So what’s a fretting investor with rate hikes on the horizon to do? There’s the obvious choice: Ease up on the equity throttle and seek the security of the fixed-income market. That’s what Warren Buffett’s favorite valuation indicator seems to be saying (see “the chart” below).

We’re seeing some of that thirst for safety prop up Treasuriess lately. Even as China has cut back its holdings in U.S. debt by about $180 billion, according to Bloomberg, the market has barely budged. That’s because, from banks to mutual funds, there are plenty of buyers out there.

Buffet’s indicator is a comparison of total market cap to the gross national product. Going back decades this has been a good indicator for when it is time to buy bonds or stocks. Now, it would appear that the indicator is telling us it is time buy bonds.

So Why Did Treasuries Fall?

The Wall Street Journal reports a pullback of U.S. government bonds as stock rally.

U.S. Treasury bonds pulled back on Monday after a recent rally, as hopes of fresh monetary stimulus to support China’s slowing economy boosted investors’ appetites for riskier assets.

China’s stocks rallied after soft exports bolstered market expectations that Beijing would increase spending and continue to prop up the equity market by buying shares.

Looming new U.S. government debt sales also weighed down bond prices. A $24 billion sale of three-year Treasury notes is due Tuesday, followed by a $24 billion sale in 10-year notes Wednesday and $16 billion in 30-year bonds Thursday.

In recent trading, the yield on the benchmark 10-year Treasury note was 2.214%, compared with 2.173% on Friday, according to Tradeweb. Yields rise as prices fall.

Does this refute the wisdom that it is time to sell stocks and buy bonds? The fact is that the market cap to GNP indicator is a general indicator and an accurate one. It does not apply to which individual stocks you own but to the market in general. And even though bonds may have their issues they are a safe haven when the stocks market goes bust.

Lost Touch with Reality

Bloomberg Business says that the S&P 500 flouts history as it ‘breaks with bonds.”

As far as credit markets are concerned, U.S. stock investors have lost touch with reality.

That’s seen in the extra yield bond investors demand over Treasuries. The spread has expanded by 0.48 percentage point from a year ago, the most since 2012, even as the Standard & Poor’s 500 Index rallied.

While not without precedent, instances when anxiety in bonds didn’t seep into equities are rare. More than 70 percent of the time since 1996, as spreads widened as much as they have since April, the S&P 500 has fallen, with the average decline exceeding 10 percent, data compiled by Bloomberg show.

The average fall in stocks has been ten percent over the last fifty years whenever market cap goes too high in comparison to the GDP. One more voice has been added to the chorus that is singing, it is time to buy bonds.

Time to Buy Bonds PPT

It is not as though other nations are without sin in this matter of casting stones at debt. The United States’ total debt is calculated at nearly 95% of gross domestic product. The entire Group of 7 has debt to GDP percentages above 79%. China’s debt to GDP percentage is 22% according to Chinese government figures. The problem many see in China is its practice of taking government debt off the books. When the Asian currency crisis hit in the late 1990’s Indonesia, Korea, and Thailand were in trouble. China avoided the worst but still found that its banks had written a huge number of loans that became uncollectable when foreign investment faltered with the currency crisis. What China did was to create “management companies” for its four major banks. These companies took over the debt from non performing loans and issued bonds for these “assets.” The bonds were for ten years and the problem was swept under the rug. Picking new winners in China as the recession lifts will require a clear assessment of how much debt a company has and how strong its balance sheet is.

It is interesting that when ten years passed after the Asian currency crisis the four management companies all had different stories about residual debt but all of them went looking for “strategic partners.” Beware of investing in China with companies heading to the rescue of these debt management arms of Chinese banks. The passage of time will add other issues for investing in China. The country has had and enforced a one couple one child rule for decades. This policy has slowed growth in the world’s most populous nation to where India recently passed China as the nation with the most people. Fewer children has had the effect of aging China’s population. The traditional means of supporting the old in China is gone with its large families. Although the Chinese are big savers the government has no retirement programs and no health insurance programs for the elderly. Old age costs will come out of savings. The high savings rate in China will not come to the government’s rescue in a time of high national debt. It will go to caring for the elderly. Those interested in stock investing in China will need to look carefully at tax rates and social needs as they affect business growth in the nation. The Chinese government does not admit to any debt off the books but it is going to abandon loan guarantees for investment companies having local governments issue bonds instead, thus shifting debt responsibility to investors and away from government. Give thought to hidden debt when investing in China.

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NAFTA

According to the NaftaNow web site:

The North American Free Trade Agreement (NAFTA) is a comprehensive trade agreement that sets the rules of trade and investment between Canada, the United States, and Mexico. Since the agreement entered into force on January 1, 1994, NAFTA has systematically eliminated most tariff and non-tariff barriers to free trade and investment between the three NAFTA countries. It is a formal agreement that establishes clear rules for commercial activity between Canada, the United States, and Mexico. NAFTA is overseen by a number of institutions that ensure the proper interpretation and smooth implementation of the Agreement’s provisions.

