Beating Buffett

Buy what everybody hates. Mentally difficult, financially brilliant!

The AAII sentiment survey dated July 12, 2012 showed the lowest level of bullishness since the October 2010 market bottom. Of course, the dour October mood was inspired by the big sell-off from the April 2010 high that preceded it.

Nothing makes investors more bearish than having just gotten their collective bullish asses kicked. That was especially true after a series of false, fit and start rallies in May, June and July that year.

That exact point of maximum pessimism marked the beginning of an almost uninterrupted more than 30% rally which lasted six months. Those who missed the entry point never got a ‘fill the gap’ decline to get invested. You paid a big price for being out at the turning point.

The July 12^th low in bullishness by ‘mom and pop’ traders followed a significant six-day sell-off after what many suspected was a false start rebound in June.

Only time will tell if we’re at the start of another multi-month, large percentage rebound in the broad averages. What’s already history is the rebound to above 13,000 on the DJIA for the first time since early May.

Professional financial advisors are often guilty of giving clients what they want rather than what they need. Most private investors match the AAII profile. They ask for whatever’s just finished doing the best while shunning asset classes that have recently done badly but offer the best values and the chance to rebound strongly.

SentimenTrader’s excellent chart shows how financial advisors’ recommended stock allocation is now lower than the 2009 lows. Conversely, their weighting towards bonds (offering the lowest coupon rates in our lifetimes) is now at all-time highs. This is nothing short of insanity.

Everything in nature regresses from extremes towards normal over time. Demand for stock will rise again. Those willing to lend money at negative real interest rates are sure to diminish in magnitude.

When will the tide turn? Has the train already left the station? Nobody can say for sure. I defer to The Bard for the answer to that question.

“Better three hours too soon, than one minute too late.”
…William Shakespeare

Failing to plan is planning to fail.

Dr. Paul Price RealMoneyPro@TheStreet.com July 28, 2012

Truth can be stranger than fiction. A well-known regional brokerage firm put out this somewhat enigmatic (to me) ‘upgrade’ announcement regarding Lumber Liquidators [NYSE:LL] on Thursday July 26^th.

It was further distributed by Barrons.com later that same day. I am withholding the name of the opinion’s authors to protect the guilty.

Barrons noted that with LL at $41.31 the brokerage firm was moving from a SELL rating to NEUTRAL. The researchers noted that LL had had downgraded to SELL on February 14, 2012 on fears of a declining growth rate and management’s desire for a sharper focus on existing operations.

LL’s closing price on February 14, 2012: $21.16 Rating: SELL

The trio of analysts fessed up to having been wrong while the shares had doubled. They gave explanations for missing two key factors that might have kept them from the misguided Valentine’s Day lack of love for LL.

In a final, hard to imagine, conclusion they noted their ‘fair value’ estimate was now $35 as “…beats and raises are required for the remainder of the year to justify current valuation.”

Translation: Barring unexpected good news our Neutral rating would allow for a 16.9% drop to our own estimate of true value.

Do clients see value in this type of research? Why did Barrons.com republish this?

Dr. Paul Price July 27, 2012

Most of us don’t have unlimited funds to invest. At some point we get maxed out where all available money for equity purchase is ‘in the market’. If you come across a new and compelling idea you must triage your portfolio and sell to buy.

There’s nothing earth shattering about that concept. The process is often done haphazardly or even against traders’ best interests. If tax consequences were not a factor you’d theoretically search for the weakest link in your current holdings and sell those shares to fund the new purchase.

Human nature often clouds that fairly easy goal and leads to bad decisions. Suppose you have one position [Stock #1] that was purchased for $10,000 and is now worth $20,000. You also have a different holding [Stock #2] that was bought for $30,000 and has declined to $20,000.

You feel great about the winner as it’s ahead by 100%. That bad position represents a 33.3% paper loss. That makes you feel like a chump, not a champ. Here’s a quick look at the possible actions you could take to get the cash for your newest exciting idea.

In either case you would free up $20,000 of cash to make the new investment. Selling the winner made you feel smart but adds a big tax liability. Exiting the losing position abandons all hope of a recovery by locking in a loss. Either action provides $20,000 for the new investment. It could cost $2,000 - $4,000 next April 15^th to revel in your success. Any psychic damage from feeling dumb is offset by the hard cash tax savings.

Even knowing all the above doesn’t stop most people from taking the gain while continuing to ride with the underwater position, hoping to reach breakeven.

Before making your own choice, go back to your research. Evaluate each company based on all available information available right now. Figure a realistic target price for each. Unless the presently depressed stock has substantially better future potential than the winning stock does think about taking the loss and shifting the funds to the new, more promising shares.

The taxation angle gives that strategy a big statistical advantage.

Dr. Paul Price for Real Money Pro July 24, 2012

Saturday’s news services all reported the story that President Obama now backs bankruptcy as an option regarding privately held student loans. The process wouldn’t affect the 85% of total student debt borrowed through federal direct lending government. It would only apply to approximately $150 billion of outstanding student loans now held by Sallie Mae and private banks.

Why were these loans not dischargeable through bankruptcy previously? College age students seeking loans rarely have substantial net worths, good credit ratings or present day earnings power. Private lenders were betting that a good education would unlock young people’s potential and lead to secure jobs with the ability to repay what was being borrowed.

With many colleges now charging $20,000 - $60,000 per year it wasn’t unusual for borrowers to owe six figure amounts, particularly if graduate programs were included. What would prevent every new graduate from filing bankruptcy after school ended but before they started their first job?

