April 2013

………….Thoughts And Comments

In a number of newsletters last year, I complained about the volume of “news” being produced without an equal dose of quality.  In December, I quoted Spanish philosopher Baltisar Gracian about brevity, and earlier in the year it was a modified Thumper Rabbit saying.  I took these thoughts to heart, which is why we are now writing again in April after a four-month hiatus.

Economically, little has changed since December.  The “fiscal cliff” didn’t happen, nor did the U.S. government shut down.  Cyprus was the latest country to have a banking crisis – which is worth a review – and Japan is the latest country to use the printing press to try to work its way out of its economic conundrum.

With that as the economic backdrop, Japan is up, the S&P 500 is at new highs and gold is at two-year lows.  Oil is also weak, though not so much as gold.

Peeling Back the Onion

The First Layer:  The Economy

The top layer of the onion is the worldwide economy.  In the U.S., the economy continues to stumble along.  Numbers are very mixed from week to week and month to month.  The very latest numbers (out in the past two weeks) show manufacturing, consumer retail spending, and job creation weakening over the prior month.

At the same time, the economy in Europe is continues to slide, with most countries in a recession.  Cypress is the latest European country to have a banking crisis.  From a recent interview by the Wall Street Journal with the former governor of the Central Bank of Cyprus, it is clear that the crisis in Cyprus is due to the same causes as everywhere else; they are simply the latest to experience the problem.  A combination of excessive government spending, excessive bank leverage, the exposure to other people’s debt (in this case to Greek debt) and an unexpected recession, resulted in the banking run.  Just think what would happen if a surprise recession happened in a larger economy.

What was different this time is that, for the first time, the EU tried to make the bank depositors actually take part of the loss.  What isn’t a surprise is that the general public was very upset with such a notion and so to save their jobs, the political leaders quickly revamped the plan to only tax those with more than 100,000 euros in an account.

I expect it will become apparent that the tax that the EU required in order to bail out Cypress will be far smaller than planned.  All this just goes to show how far politicians and the public will go to avoid dealing with problems.  And you think everything is fine in the EU and Asia and the U.S. financially?

In Asia, economies are not as weak as in Europe, but they are struggling to grow at their previous levels.

China turned on the cash pumps starting last summer, yet their growth has been lackluster (for them) and the leverage strains are showing up in the ever-more evident number of bankruptcies being hidden by bailouts.

Japan is aggressively printing money and targeting 2% inflation to try to get the economy growing after decades of stagnation.

In Central and South America, economies are mixed as well.  Argentina struggles with its debt and is trying to default.  In Brazil, inflation is rising, consumer spending is slowing and government stimulation is not working.  Mexico, with a lower labor cost than China is doing well, but inflation is increasing.

The Second Layer: The Markets

The next layer of the onion seems to have no tear-inducing smell whatsoever.  The stock market, as measured by the S&P 500 was up 10% in the first quarter of 2013 and the Nasdaq was up 8.2%.  The warnings about the fiscal cliff, a government shut-down, a government default, or the government sequester did not slow the stock markets at all.

Bonds were volatile, with the 10 year Treasury moving from 1.73% up to 2.20% and back down 1.71% during the past three and a half months.  So the bond markets seemed to believe the various U.S. government issues would be a problem, but then when Cyprus erupted they stopped worrying about the U.S. because the U.S. suddenly became the safe haven for Europe.

Gold, which has tried to rally several times, basically just went down the entire quarter, officially down 4.7%.  So all the economic fear in Europe, the U.S., Japan, China and Brazil was meaningless, and  “investors” (yes, I am using that term very loosely) decided that stocks made much better sense than gold.

Looking at all of these inputs is enough to give anyone a headache and intuitively, they seem to all conflict.  After checking with my ophthalmologist to make sure I have not gone cross-eyed, we here at Harmony have dug into the details a little more.

