bizzXceleration: Performance, Value and Profit

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Long View: Difficulties in identifying breed of bear markets Bears come in many species. Some are vast and vicious hunters, living off raw meat. Some eat fruit. And some, like koalas and pandas, are not bears at all. World stocks are this weekend in a bear market. But bears come in as many varieties in the markets as they do in the wild. There have been 30 bear markets, so defined, for the S&P 500 since 1900. According to Thomas Lee of JPMorgan, four of them troughed at 20 per cent down. A further 11 dropped only 10 per cent or less after the point at which they finally hit the 20 per cent barrier. But nine of them still had more than a year to go before hitting rock bottom, and five would see further falls of 30 per cent or more. But if we take account of inflation, the S&P never regained the peak it set in March 2000 during the tech bubble. This more significant measure implies that we are in the latest downward phase of an eight-year-old bear market. So it is best to assume that we are not in what Mr Lee calls a "cub market" when the worst is over soon after the 20 per cent barrier is breached. This puts us in uncertain territory, as we lack a large sample of protracted bear markets. But two things are clear. First, bear markets are bad for your wealth. Once a big secular bear market is under way it generally lasts a decade and no asset class performs very well. Second, if you buy at the bottom, you make fantastic sums. There is no better time to buy. It is dangerous to leave stocks altogether. Since 1900, there have been only four secular bear market bottoms: in 1921, 1932, 1949 and 1982. The bottom is preceded by a period when the market falls on low trading volume and rises on high volumes. Rather than a final "capitulation" which Napier finds to be a myth (although, short and sharp "cub markets" can end this way), a bear market instead ends when investors simply lose interest. This is nothing like recent huge falls on record volume. As for valuation, cyclically adjusted price/earnings ratios need to be far below their long-term trend. They are above it. It looks very much, therefore, as though the world has to see through the final effects of the credit squeeze, which with this week's doubts about the US mortgage agencies appears to be worsening, and the resultant economic pain, before hitting bottom.

Where we are and where we're going: 10 market themes As last year drew to a close, we revisited our 2007 themes and weighed them in kind. Many of them came to fruition, others were early, but most hit the mark. See related column When we entered 2008, we offered a fresh set of forward-looking expectations. With a conscious nod that we must stay humble or the market will do it for us, it's time to reflect on those thoughts as we cast an eye towards the back nine. See related column Theme 1: Hedge funds buying brokers…. Theme 6: Dislocation January thought: Despite Herculean efforts by global central banks, I believe we will see a market dislocation this year as measured by a 10% move (or more) in a single week. Update: We often talk about the difference between taking our medicine as a function of time and price and being injected with artificial drugs with hopes of staving off the disease. There have been several instances when supply seemed ready to overwhelm demand but the powers that be were at the ready. The market has suffered three quarters of negative return for the first time since the 1970's and the June swoon was the worst showing since the Great Depression. Still, perhaps as a function of the liquidity injected into the system, the VXO -- widely considered to be the angst proxy on Wall Street -- is less than half the levels we've seen at previous historical fear fulcrums. Once we cycle through the deleveraging process, the foundation for a legitimate economic expansion will be in place. Unfortunately -- and please don't shoot the messenger -- we could be in for five lean years before that happens. The destination we arrive at isn't as important as the path that we take to get there. As such, I continue to operate with two buckets of capital -- a short-term trading pool (that attempts to capture volatility) -- and my nest egg, which is 100% cash (backed by T-bills with no commercial paper).

(5*) Deutsche Bank's Anshu Jain Says Global Credit Crisis Is `By No Means Over' Jain, at a Euromoney conference in London today, said the crisis ``has wiped out $200 billion,'' or about 22 percent of the tangible equity of the banking industry. That impact is similar to the combined effect on the insurance industry of Hurricane Andrew, the Sept. 11 attacks and Hurricane Katrina, he said. ``This banks crisis is really at a point where it equals the three biggest crises faced by the insurance industry,'' Jain said. ``It's by no means over.'' Banks and securities firms have turned to investors for $322 billion to replenish reserves after $403 billion of writedowns and credit losses tied to the collapse of the U.S. subprime market. Frankfurt-based Deutsche Bank said yesterday it expects to report a profit for the second quarter and currently has no need to raise further capital. VIDCLIP

