London , England

We got back from South America on Friday… ready for a rest. So, we spent the weekend reading… and occasionally, thinking.

What we’ve been thinking is that the dollar is dead meat in the long run. But in the short run, it might have enough life in it to bite investors on the derrière.

The US stock market rose 73 points on Friday, to bring the Dow just 30 points south of the 10,300 mark. Why is this level important? It’s not really. But it reminds us that this is still just in “bounce range.” Big drops in stock prices are followed by bounces – always. A bounce of 50% of what was lost is not unusual. That’s what happened after the Crash of ’29, for example. So, there’s nothing exceptional about what we’re seeing on Wall Street.

But here at the Daily Reckoning we’re not smart enough or fast enough to play the countertrends. We want investment positions that we can ignore for years… We want to be able to go on a long trip… say, down the Inca Road or over the Hindu Kush. And when we come back, we want to find that we have at least as much money as when we left.

If stock market buyers – in the US – have more money a year from now than they have now, we’ll be surprised. The private sector is still more than 2/3rds of the economy. And the private sector has begun de-leveraging. Nothing that has happened in the last 8 months makes us think that that trend is going to reverse any time soon. There are 70 million baby boomers who need money for retirement. They’ve got to save. That means cutting back on spending. And that means less income for business. Are stock prices really going to go up when business income is going down? No.

We leave our “Crash Alert” flag flying, here at the worldwide headquarters. We don’t know when… or IF… stock prices will crash. But the downside risk is not worth the possible upside. Daily Reckoning readers should be out of all US stocks, except those they wouldn’t mind holding through a 50% correction.

The other thing we mistrust – aside from politicians, stock promoters and tap water – is the dollar. But here the story is more complicated. Because the next downswing in stocks could push the dollar up! Everyone is betting against the dollar. And most think it is a one-way gamble. But it’s not like Mr. Market to grant investors a one-way bet. He’s got something up his sleeve.

Last week, the Financial Times reported that a group of IMF economists had made a “Plea to reduce demand for dollar reserves.”

That is another way of saying: find something else to put in your vaults rather than dollars!

To read the complete article at The Daily Reckoning, click here.

And with good reason. The United States has a bigger and more-troubled financial sector than most countries. It also has a bigger overhang from the housing bubble, has a bigger balance-of-payments deficit and has a budget deficit that’s fat enough to stall the recovery.

It would be nice to have an economic recovery to invest in that didn’t have all of these problems.

Truth be told, such an investment play does exist. What’s more, the market I have in mind is advanced enough for us to invest in it without having to go through all the rigmarole of American Depository Receipt (ADR) investing. Nor will you have to make a potentially risky foray out onto some foreign stock exchange to buy the shares, because they are almost all listed here.

The country I’m talking about is Canada. Think of it as being like home – but without the problems that our home market (the United States) currently suffers from.

Our Healthy Neighbor to the North

When the recession struck, Canada was hit by it quite badly, but for different reasons from its southern neighbor. The Canadian housing market was nowhere near as overheated as its U.S. counterpart. So Canada’s housing downturn wasn’t as deep.

And what about the banking systems? To be sure, Canadian banks received a bailout, but it was less than $20 billion in total. Compare that to the veritable alphabet soup of U.S. bailout programs ranging from “TARP” and “TALF” that have injected more than $2 trillion into the U.S. financial system.

On the other hand, natural resources prices crashed last autumn, which had a major effect on Canada’s resource-based economy. A number of large projects in the Athabasca Tar Sands region were cancelled, for example – since this region has oil reserves around the size of the entire Middle East, its development is crucial to Canada’s future.

The “loonie,” Canada’s currency, declined from around “parity” to the U.S. dollar to an exchange ratio of C$1.30=$1 U.S. In effect, this was a “flight to safety” into the dollar and U.S. Treasuries. And it affected Canada as it did other countries.

In 2009, however, Canada and the United States have traveled down totally different paths. Canada did very little “stimulus,” so its state budget is in much better shape. The deficit for the 2009-2010 fiscal year $53 billion (C$56 billion) is only about 4% of gross domestic product (GDP). For the 2010-2011 fiscal year, the deficit is expected to be about $42 billion (C$45 billion), or 3.2% of GDP.

Energy Powers the Rally

The bounce in natural resources prices has really helped power up the rebound of Canada’s market.

Investment in the tar-sands region has picked up again, with a big merger between the two largest tar-sands-extraction companies: Suncor Energy Inc. (NYSE: SU) and Petro-Canada. The rising gold price hasn’t hurt either – mines are appearing all over the place! All this new activity has made the loonie bounce, so it’s back to about C$1.07=$1. While interest rates are as low as the United States, the Bank of Canada hasn’t done much “quantitative easing,” meaning that inflation isn’t too much of a worry.

The strong loonie helps here, too.

Canada seems to be recovering nicely. Its index of leading indicators jumped 1.1% in August, while manufacturing sales grew 5.5% in July. The country presently runs a modest current account deficit, but it’s only 2% of GDP. That’s much lower than even the current U.S. deficit, let alone that of 2007. It had a little more public debt than the United States in 2008, but given current U.S. deficits, those two lines almost certainly have crossed by now.

