TBT, which is a blend of Treasuries that produce a 20 year maturity, moves higher with interest rates. It is the “ultra short” version of the bond price, but seems to be a good proxy for 10 times the interest rate. Today it is at 48.50, which is almost exactly 10 times the 4.8% interest rate of a 20 year bond. It was 70 in early 2008 (when it was created) which was similar to 10x the interest rate for a 20 year note at that time. It is not really pegged to that rate, but should move proportionately.

I think we can all agree that interest rates move higher from here. So, I suggest buying the 38 June call and selling the 58 June call. This gives a 20% upside between now and June on a $9.70 investment, which means a better than 100% return if interest rates move over 5% by that time. I just got done discussing using a put to protect the downside, creating a collar, but there is no point in this case. The price never got below 38 in the crisis and it is hard to see lower interest rates than what we just had….forever.

I like using options for any of the “Ultra” or amplified short ETFs because they all use Swaps and the futures market to build their positions. Trading costs and other futures market ineffiiciencies cause the price of such ETFs to deteriorate over time. Using options forces a repricing of the underlying as the traded options expire. This manages (does not eliminate) the problem with short ETFs.

Here are the tickers:

Buy June 38 TBTFL Call for 11.00
Sell June 58 TVTFF Call for 1.30

Net Cost = $9.70 / contract

I think we will be able to keep this trade on, rolling forward and upward, for the next 2-3 years as interest rates climb back into “normal” territory with the 20 year maturity average getting back to 7%. If inflation explodes because the Fed screws up, this is an even better trade and those levels, and beyond, come much faster.

Related posts:

1. Call Spread on Fluor Engineering -FLR- for High Return
2. Changes to Stock Options Symbology Coming

As bad as 2008 was, it is really the past ten years that have been very poor for investments of almost all kinds.  Those who say we are at the beginning of a multi-year bear market really haven’t done their homework.  The Bear began in early 2000 with the collapse of the Tech bubble.  The Nasdaq 100, which was as high as 5100 in March that year dropped below 1100 in October 2002, a collapse that rivals the Dow Industrials collapse from 1930 to 1932.  Yes, the markets recovered (as they did in 1933-36), and the Dow Industrials, really an old-world and narrow index today, did reach new all-time highs of 14,200 in October 2007.  But the Nasdaq stocks barely recovered to 50% of their all-time highs (a classic Fibonacci retracement).  The bubble transferred from equities to real estate in the mid 2000s.   Of course, it was here that historic damage was done over the past two years.  

Given all this, I take some very small satisfaction in being down only an average of (-1%) annually for the past ten years in my overall portfolio.  This is especially true because much of my capital contribution was at the end of the period (2006-07) making the subsequent drop that much more damaging to my portfolio.  During the same ten year period, the SPY (-0.63%) and the FFFDX, a life benchmark portfolio for people retiring in 2020 (+2.23%) have better performance.  I am biased to the optimistic side of investing and comfortable with risk and so have a “higher beta” portfolio than most my age.  But had I seen the 10 year bear to rival the 1930s coming, I might have just left my investments in a bank account.  Hindsight is 20/20 so I am not second-guessing myself, and am happy to have kept up with passive index funds. 

It is a perilous but fun exercise to predict events over the course of a year.  It is impossible to really know the future, but mentally stimulating to give it a try.  And the result helps shape decisions throughout the year.  Here are the Wealth-Ed.com predictions for 2010:

