Some Musings About Q3

Musing 1. Why do new home sales data releases by HUD possess any significance?

Maybe so that the HFT houses have a headline for an algorithm to pump millions of unfilled bids into a market. It’s baffling. For me, the most important part of a release by HUD regarding new residential sales is the Explanatory Notes. In this section they tell you how wrong their data could be and they lay out all the statistical errors that could be occurring due to things such as “bias, variance from response, nonreporting, and undercoverage.” Reported numbers are consistently displayed with standard deviations of plus or minus percentages in the teens or twenties. For example, September’s results show a 0.2% (+/- 15.7%) above revised August new home sales.

That means the actual number may have been as low as -15.5% or as high at 15.9%. The dispersion is so wide as to render the results effectively meaningless, which is why there are always revisions. But why would revisions possess any more statistical relevance when weighed against the potential of HUD’s self-reported surveying errors? Observe the median sales price from August to September. It went from $275,600 at the end of the summer to $259,000 in the beginning of the fall. While the average price of a new home sale dropped from $348K to $313K. Drops of that magnitude have to make you question the credibility of the August new home sales pricing data. Did prices for a new residence actually drop that much in a single month or was it that the data was massaged to begin with? Not even the Census Bureau will provide a quality answer. I know the confidence level of the statistics is at least 90% but c’mon. Honestly.

Can you imagine if other industries were allowed to utilize such wide standard deviations in their statistical reporting. Take biotech. “Each participant that takes the pill in the study has approximately a 50% chance of increasing their lifespan by 12 more years…plus or minus 40%.” Or how about plane engine manufacturers. “We believe this critical engine component will operate in extreme conditions with a failure rate of 0.03% (+/-72.7%)” These are extreme, outlandish examples to be sure, but you hopefully get the point. Admittedly, my statistical skillset is decidedly above the average dolt off the street, but assuredly below regular practitioners such as finance & economics professionals or academics. The book is still open on whether or not to reject the null hypothesis that MarginRich is actually just one of the said dolts off the street.

Musing 2. What’s the big deal about oil reserves vs. oil resources?

This musing stems from an article I read at Bloomberg that was titled, We’re Sitting on 10 Billion Barrel of Oil! Ok, Two. The theme was expanded on at Zero Hedge that potentially the whole petroleum renaissance is nothing more than smoke and mirrors. Now I enjoy Zero Hedge as much as the next bloke, but I wouldn’t expect them to so quickly jump on the extremist bandwagon when it comes to E&P’s sharing their opinions on resources.

The basic gist of the Bloomberg piece was that oil and gas companies are grossly irresponsible in reporting resource potential in their corporate presentations versus the actual reserves they are filing with the SEC. However, before they get into the meat and potatoes of the article they share a giant caveat about investors and the differences between reserves versus resources. The authors quote Scott Sheffield, CEO of Pioneer Resources, one of the largest players in Texas with significant rig counts in the Permian and Eagle Ford. Sheffield states that experienced investors know the difference between the two numbers. Specifically, “Shareholders understand. We’re owned 95 percent by institutions. Now the American public is going into the mutual funds (or ETFs), so they’re trusting what those institutions are doing in their homework.”

Precisely. Experienced and sophisticated investors know that resource potential is not the same as current, existing barrels of oil in ground. That doesn’t mean that through innovative techniques that a high percentage of those resources cannot be converted into reserves. Patience and demand are the keys to the development of refined exploration techniques that can continue to expand the US energy base. The article implies that the shale boom is potentially a large scandal waiting to blow-up with Enron-like repercussions. That is an epically gross exaggeration. E&P companies have time and again improved or grew reserves at rates consistent with estimates. Additionally, we’ve seen the oil and gas players consistently beat reserve estimates established by the EIA for various geographic areas.

