Tuesday, June 24, 2008 10 comments ++[ CLICK TO COMMENT ]++

Marc Faber Speech in Tokyo

UPDATE: Added a short summary of some points that were mentioned

Poor audio quality but Bloomberg managed to capture a speech by Marc Faber at a Tokyo investment conference (click here for the audio). I'm not sure if I'm exceeding the fair use limit by quoting the majority of a short article but, in any case, here is what Bloomberg says:

Japanese stocks, Asian real estate and commodities are investors' best bets as faster inflation erodes returns in the rest of the world's markets, investor Marc Faber said.

``Demand for commodities and oil will not vanish,'' Faber, the Gloom, Boom & Doom Report publisher, said at a conference in Tokyo. ``The shift in demand that drove up commodity prices is not going to go away.''

...

Faber, who told investors to buy gold as the metal began a seven-year rally, predicted inflation may boost Japanese share prices and Asian property will benefit as more people gain access to mortgages.

``For Japan, inflation is favorable,'' said Faber, who oversees about $300 million at Hong Kong-based Marc Faber Ltd. It ``will bring cash out of the mattress and into equities and real estate.''



Marc Faber isn't always right but him, and his friend Jim Rogers, are two of the commodity superbulls who jumped on the train long before anyone even knew it took off. He also tends to be plugged into Asia more so than others and provides a unique opinion.

I'm taking an opposite position from Marc Faber when it comes to commodities in general and oil in particular. I am expecting oil to drop due to demand contraction but Faber seems to think that demand is not going to decline.

The most interesting thing to me is the fact that Marc Faber likes Japanese stocks (Jim Rogers has also indicated that he likes the Yen but not sure about his views of stocks.) It is also interesting to see that inflation is actually considered positive by some in Japan, whereas it is getting to be a detrimental problem elsewhere.

I don't know about the outlook for inflation but all I know is that Japanese stocks are depressed (in book value terms) and there is a massive Yen carry-trade that is a de facto bet against Yen-denominated assets such as Japanese stocks. The big problem in Japan, though, is that the economy has very low growth potential due to a whole hoard of issues (demographics and government interference foremost reasons) and their economy is very cyclical. A big chunk of their economy consists of industrial companies that are dependent on exports. Although exports to growing regions in Asia and elsewhere is strong, USA still represents a big chunk of their economy. Japanese real estate may be a better bet than other companies.

Well, there is a reason they call him Dr. Doom. Here is a quick summary of some interesting points (not in any order):


  1. Bullish on commodities in a general sense and bearish on most financial assets
  2. Bullish on farmland
  3. Believes S&P 500 corporate earnings for 2009 are too high and hence market has to price everything down
  4. Bearish on financials and thinks it can get worse... financials (including finance arms of industrials eg. G.E. Capital) made up something like 10% of S&P 500 in the 70's and they made around 40% in 2007 so he sees it dropping
  5. Likes Asian real estate
  6. Thinks tourism in Asia has the potential to take off... cited some figures about tourism in Britain and other places versus China. There is practically zero tourism in China and this will increase.
  7. Bullish on global infrastructure... my question for the infrastructure bulls is how some of these countries are going to finance them. Some countries making a lot of money off commodities can but how about the rest?
  8. Bullish on Africa... says corruption is high--similar to Asia but big potential
  9. Bullish on Japan... 13 year bear market... thinks the rally from 2003 to 2007 was the first bullish ascent, with a bear market from 2007 to present... sees potential in Japanese financial institutions... cited some figure (don't recall exactly what it was) indicating that Japanese bank capital as a precent of world capital was semething like 40% in 1989 and is only 10% now. He thinks that figure can go up to 20% or 30%... He thinks inflation will help Japan, since it will get people to spend money parked in low-yielding cash accounts. During deflation, which is what Japan has been going through, cash is valuable; during inflation, cash is deflating so no incentive to keep it... My big problem with Japan is that their companies are very inefficient. Hard to find companies with 10%+ ROE. Although small steps are being taken in favour of shareholders, it remains to be seen how fast anything will happen.
  10. He think regional US banks are the next shoe to drop... sees risk arising from construction and commercial real estate loans... he is of the opinion that commercial real estate will also correct hard... This is very bad news for the financial sector and bad for bond insurers with commercial real estate exposure (such as MBIA). I think Faber is wrong about commercial real estate but we shall see. I don't see any grave problems in commercial real estate because subprime loans weren't really an issue. Subprime basically refers to people with low credit quality and unlike residential home buyers, commercial real estate does not seem to have undergone similar loan underwriting. Risk was under-priced in practically all assets (including emerging market bonds, the next shoe to drop IMO) but the degree differed. Subprime mortgages had one of the worst mispricing, whereas, say, corporate debt wasn't as bad. Although people will lose money on corporate debt (especially those dubious LBOs with weak economics,) it won't be anywhere near the losses in subprime mortgages... looking at history, we had financials getting whacked during the savings & loan crisis due to commerical real estate problems but residential real estate wasn't a big problem (house prices dropped during the 1990 recession but it was normal.)
  11. Not a fan of Federal Reserve, Ben Bernake, or weakening currencies...