1. The American stock markets will rise by 10-15%, defying the consensus which considers the market to be either fully or over-valued as of December 31, 2009 (too far, too fast).  SP500 will reach 1,270 during 2010 and will end the year close to that level; range will be 9500 – 11,300 DOW; 1020 – 1270 SP500; 1980 – 2490 NDQ 100;
2. SP500 aggregate earnings will exceed consensus expectations of $65-75.  They will finish the year at $85 which will justify a 1,275 SP500 price based on a PE of 15
3. The stock markets will follow the classic pattern of strong in winter and fall and weak in the late spring and summer which is the source of the saying: “sell in May and go away”; it will be a good year to follow that advice
4. The US dollar will strengthen into the second week of the new year and will then fall through the winter months as Treasuries are sold to finance riskier equity investments;  there are a record $8.4 trillion dollars on the side lines in cash, money market and other near money funds (as measured by M2, according to Fed Reserve report H.6); the dollar will drop to $70 DXY by the end of March and then rebound in the late spring so DXY (dollar index)  will exceed $80 by September.  An improving economy and higher Treasury rates will be the impetus for dollar strengthening
5. The Fed will hold short term interest rates low until mid-summer; it will allow long term rates to drift higher and the 30 year Treasury will hit 5% by June;  by July, the Fed will begin to signal its intentions to let short term (Fed Funds) rates increase as the economy continues to strengthen and the unemployment rate finally starts to decrease (first in June); evidence of higher interest rates will push the stock market down and the dollar will strengthen;  the 10 year Treasury (the basis of many mortgages) will finish the year over 4% from a current 3.5%;
6. As the dollar weakens to 70 DXY in the first half of the year, the “carry trade” will re-appear from its Holiday hiatus and weak dollar investments will excel, including Energy, Materials and Emerging Markets; but sell those investments in April as the dollar shows signs of reversing; TBT will be a very good way to play the reversal in the dollar (ultra short the Treasury complex); by October, the shock of higher interest rates wears off and the stock market picks back up with domestic and cyclical stocks taking the lead from the weak dollar stocks of the year’s first half; advice: rotate investments away from commodities and towards cyclicals and industrials as dollar strengthens at end of year;
7. Healthcare stocks continue their comeback as the Senate finally gets a greatly weakened bill passed in January.  It goes back to the House for conference and is finalized by the end of March.  The public option is gone but the expanded Medicaid program remains bringing another 30M people onto the public funded program.  Healthcare stocks continue their recovery with more people to receive care in 2010 and beyond; buy UNH, WLP, BDX, MDT, MRK, JNJ and PFE early in the year
8. Gold reaches its peak early in the year at 1400.  Gold bugs are crushed when the dollar strengthens later in the year.   The Fed proves to be much more adept at taking liquidity back out of the market than was anticipated by doomsayers and gold falls back below $1000.  Severe inflation (over 5%) never materializes due to the global production and labor overcapacity
9. Oil prices range between $60 for a low and $100 for a high in 2010; the low will occur in the late spring or early summer as winter demand dissipates and the dollar begins to strengthen with the beginning of tighter money supply, but though “weak dollar” speculation dissipates, the price peaks at $100 as the economy picks up pace at year end;
10. Natural gas outperforms oil as record supplies are reduced and demand begins to exceed supply by year end; gas ends 2010 at nearly $8 per mmcf  propelling the natural gas oriented production companies back to 2005 levels; PWE reaches $30 in late 2010 (was as low as $6.50 in March; I have stayed with this for the round trip);
11. The Republicans gain seats in both the House and the Senate as Independents that voted for change in 2008 are sorely disappointed in what is delivered and vote for economic stability and a balanced budget which the Republican party promises.  Enough seats are gained so that the Democrats lose their supermajority in both houses.  Awareness of this political shift is what fuels the market to new highs from the summer doldrums, starting in October.

Regarding 2009: I was in such shell-shock from the beating I took in Q4 2008 that it was January 3 before I got to my annual crystal-ball adventure.  But predict I did and those predictions are below or by clicking here: 2009 Wealth-ed Predictions.  This will be the ninth year I have made my annual predictions;  the first time in December 2001.   In December 2002 I made a call for the 2003 market to begin a great run starting in March.  I hit that one out of the park and expect to do the same this year.  Looking back at my early 2009 post on the direction of the market, I did prognosticate quite a bit of the year’s direction and events correctly with only a few minor errors in timing or magnitude, not direction.