Bloomberg provided a snapshot of companies to graphically show the disparity between the two numbers:


Any speculator in hard assets, knows what the steak and the sizzle are in natural resources. The reserves are the steak. The resources are the sizzle. It would help if more of the E&P players would utilize the P’s more in their presentations for the retail players who want to get in on the action. The P’s stand for proven, probable, and possible. Proven or 1P reserves have a high probability of being produced and you can count on the number. Then there is proven and probable, which is 2P; and then proven, probable, and possible is 3P. The higher the number of P, the less likely the company can produce the reserve. However, that doesn’t eliminate the current or future viability and economic potential of the resource. These P-designations, standard nomenclature in the industry, are easy to understand and not nearly utilized enough in company presentations. Oil and gas are no different than gold, silver, platinum, copper, or any other natural resource. All natural resource companies report reserves and resources and it’s up to the speculators to conduct their own due diligence.

Musing 3. There’s some serious Kool-Aid drinking at First Trust

First Trust is an investment advisory firm founded back in 1991. They’re fairly sizeable in that through their assortment of ETFs, mutual funds, and other various products; they’ve been able to garner $32 billion in assets under management. A hefty sum by any measure, but very small compared to the biggest players in the game.

The Monday Morning Outlook is a weekly little opinion piece that First Trust puts out that also includes a schedule of important economic releases for the week. Content is hit or miss with this shop, however, there was one piece from last month that struck me as an egregiously, cowardly article. You can have a read for yourself to see if I’m out of bounds in my assessment. I admit that based on my own opinions shared at this site, that I could be labeled a doom & gloomer, but I simply refuse to un-acknowledge the current and future distortions that have and will occur in asset markets around the world thanks to central bank interference.

The piece titled Why Do Stocks Keep Rising?, from September 8th, pumps First Trust’s fist in the air behind a sis-boom-bah of how the markets have continued their upward ascent despite the steady flow of negative-impact events over the last 5 years. They don’t understand how pessimism can remain so ingrained for certain pockets of investors under such conditions. I know it’s a quick 1-page offering that they throw up every Monday, but you can’t just break out the pom-poms and then stick your head in the sand without truly acknowledging the reasoning of the very parties you are criticizing. Amateur hour!

They don’t touch on how central banks have kept the cost of capital at virtually zero for longer than any period in history despite an “improving” economy and “improving” employment. They extol the virtues of the rising profits across industries but share nothing on top-lines and how that will affect profits going forward. Or how slashing SG&A and CapEx in combination with share repurchases has significantly affected stated earnings to the positive. Nor do they expound on how these behaviors are unsustainable. They fail to acknowledge that the current situation of central bank involvement in the developed nations has absolutely no precedent, and thus, no back-testable strategy for when the house of cards begins to wobble.

As an investment adviser it behooves them to cheerlead so as to grow assets under management higher and higher. That’s fine and they have a right to share a one-sided puff piece. They should just try not to be so damn cowardly the next time they want to cheerlead investing in a rising market right before a 7%(which I stated will not be the low) haircut commences.

Before signing off, I wanted to touch on the current action in the S&P 500. In my last article, I had stated that if the price action is simply a bounce within a larger correction that I thought the 1,950 area to be a solid resistance point before turning down again. Today’s close at 1,964 is still around 1,950, so we’re not quite out of the woods just yet. If we move onto sustained new highs then I will offer a mea-culpa, but I continue to think that caution is warranted. I’ll leave you with a chart shared by Lance Roberts at STA Wealth that displays the price action in the S&P 500 during the last two corrections that reached a depth of 10% or more.


Analogous Equities Markets – 1970’s & 20Teens

Secular bull? Or bear about to do its thing on “unsuspecting” market players? These are questions making serious rounds on the world wide interlinking-web. That’s because fear sells and nothing gets eyeballs and clicks for the user-ravenous financial sites like some market-topping bear talk.

If you were alive and investing in the 70’s, or like myself, have read up on the stock market action of the 70’s then one can see how similar the two time periods seem to be acting(at least in the S&P 500). Don’t worry, I’m not about to hit you with yet another comparison chart of some calamitous US financial event laid over current action. Instead, I’d like to share some work by Lance Roberts. For the record, I like those comparison charts but I also take them for what they are…entertainment. At best they’re another useful input and at worse they’re just noise.

If you’re unfamiliar with Mr. Roberts, he consistently writes compelling market pieces. I happen to think he’s one of the more under-appreciated financial commentators on the web right now. He’s the co-founder and general partner of STA Wealth Management. Earlier in the year, Mr. Roberts shared some graphs comparing current times to the secular bull formed in the 80’s and the fakeout in the 70’s. At STA they definitely have Austrian economic tendencies in their communications regarding the markets, and so obviously can lean toward a more bearish stance at times. Or as other Austrians call it, just being realistic in light of all the economic data readily ascertainable.

They have significant assets under management of approximately $500 million to $600 million, so these guys are the real deal. Specifically, they focus on the client who possesses low six-figures to approximately $5 million in capital, so they’re not exactly whale hunters. STA feels that market is an underserved niche of wealth management. I’m not trying to plug their services nor do I have any relationship with their firm. Like other commentators or service providers I include in my posts here at, I’m fairly certain STA doesn’t even know this blog exists. I just want to share with my readers another financial blogger whose work I really enjoy. You can also find work by Lance Roberts at Advisor Perspectives, home of dshort.

Now back to the charts Roberts shared in January. The first one shows a direct comparison of the current period to the false breakout of the late 60’s into what looked like a new bull going into 1973.


As we all know, The recession starting in 1973 was one of the worse times to be in the stock market in its history. The next chart shows the S&P’s performance and the realization of the false hopes for investors during those time periods.


Sorta looks like the decade of the Oh-Oh’s, except the action up to 1973 produced higher highs. As opposed to what we experienced in 2000 and 2007 in the S&P 500 with virtually equal tops. The reason for that was obviously all the capital was pouring into the NASDAQ in 2000.

Moving on to the last chart. Roberts shows the total picture with the final washout in 1981 and the true beginning of the 18 year mega-secular bull market that helped to explode the growth of the mutual fund and retirement investing industries. Of course there were up’s and down’s during the real secular bull, but boomers blessed with the easiest time to make buy and hold gains during peak earning years helped to build the academic case of always investing in stocks for the long run. Not that I want to get into any philosophical debates on investment strategies or the level of difficulty of investing through the 80’s and 90’s. I use the term “easy” through the lenses of hindsight.


The point of sharing these charts is to increase awareness that this 5 year run that America has been on off of the 2009 lows, may not be the start of a real secular run like we saw from 1982 to 2000. In 1982, the conditions were more like a final “cleansing”, so to speak. The new CEO of America was instilling a lot of genuine hope and assuaging genuine fears with genuine actions, not lies or baseless rhetoric. Valuations were exceptionally low with single digit P/E’s and very enticing dividend yields across the market. Price inflation had been beaten back by the last semi-responsible Fed head.

Simply put, these are not conditions that exist today. In fact, the exact opposite of each of those conditions exist today. I understand that the music is playing but do you want to keep dancing? Conditions are decidedly different due to deep distortions across the financial landscape. But hey, I’m only one voice of many and if you’re one of plenty of people(including professionals) who think we’re in the midst of a secular bull market, then by all means keep putting new money to work. However, even if you’re dollar cost averaging and you don’t believe in “timing” the market, now may be a time to build your cash levels.

Don’t just take my word for it. In a previous post I cited some thoughts shared by Seth Klarman and Jeremy Grantham. They each communicated their fears of the frothiness of these markets but that the markets will continue to move higher before an inevitable bust. Now the inimitable Howard Marks has essentially shared the same sentiment in his latest Memo From Our Chairman. Collectively, these 3 gentlemen help oversee more than $200 billion in assets under management. In addition to their combined multiple decades of experience, their respective savvy has made each of them billionaires. Now if scions of the investment world such as these fellas are telling you to be cautious, do you really want to be the rebel without a cause out there allocating your capital based on the premise that trees DO grow to the sky?

Look I know the path of least resistance for the markets is up and I’ve reinforced that in previous posts. It’s just that based on the distortions, it really feels like a reckoning is coming. And just some basic cycle research yields a time table of approximately 12 to 24 months from now for some potentially tough times as an investor. I’m not talking about exiting the markets entirely. I’m talking about raising cash levels to be prepared when the real values potentially present themselves and minding your stops. Next time I’ll share some hopefully enlightening charts and thoughts on those aforementioned distortions.