling.  If things go right, in less than 40 years, the BRICs economies together could be larger than the G6 in US dollar terms.  By 2025 they could account for over half the size of the G6.  Currently they are worth less than 15%. Of the current G6, only the US and Japan may be among the six largest economies in US dollar terms in 2050.

This call was bigger and more prescient than any I can think of this decade.  It literally encompasses every major theme, from currencies to commodities, from the cost of technology components to the price of a barrel of oil, from the exchange rate of the dollar to the growth rate of the global middle class.

As far as percentage gains, in some instances, we’re talking about thousands of percentage points in whole indices!

Congratulations to Goldman Sachs for nailing this story back in 2001 and to anyone who got in and rode the BRIC trade this decade.  From where these markets stand today, even after the Credit Crisis, O’Neill’s original paper is starting to look like a once-in-a-lifetime call.

Here’s how right GS was, a look at each of the BRIC markets since 2001:

 

Sources:

Unfortunately, I have been unable to locate the actual Paper #66, but here’s a link to Goldman Sachs’ BRIC Research Archives, which seems to go back to 2003:

http://www2.goldmansachs.com/ideas/brics/index.html

Read Also:

Emerging Idol: Auditions for BRIC without the “R” (TRB)

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See Also:

• Goldman Loves These 50 Stocks With Heavy BRIC Exposure
• A Monster Month For Emerging Market Hedge Funds
• Marc Mobius: Here Comes Another 40% Surge For The BRICs