Layer Number 3:  da Vinci

Leonardo Da Vinci was born on yesterday in 1452.  So it is appropriate to turn to his wisdom when considering the investment world.  While the closest to an onion I could find was a study he did comparing the skin of the human scalp to an onion (click here if you are interested) ole’ Leo (we would have been great friends had we been born in the same era) said something that every investor should take to heart:  “The senses are of the earth; Reason, stands apart in contemplation.”  What is called “news” these days, most people take for gospel – it must be true if “they” said it, whoever “they” is.  But a little digging, while it takes time and energy, may prove the “they” wrong.


We noted that the stock markets have gone straight up while economic and financial information has been less than purely bullish.  The obvious question is why?  What are we missing?

A detailed look at the components of the S&P 500 provides some interesting information.

1)    On an unweighted basis, the S&P 500 sectors did quite well by-and-large in the past three and a half months.  Consumer staples were up the most, almost 18.5%.  Only the materials and telecom sectors had single digit performance, up 2.3% and 7.5% respectively.

However, a closer look at the numbers reveals that the numbers are not as consistent as they appear at first blush.  41 names make up the consumer staples sector but 27% of the 41 names are outliers (i.e., their year-over-year growth was greater than 99% or less than -99%).  The next highest sector was the healthcare sector and a full 17% of the set were outliers.  This is not to say that the numbers in general weren’t up strongly, but that the large number of outliers suggests that volatility underneath the indexes is quite high.

2)  Net margins peaked  in Q3 of 2011 and have been dropping ever since.  P/Es are on the very high end.



3)     Net income growth is slowing to a flat-line.  Revenues are growing but at a slower pace.  Combined with a slowdown in the growth of capex, this suggests growth in revenues and earnings may be at an end until companies start to expand their employee counts.





All of this suggests that stocks are at a cyclical high: remember the economic expansion, as weak as it has been, is now in it’s fifth year, which is longer than the normal cycle.


Gold has hit its lowest level in two years today.  Bullion closed at $1360.60 and hit a low of $1338.00 per ounce intraday, marking a 29.1% drop from its high in September of 2011 and the largest single day drop in percentage terms since 1983.

While headlines have been predicting the end of the bull market for gold for several months now, the latest headlines are even more dire.  “Gold collapses as investors race for exits, brace for end of bull market” is the Financial Times headline.  “The big question is whether the gold bull market is over after 12 years of consecutive yearly gains. Gold hit the lowest price since February 2011 and has now almost halved its rally since the 2008 economic crisis, leaving the metal around $550 below its record high of $1,920.30 set in September 2011.

Recent signs that Fed officials appeared to be nearing a decision to start winding down their bond purchases to end stimulus contributed to the negative tone for gold, even though inflation has failed to materialize as feared during its rounds of post-financial crisis quantitative easing.”

The problem with the article is lack of facts and the use of hysteria and opinions as a replacement.

“Recent signs that Fed officials appeared to be nearing a decision to start winding down their bond purchases to end stimulus…”

Fact:  The Fed has suggested multiple times that they were close to ending QE only to expand it and extend it.  Just a few months ago the suggestion was that they would end the printing this summer and now they are suggesting it will happen at the end of the year.

Of course the Fed says that – they want to look tough on inflation because once people believe inflation is in place, inflation will rise.  So the Fed has to make sure people don’t believe there is inflation.  However, they aren’t stopping the presses now, and the likelihood of their doing it at year-end is very small.  Bernanke and his expected replacement Yellen have both made it very clear that unemployment has to drop well below current levels before they will stop printing (if even then), and there is little to indicate the economy is about to get that strong any time soon.***

Once again, a closer look adds clarity.

1)    We own gold because of the massive money devaluation executed by the Federal Reserve by printing dollars at an ever-faster rate.  We are into QE4 now, with the Fed printing $85 billion each month.  With each new version on QE, the amount the Fed has had to manufacturer has grown larger and the results from their printing have become less and less helpful.

2)    Japan last week announced that it intended to double its money supply over the next 18 months.

3)    China announced Sunday night that its stimulus program announced last summer is not performing as well as hoped.  GDP figures missed lowered estimates of 7.9% growth.

4)    Wall Street has all-but-unanimously decided that gold is a bad investment in the past two months.  The following details come from Fred Hickey, a smart investor who also actually does research.  I have quoted a number of his points from his latest newsletter, “ The High-Tech Strategist,” published Sunday April 14.

