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Daily Reckoning
Daily Reckoning

“Fear Gauge” at its Lowest in Over a Year

December 25, 2009
1) As we approach the end of the decade, we take stock of The Daily Reckoning’s beloved “Trade of the Decade.” You know it by heart, right? “Buy gold on dips, sell stocks on rallies.” Bloomberg News has tallied up and reported the satisfying results…


“A $100 investment in gold would now be more than $380,” Bloomberg calculates, “while the same sum in commodities would have grown to about $357, according to the Standard & Poor’s GSCI Enhanced Total Return Index.”

How will this trade perform during the NEXT ten years? Check back in December of 2019 and we’ll let you know.

If the consumer is supposed to generate economic recovery, he’s going to have to do better than this. The relevant data points yesterday morning:

  • Personal spending rose 0.5% between October and November – a bit less than analysts expected. Incomes rose 0.4%, also less than expected. On the bright side, the spending figure has risen six of the last seven months.
  • Consumer sentiment as measured by Reuters and the University of Michigan is up from last month, at 72.5. But that’s lower than the initial estimate, and lower than analysts expected.
  • New home sales fell 11.3%, to their lowest level since March. Yes, that was lower than expected too. The perky activity of late in existing home sales is not translating to new construction.
3) US stock indexes are taking all of this in stride. The NASDAQ Composite reached a new 14-month high in yesterday’s trading and no investor, it seems, can think of any reason NOT to buy stocks. Accordingly, the VIX – the index measuring stock market volatility – shows a very high level of investor optimism. This index, also known as the “Fear Gauge” is the lowest it’s been since August 2008 – just before everything hit the fan.

4) The stock market may be feeling mellow, but the bond market is becoming a bit agitated…about inflation.


The yield curve – the difference in yield between a 2-year Treasury note and a 10-year Treasury note – sits at a record 285 basis points. Fork over your money to the gubmint for two years and you get a paltry 0.88%.

But 10 years? You get 3.73%. Yes, that’s paltry too. But it’s hard to ignore the gap being this wide. Bond buyers expect a substantially higher yield if they’re going to lend money to Uncle Sam for the next 10 years. That means they sense the value of the dollars they get back will be diminishing.

At least that’s what they sense right now. We hesitate to suggest the bond vigilantes are out in force, but at least they’re out. There’s also evidence the mortgage vigilantes are out wandering around again. The spread between 10-year notes and 30-year mortgage rates is widening, and also points to growing inflation expectations for 2010.

Then again, some of the most celebrated hedge fund managers are seeing the same thing we’re seeing. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation,” John Paulson said in a recent speech. (He also retains his big positions in gold.) Julian Robertson is also playing the yield curve with long-dated out-of-the-money puts on Treasuries.

Short term, we may get a clearer picture when the Treasury plans to auction a record-tying $118 billion in notes next week.

About the author:

Daily Reckoning
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 4.0/5 (5 votes)


Superguru - 7 years ago    Report SPAM
That is why asset allocation is so important.

If stocks have another decade like the last one then even cash will beat the stocks like it did for last decade. As there is no way of knowing the future, proper asset allocation to different asset categories should help improve returns.
JBF - 7 years ago    Report SPAM
Very interesting. How did timberland do?
Superguru - 7 years ago    Report SPAM
For last decade US stocks was the worst asset class. El Erian asset allocation makes more and more sense.
Buffetteer17 premium member - 7 years ago
With the VIX at an extreme low below 20 and the market up, now would be a good time to buy some OTM index put options, just in case the market recovery doesn't work out so well.
David Pinsen
David Pinsen - 7 years ago    Report SPAM

I agree that this is a good time to buy OTM puts, but instead of buying them on indexes, I am building a basket of puts on financially-distressed stocks that come up on Short Screen's screener. I think a basket of financially-distressed companies may fall further than the broader market when the market corrects.
Buffetteer17 premium member - 7 years ago
Hmmm. I think it is time to check out your short screen. I wouldn't mind putting a fraction of my hedge into company-specific shorts.
David Pinsen
David Pinsen - 7 years ago    Report SPAM
Makes sense, if you think about it: you pick stocks on the long side, because you feel you can outperform the market over a full market cycle -- so why not pick stocks on the short side? Send me a PM, if you like, and I'll give you a discount code for Short Screen.

