Week Ending: June 19, 2009

The most oft cited concern I hear is about the impending "hyper inflation."  And while above-average inflation is certainly a possibility given the reckless increase in money supply, let's take this "hyper inflation" thesis apart.

• As I've mentioned here before, I've never known a major economic turn of events to be predicted by a wide swath of the public in advance.  That's worth discounting the likelihood of hyper inflation, for that reason alone.

• The term "hyper inflation" gets used too easily.  I suspect that many of those that use it are really referring to what might better be termed "above-average inflation."  In fact, it's not even an economic term at all--there is no accepted definition of "hyper inflation."  But usually, "hyper" inflation is the kind that's measured in double-digit-percentage-per-month--and at a minimum is 50% annual inflation.  And when you ask people who are lecturing you about hyper inflation if they really think there's going to be 50% inflation or more in the US, they usually back down and say something more like 20% annual inflation.  Extraordinary, but not "hyper" in the context of Third World experiences. 

• Remember, the markets are smarter than their smartest participants (what is referred to as "rational expectation theory"), and what the markets are saying about the likelihood of hyper inflation is "fat chance."  Consider the TIPS spreads (implied inflation built into Treasuries over Treasury Inflation Protected Securities [TIPS]).  Markets are saying that 5-year annualized inflation will be 1.6%!  On a 10-year basis, it's less than 2%!  That can and will change, but it's a long way from 50%+.

• The deflationary forces are the most they've been since the Great Depression.  The liquidation purge that started last Fall has caused a 30%+ decline in prices for most consumables, most investments, and people's largest asset--their home.  Inflation comes from full capacity utilization (90%+) and right now it's below 70%.  Meaningful inflation must appears in wages and right now, wages are growing at 2% and falling (per the Employment Cost Index).  Now, these are measures from today, and are certainly subject to change, but it's hard to envision a massive increase in inflation that reverses the massive deflationary forces underway in the next couple of years.

• Get ready for the Mother of All Monetary Constrictions.  Fed Chair Bernanke comes from the school that fears the inflation of the '70s.  As soon as the economy shows signs of life, expect the Fed to react aggressively, by increasing the Fed Funds rate dramatically and reversing their "quantitative easing."  Namely, instead of buying Treasuries and other assets (like mortgage backed bonds) to put money that was created ex nihilo (out of nothing) into the system, the Fed will saturate the markets with their assets, driving instrument prices lower, and thus their interest rates higher.  While this may occur with above-average inflation, it's likely to halt rapid price increases and bring the economy to its knees, leading to a Double Dip recession.

So while hyper inflation remains a possibility, it's a very low probability--certainly relative to the focus its receiving.  The more likely result of the "stimulus" (the "sugar high") is above-average, but not hyper, inflation for a time, and then weak economic conditions.

On a different note, how about that Ford Motors?  Not content to take dirty money from the Feds, it's seen a resurrection of sorts.  The Chart of the Week compares GM to Ford over the last year.

CHART OF THE WEEK

THE RICH LIFE: Like you, I'm heartened to see Iranians protest the election results that have supposedly left the religious totalitarians in charge.  I can't help but wonder what role freedom in Iraq has played in all this.  In any case, I hope it resolves itself in a way that gives a leg up to freedom in that country.  Rich living for all tolerant, peace-seeking Iranians!

Week Ending: June 12, 2009

For those that try to trade tactically (...a laudable endeavor within reason...but a difficult one to do profitably...whose necessity gets overstated in Bear markets...) the inclination to exit growth assets now (stocks, commodities, real estate, etc.) is tempting.  It's been a huge move up over the last three months or so.  Here's my precautionary warning: there's a lot of pent up buying pressure still making these markets tough to try and profit-take from.  It's much easier to pick bottoms than tops.  Bottoms (short- intermediate- and long-term) are easier to spot.  They're characterized by panicked bursts.  Overbought markets, however, can continue that way for weeks and months.  Selling early, while seemingly prudent, often results in opportunity cost. 

Two things provide unusual support for growth assets that make the overbought-trade dicey right now.  One is the Federal fiscal and monetary sugar high that the system's beginning to metabolize (extraordinary money creation, "institutional backstopping," and moral hazard).  Second, and perhaps more immediately important, is the Power of Regret.  The more growth markets recover, the more they draw money off the cash-sidelines.  Nobody wants to miss the train if they perceive it to be leaving the station. Let's use stocks as an example.  The chart of the week below shows the US stock market over the last year.

