Part of Google’s initial entry into the Chinese market was conditional on censorship of certain internet material under the Chinese government’s instructions. However, with recent considerable hacker attacks from China on various websites to stop censorship, largely on Google, the titan ultimately blamed the Chinese authorities for censorship in the first place.

The Chinese authorities obviously like to keep a tight hold of the content its citizens are exposed to. Smells a little like propaganda activity to most people. The Chinese authorities promote the internet for education and business, but keep a tight grip against obvious material such as porn, but interestingly also human rights and pro-democracy material that can expose its citizens to politically sensitive information… and maybe open them to new thoughts. More importantly, Google was on the righteous side of the battle and supported many human rights activists in China whose G-Mail accounts were part of the hackings.

Speaking of propaganda, interestingly, several Chinese newspapers actually counter-accused Google of having its own political agenda and claimed that foreign firms operating in China must abide Chinese law. It’s true – it’s never really clear what Google is up to. It dabbles around in almost every field in business, as this interesting video shows.

But, as far as this story goes, Google boasted the right part of its backbone. Censorship is as outdated as Marxism. The Chinese government will be able to contain the force of the country for only so long, and eventually (although possibly long), like every country, its boarders will open to the rest of the world. I’m not the only one that feels this way. Much support has been heard from the human rights activists whose accounts were hacked, and after Google announced its plea to fight censorship, some Chinese populace placed flowers outside their office in Beijing. Sounds like a plea for freedom to me.

It’s been said Google’s potential revenue in China is $500-600M, or about 2% – 2.5% of its 2009 revenue. In terms of monetary losses, it will be a small step if Google fully backs out of China, but it could turn out to be a big step for the mankind of China and their freedom.

Disclosure: no positions

The most obvious way to split investment types pertains to investment horizons – there are short term investments and long term investments. These coincidentally align with the way the finance world is split, as you may have read in the past, into the buy side and the sell side. The sell side is more focused on short term investments, such as trading equities, options, forward contracts, and derivatives. On the other hand, the buy side is focused on long-term wealth allocation to numerous investments, some of which can also be long term equities and instruments, but also vehicles such as bonds, some ETFs and foreign currency.

What’s the difference?

Short terms investments are expected to show substantial gains in a short amount of time. For example, expected currency impacts due to an upcoming government legislation change or stock options with an expiry date would classify as short term investments, and often range from a few weeks to a few hours, even minutes at the extreme. On the other side of the playfield, long term investments often have a broader investment horizon such as a year, 2 years, 5 years, or even “forever”, an investment horizon often associated with investing guru Warren Buffett. Long term investments are expected to produce value for a long period of time, such as the stock of a persistent and global company such as Wal-Mart or British Petroleum.

Which is better for me?

The important thing to remember in finance is that risk is often (there are exceptions) correlated with return. The higher the risk, the more profitable an investment can be. On the other hand, the safer an investment is considered (i.e. bank GICs), the lower the return is.

On that train of thought, short term investments have incredible potential in the short term, but for that same reason, are often categorized as more risky investments due to the high volatility and fluctuations they can undergo. Consequently, short term investments often require more attention since the price can change without warning, and often requires greater expertise in the financial markets as they are usually more technical in nature. The chase for a higher yield often lays in short term investments at the risk that a lot of money could be lost.

Long term investments, when chosen with tact and careful analysis, can provide steady and reliable returns for years. For example, purchasing stock in a solid company like Procter & Gamble is not much of a gamble (pun intended), since the company will likely continue flourishing for a long time to come, and the underlying value of its shares involves less risk along the way with a steady return. But, for the safety provided, PG knows it does not need to pay as high dividends, and thus long term investments usually provide lower annual returns.

For the reasons above, people who are closer to retirement invest for the long term. Younger people can handle more risk since they don’t need a nest egg to rely on in their retirement risks. But, as always, there are exceptions to both sides.

Now that you have a good idea of what both consist of, try to assess your risk tolerance and see what types of investments fit better for you. Here’s a way to assess your risk tolerance. http://njaes.rutgers.edu/money/riskquiz/

Side note on Mutual Funds and ETFs (on long-term investing)

Mutual funds have been around for ages, and are often regarded as the simple investment alternative for folks who do not want (or have the technical proficiency) to conduct their own investment research, such as families, doctors, plumbers, and most importantly, young people. Unfortunately, even though mutual funds have a “safe” and “reliable” image, they are one of the worst long-term investment alternatives there are. Here is why. On the other hand, a recent investment vehicle known as ETFs (exchange traded funds), have paved the way for a new type of long term investment. Here’s a great article for why ETFs, specifically active ETFs in this case, trump mutual funds.