There are two caveats. The first is an obvious one: If commodity prices crash to earth, Canada will have some difficulty because commodities are a large part of its economy. Personally, I don’t see that happening. It’s notable that PetroChina Co. Ltd. (NYSE ADR: PTR) has just invested $1.7 billion in a Canadian tar sands project, so China must not think so, either.

The other risk is political. The current minority Conservative government of Stephen Harper has done a good job, but the opposition Liberals have withdrawn their parliamentary support. That means there may be an election this autumn. A Liberal majority government would be no disaster. They might be a bit sticky about oil-drilling permits, but would not otherwise rock the boat.

However, a Liberal coalition with the leftist New Democrats could push public spending and the deficit up, and there’s no guarantee against that. (One of the problems with multi-party systems like Canada’s is there is an almost infinite variety of possible governments after each election, some of which can be fairly alarming from a business perspective.)

However, Canadian elections are a much smaller risk than you get in most countries, and the commodity/oil price crash, if it happened, would help the U.S. economy and, presumably, your U.S. portfolio. So it’s worth having some Canadian exposure, perhaps with the Canadian market exchange traded fund (ETF) iShare MSCI Canada Index (NYSE: EWC).

For years it was almost fashionable to dismiss Canada from an economic standpoint. Now, however, that may well be where the smart money would like to go. As an economy, Canada is competent and stable.

It’s the kind of country that looks to be a good place for some of our money.

Mr. Market can do what he wants, of course. We’re just trying to read his mind. If we were Mr. Market, what would we do? We’d give investors a fright!

Two things make us think the bear market is not over.

First, there is market history. Bear markets do not end with stocks still trading at nearly 20 times earnings and the dividend yield barely at 3%. And they don’t end when people are hoping, praying and expecting them to end. They end in despair…after people have given up hope. They end with dividend yields over 5% and prices at only 5 to 8 times earnings.

What’s more, stock market trends tend to follow long cycles. The last bear market bottom was in ’82. It came after 14 years of disillusionment and disappointment. By the time stocks were ready to go up investors were sick of hearing about them. And then, you could buy some of the best companies in America for only 5 times earnings…and get paid to hold them, with dividend yields over 5%.

By our calculation, the bear market in stocks began in January of 2000. Since then, stocks went up in nominal terms. But adjusted for inflation, investors made nothing. Still, they didn’t seem to notice…and remained enthusiastic about stocks. Then, in 2007, a new down-cycle began…continuing until March of 2009, when the Dow hit a bottom at around 6,950. But was it THE bottom…or just a temporary bottom?

Most likely, it was a temporary bottom…a ledge from which investors could leap…before falling further down.

We say that because stocks never went low enough to qualify for a genuine bottom…and investors never showed the kind of disgust that you usually get at real bottoms.

We say that, too, for a second reason – the economy. In order to have a booming stock market, you need a booming economy. Earnings need to go up. That justifies higher prices. It also contributes to the positive mood among investors that persuades them that things are getting better and better…and that stocks deserve not only higher prices corresponding with their higher earnings, but also higher P/E multiples. That was the kind of mood that sent the Dow up from under 1,000 in August 1982 to over 14,000 twenty-nine years later.

But now the tide as turned. It rushes out between our toes and takes with it our fondest hopes. After expanding during our entire lifetimes, credit is now contracting. And that means more savings…but fewer sales, fewer jobs, and fewer profits. Can working people reasonably expect to earn more money next year? Five years from now? No. Can businesses expect rising sales and profits? No. Will the feds balance the budget, cut taxes, or increase benefits in the years ahead. No. No. No.

The outlook is not rosy. It’s grim. As we reported yesterday, household discretionary spending is at a low it hasn’t seen in 50 years. A half-century of economic progress wiped out! Real unemployment is closer to 16% than to the official 9% – and it’s rising.

Yesterday came a report from August: companies had cut more jobs than expected.

And even economists who are silly enough to believe the stimulus is working still say unemployment will likely remain stubbornly high for years to come.

So let’s add this up. Fewer people with jobs. Those who have jobs are paying off debt. Less consumer spending (back-to-school spending was disappointing, say the press reports). So, lower business earnings.

What would make stocks go up under those circumstances?

We also get word that insiders are selling stock heavily…and that consumer bankruptcies are up 24% over a year ago.

New economic boom? Not likely. New boom in the stock market? Not likely either.

But stocks don’t stand still. If they can’t go up…they will go down.

What will cause a break in the stock market? Who knows? Here’s a possibility: The Chinese stock market could crack. Maybe it already has. China is the great hope of the world economy. When it becomes clear that China is a bubble economy…and not a genuine growth economy…Western investors are likely to lose heart. Then…watch out!

We like the Bedford Springs Hotel. It is a 19th century resort…with class. It was in ruins in the ’80s, then bought by investors…who spent $120 million restoring it. They went broke 18 months later.

Not hard to see why. When we were there the place was almost empty. Still, it had a full staff…and beautiful appointments.

