Turning Against the Stock Market

It still looks like the US stock market is rolling over. The Dow dropped another 39 points yesterday.

The Fed has already said it will leave its key interest rate at a very low level for a very long time. The US Treasury has already announced a budget with more than $1 trillion of fiscal stimulus in it. “Cash for clunkers” ...first time homebuyer tax credits...TALF – the “recovery” programs have all pretty much run their courses.

And yet, the correction shows no sign of coming to an end.

In the housing market, one of seven mortgages are delinquent or in foreclosure. The number of foreclosed houses is on target to exceed 1 million this year...with more than 7 million in “shadow inventory.”

Bloomberg:

A report tomorrow by the Chicago-based National Association of Realtors will show July sales of existing homes plummeted 12.9 percent from June, the biggest monthly loss of 2010, according to the median estimate of economists surveyed by Bloomberg.

New-home sales, which account for less than a 10th of housing transactions, stayed at the second-lowest level on record last month, economists predict Commerce Department data will show on Aug. 25.

Federal efforts to help have had little success. Of 1.31 million loan modifications started under the Obama administration’s Home Affordable Modification Program, 48 percent were canceled by the end of July, the Treasury Department said Aug. 20. More than half of all modifications defaulted again within 12 months, the Office of the Comptroller of the Currency said June 23.

Shadow inventory, or the number of homes repossessed or in default that eventually will be offered for sale, stood at 7.3 million in the first quarter, according to Laurie Goodman, an analyst in New York at mortgage-bond broker Amherst Securities Group LP. As those properties hit the market, prices will come under pressure and buyers will wait for better deals.

“The only thing that’s going to fix the housing markets right now is a work-through of what excess supply is on the markets and improvement in unemployment,” Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said today in an interview on Bloomberg Television’s “In the Loop with Betty Liu.” “That process is a very, very long-term process.”

Yes, dear reader, have a seat. Make yourself comfortable. This correction is going to take time.

The broad money supply – M3 – as calculated by John Williams, is still contracting at about a 6% annual rate. More than 14 million Americans are out of work. And an “epidemic” of frugality seems to have infected US consumers.

And now, as predicted just yesterday, we are already seeing, as The New York Times puts it:

Small Investors Flee Stock Market

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked.

One of the phenomena of the last several decades has been the rise of the individual investor. As Americans have become more responsible for their own retirement, they have poured money into stocks with such faith that half of the country’s households now own shares directly or through mutual funds, which are by far the most popular way Americans invest in stocks. So the turnabout is striking.

So is the timing. After past recessions, ordinary investors have typically regained their enthusiasm for stocks, hoping to profit as the economy recovered. This time, even as corporate earnings have improved, Americans have become more guarded with their investments.

The notion that stocks tend to be safe and profitable investments over time seems to have been dented in much the same way that a decline in home values and in job stability the last few years has altered Americans’ sense of financial security.

It may take many years before it is clear whether this becomes a long-term shift in psychology. After technology and dot-com shares crashed in the early 2000s, for example, investors were quick to re-enter the stock market. Yet bigger economic calamities like the Great Depression affected people’s attitudes toward money for decades.

For now, though, mixed economic data is presenting a picture of an economy that is recovering feebly from recession.

“For a lot of ordinary people, the economic recovery does not feel real,” said Loren Fox, a senior analyst at Strategic Insight, a New York research and data firm. “People are not going to rush toward the stock market on a sustained basis until they feel more confident of employment growth and the sustainability of the economic recovery.”

So far, we have seen just the very beginning of this trend. Stocks are still trading around 20 times earnings. The Dow is still over 10,000. Just wait until it dives down below its March, 2009, low. That’s when Americans take another look at the stock market.

“How could I have ever been so stupid?” they’ll say to themselves.

Currently, they are merely shy. They believe that stocks are generally a good way to go, but maybe not just now. When the Dow approaches 5,000...and the P/E sinks below 8...they will decide that stocks are never a good idea. They will turn against stocks as they did during the Great Depression – for an entire generation...

...while stocks quietly rise again.

“I read that the average American consumes two eggs a day,” said a neighbor. “According to my calculations, that means that there must be 29 million chickens in America that do nothing but lay eggs for the unemployed. I don’t see how the economy can survive under those circumstances.”

We had never looked at it like that. But it’s true. America has a huge population of zombies – many through no fault of their own – who must be fed, clothed, housed, schooled and entertained. The unemployed alone are greater than the entire population of Cambodia, for example. And then there are the 40 million on food stamps. And the millions more who live off of government in one way or another – as employees, students, retirees, welfare recipients, contractors, suppliers, lobbyists and chiselers.

Most of these people add nothing to the nation’s real wealth, of course. But they also consume wealth created by others. Chickens must be fed, even when their entire purpose in life is to provide eggs to zombies.

