"Armaments, universal debt and planned obsolescence - those are the three pillars of western prosperity." - Aldous Huxley
I tend to agree with Aldous. In times of war government spending creates jobs and prosperity for those that are not in the trenches. For some that are in the trenches it is better than being at home unable to find a job and wondering why life has dealt you such a poor hand. A man needs to work for his soul more than anything. He needs a place to go, where he can feel wanted, needed and a part of something, whether it is fighting on the front line or working on Wall Street. A sense of purpose goes a long way to cultivating a positive attitude about the future. Those of you who follow this blog will know that I believe that a lot can be accomplished with positive consumer confidence.
Planned obsolesce is what technology thrives on. Think back just five years and try to remember what your cell phone could do. I am unsure if mine could even download emails let alone surf the web, play music, take pictures, give me directions, pay a bill, deposit a check, reserve an airline ticket and then be that ticket at check in, just to name a few. Technology creates obsolescence and this drives the consumer to upgrade and consume.
So with wars all over the globe and technology creating new products left and right plus a rapidly growing governmental debt burden we should be primed for inflation right? Not so fast. There are a number of people that think that deflation could be on its way and if they are correct then we are really looking at a long protracted problem.
In order to create inflation you need to have excessive demand over supply. Pumping money into an economy and lowering interest rates normally does the trick but the problem is that this works when other economies around the globe are growing and have a demand for your goods and services. The issue right now is that pumping money into the global pool is not working for two reasons; first there is no demand for the money no matter how cheap you make it, and second the bubbles that burst in the housing and the derivative markets were so large that the influx of cash is soaked up in a nano-second before reaching their intended targets.
With every government around the globe trying to resuscitate their economies at the same time the world is awash with cash. Furthermore the large companies of the globe are sitting on more than a trillion dollars. Pumping more money into the system is therefore having no effect. Those that can borrow do not need the money and those that desperately need the money are unable to get a loan. Consumers are trying to cut debt as fast as possible and are certainly not interested in adding more debt, so the Federal Reserve is pushing on a string.
Furthermore the recession is driving the prices of virtually everything down. Technology is one factor that is driving deflation but there are others. Amongst them is the continual depreciation in the price of housing and other assets. In addition, the lack of demand is forcing businesses to cut the price of thousands of items. Look no further than Walmart or all of the discount airfares and hotel prices that abound. The four stand-outs that are not getting cheaper are gas, food, health care and education. Of these I would expect that gas prices will start to drop as demand for oil drops. Food prices should continue to spiral higher as the world demand for food continues to outstrip supply and medical expenses will spiral higher as long as the government meddles. Education is similar to medical in that the government subsidies are creating a false market for these products and hence drive the prices higher, but these are the only three places where I can see sustained price growth.
Should we therefore be concerned that inflation is around the corner. For that to happen you require demand to exceed supply, therefore you need the consumer to buy more goods than are available. Think of what happens at Walmart and other stores on Black Thursday when prices are dropped to ridiculously low prices for one day just to drive traffic. It is madness and shows in real life what it is like to have demand exceed supply. In the real world however we have massive unused capacity at the factories around the world and there are million of unemployed workers looking for employment. Until these two data points start to dip it is hard to see how inflation can resurrect itself. You need consumers to buy goods but they are out of work and those that are working have seen their pay getting cut or are trying to whittle down their debt burden. Companies are not necessarily laying people off, but they are not hiring. In this environment I would expect to see increased productivity numbers as less workers produce more goods. So until there is a binge of hiring (which I do not see in the immediate future) we will be stuck in this quagmire.
In this environment consumers tend to save as buying assets is a losing proposition. Just look at Japan who has one of the highest savings rates in the world and who has been stuck in a deflationary environment for two decades. I would expect to see the US savings rate climb to a double digit number in the coming years and this will create a drag on economic growth for years to come. Furthermore, interest rates should remain low for years because until there is demand for the money being lent there is no reason for rates to increase. The incentive to borrow is that rates are low so take on debt, but when no-one wants to borrow rates can stay low for decades. Once again look at Japan which shows how this situation will be exacerbated by an increase in the savings rate.
Sluggish growth will not help the stock market and therefore I am firmly in the bear camp. That said there will always be rallies within a bear market so for you traders who can sniff out the next rally I wish you luck. For the rest of you I would continue to recommend that you sit in cash and start to get used to returns of three percent or less on your money.
Wednesday, October 19, 2011
Friday, October 14, 2011
The Great Stock Recovery - Or Not?
"You can fool all the people all the time if the advertising is right and the budget is big enough." - Joseph E. Levine
Let me start this blog by saying that I am not a perma-bear (a person that is constantly negative on the stock market), I am just giving you the best advice I can based on my overall economic outlook. Let me also say that this blog or quote is not about Apple stock or its products both of which I believe are overly priced stocks and gadgets that have been hyped by an exceptionally brilliant salesman.
No, I am referring to the market which has just rallied more than 10 percent in less than two weeks. Many are talking about this as the beginning of the next bull market but I would caution you to remain on the sidelines. In dissecting the stock market movements that have occurred during the previous decades it is clear that the market has averaged returns north of 7 percent a year. This number is often touted by unseasoned professionals and financial planners as the reason to invest in a portfolio of stocks. The return is higher than those of the bond market or most other investments the argument goes, so it is imperative to hold stocks (and a large portion of them) in your portfolio. Not only should you buy them but no matter what the outlook you should remain in stocks as you can never time the market and the average return will even out over the long-term.