“Hey…this is pretty nice,” we said to the desk clerk. “No one is here.”

“They come on the weekends. We have a full house this weekend…and a full house in October, when the fall foliage is at its peak.”

“Oh…well…it looks kind of quiet now…”

“Yeah, it is quiet most of the time.”

“It is such a nice place, I think I might want to live here. I know you’ll take care of me. I could live quite well here.”

“Maybe you could give me a good price…and I’ll move in.”

“You need to talk to the management…”

On the wall of the Bedford Springs hotel is a short note telling us that George Washington stayed there when he put down the Whiskey Rebellion of the 1790s.

In fact, Bedford was his Western headquarters. But the real action was farther to the West. Bedford was more like a staging area, as near as we can figure.

The Whiskey Rebellion is a worthy subject for recollection, though a sordid chapter in American history. Accounts of it vary, depending on which history book you read. It is usually seen as a test of the new country…a test which Washington and Alexander Hamilton met with vigor and resolve. But by our reading of the history, the new republic failed on every count.

After the war against England, the federal government was in debt. It needed money. Hamilton saw an opportunity to raise money by taxing the small distillers out on the frontier. They were too far from Philadelphia to cause trouble. He figured they would resist. But this would give him an opportunity to march out at the head of an army, assert the power of the central government over the riff raff, and gain for himself a marshal victory that might elevate his stature closer to that of his boss, George Washington.

Washington himself may have had mixed feelings. He certainly had mixed interests. The tax was set up so to force small distillers to pay 50% more tax than large distillers. Washington was one of the largest whiskey makers in the country. He might be happy to see the small fry pushed out of business. On the other hand, he had spent much of his life out on the frontier. He knew how tough the frontiersmen could be; he probably wasn’t eager to tangle with them.

But the tax was proclaimed throughout the land, and the whiskey distillers took offense. After the war against Britain they had gotten the idea that they lived in a free country. Certainly, out on the banks of the Monongahela there was little to make them think otherwise. They were used to doing what they wanted, free from any sort of authority. So the sight of tax collectors trying to take their money (of which they had little…it was still a subsistence/barter economy out in the woods) probably set them off. At least one of the federales was attacked by a mob of them; his hair was shorn and he was tarred and feathered.

Then, Hamilton called up the New Jersey and Maryland militia…and set out for the West. He forgot, however, to provide sufficient victuals for his men…and soon the soldiers were cold and hungry. Naturally, they did what soldiers do under the circumstances; the robbed the locals. Thus did Hamilton’s army continue its march – in disorder, disgrace and larceny…stealing provisions from the people it was meant to protect from the scofflaw distillers.

Once on the field of battle, the whiskey men were ready for a fight. But cool heads prevailed. After a pow-wow, the feds arrested a handful of men…of whom two – a “simpleton” and an “insane” person, according to Washington – were charged with treason. Washington pardoned them, seeing no profit in hanging mental defectives. The rest paid a fine and were let off. One man died in jail. The rest went on their way.

Thus was the rebellion brought to a close. The distillers moved their stills out to Kentucky and Tennessee, where the feds couldn’t get at them. And the feds went back to doing what they always do – making a mess of things.

Until tomorrow,

Bill Bonner

Source: The Bear Market is Not Over

You want to know the really funny thing? Traders and investors don’t care! All they care about is that Washington has Wall Street’s back. And that the Fed and the Treasury can keep on producing dollar bills like Willy Wonka produced Everlasting Gobstoppers.

In our eyes it’s no different to Bernie Madoff’s little scam. Big Wall Street players shoved money into Bernie’s Ponzi scheme knowing that the profits were ginned up somehow. But they didn’t care. They knew it didn’t really matter how Madoff was producing his profits; it just mattered that he was producing them. They knew that some poor schmuck down the road would get clobbered.

And that’s how it’ll be with this rally. When it seems like stocks are going up and will never come down… and the networks, giddy with excitement, can do nothing but praise God for the coming V-shaped recovery… and when every last mom and pop investor is sucked in… it will all come crashing down.

It may not be quite as spectacular as the end of the 48% 1930 bear market rally… But it will be ugly…

Of course, there are always pundits willing to give sensible reasons why stocks are defying gravity. Right now, there are three eminently sensible reasons being splashed around the mainstream press (hat tip, David Rosenberg):

Eminently sensible reason #1: Bernanke reappointedWe really fail to see how it could possibly be that the same central bank official, who, over a span of a decade, presided over two massive bubbles and their busts, can be viewed as being a positive force for the markets. Perhaps there is some solace in knowing that the same person who created this awesome and complex $2 trillion Fed balance sheet will be around to dismantle the largesse since he’s probably the only one that knows how.

Eminently sensible reason #2: The first monthly increase in the Case-Shiller home price index

As for the second point, there is a difference between a trendline and the noise around that trendline. Home prices are down a massive 31% from their peak and have been in a vertical-down pattern for nearly three years. Perhaps a respite is in order, but with the true underlying unsold inventory near 12 months’ supply, which is double what would typify a balanced housing market, it would seem like wishful thinking that we have suddenly achieved a fundamental low in residential real estate values (especially at the high end).