• Government backed interest rates (mortgages and Treasuries) will stay low throughout 2009 (less than 1% for 2 year bonds); but sometime thereafter, maybe early 2010, they will start rising and continue going up as inflation heats up along with an economic recovery. Right – the commitment to easy money by the Fed pushes the normalization of interest rates out to mid to late 2010 now; I never imagined Bernanke would stay this aggressive this long, but am glad he has; 
• By July 2009, the high yield and corporate bond interest rates will begin to decline, narrowing the historic spread against risk free Treasuries; Right – this was my best call in early 2009; the Junk-to-Treasury spread peaked at over 2000 basis points (20%), historic highs; I loaded up on high yield debt (via FAHDX) in March and it returned 70% from there before I began getting out of the fund in October.
• Crude oil will continue weak throughout 2009 in a range of $25 -$60 per barrel; as a result production and exploration will be reduced and lower production with higher demand will set the stage for a rebound to over $100 sometime in 2010 or 2011; enjoy low gasoline prices while you can; Right – on the downside but not on the upside; and right on the general weakness in demand and its impact on supply, which has really dropped (as indicated by active drilling rig count); the peak price  ($83) exceeded my expectations because of excess monetary liquidity created by the Fed that sought out risky assets; still I benefited from this rebound as oil/gas producers via the Canroys, remain one of my largest positions;
• Gold prices will stay under $1000 in 2009, but will not decline under $600; but gold could increase to over $1500 by 2012 because of a weaker dollar caused by inflation from excess money supply created in 2009; Wrong - but for reason of timing as the Fed has been much more successful in creating monetary stimulus than I thought they would; but it is a good thing that there is excess stimulus, some of which ends up in risk assets like gold,; the spike in gold prices also mistakenly anticipates hyperinflation; If the Fed can withdraw stimulus in a timely way in late 2010, they can avoid high inflation, which will stop the gold spike below $1500. (and if they are unsuccessful, the spike can proceed to $3000 the next few years)
• In early 2009, GM will be forced to declare bankruptcy (or an equivalent government reorganization); same for Chrysler; this will set the stage for a revamping of the American auto industry and will usher in a new era of manufacturing competitiveness; Ford will escape bankruptcy, but will benefit from the changed labor and franchise rules; Right – but I didn’t think Obama would be as brash as he was in protecting the unions at the expense of bondholders, including individuals and retirees; but given his constituency, I was not too surprised at who he chose to favor;
• At least five major mall retail brands will declare bankruptcy and will be closed; candidates: Abercrombie, Zumiez, GAP, Hot Topic, Lane Bryant, Foot Locker, Eddie Bauer, Ann Taylor; but look for the retail sector to outperform as soon as 2010; Wrong and Right - wrong for good reason that the Fed was more successful stimulating the economy than I thought possible; but the names above are all in deep trouble and would have gone down if not for the Fed actions; support to consumer spending has unexpectedly helped GGP (see next); Right: Eddie Bauer went bankrupt in June, Ann Taylor closed half its stores, Lane Bryant and Foot Locker closed many of their stores, just avoiding bankruptcy;  but the retail sector did better than expected at year end as stimulus got consumers spending again (RTH +17.8% for 2009)
• General Growth may become a victim both due to the above store closings / bankruptcies, but also due to the debt it took on to acquire Rouse Companies; its survival depends on selling several of the Rouse flagship properties: Fanueil Hall (Boston), Harborplace (Baltimore) South Street Seaport (NYC) and its Las Vegas malls (Forum Shoppes, Fashion Mall, Highland Mall); Wrong – but I figured out I was wrong in April and bought GGP at that time instead at $0.65 / share; the key to investing is to stay nimble;  now it looks as though GGP won’t have to sell any properties as it exits bankruptcy; I closed my GGP out at $6.60 in early December;
• Official unemployment will top 8%, but will not top 10%; Wrong – even the “official” number could not be kept under 10%, though it probably will not go any higher than 10.5%
• Mortgage rates for 30 year fixed rate Fannies will be less than 4.5% with no points; but these rates will rise in 2010; Right – though credit is so tight that few people can qualify for the record low interest rates; look for mortgage rates to rise once unemployment declines for 3 straight months and as the govt pushes banks to start lending again;
• The stock markets will see a range and return by year end of DJI: 7000 – 10,500 (13%); S&P500;: 725 – 1100 (15%); NASDAQ100: 1400 – 2200 (10%); with the lower end of the range reached in the first half of the year (there will be a retest of the November low, but that retest will be the bottom of a new 20 year secular Bull market, albeit the new Bull will be sleepy for several years while the economy and debt are repaired);  Right – in fact, one of my best calls as I was two months earlier than Doug Kass on my market recovery prediction; I did not forecast the “panic bottom” in early March, but that lasted for only three weeks; I nailed the DOW as it ended up 13.5% for the year; SP500 was up 19% and NDQ100 was up 42.6% (my prediction was 2200 and it is 2210 today)
• The best asset class return in 2009 will be in high yield bonds (junk) with a 30% total return; Right by a landslide; and the returns were quite a bit better if catching the bottom in March as I did (+70% from January, but +90% from March);
• The 2nd best asset class return in 2009 will be in energy stocks, both producers and equipment providers, though producers will have the best total return at 25%; Right – sort of; a close call between Technology (+60%) and Materials (+48%) / Energy (+30%); I lump energy and materials together because they trade in a similar way; they all did well for the same reason, the weak dollar and easy money chasing risk assets (and foreign markets);  my idea of energy for investment are Canroys which did much better than the big integrateds like Exxon that make up the indexes; PWE which I own in a big way, is up 76.8% for the year, dividends reinvested; PVX is up 71.2% and PGH is up 41.1%
• The worst asset class in 2009 will be Treasuries with 30 year bonds returning a negative 20%;  Right – the TLT, which is a basket of Treasuries with an average maturity of 20 years, is down (-24.79%) as of today (December 25) and 30 year is worse;  this trend should continue in 2010 and longer term Treasuries should again be a poorinvestment with net losses over the year; long TBT in 2010 is a good way to take advantage of this future trend;

Related posts:

1. Doug Kass 2009 Predictions: He Should Have Stuck With Them

All the “sovereign debt default” talk about Dubai, Greece and Spain is old news that is just now getting press because what was already in motion at the top of the debt bubble in 2007 is finally coming to fruition.  Now that the commercial bank crisis has been for the most part averted, the sovereign debt issues that are closely related come to the fore. The Dubai problems were obvious two years ago or more. And Abu Dhabi and other UAE brethren have little patience for the profligacy of Dubai. They will backstop Dubai only after those who overextended get taken out. Then they will ride to the rescue and take control of many of the assets.