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10 Response to Marc Faber Speech in Tokyo

contrariandutch
June 25, 2008 at 3:05 PM

Demand for commodities will nog vanish, but current prices (esp. oil) are far above marginal production costs. Supply will expand rapidly as a response and on top of that, demand destruction is in full swing at current prices. I'd bet Faber a commodity heavy portfolio will be trounced over the next five-ten years by almost any reasonable alternative investment.

contrariandutch
June 25, 2008 at 3:40 PM

Following up on my oil short idea I have been looking at marginal production costs and Royal Dutch Shell seems to think it can get shale oil profitable at $30/barrel while tar sands appear to be doable at $25/barrel. Deep Water wells are more expensive but I see costs quoted at about $40/barrel. It appears the $70/barrel cost for these "unconventional sources" I had in mind is really obsolete and off the mark. Technology advances faster then I initially expected. Commodity bulls had better get the silver platters shiny for when they get their heads handed to them.

synchro
June 25, 2008 at 5:12 PM

I don't really have an opinion on the energy or commmodities, and am flat as far as energy is concerned. But I am perplexed by why you and Sivaram seem to like to pick the _hardest_ way to make money, i.e., top-picking parabolic bubbles and bottom-fishing crashing stocks.

This form of financial masochism is perplexing to me.

June 26, 2008 at 9:57 AM

ContrarianDutch,

How about the fact that the lead time to increase production is quite long? It would take at least 3 or 4 years, minimum, to materially increase production from unconventional sources. That is a big risk if you are betting against oil using options (even if expiry is a few years away, it may not be sufficient.)

Some investors such as Warren Buffett seem to think that oil will not correct so it's something to keep in mind. Buffett generally isn't good at macro calls but if he doesn't see an obvious reason for oil to drop, he may be onto something...

I don't like your oil short idea. Potential can be big but shorting speculative bubbles (if it is indeed one) can be lethal.

June 26, 2008 at 10:09 AM

Synchro,

What strategy do you suggest? I'm not too big on ContrarianDutch's oil short idea but he is more knowledgeable and seems convinced of a correction. As for bottom-fishing, that's what I'm trying to master. What's wrong with it? You really haven't said anything other than the fact that the market may be right for the beaten-down stocks.

synchro
June 26, 2008 at 3:24 PM

My suggestion is forget about individual security selection. Use a trend-following tactical asset allocation strategy w/ low-cost broad-market ETFs as suggested by Mebane Faber's paper. You only need to check your allocation or whether a sell trigger is tripped once a month. Due to its use of long-term moving averages, any gains that you do have will tend to be long-term capital gains taxed at a lower rate, whereas your losses you realize will be short-term in nature offsetting your taxable income. You will be out of market when markets are trending down. You will be in the market when markets are trending up.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962461

You can see that such a method and its variations can be objectively replicated and tested to see how it works.