With tons of debt and no income what judge could deem them capable of paying what they owed? SLM or the banks would end up having to write-off massive amounts. That’s why the law reads as it does; prohibiting discharge of student debt through bankruptcy.

Dictating a change allowing this to occur is the taking of private property (the principal and interest owed) from SLM and private lenders by retroactively changing the contract terms.

It is noteworthy that the proposal exempts this process for the $850 billion or so in government direct lending programs. It’s apparently ok to steal from the private sector as long as the public is not at risk. No new private lending would be likely to occur once the prospect for default, after college but before a career begins, was definitely on the table.

It would be the death knell for all private lending that did not involve non-student cosigners.

Today’s direct federal lending programs now have forgiveness provisions that kick in 10-20 years after graduation depending on whether your career choice squares with what is considered ‘good for society’.

This new policy proposal is nothing more than a thinly veiled half-step towards making government programs the only source for student loans. It also advances the goal of making post high school education yet another entitlement that shifts costs from the actual users onto all taxpayers.

You may or may not agree with that sentiment. You should at least be aware of what is being proposed to take place without any congressional debate.

Dr. Paul Price July 21, 2012

Total issuance of Treasury debt has skyrocketed

Foreign buying has been drying up leaving the Fed to soak up demand while artificially lowering rates. Where would rates be with this intervention (manipulation?) into what are supposed to be auction markets?

Certainly a lot higher than they are today. Who benefits from this deception? Politicians who need less cash to service the ever growing national debt and banks. Who loses when interest rates fail to respond to true supply/demand? Savers and investors, pension plans and private lenders who are now earning next to nothing on their life savings or retirement assets.

The ability to simply ‘print money’ without destroying the value of the $US is not unlimited.

My wife has to listen to me simply because we occupy the same house. She’s heard me say that Iceland is the blueprint for countries to regain prosperity after finding themselves overwhelmed by excessive debt. Last night she asked me to give her a really short version of how they did it that even she could understand.

Here it is:

Iceland’s entire banking system failed in 2008’s due to world-wide real estate and financial melt-downs. Iceland owed foreigners about 8x their entire GDP. They needed to figure out how to recover from what was essentially a national bankruptcy.

So they did. Icelandic citizens rejected the idea of fiscally killing themselves simply to make good on debt to non-Icelandic counterparties. They told the rest of the world they weren’t going to pay them what was owed (translation: they defaulted on their debt).

Iceland was lucky enough not to be part of the Euro currency group. Icelandic citizens were protected from the bank failures by their version of our FDIC. Domestic households which had 1 MM kronur in their account still had the same nominal balance post-crisis.

So, why would the people of Reykjavik even care? Once Iceland was no longer credit worthy their currency’s exchange rate plummeted from around 60 to the $US (at the start of 2008) to an all-time low of 148.33 per $US in December 2008. At that moment it took 2.47x more kronur to buy anything imported than it did at the start of the year.

Gasoline, automobiles, non-locally grown foods etc. all shot up in price very dramatically. 1 MM kronur went from being worth $16,667 to only $6,742. The banking crisis had devastated the buying power of ordinary citizens despite leaving their nominal net worths unchanged in local currency.

The good news was that Iceland became a bargain destination for tourists where their dollars or euros now received tremendous value. Likewise, Icelandic exports became much more competitive on world markets.

Without the need for external debt service tax money could be channeled back to internal uses. Less total revenue was needed to fund government.

Iceland’s recovery required an initial period of pain due to currency devaluation and the lack of international credit availability. Pure economics forced people to limit spending on imported goods. It improved the prospects for exports. It fostered the ability to attract foreign tourism which brought in much needed hard currencies.

Iceland is now one of the fastest growing economies in Europe.

Greece, Spain, Cyprus, Portugal and others need to exit the euro and go through the same cleansing process. There’s no way to avoid the initial pain because the devaluation of your local currency is what makes recovery possible. This can never happen in the world order we have today. No pain no gain.

Dr. Paul Price of RealMoneyPro@TheStreet.com July 20, 2012

CMG shares are down more than 22% mid-day Friday after reporting better than expected June quarter results. Apparently analysts didn’t realize Mexican food contained corn, with a surging cost, or that economic conditions were not conducive to future strong quick service restaurant sales growth.

From the 2012 high of $442.40 CMG is now off by about $130 per share. Why should this shock anyone? Momentum traders who paid that April peak price were laying out 50.3x projected EPS of $8.80. That put the earnings yield (the inverse of the P/E) at 1.99% based on the forward estimate. How excited should anyone have been at the prospect of getting less than a 2% after-tax return on investment? That meager return was predicated on better than 30% year-over-year growth this year.

If it’s any consolation to those licking their wounds today you could note that in late 2007 even crazier traders paid 73x trailing earnings for CMG. While that eventually worked out for the buy and hold crowd you would have had to sit tight while the stock declined by 76% from $155 to $36.90 in November 2008.

Non-momentum value- oriented investors could have scooped up the same shares at 12x – 16x projected earnings in late 2008, early 2009 and then once again at the beginning of 2010. The same shares were great buys at the right price and horrible trades when too expensively priced.

After today’s drop CMG is only inexpensive when compared to the grossly overpriced valuations seen during late 2007and in 2011 – 2012 YTD. I would advise staying on the sidelines unless we see a much bigger sell-off.

Buy the burritos and tacos but wait on getting the shares ‘to go’.