My beef with this argument is that the long-term is often longer than any of us have left in our lifetimes. This average return has been averaged over roughly 100 years! I am sure I do not have that long left on this planet and if I do then my son will have his hands full in supporting me! No, most of us have a horizon of 10 to 20 years at most, so I would argue that you need to look at returns over those periods of time. Taking these parameters the landscape changes in an instant. Stocks have not moved at all since 2000 and in fact are well below that peak and have provided a negative compound annual rate of return of (0.5) percent. Going back another 10 years (1990 to 2000) and suddenly you are rewarded for being in stocks with compound annual returns of over 13 percent for that decade. Taking the two decades together and your total return falls to just over 6 percent or below the general trend.
So buy stocks now and be rewarded over the next 10 years? To answer that question we have to look at what drives stock returns. Returns to stocks are highly correlated to the increased earnings that companies enjoy as the economy expands. Looking back at the 1980s through to 2000 the US economy benefited from years of overspending by the US consumer whose savings rate dropped from 12 percent to 1 percent. Furthermore household debt increased from 65 percent of disposable after tax income to 135 percent. Added to this was low interest rates, easy money loans and many other exuberance's that were unsustainable. It was just a matter of time until the party was over and it is now over. These excesses are going to take a long time to unwind driving down economic growth and therefore company profits. I expect that the current economic environment will last at least another five years if not a decade therefore I conclude that the stock market will produce returns close to zero or even negative returns during that time frame. Assuming no return for the next decade takes the average return in the market for the 30 year period down to 3.85 percent. Certainly not something to crow over.
I would argue that rather than risk your money in a volatile stock market that is producing no returns but which has the propensity to nose dive at a given notice that you should exit stocks for an extended period and start to realize that a return of three to four percent on your money is the new "normal". At least for the next decade it is. If you then factor in the real probability that there may be global deflation coming your real rate of return on an investment yielding 3 percent could be as high as 6 percent. No-one would sniff at that now would they? (In my next blog I will look into the reasons that deflation is still an impending problem and how it will affect your investment outlook for years to come.)
In these poor economic times and until the global economy gives signs of stability I believe that you should exit stock positions and look to invest the proceeds in income bearing investments. If you must own stocks then look to large cap dividend plays as these companies will be able to sustain an extended downturn far more safely than smaller companies. Don't get me wrong, I believe that there will be plenty of companies that make a lot of money in this environment and innovators will succeed as always, but outside of these exceptions stocks are not a good place to be invested at present. Furthermore I would argue that finding a safe return of 3 percent will be looked upon as an excellent investment in the coming years.
Let me start this blog by saying that I am not a perma-bear (a person that is constantly negative on the stock market), I am just giving you the best advice I can based on my overall economic outlook. Let me also say that this blog or quote is not about Apple stock or its products both of which I believe are overly priced stocks and gadgets that have been hyped by an exceptionally brilliant salesman.
No, I am referring to the market which has just rallied more than 10 percent in less than two weeks. Many are talking about this as the beginning of the next bull market but I would caution you to remain on the sidelines. In dissecting the stock market movements that have occurred during the previous decades it is clear that the market has averaged returns north of 7 percent a year. This number is often touted by unseasoned professionals and financial planners as the reason to invest in a portfolio of stocks. The return is higher than those of the bond market or most other investments the argument goes, so it is imperative to hold stocks (and a large portion of them) in your portfolio. Not only should you buy them but no matter what the outlook you should remain in stocks as you can never time the market and the average return will even out over the long-term.
My beef with this argument is that the long-term is often longer than any of us have left in our lifetimes. This average return has been averaged over roughly 100 years! I am sure I do not have that long left on this planet and if I do then my son will have his hands full in supporting me! No, most of us have a horizon of 10 to 20 years at most, so I would argue that you need to look at returns over those periods of time. Taking these parameters the landscape changes in an instant. Stocks have not moved at all since 2000 and in fact are well below that peak and have provided a negative compound annual rate of return of (0.5) percent. Going back another 10 years (1990 to 2000) and suddenly you are rewarded for being in stocks with compound annual returns of over 13 percent for that decade. Taking the two decades together and your total return falls to just over 6 percent or below the general trend.
So buy stocks now and be rewarded over the next 10 years? To answer that question we have to look at what drives stock returns. Returns to stocks are highly correlated to the increased earnings that companies enjoy as the economy expands. Looking back at the 1980s through to 2000 the US economy benefited from years of overspending by the US consumer whose savings rate dropped from 12 percent to 1 percent. Furthermore household debt increased from 65 percent of disposable after tax income to 135 percent. Added to this was low interest rates, easy money loans and many other exuberance's that were unsustainable. It was just a matter of time until the party was over and it is now over. These excesses are going to take a long time to unwind driving down economic growth and therefore company profits. I expect that the current economic environment will last at least another five years if not a decade therefore I conclude that the stock market will produce returns close to zero or even negative returns during that time frame. Assuming no return for the next decade takes the average return in the market for the 30 year period down to 3.85 percent. Certainly not something to crow over.
