This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, December 28, 2009

Lessons from a Lost Decade

Very rarely does any one person receive the best and worst the life can throw at someone. Even more rarely is anyone exposed to completely opposite ends of the spectrum at the same time. I guess Fed Chairman Ben Bernanke must just be lucky.

While being chastised by Congressmen and loathed by a large portion of Americans, Bernanke has somehow been blessed with the love and admiration of many of his colleagues – big bankers – and the media, most notably Time Magazine, whose cover his visage recently graced.

Though Time praises the professor-turned-bureaucrat for his apparent victory over the free markets, a sense of foreboding is in the air. Well-read individuals will, of course, recall at the cover of Time once depicted the face of another banker – Alan Greenspan – right before the economy turned sour and the sky started falling.

Ben Bernanke’s tenure has Chairman has coincided with the second half of what may very well prove to be the worst decade in stocks in recorded history (Lauricella, Wall Street Journal). You read write; even the 1930s, home in history to the Great Depression, can’t hold a candle to the decade we’re just exiting. Great Recession, they say? Ya, sure.

But fear not, there’s still good news, for the last decade, terrible as it may have been, is now ending. And as any good investor knows, odds are that terrible decades tend not to gather in groups. Put more simply: expect better times in the 2010s.

Like the 2000s, the financial markets had a very difficult decade in the 1970s, culminating with Jimmy Carter. However, after a final shakeout in the markets during the late ‘70s, improvement came swiftly in the 1980s under Ronald Reagan – after all, they don’t lend popular economic terms like Reaganomics to just anyone.

While we can bet there are better times ahead, hopefully we can emerge from this decade with a few lessons learned; lessons that will make the next decade all the more bountiful. If the 2000s have taught us anything at all, hopefully they have left no doubt in our minds that the theory of buy-and-hold as an investment strategy is deader than a doorknob.

Hopefully investors can leave the 2000s with a greater respect for the financial markets, and for the knowledge required to use those markets to one’s advantage. Hopefully advisors, in their downtime, have finally gotten around to reading the last chapter of Markowitz’s pioneering work on diversification, Portfolio Selection: Efficient Diversification of Investments.

The chapter I’m referring to, as boring and academic as it is, specifically mentions that the principles discussed were not intended for real-world application.

Of course, the appeal of Markowitz’s work to the masses is at least partially due to laziness. Using concepts laid out in Portfolio Selection and developed even further by academics, the investing public fell in the love with the idea that they could somehow build a diverse portfolio spread across several classes of assets, and then stuff it in the back of a drawer until tax time.

Unfortunately for investors, this simply isn’t the case. The financial markets are not a beast that can be understood withr only occasional review. They require constant study and continual maneuvering in order to achieve any kind of profit. Anyone who thinks otherwise will likely experience many more decades of poor performance going forward.

Monday, December 21, 2009

Unclear Economic Data Makes Research a Must

As expected, the market has been relatively slow over the past week. Oil, which we had said was overextended, has since corrected; while the dollar, which we claimed to be oversold, has rallied over the same period. Earlier this week the stock market attempted to break out of its recent consolidation pattern, only to pull back into that trading range once again.

Meanwhile, ten- and thirty-year Treasury rates have been creeping up ahead of this week’s Federal Open Market Committee announcement. This would seem to suggest that, regardless of what the FOMC says, the market believes that the Fed should be raising rates in order to price risk appropriately. This recent action could also be hinting at a growing belief in the market that inflation could be on the way.

For the month of November, retail sales have been up slightly year-over-year, so while this holiday season hasn’t been great, it’s provided the economy with at least respectable numbers. However, the Empire State Manufacturers’ Index has been surprisingly weak, especially given retail sales.

This anomaly most likely indicates that holiday sales have thus far been working through pre-existing inventory. This, in turn, tell us that presently the economy is, for lack of a better word, “spotty,” meaning that while things aren’t getting worse, they really improving either.