US exports at the beginning of the decade were $248.2 billion to Canada and $163.3 billion to Mexico. These nations have been the top two purchasers of US exports. At the beginning of the decade exports within NAFTA amounted to a third of all US exports. Top exports include machinery, vehicle parts, electrical machinery, mineral fuel and oil, and plastics coming to well over $200 billion a year. The USA exports over $30 billion in agricultural products to its NAFTA partners every year.

The European Union

The European Union (EU) is both a political and economic union comprised of 27 member states. Unlike North America the EU nations give up a degree of sovereignty in return for membership in the trade zone.

EU and North America

The GDP of North American nations is around $18 trillion. That of the EU is just under $13 trillion in US dollars. The $31 trillion combined economies of North America and the EU amount to 43% of the world economy (world GDP is just under $71 trillion). The rationale for a combined North American European free trade agreement is clear. Create a free trade zone that includes nearly half of the world economy and stimulate business and economic growth on both sides of the Atlantic. If such a treaty comes to pass it could change international investment strategies for many investors.

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Fix It Now, Please!

There are a number of pertinent issues regarding the so called “fiscal cliff.” First of all it is not a cliff. What if the President and Democrat dominated Senate cannot come to terms with the Republican dominated House of Representatives? The effects will play out over several years. If the middle class tax cut is not extended, it will have a measurable effect on the economy, over a period of months and years. Likewise, if the tax cut for the highest US income earners is not extended it will also play out over months and years. The same applies to mandatory cut backs on military spending and social programs. A smart investor can manage his or her investment portfolio to accommodate any and all possibilities. However, a fiscal cliff fear factor, a fear of uncertainty and unnamed economic catastrophe, can drive the market and cause investors to make poor choices that will serve them badly in the long run. The better result for long term investors will be for the President and Congress work to an early solution so that the fiscal cliff fear factor can go away. Then the average investor can choose his or her stocks, invest for retirement, and collect on his dividend stocks without the gnawing sense of uncertainty that is the fiscal cliff fear factor.

And if the Problem Continues?

Let us assume that business as usual will continue in Washington. Republicans will probably dig in their heels. They will continue to work on their long term goal of rolling back the social programs of the Great Society of the 60’s and New Deal of the 30’s. Democrats will seek to preserve the same social programs while dealing with budget deficits, the likelihood of a steadily devaluating dollar, and the risk of losing the White House in 2016. The eternal cat fight on Capitol Hill never seems to serve the interests of the Nation but that is how it is. How can an investor benefit from the market chaos caused by the fiscal cliff fear factor? No matter how heated the arguments become there will eventually be a solution that preserves the US military, social programs, and reduces spending for both. Consumer products stocks are typically a good refuge in tough times. One might think that it is time to sell defense stocks, but the better choice may be to wait for market prices to fall and buy at bargain prices before a deal is made. This argument probably applies across the board. Let the fiscal cliff fear factor drive prices down and buy when prices bottom out. When the cat fight on Capitol Hill finally resolves itself, prices will likely go back up. As usual do your own fundamental analysis and look for a good margin of safety in the stocks that you buy.

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A Relatively Easy Calculation

Limit your offshore investments to American Depository Receipts (ADR’s) of foreign companies. Level I ADR’s must comply with the same SEC rules as US companies. This allows for sound fundamental analysis of these equities. It is reasonable in this case to use US Treasury yields as a base for comparison or simply a composite yield of a basket of US stocks. If your offshore stock investment promises a better yield than a comparable US stock it should be valued higher. If it is not, the foreign stock has an intrinsic value higher than its current market value and you should buy it.

A More Complicated Appraisal

There are certainly many more offshore investment opportunities than buying foreign ADR stocks. US companies that do business offshore offer a diluted version of foreign and stocks are amenable to the same intrinsic value calculations as foreign ADR’s. Foreign stocks purchased on a foreign stock exchange, however, may be a little harder. The issue often times when investing in foreign stock markets is that the amount of hard information that a prudent investor requires is simply not there. Thus the investor needs to use a large “fudge factor” when making his calculation. In a really difficult foreign market this is not stock investing but rather pure speculation or gambling. To the degree that one has insider information it may still be profitable. To the degree that the foreign government does not bar insider trading it may not even be illegal. Nevertheless proceed with caution when trying to calculate the intrinsic value of overseas investments in non transparent markets.