Eminently sensible reason #3: The seven-point jump in consumer confidence in August

With regard to point number three, we welcome any rise in consumer confidence but an honest appraisal of the data would show that 54.1 is still a very depressed level. In fact, the average index level during recessions is 73.0 – August’s reading was nearly 20 points below that. So, if the recession is indeed over and done, somebody forgot to tell this 70% chunk of GDP otherwise known as the consumer.

Consumer confidence, of course.

We recently vowed to stop calling our national brethren “consumers” in favor of less degrading words — like Americans, citizens or just plain-old people. Thus, we report the Conference Board printed a surprisingly optimistic gauge of American consumption attitudes (doesn’t that sound better?) yesterday. After two months of decline, the index kicked back up to 54.1, just shy of a 2009 high.

Coupled with the latest printing of the home price index, that was enough to keep this mega-bounce alive and kicking. The news shot the S&P 500 to a 1% gain within moments of yesterday’s opening bell, which eventually faded into a 0.25% advance. The index is up almost 4% in the last five trading days. The Dow hasn’t fallen for six days in a row.

We accept that improving consumption attitudes could bump stocks higher, especially retail. But we wonder… do consumption attitudes lead markets, or the other way around?

Seems like Joe Six-pack is routinely late to the party, no? We blew the post Lehman crash, stayed gloomy during the best of the stock rebound, got bullish in June when stocks went nowhere and lost confidence last month when the market shot up again.

So what does a big improvement in consumption attitudes tell us now? If anything, that the stock rally is about to cool off.

“Retail is a terrible business to be in during a recession,” says Dan Denning, belaboring an obvious idea that seems lost on the world right now. “Don’t forget the primary economic and social trend right now: People are reducing their debts. They are cutting back, becoming more frugal and learning to live within their means.

“Of course, we think this is happening. But it could be totally wrong. Maybe the credit cards are finding their second wind and consumers are gearing up for one last credit bender. But our suspicion is that you are in the middle of a generational/cyclical shift in the attitudes toward debt and that this is generally bad news for retail stocks.”

Source: Can Consumers Lead the Market?

“No rally can be sustained with yields and P/Es so poorly valued,” says underground investor Chris Weber, writing for DailyWealth. Chris is a very special kind of investor. When he was 16 years old, he turned just $650 (saved from his paper route) into $1.8 million through a series of remarkably insightful investments. So naturally we’re all ears when Chris gives his opinion on the direction of the market.

Chris is bearish on US stocks. (He’s mainly in cash and precious metals.) Why? Because there’s no value in the US stock market.

As of the end of July, the dividend yield on the S&P 500 has fallen to only 2.13%. When the rally began in March, the yield was over 3.5%. That is a huge fall in a short time.

Then, as stock prices have soared, earnings of companies have just not kept pace. In many cases, they are down sharply. This imbalance in price to earnings is shown in the weird spike in the P/E ratio on the S&P 500. It is now up to 127 times annual earnings, up from less than 20 times earnings at the rally’s start in March.

In other words, the dividend yield and the P/Es were not what you see at real bottoms. In really low markets, investors are shaken so much that years are required for them to regain bullishness.

Instead, I think what we’ve been seeing are the types of violent rallies within bear markets we saw throughout both the 1930s and the 60s-early 70s.

So once again, I’m just watching the stock markets. My position is that if the Dow Industrials and Transports can both better their previous record highs that they reached back in the second half of 2007, then I’ll be interested and ready to say that we are really off to the races again.

What I think is more likely is a repeat of the period of 1966 to 1975, where we’ll see a series of rallies within a bear market. In other words, this will be an easy time to lose money, and a hard time to make it.

Porter Stansberry has another take on stocks. He reckons we’re in the early stages of a “massive inflation.” Porter’s argument is simple. As long as the government keeps printing up trillions of dollars a year and holding short-term rates at nearly 0%, financial stocks are going to rise… And as long as financial stocks rise, the rest of market will follow.

Financial stocks are on a roll, as you can plainly see from the nearby chart of the financial sector ETF (XLF). Now, ask yourself a very simple question: Are investors buying financials because of their strong balance sheets and smart management or are they buying because they know that the government intends to keep pumping money into these boated behemoths?

Say what you like, US stocks are rising. All we know is we don’t like it one little bit. And we wouldn’t touch stocks knowing what we do about the market. As Chris Weber says, “This will be an easy time to lose money, and a hard time to make it.” Amen to that.

So today we turn away from the markets and focus on something more important: basic investment principles. As Alexander Green, investment director of The Oxford Club, puts it over at InvestmentU.com, “It’s not uncommon to run into investors who are knee deep in option trading, currencies, short selling, or sophisticated arbitrage strategies without mastering – or even understanding – basic investment principles.”

Here’s what Alex believes are the six factors that determine the value of your portfolio’s. Only one of these six factors is beyond your control: your assets’ annual compounded return. That means it only makes sense to focus on the other five.