With respect to housing, data remains mixed, partially because the market isn’t being given a full picture of current circumstances. As we mentioned last week, housing inventory numbers released by the government don’t include homes that have been foreclosed but are not being put on the market by lenders.

Over the last two weeks, gold has fallen more than $100 from its high near $1210. Weekly readers will remember that we have recently been bearish on gold, as it has undergone a substantial rally that we believe unjustified by current fundamentals. Utilities, where we’ve been positioned for some time, have been gathering momentum over the same period. Utilities as a sector have been gaining popularity among investors seeking higher yield than can be found in most fixed-income investments.

We have stressed repeatedly, and feel the need to remind readers that this market is not conducive to a hands-off approach. Unlike the last few years, today’s economic environment requires constant study, and investors trying to manage their own portfolios need to understand the amount of time required to sift through information, determine what’s relevant, and have the background to interpret information and apply it to the markets.

Those investors who lack the time or ability to commit to their investments need to at least put in the time to find an advisor who is willing and able do the job for them. Even more importantly, advisors need to be sufficiently knowledgeable to use pertinent information to make sound investment decisions on behalf of clients.

All too often the investment world is plagued by fads, either in the form of burgeoning sectors or money managers with so-called “hot hands.” It is absolutely necessary for investors to ensure that they are picking an advisor with the knowledge to add value to client portfolios over the long term. In the short term, get-rich-quick schemes come and go, and flavors of the week all eventually turn sour.

Monday, December 14, 2009

End of Year Conditions Blur Trendlines

With 2009 drawing to a close, the market is now heading into end-of-year trading, typically characterized by lower trading volume and, as a result, increased volatility.

Towards the end of every year there are variables aside from market conditions that come into play which can have drastic effects across any and all asset classes.

At the end of each quarter, and even more pronounced at year’s end, many traders and investors undergo strategies of window-dressing and/or profit-taking. Window-dressing is a strategy where professionals, especially financial advisors, begin purchasing assets that have been performing well, with the intention of making end-of-year statements of client portfolio holdings appear more attractive.

Conversely, profit-taking is just what it sounds like; traders, investors, et al sell assets that have been performing well in order to lock in gains and decrease exposure to market risks. There are many reasons for profit-taking, but the underlying theme is that investors see market risks as outweigh any potential gains.

Historically speaking, window-dressing tends to bolster market returns as an influx of cash pours into already-high prices. Contrarily, profit-taking acts as a negative effect on prices, since many market participants are rushing to unwind positions before a perceived deadline.

Each year the battle rages on between these two counteracting forces, and while this year has seen remarkable returns among a wide range of investments, we feel there is a much stronger argument that profit-taking will dominate window-dressing.

One such argument is in regards to tax policy. With the likely repeal of Bush capital gains tax cuts during 2010, investors who choose to take profits before the New Year will be taxed at current rates, while those who wait run the risk of those tax rates increasing over the next reporting period.

On the other hand is the argument that we are in the beginning of a significant economic recovery, and for that reason window-dressing could be much more likely that profit-taking, and the market will likely advance.

Those who make this argument point to falling housing inventory numbers. They conveniently forget that many November home sales occurred because it was not immediately announced that the government would renew the first-time homebuyer tax credit. This had many Americans moving up their closing dates to ensure they received their tax credit.

Even more importantly, housing inventory, as it is reported, does not include the more half-million homes in foreclosure, which lenders may or may not choose to dump on an already-saturated market.

Market bulls also point the recently reported improvement in employment numbers. However, few realize that this so-called “improvement” is almost entirely due to seasonal adjustments made by Federal Reserve and Bureau of Labor Statistics. They also do not include Americans who have given up their search for work.

Fortunately, some Americans have undoubtedly found part-time seasonal work, and employment numbers may very well recover in the future, given the right government policies. In fact, a new article on CNNMoney discusses President Obama’s recent hints at changes in tax policy may provide incentive for small business hiring (Obama Touts Tax Breaks to Boost Small Business Hiring, Clifford).