And More So

A common approach to offshore business is to set up production close to growing offshore markets, use cheap offshore labor, and take advantage of tax breaks offered as enticements by local governments. These sorts of strategies can be very lucrative if done well and an absolute disaster if done poorly. Calculating the intrinsic value of overseas investments of this sort requires a very clear view of the business involved, the available markets, and the ease or difficulty of doing business in countries where bribes are a way of life. To the extent that one can get a clear view of the profits that one will gain from international investment strategies , the potential intrinsic value of overseas investments of this sort may be so high as to make it foolish not to invest.

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Economic Growth

Coming out of the 2008 Great Recession, Asia has largely been the engine of growth. However, the US economy is also slowly recovering. The key word for the US economy, as well as Europe and Japan, is “slowly.” Mature markets in North America and Europe rarely provide rapid growth whereas evolving economies in Asia, Latin America, Russia, India, China and other parts of the Asia Pacific. The so called BRICS nations (Brazil, Russia, India, China) have room to grow which presents offshore investors with opportunity. International investment strategies in these locations may provide a greater rate of return on investment and time spent than similar endeavors in the more mature economies of the world. When value investing for long term profits, going where the growth is, is the beginning of a good strategy.

Access to Technology

The United States, Europe, and Japan are still world leaders in technology. However, Korea, China, India, Russia, Brazil and others are gaining ground. One clear effect of US homeland security policy has been to make it hard for smart people from around the world t come to the USA to work. The recent Bush administration policy of limiting government funding and therefore access to cell lines for stem cell research drove much of that research offshore. In today’s world it may be much easier to get stem cell related treatment for diseases by going to Thailand, Korea, or Brazil. Depending on the market niche, international investment strategies for high tech industry may drive businesses to Latin America or Asia instead of the USA.

Access to Markets

Close access to growing markets is a decided plus when the cost of transporting goods or providing services at a distance is significant. In addition, setting up business in a nation that is within a specific free trade zone may provide significant advantages over trying to sell into that market from the outside. International investment strategies, such as doing business out a nation such as Colombia which has trade relationships across the hemisphere, could be more profitable than doing business from home.

Manpower

An all too simplistic view of manufacturing offshore is that labor is cheap. For a nation such as China, cheap labor can be a plus. However, a well trained and intelligent worker can easily out produce his underpaid counterpart anywhere. When considering international investment strategies, it is often wiser to look for a well educated and often English speaking work force than one that works for cheap but has a poor skill set. This is a good reason for the success of India in doing work for companies in the West. A large part the fundamental analysis required for setting up or investing in offshore businesses is making sure that the workforce involved has the skill set necessary.

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Stimulus in China

China has used economic stimulus by the government to support its lagging manufacturing sector over the last few years since the onset of the 2008 recession. Interest rates have been kept low and the government has poured money into infrastructure projects. Chinese economists predict a rise in economic growth into the eight percent range. An optimistic read of the situation is that China specifically and Asia as a whole are in the recovery phase of a traditional recession. If fundamental analysis of the Chinese manufacturing increase is consistent with a routine economic cycle it could well be time to buy Chinese manufacturing stocks. As with the USA and Europe, investors are well advised to watch what happens as government stimulus tapers off and the Chinese manufacturing sector must grow on its own.

Bull or Bear on Chinese Stocks

Despite a generally favorable response to the announced Chinese manufacturing increase, the composite index of stocks fell on the Shanghai market. This may be a matter of buying on anticipation and selling on the news. Over the long term a major issue for China is the ability of the world to buy more and more Chinese products. Europe had been China’s number one customer. Now, as the Euro Zone lingers in debt and recession Chinese industry needs to look elsewhere for customers. Raw materials are always a concern for a growing industrialized economy. As China extends it political as well as its economic clout, it hopes to secure customer bases as well as access to raw materials. However, as the USA found out over the years, being perceived as the country with all of the power and money puts a nation in a different light. The political as well as economic cost of buying favors and getting access to raw materials as well as markets can become costly and become a burden on those at home. If you are investing in foreign stocks, Chinese stocks certainly deserve a look. But, remember Japan at the end of the 1980’s. The nation seemed to be set to take over the world. Then a set of handshake, good old boy, loans was disclosed and the Japanese economy went flat line for over a decade. China is still not a transparent society. The apparent Chinese manufacturing increase sounds good but just how good is the data? Investors in China are advised to constantly do their homework and check their results.

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Iran, the Persian Gulf, Oil

The fundamental analysis for this is basic. A fifth of the world’s oil passes though the choke point of the Straits of Hormuz on its way out of the Persian Gulf. A widened conflict in the Middle East would certainly drive the cost of oil higher. The closure of the Straits of Hormuz during war time could drastically raise the cost of crude oil and drive the already shaky economies of Europe into a recession. The effect of a broader Middle East conflict on stocks in this case would send oil stock higher, crude oil futures higher, and damage a wide range of stocks in markets across the globe.

