QE2 Effectiveness | Shilling Anticipating an Equity Selloff

For the past few weeks, the number one item I've been contemplating is QE2 and whether or not it will be effective at stimulating the economy.  Of the "educated guessers" I've spoken with there is no consensus.  Most think it will eventually bring inflation but the crowd is mixed on the short and medium term expectations.  Gary Shilling recently told Bloomberg that he doesn't believe QE1 or 2 is going to do the trick and a equity selloff is coming.

Gary Shilling Sees `Significant' Stock Selloff Within 12 Months

By Rita Nazareth - Nov 12, 2010 1:47 PM

Gary Shilling, who predicted the U.S. housing collapse, says the stock market is overvalued and foresees a “significant” selloff within a year as the Federal Reserve fails to stimulate economic growth.

The Standard & Poor’s 500 Index has climbed 17 percent since July 2 as investors anticipated the Fed’s plan to buy $600 billion in Treasuries to boost growth. The benchmark gauge for U.S. equity trades for 15 times profit from the past year, up from 13.7 in July, data compiled by Bloomberg show. Fed Chairman Ben Bernanke previewed his strategy of quantitative easing in an Aug. 27 speech in Jackson Hole, Wyoming.

“I don’t think it’s enough to make a great deal of difference,” Shilling, 73, president of the investment research firm A. Gary Shilling & Co. in Springfield, New Jersey, said in a telephone interview. “The earlier QE1 didn’t and I don’t think this will, either. The economy is weak and it doesn’t take very much of a shock to push it into negative territory. I don’t think that’s enough to justify where stocks are now.”

Shilling, who predicts real gross domestic product growth of 2 percent “and maybe less in the next couple of years,” said the government is out of options for fixing the economy.

No Magic Bullet

“There’s not much that can be done,” said Shilling. “There isn’t any magic bullet. There isn’t anything in my view that’s going to return us to the solid days of the 80s and 90s when consumers were spending freely. I don’t think that’s going to come back. The need to deleverage is just too great.”

The S&P 500 lost 1.2 percent to 1,199.21 as of 4 p.m. amid speculation China will lift interest rates. The index has fallen 2.2 percent since Nov. 5 for its first weekly decline in more than a month, data compiled by Bloomberg show.

Shilling’s past predictions had mixed results. The economist forecast the recession that began in December 2007 and warned investors a year earlier that residential real estate was in a bubble that would burst. The S&P 500 lost 57 percent between October 2007 and March 2009.

With the S&P 500 at a 12-year low that month, he said that higher unemployment would curb consumer spending, leading to “weaker stocks.” An investor following his advice would have missed the start of an 80 percent rally.

Deflation Board Game

Shilling, a long-time market skeptic who once created a board game to show the dangers of deflation, earned a doctorate degree in economics at Stanford University, according to his website. In his book “The Age of Deleveraging,” which was published this month, he theorizes that the global economy will struggle for years. Other books include “Deflation: How to Survive and Thrive in the Coming Wave of Deflation” in 2002 and, “After the Crash: Recession or Depression: Business and Investment Strategies for a Deflationary World” in 1988, according to Amazon.com Inc.’s website.

The U.S. economy, which grew at a 2 percent annual pace in the third quarter, may enter a recession in the next year or two, Shilling said. The U.S. gross domestic product will grow 2.7 percent this year and 2.4 percent in 2011 after 2009’s contraction, according to a Bloomberg survey of economists.

The S&P 500 posted its biggest September-October rally since 1998 as economic data showed the threat of a recession is abating. The gauge extended the rally into November after the Labor Department reported a bigger-than-forecast decrease in jobless claims and as orders placed with factories and production rose to a five-month high.

Beating Estimates

Earnings have topped estimates at 76 percent of the 433 companies in the S&P 500 that have announced results since Oct. 7, according to data compiled by Bloomberg. Net income has grown 29 percent for the group as sales increased 9.2 percent.

While estimates for U.S. corporate profit fell last quarter, they still indicate that S&P 500 companies will report record earnings in 2011. The equity benchmark is valued at about 12 times projected income for 2011, according to data compiled by Bloomberg. That’s the cheapest level since 1988, excluding the six months after New York-based Lehman Brothers Holdings Inc.’s filed for bankruptcy in September 2008, relative to reported profit from the past 12 months.

“Stock valuations remain attractive,” said James Dunigan, chief investment officer at PNC Wealth Management in Philadelphia, which oversees $105 billion. “The earnings prospects continue to be positive. We’ll likely get back to an economy which is expanding in the early part of 2011. The story is pretty good.”

Stock Returns

Shilling, who predicts that stocks will return 5 percent to 6 percent annually after inflation adjustments over the next decade, says that half of that will come from dividends and not from appreciation. The S&P 500’s dividend yield, currently at 1.92 percent, may rise to at least 3 percent, Shilling said, without specifying a time frame.

“You see a lot of companies being pressured to pay dividends,” he said. “Look at Microsoft. They borrowed money to pay dividends. It tells you that investors want dividends.”