Image credit: Amanda Woodward under a Creative Commons license

In our first edition of

Puru also produces a popular monthly report known as Money Matters that is available on the firm’s website, and regularly  writes at several reputable locations, including The Daily Reckoning, Bullion Vault and Financial Sense.

1. Puru, what is your passion, and how do you stay passionate about it?
My passion is to learn about the world and spot the major changes taking place.  I really enjoy learning about the economy and finding solid companies which are poised for long-term growth.

2. How would you describe the investment philosophy that you utilize in your decision making process?
Our prime objective is to produce growth over the full business cycle.  We believe that credit cycles are responsible for booms and busts and we try our best to stay on the right side of the credit cycle.  When monetary policy is loose and interest-rates are low, we prefer to be invested in growth producing assets.  However, when monetary policy is tight and central banks are raising interest-rates, we become cautious and re-position our clients’ portfolios.  Furthermore, we believe that stocks represent partial stakes in operating businesses and they are claims on the long-term cash flows of the underlying businesses.  Over the long-term, every stock’s performance ultimately depends on the operating results of the business and we try and buy into good businesses at favourable valuations.

3. How do you identify and differentiate the important trends worth considering versus the noise that is becoming an increasingly bigger part of the market?
In the world of business, the most important variable is the cost of money or the interest-rate. So, we watch these very carefully and we also monitor the yield curve.  The interest-rates determine the value of every asset in the world, so we watch these like a hawk.  Furthermore, we also utilise technical analysis to see whether we are in an uptrend or a downtrend.  Finally, we try and gauge the broad sentiment to see where we are in a market cycle.  It is our contention that bull-markets are born on pessimism and they exhaust themselves during widespread euphoria.

4. You have written a lot about inflation before. The US Fed recently hiked the discount rate in a surprise move. Do you think it’s too late to prevent the repercussions of the unprecedented monetary stimulus?
Inflation depends on two things:
a. Ability of a central bank to monetise debt (print money to buy government debt)
b. Willingness of a government to take on more debt (issue more government debt)

Unfortunately, in a fiat-money world, politicians have the will and ability to debase their currencies and this is why we foresee high inflation over the next decade.  The debt overhang in the West is simply too large and if one needs to avoid sovereign defaults, inflation is the only option.

5. How do you see the sovereign debt situation in Europe evolving? Do you think the bailout strategies used by the US government could also work as well in the EU?
The debt situation is hopeless in much of the developed world and unfortunately, there is no way out of this mess.  We suspect that the EU will also bail out all the weak members but this will have a negative impact on the Euro.  And it will lead to even higher inflation down the road.

6. Have we reached a stage where growth and economic strength has permanently shifted to developing nations that are not suffocating their economies with debt?
Nothing is permanent in the business world. But, over the next decade or two, the developing nations in Asia are likely to outperform the debt-plagued nations in the West.  Today, nations in Asia have large surpluses, huge savings and massive reserves.  This is extremely favourable and should lead to a boom in domestic consumption. So, we are optimistic about China, India and Vietnam.

7. Given recent developments, attention has moved away from commodities. What are your thoughts on that asset class?
We are still very positive about crude oil and the energy complex.  Unfortunately, we are sleep-walking towards an epic energy crisis and within the next 2-3 years, we will see major problems.  Essentially, the world’s daily flow rate of crude oil is about to peak at a time when demand is rising.  This will be unpleasant and lead to a spike in the price of crude oil, which will cause another recession.

Apart from crude oil, we also like gold and silver.  In our view, precious metals are in a major bull-market and they should benefit from the ongoing debasement of paper money.  Accordingly, we own positions in gold and silver mining companies.

8. Are US treasuries in a bubble?
Yes, US Treasuries seem to be overvalued, but they can remain overpriced for many months.  As long as investors are uncertain and worried about sovereign risks, US Treasuries shouldn’t fall apart. Over the longer-term, we expect US interest-rates to rise, but first, we may decline in case of any another deflationary scare.

9. Do you think today’s markets are directed a lot more by short-term developments instead of long-term fundamentals?
Yes, with the advent of the internet and information overload, short-term noise dictates market movements over the short-term, but the fundamentals still decide the long-term fate of every business.