Fred pointed out the numerous Wall Street research reports on gold since February:

Goldman Sachs February 25, 2013  research:  “The turn in the gold cycle has likely already started.  It cited the “collapse in gold ETF holdings,” as a key cause.  Goldman slashed gold target prices to $1200.

BoA Merrill Lynch on March 25:  Lower gold prices could make miners “worthless.”

SocGen April 2:  Gold in a “bubble.”  Title of the report: “The End of the Gold Era.”

In the report it said, “Rising interest rates, driven in part by a positive view of the US economy with an associated improvement in the dollar, could be the perfect storm to start a longer-term bear market.”  Start?  If it started, it started in September 2011.  But such was the hyperbole.

CitiGroup Feb 20:  Gold & silver long cycle has “peaked.”  The analyst had been raising gold target prices after the peak in late-2011.

CIBC Feb 21:  Gold’s “glorious run” is ending.”  The title of the report: “Why Gold’s Luster Will Fade.”  CIBC predicted the Fed would end money printing in a matter of months because the economy was on the upswing.

At the same time, economic numbers for April have been weak.  “ There were the awful manufacturing and services ISM reports.  And the rising jobless claims, weakening retail sales, and then Friday’s shockingly bad jobs report.”

“Under these withering Wall Street attacks in February and March, gold had slid to the mid-1500s, but rallied back each time and did not break down through technicians’ key chart point levels (1525, 1536).  Now, with the jobless report effectively ending the “early” Fed exit talk and the massive BOJ debasement policy in full view, gold and miners on this past Tuesday, (April 9) had another big rally (wiping out all of the shorts’ gains since the Goldman Sachs’ attack on Feb 25).”

April 10 “Goldman Sachs issues a “Top Trade Recommendation” to outright short gold.  “I’ve bolded and underlined below the most egregious part from the Goldman Sachs report.  Net long gold positions across COMEX futures & gold ETFs near record highs?  We’ve seen the biggest puke (200 tons) from gold ETFs on record and the net long gold futures position has plummeted 76% since October – and they make the claim that gold may plunge faster than they expect because aggregate speculative net long positions in gold are “near record highs?”  Remember that in their February 25 report they themselves cited the “collapse in gold ETF holding.

Thursday, April 11:  New York Times Headlines “ Gold, Long a Secure Investment Loses Its Luster.”

Who is right?  Time alone will tell.  However, whenever Wall Street as a group are all-in in one direction, and the press is crowing the same information, I run the opposite way.  As an example, remember 1999?  Everyone was piling into tech stocks.  Valuations no longer mattered because times were different.  Revenues and earnings were meaningless.  Yet, a year later, all of the tech stocks sank – on average losing 90% of their value and most have not yet even come close to recovering 50% of their peak prices.  In fact, I doubt any of our readers will be around to see those prices to ever achieved again.

Now is the time to buy gold rather than sell it (more on this later) as nothing has changed except the price.  This is even truer of the gold stocks.  Companies with real earnings and real growth are selling at discounts not seen in years.


Interest rates fell as worries about the fiscal cliff took hold.  As soon as that didn’t happen, stocks started to rise and so did bond yields.  The logic was that the economy was going to get better and so rates started to rise.

Then there was the worry about sequestration and how that was going to send the U.S. into a recession and so once again interest rates fell, only to start rising again once it became apparent that there wasn’t a recession at hand due; the ten year hit a peak yield of 2.20% in March.

In March and April came the Cyprus banking crisis, the Japanese announcement of their intentions to double their money supply and weaker economic numbers here in the U.S.  This led to interest dropping back to their lows of 1.71%.

None of this sounds like much of change, what is a move of a half percent?  But that half-percent move is equivalent to a 30% change is yields and thus in prices – and all of this over the course of a few months.


10 year  U.S. Treasury yield


During this time, the stock market went straight up and the gold market went straight down, which makes them all contradictory indicators!