According to his speech given Tuesday at the Brookings Institute, the Obama administration has recently begun considering a program for instituting tax breaks for small business who hire new employees.

Additionally, there have reportedly been talks to cut capital gains taxes for small business, also as an effort to spur employment. While the link between capital gains from company investments and employment is so far unclear, any tax incentive would certainly be an improvement.

For a brief market update, the last week has seen the US dollar strengthening and the prices of commodities simultaneously weakening. While it is unclear whether these two events are directly connected, and even more importantly, whether the dollar is beginning a significant rally.

There can be no doubt that recently the dollar had reached oversold levels, but it remains to be seen whether the currency has reversed its recent trend. However, it has certainly been showing signs of life.

Helping to fuel the dollar’s recent decline, a huge carry trade has lately built up as investors have borrowed dollars and purchased foreign assets, only to pay back borrowings later with weaker dollars.

If the dollar really has turned a corner and this trend reverses, a large rally in the dollar would eliminate this carry trade and leveraged traders would be forced to unwind their positions, making the reversal quick and violent.

This rapid change in market direction would create rampant demand for dollars as investors scramble to shed other assets to pay back borrowed dollars before they are wiped out by leverage.

So far the dollar’s strength is little more than a flash in the pan. Only time will tell whether the tides are changing or the dollar will continue its already-substantial decline.

Dock David Treece is a stockbroker licensed with FINRA. He works for Treece Financial Services Corp., The above information is the express opinion of Dock David Treece and should not be used without outside verification.

Monday, December 7, 2009

Golden Goose Eggs Rarely Hatch

Lately it seems nearly impossible to turn on the TV or radio without hearing another pitch to buy gold. And why not? After all, it’s the easiest story in the world to sell. In this economic and political climate, everyone has fears and doubts that a good salesman can exploit for profit.

Between the bailouts that have recently caused Washington to speed up the printing presses, the prospects of future policies coming down from Capitol Hill that will lead to only greater spending, and the declining value of the dollar in foreign exchange, it’s pretty hard to be an optimist when it comes to the greenback.

Not to mention that lately gold has been making all kinds of headlines, setting new highs on almost a daily basis. In fact, the price of gold has advanced almost every day for the past two weeks.

But one man’s treasure is still another man’s trash. In other words: The same reasons that gold is being touted lately as a great investment idea for the same reasons we as contrarians intend to avoid it, at least for the time being.

Gold’s recent rally, while remarkable, is not unprecedented. One comparable run occurred in the NASDAQ during March of 2000. Of course, that was right before the tech boom ended and the market came crashing down.

One of the favored lines among gold dealers is that the declining value of the dollar will continue to push gold higher. While that is obviously one trend, history has shown us that it is not always true. Several times, even during the 1980s and ‘90s, both the dollar and gold fell at the same time.

And yet radio and TV are flooded with ads from the likes of Goldline, Lear Capital, et al. People just don’t seem to get it: Those companies running commercials are trying to sell you THEIR gold in exchange for YOUR dollars. What exactly does that tell you about their outlook for the price of gold, much less the dollar?

Right along with those commercials, Aaron Regent, the CEO of Toronto-based Barrick Gold, the largest gold mining company in the world, has been running around lately pushing gold because his company recently unwound the last of its hedges.

What that means is that Barrick is no longer protected from a falling gold price. Of course, if Barrick is really so omniscient, it’s curious that they didn’t unwind those hedges ten years ago, before gold quadrupled in price. Instead, they waited until gold reached all-time highs to start participating.

Mr. Regent has also been peddling the idea that the world currently at peak gold. His argument is that production has been decreasing since 2003, so the world must be running out of gold. How strange, then, that production numbers have lately increased in China, Russia, and Australian in reaction to gold’s increased profitability as of late.

