You Can Lead Investors to Liquidity but You Can’t Make Them Buy Stocks

You Can Lead Investors to Liquidity but You Can't Make Them Buy Stocks8.51010

Howzit? That seems to be the way everyone greets one another in South Africa. We ask it of the stock market as we get back into the groove and close out the year. What did we miss last week in Australia?

For starters it looks like we missed a $45 down move in gold. All up, gold is down over $100 in the last two weeks. Gold is still up nearly $300 in the last twelve months - or about 35%. But if you're a new gold investor - and many people are - a $100 move down gives you the willies.

The nice thing about being away from the news cycle for a week is that it gives you time to think. We did a lot of thinking last week. And a lot of listening. Our main observation for the week is that things are probably unfolding in just the way we're expecting, but not exactly at the pace we expected.

We'll get to what we mean by that. But we should have a look at the markets and see what's cooking. Behold the Santa Rally, says equities analyst Julia Lee of Bell Direct! Lee says that despite five daily declines last week, the index has risen in December twelve times in the last sixteen years.

"The Santa rally is not just a figment of the imagination," Lee says. "If history is any guide, expect another one this year to top off a year of strong gains."

Yes Julia, there is a Santa Claus! His name is Ben Bernanke and he drives the Fed Sled filled with money. But strong gains?

Well, it's true. The S&P ASX 200 is up over 1,000 points and 25% from where it began the year at 3,659. And from the lows the rebound is even more impressive. From the March sixth low of 3,111, the index is up 48%. Merry Christmas!

Not to be a Scrooge about things, but in that 16-year period, there WERE four years in which Aussie stocks did not rally in the month of December. Out of curiosity and for the sake of thoroughness, maybe those are worth investigating. Those years are 2000, 2002, 2007 and 2008.

You could say that in two of the last three years, the Santa Claus rally has failed to show, but that would not confirm the happy story. So what, if anything do those four years tells us? Are those four years recent evidence that the 16-year trend of happier Decembers is over?

Well you should know we don't really care about what happens in December. It's the longer trend that matters most. And by our reckoning, those four years DO matter a lot. They tell you a much different story about what to expect NEXT year.

Our version of this Christmas story is that a long-term bear market began in 2000. This was the fall-out from the dot.com boom and the end of an 18-year bull market in stocks that had begun in 1982. Left to its own devices, the market would have declined to more reasonable valuations and companies would have sorted out real ways to grow earnings.

But you know what happened next. Alan Greenspan cut interest rates over and over again. To be precise, the Greenspan Fed cut the discount rate 13 times from January 2001 to June 2003, lowering it from 6.5% to1% and leaving it there for a year. Cometh the rate cuts, cometh the boom.

However, to paraphrase an old saying, you can lead investors to liquidity, but you can't make them buy stocks. The rate cutting frenzy didn't save the stock market until 2003. But by then, low short-term rates had dragged longer-term rates down in sympathy. This lowered mortgage rates in the States, kicking off a mortgage bubble.

You know the rest of the story. Through CDOs and the magic of securitisation, America's mortgage boom was sold, via Wall Street, to the world. And in 2007 and 2008, that boom went bust, along with a lot of other leveraged asset bubbles made possible by historically low global interest rates.

Those four years, then, in which Aussie stocks did not finish up in December were all years in which the primary forces of deleveraging asserted themselves. In the first two of those four instances, rate cuts spurred rising asset prices again. But in 2007 and 2008, rates had already been cut as low as they could go. Which brings us to today - where stocks are again up and seeking further stimulus.

But today, interest rates are rising. It will be interesting to watch Wednesday's GDP figure. A weak figure (which economists are predicting) may slow down the Reserve Bank in its rate rise campaign. But that may not matter all that much anyway.

Our main observation - the one we gained from thinking and talking last week in South Africa with our mentor Bill Bonner - is that stocks are probably better sold than bought in the next decade. Not only are valuations high at these prices, but it's the trend that matters - in a world of excessive public debt and deleveraging, corporate earnings aren't going to grow at the go-go rates of the boom years.

Mind you stocks may be a better hedge against inflation than bonds. Bonds are probably the great "short" opportunity of the next ten years. But you have to be pretty selective with stocks. You have to pick industries or sectors that will do relatively better than declining paper money. Luckily for Aussie investors, we think that means precious metals and energy shares.

But who knows? Maybe that's just the jet lag talking. Still, when you step away from the computer screen, turn off your mobile phone, and stay away from the television, a funny thing happens these days. Time gets less compressed.

With the omnipresent news cycle, there's an urge to digest every piece of news as it comes in and instantly discount what it means to the economy and stock prices. But this is nonsense. In the aggregate, there IS some immediate pricing in of what people think "the news" means. But "the news" does not generally trump "the debt" or "the fundamentals."

The more we think about it, the more we think people are thinking less and reacting more. This leads to pricing mistakes; bubbles on one hand and oversold or ignored assets on the other hand. The problem with a liquidity boom is that it's hard to find anything that's really oversold. You have to settle for avoiding the obvious traps and picking your other targets carefully.

And finally, on a completely unrelated note, do a peacock's feathers contribute to its survival strategy? Whenever we see any kind of physical trait or behaviour in nature, we assume it exists because it promotes the survival of the animal or its species. We can understand how a peacock's feathers make it attractive to potential mates. But what about predators?

Of course in the garden at the hotel we were staying at in Johannesburg last week there were no predators. A solitary peacock was presenting himself/herself to some French airline pilots and Arab oil men. In exchange for the extravagant effort it was served up a few bread crumbs. It probably came out ahead in terms of calories received versus expended, putting on the show.

Incidentally, asking how a social behaviour is useful in evolutionary terms does not always work with human beings. Why? Surplus. Human beings - at least a fair portion of those living in 2009 - have more surplus time and calories than probably any other animal in the history of the planet.

This huge amount of surplus - partially a function of the misallocation of resources from the credit bubble - allows people to do indulge in incredibly stupid and wasteful behaviours, like karaoke and politics. Spend a few hours waiting in line in an airport and you'll quickly come to the conclusion that without so much surplus (and the division of labour) quite a few of today's homo sapiens wouldn't last long in a world of scarcity. They would be lion food.

Fortunately, 300 years of free trade has built up a lot of accumulated social and real capital in the world. Lions can be seen in zoos, circuses, on the television in high definition. They don't have to be dodged on your way to work (although that might make an excellent reality TV show). For most people, living standards have risen. But most of that was a function of cheap energy and cheap credit. And today...we reckon both of those economic inputs are getting more expensive or scarce. Uh oh.

Dan Denning
for The Daily Reckoning Australia

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