I would argue that rather than risk your money in a volatile stock market that is producing no returns but which has the propensity to nose dive at a given notice that you should exit stocks for an extended period and start to realize that a return of three to four percent on your money is the new "normal". At least for the next decade it is. If you then factor in the real probability that there may be global deflation coming your real rate of return on an investment yielding 3 percent could be as high as 6 percent. No-one would sniff at that now would they? (In my next blog I will look into the reasons that deflation is still an impending problem and how it will affect your investment outlook for years to come.)
In these poor economic times and until the global economy gives signs of stability I believe that you should exit stock positions and look to invest the proceeds in income bearing investments. If you must own stocks then look to large cap dividend plays as these companies will be able to sustain an extended downturn far more safely than smaller companies. Don't get me wrong, I believe that there will be plenty of companies that make a lot of money in this environment and innovators will succeed as always, but outside of these exceptions stocks are not a good place to be invested at present. Furthermore I would argue that finding a safe return of 3 percent will be looked upon as an excellent investment in the coming years.
Thursday, October 6, 2011
A Liquidity Trap?
"Putting somebody who is suffering from anorexia on a diet doesn't make a lot of sense to me." - Paul McCulley
A liquidity trap is loosely defined as a period in which the private sector delevers their balance sheet of debt or increases their savings rate at which time reducing interest rates has no effect on aggregate demand as there is no desire to accept more debt regardless of how cheap. During these periods the Keynesian economists believe that the only way out of this trap is to have the government shoulder more debt until such time as the private sector has cleaned itself up and is ready to start to grow again. In this argument, cutting government spending and stimulus during this period is suicide as this will lead to further contraction and exacerbate the problem.
The main example of how this worked in real life was back during the great depression era. The great depression ended in large part to WWII. The massive influx of spending from the government produced the stimulus needed to pull the economy out of its malaise. Furthermore the GI Bill helped millions of Americans returning from the war purchase a house and get retrained. In those times it was considered a privilege rather than a handout (as it would be today). Having been in combat myself I can assure you that it is a privilege that is deserved whereas right now it is definitely a handout.
At present there is a global call for governments around the world to delever their balance sheets and this could push the entire global economy over the edge. I must admit that to some extent I agree with this argument. Cutting government spending would mean cutting jobs and this would lead to an increased unemployment level reducing demand for goods and services even further. On the other hand having the government spend more money sends a chill down my spine. So why is that and what are the differences between then and now?
The difference between the government spending money on a war and spending money during peace time are significant. During a war you send away (or employ) thousands of people to fight, many of whom never come back. This contracts the workforce significantly. During WWII it resulted in there being a lack of employable men to run the factories so the women stepped into that roll. Furthermore the government spent money on factories and innovation, a direct stimulant to the economy that required immediate employment. The result was that after the war the boom continued and lasted for decades as the private sector stepped in to monetize the opportunities.
Today we see a government that is bent on spending but the use of the money is what is exasperating. To date we have spent more than $3 trillion to fix nothing. Had the government used that money to hire people to work factories and innovate rather than sink it into the hands of a few large failing banks and businesses we would have a different outlook. People would be back to work rather than collecting unemployment checks for 99 weeks. This would have the effect of turning our current pessimistic outlook into a positive outlook and we have all seen what happens when everyone believes in the future - the future is bright.
The current pessimism around the world is a factor of a poor economy AND a lack of leadership. If it were just a poor economy people would be of the mindset that the vacation this year may have to be cancelled. Adding in weak leadership and people start to think that not only will we not go on holiday this year but we will never go on holiday again. Furthermore they begin to question the government spending programs and start to call for austerity right at the time when we need the government to step up spending.
Do we still have time to fix this? I believe that we do, however I do not think it will happen until we have a leader that takes the helm and drives the ship away from the rocks towards which we are headed. At present we have the capacity to take on more debt. Due to the weakness around the globe every country is trying to weaken their currency. With everyone trying to weaken stimulating more should not create a capitulation in the dollar. The problem therefore is not that we are unable to print more money (like Greece) but that if we do we will not spend it in the correct manner.
Based on this it certainly appears that the economy will stagnate for a longer period than anyone is prepared to accept. My view is that at present we are locked into this malaise until the property market clears and that is looking like at least another five years if not longer. Low interest rates are here for the foreseeable future as well as there is no demand to borrow from the private sector. Furthermore inflation seems to be contained as there is such an output gap that further stimulus from the government should keep a lid on this for the foreseeable future. In addition the price of raw materials is falling as weak demand is starting to seep into those prices. For example oil is down more than 25% from its recent highs.
In this environment stocks will not perform well and there will be limited opportunities to make money on your investments in the traditional ways. Look to alternative investments and once you have found an opportunity make sure that you scrub it down thoroughly as often times the risks associated with the investment will far outweigh the potential rewards.
A liquidity trap is loosely defined as a period in which the private sector delevers their balance sheet of debt or increases their savings rate at which time reducing interest rates has no effect on aggregate demand as there is no desire to accept more debt regardless of how cheap. During these periods the Keynesian economists believe that the only way out of this trap is to have the government shoulder more debt until such time as the private sector has cleaned itself up and is ready to start to grow again. In this argument, cutting government spending and stimulus during this period is suicide as this will lead to further contraction and exacerbate the problem.