If you insist on using a value-based strategy to pick individual stocks, use an objective quantitative screen criteria such as Piotroski's rank order system to build a diversified portfolio. A tool such as portfolio123 (http://www.portfolio123.com) would aid in back testing whatever objective rules you come up with.

The point of all this is to force yourself to follow a _complete_ investment plan: when and why to get in, when and why to get out (risk control), know how your positive edge/expectation is derived and have an objective exit strategy.

For the "contrarian investment strategy" as described here, it is impossible to distinguish between true investment insight/skill and boneheaded stubbornness/delusional rationalization. You are obsessed w/ low-probability "homeruns" while in reality the investment business is, at its essense, steady accumulation and avoiding devastating losses.

contrariandutch
June 26, 2008 at 4:39 PM

Synchro,

The simple (yet lethal) problem with any sort of trendfollowing (and quantitative) strategies is that it works fine until it doesn't. Sometimes the trend reverses abruptly and then these strategies blow skyhigh with no real chance of recovery. The historical record shows trendbased investing has at best produced mediocre returns interspersed with disasters while value oriented buy and hold strategies routinely beat the market over the longer term.

Note that the current credit/real estate mess has already established the names and fortunes of contrarians who went decisively against the trend. William Ackman turned against the monolines when they were riding high. John Paulson shorted senior CDO tranches when everybody believed them save as houses. David Einhorn turned against the investment banks when they were widely believed invincible. All these guys only joined the trend when the trend suddenly joined them. If anything, by remaining vociferously bearish now that their bearisch bets have already paid off they are breaking with their established (contrarian) strategies and this may yet be their undoing (Ackman does seem to have mostly cashed out his monoline shorts, not sure where the others are). Interestingly, both Ackman and Einhorn seem to agree with Sivaram about battered US retailers, they certainly like Target a lot. Perhaps even more interestingly Einhorn has pretty big stakes in financials. Ahead of the trend again?).

While the above mentioned contrarian investors made a fortune quantitative and trendfollowing hedge funds imploded in droves.

I am convinced it will be the contrarian/value investors again who come out ahead when the current trends inevitably reverse. Calling the exact reversal point (top or bottom) is a fool's errant and I make no attempt to do so. By establishing reference points outside the current market price it is possible to pick a point that the price must go to at some point. For commodities in the longer term prices cannot much exceed the marginal cost of production. For stocks, book value and P/E are essential yardsticks to establish where the stock price is going. The rest is a matter of patience.

For now, I will stick with my contrarian approach. It has worked well in the past and I am confident it will work in future. You can use a trendfollowing/quantitative approach and we will see in five years what worked best.

As for the oil short, I am still not convinced of the use of doing it. I am certain the reversal will come, but not sure when this will happen. Speculative bubbles often persist exasparatingly long and put options always come with an expiration date. It would be deeply frustrating to see a position expire worthless only for the basic thesis to be proven correct a little later. Long positions in stocks don't have this problem, a major reason to prefer them.

I don't think I am obsessed with low probability homeruns. We do differ enormously on the probability of certain events. Basically, I am seeing very high probability homeruns where you see impossible/low probability odds. It could be a matter of timeframe, but I am not sure.

Are you expecting a total collapse of the world economy like the more extreme bearish pundits? That really is the only situation where the monoline postion would go bad in my opinion (but an oil short would be great!)

Last but not least, no investment style can ultimately distinguish between luck and skill. Given that the probablity of very long runs of unbroken luck seem very low, if somebody can beat the market over many years that suggests skill.

synchro
June 26, 2008 at 6:13 PM

I would NEVER do what Eihorn, Ackman, Paulson and these bunch did. They are NOT the right investment role model to follow. They are doing EXACTLY what you are doing. Ex post, they came out winners. But I wonder how many losers followed the same strategy and ended up closing up shop with a whimper and were never heard from again?