Same thing in Spain or Greece. Spain dug itself a deep hole by committing significant debt to aggressive expansion of public works, most notably the 3GW solar power expansion.  The EU will backstop those countries, but only at a price. It is in no one’s interest to let the fire burn out of control. I compare this to hot spots after a forest fire. If they don’t threaten to flare up and ignite new fires, you let them die out on their own.  Other times you douse them (with financial liquidity in this case) to put them out before they spread. If the infection spreads to Japan, that would be a much more serious event than Dubai, only because of the size of the Japanese economy and the relative importance of the yen. But I think the global central bank leaders have an eye on this and will prevent a Japanese economic collapse. As long as all major economies pull together, there is no reason to think we will have a financial calamity. Economic collapses require the public to panic (and stop spending). Panic is totally a psychological phenomena and can only be brought about by careless or reckless political actions (or inactions).

It is very important to note that the countries that are in danger of defaulting, are not key world economies. The talk of a major economic power like Germany, Japan or the USA being forced into insolvency is from someone ignorant of what it takes to force a financial default. Defaults don’t just happen, they are initiated by a creditor. If the debtor is large enough as compared to the creditor, then it is non-sensical or impossible for the creditor to force the default. The punishment will fall as much or more on the creditor as compared to the debtor. To force a smaller debtor to default, though, makes sense. Assets can be seized and held or resold to recoup the investment. Just who would force the USA, Germany or Japan into default? Who could gain? Who could manage the assets that were forfeited for the debt? There is no private money (hedge funds, ala John Paulsen) with the size to force a large sovereign to default.  China is the only creditor nation with the size to force such a default. But China won’t do it because it would be suicidal. China, the creditor, needs the developed world as much as the debtors need China and other developing, export-driven creditor nations. It is totally symbiotic, or co-dependent if one wants to be cynical about the situation.

To make my point about the relative size of creditors and debtors as it relates to default: I just made a good return recently on General Growth Properties (GGWPQ.pk) because I understood this dynamic. GGP was in technical default because of the financial crisis and its inability to roll forward short term debt taken on during the two to three years prior to the financial collapse. It was / is still cash flow positive and can cover the costs of its interest obligations, much like sovereigns with their ongoing ability to raise revenue from tax.  But GGP wisely had filed for bankruptcy as a single entity and had pulled all its various mall properties under the single corporate parent umbrella. This made GGP in effect, too big to fail. No single creditor had the legal power to force all the properties into a firesale. The court (Judge Gropper) saw it the same way and made the decision to force the parties to work out the mortgagtes (to refinance). When the creditors found out they were not going to be able to drive a hard bargain and take away the mortgaged property for much less than market value, they had to deal. Now GGP is close to exiting bankruptcy with all its property intact.

Even though sovereigns are unlikely to default in a cascading way, the global economy still remains weak.  It will take consumers and businesses a long time to regain their confidence to buy and bankers to lend.  For the overall American market, from this point on, the economy must improve significantly to get the SP500 much above 1200. But I think that is the higher probability over the next year or two as compared to a melt-down. Politically, I think President Obama is finding out that it isn’t prudent to be too anti-business. He seems to have finally gotten the point that the top priority is jobs. Health care and environment are lower priority since there is no money to pay for them if we don’t have near full employment and full tax revenues. We aren’t hearing too much health care talk from the Admin or Congress the past 2-3 weeks. To demonstrate his new-found love for business, Obama just had T-Sec Geithner spell out the capital gains tax freeze and investment tax credits for 2010. This will help jump start business and improve consumer sentiment as people start getting jobs.

As Obama and other world government leaders turn their attention towards restarting business, the world economy will heal and the markets will respond. Asian stock markets might be a little overdone just because of being the crowded trade, so I have backed off on them, for now. I have moved almost everything back to domestic large cap stocks or energy / commodities. I think 2010 will be a “consolidation” year with only a little index movement, maybe from 1100 to 1250. 2011 might be a similar year, with gradual improvement from 1250 to 1400. That would get us back to May 2008 which was about where the final dive started (down to 666). Maybe we pull back 100 points (10-12%) somewhere in the next 2-3 years. But by 2014 we can pass 1550 and set new highs, if the government continues to be supportive of business and doesn’t get too radical (seems more likely right now than 6 months ago).