The main example of how this worked in real life was back during the great depression era. The great depression ended in large part to WWII. The massive influx of spending from the government produced the stimulus needed to pull the economy out of its malaise. Furthermore the GI Bill helped millions of Americans returning from the war purchase a house and get retrained. In those times it was considered a privilege rather than a handout (as it would be today). Having been in combat myself I can assure you that it is a privilege that is deserved whereas right now it is definitely a handout.
At present there is a global call for governments around the world to delever their balance sheets and this could push the entire global economy over the edge. I must admit that to some extent I agree with this argument. Cutting government spending would mean cutting jobs and this would lead to an increased unemployment level reducing demand for goods and services even further. On the other hand having the government spend more money sends a chill down my spine. So why is that and what are the differences between then and now?
The difference between the government spending money on a war and spending money during peace time are significant. During a war you send away (or employ) thousands of people to fight, many of whom never come back. This contracts the workforce significantly. During WWII it resulted in there being a lack of employable men to run the factories so the women stepped into that roll. Furthermore the government spent money on factories and innovation, a direct stimulant to the economy that required immediate employment. The result was that after the war the boom continued and lasted for decades as the private sector stepped in to monetize the opportunities.
Today we see a government that is bent on spending but the use of the money is what is exasperating. To date we have spent more than $3 trillion to fix nothing. Had the government used that money to hire people to work factories and innovate rather than sink it into the hands of a few large failing banks and businesses we would have a different outlook. People would be back to work rather than collecting unemployment checks for 99 weeks. This would have the effect of turning our current pessimistic outlook into a positive outlook and we have all seen what happens when everyone believes in the future - the future is bright.
The current pessimism around the world is a factor of a poor economy AND a lack of leadership. If it were just a poor economy people would be of the mindset that the vacation this year may have to be cancelled. Adding in weak leadership and people start to think that not only will we not go on holiday this year but we will never go on holiday again. Furthermore they begin to question the government spending programs and start to call for austerity right at the time when we need the government to step up spending.
Do we still have time to fix this? I believe that we do, however I do not think it will happen until we have a leader that takes the helm and drives the ship away from the rocks towards which we are headed. At present we have the capacity to take on more debt. Due to the weakness around the globe every country is trying to weaken their currency. With everyone trying to weaken stimulating more should not create a capitulation in the dollar. The problem therefore is not that we are unable to print more money (like Greece) but that if we do we will not spend it in the correct manner.
Based on this it certainly appears that the economy will stagnate for a longer period than anyone is prepared to accept. My view is that at present we are locked into this malaise until the property market clears and that is looking like at least another five years if not longer. Low interest rates are here for the foreseeable future as well as there is no demand to borrow from the private sector. Furthermore inflation seems to be contained as there is such an output gap that further stimulus from the government should keep a lid on this for the foreseeable future. In addition the price of raw materials is falling as weak demand is starting to seep into those prices. For example oil is down more than 25% from its recent highs.
In this environment stocks will not perform well and there will be limited opportunities to make money on your investments in the traditional ways. Look to alternative investments and once you have found an opportunity make sure that you scrub it down thoroughly as often times the risks associated with the investment will far outweigh the potential rewards.
Thursday, September 29, 2011
The Power of Compounding
"The safe way to double your money is to fold it over once and put it in your pocket." - Frank Hubbard
I know that this is a subject that most of you understand but most of us tend to forget how powerful it is over the long run. I spend a lot of my time chatting to investors about how to maximize their investment returns and it simply boils down to maintaining a consistent positive return year after year.
When I talk about consistent I am referring of course to small amounts of volatility. Volatility is fine if you are trading but it can be murder on returns. Selling at the lows and buying at the highs is the most common mistake made by pretty much all investors. Eliminating this from your portfolio will produce far better returns. If you could cut the losers from your portfolio and let the winners run I am sure you will agree that you would be in a far better financial position.
Now this is not easy to do for a number of reasons but the most prevalent reason of them all is that people get emotionally involved with their investments. After months of research you buy into a position just as the market turns and you are instantly in a losing position. You double down and it falls lower so you buy more. Down it goes again. Now your pride is hurt and you want to get even but the more you buy the lower it goes so the trade now turns to a long term hold. There is no way that you will sell now that your pride has been called into question. Rather sit on the position for eternity until it at least comes back to where you purchased it so that you can proudly tell everyone that you did not take a loss.
This is where you have thrown all thoughts of compounded annual rates of return out of the window. The way to true wealth is through compounding but by dragging along a loser for years you have immediately dropped your total rate of return and thereby reduced the compounding effect on your overall portfolio. Rather take the loss early and look to get in when the position is a lot lower or reinvest the proceeds into something that is working than have the drag on the portfolio.
Furthermore the psychological impact can be immense. First off there is the negativity that can impact your social life and secondly it can have a negative impact on your next trade. If the next trade does not go well then you can end up losing confidence and this can destroy a person's trading career. I do not say this lightly as it has ended many a career on the trading floor.