Gold, like any other commodity, responds to supply and demand. Take oil for example, particularly the tar sands in Canada, where oil is drilled on the occasion that it is a sufficiently profitable operation. Production has to be profitable in order for miners, drillers, etc to ramp up production.

Even more disturbing is that the demand for gold recently is not for physical bullion, but paper gold. The world’s largest consumer of physical gold is India, where gold is used extensively in jewelry, especially during wedding season. But Indian brides aren’t exactly scrambling for the yellow metal.

Instead, the vast majority of demand for gold is among traders, and that is for paper gold in the form of futures and options contracts. Speculators (i.e.: traders in the gold market who do not represent miners, refiners, dealers, bullion banks, or central banks) have recently been piling into gold – at least on paper.

On the other side of those contracts, commercial traders (read: smart money, traders representing those companies intimately involved with the precious metals industry) have been amassing record-setting short positions.

It’s understandable why, in today’s climate, people are nervous and want some kind of insurance policy, or even some investment that can help propel their portfolios back to pre-crash levels. However, put plainly, investors ought to know that if they are buying gold, realize that the smart money is lined up against you. Further, know that those traders have the kind of balance sheets required to prove themselves right.

This is neither a test of wills, nor a question of right versus wrong. The gold market is, on a relative basis, extremely small, and its workings understood by a very small group of people. Outsiders would do well to tread very, very lightly, if at all.

Monday, November 30, 2009

The Deflation Debacle and Our Road to Recovery

The Deflation Debacle and Our Road to Recovery
Dock David Treece

As the endless stream of economic data continues to flow, let’s review our calendar of economic and monetary events.

Over recent weeks we have heard arguments back and forth by bankers, economists, et al, all weighing in on the inflation/deflation debate. Much of the disagreement in the inflation/deflation debate can be traced back to varying definitions and underlying assumptions. As a prime example, we have seen commentators bounce back and forth with regard to how they define inflation, as well as how they measure it.

After hearing references to everything from money supply growth and CPI to foreign exchange, we consider it of utmost importance that all commentators work from the same textbook. Without going into excessive detail, let us say that our definitions, which have remained consistent, are the following:

Inflation: a monetary event consisting of an increase in money supply in excess of growth in GDP over the same period.

Deflation: a decrease in the money supply circulating through the American economy that is not due to the destruction of wealth

Price inflation: measured by CPI, a symptom of monetary inflation that might also be due simply to supply and demand

Debt deflation: a loss of value on an asset that serves as collateral for a loan that leads to losses on the part both the bank and the creditor, who now has negative equity

In the near-term we still consider deflation to be a substantial threat to the global economy. We are particularly concerned with the prospects a second wave of debt deflation, spurred by another surge in real estate defaults, this time in commercial properties.

What’s more, with troubles in commercial real estate rapidly approaching, housing is still hardly out of the woods. With nearly 15% of Americans are behind on their mortgages (Mortgage Loans: Record number are late,, 23% are underwater on their homes (now having negative equity) (The Negative Equity Report, First American CoreLogic), and 7 months of inventory is sitting on the market (October 2009 Existing Homes Sales, Bloomberg), it seems hardly likely that housing will be returning to its glory days anytime soon.

As a brief side-note, after watching the activity of the Treasury and Federal Reserve for months and wondering why they continued to let banks hoard cash in excess reserves, be believe that we have finally found an answer in this theory.

We now believe that the Fed and the Treasury are both aware of the coming problems in commercial real estate, and they are allowing, nay encouraging banks to stockpile massive reserves – rather an extend credit to individuals and businesses – in order to cushion their books for a coming wave of write-downs in commercial real estate.

We find support for our hypothesis of coming debt deflation not only in bank losses/write-downs, money supply growth numbers, and a still-decreasing demand for consumer credit, both new and outstanding, but also in price indicators which typically measure the symptoms of inflation, namely CPI and PPI.

