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I’ve been arguing that investors should overweight stocks over bonds, in large part because I don’t forecast a near-term recession.  To say the least, things have not exactly played out like I expected over the past two months.  Recession talk is all the rage, and of course the stock market has sucked.  Time to revisit the analysis.  Could I be wrong?  I know that sounds crazy, but the possibility must be considered.  I’ll review my recession forecasting tool and compare it to the shape of the yield curve, another popular forecasting tool. 

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I have to add a corollary to my “investor PTSD” theory.  Yes, a financial disaster creates in investors an irrational fear of revisiting the scene of that disaster.  But I now add the corollary that investors quickly dust themselves off and confidently hop on to the next bubble.  Up next is the government debt bubble. 
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I, Mr. Buzzkill, find myself in the unusual position of being in an optimist amidst an increasingly pessimistic view of the economy.  Looks like I'll be dedicating a lot of posts in the coming months to defending my optimistic outlook.  A recent article from CNBC warned of a looming corporate "debt bomb".  This post pressents facts that contradict that view.  I continue to suggest overweighting stocks, particularly as more of them hit attractive valuations.
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I continue to recommend overweighting stocks over bonds because the US banking system remains relatively conservative.  Recession therefore seems quite unlikely for the foreseeable future.  But China is in a debt bubble.  This article provides evidence, and addresses the consequences.
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Avoiding investor PTSD is hard to do.  I failed miserably with Wayfair, as this post explains.  But I’m hanging in there for the long-run with housing stocks.

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“Yes, the stock seems cheap, Gordon.  But what’s the catalyst?”  My best guess is that a relentless stream of earnings that over time will convince more and more investors that the housing market is far healthier than they fear and the mortgage insurers, rather than in imminent danger of earnings hits, will grow their earnings consistently over the next five years.  In my last blog post I noted MGIC’s strong Q3 earnings, and said that Radian and National Mortgage Insurance’s earnings this week would do the same.

I was right.  This morning, Radian reported operating earnings per share of $2.68 annualized, compared to a Wall Street forecast of $2.52.  And last night, National Mortgage delivered $1.84 annualized versus a $1.64 forecast.  MGIC should reasonably trade at $20 a share, up 60% from its current price.  And Radian should be at $32, or up 70%.

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Since October 17, when MGIC, one of my favorite housing-related stocks, reported strong earnings, its stock price fell by 10%.  So did its peer Radian.  This puts MGIC’s earnings yield (2018 expected earnings per share divided by stock price) at 13%, and Radian’s at 14%.  Could MGIC’s stock really be lower in two years than its current $11.65 price?  $20 a lot more realistic by then.  Little chance of a decline (the risk) and a reasonable chance of up 70% (the reward).  For Radian, I believe the upside is more like 100%. 

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Investors remain afraid that home sales, mortgage credit and airline excess capacity will return to crisis conditions.  Reality is quite different, as evidenced by solid earnings reports this month from homebuilders Lennar and Pulte, mortgage insurer MGIC and airlines United and Delta.  The difference between current investor emotion and reality should create a very large investment opportunity.  When will fat tail fears abate?  Who knows.  The inflation story says it takes a long time.  But I for one expect the wait to be worth it.  To keep it simple, my Skinny Tail Mini Investment Fund consists of Pulte Homes, MGIC and American Airlines.
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Last week the 10-year Treasury bond yield hit 3.2%, its highest yield since 2011.  And last week the stock market got beat up pretty good.  So is it time to shift some investment assets from stocks to bonds?  I believe the answer is “No”, for two reasons.  First, bond yields still stink relative to inflation.  Second, I expect the US economic expansion to continue for the foreseeable future.  If so, stocks are highly likely to outperform bonds.

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Pulte Homes’ stock closed last night at $23.86.  Stock analysts polled by Yahoo Finance expect Pulte to earn $3.84 a share next year, so the stock is selling at a 16% earnings yield.  That huge yield clearly indicates that investors expect home construction to fall off the cliff in the not-too-distant future.  That is an understandable view considering that the US is in its 10th year of an economic expansion, and new home sales in its 8th year.  But I argue here that this housing cycle is quite different, and both the economy and homebuilding in particular have at least several good years ahead that will make it worth buying Pulte at its current price.

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