CHART OF THE WEEK

What you can see is that, roughly, anyone and everyone who left the stock market in the last seven months is now at a loss for doing so.  There's at least $1 trillion investor dollars to whom this applies--well intentioned folks who just couldn't take the abuse any more and threw in the towel.  The Market's now 42% up from its bottom (but still 40% below the October 2007 peak), and every positive day it has draws more money back in.  As I've said, for millions of investors, the worst thing that will ever come to them this decade was their decision to leave growth assets at a low level, only to return at a higher level--not the Bear market, but their response to it.

Am I telling you to not sell right now?  Nope.  That's not what we do here.  Instead, I'm suggesting that if you're going to make a big bet against growth assets, it better be well timed.  As I mentioned a couple of weeks ago, we made a slight move in the profit-taking direction, but I'll need further deterioration evidence before making any more out of it.  Eventually this year, markets will cool.  But 2009 will go down as a good year for growth assets (evidenced by the still seemingly implausibility of this forecast).  Now, beyond 2009 it's a different story altogether...

THE RICH LIFE: The "rich life" is not about material wealth.  It's about surrounding yourself with things of real value: your family, your friends, your health, your hobbies and interests, and your contributions and creations.  He who dies with the most enriching relationships and experiences wins.

Week Ending: June 5, 2009

This is the "Victim Era" and our government is promoting "Absolution For All" to a public all too eager to hear how they were coerced into poor decision making.  And that's a shame.  Older generations are shaking their heads.  I don't blame them.

The Financial Crisis is being spun as one created by greedy mortgage lenders, thrust on an unwitting public.  But I for one will go down swinging.  There is an opportunity slipping through our fingers, to embrace financial responsibility, lest we repeat our mistakes again in the coming decades, which seems to me to be a fait accompli at this point.  To wit, last week Congress added Credit Cards to the latest form of borrowing being perpetrated on the public.  In the process, punitive terms on borrowing from Credit Card lenders have been watered down. This is a mistake.

Setting aside the fact that onerous terms on borrowing on a Credit Cards have always been spelled out in accompanying literature, Congress has determined that tough conditions are unfair, and we're not responsible for accepting these terms. I believe that late payments should be treated harshly.  I say allow Credit Cards to charge usurious rates on borrowers that can't fulfill their obligations on time.  (I've fallen prey in the past.)  What a great incentive to practice responsible debt management! 

And yet, we're targeting the supply of credit, to the exclusion of the demand.  It's like blaming drug addiction on the dealers, not the users.  Overuse of debt for consumption is an addiction, and a malady.  The claim against lenders is that they made the drug too accessible, and too addictive.

Undoubtedly, lowered lending standards, borne out of a tidal wave of money-for-lend, made borrowing too easy.  And some regulatory reform is necessary.  But where are the admonitions against borrowers?!  The Depression Generation learned thrift and financial austerity the hard way.  Their knowledge was passed down to the generation immediately following them; but a period of unrivaled prosperity in this country drown out the voices of restraint over the successive decades.  We went from saving 10% of our income, to none.  And now we're in trouble.  Let's help people unwind their leverage, but create a lasting lesson in the process, instead of giving away our diminishing, laudably-earned Treasury just because it's expedient and plays to the feel-good nature that comes from a lack of accountability.

CHART OF THE WEEK

This is the 3-year look at the TED Spread.  The counter-party risk has clearly abated.  That's a very positive divergence from last Fall.  Beyond that, it doesn't say anything about economic or market recoveries.  But the wheels clearly remain firmly attached to the cart.

THE RICH LIFE: I didn't recall all the hoopla from years past surrounding the end of the school year.  The events seem endless...but what the heck?!  Have a great summer boys!

Week Ending: May 29, 2009

The snap-back rally (from March 9th), which was the easiest-earned money in years, seems to have run its course.  Our plan was to be high-beta (across multiple asset classes), and own the particularly-beaten-up (except financial stocks--too unpredictable).  And we've recently parted ways with some of the things we did very well with, specifically the Ultra REIT ETF and the Homebuilder stocks ETF.  The seemingly credible scenario from a few months ago--a full-blown collapse--has given way to one that suggests that while we may not be out of the woods yet, the worst is behind us, the bottom (for markets) was in March and we're on the path to recovery. 

But what a great ride it was...  We'll further increase or decrease portfolio beta, depending on events in the coming weeks.