Consumer Prices as a whole are down from this time last year (CPI, St. Louis Fed), and since stopping their decline a major portion of increases in prices can be accounted for by increased energy costs that are more a function of a weaker dollar in foreign exchange – remember, oil is priced in dollars – than inflation.

In the longer-term we consider inflation to be a substantial threat to the global economy, particularly in the United States. Remember that an incredible amount of money was created out of thin air by massive government bailouts, and in all likelihood will continue as a result of quantitative easing.

That new money is presently creating a bubble in stocks and commodities that is being perceived by many economists as inflation. They’re wrong; the real inflation, an increase in money supply beyond growth in GDP, occurred with the expansion of money supply over the past decade, culminating with the government bailouts. “Inflation,” as defined by increasing prices and a currency declining in value, won’t occur until all this new money makes its way into the economy.

Inflation ultimately will become an issue. The government can’t double the monetary base without consequence (St. Louis Adjusted Monetary Base, St. Louis Fed). However, price inflation will not become a real factor until a true economic recovery begins.

This recovery will be characterized by the free flow and expansion of credit, otherwise known as an increase in velocity, which is thus far still contracting as the US savings rate climbs. Once velocity does pick up and the real recovery starts, inflation will be a major concern. However, it will be characterized not only by an increase in prices, but also in wages.

Remember: even Zimbabwe, with its recent run of hyperinflation that left its dollar worthless, experienced wage inflation along the way. Wage inflation is something that this country is, in our opinion, far from experiencing.

At this point unemployment is too high, too long, and still growing for there to be any kind of significant economic recovery. In our opinion, seldom are jobless recoveries are the real thing. This is evidenced by recent reports, durable goods among others.

It’s important to remember that the stimulus plans that were passed were never meant to foster an economic recovery, just to give the banks the keys to the Treasury. This administration, in the words of Hilary Clinton, does not want to waste a good crisis. The problem is that the crisis has gotten way out of hand, and the administration’s total lack of understanding of economics is becoming well-known.

At some point we as a country have to get beyond this crisis. If this administration doesn’t get us past it, rest assured that the next one will. What we desperately need is to find a sector that can provide the kind of jobs needed to pull us out. Unfortunately, we can safely say that the sector to lead this recovery will not be auto (which led in the 1980s), housing (as it did earlier this decade), tech (1990s), or green jobs, especially after everything that is now coming out about the Hadley Institute.

In our opinion, the only two sectors that might foster the kind of job growth that is required in an economic recovery could be energy (of all types, not just “green”), which also led a recovery in the 1980s, or possibly manufacturing (which led almost every economic recovery before 1980), if the recent trend continues of bringing back these kinds of jobs from overseas.

One major problem is manufacturing coming back to this country is that it is a long process. It took years for manufacturing to move abroad as outsourcing became popular. To bring it back requires massive investments in facilities, commercial processes, etc.

However, an even bigger obstacle standing in the way of creating both energy and manufacturing jobs is government. In order to encourage the kind of investment that is needed to create jobs, encouragement is required in the form of both deregulation and tax incentives. However, neither of those, much less job creation in any form, is on this administration’s agenda.

Monday, November 23, 2009

Economy May Prove a Grinch

Will Christmas 2009 turn out to be the season of scrooge?

As Black Friday approaches, around the world all eyes focus on retailers. While consumers prepare for some great deals on holiday shopping, investors and economists prepare for an influx of data that will provide significant insight into the health of the global economy.

Most readers know that Black Friday is the Friday after Thanksgiving. Fewer understand why: the majority retailers operate at a loss from January through November, and make their profit during the holiday season – or get “back in the black,” in accounting terms.

After Black Friday, bargains for this holiday season are likely to keep getting progressively better as the holidays draw nearer. However, physical inventory will likely fall as retailers make it their top priority to liquidate inventory.

Of course, holiday shopping this year is likely going to be weighed down by several economic factors. With the unemployment rate near 10% and the so-called “underemployment” rate, which includes workers whose hours have been reduced, over 17%, many Americans will be forced to cut back on their holiday spending.

