Blogging About Money

Why I am convinced of a United States Recovery

2011-11-30T08:39:00.000-08:00

In my opinion, the apparent complete lack of economic coordination in Europe, and the lack of currency adjustment in China, has led many great investors (Warren Buffett and Seth Klarman to name a couple) to become bullish on the United States. When you look at world GDP, it was approximately $63.04T USD. Of this, the Eurozone represents $12.17T (both figures according to the World Bank). China is currently at $5.88T, and facing a hard landing on its economy, and Japan has a GDP of $5.50T, and embarking on its rebuilding efforts following the earthquake and tsunami this year. Finally, there is the United States ($14.58T), with a long history of capitalism, ebbs and flows, recessions, reactions and recoveries, watching everything unfold with no issues of lack of economic coordination, a three year head start on recovering from its own housing downturn, no major natural disasters from which to recover, and a fairly free moving currency that makes the country look more and more attractive everyday versus China.

While I have not seen consensus, the last forcast I have is for a 3.2% increase in global GDP (World Bank website). that would mean that we should expect a growth of $2.02B in GDP globally. Excluding Japan, Eurozone, and the United States, the rest of the world has a combined GDP of $30.79T. Assuming a very aggressive 5% growth rate for these areas (note that I have not excluded Canada, U.K. from the list, which are among the top ten largest economies in the world), the emerging markets should provide $1.54T of the growth. From the remaining three economic zones, we should therefore presume that we will see $0.5T of growth. If the Eurozone continues to falter, investment will be pushed to one of China, Japan or the United States, I would anticipate. Let's look at a scenario where the Eurozone simply stagnates and produces a GDP growth rate of 0% (I believe they will be in recession next year).

In China, we are in a scenario, where the country is importing inflation as a result of pegging its currency. Therefore, labour and commodity prices are rising for the same finished products. This is then sold out to Europe and the United States (predominantly), where in many cases the prices remain fairly stagnant (due to the economic situation of high unemployment). The scenario lowers margins for many companies, so it would be safe to say that China may not experience supernormalized returns from its current 9-11% GDP growth rates. So this really leaves the future investment to the US and Japan. With Japan facing a rebuilding and an already aging population, it would be safe to also suggest Japan will not experience more than a couple of tenths of a percent of growth in the coming years. This leaves us with the United States. I would presume that much of the European slack would come from the United States, due to its similarity in industrial output, primary economic drivers, and labour force. This projection, even with many of its flaws, would mean the US would grow 3.2%, far higher than the new OECD expectation of 2%. With government cutting back on investments, this would mean more than 100% of the growth would come from the United States. This would bolster growth, and improve financial metrics of US public companies.

Just my thoughts. I may be wrong, but I'll still bet on the U.S. over Europe.

Radiation Leak adds further pressure to Nikkei: Nikkei 225 Futures down 14.5% at Midday Break

2011-03-14T20:25:00.000-07:00

Before I begin this post, I would like to convey my feelings on the recent destructive earthquake and tsunami in Japan. The tragedy in Japan has been heartbreaking, and my thoughts and prayers go out to the Japanese people. I hope that all nations and capable people will do whatever they can do to help the people that have been affected.

Please donate to a charity that can help the recovery efforts, like the Red Cross (I have linked to the Canadian and American sites), Doctors Without Borders (U.S.) or Medicins Sans Frontieres (Canada), or UNICEF.

After such a devastating few days in Japan, the news continues to shock the world. While I may sound presumptive, it does appear that the latest explosion in reactor #2 and the fire in reactor #4 of the Fukushima Daiichi Nuclear Power Station have allowed large amounts of radioactive material to be released into the air, and the containment structure may now be breached. The government is now speaking of radiation that is harmful to humans, and that anyone within a 30km radius from the power station should stay indoors. Unfortunately, the odds appear to be very slim that disaster can be fully averted. The futures worldwide have reacted as a result.

The issues in Japan are unprecendented, in terms of the natural disaster and the chaos that may ensue. At this time, the best position of any investor is to look for Mr. Market's most irrational moves, and build positions in strong companies.

And please donate!

Unrest in Saudi Arabia sparking Oil rally, further Volatility

2011-03-10T10:41:00.000-08:00

According to the Associated Press, Saudi police have fired on protestors in the Eastern part of the country. If this is true, and becomes escalated, this could spark a huge rally in oil and petro-currencies, and further declines in the world markets. Any disruption of oil supplies from Saudi Arabia would result in a complete imbalance in demand vs. supply of the commodity, and could push oil significantly higher than any disruption caused by Libya, Algeria or any of the other Arab country, where unrest persists.