In September, Microsoft Corp., the world’s largest software maker, sold $4.75 billion of bonds at the lowest coupons on record. A day earlier, the company raised its quarterly dividend by 23 percent to 16 cents and received approval from its board to sell as much as $6 billion in additional debt.

Shilling reiterated his view in an Oct. 4 interview with Bloomberg Radio that looming deflation means U.S. Treasuries are still attractive. He says the yield on the U.S. 30-year bond will drop to 3 percent within the next “couple of years” from about 4.3 percent. Shilling also said he doesn’t see a collapse of the U.S. dollar because of debt problems in Europe.

The euro slid to the lowest level in more than a month versus the dollar yesterday as concern that some European countries will have difficulty paying their debt and a drop in stocks curbed investors’ appetite for risk.

“The dollar is probably going to strengthen,” Shilling said. “We’re going to see increasing problems in Europe, led by Ireland. As a result, we’re seeing a rally in the dollar.”

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net.

Contrarian View: James Altucher "11 Reasons Why the Gold Bubble Will Burst"

We have seen a lot of articles on why QE2 is going to cause everything to rise so I thought it would be good to post a contrarian view on gold prices.  This article by James Altucher is from Seeking Alpha.

I first wrote about gold in early July at WSJ.com. I took a lot of heat then but the jury is still out. In fact, since July 9, stocks and gold have performed almost exactly the same. But with stocks trading at record low multiples over earnings (versus bond yields) and with gold at an all time high I can think of 11 straightforward reasons why the Gold Bubble is going to burst and stocks are the primary place one should put their money.

• It has very few industrial uses. Almost every industrial use of gold is also an industrial use of silver. Since silver is much cheaper than gold you can imagine that people would rather use silver than gold for industrial purposes. It's no suprise that silver has outperformed gold this past year despite all the media fuss about gold.
• Gold has no dividend yield. Buy a stock that consistently increases its dividend and eventually the dividend alone will pay back your investment. How about the world's largest store, which is already benefiting from an improving economy plus globalization which allows it to bring down prices and increase margins. Walmart (WMT) increased its dividend by 11% this year. It's been increasing dividends every year since 1974. Or Becton Dickinson (BDX), the medical supplies company, which has raised its dividend every year since 1973. This is a Warren Buffett holding and is probably a bet on the massive demographic trend of aging baby boomers needing more medical care as they grow older. They don't need more gold. They need more medical care.
• Gold has no earnings yield. With corporate profits growing nine quarters in a row (what more proof do people need that the economy has been improving) ultimately it's better to buy stocks with improving earnings yields. How about buying companies with actual innovative products that consumers will keep on buying for years, driving up earnings even more. Apple (AAPL), Google (GOOG), eBay (EBAY), Cisco (CSCO), all solidly increasing earnings.
• The US should start selling its gold to pay down its debt. I'm not making a judgement here. It's just inevitable with gold prices this high that the US government, which wants to drive people into stocks anyway, will start pushing down gold prices by selling its stash.
• Interest rates are at zero and the Fed is printing money. Eventually interest rates will begin to go up as the economy firms (which it will do at even the slightest hint of re-inflation), driving up the value of the dollar. Gold will collapse at that moment.
• John Paulson and George Soros, plus billions of dollars worth of their followers, have plowed $10s of billions into Gold in the past few months. OK, that type of buying won't last forever and is probably already finished. Soros has even begun reducing his position in the gold ETF, GLD. He also reduced his position in Novagold (NG)
• 2006, 2007, and 2008 world gold production was down (decreasing supply while demand was increasing due to the financial crisis and weak dollar). In 2009, guess what? Gold production was up 10% year over year. And production is not going down anytime soon for a simple reason. There's a new sheriff in town. China, in 2005, produced 224mt (supplying 8.9% of the world's gold production) making it the #4 producer. In 2009, they produced 313mt, 12% of the world's production, and was by far the #1 producer (next in line was Australia at 277mt). The main producers of gold are trying to make money hand over fist with prices so high. They will keep increasing supply until the price goes down.
• Gold sentiment is at an all-time bullish high. For the first time ever, gold ATM machines are dispensing bars of bullion. The first ones opened up in Abu Dhabi, Munich, and Madrid. Next in line are Boca Raton and Las Vegas in the US. What are you going to do with all that gold? Bury it in your backyard? Have no fear. Here are 5 obnoxious uses for gold
• Whenever we see gold sentiment at the levels in the below chart prices tend to pull back, at least in the short-term.

Assets in the GLD ETF, the ETF which tracks gold, are also reaching a level usually associated with a top

Warren Buffett is not always right. But when it comes to long-term investment predictions there is probably nobody better than him in the world. Here's what Buffett recently said about gold in an interview with Ben Stein: " "Look," he says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils (XOM), plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?" "

Can Twitter predict the stock market?

(Wired) The emotional roller coaster captured on Twitter can predict the ups and downs of the stock market, a new study finds. Measuring how calm the Twitterverse is on a given day can foretell the direction of changes to the Dow Jones Industrial Average three days later with an accuracy of 86.7 percent.