Where do go from here?  Not sure.  I suspect we'll get continued general improvement in economic conditions, not because of government involvement, but in spite of it.  The uneven recovery will allow most asset classes to continue to recover, and commodities remain the most attractive as they are propelled by economic recovery AND inflationary concerns.  The stock market is overdue for a break--be it a decline or a sideways-move, but I believe it will ultimately resume its upward climb in the second half of the year. Leadership will likely rotate from the impaired industries (banks, real estate, materials, etc.), to those less driven by credit conditions.   The longer term picture remains bleak as America slips further towards the middle of the pack of other socialist, Western systems. 

But the rest of this year holds promise...

CHART OF THE WEEK

These are growth assets, measured from the "bottom" (3/9/09).  SP500 = S&P 500 (US stocks) | UDN = Foreign Currency | VEU = Non-US stocks | IYR = REITs (real estate) | DJP = Commodities

And last week's "mystery" chart?  JDS Uniphase, of course.

THE RICH LIFE: I'm proud of my Little Leaguers.  After a rough start this season, we've gone on to win three of the last four, including a victory over the (previously) undefeated Rays, and a first round playoff last night.  Go A's!

Week Ending: May 22, 2009

This is an interesting time for old line media: newspapers, magazine, radio, and TV.  The advertising-based and central-source-distribution models are under tremendous strain from the economic weakness and the competition of Internet based media (online news, blogs, podcasts, etc.).  It's an exciting and scary time for those of us in the media, and for all of us reliant on external news sources. 

And maybe it's the deterioration in the fundamentals of news gathering, or my increasingly strident attitude as I age, but I am increasingly aghast at the lack of veracity in the quality of what's put out as "news."  If it gets printed, it gets read.  And if it's read, it's believed.  Like Jim Morrison's quote above (“Whoever controls the media, controls the mind.") Few will ever take the time to independently fact check an article in their life time.  I do it all the time.  I've been praised as an "independent thinker," and it's not only very flattering--it's by design.  Everything you need to supplement your understanding of an issue is probably online today.  Especially economic stuff. 

At any rate, this is coming up because I was chuckling my way through a New York Times article about the Dollar, when I realized that most people that were reading the same article probably believed it.  The article suggested that because the Treasury was running the currency printing press, we were flooding the world with dollars and devaluing them in the process--that's why the dollar is weak and doomed to remain so, in the authors mind.  The article was based on views from unnamed "experts" and it dropped a couple of quotes in that were loosely related, at best, to the point of the article.

Let's set the record straight:

• The Fed hasn't increased the money supply by "printing currency."  People use the metaphor all the time...but few understand it's a metaphor.  Anyone can look up how money is created, and it has little to do with paper and ink. 

• The dollar is falling because money is reversing the flow of last Fall, when global financial panic created a stamped to T-Bills (transacted in, duh, US dollars).

• The dollar won't fall relative to another currency, due to an increase of our money supply, if that country is growing money similarly.   And ever major economy in the word has been growing money through this period.

Now, you can disregard my counter-points to the Times article, and join the legions buying into the two populist themes du jour: the Dollar Debasement and Hyper Inflation scenarios, or you can dig a little deeper.  If you still arrive at one of those conclusions, fine, but at least you'll not have digested them simply because they were spoon fed by an over-stretched and under-rigorous media.

CHART OF THE WEEK

Isn't that a remarkable chart?  Recognize this one-time high flyer?  Yes, it's a tech stock--one that seemingly everyone owned back in "the day."  And it 's still trading.  Check back next week for the answer...

THE RICH LIFE: I'm among those who lost a friend last week with the untimely death of Steve Larsen.  A an elite athlete turned businessman, he was a great father and husband, and all around good guy.  We can take two things away from this travesty.  One to emulate his lifestyle--the true embodiment of "rich living."  Steve balanced family (wife Carrie and five kids), competitive athletics (despite being "retired" from the professional circuit), two businesses (his own commercial R/E firm, and an online sporting gear company), his health, and his friends and hobbies as well as anyone I've met.  But let's also use this reminder of the frailty of life and the lack of any guarantees any of us have about our future, to live more deliberately now.  Too often we live life like it's a dress rehearsal, assuming we have an infinite chance to go back and life differently, and more fully than we do know.  As best as I can tell, it takes a lot more than the utterance of "carpe diem!"  From what I've been able to learn--and I remain but an eager neophyte in the ways of rich living--we can only fully live when we take it on as the central point of our life.  It's not easy to do--we're nothing but a series of patterns repeated daily, and a concrete set of limiting beliefs.  But it's worth a try, and to create meaningful chance and lasting richness in life, it takes an intense focus and a herculean effort--the kind of thing we can emulate from Steve Larsen.  In the meantime, love your family like every day is your last.