As per many sources, tomorrow is expected to be a "Day of Rage" in Saudi Arabia, with protests expected in the Eastern region.

Overnight Developments - March 10, 2011

2011-03-10T00:42:00.000-08:00

Some information that may affect the market:

1. Japan GDP shrinks a greater than expected 1.3% last quarter.

2. China reports a $7.3b trade deficit, its highest in 7 years.

3. Spain downgraded by Moody's, outlook negative.

Of course, everyone is awaiting today's jobless report, at 8:30 am ET.

Forbes list of World's Billionaires released, shows that it pays to be Slim.

2011-03-09T22:28:00.000-08:00

2010 appears to have been a banner year for Carlos Slim. The world's richest man increased his net worth $20b to a cool $74b, $18b more than Bill Gates, the world's number two. Overall, there are now 1,210 billionaires worth over $4.5 trillion.

Other interesting tidbits:

Mark Zuckerberg is no longer the World's youngest billionaire. His Harvard roommate, Dustin Moskowitz, 9 days his junior and the third employee to Facebook, is now a billionaire, thanks to Facebook's valuation increasing 238% in 2010 (to $50b). The valuation has subsequently increased another 30% since, to $65b. On another note, Eduardo Saverin, former best friend of Mark Zuckerberg, is now worth $1.6b, based on his 5% stake in Facebook (reportedly brought down to 2% through share sales), and Sean Parker is also now worth $1.6b.

The list includes 30 hedge fund managers, 54 investment managers, and 1 drug trafficker, Joaquin Guzman Loera ("El Chapo"), of Mexico.

Moscow, with 79 billionaires, is home to the most billionaires, followed by New York City at 58.

108 of the 214 new billionaires came from the BRIC countries (Brazil, Russia, India and China).

According to Forbes, there are 24 Canadian billionaires, including newcomers Frank Stronach (Magna) and Chip Wilson (lululemon).

Why I am Short Netflix, Inc. (Nasdaq:NFLX)

2011-03-08T08:29:00.000-08:00

Background

Netflix, Inc. is a subscription based service, providing access to thousands of movies and television shows on demand to over 20 million subscribers. Recently, the most vocal short-seller, Whitney Tilson of T2 Partners closed his short position. I believe that Tilson was right in shorting Netflix, and when Tilson closed his short position, it actually sparked the recent peak for Netflix (as all major analysts and investors in NFLX were then buyers of the stock).

Why is NFLX so successful?

Netflix was first successful in filling the vacuum left by Blockbuster’s bankruptcy. Blockbuster’s bankruptcy fragmented the movie rental business, allowing another company to step in, and take further market share. While Netflix was the market disrupter that proved to be the catalyst for Blockbuster’s demise, it was also the temporary beneficiary of Blockbuster’s losses. Innovativeness allowed NFLX to move with consumer demands, especially when it moved to the streaming subscription service from its mail-order DVD rental service. I believe that both the market gains from Blockbuster’s bankruptcy and Netflix’s innovativeness will only be temporary gains for the company. Eventually content-owners will try to capture much of the supernormal returns (charging more for content, or in the form of competition, as the Warner Brothers/Facebook deal shows), and further third party competition (like Amazon and GoogleTV) will reduce earnings to more normal levels. Competition is only starting to heat up, and access to the lucrative European markets is already threatened by other early entrants, which could restrict profitability in the region.

Aggressive Valuations

Regardless of all my theses above, let’s consider what could happen if NFLX were to achieve 50% market share in the United States, based on current market conditions. Currently, there are 83.3m broadband subscriptions in the United States (Source: OECD, http://www.oecd.org/document/54/0,3343,en_2649_34225_38690102_1_1_1_1,00.html), with intentions to increase this to 100m households with broadband access by 2020. If we assume an aggressive 50% subscription rate, at the current $7.99/month subscription rate, we arrive at $4b in annual revenue. The historical expected gross margin rate appears to be around 35%, resulting in $1.4b in annual gross margins.

I have assumed that the OPEX run rate would have to stay at the current 25% rate, as Netflix would have to continue to be aggressive in its marketing of the service in the face of higher competition, as well as in continuously trying to be the first-entrant to new technologies. At 25%, OPEX is expected to be $1b/annually, which results in an annual net operating income of $400m.

If I apply P/E of 20 to the net operating income (I applied an aggressive P/E to match with the typical technology stock, as well as allow for errors in other assumptions), I arrive at a market capitalization of about $8.0b. The current market capitalization is over 20% higher than this aggressive figure! I realize that expansion internationally is possible, but this would not necessarily lead to $8 monthly subscription costs in other countries, and content costs would increase as foreign language films and institutions would need to be added to the company’s library.