10. Sitting in Asia, how would you say the investor perceptions of this long, sharp equity rally differ between Asian investors and North American investors?
We don’t know how North American investors relate to Asia but to us it is obvious that nations like India, China and Vietnam are climbing up the prosperity ladder.  And their fast-growing economies are grabbing investor attention and this is why we have big bull-markets in the East.  Over the course of this business cycle, Asian markets should continue to outperform the West.

11. If you were in 100% cash, how would you allocate that cash right now, looking at a horizon of 2 years?
At present, we are fully invested in our preferred companies but if we had to choose currencies, we would keep cash in the Canadian Dollar, Australian Dollar, Indian Rupee, Singaporean Dollar and Chinese Yuan.  However, it is worth noting that every country is inflating its currency and this is why we don’t like cash over the next 2-3 years.

Puru, thanks for providing our readers with your professional insights. We wish you all the best from across the (consistently shrinking) globe!

Looking back at it now, one question still glows in embers – who was responsible? As the worst recession in our lifetime is slowly turning into a memory, millions of people are still suffering in a recovering global economy. The haste of numerous banks in creating toxic securities was not just the result of the US Fed creating a speculative real estate bubble with low interest rates, but also a result of greed. Greed and recklessness.

As most of us are familiar with what happened after, mortgages that should have never been permitted were granted with little financial reason. “No down payments? No credit history? No loan documentation? No problem – we’ll get you a loan”. And the gluttony of the culprits lead to the use of these mortgages to create packaged, yet questionable, debt securities that infected the global financial system. A vaccine was not even available as few people knew the true nature of these “investment vehicles”, the few that unleashed them.

When the truth got out and it was clear that the dreamed-up value of these synthetic instruments was sure to crumble sooner or later, the hurricane began and it destroyed everything in its path. There goes Lehman and Bear Stearns. Complete and utter paralysis ensued – one that had an unfamiliar feel to Wall Street. Nobody knew what to do, so why would institutions make credit available? Credit paralysis lead to the bankruptcy of numerous debt-dependent businesses, showing how hopelessly reliant on debt the US economy is, and the recession stepped in full force. Almost all bank executives were booted, except at Goldman Sachs, the largest producer of toxic synthetic instruments.

Hey – now, it’s not all that bad. Our vehicle manufacturers are stabilizing as Toyota suffers, gold and oil are on the rise, S&P is back up at 10,500 (almost double from a year back), and the US economy grew 5.9% annualized in the 4^th quarter of 2009. Great stuff!

As I opened up my news feed this morning, I realized the crisis is just a memory. Bonuses are back up after the year-end earnings reports and investment bankers are once again trying to profit from other peoples’ money. It was nice to hear that the Goldman Sachs that we all know and love kindly helped Greece through complex derivatives. Were the real culprits of the crisis penalized? Did they learn their lesson from the events of just a year or two ago?

As I said, it’s not all that bad. What’s AIG’s $8.8 billion loss compared to last year’s $61.6 billion? Peanuts.

Image Credit: Ani Carrington under a Creative Commons License

In this edition of

Babak is also the founder of Trader’s Narrative blog – offering “Freshly squeezed market commentary & analysis” at http://www.tradersnarrative.com. Babak found Trader’s Narrative to collect his thoughts in an honest manner, become a disciplined learner, and generously provide guidance to his followers, speaking of which, are regular and devoted visitors to the Trader’s Narrative.

1. Your website offers “freshly squeezed market commentary & analysis”. What’s your background with the Trader’s Narrative and aspirations with the blog?

The tagline is a bit tongue in cheek, but it also encapsulates my approach. I mean, who doesn’t love freshly squeezed orange juice in the morning? Especially compared to the stale frozen variety. Not only is it higher quality, there is a personal touch, a craft, if you will, to it. That’s how  I approach market analysis. I have an infinite curiosity when it comes to finance and wanted to  share that sense of wonderment with others. A long time ago I discovered that I learn best and benefit the most when I try to share something with others so what may look like an altruistic endeavour, is in reality a rather selfish pursuit.

2. What is the most important idea that you have been trying to communicate to your readers in the past 3-6 months?

The one idea that has the most repercussion on future prices of almost everything is the battle between the two opposing economic forces of deflation and inflation. The economic collapse unleashed deflation, of course. We had the price of almost everything fall: real estate, commodities, stocks, etc. Central banks responded en mass with the largest cooperative effort to stoke inflation in modern history. Which force will ultimately win? I don’t know but I have my own ideas. If you happen to be a time traveller from the future, please let me know – I promise to not tell anyone.