1. The amount of money you save. To put it bluntly you have to start by maximizing your income, minimizing your outgoing and paying yourself first. Why? Because expenses always rise to meet the income available. As soon as you get a raise or a higher paying job, you’ll find that you need a new car, a bigger house, better furniture and a new set of Callaway irons. But you have to draw the line somewhere. You can’t save a pittance and expect your portfolio to perform miracles each year.

2. The length of time your money compounds. The sooner you start investing the better. And the longer you leave it alone the better. If you start too late – or raid your portfolio to redo the kitchen or take the kids to Disney – you’re going to have a lot of catching up to do down the road. The old chestnut is true: Don’t touch your capital. It’s like eating your seed corn.

3. Your asset allocation. Studies consistently show that how you divide your portfolio among non-correlated assets – stocks, bonds, real estate investment trusts, precious metals, etc. – determines 90% of your portfolio’s long-term return. (The rest is due to security selection.) If you’re too conservative – or too aggressive to stick with your program – you simply won’t meet your goals.

4. Your assets’ annual return. This, of course, is the great unknown. Not even Warren Buffett or Ben Bernanke can say what their portfolio will return each year. But the better your security selection and asset allocation decisions, the higher your annual compounded returns.

5. What you pay in expenses. Don’t be oblivious to what all those financial intermediaries are charging you. You can sacrifice far too much in commissions, bid/ask spreads, wrap fees, management expenses and other costs. All things being equal, the lower your expenses the higher your net returns.

6. How much you pay in taxes. Too many investors are oblivious to the tax ramifications of their investment moves. When possible, put your high-yielding investments in your tax-deferred accounts and your tax-efficient funds and individual stocks in your non-retirement accounts. (I call this your asset location strategy.) Hold positions 12 months or more to qualify for the lower long-term capital gains tax rate. Offset your capital gains with capital losses if possible.

You see what most investors don’t understand (and probably never will) is that market timing and stock picking make up only a small part of serious wealth building. It’s a secret the “ultra wealthy” have known for a long time. And they spend a lot of time and money making sure these six factors are right (and others, too, that would be too complicated to explain here). It’s how they hold onto their wealth for generations.

It’s actually what we’ve been working on while here in France. Along with my dad and your Notes co-editor, Chris Hunter, we’ve been researching these wealth preservation secrets. And we’ve discovered that wealthy families nearly always have something called a “family office.”

Most of these require massive amounts of cash to join. (One group in London my dad went to talk to was looking for a $200 million minimum!) So that’s why we decided to set up Bonner & Partners Family Office. It puts all of the money management secrets of the ultra wealthy to work… without the massive price tag.

Partners will enjoy the following benefits:

Access to what my family is doing with its money. Over the years we’ve spent literally hundreds of thousands of dollars on high-level wealth management advice. It’s been distilled into our family portfolio, which partners will have full access to.

Twice-daily market advice from full-time money manager Simon Mellon. The family has spent a lot of money, and considerable time, finding the right investment director for the family office. Simon has a resume as long as your arm. And his insight into the market is the kind that comes only with years in the trenches in New York and London.

Full-time tax planning advice from Raife Nueman. Raife went to university with your editor at St John’s College. And he’s one of the brightest attorneys we ever come across. (He has been elbow deep in the US tax code over the past two months, and he’s identified a way to drastically reduce your tax spend – to as much as 0% in some cases.)

Access to all of Agora trading advice and investment research. Family office partners will have full access to the entire daily output of Agora, the family publishing company. This amounts to 34 trading and investment research services. (A total of over $97,000 worth of subscription services a year.)

We will be sending out an invitation to join us as a family office partner this week. As a Notes reader, you can join the invitation list early by sending an email to info@contrarianprofits.com. Just make sure to put “Family Office” in the subject line so our staff will be able to quickly add you to the list before the invitation goes out…

In fact, the evidence is that most investors have the attention span and patience of a field mouse. Here’s the average holding period for a stock on the New York Stock Exchange:

What jumps out at you right away is that the average holding period is less than a year. That means that, on average, an “investor” typically holds an NYSE stock for a matter of months. This is not investing, which is why I put the term in quotes. I don’t know what it is. Mindless gambling comes to mind.

It’s no surprise that the last time we were down here was in the Roaring Twenties. We all know what that was the opening act for.

This chart also speaks to a larger problem in the markets today — there are too few owners and too many renters. Just as in real estate, owners generally take better care of a property than renters. Why should it be different with companies?

Source: Stop Trading

At least the Europeans are owning up to the fact; in the U.S. investors are still pretending that the emperor’s new clothes are real. The pan-European Dow Jones Stoxx 600 index is down 1.2%, down the second day in four.

Shanghai stocks have also taken a bath. They’ve suffered their worst fall since November. This time, the worry is that the Chinese government will tighten its loosey-goosey monetary policy. According to MarketWatch, “The Shanghai Composite Index dropped 5.8% to 2,830.63, closing below the 3,000-point level for the first time since the end of June.”

Japanese shares are also down, despite recent data showing that the Japanese economy expanded during the second quarter. Japan’s Nikkei 225 Average fell 2.2% in today’s trading in Tokyo, after ending at its highest level since October on Friday.