Conclusion

Based on the above findings, and the recent parabolic move in Netflix (from $180 to $245 in about 15 trading days), I believe that short sellers can still be rewarded in shorting NFLX here, even after its move below $200 today.

I am currently short NFLX. These statements are for entertainment purposes only, and should not be construed as investment advice. Please contact your investment advisor before acting on any information.

Stock Picks - 2011

2011-01-04T07:25:00.000-08:00

Details to follow:

1. BP plc (NYSE: BP)

2. Johnson & Johnson (NYSE: JNJ)

3. Citigroup (NYSE: C)

4. Oshkosh Corp (NYSE: OSK)

5. M-Split Shares (TSX: XMF.A)

Approaching Flash Crash Bottom

2010-05-20T20:07:00.000-07:00

I spoke to a couple of friends during the Flash Crash, indicating that the market would have to fall at least to those levels before we could see the correction dissipate, or at least calm down. We are now within a couple of percentage points of this reversal mark. While still bearish about the European prospects, and worried about the credit drought building there, I am now of the opinion that it is time to wade into higher quality stocks that have at least 65% of their revenues residing in North America, and are in less volatile sectors. National Presto, Laboratory Corporation of America, and Quest Diagnostics are some companies that appear qualify for purchasing at this time. I don't know where this market is headed, but companies with these characteristics should still profit during these times of economic uncertainty.

Full disclosure: I am long both NPK and LH at this time.

A $1T waste of money???

2010-05-10T22:13:00.001-07:00

The $1 trillion dollar measure to support the Euro, and Euro-zone countries did not address the fundamental and structural issues surrounding the countries that it intended to save, and, to me, this is the one reason I think it will not resolve anything. The political maneuvering of Angela Merkel (German Chancellor) did not save her from losing control of Germany’s upper house, nor will it have saved the slide of the Euro and the remaining Club Med countries’ debt problems. The ECB will have to devalue its currency intentionally to really show that it is taking action. Throwing money at this problem is only showing to the world that the southern European nations have influenced the north, and now the whole Euro-zone is willing to destroy their fiscal responsibility.

The Euro must establish and enforce new austerity measures on EVERY country within the Euro-zone, including the usually responsible countries of Germany, France and the Benelux region. It is time the Euro-zone take responsibility, and promote productivity, deleveraging and individual responsibility.

Germany's vote: The key to the next two weeks.

2010-05-06T18:35:00.000-07:00

The unprecendented (we have never seen such a drop and immediate turnaround) action in the markets have led to many theories. Trader error, computerized trades, plunge protection team, etc. are all theories brought forward to explain what is a fat-tail event. At one point trading institutions were compounding the situation, and the Nasdaq and NYSE ended with their highest and second-highest volume totals respectively. The similarities to 2008 has been uncanny:

1. Iceland could be considered the Bear Stearns of sovereign economies. It fell first, and provided us with a sign of things to come.

2. The Club Med countries (Spain, Portugal, Italy, Greece, etc.) are all behaving similarly to the remaining financial companies in 2008. Their markets are all clearly falling, and they are bringing the Euro down with them.

3. Germany, one of the largest investing countries in Club Med, has hesitated in addressing the bailout. Like the US Senate, who hesitated on the economic bailout, members of Germany's controlling coalition are hesitant on accepting the bailout.

4. The feeling on the marketplace now appears in complete meltdown mode, and is now in a death spiral, with lack of confidence in counterparties and in the economies around the world.

With everything in turmoil, the biggest saving grace will be Germany's vote on the Greek bailout. If Germany votes unanimously to bail out Greece, it will provide some footing to the markets, and confidence that Germany will continue to support the Euro. If, however, German opposition and members of the key coalition decide to vote against the measure, either making the vote extremely close or even allowing the bailout to fail, the markets could go into freefall. With Germany investing in a substantial amount of the Club Med debt, I expect the vote to pass quite comfortably. But, I expect the markets to remain very skeptical of Spain, bringing them to the limelight in the next few weeks.

As I have stated before, I question the Euro's ability to survive the market action of the last 2 years (refer to my posts in October 2008 and January 2009). I personally feel that in order to survive, either all Euro countries need to accept devaluing the currency, or expelling the countries that cannot meet strict monetary disciplinary practices.

I am currently holding put options on NYSE:EWP (Spain) and NYSE:FXI (China), and intend on going short NYSE:EWG (Germany).