As a brief recap on compounding, the table below shows you the impact that just 3 percent can have on a portfolio of $1 million:
Compound annual rate of return at 5% for 10 years = $1,283,359
Compound annual rate of return at 8% for 10 years = $1,489,846
The difference after 10 years is over $200,000. This is not insignificant. If you increase the time frame to 20 years the difference balloons to $2,214,162. That is real money and therefore you should pay strict attention to all the investments in your portfolio to ensure that they are providing you a few extra percentage points of return as this can mean the difference between a happy retirement and one that is a struggle.
The last issue with this is that normally it takes a lot more risk to get those few percentage points than it is worth however one place that you can look is your cash deposits. These create a huge drag on a portfolio as they are currently earning nothing. Find a place that can provide you 2 or even 3 percent on this cash like fixed rate deposits and this will provide your entire portfolio the boost that it needs to get you to retirement sooner rather than never.
I know that this is a subject that most of you understand but most of us tend to forget how powerful it is over the long run. I spend a lot of my time chatting to investors about how to maximize their investment returns and it simply boils down to maintaining a consistent positive return year after year.
When I talk about consistent I am referring of course to small amounts of volatility. Volatility is fine if you are trading but it can be murder on returns. Selling at the lows and buying at the highs is the most common mistake made by pretty much all investors. Eliminating this from your portfolio will produce far better returns. If you could cut the losers from your portfolio and let the winners run I am sure you will agree that you would be in a far better financial position.
Now this is not easy to do for a number of reasons but the most prevalent reason of them all is that people get emotionally involved with their investments. After months of research you buy into a position just as the market turns and you are instantly in a losing position. You double down and it falls lower so you buy more. Down it goes again. Now your pride is hurt and you want to get even but the more you buy the lower it goes so the trade now turns to a long term hold. There is no way that you will sell now that your pride has been called into question. Rather sit on the position for eternity until it at least comes back to where you purchased it so that you can proudly tell everyone that you did not take a loss.
This is where you have thrown all thoughts of compounded annual rates of return out of the window. The way to true wealth is through compounding but by dragging along a loser for years you have immediately dropped your total rate of return and thereby reduced the compounding effect on your overall portfolio. Rather take the loss early and look to get in when the position is a lot lower or reinvest the proceeds into something that is working than have the drag on the portfolio.
Furthermore the psychological impact can be immense. First off there is the negativity that can impact your social life and secondly it can have a negative impact on your next trade. If the next trade does not go well then you can end up losing confidence and this can destroy a person's trading career. I do not say this lightly as it has ended many a career on the trading floor.
As a brief recap on compounding, the table below shows you the impact that just 3 percent can have on a portfolio of $1 million:
Compound annual rate of return at 5% for 10 years = $1,283,359
Compound annual rate of return at 8% for 10 years = $1,489,846
The difference after 10 years is over $200,000. This is not insignificant. If you increase the time frame to 20 years the difference balloons to $2,214,162. That is real money and therefore you should pay strict attention to all the investments in your portfolio to ensure that they are providing you a few extra percentage points of return as this can mean the difference between a happy retirement and one that is a struggle.
The last issue with this is that normally it takes a lot more risk to get those few percentage points than it is worth however one place that you can look is your cash deposits. These create a huge drag on a portfolio as they are currently earning nothing. Find a place that can provide you 2 or even 3 percent on this cash like fixed rate deposits and this will provide your entire portfolio the boost that it needs to get you to retirement sooner rather than never.
Tuesday, September 20, 2011
QE3?
"Enjoy when you can, and endure when you must." - Johann Wolfgang von Goethe
Europe is a mess. Italy has just been downgraded and Greece will default at any moment. The stock market, the only beneficiary of the Federal Reserve's quantitative easing, is struggling and the fear around the world has pushed gold to new highs. Every investment conference I go to touts gold and gold mining stocks. A bubble is starting to form in the space. Don't get me wrong it is still a long way from a bubble but it is coming. I would still load up on the gold mining stocks as the market has not yet priced in the gold price move but I doubt that this will be a long-term hold but rather a short-term trade.
The Federal Reserve is currently meeting. They have extended the meeting an extra day to make sure that everything that needs to be discussed is discussed. They have a lot to talk about and I believe that a lot of what will be said will be about another round of quantitative easing.
It is clear that the stock market needs the juice provided by the Federal Reserve to operate. Take the stimulus away and it is all over for the stock market. The housing market continues to drag and the shadow inventory will begin to show up in the very near future forcing prices even lower. The government entities are holding almost 1 million houses in inventory. They need to unwind these but there is no market for them. Add to this the number held by the banks and it is easy to see why the price of housing has nowhere to go but down.
With all of these issues and the problems in Europe, the Federal Reserve has no option but to continue to print money. They are already adding to the Eurodollar reserves. Even though I believe that the policy is flawed they are too deep into it to stop now. The questions are how large is the stimulus going to be and when will it happen? I believe that they will announce round three at the close of the meeting this week and that it will be a large amount. The reason for this is that this is really one of the last opportunities that they have without bringing into question their neutrality.
Already there is a lot of mud slinging going on in congress and President Obama has recently unveiled a tax hike aimed at the rich. Jobs and a balanced budget are front and center in the political debates and the Federal Reserve cannot be seen to support either side. Delaying the inevitable will create a situation that drags the Federal Reserve into the political spotlight. It cannot afford this if it is to remain intact. Already there is a high level of distrust of their policies and the politicians are eager to find somewhere to place the blame. What easier target than the Federal Reserve.