Differences in opinion is what makes markets. Good luck on your contrarian strategy. All I can say is I'll be joining you when the trend does change on oil, housing, Bill Miller, etc. -- But not before. By definition I'll be later than you on all these "brilliant" bottom and top calls. I am humble enough to know that I won't be able to call the top and bottom of these things.

Whipsaws are part of the game of trendfollowing, but there are ways to minimize it. I think you overstate the case in your first paragraph. In any case, you completely missed my point: my method is whatever method that can be tested objectively and replicated and judged in terms of its return, volatility, expectation, maximum drawdowns, etc. I simply do not trust myself to rationally evaluate a situation when I am sitting on a huge loss, such as when ABK went from $25 to 1.80.

June 26, 2008 at 8:34 PM

Good posts by both of you. Since my thinking is quite similar to ContrarianDutch, let me address Synchro:

First of all, I am not as confident as ContrarianDutch and am open to the possibility of being wrong. However, being wrong is not the end of the world. Depending on how you allocate your capital, even if one investment blows up, you can be fine if the others are ok. Although I am hoping this isn't the case for me or anyone else, one can actually take a 100% loss if the gain is, say, 200% on another (depends on how the portfolio is weighted).

That gain might seem unlikely to most investors but if you were looking at distressed investments, it is actually quite normal. For example, some beaten-down stock like Ambac can go up 5x very easily (in fact, it rose around 100% in something like 3 days after it initially collapsed many months ago.) I'm not saying one should expect these gains (most of the gains were temporary and no one would have timed the exact bottom) but it is within reach. I think it goes with this territory.

If some quantitative strategy works for someone, they should use it. But it doesn't work for me, and as Synchro has alluded to, it may not work in the long run.

If I may attempt to poke holes in Synchro's strategy, I think his big risk is being left out of the market. For instance, I actually think that we may face a sideways bear market. Is the quantitive benchmark ever going to give a buy signal? I guess it depends on what the definition of "trend" happens to be but I can really see such a system going nowhere in a flat market.

The other problem with quantitative systems (this isn't necessarily directed at Synchro's suggestions since I have no idea how that system works) is that things always change. Even somewhat reliable value metrics like P/E ratios change. I remember reading Kenneth Fisther in his book Wall Street Waltz saying that him and many other market participants thought the stock market had reached a peak in 1987 (this was before the crash). He said they ended up being completely wrong in the end. P/E ratios looked very high compared to historical norms but they kept expanding for another decade. Similar to such a scenario, backtesting a system, although recommended, may not mean much in the end.

synchro
June 26, 2008 at 10:15 PM

I find it somewhat amusing that it sounded almost like relief to you and contrariandutch that you finally have something from me to critique on...which is fair.

But i think the critique would be taken more seriously if it is more than just non sequitur sentences such as "The other problem with quantitative systems..... is that things always change."

or

"The simple (yet lethal) problem with any sort of trendfollowing (and quantitative) strategies is that it works fine until it doesn't."

I am not really sure how to continue the conversation with such briiliant observations.

If you don't want to spend the time examining the strategies I talked about, that is perfectly fine. Just say it. Nobody is forced to do anything.

The quant methods are not panecea, but it is a way for me to stay in the game psychologically. One thing the trend-following system will do is to make sure you won't miss out on the big trend. Whipsaw is a real posibility, that's why you increase your odds with multiple asset classes in a portfolio approach. One benefit of backtesting is to examine the details of the backtested trades and see if you can psychologically withstand the whipsaws. If you can't, ditch the system. But then, backtesting systems, looking at statistical significance...gosh...that just sounds...like..oh my gosh, SO MUCH HARD WORK.

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