The Jobs Report - Good Friday Edition

2010-04-02T09:44:00.000-07:00

For the third month in the last five, the U.S. job market has started to show signs of a pulse. Nonfarm payroll increased by 162,000, while the unemployment rate held steady at 9.7%. Overall, the Civilian Labour Participation Rate (the proportion of individuals employed versus the total population of individuals of employable age) is at 64.9%. Temporary workers, both for the Census and the private sector, continued to dominate the growth side of the ledger, as did healthcare (more on that later).

Whereas the unemployment rate is reported as 9.71%, the true U.S. unemployment rate is far higher than this, when we consider the fact that the Civilian Labour Participation Rate has declined from 67.3% in March 2000 (when the secular bear market began) and 66.4% in January 2007 (when the housing market collapse was confirmed), it is apparent that many individuals have simply left the job market. If we were to simply look at the unemployment rate using the past participation rates, unemployment rates are closer to 12.93% and 11.35%.

What does this all mean? Simply put, we are not nearly close to peak employment, and thus many inflationary pressures internal to the U.S. should remain low (such as housing and consumer capital goods). We should also hope that the U.S. Federal Reserve takes this into account when considering interest rate hikes in the future (after all, you don't want to alienate further parts of the population permanently out of the market).

The interesting labour trend of the last 3 years has been the increase in temporary and healthcare workers. Increases in temporary workers makes sense in the worst recession since the 1930's - companies are unwilling to risk their futures on a "shaky" economic outlook. However, the trend of increasing health care workers may be a sign of where the next economic bubble may occur. In the past, we have seen the first economic gains during recessionary times in areas where the bubbles form, like in the finance and construction sectors in the early 2000's and the technology sector in the early 1990's. I know it's early on, but the opportunities to make supernormal returns may present themselves in this field for the next 3-4 years, as investors identify the trend, and returns continue to grow. Compound this with the new healthcare bill, and we may have a winner (temporarily, of course!).

Five Stocks for 2010

2010-01-04T20:54:00.000-08:00

Just for fun, here are my 5 stocks/ETF's for 2010:

1. National Presto Industries (NYSE: NPK): Who doesn't like some Presto cookware with some ammunition?

December 31, 2009 Price: $109.23 USD

2. Manulife Financial (TSX: MFC): Cheap, cheap, cheap. Beaten down because of shoring up capital. We'll see the upswing as people realize it is undervalued.

December 31, 2009 Price: $19.33 CAD

3. Progressive Insurance (NYSE: PGR): Huge cash flows, lots of premiums (unrealized claims) that generate large investment gains for the company. Just like Geico, this stock is ripe for growth.

December 31, 2009 Price: $17.99 USD.

4. Fastenal Corporation (Nasdaq: FAST): Simply put, this company sells small tools at construction sites and in industrial zones. If the stimulus package States-side is for "shovel ready" programs, than Fastenal should reap the benefits.

December 31, 2009 Price: $41.70 USD.

5. Barclay's India ETF: My opinion is that India will show accelerating growth and future prospects due to infrastructure, and attention to the largest democracy's growth prospects. After all, most Americans will be looking for safer alternatives to the US market and exposure to the USD.

December 31, 2009 Price: $64.11 USD.

Guessing the S&P 500 December 31, 2010 value: 1,231.49.

These picks are for fun, and should not be construed as investment advice. Contact your professional advisor for any investment advice.

Abu Dhabi bails out Dubai

2009-12-13T20:59:00.000-08:00

In a sign that the risk trade has been restarted, Abu Dhabi announced that it will provide $10b to Dubai World, the sovereign wealth fund that was over-leveraged on risky assets. With this move, we should see stock markets power past their recent resistance points. In this market full of government cash and support, and little recourse for poor decision making, we should be mindful of investing in good balance sheets, and building our personal balance sheets for the next crisis to come. It will only be a matter of months before we start seeing an inflation crisis that will pull the weakest personal balance sheets to insolvency.

New Zealand steps out from the Recession

2009-09-22T21:06:00.000-07:00

New Zealand became the latest country to statistically step out of the shadow of the recession, sparking an increased appetite for the carry trade, and thereby bringing the USD under pressure again overnight. Ironically, the country's growth was partially a result of dairy sales, which have caused such grief in Europe.

What's the Fed to do?