I am buying up some of the banks that look like they are turning the corner and will be survivors. I have a bunch of the leveraged financial index, UYG, which is weighted towards the survivors like GS, JPM or WFC. But I also am buying some BAC now (as of two weeks ago). Even Citi might be a buy at this point, now that they have a plan to exit TARP. But I am passing on them for now.

Otherwise, my theme is Tech, commodities, energy and materials. Tech is due for a positive replacement / upgrade cycle after 10 years of being down.  Microsoft’s (MSFT) Windows 7 should be the catalyst in 2010 once the IT budgets are approved. Just buy the XLK if you don’t have any favorites. SMH is the semicon index which has more beta than the XLK. My favorites in commodities tend to the miners and energy stocks, though I have recently picked up some Potash (POT).  I also have call options on (FCX) and (BHP).  This is a better way to play the weak dollar trade than gold, in my book, as operating leverage contributes to performance and generates cash flow which actually has value to an investor.  They have all outperformed Gold in 2009.  Commodities and Energy will benefit from the global economic expansion that is the natural reaction to the collapse. I find it interesting that Suncor (SU) was going up the last two days while oil futures are going down. I find that a very positive sign. I have really loaded up on Pennwest (PWE) and Provident Energy (PVX) .

Related posts:

1. A Look Back to Help Find the Way Forward
2. A Short Term Turn in the Market?
3. Tough Sledding in the Markets and Economy

IMF Managing Director Dominique Strauss-Kahn said the countries at the heart of global imbalances needed to take various measures to ease them.

In the case of China, that means an increasing emphasis on domestic demand, especially private consumption, Strauss-Kahn said in remarks prepared for a financial conference in Beijing.

“A stronger currency is part of the package of necessary reforms,” he said. “Allowing the renminbi (yuan) and other Asian currencies to rise would help increase the purchasing power of households, raise the labour share of income, and provide the right incentives to reorient investment.”

His remarks come as U.S. President Barack Obama is in Shanghai on the first leg of a four-day visit that will grapple with economic imbalances and the future of the yuan.

Strauss-Kahn noted that Chinese authorities were already taking steps to boost household consumption, including health care reforms.

“But more can be done to secure a lasting, structural shift towards consumption, by expanding the scope of social policies, moving ahead on financial sector reform, and undertaking corporate governance reforms,” he said.

Conversely, countries with large current account deficits need to increase savings, and for many of them, including the United States, fiscal consolidation must take priority for them, he said.”
 

What does this shift imply for American based investors?  As the remnibi takes an increasingly important role in world trade and is gradually rebalanced to reflect the strength of the Chinese economy, it will cause investments in Asia to rise in value as the dollar declines against the Chinese currency with the resultant de-linking.  This trend will affect not only Chinese stocks, but also stocks trading in the markets of other major Chinese trading partners like Singapore, Taiwan, Indonesia, South Korea and of course, Hong Kong.  Those economies must rethink their own currency indexing strategies to maintain competitive trade parity and are very likely to emphasize indexing the remnibi as opposed to the US dollar.  Even Japan will probably see its currency strengthen versus the American currency as the Remnibi gains favor as an Asian trading currency.

Now is the time to acquire additional shares in Asian stocks, funds and ETFs.  Because of the recent runup in 2009, it will be better to average in a larger position over time rather than making a lump sum commitment.

Related posts:

1. Bretton Woods 2: Wither American currency?
2. What is Next for our Economy and Currency?
3. Gold: An Investment for Decades to Come

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1. GMO and The Persistence of Stock Market Returns
2. A Statistical Look at SP500 Forecasts
3. Doug Kass, Thy Name is “Doom” (Especially for Thine Investors)

Three good things happened for GGP the past two weeks:

1. GGP released its 3rd Quarter financials on Monday, November 9.  They were better than expected.  Year over Year (YOY) results were down, naturally, given the near depression we have experienced since Q3 2008.  But they were down much less than had been expected by analysts still following the company.  Cash Flow (FFO) was actually positive by $671M ($2/share) when $700M of one-time, non-cash expeneses are added back while revenue and operating earnings were down only marginally (less than 5%).  The ”comprehensive” earnings were down substantially because of the large non-cash impairment charge to reserve for future unknown expenses attributable to the very weak economy.  But all in all, the Q3 report was very encouraging.

