The problem I have with this dogmatic definition of a bear market rally is the following: Assuming (and this isn’t a forecast, since I really haven’t the foggiest idea where stock markets will be in six or 12 months’ time) the S&P 500 moved up to 1350 and then declined to 500, as an investor should you care if the move to 1350 — a 100% gain! — was a bear market rally?

My impression is that investors’ fixation on the recent rally being a bear market rally has actually kept most investors on the sidelines and hoarding cash. Now, put yourself in the shoes of a fund manager who, in the last 18 months, has lost 50% of his clients’ money and missed the recent rally (34% for the S&P 500). What is he likely to do? I would think that he would be inclined to purchase equities as they correct the sharp advance since early March, especially as the economic news in the near term becomes less negative.

Based on our conversations with numerous managers in recent weeks, we believe that most quantitative managers’ portfolios were not positioned in expectation of a rally. Of the nearly 80 managers we have talked to, only one manager said they were up since March 9th and the clear majority admitted to being notably down or stopped out on their positions. These managers were both long-only and long-short quant managers using market neutral and non-market neutral strategies, sector neutral and non-sector neutral strategies, longer term and intermediate-term holding periods. It is fair to say that just about everyone is bewildered and trying to understand when this rally will end.

Another factor to consider is that there has been a significant improvement in the technical position of world stock markets. In the US the largest number of new 12-month lows was reached in October. At the November 21 low at 741 for the S&P 500, the number of new lows had already contracted, and even more so at the index’s March 6 low at 666. Also, market breadth and the number of stocks moving above their 200-day moving averages have taken a decisive turn for the better, indicating that the stock market advance is broadening and that the number of stocks that have bottomed out (at least in the intermediate turn) is expanding.

I have explained repeatedly in the past that if a government is really determined to try and postpone an inevitable collapse by “printing money” in order to lift or support asset prices, it can be done. However, the result of such a monetary policy is to lower the purchasing power of its paper currency, with catastrophic long-term consequences for its economic and financial volatility.

It forces individuals and institutions with cash to buy something…anything. So, this cash is channeled into gold and/or different paper currencies, commodities, equities, bonds, real estate, and consumer goods and services, but obviously with different intensities and at different times. For instance, at some times, such as in 2008, more money will be allocated to gold; while at other times, such as since early March, more money will flow into equities and industrial commodities. It is well understood that these money flows are driven largely by speculative activity (and more than a little dose of manipulation). The result in all asset markets is very high volatility and price fluctuations that don’t appear to make any sense to most market participants and observers who don’t understand the new rules of the investment game that were brought about by “money printing”.

This is where we are today, irrespective of whether or not you and I like policies of “quantitative easing, massive bailouts, and frightening fiscal deficits” and their long-term consequences! Another positive factor for stock markets is that a large number of Asian stock markets and individual stocks in the region had already bottomed out in October and November of 2008 and didn’t confirm the new low in the S&P in early March.

In Asia, the Taiwan and Shanghai indexes, and Korea’s Kospi Index, are all up by more than 50% from their late October 2008 lows. (The Shenzhen Index is up 90%.) But it is not only the Asian equity markets that have outperformed the US and Western European markets over the last few months; since late January 2009, the RTS Russian Index is up 66% and the MSCI Emerging Market ETF is up by 55% from its early November 2008 low.

This is not to say that the global economy is about to embark on a strong and sustainable growth phase. It also doesn’t mean that a new bull market in global equities à la 1982– 2000 has begun. But I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively. Therefore, in the case of resource and mining stocks, as well as Asian equities (and, for that matter, most emerging and other stock markets around the globe), the lows thatwere reached between October and March of this year are likely to hold — that is, for now.

The markets that have the highest probability of having made major longer-term lows are resource-related equities, emerging markets, and Japan. Conversely, the asset market that has the highest probability of having made a secular high (such as Japan in 1989, or the Nasdaq in March 2000) is the US long-term government bond market.