Is this tidal wave of losses and bad news going to hit US shores? It wouldn’t surprise us in the least, dear reader. We’ve been calling the end of this sucker’s rally for months now – sooner or later we’ve got to be right! Our bet is it won’t survive September.

As we pointed out in last Tuesday’s Notes, options traders are now betting that the VIX – the widely watched volatility index – will spike 13% over the next five weeks – the biggest spread since August 2008… just before the S&P 500 saw its worst two-month plunge in 21 years.

But it’s just a hunch… Anything could happen in the Twilight Zone economy. Every time we look at the US stock market shooting higher we’re reminded of horror-movie zombies clambering out of their graves and shuffling around in search of human flesh.

We think the analogy is apt. According to the tenets of voodoo, where the zombie myth originated, a “bokor” (an African or Haitian sorcerer) can revive people from death and take control of them.

In the case of the US stock market, the bokor is none other than Ben Bernanke; the magic reviving ingredient, of course, is the excess liquidity he’s pumping into the economy.

As we pointed out on Wednesday, a study by Deutsche Bank economist Sebastian Becker shows that excess liquidity – measured as a rising stock of money to GDP – is now being created in the US, British, Japanese, Canadian and euro zone economies faster than in the late 1990s stock-market bubble and the subsequent housing boom.

The more we think about the zombie analogy, the more we like it. We recall the work of Harvard ethnobotanist Wade Davis, author of The Serpent and the Rainbow.

It’s a spooky tale, but in 1982 Davis traveled to Haiti on the trail of real-life zombies. He made the controversial claim that Haitian bokors turned living people into zombies by administering two special powders into the bloodstream. This from Wikipedia:

The first, coup de poudre (French: ‘powder strike’), includes tetrodotoxin (TTX), the poison found in the pufferfish. The second powder is composed of dissociatives such as datura. Together, these powders were said to induce a death-like state in which the victim’s will would be entirely subject to that of the bokor.

In our view, Mr Market is in a “death-like state” right now. All that excess liquidity is fuzzing up his brain, and he can’t help but shuffle along thanks to the twin “coup de poudres” of monetary and fiscal stimulus.

How else do you explain investors’ brain dead belief that we’re back in a secular bull market? As Gluskin Sheff’s David Rosenberg pointed out last week:

With every 1 in 8 Americans with a mortgage either in arrears or in the foreclosure process; 1 in 4 homeowners “upside down” on their mortgage; 1 in 6 either unemployed or underemployed; and 1 in every 7 housing unit in the United States sitting vacant right now, it will be interesting to see exactly what sort of recovery we end up with.

In among the “green shoots” there’s still plenty of really ugly data emerging. US foreclosure data for July has hit a record of 360,149. That’s up 7% month-on-month and up a truly shocking 32% year-on-year.

US July retail sales news was almost as bad. Last month’s sales were expected to rise by 0.8% month-on-month. Instead, they came in at -0.1%. The problem is July was supposed to be a positive month because of the feds’ “cash for clunkers” program.

Then you’ve got corporate revenues. Pick up a newspaper and you’d be forgiven for thinking that corporate revenues are up. But the reality is that earnings are beating estimates thanks to cost-cutting, not top-line revenue growth.

The truth is corporate revenues were down -10% in the second quarter. When the market started its recovery in 2003, revenues are up 13% in the first quarter. And they continued to rise into the bull run that followed.

Still, 27 out of 47 economists surveyed recently by the Wall Street Journal say the recession has ended. Problem is they’re probably the same 27 economists who thought the US economy wasn’t in trouble following the August 2007 subprime collapse!

Here’s what the mainstream either doesn’t know or doesn’t want to let on it knows. On average unemployment rises for five years following a financial crisis. That means another 2.5 years of rising jobless rates and contracting consumer spending.

But that’s not what really scares us, dear reader. Downturns are to be expected; the economy is cyclical after all. What scares us is the black magic being used by the feds to ‘fix’ things – the economic voodoo of the government’s printing presses. This from underground investor Porter Stansberry in today’s DailyWealth:

There is no way for an economy to outrun a printing press. The Fed has the power to create an unlimited amount of money or credit and the power to inject that money into the economy in any way it sees fit.

Let’s look at the numbers. Let’s assume the total collateral damage of the banking crisis turns out to be $5 trillion. Yes, that’s a huge hit – roughly half the output of our economy each year. It’s the equivalent of sending every American household a bill for $50,000 – due immediately. However, in less than a year, the Feds have already created nearly $4 trillion in new money and credit. The hole in the system has already been plugged. It only took a few months.

The fight between inflation and deflation is over. Deflation was knocked out in the first round.

The big risk is what happens next. Having turned on the presses to save the day, who will have the political clout and the desire to shut them off? Barack Obama’s budget calls for annual deficits in excess of $1 trillion for the next eight years. Thus, by the end of this year, not only will all of the damage from the mortgage collapse ($5 trillion) be replaced by new money and credit, there will be significant inflationary pressures in the economy.

The good news in our economy this year, so soon after such a major collapse, means we will certainly have a massive inflation during 2010 and 2011. There’s no such thing as a free ride. Bailing out the banks will carry a heavy price for anyone who doesn’t have the resources or the knowledge to escape the dollar.