2. The second big news event happened early last week (November 17) when  Simon Properties (SPG), the other really big mall REIT other than GGP, did a SEC filing that it had retained a law firm (Wachtel, et al) and investment firm Lazard to explore acquiring some or all of GGP’s assets.  This creates a market for the malls owned by GGP, which will definitely help its valuation.  Part of the problem for GGP and other CRE companies the past 18 months has been an increasingly dreary commercial real esatate market as financing disappeared.  Just as with the derivatives market, when buyers disappear, the market value of the assets get marked down dramatically.   Now that there is a buyer on the horizon, I expect the GGP Board of Directors to work towards a sale of the properties at a price near the current market value.  Bill Ackman and Pershing Square Capital have a large equity stake in GGP and sit on the board.  It is Ackman’s job to realize value for his fund investors and will therefore likely work towards an exit strategy.   He needs a large buyer to absorb his 23% share and SPG looks like just that buyer.

3. And third, on Thursday this past week, mortgage holders / lenders on (170) of the mall properties that were in bankruptcy, agreed “in principle” to refinance $8.9B of the mortgages for GGP properties by extending maturities.  This agreement eliminates the pressure to liquidate those properties which were in technical default when many mortgages came due at a time late last year and earlier this year 2009) when there was no ability to refinance in a frozen credit market. 

All these are very positive situations and increased the value of GGP in some ways that are admittedly hard to measure at this point in time.  How much are GGP’s assets worth to Simon Properties?  Are they willing to pay a fair price based on cash flow (FFO) or do they think they can get a steal based on the depressed CRE market?  And how fast does the economy recover? 

For the reasons that the stock now seems fully valued with the balance sheet owners equity at $5 per share and a small premium now available due to the brighter  future prospects, I have liquidated all my position in GGP as of Monday, November 23.  Sure, the stock could even go higher.  It was near $60 in early 2007 and could be worth north of $20 if everything goes perfectly from here.  But best not to get greedy.  It was a very good ride while it lasted.

Related posts:

1. Bill Ackman discusses General Growth Properties on CNBC May 11
2. Update on General Growth Properties – GGWPQ.PK
3. Is General Growth Properties an Outstanding Speculation?

The basis for my opinions on monetary reflation are derived from Hyman Minsky’s work. PIMCO’s Paul McCulley has written on “The Minsky Solution” many times the past two years. In early January, I featured one of McCulley’s articles in a post: http://wealth-ed.com/2009/01/reflation-economics-or-the-minsky-solution/

To deflate assets requires the value of the currency those assets are denominated in to increase as the quantity decreases (this might be counterintuivitive for most). In essence, $15T of dollars were destroyed or disappeared (not physically, but notionally with debt paper markdowns). Less dollar supply at a given demand = higher price / value. Central bankers everywhere understand this dynamic. So, in a coordinated way to restore stability to global assets, currencies are being expanded to replace those notionally destroyed through markdowns during 2008 (the paper that underpinned all those assets, CDOs, RMBS, etc).

The most intelligent dissertation I have seen on repairing a deflation was printed in Barrons last February. Ray Dalio, a rare Barrons contributor, was interviewed. I reference this interview on this blog: http://wealth-ed.com/2009/02/fixing-a-deflation-a-most-intelligent-analysis/

To recap what Dalio said, then, and most presciently: this CB driven monetary expansion is NOT inflationary to the extent that aggregate asset values are being returned to 2007 levels. “How can this be?”, say all the skeptics at this point.  My answer: by definition, the reduction of the value of $40T national assets to $25T assets is DEFLATIONARY. In America, $15T of the global reserve “currency” (almost all of it electronic bookkeeping and not “paper”) can be created to replace the “paper” that was lost in 2008, with mostly positive effects. There is no deleterious effect so long as the re-creation of the lost currency is done slowly enough as to not be disruptive to global currency flows (currency destruction in 2008 was disruptive enough, don’t we all agree?)

$80 Oil and $3 copper is probably in the area of “fair value” vs. the dollar given a mid 2007 USD reference. But $1100 Gold? Unlikely. Gold is now trading on speculative fear of inflation, not the reality of inflation itself. So far, the dollar has not even been expanded (reflated) sufficiently to move asset values back to mid-2007 (check local house prices). Monetary expansion is definitely not inflationary, in America, at this point in time. For gold to be worth $1100, let alone $1500, then global central banks must be unable to stop the expansion that has started in an effort to stabilize asset values. Maybe that is a reasonable speculation, and maybe not (and I own a prudent number of gold shares as a hedge, just in case it is). But like many others, as a more significant inflation hedge, I would rather take my chances with commodities that have fundamental industrial value, and not merely the psychic value of gold.  As is pointed out, gold is worth nothing unto itself. And worse, gold is not consumed, so supply forever increases. This ever-increasing supply dynamic is NOT the hallmark of a good investment.