Despite a still-weakening economy and massive quantitative easing, long-term bond yields appear to be on the verge of breaking out on the upside. I have listed again below all the equity recommendations I have made since December 2008. Some of these equities have already moved up substantially (resource and mining companies, in particular) and, therefore, I would only buy most of these recommendations on a correction.

In addition, a number of BRIC and other (mostly emerging market) closed-end country funds and ETS were recommended, such as Brazil ETF (EWZ), the Templeton Russia Fund (TRF), the Greater China Fund (GCH), the Asia Pacific Fund (APB), Taiwan iShares (EWT), the Japanese ETF (EWJ), the Japan Smaller Capitalization Fund (JOF), the Morgan Stanley India Fund (IIF), the Turkish Fund (TKF), and the MSCI Emerging Market ETF (EEM).

In the US, late last year we recommended buying the iShares iBox Investment Grade Corporate Bond (LQD) and Nicholas Applegate Convertible & Income Fund (NCV), while earlier this year we recommended the accumulation of stocks of high-tech companies such as Cisco (CSCO), Intel (INTL), Oracle (ORCL), and Yahoo (YHOO). More recently, we recommended beaten-down insurance companies and financials as rebound candidates, including Leucadia National (LUK) and CNA Financial (CNA), Citigroup (C), the BKX, the Financial Bull 3x Shares (FAS), and the Financials Select Sector SPDR.

The market’s advance had been broadening and that more and more groups such as airlines (AMR), homebuilders (TOL, CTX, HOV), and cyclicals such as Dow Chemical (DOW), International Paper (IP), and Alcoa (AA) are showing signs of having bottomed out. Among commodities, I am particularly intrigued by natural gas. There are natural gas ETFs (UNG, GAZ), but costs are high. A better way is probably just to buy future contracts, or Pioneer Natural Resources (PXD) or the First Trust ISE Revere Natural Gas Index Fund (FCG).

Source: What to Buy…or Not Buy

Leucadia National (NYSE: LUK) has been around a long time. Since 1978, the company has compounded its equity at a 20 per cent annual clip. Every dollar invested in Leucadia in 1978 turned into over $900 today – a track record that lays waste to the return on the S&P 500 over that span, beating it 16-fold.

Leucadia buys assets that are out of favor and cheap, often in bankruptcy, and then it works to rehabilitate the company. Basically Leucadia is a vulture.

Lately, though, the results have no been so stellar. Ian Cumming and Joseph Steinberg, chairman and president, respectively, readily concede that their results over the past two years have not been good.

Their accounting for this in their annual letter is insightful. First, they recall a similar time in the late 1990s when there was a tremendous increase in asset prices. Leucadia sold many of its holdings at that time for huge gains – sales that, in retrospect, look brilliant.

Cumming and Steinberg note the competition from “35-year-old hedge fund managers – private equity firms who have never known a bear market – and other investors willing to invest at high prices in risky assets with seemingly cheap money.” They call them “unguided optimists.”

The Leucadians, too, cite their own reasons for optimism about the future. They note that of the dozen or so companies that still maintain AAA-investment grade ratings, four are under investigation for alleged financial mischief. In discussions with a bank chief, Cumming and Steinberg relate how the banker that “allowed that many deals will likely blow up.”

“While we thank the banking community for creating future inventory for future investments,” they write, “It is difficult to remain disciplined and on the sidelines in a game we love.”

Leucadia sits on a pile of cash: about $1.6 billion ready for future investment, as I write. As Cumming and Steinberg say, their investment philosophy is “bimodal”: either they invest in high-return opportunities or they sit on the sidelines. There are few better ways to play the turn in the credit cycle than to shack up with Leucadia and its excess cash.

Leucadia relies on a handful of investment principles that stitch together the apparently unrelated investments that make up its portfolio.