“We were pretty astonished that this actually worked,” said computational social scientist Johan Bollen of Indiana University-Bloomington. The new results appear in a paper on the arXiv.org preprint server.

Bollen and grad student Huina Mao stumbled on this computational crystal ball almost by accident. Earlier studies had found that blogs can be used to gauge public mood, and that tweets about movies can predict box office sales. An open source mood-tracking tool called OpenFinder sorts tweets into positive and negative bins based on emotionally charged words.

But Bollen wanted to build a more nuanced emotional barometer. He used a standard psychology tool called the Profile of Mood States, a quick questionnaire that is used frequently in pharmaceutical research or sports medicine.

The original questionnaire asks people to rate how closely their feelings match 72 different adjectives, including “friendly,” “peeved,” “active,” “on edge” and “panicky,” and uses the responses to measure mood along six dimensions: calmness, alertness, sureness, vitality, kindness and happiness.

Bollen and colleagues checked a huge Google database to see what other words are commonly used in conjunction with the original 72 adjectives, and added those words to their lexicon. Then the researchers took 9.8 million tweets from 2.7 million tweeters between February and December 2008, selected the tweets that indicated a confession of emotion (tweets that included the words “I feel” or “I’m feeling,” for instance), and ran the test on the entire data set.

“We’re using Twitter like a psychiatric patient,” Bollen said. “This allows us to measure the mood of the public over these six different mood states.”

As a sanity check, the researchers looked at the public mood on some easily-predictable days, like Election Day 2008 and Thanksgiving. The results were as expected: Twitter was anxious the day before the election, and much calmer, happier and kinder on Election Day itself, though all returned to normal by Nov. 5. On Thanksgiving, Twitter’s “Happy” score spiked.

Then, just to see what would happen, Mao compared the national mood to the Dow Jones Industrial Average. She found that one emotion, calmness, lined up surprisingly well with the rises and falls of the stock market — but three or four days in advance.

“I sank into my chair. That’s a pretty big result,” Bollen said. “It was one of those ‘Eureka!’ moments.”

But this surprising correlation said nothing about whether Twitter could be used to tell the future. To test that idea, the researchers trained a machine-learning algorithm to predict whether the stock market would go up or down, first using only the Dow Jones Industrial Average from the past three days, then including emotional data.

The algorithm did pretty well using stock market data alone, predicting the shape of the stock market with 73.3 percent accuracy. But it did even better when the emotional information was added, reaching up to 86.7 percent accuracy.

“Including this mood information leads to higher accuracy,” Bollen said. He stressed that their algorithm is highly simplified, and not the best stock market predictor anyone could come up with. But “we’re presuming on the basis of what we found, if you have some kind of super-duper algorithm and you add our time series, its accuracy will go up, as well.”

The fact that Twitter mood could predict the stock market’s movements even in the middle of 2008 is also significant, Bollen added.

“This was probably one of the most difficult periods to predict,” he said. “We had a presidential election, we had what looked to be financial Armageddon, we had the start of what has been the deepest and greatest recession since the 1930s… If our algorithm was able to predict Dow Jones Industrial Average in that period, we figured that may establish some kind of lower baseline. It could do a lot better in other periods of time.”

But why does it work? “The short answer is, we don’t know,” Bollen said. It’s reasonable to assume that people’s moods will have some effect on their investments, he says, but more research is needed to figure out exactly how.

“It’s a pretty interesting result,” commented computer scientist Sitaram Asur of HP Labs. But even though the correlation is there, Asur is reluctant to believe that the moods captured on Twitter can cause the stock market to change. Not everyone on Twitter plays the stock market, he notes, or even lives in the United States. And he would like to see the algorithm used on tweets from a wider span of time.

“If it is true, if we can actually find this correlation to be consistent, that will be a very important result,” he said. “But right now, I would be cautious about saying how important this is.”

Bollen agrees that the result has some shortcomings. “We need to expand this,” he said. The next step, he said, is to “put some of our money where our mouths are, and try to do this in real time.”

Read More http://www.wired.com/wiredscience/2010/10/twitter-crystal-ball/#ixzz12sH1rlPd

Mr. T on Gold

Fran Kinniry principal at Vanguard's Investment Strategy Group on Bond Bubble

Morningstar interviewed Fran Kinniry about the bond "bubble".  Here are some of his comments:

...the bubble of the stock market typically, you think about a decline of 20%, and same thing even with the real estate bubble that we just saw--significant decline.

So, while we think bonds may be a little bit ahead of themselves and current yields look quite low, a bubble of that magnitude is probably unlikely.

I think most people are not used to having a negative return in bonds. And that certainly is a possibility if not a probability at some point in the future when interest rates rise. But if you're broadly diversified and have an intermediate duration, which is a core bond holding, then the order of magnitude of losses have, in the past, come inside of negative 10%, and so something around that should not be ruled out and something even worse. But to think of bubbles that have occurred in other asset classes, we would not expect to see that kind of magnitude of losses.