2009-09-22T19:36:00.000-07:00

Tomorrow will be a significant day for the markets. It may mark the first day we hear the Fed's plans to exit the quantitative easing program initiated during the midst of the crisis. This could cause significant pain to the market short-term, but may provide a catalyst for the markets to move higher. As the Fed moves out of the mortgage business (effectively ending its purchases of 10 and 30-year treasuries), the market will need to soak up all the Treasury's liquidity without the U.S. government's assistance. I'm not sure where the heavy lifting will come from, and this may prompt higher yields in longer term treasuries. While this will reduce confidence in the U.S. dollar, it will do wonders for the competitiveness for U.S. exports, and bringing some inflation into the market. Depending on the velocity of the Fed's tightening of the money supply (through reduced treasury purchases), we will see this inflation bring higher commodity and equity prices, as future earnings prospects will accelerate.

On another note, it will be some time before we see the Fed increase the fed funds increase, as the Fed will need to first remove the layers of support that have been thrown over the faltering economy, including the quantitative easing, TARP and TALF programs. Thus, I see a steeper yield curve, a lower U.S. currency (vs. commodities at the very least), and better future prospects for the equities market. Only time will tell - the initial reaction is not necessarily the right one in the market.

Permabears turning bullish...Many bulls remain frozen in the headlights...

2009-09-21T21:38:00.000-07:00

James Grant, a famous bear who had been harping about the housing and credit bubble for years, has turned remarkably bullish, in spite of his fears about the long-term implications of shoveling money into the economy. Grant evidences that in each major recession in the past, the economy has rebounded very quickly, and the harder we fall, the faster we rise.

With the economic meltdown as severe as it was in 2007-2009, it is clear that the next bull market will be much steeper than many predict, and it's great to have a permabear trade in his claws for some horns and hooves.

While Grant has become bullish, many economists and institutional managers alike remain bearish. This in itself is a bullish sign, and I am in the camp that we have entered a secular bull market, that many will only conclude is such a market when we make new highs on the S&P and Dow, which may still be years away. While we may have corrections (even at the current levels), my personal opinion (to be taken with a grain of salt) is that any correction will be fast and furious, to flush out the weakest of hands and the gambling speculators.

Thesis on the Market Recovery

2009-08-25T22:07:00.000-07:00

It's been a few weeks since Warren Buffett's op-ed piece, "The Greenback Effect". Obviously the concerns being portrayed are one of a depreciating US currency. I personally see this as being only half the story.

I personally believe that most of the developed world is building a Ponzi scheme of debt, financing each others' ambitious infrastructure plans that will save capitalism from collapse. I don't doubt that this will have been the best approach given the circumstances in the marketplace at the time (frozen credit markets and a catatonic consumer base).

I theorize that the US currency may not fall versus most currencies worldwide, but most currencies will depreciate against hard assets and useable commodities, like oil, copper, etc. With the flood of cash, and some evidence that the credit markets are thawing (see the 750,000 cash for clunker deals that have taken place - at least some of those had to be financed), I expect that the velocity of cash will accelerate quickly through the economy, increasing demands for credit, in order to "get ahead of the curve". As companies will start showing increasing profits and revenues through this "cheap cash", the cash will continue to produce increasing cash through the marketplace (courtesy of the economic multiplier). This cash won't generate jobs as quickly as people anticipate - the market is not quick to bring jobs back into the forray, but productivity gains will continue to increase. The middle class is squeezed by the fact that jobs don't return as quickly as the economy does, and the price of goods increases by worldwide demands. Therefore, middle class individuals lose on two counts: less job stability and inability to increase compensation at the rate of inflation. Until we reach full employment, middle class employees are squeezed, and their wealth is reduced in real rather than nominal terms.

Buffett's latest take - an Op-Ed in the New York Times

2009-08-19T09:23:00.000-07:00

This is an important report about the implications of opening the coffers of debt to save the U.S. economic system from collapse. More to follow.

http://www.nytimes.com/2009/08/19/opinion/19buffett.html

Hurricane Season - the Ace in the Hole for the Market?

2009-08-08T14:04:00.000-07:00

While hurricanes pose huge risks for cities and individual safety, they may provide another reason for commodities to rise, and inflation to arrive sooner than most analysts think. The Atlantic basin, while quiet, is warming up, and looks like it will bring its share of storms in the coming months. With the Gulf of Mexico already in the 80s (Fahrenheit), it will become a concern (as it does every late summer) to funnel major hurricanes into the major refineries and the major U.S. oilpatch. This year, this will almost certainly bring with it $80 oil, increasing prices for many commodities, and potentially, another reason for the market to move up.