Related posts:

1. Gold, Great for a Trade, Risky as an Investment
2. Refuting the Arguments of Gold Bugs
3. A Look Back to Help Find the Way Forward

I have business associates in Japan, and the economy has been in virtual depression for many years. They have a homeless problem like you would not believe with tent villages on public grounds in the cities, especially around the old castles (but being Japanese, they are very tidy tent villages).

From my take on the Japanese people, the problem is mostly to do with their domestic reluctance to consume. They have a domestic consumption economy much too small for the size of the country (by population). The older generation that came of age post WW2, was reluctant to spend on anything, understandably so given what they went through in the years after 1945. Even the business leaders who make a very nice income by American standards, are very frugal in how they live. The wages for the workers among the younger generations are very modest. I was able to determine that a sales person selling the same products as me, with the same skill set and experience, was making half the wage. The Japanese I know can’t believe how well we live here in America and some consider us wasteful and decadent (though they enjoy participating in the decadence when they visit).

And with the WW2 generation being very conservative about their own future, they had small families with birth rates below the “replacement rate” of about 2.2 children per family. This, along with virtually no immigration, leads to the well known problem of Japan’s gentrification. Who is going to take care of all the older people on government pension and healthcare?

And now Japan has lost the one thing that kept it going and growing the past 40-50 years: a leading global position in manufacture and export of consumer goods. China and its siblings (Taiwan, Singapore, Thailand, Vietnam, etc) are taking over this role on the world stage. Japan is left to try and export capital goods and engineering know-how to China and siblings, much like America. But America has a population that always expands from immigration (a reason I am VERY pro-immigration) and an established consumer psychology that will recover within the next few years, Bill Gross’ proclamations to the contrary. Our desire to consume is genetic. It is the source of the proverbial “American Dream”.

A second significant problem for Japan is that Japan has no natural resources to export. So, they have lost their consumables export leadership and have nothing left to sell the rest of the world to drive their economy. Japan does not consume enough as a nation to fully utilize its own productive capacity for domestic demand and to keep its younger workers employed to pay for the retirements of the older workers. This is the source of Japanese deflation.

I think Japan will either evolve out of necessity into a consumer nation over the next 20 years as the younger generations with Western ideals take over management of the country, or Japan’s financial system will go into default. In October last year, the world financial system came to the rescue of America with its heavy importation of manufactured products and its reserve currency. The world had to save American banks in order to save itself. But for Japan, there will be no such salvation. Its banks will be allowed to fail and the Japanese people will have to build the country all over.

If Japan defaults, it will be VERY ugly (Iceland times 100). So, I expect global financial interests to push the Japanese to avoid that fate before it happens. Ironically, the Japanese need to spend their savings (those infamous Postal accounts). That is their one chance to save themselves and the rest of the planet a lot of pain. Strange as it seems for Americans with our low national savings rate, it is possible for a nation to be too thrifty (called “The Paradox of Thrift”). There is a need for balance in a sustainable economy: not too little savings, but not too much; not too little social security, but not too much (Obamacare for example); not too little immigration, and not too much. And so on.

Just be glad this is happening now and not in 1990. The Japanese economy (including real estate and stock market) has already deflated by 80%. The crash if it happens, will not be as precipitous from these levels as it could have been. But it is shocking to contemplate. I think the weakness of Japan’s economic system, its lack of domestic consumption and its long term social liabilitites, is the reason the Yen will never become the world reserve currency. The dollar remains safe in that role for some time to come.

Here is a link to the article that inspired this post published in the UK Telegraph on Sunday (bottom of post). It is somewhat frightening reading. But as mentioned, I don’t think the Japanese economy has a great deal of direct influence on the Rest of the World. Besides, as Warren Buffet says (quoting someone Ben Graham I believe), “Buy when everyone is Fearful and Sell when everyone is Greedy”. He did that today when he acquired ALL of Burlington Northern Santa Fe rail (BNI) for $44B.

“It is Japan We Should Be Worrying About, not America”

Related posts:

1. On the Persistence of Economic Growth
2. Investing Away from America

After recently rewatching “Sleepless in Seattle” for maybe the fifth time, I am once again struck by how Tom Hanks is the greatest actor of all time. We who saw him in Bosom Buddies knew right then that a star was born (anyone who can pull off cross-dressing and keep a series going 3 years with that strange premise). Only Jimmy Stewart can be mentioned in Hanks’ company in terms of character range, creating sympathy, a wonderful light comedic touch that is never “over the top” even in roles where it would have been easy to overplay (Gump). Other adjectives that describe a typical Hanks role: sincere, vulnerable, dignified, righteous, understanding, caring, courageous, humble, trustworthy. Everything that any woman or man would want in a best friend or spouse. This is his magic.