Pierre Gave, head of Asia research at GaveKal Holdings Ltd., talks with Bloomberg's Haslinda Amin from Hong Kong about the outlook for Asian stocks, and his investment strategy. [This is a mechanically awkward interview but deeply insightful and will repay some careful listening] VIDCLIP

Bearish battalions  Almost everything that could is going wrong for world stockmarkets. The American stockmarket had its worst month since 2002 in June and is now down more than 20% from its peak, the definition of a bear market. It is not alone. According to Standard & Poor’s, a rating agency, the value of global stockmarkets fell by $3 trillion during the month, thanks in particular to a 10% decline in emerging markets. Share prices are suffering because of the outlook for four forces that impel stockmarkets: economic growth, profits growth, interest rates and inflation (see article). At the moment, the first two seem to be slowing while the last two are rising. That is the worst possible combination. The past six months could be seen as a dreary exercise in sharing out the pain. Will workers suffer by seeing their wages rise more slowly than inflation? Will companies have to compensate their workers by raising wages, sacrificing their profit margins? Will central banks treat high commodity prices as a blip, and leave real interest rates low, penalising savers? Or will they raise interest rates and risk pushing the economy into recession? None of these choices is palatable. All this has been made worse by the credit crunch. Now, chastened by the huge amounts of capital they have had to raise to strengthen their balance-sheets, banks are being more careful. According to Ian Harnett of Absolute Strategy Research, a consultancy, the availability of credit in Europe for both consumers and companies is now at its lowest level since 2003. The problem for financial markets is that the virtuous circle which pushed asset prices higher in the middle of this decade may be turning vicious.

(???) Deutsche, UBS Fight History Forecasting Best S&P 500 Since 1982 Deutsche Bank AG, Lehman Brothers Holdings Inc. and UBS AG say the Standard & Poor's 500 Index will gain the most in 26 years during this year's second half. That isn't going to happen, if history is any guide. The S&P 500 will rise 18 percent by January, according to the consensus projection of 10 U.S. strategists surveyed by Bloomberg. The forecasts are based partly on estimates that profits will jump 50 percent in the fourth quarter after falling for the past year. Even if that happens, it may not be enough. In 2001, the last time profits fell as much, they then had to climb for three straight quarters before stocks rebounded. Analysts' earnings estimates for this year still represent a decline from 2006 levels, making the strategists' optimism harder to justify, investors say. Rosy S&P 500 Outlook

Falling stocks reflect reality -- for a change It's becoming evident that what was first perceived to be a short housing-led slowdown is now quickly converging into a full-blown capitulation of anything that could be vaguely defined as consumer discretionary. Last week a multitude of stocks in sectors most sensitive to a prolonged slowdown established new lows: casinos, autos, lodging, recreational vehicles, regional banks, airlines, old media (newspapers and TV), construction and retailers. Even the formerly bulletproof oil, gas, materials and agricultural darlings have posted double-digit declines in the past several days, with more declines on the horizon. What is even more troubling: The CBOE Volatility Index ($VIX.X), better known as the VIX, is trading around 26, far away from the 30-plus capitulation level reached twice earlier this year.Why is it important? Let's step back for a second. What happened during the last few capitulation days, back in August 2007 and this past January and March? Every time when it seemed like things were almost slipping into the "sell everything and forget the stock market forever territory," the Federal Reserve stepped in and bailed out investors with interest-rate cuts.

El-Erian: Traversing Mkt. Swings Today’s markets are particularly tricky as they provide the duality of both great opportunity and enormous risk. And in contrast to recent years, investors will not be able to appeal to a few macro themes; be they bullish (”the great moderation” and ”goldilocks”) or bearish (”debt exhaustion” and the collapse of structured finance). Instead of the phase of highly correlated market moves, up and then down, we will witness the gradual assertion of fundamental differentiation between market segments and for instruments in the capital structures. To illustrate, let us start with the unpleasant side of the duality. Successful risk management must reflect the fact that markets are now in the grip of three distinct but reinforcing forces that will play out over a number of quarters. First, look for further balance sheet contractions in the financial sector that will continue to suck oxygen out of, and undermine risk appetite in credit and equity markets. Second, markets are yet to adequately price the morphing of the credit crunch into a full-scale US economic disruption. Prepare for even stronger headwinds fuelled by declining real income and eroding household wealth. Third, there are no easy policy solutions. Instead, policy makers face an extremely difficult situation in which any action, no matter how well-intentioned, entails unstable feedback loops and impose distortions elsewhere. Collateral damage cannot be avoided, yet its exact characterisation is uncertain given the extent of still-hidden vulnerabilities in both the real economy and the financial sector.