U.S. GDP - A Primer for the Second Half

2009-08-02T12:15:00.000-07:00

Last week, second quarter GDP numbers came in with a contraction of 1.0%, better than the expected decline of 1.5%. While nothing to cheer at, the pace of contraction has now been pared, and we finally appear to be stepping out of a technical recession, although increasing unemployment will make the recession feel a lot longer.

The topic on most economists' minds is whether the recession is officially over. I think that we are likely to see a very steep recovery in GDP, contrary to most economists. The reason I say this is from the interesting news stories we have seen in the last week or so.

For one thing, inventories in most sectors are already at very low numbers, and big-ticket items like houses and cars are now being purchased hand over fist thanks to the current and prior U.S. administrations' willingness to burn cash like a California wildfire. In four days, the entire $1b "Cash for Clunkers" budget was used. Given the average car costs about $28,000 and the program provided $4,500 in cashback for trade-ins, this means about $6.2b in vehicles were sold (about 222k cars) - in four days! Last year, the US sold just over 16m cars and trucks, without any government sponsorship. The auto manufacturers have already reduced their inventories significantly, temporarily and permanently shutting down plants across North America.

When inventory is sold at such extremely high rates, especially when the forecast is for government programs to last 12 weeks, it makes me feel that the American consumer is again willing to spend money more quickly than Wall Street thinks. The pent-up demand will push inventories to ridiculously low levels in these big-ticket items, meaning higher prices, and a push back to inventory builds, and higher employment in the near-term (6-9 months, rather than 18-24 months). While the US household has been beaten and bruised, it is a resiliant entity, prepared to buy, buy and buy some more.

Unlike the recovery of 1982 (when we had "V" like recovery - like I anticipate this time around), we have Fed sponsorship in the recovery, with trillions of dollars sloshing through the economy, and we are likely seeing the first signs of acceleration of this moneyflow through the market place (with the highest credit worthy consumers snatching up vehicles and homes). This makes me a believer that we will see massive worldwide growth, a return to increasing commodity prices, and a more permanence to the inflationary conditions plaguing North America in the 2005-2008 period. Commodity capital projects have been halted or delayed and developing countries are showing signs of growth and demand, making me convinced that we will see demand overtake production very quickly, and we will need to wait for capital projects to end before the inflationary pressures reduce to more normalized levels.

Thoughts on the state of the World Economy

2009-01-18T21:08:00.000-08:00

I have said that my appetite for purchasing equities has increased in recent months, and I continue to look for opportunities to do so. That said, I have had some interesting thoughts about the world markets that I'd like to share.

The United States vs. China

I am deeply worried about how the overall world economy can grow in the future without some decoupling of the Chinese currency from the U.S. currency. Only a year ago, the U.S. government was begging the Chinese to remove their peg of the U.S. dollar (by selling the dollars/Treasuries they currently own - in the trillions of dollars) - and allow the RMB (yuan) to inflate from its artificially low USD peg. Twelve months later, I'm sure the Chinese are wondering why they didn't move to further de-peg their RMB. The USD has been rapidly strengthening against virtually all major currencies, save for the yen, and it has caused quite a Catch-22 for the US and China. Should the Chinese sell those treasuries and dollars to the open market, surely the appetite for US dollars will appreciably fall, and the dollar could collapse under the weight of the US's very own printing press. This could have one of two effects, one desirable and one undesirable.

If this were to occur, we may worldwide be lucky enough to see a decline in the USD - and the return of inflation, the growth engine of the world. A stronger RMB is in the cards in the next 5-10 years anyways. The Chinese will become a consuming nation of finished goods rather than a supplier of them, and will need to offload its peg to be able to consume more using a higher valued currency. Why not now?

Well, the flip side of the question is the answer to that question. The Chinese economy could potentially trade places with the U.S. by selling its treasuries. By strengthening the RMB at this time, it loses its global position of cheapest mass producer, which is the engine it has now. If it doesn't sell the USD and treasuries, it is already losing that position with other global players like the EU.

The European Union - is the model sustainable

The EU continues to lower its interest rate, to stave off huge problems for behemoths like Spain (the housing bubble) and Germany (which has seen its share of problems with the likes of VW). This brings me back to my old question - will the Euro survive? By creating the Euro, Germany and other large European countries placed their confidence in the hands of emerging economies like Slovakia and Slovenia. The dynamics in each country can conflict with each other, and result in movements by the European Central Bank that may run contrary to the needs of individual member states that have adopted the Euro. In late-2008 Germany was already handing hundreds of billions of Euros to its banks in an effort to shore up its banks, while the ECB was still being implored by the world to lower its rates. The ECB seems to be very much behind the curve now, and is desperately trying to catch up with lower rates that the US has already applied. I feel that the EU is showing tremendous cracks under the pressure of its model. While free trade is always an ideal, countries giving so much control of their economic viability to a central bank certainly is not. How this affects trade with China and the U.S. is still emerging.