Week Ending: May 15, 2009

Buy and Hold is dead!  Long live Day Trading! 

It's a popular refrain in Bear Market Bottoms--for good reason.  Investors in stocks have little beyond the 2% annual dividend yield to show for the last decade.  The alternative then, must be a process of buying and selling at opportune times to add to the paltry returns afforded the buy-and-hold strategy.  Sounds simple enough.  Simple, yes...easy, no.  It takes an extraordinary individual to beat the index return--and for all the loud talkers out there, there's really only a small minority that beat the static market.  That's because they face three stiff headwinds:

• Transactions costs...the least of which is commission.  More importantly, it's the bid-ask spread and the friction cost (impact on price from buying/selling--more pronounced in illiquid stock).

• The crowd is smarter than its smartest participant.  Consistently beating the crowd is very difficult to do with a large sample size, such as you find in the investment markets.

• Emotional handicapping.  Investors behave irrationally most of the time.  They sell at bottoms and buy at tops.  They're almost completely driven by fear and greed. 

So, in most cases, and this has been documented in the studies of day traders post-tech-bubble burst, the more frequent a trader, the bolder the trader, the worse the outcome. 

Well, if active trading leads to poor results, and passivity leads to poor results, what's the answer?  The only thing you need to get right is the asset allocation mix.  Stock picking and mutual fund picking are wastes of time--myths created by the brokerage and fund industries to get you to pay higher fees and commissions).  A modifying asset allocation strategy--somewhere between Strategic Allocation (rebalancing asset allocation based on targets) and Tactical Allocation (rebalancing asset allocation based on hunches) can add value because it takes advantage of temporary dislocations (overweighting du to greed, underweighting due to fear) and allows you to play the other side--without over betting the farm.

Introducing: CHART OF THE WEEK.  Each week, I'll share what I hope you'll find to be an interesting chart.  I love graphic displays of information (I once justified to my Mom why I wasn't married at 25 using a chart of maturation [y-axis] vs. age [x-axis] and a half hyperbola--aren't I romantic?!)  Below is the Volatility Index (the "VIX").  It approximates near term uncertainty (derived from forward-month, at the money stock index options).  To my point above, uncertainty translates to risk more reflective of fear-uncertainty than opportunity-uncertainty.  What you see below is that apprehension levels are back to where they were prior to beginning of the "Crisis."  That's bullish and it implies that because a certain amount of the stock sell-off was attributed to panic, absent a completely unanticipated reason for panic, the Market's not going back to where it was on March 9.

CHART OF THE WEEK

THE RICH LIFE: Running total of fishing trips I've taken a pass on, in 2009: 5.  Enough!  Next chance to target the magnificent redside rainbow trout I get...I'm taking it!

Week Ending: May 8, 2009

We learned this week (from Zillow.com) that 22% of all homeowners (20.4 million homes) are under water (more mortgage debt than home value).  Considering that there are about 45 million residential mortgages, that means nearly half of all mortgagees have no equity in their home.  Wow! This is the economic reality of the day, stock-market-recoveries-notwithstanding.  It's part and parcel with my view that we won't have a material improvement in residential real estate for the next three years.  But it also speaks to the financing choices our country has made.

The above quote is one of the first I've come across (Hanson is a Hoover Fellow, and the quote the opening line on his latest syndicated column) that is inline with my view that I fear that the current generation of Americans fail to exhibit those characteristics associated with triumph over strife and personal accountability--traits that served prior generations well, and for which we all are truly indebted to them.  My hero, Theodore Roosevelt, waxed romantically about the virtues of "the strenuous life."  Those that came before us were defined by the forming of a new nation, settling this vast country, enduring a civil war, overcoming the Great Depression, and triumphing over two World Wars.  Every day we lose to old age our few remaining citizens that have truly endured that strife to make this country great, and their zeitgeist is dying with them.

And I consider myself among those contaminated by a sense of entitlement, and can easily take my good fortune for granted.  I've never endured strife, and have never done anything truly great (aside, perhaps, from my current endeavor to mold four great future citizens, along with my wife).  And while I don't think this generation need to apologize for not having been tested, we can remember those that came before us, and acknowledge them, and aspire to their sense of industriousness and responsibility.