3. How do you generate ideas? More importantly, how do you spot and distinguish the important trends from the noise?

I usually get a torrent of ideas just by watching the market and monitoring not only major stock indexes but also commodities and econometric indicators. I try to stay on top of sentiment as well. Most days I have about a dozen things on my mind and the hardest thing is to filter it and figure out which I really want to write about. Readers are also a great source of ideas. I have wonderful readers who are constantly challenging me, asking questions, teaching me, etc.

Regarding managing the noise to signal ratio, it is easy to get swept away by an idea or concept, especially when everyone is suddenly talking about it.  Usually blogs and the mainstream media bombard you with it and then poof! everyone forgets about it, only to jump onto the next thing. Rinse and repeat. That’s just the nature of the beast so you have to step back and get perspective.

If you are a mental midget like me, stand on the shoulders of giants; listen to what they are talking about, what has captured their expensive attention and try to absorb their wisdom. To mix metaphors, I call these mental giants the “greybeards”: Doug Kass, Warren Buffett, Jeremy Grantham, George Soros, David Rosenberg, Marc Faber, Paul Desmond, etc. They have not only been around for more than a few market cycles, they also bear the scars and loot to show for it. Experience is an expensive teacher – what it gives you in wisdom, it steals in its own currency, time. So learn as much as you can from the experience of others.  But let me stress, this doesn’t mean you shouldn’t think for yourself!

4. Your analyses and book-recommendations indicate your passion for technical analysis. How effective has technical analysis been for traders in the last 6-12 months?

It depends on which framework they used and how competent they were in applying it. For example, Stan Weinstein has a simple and effective framework. So does Prechter with Elliott Wave. So do the Turtles. And so on.

The superciliousness is off the charts when traders get into dustups over which framework is better. It reminds me of the endless nerdy debates I used to have with my friends in elementary school. “Who would win in a fight between Batman and Superman? Or Wolverine and Spiderman?” The question itself is ridiculous of course. What will ultimately decide your success as a trader is discipline and money management.

5. After the confusion of the last few years, what indicators do you NOW follow to give you an accurate picture of the market that you didn’t use before?

As luck would have it, I took a break which coincided with the top of the market in 2007. I will always wonder, had I been watching the market, would I have identified it? To be perfectly honest, probably not.

I’ll never know really but unlike, economists, regulators, and rating agencies who should be questioning the very foundation of their work (if not their very existence), nothing much changed for traders. The financial crisis didn’t destroy any important indicators that I watch or create new ones, sadly. I say sadly because getting to play with a new indicator is as fun as groggily opening Christmas presents at 5 am.

Towards the end of 2008 I grew cautiously optimistic and then eventually outright bullish. For example, in late November 2008 when the S&P 500 was trading around 850, I wrote: Why Long Term Investors Should Consider Buying.  As you may recall, this was also the time when “greybeards” like Grantham started to slowly build long positions while the majority of the investing public was running around rending their garments and wailing. By the end of March 2009 I wrote: Another Reason We’ve Seen The Market Low. And then by May 2009 I was quoting the Simpons: “I, for one, welcome our new bull market overlords.” anticipating the all clear from the Coppock Guide. So that should give you a good overview of some important indicators that helped me to be on the right side of the intermediate trend.

Watching sentiment is also an important part of how I approach the markets. Most people concentrate on the news. That is, what is happening or where the collective attention is at the moment: the President’s state of the union speech, LEI numbers, unemployment data, monetary policy meetings, etc. But the truth is that news does not make price. Price makes news.

Put another way, what really matters is not what happened but how the market reacts to it. If you’ll allow a tangential thought, this is also the key to life. What happens to us is not really important. What is pivotal is how we give meaning to it. Two different people can have the same experience and come away with vastly different destinies based on how they choose to find meaning in that experience. For that nugget of wisdom, I’m indebted to my brother who is a brilliantly successful brief therapist.

Anyway, as I wrote more and more bullish comments, there was a surprising amount of pushback from people. I could understand that from the general public, since they had been wiped out from the real estate and stock market crash. But even your average trader hated hearing positive things being said about the market. Without fail, every single time I wrote bullish things, they criticised it, picked it apart, came up with excuses why it wouldn’t work, etc. This went on for month after month as the market clawed its way higher. So it was obvious that the majority where leaning against the rally in a very emotional way.

6. You wrote about treasuries recently, and it appears that you don’t think treasuries are in a bubble. Would you put money on that theory?