This is the primary reason I love macro-economics - there are millions of issues at play (with a few Black Swans that will emerge along the way), and it takes market makers months to digest a slice of that information to make decisions. We are participants of the most exciting film (I just hope most of us can leave the theater with our shirts) the world has seen in some time. This is the essence of globalization: we will see more volatility, more Black Swans and more currency blowups.

Thinking Long-Term: Secular Bear Markets

2008-11-08T14:32:00.001-08:00

Fear has gripped world markets, world governments, and pretty much everybody around the world. This economic disaster is the result of the excesses that the world enjoyed throughout the 80s and 90s. We are now paying for the leverage and lending bubble that developed, as people tried to keep the party going. Now, everyone's scared that the world will end up in a long-drawn recession, or much, much worse (I'm just as worried as everyone else). If you've been reading this blog, you can see that I hedged myself against a market meltdown, which we experienced over the last 6 weeks. Contrary to most, I'm feeling much better now than I did then.

I have been a proponent of the "Dow Theory". Essentially what this stipulates is that the market goes through cyclical ups and downs over the short-term, and secular ups and downs over the long-term. These cyclical movements can result in 3 month to 6 year trend movements in the markets, whereas longer term secular movements can result in 7 to 25 year longer term trends. In a secular bear market, the markets can move in cyclical bear or bull markets, but ultimately the market cannot break its former highs. Make no mistake of it, we are in a secular bear market, and have been in one since the dot-com crash in 2001. The S&P 500, the 500 companies deemed to represent the U.S. economy best, has not been able to break the 1,580 to 1,600 mark for the last 8 years. Over this time, the world economies have been growing dramatically, but as a result of huge P/E ratios and expectations in the late 90s, early 2000 period, we are going through a period of consolidation in the marketplace. Ultimately, in general, historical P/E ratios reach the single digits before the market can once again proceed forward into a new secular bull market.

In essence, the businesses are catching up to the lofty expectations in the 90s. It's as though the market was the driver in a very serious car accident. While the accident only takes a moment, it takes years to resusitate, rehabilitate, restrengthen and renew the driver and his/her health and confidence before we can move forward. However, ultimately, before the renewal of the driver's confidence, we know that their health is no longer in question. The market will get project this health much sooner than we as individuals get the confidence to fully invest again. We must be willing to step in front of the train with the hopes that it will stop before it hits us smack in the face (figuratively-speaking of course).

I'm not calling a bottom, nor am I saying I have closed all my hedged positions (buying ETF's that move inverse to the markets). What I am saying is this: even in the 1930s, the bottom happened within 3 years of the start of the Depression. If you have a longer-term outlook, you have to be compelled into investing somewhat into the markets. I have been slowly closing hedges, and buying equities. Mostly, this equity is in low debt stocks or large-capital stocks that will continue to sell goods the world needs.

Within the rubble of any disaster lies the tools, lessons and catalysts for the next great growth period. In this market, there are companies that will become the next great stocks to hold as the market starts to move upwards again.

When the crisis will end?

2008-10-09T20:52:00.000-07:00

I have been seeing the markets crumble around us, and I am of course concerned like everyone else. The central banks around the world have been trying to stave off the abyss, and have thrown everything at the markets. Nothing has worked. There are several problems in the markets these days.

There is over $360 trillion (yes, trillion with a T) in financial contracts in the marketplace that is subject to LIBOR (the London interbank offered rate - the rate that banks lend to each other). According to Bloomberg.com, that's over $53,500 per person on earth. When you look at it, ultimately debts are held by people, even if it is artificially held in corporations. This debt becomes the debt for the world, and each and everyone of us is burdened by this. As the amounts are absolutely unsustainable, these financial contracts must be reduced. The market cannot afford this. These debt amounts are absolutely unsustainable. It was absolutely necessary for the banks to deleverage. It just happened that the financial industries appetite for risk (hedge funds, derivatives and mortgage-backed securities) had to doom us. Even though the government has been pumping trillions of dollars into the marketplace, this will not result in reduction of the credit rates. We have seen cuts to bank rates, it has not resulted in lower LIBOR. LIBOR must, must, must decline to more manageable levels before we can return to financial normalcy. Therefore, even if the governments around the world continue to pump money into the markets, we will see the money supply continue to decline as that $53,500/person drops to more normal levels, and LIBOR finally drops to levels closer to the US Fed funds rate.