Incidentally, I just added another short position to the basket today: puts on UAL.
Sivaram - 7 years ago    Report SPAM

SuperGuru: "That is why asset allocation is so important.

If stocks have another decade like the last one then even cash will beat the stocks like it did for last decade. As there is no way of knowing the future, proper asset allocation to different asset categories should help improve returns."

Not to be nitpick but how is any of this "proper" asset allocation?

All Daily Reckoning and others like it have done is to blindly bet on gold. It looks so great because, well, gold has been a great performer. But the reason for owning it is always a mystery. How does one know it is still undervalued? Or is it overvalued? I mean, one can use the same argument and hold gold for the next 100 years and I'm pretty certain it will underperform stocks.

On the topic of diversification, let's not forget that some of the biggest losses out there have been posted by widely diversified endowments and pension funds. These institutional funds often hold very safe bonds and yet they are posting numbers close to a 100% stock portfolio!

So to sum up, I agree with SuperGuru that asset allocation is extremely important. However, diversification doesn't mean that you will outperform the market in the long run.
Cm1750 - 7 years ago    Report SPAM

I really don't think the lesson of the decade is the importance of diversification. Rather, I think it is the value of rational valuation analysis.

On January 1, 2000, many stocks were ridiculously overvalued. A great company is not a great investment if you overpay for it.

Great companies such as CSCO, MSFT, GE, WMT etc. were trading at over 50x P/E. Unless these companies could grow at high rates for decades, they were obviously overvalued if you did a simple perpetual FCF model.

Over the past decade, WMT has seen its EPS grow by over 200% and the stock has declined 20%. 10 years ago the forward P/E was 55x, now it is 13.7x.

MSFT has seen its EPS grow 130% and the stock has dropped 45%. 10 years ago the forward P/E was 65x, now it is 15.5%.

At this point, many high quality companies seem to be fairly priced and should return at least high single digit returns for the next decade - examples are PM, CLX, PFE, PG, IBM, MCD, PEP, JNJ etc. These returns will almost surely beat treasury notes, which are overpriced IMO as well as stocks like AMZN which seems overvalued based on a simplistic valuation analysis in Barron's recently.

If you think of a stock as an investment with a calculated expected IRR based on FCF and focus on stocks with wide moats and good economics, diversification is much less important as long as your time horizon is over 5 years.
Batbeer2 premium member - 7 years ago
Good points cm1750.

I would add that rational value analysis is not necessarily limited to stocks.

IMHO if you are not a stock picker but you do want exposure to the stock market, buy an index fund. Anything in between is fooling yourself.

If stocks have another decade like the last one then buy !

JNJ at 125B, KO at 100B...... as long as the fundamentals remain the same, let them drop. The trick is not to be a buyer if they hit 300B in between. The pressure to buy then will be as great as the urge to sell was last march.
Max7777 premium member - 7 years ago

The only thing I learn from this past decade is to expect the next decade to statistically perform better, since having poor returnsin stocks in one decade usually means higher return the next decade. (and the opposite is also true, if we were just ending a great decade i would expect lower returns. I mean look at GMO data or even Stocks for the Long Term. (both Jeremy's agree on this pt)

Now this is a very positive fact and it should influence my asset allocation, (to put more in stocks) but I remember that Buffett thinks that asset allocation is the dumbest thing since you should place most your bets on your best idea according to him (he once had 50% of his assets in Amex.) He thinks asset allocation was only invented by academics and wall street to justify poor research and only hurts returns and does not reduce risk.

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