Therefore I believe that if we are to see some new easing it will be in the very near future and could easily be tomorrow. As such if you are a gambling man you could take a swing that it happens tomorrow and go long the market as if the announcement happens there should be a good upside pop. On the flip side I believe that the market is starting to price in another round of easing and if it does not happen you could be in for a huge decline. A safe way to play this is to buy options on the market. If you straddle the market with a put and a call option at the money then you could benefit no matter which direction the market goes. All you need is a big move and I believe that one is coming.
As this is a short-term trade I would not go all in on this but would limit your risk by moving the bulk of your investments into cash if you have not already done it. Look to alternate investments options and if you are at a loss as to what those may be contact me and I will point you in the right direction.
Europe is a mess. Italy has just been downgraded and Greece will default at any moment. The stock market, the only beneficiary of the Federal Reserve's quantitative easing, is struggling and the fear around the world has pushed gold to new highs. Every investment conference I go to touts gold and gold mining stocks. A bubble is starting to form in the space. Don't get me wrong it is still a long way from a bubble but it is coming. I would still load up on the gold mining stocks as the market has not yet priced in the gold price move but I doubt that this will be a long-term hold but rather a short-term trade.
The Federal Reserve is currently meeting. They have extended the meeting an extra day to make sure that everything that needs to be discussed is discussed. They have a lot to talk about and I believe that a lot of what will be said will be about another round of quantitative easing.
It is clear that the stock market needs the juice provided by the Federal Reserve to operate. Take the stimulus away and it is all over for the stock market. The housing market continues to drag and the shadow inventory will begin to show up in the very near future forcing prices even lower. The government entities are holding almost 1 million houses in inventory. They need to unwind these but there is no market for them. Add to this the number held by the banks and it is easy to see why the price of housing has nowhere to go but down.
With all of these issues and the problems in Europe, the Federal Reserve has no option but to continue to print money. They are already adding to the Eurodollar reserves. Even though I believe that the policy is flawed they are too deep into it to stop now. The questions are how large is the stimulus going to be and when will it happen? I believe that they will announce round three at the close of the meeting this week and that it will be a large amount. The reason for this is that this is really one of the last opportunities that they have without bringing into question their neutrality.
Already there is a lot of mud slinging going on in congress and President Obama has recently unveiled a tax hike aimed at the rich. Jobs and a balanced budget are front and center in the political debates and the Federal Reserve cannot be seen to support either side. Delaying the inevitable will create a situation that drags the Federal Reserve into the political spotlight. It cannot afford this if it is to remain intact. Already there is a high level of distrust of their policies and the politicians are eager to find somewhere to place the blame. What easier target than the Federal Reserve.
Therefore I believe that if we are to see some new easing it will be in the very near future and could easily be tomorrow. As such if you are a gambling man you could take a swing that it happens tomorrow and go long the market as if the announcement happens there should be a good upside pop. On the flip side I believe that the market is starting to price in another round of easing and if it does not happen you could be in for a huge decline. A safe way to play this is to buy options on the market. If you straddle the market with a put and a call option at the money then you could benefit no matter which direction the market goes. All you need is a big move and I believe that one is coming.
As this is a short-term trade I would not go all in on this but would limit your risk by moving the bulk of your investments into cash if you have not already done it. Look to alternate investments options and if you are at a loss as to what those may be contact me and I will point you in the right direction.
Monday, September 12, 2011
Investing versus Trading
"Business is the art of extracting money from another man's pocket without resorting to violence." - Max Amsterdam
This week's blog is very near and dear to my heart. When I began in this business over 20 years ago I was an investor through and through. The only way to invest was through hard work. Start with a detailed analysis of a company, drill down into the numbers to find hidden value, interview management to make sure that nothing was missed and if the stock was still cheap relative to the results from my analysis then I would load up on the position. If the stock dropped lower I would confidently add to my position and then wait patiently for the rest of the market to discover my hidden gem and take it to my target price. Once there I would offload.
Of course I would keenly await the quarterly reports and raise or lower my expectations based on management comments and the reported numbers and guidance. I would hold positions for months if not years and normally I would be rewarded for my effort. Time, effort and patience were virtues and a formal education in analysis was important. Do your apprenticeship with a financial consulting firm or one of the major investment banks and you had a ticket to riches.
This all changed with the NASDAQ bubble and the advent of massive computer power. I clearly remember during the NASDAQ bubble in 1999 a technical trader friend of mine asking which positions I held. After our discussion he took five minutes to evaluate each of these technically and purchased a few of the names on their "breakout". He proceeded to buy more and more as the stocks moved higher and then exited near the top for a massive profit. I was amazed that anyone could base millions of dollars on a technical chart.
Over the years since I have become a keen advocate of technical analysis mainly because the market has changed so much that it almost makes financial analysis worthless. Certainly there is a place for financial analysis but it is more and more likely to be found in private equity funds than in Wall Street hedge funds. Traders have taken over the market and seek to gain an edge not by superior financial analysis but through superior speed and cheaper price of execution of a trade.
Traders seeking an edge try to sit right next to the market (literally) to get a millisecond advantage over the competition that is sitting a thousand miles away. This is all that they need. Company stocks are unknown only tickers are relevant and price to earnings ratios are replaced with stock price momentum. This is why you have situations where high priced stocks just keep on going while lower priced stocks do not move.