I will add one thing: I personally feel that we will need Keynesian economics to recover from the long-term problems that we will see from this crisis. Without concerted and worldwide coordinated government projects, the world industrial output will come to a standstill.

Europe vs. the World - Can the E.U. survive this debacle?

2008-10-07T21:06:00.000-07:00

As we have been facing this complete freefall in the market (can someone say capitulation?), I think we need to evaluate where to put our hard-earned dollars when it comes to the equities market. As I've stated before, I believe that we are facing deflation, in spite of all the unsuccessful US actions to increase the money supply, and try and shore up the lending system. With lending at a standstill, and deleveraging already underway with the banks, I often wonder where to put my money. But a more pressing issue to the world should be, how will the E.U. deal with this?

The reason why this question is so pertinent is that the European Union has one central bank for those countries that use the Euro (so U.K. is excluded among a group of the E.U. countries). That assists the Euro-zone in creating a central interest rate, and a central monetary policy. The big problem within the E.U. is that each country has its own Treasury function, and each country still has its own government with its own budgetary system. Because of this, countries in the Eurozone will decide to take different actions to shore their economies, thereby affecting all countries in Europe. This can create a worse problem than in the rest of the countries around the world. When a country doesn't control its own monetary policy, but controls the treasury function, it can only hinder coordinated attempts to stabilize an economy. I will be interested to see how Europe copes with the current meltdown, and I even feel there is a remote possiblity that the Euro could be rejected in some countries and even the total rejection of the European Economic Community by others.

What was Congress thinking? Markets collapse in the wake of "No" Vote.

2008-09-29T20:51:00.000-07:00

I'm not going to mince words. The U.S. Congress showed its true lack of leadership, and its total ineptitude in the face of the worst economic crisis in the last 80 years. Congress is holding the world hostage, in the face of an election. This may be the first time in a few years that I have felt that George W. Bush, who has nothing to gain from pushing the $700B package, appeared to be acting in the best interests of the United States (and the world for that matter), while the U.S. Congress was doing just the opposite. In order to get re-elected, these people are willing to vote down an economic plan to unfreeze the credit markets (not "bailout" the financial system, as everyone is stating) by purchasing already discounted debt-backed securities, providing much-needed liquidity to the banking system, so that they can lend to each other, and more importantly open credit markets up for businesses and people. I'm surpised the markets didn't fall further. You only have to look at the terrible deal Caterpillar had late last week to see how bad it has gotten.

A company of the caliber and creditworthiness of CAT having to pay huge premiums in the credit market makes me question whether many companies will even be able to borrow to finance short term cash requirements, like employee salaries and working capital requirements. This means obvious things to me: companies are going to hoard cash, reduce their payrolls by cutting staff, and reducing capital spending over the next year. This ultimately will result in pushing us further into a deflationary market, worldwide. A credit crisis as intertwined as this means no country is immune to its issues. Deflation is the worst disease to strike an economy. It results in a downward spiral - this toilet will flush like it's broken, and we don't have a plumber to fix it. As deflation occurs and Wall Street suffers, people on Main Street will lose their jobs, lose their homes, lose everything - I'm not trying to be an alarmist, but the market needs intervention, because it won't resolve itself until most banks in the U.S. fails (the small regionals - remember, over 1,000 failed in the 1980s and 1990s in a less serious crisis). We only have to look at the Japanese markets to see that this can be a long drawn issue. Eighty years of inflationary growth presents a potentially long-term deflationary issue for the markets.

So what does one do in this market? The only thing I can see myself doing (and I'm not an expert nor am I recommending you follow my advice) is reducing risk and buying the companies that I feel are best of breed. I will not be selling in this market: as much as I hate the actions of the US government, I still feel that things can change in an instant, and I know that I am not smarter than the market. Not only will I maintain my asset allocation while facing this uncertain and tough market, I will actually add to my portfolio in stocks with little or no debt, but only in cases where their competitors have moderate to vast amounts of debt. Stalk these companies - they are being punished in the down market, and they may earn less money in the future. However, these companies will have pricing power, and they will have long term competitive advantages. As their competitors fail or downsize, they will be able gain market share for many years to come. And if they haven't raised money in the equity markets (as a substitute to the credit markets) over the last 3-5 years, even better. These companies are growing organically, and won't need capital while others suffer looking for it, and getting punished in a risk-averse market. In my retirement accounts, where I hold no individual stocks, I will simply continue my pre-authorized purchases, and re-allocate at the end of October.