These principles are often repeated in their annual letters (I’ve read them all going back to 1998):

1. Don’t overpay.
2. Buy companies that make products and services that people need and want and that provide them as cheaply as possible with consistently high quality. Search out candidates in out-of-favor industries that have turnaround potential. Our record as midwives to resuscitating disorganized, unprofitable, bedridden, and moribund companies is pretty good.
3. Earnings sheltered by net operating loss carryforwards are more valuable than earnings that are taxed by the IRS.
4. Pay employees for performance and expect hard works and honesty in return.
5. Don’t overpay.

This is a neat collection of simple but effective principles. Leucadia’s disparate collection of businesses makes a lot of sense in the context of this investment philosophy.

A Throwback to the Way Business Used to Be

I also like the fact that Cumming and Steinberg own 25 percent of Leucadia between them. Compensation is modest, only $650,000 in salaries each last year- a drop from $1.8 million each in 2003. You hardly ever see that.

There was a time when it would have stuck the investing public as absurd that a man would run a company without owning a big stake in the enterprise. This is a point made in Frederick Lewis Allen’s The Big Change, a highly readable and entertaining look at sociological changes in American life, published in 1952. Allen discusses the radical change in corporate ownership:

In 1900, capitalism was capitalism indeed. Businesses were run by their owners, the people who had put or had acquired the capital with which to finance them… It would seem wildly irrational that a man should manage the destinies of a corporation while owning only a minute fraction of its stock, as so frequently happens today.

Leucadia is also a bit of a throwback in this respect, in that management owns a good chunk of the enterprise. This should align their interests more with yours as a shareholder.

An investment in Leucadia is also a bet on the investment acumen of Cumming and Steinberg. Bearish commentators worry about succession plans, as Cumming and Steinberg are both in their late sixties, in much the same way people worry about replacements for Buffett and Munger. Fortunately, money management is a game that can be played late in life. Marty Whitman is still chugging along past his eighties, and Sir John Templeton is in his nineties. I think worries about succession are a bit premature in the case of Cumming and Steinberg.

Anyway, I love Leucadia as a long-term keeper stock, as long as Cumming and Steinberg are calling the shots. It’s also a great way for the everyday investor to play the vulture market.

Otherwise, while I like the idea behind vulture investing, it’s beyond the pale of most investors. I’ve added it on here only because so few investors seem aware of the money to be made in this area. Plus, you can keep your eyes out for companies coming out of bankruptcy and give them a good look. While you won’t make the killer gains the vultures made in the bankruptcy process, you can still make massive gains, since most investors will likely shun a fresh bankruptcy graduate – giving you an opportunity to get the jump on the rest of the field.

[Joel’s Note: Don’t know of any beleaguered financial institutions that might be filing chapter 11 anytime soon, do you? For fine-tuned vulture investors like Cumming and Steinberg, the pickings ought to be plentiful up and down Wall Street over the next few months.

Chris is an expert at sourcing out these kind of opportunities; ways you can hook onto what the best investors of the era are doing, grabbing a piece of the action for yourself along the way. Today’s insight is an excerpt from Chris’ new book, which is positively packed with ideas just like this. You’ll get through it a lazy weekend, but it will find a nice slot on your shelf as a reference book in the future. If you’d like to pick yourself up a copy, click here: Invest Like a Dealmaker: Secrets From a Former Banking Insider

—- Investing in the Era of “Peak Everything” —-

Oil hit a new record high… Gas could soon be $4 a gallon… silver, wheat, corn, you name it — all the “resources” of daily life are soaring in price!

Yet there’s a way to protect yourself and profit in the days ahead…

Join Us in Vancouver in July for an Exclusive Look at…

A View From the Peak: Seeking Profits in a Time of Risk and Scarcity

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[Joel’s Note: Not wanting to leave the head honcho of the central planners out of it, we hunted around quickly for a quote befitting of Mr. Bernanke himself. Thanks to the great Douglas Adams for this one.

“If it looks like a duck, and quacks like a duck, we have at least to consider the possibility that we have a small aquatic bird of the family anatidae on our hands.”

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening