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Comstock Partners, Inc.
Rolling Thunder By ALAN ABELSON | Barrons
January 29, 2011
Mideast upheavals augur political and economic troubles, and perhaps we have signals for a stock-market downturn.

The natives are growing restless everywhere. And they're taking to the streets, boiling mad. Even in Brooklyn and Staten Island, too. Of course, in Brooklyn and Staten Island they have no choice, since the sidewalks are covered with snow and ice and your typical native is rarely equipped with a toboggan. In more temperate zones like Tunis and Cairo, they are in the grip of a powerful political contagion of displeasure with their Pooh-Bahs, and they're likely to vent their anger with bricks (if the natives are moderate) and guns and knives (if they're not).

The rolling thunder of revolt moving seemingly inexorably from one Middle Eastern country to the next, with its vast potential for roiling our relations with that slice of the world and sweeping possibilities for disturbances in trade and undesirable curtailments of energy and other vital commodities, has resounded in bourses of every kind and around the globe. It had a very sharp and immediate impact on our own robust stock market, which seemed poised to bust through to new peaks in its unparalleled thrust upward.

Among the few "positive" (at least for producers and select shareholders) effects of this serial discontent was to fuel a big leap in fuel prices-and not coincidentally-a gain in resource-rich Canadian entities, which are conveniently located in North America and are free of political risk, and to bolster bullion, which had been gracefully sagging. And, lest we neglect the greenback, to send uneasy investors rushing to the comforting safe haven of the dollar.
But the exceptions were glaringly few as traders and investors decided not to fight the tape or the volatile happenings in the Middle East and were all the more reluctant to do so with a weekend looming. The market, in any case, has been acting somewhat desultorily, as if it needed to take a breather and might seek a less elevated level from which to regroup for another dash toward cyclical peaks.
There were, moreover, some minor disappointments in corporate results-Microsoft and Amazon.com-and economic numbers-GDP was up, but not as much as expected, while wages and benefits squeezed out a pathetic gain of 2% in 2010, the second worst showing in 30 years. On that score, weekly new claims for unemployment compensation jumped 51,000 (blame it all on the snow, natch) and foreclosures, RealtyTrac reported, were up last year in 149 of 206 largest metropolitan areas.

A week earlier-or possibly even a few days earlier-chances are such news would have elicited a yawn rather than a yelp, particularly since there was more than a little offsetting bullish news, notably consumers showing a revived willingness to spend, even though incomes were lagging.

It wouldn't exactly knock our socks off if it turns out we've been witness to at least a temporary but significant stock-market top. What gives us pause is the ostensible cause of Friday's steep and virtually all-embracing retreat. If the turmoil in the Middle East continues, let alone worsens.but, hey, why should we spoil your weekend?

IN CASE YOU HAVEN'T NOTICED, 2011, now almost a month old, happens to be year three of the presidential cycle. The less couth out there may utter, "So what?" and ask whether we have any other brilliant epiphanies to share with them. While we're always fully stocked with brilliant epiphanies, we sympathize with the sardonic reaction, so allow us to explain.
Year three of the presidential cycle is highly regarded by any number of mostly sane investors as a bullish omen for the stock market. To the casual observer of Wall Street, this may smack a bit of voodoo investing. However, in this instance, superstition is trumped by history and logical inference. The history part is more descriptive than analytical, since it boils down to the incontestable fact that the third year of a president's tenure is usually accompanied by rising share prices.

That's not hard to understand, as it also is the year when the chief executive addresses easily the most important and heartfelt task of his entire tenure-holding onto his job, come the following year's election. To achieve that precious, primal goal, he leaves no ear unbent and no dollar unspent in relentless pursuit of making the citizenry feel good. And nothing is better calculated to make the common folk grateful than a vibrant economy and all the resplendent goodies that typically issue from it, not least of which is a snorting bull market.

What got us rambling on this way was Jeremy Grantham's letter to shareholders. Jeremy is the main man at GMO, and, to dip into the vulgar vernacular, one smart dude, with a neat sense of humor. Strictly his own man, he's a refreshing iconoclast among portfolio pros and never afraid to speak his mind. We don't always agree with him (we can hear him breathe a sigh of relief), but he unfailingly is worth paying heed to, and he has been right as rain on this market, cannily picking the bottom almost to the day in March 2009.