·         PIMCO’s Secular Outlook by Mohamed El-Erian: A Tale of Two Cities

·         Mohamed El-Erian Discusses PIMCO’s Secular Outlook and Investment Strategy

Will Earnings Show Spread Of Malaise? Brace yourself for another ugly earnings season Wall Street didn't see coming. Alcoa reports Tuesday, launching an armada of second-quarter profit results. Staying afloat will be a challenge. Wall Street analysts estimate S&P 500 operating earnings -- income excluding one-time items -- fell 11.5% in the second quarter from a year earlier, the fourth straight negative quarter. That's the longest such stretch since 2001-02. Based on their track record, analysts likely underestimate how bad earnings will be. In every quarter so far in this downturn, they have slashed forecasts as reporting season approached. By the time it ended, those expectations were revealed as still too optimistic. One difference between this earnings recession and the one in 2001-02 has been how well most sectors have held up. In the profit downturn earlier this decade, earnings in most S&P industries quickly turned negative. In this downturn, at most only three or four have been negative at once. That could mean the economy has effectively compartmentalized the damage in financials, housing and autos, keeping the whole ship afloat. Or it could mean the pain has only just begun to filter through. Analysts seem to hold the rosier view: They see earnings rising 13% in the third quarter and 59% in the fourth quarter.

Mortgage ruling could shock U.S. banking industry A lawsuit filed by a Wisconsin couple against their mortgage lender could have major implications for banks should a U.S. appeals court agree that borrowers can cancel their loans en masse when their lenders violate a federal lending disclosure law. The Andrews filed the case seeking class action status; and in early 2007, U.S. District Judge Lynn Adelman ruled that the bank had violated the Truth in Lending Act, or TILA, and that thousands of other Chevy Chase borrowers could join them as plaintiffs. The judge transformed the case from a run-of-the-mill class action to a potential nightmare for the U.S. banking industry by also finding that the borrowers could force the bank to cancel, or rescind, their loans. That decision was stayed pending an appeal to the 7th U.S. Circuit Court of Appeals, which is expected to rule any day. The idea of canceling tainted loans to stem a tide of foreclosures has caught hold in other quarters; a lawsuit filed last week by the Illinois attorney general asks a court to rescind or reform Countrywide Financial Corp mortgages originated under "unfair or deceptive practices."

Toxic CDOs Given Up for Dead Coming to Life as Re-Remics for Pension Funds Collateralized debt obligations that helped drive banks to $400 billion of writedowns and credit losses are finding buyers under a different name: Re-Remics. Goldman Sachs Group Inc., JPMorgan Chase & Co. and at least six other firms are repackaging unwanted mortgage bonds as sales of CDOs composed of asset-backed securities fall to less than $1 billion this year from $227 billion in 2007 because of the global credit crunch. Re-Remics contain parts that are structured to guard against higher losses on underlying loans than most CDOs, allowing holders to sell or retain other sections at lower prices that can translate to potential yields of more than 20 percent. ``It's just the reincarnation of the CDO,'' said Paul Colonna, who manages more than $100 billion as chief investment officer for fixed income at GE Asset Management in Stamford, Connecticut. ``The mechanics are the same, but you're getting in at a much different level of valuation.'' GE Asset Management has considered buying the debt, Colonna said. The General Electric Co. unit may also have Re-Remics made out of bonds it owns if disposing of the riskier pieces boosts the securities' overall value. Re-Remic stands for ``resecuritizations of real estate mortgage investment conduits,'' the formal name of mortgage bonds. Sales of the securities may help revive the market for new home-loan debt, according to Bernard Maas, an analyst in New York at credit-rating firm DBRS Ltd. Re-Remics and CDO sales