Which just goes to show how rich modern society is. In much more primitive times, the old, the weak, the halt, the lame, the half-wits and layabouts, were abandoned...left behind...or eaten!

Ah, there’s the solution! Eat the unemployed! Surprising that no major politician or economist has suggested it.

*** Speaking of lame and dysfunctional societies, how’s Zimbabwe making out? Our colleagues in London report:

Mention Zimbabwe to almost all investors and you’ll probably get a very negative reaction. And that would be no surprise at all. It’s an African state that’s gone horribly wrong – and then some. This quote from the independent Zimbabwean economist Vince Musewe, writing in MoneyWeb, just about sums it up.

After Zimbabwe got its independence in 1980, “in our naiveté we assumed we’d witness the rise and rise of a liberal and democratic social economy”, he says. “With an educated populace, our expectations were that we’d inevitably become the ‘intellectual’ capital of Southern Africa, if not Africa. How wrong we were!”.

To cut a long story short, the economy became a total disaster area. The government mismanaged things badly. The ‘land grab’ from white farmers ten years ago led to a collapse in food production. GDP and exports slumped, while unemployment hit a staggering 80%. The country got involved in the war in the Congo, which proved terribly expensive. And the whole place has been riddled with corruption.

Indeed the only area where Zimbabwe actually became a world leader was in its inflation rate. Or to be more precise, its hyperinflation rate.

The country had long had a nasty inflation problem. But when the government started minting money by the ton to pay its bills, the rate really took off. It reached over 100% a year in 2001. Yet the printing presses were simply cranked up even more. Arrears owed to the IMF, salary payments for public workers and soldiers – they were all paid for by simply producing more and more banknotes.

Of course, this doesn’t create any more wealth. It just pushes up prices. By December 2008, the cost of living was rising at “6.5 quindecillion novemdecillion %” a year, according to Wikipedia. I’ll take their word for it – but in practice, it means prices were doubling every 1.3 days.

That puts the problems of Bank of England governor Mervyn King, who’s wrestling with the UK’s cost of living rising at just over 3% a year, right into perspective.

Why would anyone invest in Zimbabwe?

In fact, Zimbabwe seems like it’s been on a completely different planet. So why on earth, you’re probably asking, would anyone want to invest good money in a country like this? Surely there’s no point in even thinking about such a place?

Well, here’s the surprising bit. The outlook for the country is gradually picking up. Just over a year ago, the government stopped printing the Zimbabwean dollar. Zimbabwe now allows trade in the US$ and the euro, sterling, South African rand and Botswana’s pula. Inflation actually fell below zero within weeks of the move.

Sure, the inflation danger hasn’t gone away. And there are still “smart” economic sanctions in place. Without getting into the politics, President Mugabe doesn’t have a good reputation on the human rights front.

But the economy is starting to recover. Civil servants are being paid again, which has meant schools and hospitals could re-open. There are plans for a privatisation programme. And the economy is backed by significant mineral wealth that’s yet to be exploited. It could yet realise those hopes of 30 years ago.

Now we’ve heard this sort of thing before about Zimbabwe. At the end of last year it was described as the “ultimate recovery story” by Ambrose Evans-Pritchard in The Telegraph. Yet the economy is still hugely dependent on imports to survive.

But this month, another reason for eyeing Zimbabwe has just appeared. Top fund manager Neil Woodford has just used over £15m of the money he manages for Invesco Perpetual, to buy a near-30% stake in a Zimbabwean firm called Masawara (LN:MASA).

The group invests in the country’s agro-chemical, insurance and property sectors. It’s also planning to move into oil, mining and agriculture, as well as buy privatised assets. Masawara has just floated on London’s AIM market at 50p/share – the shares were trading at 54p yesterday, and 59,000 changed hands according to Bloomberg.

Should you invest in Zimbabwe?

So what should private investors make of all this? And should they follow Woodford by buying into Zimbabwe?

Of course, the Invesco Perpetual star player doesn’t get it right all the time. He’s backed a few wrong horses, and clearly Zimbabwe is a high risk and controversial bet that could yet go very awry.

But Woodford is no short-term punter. He’s a long-run income fund investor who can sniff out a real bargain, and is prepared to give it enough time to be recognised by the rest of the market. So when he put that amount of money into somewhere as offbeat as Zimbabwe, it’s enough to make me think it’s worth doing likewise.

To repeat, this would be a high risk, long-term investment. It would be sensible to keep it as a relatively small part of your portfolio. But over several years it could pay off incredibly well. Remember China.

If you feel like following Woodford, but don’t like the idea of Masawara, alternatively there’s LonZim (LN:LZM). This deals in hotels, pharma distribution and electronic payment services, and is planning to invest in a wide spectrum of businesses in the country.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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