I was taking the other side of the argument that I had made earlier and presented the bullish side. Previously I had written several times about the bubble in the bond market. But I try to be agnostic when it comes to the market. I’m not a perma-anything and am only seeking truth and profit. So if you present to me a persuasive argument, I’m more than happy to consider it.

Nothing turns me off faster than when someone is fastidiously wedded to a belief, either bearish or bullish, and does not change their views no matter what. It is really easy to pick a side and continuously hammer away at it from that perspective. Congratulations! You’ve chosen to see the world from your particularly colored lens and you’re losing out on all of that marvellous reality. The pom-pom waving guys over at CNBC are a great example. On the opposite spectrum are guys like Howard Ruff who are forever preaching the imminent approach of an economic Apocalypse. By the way, as you’ll see from that previous link, CNBC had Howard Ruff as a guest exactly at the market bottom, at the time I called it “a contrarian signal from the trading gods”. Another example is Jim Rogers who has been pounding the table for commodities for 18 years.

It is much more challenging (and rewarding) to be humble and jump on trends in either direction. In any case, getting back to your question on treasuries, with all due respect to David Rosenberg, I find Michael Belkin’s arguments more persuasive: fixed income is a bubble. Retail investors are notoriously clumsy and they jump on the bandwagon right when it is about to topple. Also based on historical precedents, buying bonds here is like stooping down to pick up pennies in front of an oncoming road-roller. You can read the details of these historical studies here: Why Today’s Bond Investors Will Be Disappointed. If you disagree, then basically what you’re saying are the most dangerous words in investing: “No, this time it is different.”

7. These days an important variable one day that leads the market could be completely forgotten the next day in the face of more news. Do you feel the market has hardly any memory going from one day to the next?

Yes, the market definitely has a memory. The media may not, but the market most definitely does. Technical analysis is based on the price memory of market participants with support and resistance levels set by the aggregate behavior of traders based on this same memory. So the key is to concentrate on price, not headlines. To be honest, I get apprehensive when my favourite indicators get a lot of attention. I’d much prefer they stay as esoteric as possible. When CNBC started talking about the Coppock Curve, I think I aged 5 years in the 5 minute time span of the segment. But then they quickly forgot about it.

8. One of your goals with setting up Trader’s Narrative was to continue to learn every day and help others find their path. How’s that going?

I’m indebted to my amazing readers who come and share their expertise with me and each other. I’m continuously astounded and humbled at the caliber of my readership. I’ve met so many traders over the years; hedge fund managers, institutional traders, prop traders, CTAs, etc. Recently I checked my traffic data and noticed bulge bracket Wall St. firms reading my blog. That is something that I never really thought about when I began to write.

9. Now, starting with 100% cash, how would you allocate it to various asset classes, with an investment horizon of 5 years?

Answering that is difficult. Not only because I would need more information (for example, what is the risk tolerance, sophistication and goals of the person for the portfolio) but also because I wouldn’t be comfortable with a “set it and forget it” portfolio since we are not enjoying a secular bull market. Also a 5 year time span makes it difficult to use technical analysis since most of my tools in that regard are more short term in nature.

But I’ll stop being difficult and do my best to answer your question. For an autopilot portfolio like the one you’re implying, during a secular bear market, the goal should be preservation of capital. I would suggest high quality equities, Canadian REITs, and a smattering of timber. I would also add a little bit of leverage – nothing crazy, maybe 20-25% depending on the risk tolerance.

There are some calling the Canadian real estate echo-boom a bubble. But I think there is an opportunity within your time frame. Remember, a bull market is just a bubble that you are invested in while a bubble is a bull market that you’ve ignored. If we do get inflation, then REITs will do well as the economy will have recovered and they will be able to increase rents and therefore, distributions.

As well, the Canadian government has basically outlawed income trusts through a tax law change that will go into effect in 2011. There are billions right now invested in income trusts and at least some of that yield starved capital will find its way inevitably into REITs.

Finally, Canadian REITs have incredibly solid balance sheets and are now peering over the border at the wreckage left in the wake of the residential real estate bubble and the impending commercial one. In the next few years, you’ll find them swooping down to take advantage of the carnage. So I would accumulate these REITS on any weakness.

I’m trying to stay well away from specific recommendations but will say that right now, it is very easy to find large common household name US and Canadian companies with solid balance sheets, single digit P/Es and yields around 4%. So if you’re bullish on inflation, then that means that eventually, some time in the future, who knows when exactly, these companies will gain price traction. When that happens I think you’ll see dividends keep pace with inflation or outpace it due to the economic recovery as well as healthy balance sheet positions.