Along with his missive to shareholders, which includes a plug for year three of the presidential cycle as a predictive indicator and his outlook for the market, there's a part 2: a probe into bubbles, cribbed from an earlier speech of his, and what they mean to value investors (he confesses to being one).

Especially trenchant were his comments on the mother of all bubbles-the late, great housing boom-and-bust-which he reminds us was the first of its kind ever experienced in this blessed land. Before that cataclysm, real estate alone among asset classes suffered strictly spotty declines, with one region going bust while another was booming.

That changed dramatically this time around, due to a remarkable confluence of malign factors. As Jeremy bemoans: "It took Greenspan. It took zero interest rates. It took an amazing repackaging of mortgage instruments. It took people begging other people to take equity out of their house to buy another one down in Florida."

And not least, he recalls, it took Fed chief Ben Bernanke right at the peak of the speculative frenzy in October 2006 to calmly assure the masses: "The U.S. housing market largely reflects a strong economy.the U.S. housing market has never declined." (Implying, of course, Jeremy interjects, that it never would.)

"What the hell was he thinking of?" Jeremy exclaims. "Surrounded by statisticians, he [Bernanke] could not see a three-sigma housing bubble in a market that previously had never had one lousy bubble!"
While none of Jeremy's plaint is especially new, it nicely serves to identify the leading perps of the housing debacle as well as its enormous ramifications in the larger economy-and it's timely, in light of the fierce fracas in Washington triggered by the official report on the causes of the financial crisis and the deep recession that followed. It also has the not inconsiderable added weight of being voiced by someone who saw it coming.
A lapsed bear, Jeremy, when he rubs his crystal ball, sees the likelihood "of a strong market and continued outperformance of everything risky." But, he cautions, "be aware that you are living on borrowed time as a bull; on our data, the market is worth 910 on the Standard & Poor's 500 [on Friday, it was at 1280].and most risky components are even more overpriced."

He gives the market eight months or thereabouts before it goes truly berserk and suggests you should tend your portfolio accordingly. Quality stocks remain "the least overpriced equities." He favors resource stocks, as in "stuff in the ground," as appealing long-term commitments, while stressing they've had a brisk run, and dubs forestry and good agricultural land as "safe, long-term investments."

However, he warns, to "make money in emerging markets from this point, animal spirits have to stay strong" and "this is possibly the last chapter in a 12-year love affair." Friday's action in global markets gives that warning, sounded some weeks ago, serious heft. It also prompts us to wonder if Jeremy would mind renting out his crystal ball whenever we feel an especial need for reliable foresight.

ALTHOUGH THEY MAY NOT AGREE, Charlie Minter and Marty Weiner are perma bears. Let us hasten to add that is not a term of opprobrium and, indeed, we've often had that label pinned on us (we can't imagine why). In any case, the Comstock Partners pair are good and savvy guys who have had serious reservations for quite a spell about the economic recovery and the bull market it has spawned. They've just completed an exercise that we found interesting and thought you might, too.

Essentially, they've taken eight major economic indicators and stacked them up against where they are today compared with where they were at the peak 36 months ago. They've done the same measuring for the previous two business cycles. Here's what they found:

GDP at this point in the previous two cycles was up an average of 6.4% from the prior peak versus 0.2% now; new-home sales were up 23% then, but are down 47% now; retail sales, up 14% then, are up 1% now; industrial output, up 2.5% then, is down 5.6% now; and payrolls were off 0.1% then and down 5.2% now.

Personal income was up 11% then, and is up 4% now; new orders for durable goods were up 6.2% then, they're down 2.2% now; initial unemployment claims were down 8% then, but they're up 22% now.
And what do Charlie and Marty conclude from these numbers? Simply this: The current market is based on "the same kind of delusionary views that prevailed at the tops in early 2000 and late 2007." 
E-mail: editors@barrons.com



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