Recently several big banks made headlines when they hiked up interest rates on credit cards to nearly 30%. This too will undoubtedly have a negative impact on retail sales this season as many shoppers will find it much more expensive to finance their holiday shopping.

Finally, with mortgage delinquencies and bankruptcies nearing all-time highs – with little sign of slowing – the retail sales numbers for this holiday season will provide valuable insight into Americans’ state-of-mind in these trying times.

The real question is whether Americans have the discipline to cut out unnecessary spending, or whether priorities in this country are so mixed up that holiday shopping actually takes precedence over a mortgage.

Despite these negative factors, retailers will surely see a spike in sales this holiday season, although numbers will likely be much less impressive when compared to seasonal sales of previous years.

However, no matter what the numbers are they will undoubtedly be spun in the most positive way possible to suggest that the worst is over and the economy is on the road to recovery.

For economists it is even more important this season to look past the numbers when drawing conclusions. For example, looking at same-store sales this year won’t give an accurate representation because too many competitors have gone out of business (case-in-point: Circuit City). Instead, it’s important to look at overall retail sales to weigh the success of this season’s shopping.

Monday, November 16, 2009

Headlines Reveal Investor Optimism

For eight weeks we have argued that the stock market is overbought, that we do not believe the economic fundamentals support this recent rally, and that a pullback should be occurring soon in order to realign the market with a realistic economic outlook.

However, week after week the market has continued higher, and as it has done so we have continually asked ourselves what we could have missed in our analysis. We have been forced to question our stance and ask ourselves whether what we are seeing truly is the economic recovery for which we have all be anxiously waiting.

In considering this possibility, we have looked at many arguments from differing perspectives. What we'd like to do is share some highlights with readers, which we believe support the idea that the recovery has truly begun:

National City Bank of New York anticipates an early recovery. Admits that so
far recovery hasn't been marked, but "business has been on the
down-grade for nearly a year and in the past 30 years depressions have rarely
lasted for a longer period". Says the danger now is excessive pessimism as
opposed to a year ago when it was optimism. Admits serious problems including
the worldwide business downturn and fall in commodity prices, but the country
has repeatedly demonstrated ability to recover in the past. For the last 30
years, with the possible exception of ..., when business has begun a depression
in one year it's always at least started the recovery before end of next year.
True that if we look back further there have been some more prolonged
depressions (panics of 1873, 1884, 1893). But U.S. business was much less
diversified then, and "lacked the recuperative power demonstrated in more recent
years". Also, money markets were uncertain then, as opposed to current easy
money conditions. With credit conditions this favorable and the past record of
recoveries, predicts a recovery starting slowly in the summer and apparent by

- Wall Street Journal, Market Commentary, June 2

Harvard Economic Society predicts stocks will go up because of easy money
and favorable business prospects. "Though business activity continues to make
unfavorable comparison with that of a year ago, May transactions in the
aggregate, as measured by bank debits through the 21st, have shown more than the usual slight seasonal gain over April."

- Wall Street Journal, Market Commentary, June 3
Market students have been encouraged by the general gloom for the past two
weeks. This contrasts with the "new era" thinking of last summer when no end was seen to the rise in stock prices and margin debt was hitting a record every
week. History says the current gloom is just as mistaken as last summer's
unjustified optimism. Historically there has been no case in this country since
1900 when business failed to turn upward the year following a depression.

- Wall Street Journal, Market Commentary, June 16

As you will notice, all of these headlines are from June. However, if they don't look familiar, that's because they are all from June of 1930 (News from 1930,

For a brief historical background, readers should recall that the stock market crashed suddenly in October of 1929, beginning on Black Monday (October 14, 1929) and finally bottoming in mid-November.

After bottoming in November, stocks (as measured by the Down Jones Industrial Average) recovered over several months, staging a 25% rally from the bottom and recovering nearly half of the losses incurred. That lasted through mid-April.