Basically it boils down to avoiding the expensive and buying what is on sale. Know the difference between price, value and worth. Be nimble and opportunistic. And when you figure out how to do that consistently, please teach me.

10. Where do you hope to bring the Traders’ Narrative in the future?

I hope to continue to share ideas on the market and develop as a trader.

Babak, thank you for that incredibly insightful piece. We wish you all the best!

A few weeks ago, the SEC passed a vote that will require publicly accountable entities to disclose information pertaining to climate related matters to external stakeholders. Whereas a good amount of companies were already disclosing information such as carbon emissions and ISO compliance voluntarily, the move will not be welcomed by many reluctant organizations. But, regardless of the added expenses that about 75% of the companies in the S&P (who neglected any mention of “green” items in the annual reports to date) will incur to provide the respective disclosure, the SEC is making a move that goes beyond finance and investing, and delves into global conservation.

Although the SEC move was taken because of the belief that such “green” information will affect investor decisions, whereas the effects of this disclosure will influence investor behavior is another question. Investors typically already have a good sense of what industries contribute more to pollution and which don’t, and some investors couldn’t care less. But as with most change, those that embrace it will flourish, and those who resent likely aren’t too proud of sharing their story with the public. It was refreshing to note that some of the biggest players in the oil industry, including Chevron, ConocoPhillips and ExxonMobil, were already voluntarily disclosing carbon emissions and other climate-related statistics prior to the SEC vote.

Furthermore, as a specialist at accounting guidelines and regulations, I believe the effects the new SEC requirements will have on financial statements and notes are strictly qualitative. Accounting principles (both current US and Canadian GAAP, and the upcoming global IFRS standards) have strict requirements for companies to assess known and potential liabilities in both likelihood and magnitude. For example, if a potential liability for environmental accidents or environmental clean-up costs will be incurred, there’s a good chance any company must recognize a liability on their balance sheets, or at least disclose it in their notes. For years now, these accounting standards have considered environmental costs such as the one the SEC is concerned with, so the effects of the upcoming regulations will be purely qualitative. Yes, companies affected by the SEC vote will have to provide opinion on how they are influencing global warming and the environment, but financial statements will likely remain the unharmed.

Although minor investment opportunities present themselves at the corner of this milestone, the effects of the SEC vote will have minimal impact. Companies that have already been voluntarily disclosing this information will benefit from the already-absorbed costs of tracking the necessary detail and may be presented in a more favourable light to the investing community. Consider global organizations like Coca-Cola, Hewlett-Packard, IBM and Wal-Mart who have been voluntarily disclosing carbon emissions and climate-related risks for a number of years now; yes, there may be a positive image that comes with such disclosure, but their financial statements will remain unaffected. I strongly commend the SEC for going through with a vote that has responsibility and forward-thinking attached to it, but, will such information affect investing decisions? Not likely; most investors will remain focused on financial statements, and since they will not significantly change from the decision, the effects from the SEC vote will remain buried in notes to the financial statements.

Disclosure: no positions

Image credit: tellytom through a Creative Commons license

As of today, 5 fatalities have been reported, and lawmakers around the world continue to monitor Toyota’s reactive actions to the allegedly sticking gas pedals. As responsive as Toyota has been in handling the situation, it won’t be soon forgotten; definitely not until the improved components are shown to work over a considerable time period, which could take months or even years. For now, the bad publicity is certain to cause consumers to pump the brakes on Toyota purchases, and its stock will see a similar effect. After recovering from March’s (2009) lows of approximately $57 to $91 in mid-January 2010, the stock has already seen a 19% decline to $73.

Toyota’s stock will be stabbed with two spikes. First, the immediate monetary impact of the recall is massive, which has been estimated at about $350 per vehicle and $1 billion on an aggregate recall scale. Still, this estimate does not include potential litigation expenditures, halted production in more than half its vehicles, and most importantly, the impact of lost reputation and sales for the long-term. Toyota, which was known particularly for a “strong brand” of high quality vehicles, has suffered lasting losses in customer and investor confidence, and Toyota’s sales and stock prices are likely to decline for months to come.  

Nevertheless, the recall has not resulted in slim pickings for consumers beginning car-shopping in an improving economy. As in all business, what’s bad for one corporate giant is often good for others. Where Toyota has suffered due to the recall, other automakers are quickly stepping in. January 2010 vehicle sales (in the United States) for Toyota have declined by 15.8% from January 2009 (and are at the lowest level since 1999), whereas for the same time-frame Ford sales are up 24.4%, Hyundai sales are up 24%, and Volkswagen sales have ballooned an incredible 41%. If a similar trend persists throughout 2010, the entire landscape of the auto industry in North America and around could change.