This is all very good and well but it has turned Wall Street into a glorified casino. The authorities are turning a blind eye to all of this as they are all making money. The average daily volume of stocks traded has almost quadrupled over the past decade while the market value of the Standard and Poors 500 (the largest 500 companies listed on the United States stock markets) has not moved. Money is being made by charging a fee for each share traded. Meanwhile investors are not being rewarded for this greed and are in reality the chicken fodder. Give us your money so we can pay ourselves fees and you can receive a negative return on your money.
This has to stop and is going to end badly. While everyone is making money no-one will turn their attention to these market practices. The downside is that just as the computers are pushing prices higher, at some point when the market bursts they will drive prices lower and in a hurry. At this point Congress will look into the problem but by then it will be too late. Thousands of investors will have lost their shirts but this time hopefully Wall Street will be made to pay.
Protect yourself by moving out of the market and looking for opportunities elsewhere. For those of you with a conservative edge I would advise that you take a long hard look at your overall portfolio and try to find a decent yield in a low yield environment. As I mentioned to a friend of mine the other day, it is better to get out now and protect against a 50% retracement than to try to catch a 10% increase in the market. Things are skewed to the downside so look to exit and wait patiently for the bottom. It will come and you will be rewarded, just like the old days.
This week's blog is very near and dear to my heart. When I began in this business over 20 years ago I was an investor through and through. The only way to invest was through hard work. Start with a detailed analysis of a company, drill down into the numbers to find hidden value, interview management to make sure that nothing was missed and if the stock was still cheap relative to the results from my analysis then I would load up on the position. If the stock dropped lower I would confidently add to my position and then wait patiently for the rest of the market to discover my hidden gem and take it to my target price. Once there I would offload.
Of course I would keenly await the quarterly reports and raise or lower my expectations based on management comments and the reported numbers and guidance. I would hold positions for months if not years and normally I would be rewarded for my effort. Time, effort and patience were virtues and a formal education in analysis was important. Do your apprenticeship with a financial consulting firm or one of the major investment banks and you had a ticket to riches.
This all changed with the NASDAQ bubble and the advent of massive computer power. I clearly remember during the NASDAQ bubble in 1999 a technical trader friend of mine asking which positions I held. After our discussion he took five minutes to evaluate each of these technically and purchased a few of the names on their "breakout". He proceeded to buy more and more as the stocks moved higher and then exited near the top for a massive profit. I was amazed that anyone could base millions of dollars on a technical chart.
Over the years since I have become a keen advocate of technical analysis mainly because the market has changed so much that it almost makes financial analysis worthless. Certainly there is a place for financial analysis but it is more and more likely to be found in private equity funds than in Wall Street hedge funds. Traders have taken over the market and seek to gain an edge not by superior financial analysis but through superior speed and cheaper price of execution of a trade.
Traders seeking an edge try to sit right next to the market (literally) to get a millisecond advantage over the competition that is sitting a thousand miles away. This is all that they need. Company stocks are unknown only tickers are relevant and price to earnings ratios are replaced with stock price momentum. This is why you have situations where high priced stocks just keep on going while lower priced stocks do not move.
This is all very good and well but it has turned Wall Street into a glorified casino. The authorities are turning a blind eye to all of this as they are all making money. The average daily volume of stocks traded has almost quadrupled over the past decade while the market value of the Standard and Poors 500 (the largest 500 companies listed on the United States stock markets) has not moved. Money is being made by charging a fee for each share traded. Meanwhile investors are not being rewarded for this greed and are in reality the chicken fodder. Give us your money so we can pay ourselves fees and you can receive a negative return on your money.
This has to stop and is going to end badly. While everyone is making money no-one will turn their attention to these market practices. The downside is that just as the computers are pushing prices higher, at some point when the market bursts they will drive prices lower and in a hurry. At this point Congress will look into the problem but by then it will be too late. Thousands of investors will have lost their shirts but this time hopefully Wall Street will be made to pay.
Protect yourself by moving out of the market and looking for opportunities elsewhere. For those of you with a conservative edge I would advise that you take a long hard look at your overall portfolio and try to find a decent yield in a low yield environment. As I mentioned to a friend of mine the other day, it is better to get out now and protect against a 50% retracement than to try to catch a 10% increase in the market. Things are skewed to the downside so look to exit and wait patiently for the bottom. It will come and you will be rewarded, just like the old days.
Thursday, September 1, 2011
Labor Day 2011
"Borrowed money shortens time." - Chinese proverb
Labor Day in the United States is September 4th this year. According to the knowledgeable people at Wikipedia "it became a federal holiday in 1894, when, following the deaths of a number of workers at the hands of the US military and US Marshalls during the Pullman Strike, President Grover Cleveland put reconciliation with the labor movement as a top political priority. Fearing further conflict, legislation making Labor Day a national holiday was rushed through Congress unanimously and signed into law a mere six days after the end of the strike."
To celebrate labor's day it would seem that labor should again strike, walk on the government and demand that Congress implement policies that create jobs for the needy rather than the fat cats in bank high rises. Unemployment is terribly weak after years of stimulus and this week second quarter productivity was revised down by the largest drop since the fourth quarter of 2008. For those of you with short-term memories, the fourth quarter of 2008 was the eye of the storm in terms of market weakness. Non-farm productivity was revised down to -0.7%. Yes that is correct it is negative! This has to lead to further layoffs in the near future. Not a great way to celebrate labor's day.