Worst Case Scenarios

Iran has a mutual security pact with Syria. Iran is developing the capacity to make nuclear weapons. The West has put severe economic sanctions on Iran in an attempt to halt their nuclear ambitions. Iranian leaders have numerous times spoken of their wish to eradicate Israel. Israel is the only nation in the Middle East though to have nuclear weapons. If Iran can claim that Israel is attacking Syria would it use this as an excuse for a preemptive strike against Israel? Would Israel use the presence of Iranian nationals in Syria as an excuse for a preemptive attack on Iranian nuclear installations? Virtually any worst case scenario drags the USA into the picture, damages oil facilities throughout the region, and, perhaps, rearranges the map politically if not by boarders in the Middle East. The prospect of a Greek financial collapse would pale in comparison to a worst case war in the Middle East. The effect of a broader Middle East war on defense stocks in the USA could be significant. In fact, there are contrarians who claim that the West is seeking a broader conflict in the Middle East in order to cure the malaise in their economies and broaden their influence to resemble colonial times.

Profiting from Worst Case Scenarios

There are three schools of thought regarding the effect of a broader Middle East war on stocks. Let us assume that the fighting in contained and that cooler heads prevail. The price of oil will rise and the expected European recession might happen. Oil stocks will prosper as well as all energy stocks. Defense stocks may do a bit better. Then let us assume that a broader war breaks out. Oil prices will go through the roof. Economies will falter across the globe with excessive energy prices. Defense stocks will soar. A third line of thinking is that things could get really bad. Stock markets could fall across the globe, the “blood in the streets” scenario. At that time investors who remember the words of Baron Rothschild will take advantage of the effect of a broader Middle East war to pick up bargains as they profit from a global stock selloff.

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Regional Differences

Interest rates are low everywhere but jobs especially good paying jobs are not always evenly dispersed across the nation. Salaries are typically higher in the North and Northeast than in the South and Southeast. Even with low interest rates buyers need to qualify for their mortgages. Those who would like to invest in home builders should look at who operates in which region of the country before buying stock.

What Do the Numbers Mean?

New home sales are counted when a couple signs a contract to build the home or purchase a newly built home. This contrasts with the tabulation of closings on older homes. The newly released figures are from two months ago. This was before the Fed announced its bond buying economic stimulus program. Perhaps the time to invest in home builders is now, before new numbers come out and prices go up. Already there has been an increase of more than twenty-five percent in new home sales since a year ago. As home builders have cut back in the last couple of years there is also a relative scarcity of new homes for sale. As prospects for a better market evolve sales may well go substantially higher making it smart to invest in home builders today and not after a housing boom is apparent.

Real Estate Investment

If you invest in home builders is that how to start investing in real estate? One can also consider flipping properties as prices rise or investing in the rental market. Real estate management can garner profits for the smart investor. Then there are lease options as well. A smart investor can make money in mobile homes while the housing market grows. Land trusts and real estate limited partnerships are also potential investment opportunities. Learning how to invest in real estate as the market turns up may be profitable and you will not only invest in home builders but consider the whole range of real estate investment options.

As always with these articles we are not suggesting that one invest in any specific home builder or that one invest in home builders at all. The point is to be aware of investment opportunities as the recession lightens and find profitable places to invest your hard earned money.

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How Do You Spot a Good Tip?

You are at a baseball game and two guys in the row behind you are talking about a great stock opportunity. One is giving the other a tip to buy the stock now before it goes up in price. The guy who is speaking is assured and seems knowledgeable. Is this a good tip? If you are interested check it out. Find out what the company does, what its cash flow looks like, and its profit to earnings ratio. Has there been a recent change in management? Is this a large company that is being followed by lots of analysts or a penny stock that no one knows anything about? If it is a penny stock and you have no way to check out what you have heard it is a bid tip. Ignore it and enjoy the baseball game. But, you are at the game with your good friend who works for a company that is XYZ Corp’s competitor. He gives you facts and figures to support his argument and suggests that you read a well reasoned report by a respected analyst. You can check out what he tells you and then decide for yourself. This is a good tip. So, it is not tips or research for profitable investing. For picking new winners and making profits it can be both.

Beware of Fear, Greed, and Despair

When considering following tips or research for profitable investing, your own state of mind makes a big difference. Maybe you have had a string of losses in the market. If the whole market has crashed taking your portfolio with it you may be in despair. At such times it is tempting to look for a miracle. Be careful. It is all too easy to convert losses in a bad market into an absolute disaster. There may valuable tips at such times and research always is useful. Either tips or research for profitable investing may end up with losses in a bad market. At such times the best tip may search for undervalued stocks that have been unjustly punished in a down market. There are often great deals to be found in blood in the streets investing.

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