1. Forrest Gump (Won Best Actor Oscar) – he turned this simple and fanciful story into a movie for all time and a star vehicle (Sally Fields no. 2 performance after Norma Rae for which she won Best Actress Oscar; career launcher for Gary Sinise as Lt. Dan)

2. Saving Private Ryan (Nominated for Best Actor Oscar) – an epic movie with many Oscar awards, but a movie that many good actors could have done well. Such serious movies with so many tragic situations are easier for an actor to emote than something simple like Forrest

3. Sleepless in Seattle (my own sentimental favorite, though not nominated for anything) – another very simple movie that brought out the best in Meg Ryan (her best performance followed by “When Harry Met Sally”)

4. Big (Nominated for Best Actor Oscar) – How does this simple “boy meets girl through time warp” movie even get a nomination? Tom Hanks. He also elevates Elizabeth Perkins to her best performance (did she ever do another movie that anyone can remember?) This elevation of leading actress is a common theme in Hanks’ career

5. Philadelphia (Won Best Actor Oscar) – again, it is a great acting job, but with a subject that is destined to win Oscars: AIDS and homosexuality. Great acting about a tough subject in a sympathetic way that is the mark of Tom Hanks

I will go another five since almost all Hanks movies are worth multiple watchings. None of these are Oscar-worthy performances, though he helps turn the films themselves into Oscar nominees or winners

6. Green Mile – unlovable Hanks

7. Splash! – Hanks as innocent (something he does so well); elevates Daryl Hannah to the best performance of her career (never to be surpassed)

8. Road to Perdition – Hanks as pathetic

9. A League of Their Own – Hanks as unlikable

10. Castaway – claustrophobic and psychotic

Notables (worth another watch):

Apollo 13, Bachelor Party, Youve Got Mail, Bonfire of the Vanities, Davinci Code, The Burbs, Turner and Hooch, Money Pit, Dragnet (really, Dan Akroyd’s vehicle) and any of the Bosom Buddies TV series

Related posts:

1. Obama a “Leninist”: Greatest Wealth Destruction in US History: Jim Cramer

This is one of the oldest and most solid rubricks of the stock market. (Why does it work? I think it is because of human psychology: rumors always originate at a time of fear and weakness in a company stock price; the news of higher earnings a period of time later will be met with satisfaction and smugness, which creates the circumstance for a price peak). Take a look at the charts in late July and early August. This is essentially a repeat performance. But this time, the market is 10% higher.

I think we will see a repeat performance of August and September in November and December. Once the selling has run its course, the market will kick back up for another 10% run higher to 1200 SP500. That is my thesis.

The dollar trade is also exacerbating this pattern. The currency traders, who are by defition speculators since there is no fundamental value behind the trade, have discovered the currency side of this equity-driven pattern. The currency trade is reinforced by the pattern of declining stock market leading to a strong dollar. This has not always been the case, but is now with all markets trading together and the US Dollar as the safety trade (non-risk asset). So, when the markets decline, they rotate to the dollar. This pushes up the dollar and gives the currency traders a big payday by betting against the stock market and for the USD. Here is the chart of the Euro – US Dollar cross. Note the wild swings and their relationship to the US stock market.

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So, the currency traders are adding volatility to the stock market, pushing normal buying and selling up and creating bigger market swings. This should go on for quite a while. But the fundamentals will win out, and there is nothing to indicate that the economic and business fundamentals are not getting better day by day. And the US Dollar must weaken over time against other currencies unless the Fed does something completely unpredicted (and against Bernanke’s past form) and raises interest rates and sops up liquidity way sooner than expected or warranted.

I am staying long this market and finding funds to reinvest at lower levels, by closing out of short positions (mostly covered calls). I expect the market to begin recovering on or about November 10. This is exactly the date when the July selloff bottomed out at 875. That was a time of great fear, but also a time to get long with a 25% up move from there to October 23. Now, Carter Wirth just came on CNBC’s Fast Money and predicted a bottom in this decline of 980 based on his chart work. That is just about right to fit the trading pattern established. From that point, the market can go to 1200 by year end and fit the current pattern. 1200 is also the point at which the market broke down in September 2008. That is a very significant level. After the market makes its year end top, I am in the “sideways” camp with most of 2010 moving up and down in the channel between 1000 and 1200 as the economy recovers and higher earnings eventually push stock prices out of the channel.

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Related posts:

1. Buy the Rumor, Sell the News
2. Pre-Market Ponderings – July 27
3. Bullish Option Moves in Energy and Financials