What should investors do to protect themselves? That’s the easy part. According to Porter the best way to survive and prosper in the coming inflation is to own plenty of gold bullion and “assets that will run higher in an inflationary environment, like transportation and energy assets.” Porter also recommends owning some good farmland.

Here at Notes, we think it’s a lot more practical, however, to own a good quality agriculture fund. We like PowerShares DB Agriculture Fund (NYSE: DBA).

However, the stock has underperformed since the market began its rebound on March 10. And since the end of March, Pepsi’s shares have lagged those of arch rival, The Coca-Cola Co. (NYSE: KO), since the end of March, as well.  I recommended Coca Cola last week after the company reported stellar growth in the emerging markets.

While Pepsi’s less-than-stellar performance is not yet a major concern, the trend is discomforting.  In addition, there has been a major divergence in the strategies of these two companies.

While both Coke and Pepsi divested of their bottling operations many years ago, Pepsi just agreed to buy back two of them: Pepsi Bottling Group Inc. (NYSE: PBG) and PepsiAmericas Inc. (NYSE: PAS). And it paid a stiff premium in each deal, about 24% and 23%, respectively, above their pre-deal market prices. The total value of the deal was a cool $7.8 billion.

Now allow me to say that these companies are impressive operations by themselves:

• Pepsi Bottling Group is PepsiCo’s largest bottler. The company takes in $14 billion a year and operates in the United States, Canada, Greece, Mexico, Russia, Spain and Turkey, and boasts 67,000 employees.

• Pepsi Americas is PepsiCo’s second-largest bottler. It brings in $4.9 billion annually from operations in the United States, Ukraine, Poland, Romania, Hungary, the Czech Republic and Slovakia.  In addition, its new joint venture covers the Caribbean and Central America.

So why bother with these acquisitions?

The justification for this move is that “in a rapidly changing, more-complicated global market, a leaner, more agile business model is pretty important,” said Pepsi Bottling Group Chief Executive Officer Eric J. Foss.

Pepsi touted the tie-up itself, citing such advantages as attempting to create a more-flexible, efficient and competitive system that is more inclusive of other Pepsi brands.

The idea is that a merged operation will allow for much faster introduction of new products, for bundled offers, for enhanced customer service, and for cost savings from redundancies and economies of scale.

Sure, we can buy into many of those ideas, which are sure to result in some gains.  In fact, we can even envision the many new marketing initiatives that will result from these acquisitions.

But make no mistake: What has pushed Pepsi to go in this direction is the superiority of Coca Cola in the emerging markets.  While both firms prided themselves on product innovation and marketing, Coca-Cola has come out on top, as I wrote last week.

In addition, the capital requirements of a bottling and distribution operation are very high and the return on equity is much lower than Coca-Cola’s core business of creating the product, marketing it, and selling the concentrate and bottling rights to bottlers.  This decision will make less cash available in the immediate future for stock buybacks and dividend increases and represents a big gamble.

There are two pressing questions to have in mind:

• Will the marketing synergies PepsiCo claims it will garner from the deals be successful in winning market share away from its rival and thus justify the added capital requirements of the newly acquired operations?
• And will Pepsi be able to capture the synergies from the merger fast enough?

What’s for sure is that Pepsi’s action goes against its decision to concentrate on its core competencies. Management theory has proven time and again that companies should concentrate in one segment of the entire value chain (in Coca Coal’s case, product innovation and marketing) and leave the less-attractive and less-profitable areas to others.

Furthermore, it’s clear to me that “asset-light” companies – firms such as C.H. Robinson Worldwide Inc. (NYSE: CHRW), which divested assets that have large financing requirements and that carry large fixed costs – reduce the cyclicality of the business, and thus reduce the risks to profits from economic downturns.  That means “asset-light” companies are preferable to “asset-heavy” companies.

Therefore, my bias is against the added complexity and capital requirements involved with the Pepsi deal.  And we must now wait to see if the company can deliver on the two key questions above.  But we can never count out Pepsi’s innovation and resiliency, and so we will give them the benefit of the doubt.

PepsiCo stock closed down 9 cents, or 0.16%, at $57.74 a share Friday. That’s up 32% from its hit 52-week low of $43.78, reached in Early March.

Recommendation: “Hold” PepsiCo Inc. (NYSE: PEP), but do not add to your position, and give preference to Coca Cola’s stock – at least until Pepsi is able to prove that it can execute the merger efficiencies and win market share from its arch-rival (**).

** Special Note of Disclosure: Horacio Marquez holds no interest in PepsiCo Inc.

Source: Buy, Sell or Hold: Will PepsiCo Inc.’s (NYSE: PEP) Recent Acquisitions Pay Off?

A record setting 367 companies reduced their dividends during the second quarter, no doubt leading many shell-shocked investors to conclude that income is dead.

But there’s more to this story. A total of 283 companies actually said that they boosted their payouts, and an even-larger group of companies maintained their current dividend payouts, Standard & Poor’s Inc. reported.