To add to the hurricanes battering the East coast it appears that the economy continues to be battered and the Federal Reserve has all but given up its fight. Mr. Bernanke finally admitted that the severity of the market ills is far worse than he ever anticipated and handed over the reigns to Congress when he stated that ".. most of the economic policies that support robust economic growth in the long run are outside the province of the central bank." So let me get this straight; he spent trillions of dollars with no reward other than an overpriced stock market and now he walks away and says it is all Congresses fault? Don't get me wrong, I agree with him to a large degree, but what about mopping up the mess that he created with all the additional debt that we are now burdened with? That is the problem with this country at present, there is no leader willing to take up the helm and drive the ship into the storm. We can only run on this course for so long until either the storm catches us or we crash into rocks.
Let's turn to the Congressional Budget Office (CBO). The CBO is entrusted with estimating the growth of the economy and thereby expected tax revenues, surpluses, deficits and the like. Based on their expectations Congress makes its plans for the future of the country. Well the CBO expects that growth will be at 2.3% for the year. Considering that this number has already been ratcheted down a number of times and considering that we only grew at 1.4% for the first half of the year, there is absolutely no way that they are remotely close to being correct in their forecast. Furthermore they predict a 2.7% growth rate for 2012. It is my contention that 2012 will be the beginning of a recession and that the budget deficit will balloon just at the time when we need it to contract.
With Mr. Bernanke handing the reins over to Congress to make the right decisions (become austere) and with Congress relying on the inflated numbers from the CBO it looks like the hurricane will catch up to us before we reach the rocks! The Chinese who have lent us a significant amount of money have summed it up in the proverb at the beginning of this blog: "Borrowed money shortens time." I have said it before and I will say it again, get out of the market while it has sent you a life raft in the form of a weak bounce and harbor your cash into something safe for an extended period. Do not get sucked back into the market for at least the next 12 months.
To end this blog I am attaching a link that was provided to me by a friend. it is very clever and funny, particularly if you have spent any time in the mid-west like I did many years ago. Enjoy.
Labor Day in the United States is September 4th this year. According to the knowledgeable people at Wikipedia "it became a federal holiday in 1894, when, following the deaths of a number of workers at the hands of the US military and US Marshalls during the Pullman Strike, President Grover Cleveland put reconciliation with the labor movement as a top political priority. Fearing further conflict, legislation making Labor Day a national holiday was rushed through Congress unanimously and signed into law a mere six days after the end of the strike."
To celebrate labor's day it would seem that labor should again strike, walk on the government and demand that Congress implement policies that create jobs for the needy rather than the fat cats in bank high rises. Unemployment is terribly weak after years of stimulus and this week second quarter productivity was revised down by the largest drop since the fourth quarter of 2008. For those of you with short-term memories, the fourth quarter of 2008 was the eye of the storm in terms of market weakness. Non-farm productivity was revised down to -0.7%. Yes that is correct it is negative! This has to lead to further layoffs in the near future. Not a great way to celebrate labor's day.
To add to the hurricanes battering the East coast it appears that the economy continues to be battered and the Federal Reserve has all but given up its fight. Mr. Bernanke finally admitted that the severity of the market ills is far worse than he ever anticipated and handed over the reigns to Congress when he stated that ".. most of the economic policies that support robust economic growth in the long run are outside the province of the central bank." So let me get this straight; he spent trillions of dollars with no reward other than an overpriced stock market and now he walks away and says it is all Congresses fault? Don't get me wrong, I agree with him to a large degree, but what about mopping up the mess that he created with all the additional debt that we are now burdened with? That is the problem with this country at present, there is no leader willing to take up the helm and drive the ship into the storm. We can only run on this course for so long until either the storm catches us or we crash into rocks.
Let's turn to the Congressional Budget Office (CBO). The CBO is entrusted with estimating the growth of the economy and thereby expected tax revenues, surpluses, deficits and the like. Based on their expectations Congress makes its plans for the future of the country. Well the CBO expects that growth will be at 2.3% for the year. Considering that this number has already been ratcheted down a number of times and considering that we only grew at 1.4% for the first half of the year, there is absolutely no way that they are remotely close to being correct in their forecast. Furthermore they predict a 2.7% growth rate for 2012. It is my contention that 2012 will be the beginning of a recession and that the budget deficit will balloon just at the time when we need it to contract.
With Mr. Bernanke handing the reins over to Congress to make the right decisions (become austere) and with Congress relying on the inflated numbers from the CBO it looks like the hurricane will catch up to us before we reach the rocks! The Chinese who have lent us a significant amount of money have summed it up in the proverb at the beginning of this blog: "Borrowed money shortens time." I have said it before and I will say it again, get out of the market while it has sent you a life raft in the form of a weak bounce and harbor your cash into something safe for an extended period. Do not get sucked back into the market for at least the next 12 months.
To end this blog I am attaching a link that was provided to me by a friend. it is very clever and funny, particularly if you have spent any time in the mid-west like I did many years ago. Enjoy.
Subscribe to:
Posts (Atom)