For now, investors should be pumping the brakes on Toyota stock, and certainly consider a strong upcoming year for some of the other large auto producers mentioned above. Toyota sales and stock will continue to skid through 2010.

Disclosure: no positions

Image credit: Neubie under a Creative Commons license

It seems the consensus of bullish investors and authors about 2010 predicts strong emerging markets, glimmering gold, weakening US dollar and weakening bonds, which portrays my outlook for 2010 precisely. Additionally, I’d like to add that in my vision of 2010:

Mr. “Rich” Consumer

Americans will continue to keep finding a way to live above their means. Recently, claims for unemployment and lay-offs have shown to decline to an 18-month low as the economy slowly recovers. This latest employment news has a double-pronged effect. First, a recently reported jump in average weekly working hours means increased income and ability to spend. Secondly, on a more aggregate level, the trend of stabilizing unemployment will improve consumer confidence of job security, a critical factor to assess consumer spending, especially for large-ticket items large cars. Together, these effects will translate into increased consumer spending in 2010.

Mr. “Rich” Consumer without a Job

On the other side of the argument, unemployment will remain relatively high around 9~10% for the entire year due to a prolonged economic recovery. Despite lower layoffs and unemployment claims, which represent incremental increases to unemployment (i.e. the number of unemployed is still increasing but at a slower rate), the overall unemployment rate will slightly decrease from current levels to about 9~10%. Although unemployment may remain high, the stabilization and slight-decrease in the unemployment levels will mildly contribute to increased consumer confidence, but will also generally improve with the economy.

Yes, More Housing

The housing market will stabilize as the S&P/Case-Shiller index has shown uninterrupted growth in price of home sales for the last 6 months; the absolute number of home sales has also increased in the same period. So, homes are being sold more often and for higher values. As shown in the graph below, the Case-Shiller index is barely at its 2003 highs, and down 32.6% from a peak in the second quarter of 2006, so I doubt that any bubble-concerns will arise as the market is still evening out.

Continuing Low Interest Rates from the Fed

Analogous to the notes above, the Fed is obviously aware that economic conditions are showing signs of recovery. The Fed was already noted to exercise some exit-strategies such as ending purchases of Long-Term Treasuries and also stated that debt purchases will significantly decrease into early 2010. But, rates were maintained near 0% during December, 2009. To raise interest rates now, when the level of economic uncertainty is still highly elevated would result in highly-detrimental effects to the economy and the Fed’s reputation – homicide and suicide. Until signs that unemployment levels have definitely peaked and positive economic indicators show long-term trends, rates will be maintained at a low level until 3-rd quarter of 2010 or early 2011.

All of the above point to a pretty good year for the equity markets. Recent analysis I’ve been seeing is consistent with this hypothesis, including increased EPS and operating profits for a majority of companies and all sectors in the S&P500. A recent Wall Street consensus expects forecasts revenue growth in 2010 to be 8%, with improved earnings as well.

I’m a firm believer that history repeats itself, leading me to believe the tradition of the S&P500 index will continue in 2010. Expect a good year for stocks coming up; we’re still about 30% from the market highs of 2007. So, stock market running out of steam? Leave that for 2011.

Disclosure: Long Market

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Since March, trading volumes have continued to level out (see graph below), which has intensified the debate on whether the bull rally is indicative of a W-shaped recovery or just a pause in the climb up. Psychologically, it takes time for investors and traders to get used to a new milestone market level (such as this 52-week high), so I believe this is just a pause in the climb up; a lot of main-street and smaller retail investors are in shell-shock and watching on the sidelines. With the momentum acquired in the last 52 weeks, it doesn’t require massive volumes to maintain the trend. There’s still room to move up.

A very interesting 2-year technical analysis using the S&P 500 as an example (while DJIA Index exhibits the same patterns) shows a moderate-negative correlation between price levels and volume levels. Towards the “crash” (black candlesticks in the chart) of March 2009, you can see volumes exploding more than two-fold (blue line in the chart) as buyers were scurrying away; during this year, volume has been on a downward trend as prices have been increasing. A recent S&P correlation analysis explains this relationship between price and volume has existed on a yearly and even monthly basis since the 1950’s, providing a correlation coefficient of -0.29 (monthly) and -0.3 (annual). The chart below exhibits this visually.