This financial crisis, then, is an opportunity.  We can see ourselves as victims of a handful of companies and their greedy executives, or we can acknowledge that there is no mortgage crisis without 45 million US mortgagees, that our country has been on a debt-financed consumption binge for nearly 30 years, and our government cannot and should not claim to be able "fix it" for us.  There is plenty of blame to be assigned business...but so too, must it fall on the backs of government and borrowers.  The risk is of absolving the public and our leaders is to have history repeat itself over and over, wearing away at the fiber of the greatness of this country each time, until we find ourselves ranking among those less industrious, more dependent nations ceding ground the the hungrier, more hard-working emerging countries.

THE RICH LIFE: I asked the boys to finish the sentence, "Why my Mom is important to me..," and post it to construction paper and color it, for my wife for Mother's Day.  Here's one of my faves: "My Mom is important to me because she be's really nice to me and gives me lots of hugs and kisses." - Perry, age 5.

Week Ending: May 1, 2009

The profundity of our shifting politico-economic system is apparently lost on most people.  And that's a shame, because we continue to degenerate into an ineffectual form of rule-and-incentive that will be increasingly difficult to extricate from, absent a paradigm-shifting disaster.  At stake is our entire way of life; I believe that liberty and democracy are inextricably linked to market-based capitalism and free enterprise.  You simply cannot find an exception to this in the annals of history, as far back as its been recorded.

The systemic mutation began in the waning days of the Bush administration and continues to-date, picking up steam of late.  We've apparently chosen to see ourselves as victims of a devious corporate morass, in need of taming by our elected officials. 

Let me give you just one example of our quiet drift away from American ideals.   Two weeks ago, to little fanfare, Treasury announced that they were considering the conversion of their TARP investments from preferred stock to common stock.  Best I can tell, the few that took notice responded with a giant shrug.  "What's the difference?"  I'll get to that in a second.  First, let's talk about why it's come up. 

The American people have tired of the bailouts, and are staggered by the cost (if only we could move them to outrage...).  So, right now, Treasury is trying to avoid another round of infusions, while helping its TARP recipients get to healthier capitalization ratios.  One alternative is to convert the preferred shares that the Government got for its TARP funds, to common shares.  Unlike debt or preferred shares, common equity is no-obligation capital and if the preferred shares are converted to common, the balance sheet improves.  Simple enough.  And yet...

• Stock has an indefinite life.  Shareholders can be owners as long as the company is in business.  So, unlike the Savings and Loan crisis, where the Government (RTC) was in and out  of bank ownership in under a year, as a common shareholder, the Government can hold the stock forever.  I'm not suggesting that's their intent, but it's a possibility.  The counter argument is that the Government can control it's own liquidity events (selling their stock)--and in a frictionless world, where their ownership stake is a minority, that would be true.  But if you think short sellers hurt bank stocks, watch what happens when Uncle Sam decides to get liquid.

• Investors are motivated by profits, which aligns them with the aims of the company to which they lend-money-to (debt) or buy-equity-in (stock).  Politicians are motivated by survival, and thus approval ratings--a value system that's unrelated to obscure, ideological mechanisms like the invisible hand--especially when it runs up against their desire to be approved of.  Shareholders set compensation and pick the directors.  Imagine the kind of person the government would put on a bank board.  Consider the government compelling banks to lend--not to reasonable borrowers, but those that meet a social agenda (that would otherwise be precluded from capital by the discerning private sector).  Imagine the compensation ideas they have, and how quickly anyone who's any good would leave.  Very scary.

• The US taxpayer will take on more risk and in the process, dilute existing bank shareholders.  Common stock is at the end of the line of claims against a failed company.  In a bankruptcy, shareholders are wiped out.  The government has no business exposing the country to the risk of the stock market without its consent. 

THE RICH LIFE: Got a chance to be included in the filming of an outdoors show with my friend Gary.  What a hoot. If you're looking for a procrastination excuse or like pheasant hunting and/or fly fishing, check out:

Segment 1: http://video.yahoo.com/watch/4934146/13141428

Segment 2: http://video.yahoo.com/watch/4934346/13141881

Segment 3: http://video.yahoo.com/watch/4934548/13142390

Segment 4: http://video.yahoo.com/watch/4934716/13142772

HEDGEHOG ARCHIVE