Not surprisingly, each of the two groups of companies featured some defining characteristics. The companies that had cut their dividends were largely domestic in nature, or at least had a decidedly domestic emphasis. By and large, the firms that were able to maintain or even boost their quarterly payouts were internationally focused, with the potential for some explosive business growth in the world’s key emerging economies.

A Tale of Two Markets

To understand the divergent fortunes of the two groups of companies, just look at the divergent performance of the two world economies that are most talked about today: The United States and China.

At the time of this dividend report’s recent release, the U.S. stock-market benchmark – the Standard & Poor’s 500 Index – was up a respectable 7.26% so far this year.

By comparison, China’s Shenzhen 100 Index had quietly risen 110.10% during that same period.

Such a steep run-up in stock prices often spooks investors. That’s understandable. We always evaluate such situations with caution, too.

But while most investors are worried China’s stock market could take a tumble, we would look at it as a minor near-term setback – and a major long-term profit opportunity.

Even with the double-digit – or triple-digit – run-ups the stocks of many China-based companies have already experienced, many Chinese companies remain stunningly compelling buys, especially when they feature solid dividend payouts, as well.

And China’s not the world’s only upbeat investing opportunity. The story is much the same in other parts of the world, too. Right now, there are more than 100 international income funds that feature yields of 6% or better.

So how do you tell which companies have a promising payout future? Or which ones figure to be dividend duds?

There are three key areas to examine.

International Sales: It goes without saying that fast-developing economies such as China and India will almost certainly leave their U.S., European and Japanese counterparts in the dust.  Therefore, it makes sense to begin the hunt for the world’s best dividend players by looking at companies with a significant business exposure to these and other emerging markets.

If this causes you to step out of your investing “comfort zone,” well, let’s just say that’s great.

Some 74% of the world’s economic activity currently takes place beyond U.S. borders, so it makes no more sense to confine yourself to U.S.-only investments than it does to make the same mistake twice.

My favorites include companies that derive 40% or more of their sales from the Pacific Rim, as well as from China. The fact that China’s been growing at a double-digit clip for years means that other countries in that region are experiencing spin-off growth. Taiwan, for instance, has solid manufacturing ties with Mainland China – and the relationship between those two one-time political sparring partners is closer than ever, thanks to several trade agreements signed in recent months.

Granted, one can make all sorts of arguments about the sustainability of China’s growth, but history shows that you are better off hitching your wagon to strong horses than weak ones. Because most people still tend to view China as a Third-World, Communist-led, economically backward country, they’re often stunned to discover that China has had the world’s largest gross domestic product (GDP) for 18 of the last 20 centuries.

And it soon will again – and probably a lot sooner than most investors are prepared to accept.

In fact, I’m predicting that China’s stock markets could have a larger market capitalization than their U.S. counterparts within the next five years, but that’s a story for another time.

Payout Ratios: This is one measure that allows you to gauge the relative security of your investment in any given company. In case you’re not familiar with the term, a payout ratio is the percentage of a company’s profit that it pays out to shareholders in the form of dividends.

While there are exceptions, if the payout ratio approaches 100%, and the choice I’m considering is not a Canadian Trust or Limited Partnership created expressly for dividend-payout purposes that, to me, constitutes a waving red flag. If business conditions plummet, or management doesn’t have as good a handle on cash flow as it thinks it does, any decrease in earnings will obviously affect future dividend payout plans.

On the other hand, if the payout is around 50%, history suggests that this is a sustainable level and that management is unlikely to severely decrease the company’s dividend payment. That’s barring a catastrophic earnings reversal, of course.

Distribution Source: Thanks to all manner of accounting tricks – politely called “adjustments” in corporate accounting-speak – it’s harder than ever to determine where a company’s income is coming from. For example, some investments – especially Canadian Income Trusts and shipping partnerships – prefer to pay dividends from available cash flow, as opposed to bottom-line profits, like most other public companies.  That can increase the aforementioned payout ratio, and can also mislead investors as to the sustainability of future dividend payments.

But you should look anyway.

Generally speaking, dividends come from earnings, making them reasonably predictable. The stuff that isn’t predictable is often the result of special distributions based on short-term or long-term capital gains. Because this type of income often results from one-time sales of assets, or from accounting transactions, they are usually paid semi-annually or annually (as opposed to being paid quarterly, which is the common practice among most U.S. public companies). And while these “special dividends” can provide a nice bump in payments, don’t confuse this type of payout with the cash you received from ongoing operations.

The other type of payout that can throw a monkey wrench in things is called a “return-of-capital” event. While it can result in big cash payments that investors enjoy tremendously, it’s not a regular payout, either. Like the short-term and long-term distributions we just discussed, return-of-capital transactions are not part of regular earnings. They’re typically the result of tax savings, depreciation or other changes in the assets a firm owns. Write-downs and write-ups are good examples of what I’m talking about here.

Either way, return-of-capital transactions are a danger sign in my book because the firm may be trying to return your original investment – which is a strategy often pursued when a dividend cut is imminent and not yet announced.

And that’s the last thing you should want right now.

Source: The Secrets to Global Dividend Investing