Implication? Low trading volumes are not indicative of an upcoming fall in prices. This recent fear of low trading volumes is a psychological effect to a different trading level. Low volumes are not causal of price level increases, but they are NOT causal of price level decreases either. This is my first reason for believing that price levels will not fall in the near future. Reduced trading levels naturally lead people to believe that prices will soon be falling, but history has proven this is not necessarily the case.

Low volumes are noticeably seen by some as unwillingness by main-street investors to invest or trust their advisers. The way I see it is if mostly Wall Street remains in the markets right now, it’s even easier to influence the market with larger amounts of capital, and Wall Street is definitely bullish. Wall Street investors have been and will be bullish as long as the government stimulus continues, interest rates remain low and the dollar devalues. This is because most of Wall Street has guidelines for taking big positions that a lot more political than main-street and must adhere to certain indicators and principles – and Wall Street just loves their government stimulus and low interest rates for justification to be bullish on equities.

It’s important to recognize that there is still a lot of confusion in the North American markets. The economy is not in good shape, and the Fed seems to think that consistently forced stimulus and rising debt will somehow avoid the inevitable problems of today. To believe that this short-term trend represents any long-term economic improvement is ignorant. Looking at company valuations, income statements and fundamental economic indicators clearly depicts that the market is increasingly detached from reality.

But, that’s EXACTLY the reason I remain bullish for the short-medium term. You can reap the benefits from an artificially created increase in the markets while it is available. 

How long should you stay bullish for? As seen above, low trading volumes are not a useful indicator to predict a fall in price levels, and as long as the government stays consistent with its actions, market prices will continue to rise. An economic “recovery” (real or fabricated, you choose) is at the top of the Fed’s priority list, and thus they have VERY clearly stated their position to continue stimulus and low rates. The continuous economic programs and stimulus have continued to-date, and let’s face it, if the Fed was going to raise interest rates to battle any signs of inflation, it would have been raised by now. Based on the low-volume implications above, and assuming stimulus, Fed liquidity, ultra low interest rates and dollar devaluation continues, the markets will continue rising until the government’s and Fed’s intentions appear to deviate from their actions-of-late.

So for now, why not stay invested, make some money, and enjoy the upcoming 52-week highs.

Image credit: net_efekt under a Creative Commons license. 

Especially in a time when consumers are conscientious towards quality/value, RL is there with a diverse brand portfolio that uses its core brand to dominate across markets, price points, distribution channels and geographies. This was exhibited by the 8^th consecutive EPS outperformance – a positive sign of undervaluation you don’t want to neglect.

Financials

Most recent long term debt reported of $406 million represents about 9% of total capitalization which is incredible for a retailer, and current ratio of 3.05 poses no issues with liquidity or going concern. RL also raised its share repurchase program by $225 million to $431 million. Next to some main competitors, including PVH and VFC, RL earned $287,000 revenue per employee (compared to $216K and $155K, respectively), showing well-utilized personnel, commission schemes and sales execution.

The Lauren family currently controls 86% of the voting power of all outstanding shares (thereby increases in the share repurchase program may indicate desire for future privatization), but the company’s strong executive team and increasing global focus have been capable at building a luxury brand that is appealing to new clientele in Europe, Japan, Southeast Asia and the accessories markets (particularly footwear).

International Growth

RL’s goal is to draw a third of its revenue from each of North America/Europe/Asia. However, its current sales breakdown showed 72% in North America, 20% in Europe and 8% in Asia, meaning increased efforts of Asian growth are underway. On a related note, the reputable McKinsey Consulting predicts that luxury spending in Asia is poised to increase as the number of wealthy households multiplies 2-fold to 3-fold, and RL wants to be on top of this demographic change. Significant control has been taken of manufacturing and branding efforts in Japan and China to be ready for the market growth (high end luxury goods in Japan, family brand growth in China). If they can maintain current North American sales levels, total sales increases will be enormous.

Volatility

Even a Bollinger band analysis shows increasingly appealing technicals as a price increase indicator is more than moderately likely. The company has definitely built a lot of momentum over the last year and has an expected trend to reach highs of 100$+ from the last two years.

Overall

RL’s continued expansion through international boundaries and a brand name as well identified as Coca Cola, Nike and Disney, should give investors a long-term favourable view of this stock as it is definitely one of the strongest firms in the retail landscape. I strongly recommend RL as a short-term and long-term investment with a target 12-month price of $95 based on increased EPS estimates.

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Disclosure: Long RL