So which market is wrong?  The answer is that the markets no longer are indications of the economy, but rather are bastardized by the worldwide government policy to print money.  Traders whip markets back and forth for their own short term benefit,  causing losses for many that panic but opportunity for those with foresight and  strong stomachs.

What Do We Do With All the Peeled Onions?

So what do we do when nothing seems to make sense?  The answer is to go back to one’s investment roots.  Stick with the fundamentals and ignore the chatter, the speculation, the frenzy.

In the past three months we have made a few changes to portfolios.

First, we added to several new equity positions because we found good values, even if there is a market pullback.  New positions that we added include Abbvie (pharmaceuticals) and Wabtec (railroad safety equipment) and EWJ, a Japan ETF.

Second, we have taken profits or partial profits in a few names where we simply could not justify valuations or where valuations had run up very quickly.  This includes reducing some of the gold positions we had purchased last summer, some of our Stepan Co and our positions in Dynamic Materials.

In the bond markets, we added to longer maturities when interest rates rose well above 2% and took our profits when they dropped back down to 1.7%.  We expected that we would see interest rates come down as the economy weakened, but when Cyprus happened and the rates dropped very quickly, we decided a bird in the hand and took the profits.

Net-net, equities are about 35% of our portfolios, fixed income is 45% (very short maturities) and cash is about 20% of our portfolios.

The Bottom Line…

Japan is just starting their massive currency devaluation, which means their stock market should continue to do well.

The bond markets do not offer much upside at this point and we have taken profits in our longer maturities.  We continue to take advantage of special situations where we can gain extra yield, but for the most part believe that other asset classes offer better opportunities.

While gold has not worked for the most part for two years, and stocks have been strong for the past 15 months, now is not the time to capitulate and either sell gold or buy stocks aggressively.  We will be adding gold again given the ridiculous valuations as we see a bottom being formed.

Our research suggests that stocks are likely to pull back in the next three to four months and we will then step in more aggressively when stocks are more attractively priced.

Investing in such times requires being a contrarian and being patient.  Strategies may take some time before they become apparent to others – just like it took back in 1999.



Alan E. Rosenfield, Managing Director

April 2013

*** Since publishing this, Janet Yellen, Vice Chairman of the Board of Governors of the  Federal Reserve, and expected to be the next Chairman, has given a speech sponsered by the IMF today in Washington,  Below are quotes from her speech.  If you think they are about to withdraw any of the QE you are smoking some illegal substances…oh wait, that stuff is legal now.

“The objective of forward guidance is to affect expectations about how long the highly accommodative stance of the policy interest rate will be maintained as conditions improve. By lowering private-sector expectations of the future path of short-term rates, this guidance can reduce longer-term interest rates and also raise asset prices, in turn, stimulating aggregate demand. Absent such forward guidance, the public might expect the federal funds rate to follow a path suggested by past FOMC behavior in “normal times”–for example, the behavior captured by John Taylor’s famous Taylor rule. I am persuaded, however, by the arguments laid out by our panelist Michael Woodford and others suggesting that the policy rate should, under present conditions, be held “lower for longer” than conventional policy rules imply (emphasis added).

…I see these ideas reflected in the FOMC’s recent policy. Since September 2012, the FOMC has stated that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. Since December 2012, the Committee has said it intends to hold the federal funds rate near zero at least until unemployment has declined below 6-1/2 percent, provided that inflation between one and two years ahead is projected to be no more than 1/2 percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

…Some have asked whether the extraordinary accommodation being provided in response to the financial crisis may itself tend to generate new financial stability risks. This is a very important question. To put it in context, let’s remember that the Federal Reserve’s policies are intended to promote a return to prudent risk-taking, reflecting a normalization of credit markets that is essential to a healthy economy. Obviously, risk-taking can go too far. Low interest rates may induce investors to take on too much leverage and reach too aggressively for yield. I don’t see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability (emphasis added). But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.”

She doesn’t see any evidence?!?  There is not a single Fed official that has ever seen any evidence until they looked it in a rearview mirror!  Somehow they all missed the housing bubble and the tech stock bubble – both which happened in the past 14 years!



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