The Bankers' Bull

By Mohamed Mounir - September 16, 2012 | Tickers: F, TLT, MCD, TBF | 0 Comments

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The S&P 500 closed at 1432 points one week ago, that's a 4 year high, it's now at 1465.  The S&P has risen by 16% this year and if it continues this upward momentum it could easily have its third best year in terms of performance since  2000. That would only be  after 2009 and 2003, the rebound years of the last decade.  In fact, Tobias Levkovich, an equity strategist at Citigroup believes the S&P 500 may end 2013 at 1615, an all time high!!!

So are we finally getting out of our lost decade, and more importantly is this 1982 or 2007?

One of the most important things to keep an eye on when you're investing in equities is the overall direction of the market. You could have a portfolio of the financially healthiest and fastest growing companies in the world and watch your portfolio get hammered down right before your very eyes should we enter a bear market.

I am not talking about "Timing the Market" to get in at exact bottoms and get out at exact tops in a short time frame. I think that exercise is futile, and  a dollar cost averaging or a very long term holding time frame will probably yield better returns for the average investor than trying to time the market.

What I am talking about is active management of your portfolio by watching out for key macro-economic conditions. This would have given you the foresight to get out of equities in years like 1999 or 2007 or to short the market on the way down and come back in the early 2000s or 2009-2010. After all I would rather be holding Berkshire Hathaway's class B shares bought at around $60 in 2009-2010 rather than around $90 in 2007-2008. Remember the lower the price at which you get in the higher your overall return.

With that said, what is driving our current bull market? and again is this 1982 or 2007?

There are currently two things keeping the market on its heels right now

• US Recovery
• Eurozone Worries

"Good news is good news and bad news is good news, largely because of the Bernanke put," said Eric Kuby, chief investment officer at North Star Investment Management in Chicago.

Well with regards to said put, Bernake on Thursday announced that the Fed will initiate QE3  purchasing $40 Billion of Mortgage Backed Securities per month. The market's reaction was hysterically bullish, with the major indicies jumping by more than 1.5% on Thursday.

A lot of people believe that Quantitative Easing will have long term negative effects on the economy due to inflation and dilution of the money supply. However the Fed doesn't actually mind inflation right now. Remember US debt is in nominal Dollar value so the Fed is looking for nominal US growth.  Now whether that 5% nominal growth is 4% real and 1% inflation or 1% real and 4% inflation isn't so much a concern right now. So far the earlier actions of the Fed have helped the US avoid a deflationary spiral, but hasn't had a runaway inflation effect that was expected.

Now if the economy shows signs of recovery and robust growth, inflation may kick in again, the fed may stop its near zero interest rate policy and interest rates would rise. That would definitely be good for the Proshares short 20+ Year Treasury ETF (NYSEMKT: TBF), from here on referred to as TBF which is an inverse of the Barclay's iShare 20 year Treasury+ ETF(NYSEMKT: TLT) from here on referred to as TLT, meaning that if TLT goes down by 1%,TBF should go up by 1%.

When interest rates rise, bonds, especially of the long term variety, become cheaper. So if interest rates rise TBF will benefit. However that's not the whole story. ETF's are not bonds, they are more similar to stocks and if there is a huge outflow from an ETF, its price will drop according to the laws of supply and demand. Despite record low interest rates we are still amidst a strong bond bull market that stretches back 30 years. Investors are still piling into US treasuries despite low yields due to economic uncertainty. However if investors feel more confident in the economy they will seek riskier assets with a better rate of return.  TLT  experienced an outflow of $49.4 million in the past week and almost $433 million in the past month. So TBF may go up even with Bernanke's promise of low interest rates to 2015.

 EuroZone Mess 

Now, this is where things get a little bit gloomy. Europe is in a mess, recession is all around , not to mention unfavorable demographic trends which may have a much longer and more serious impact. Half the countries using the single currency are in a fiscal debacle and the other half are getting a sour taste in their mouths from having to carry them through. In a recent poll by Forsa research institute 49% of Germans believed that Greece should leave the Eurozone.

Things at best look shady for the old continent at least from a macroeconomic perspective

However Markets all around the world surged on the Thursday one week before the QE3 announcement after the ECB pledged to buy unlimited amounts of government bonds of countries struggling to manage their debts.

Going well beyond the ECB's earlier limited bond buying program, this Large-scale purchases of short-term government bonds is expected to drive up their price and push down their interest rate, or yield, making it less expensive for countries to borrow money.

However, countries that want the central bank to help with their debts must submit their economic policies to the scrutiny of the International Monetary Fund and seek emergency aid from the bailout funds managed by the 17 countries that use the Euro. Speaking of which, the German Constitutional court has just ruled on the legality of the European Stability Mechanism.  The European Stability Mechanism will be the  Euro region’s permanent bailout fund. This bailout fund will replace the European Financial Stability Facility, the original Euro area bailout fund that was established in the summer of 2010 and is currently down to only $248 Billion of lending capacity. That amount would be severely insufficient if Spain and Italy fall under.

The unlimited bond purchasing program and the new bailout fund will not be a permanent fix and we may see some countries leaving the Eurozone in the near future, but it will buy the Eurozone time to fix its underlying problems and rescue governments from immediate disaster or to 'kick the can' so of speak.

The new optimism about Europe should help the stocks of companies with large exposure to Europe  that have been beaten down due to EuroZone worries

Two Battle Tested companies 

McDonald's (NYSE: MCD) is an almost recession proof growth stock. Don't believe me? Take a look at its stock chart. Didn't we have something called the Financial Crises in 2008? The stock almost looks unaffected and for good reason. The company was performing strongly throughout the recession as more people substituted fast food for pricier options.

McDonald's shares corrected after hitting $100 which gave the company a $100 Billion market cap. McDonald's gets 42% of its revenues from Europe, but that shouldn't worry you too much. McDonald's is one versatile company and it still has a lot of room to grow in places such as China. McDonald's plans to open 1,300 new stores this year, 250 of them in china.

Ford (NYSE: F) is another company that had experienced a pullback due to the troubles in Europe. The Company is 45% below it's post recession high of $18 in 2011. While Ford is not as versatile or recession proof as McDonald's, it's very cheap right now. The company trades at about a 0.29 P/S and a 6.94 forward P/E Earnings.  Ford was the only US automaker not to take government bailout funds during the great recession due to the foresight of CEO Alan Mulally. This means that Ford possesses one of the key ingredients of long term success; superb management.

Bull Market or Bull Something Else

By the looks of it, the market is going to rally at least for the next few months due to the words and actions of Europe's and America's Central Bankers, however Quantitative Easing and Europe's on-again off-again worries (currently off) can only push the market up for so long. In the end if we are to have a secular Bull Market like that of 1982-2000 it will have to come from real economic growth, The creation of tens of millions of new jobs domestically and internationally, soaring and consistent corporate profits, and the rise of game-changing new industries.

Happy investing!

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