In mid-April the market started back down in what everyone believed was a short-term market fluctuation before stocks would continue higher. As the news stories above illustrate, no one thought much of this brief downturn, but thought that cheap money (sounds an awful lot like today) would certainly propel stocks higher.

However, few realized that April of 1930 had been a significant top in the market. Most thought they were still in the beginning of what would prove to be a major market rally. Unfortunately, history proved them terribly wrong.

After April, 1930, the stock market resumed its decline, albeit at a significantly slower pace. This decline stretched over months rather than days, yet it took the Dow from a high around 280 points down to a low under 50 points in the summer of 1932.

All the optimism in the market, revealed in the news stories quoted above, existed even AFTER stocks at seen their top. Despite that optimism, stock prices fell by over 80% over the next 2 years.

Even worse is that all those investors, with all their optimism that the worst was behind them in June of 1930, would not see prices back at their April highs for over 20 YEARS. After the end of the bear market rally that lasted from November of 1929 until April of 1930, stock prices began falling then traded within a range for more than a decade. It wasn't until the late 1940s that a rally began which would take stock prices over their highs set in April of 1930.

The question that investors need to be asking themselves right now is where we are in the current cycle. Our argument has long-been - and will likely continue to be - that the stock market is nearer to a top than a bottom.

Let me be clear: We are NOT currently predicting another crash or a replay of the Great Depression. We are simply arguing that, despite all the market prognosticators who say the recovery is under way, we simply don't buy into all the hype. The economic numbers being released do not support the idea of a jobless recovery, or even a recovery at all.

Investors would do well to think twice about whether the worst is really over just because the market is doing well as of late. We urge investors to be very cautious when testing the waters with this market; a bit of skepticism may prove immensely valuable.

Monday, November 9, 2009

A Truism for Turbulent Times

Even since the market bottom, we’ve been hearing quite a bit from friends and concerned clients. Mostly they’re worried about what they see happening in this country, both politically and economically.

This simple observation reveals a truth that we have noticed over the years in just about any issue people face, and that is: People have a natural tendency to extend current conditions into the future indefinitely.

For example, in 1999 stocks had been delivering outstanding returns for several years, particularly from innovative technology/dot-com companies. No one saw that fad coming to an end; they thought it was the new norm. Anyone could make a fortune inventing new technologies, or trading companies that did.

Likewise, in 2005 it was accepted as fact that real estate gained about 15% in value every year. So long as you made enough income to service your mortgages, at least until you felt like flipping, you could and should buy as many properties as possible.

The problem with this tendency is that simply is not the way the world works. Everything cycles; be it stocks, real estate, interest rates, or political tendencies, even temperatures around the world.

One of the most common phrases I hear from traders is that “the trend is your friend.” The problem is that nearly all of those who use it leave out the last, most significant part: “…until it bends.” We saw this with dot-com’s, we saw it with real estate, and now we’re seeing it in the case of gold and a declining dollar.

Currently there is a growing concern among Americans regarding the tendencies of the current administration. Yesterday’s elections have shown that the majority, long-silent, is awake, and it’s angry. In a single night a very clear message has been sent to Washington that politicians who continue to pursue recent fads will likely find themselves unemployed in short order.

The fears of some focus on the US dollar and the idea that it’s going to be worthless. Consider this: If you told someone fifty years ago that the dollar they were holding would lose 85% or more of its purchasing power by today, do you think they would have been concerned?

And yet, according to CPI – which is a conservative estimate of declining purchasing power – the US dollar has done just that. Yet we seem to be getting along just fine. Face it, folks. We’re already living this fear. The dollar is worthless. The sun still came up this morning.

When it comes to inflation, the bottom line is that ever since governments discovered how to dilute money, they’ve been doing it. Historians can trace it all the way back to the Roman Empire when emperors started shaving coins so they didn’t contain as much metal as they were supposed to.

My point is that, since politicians have figured out how to run the printing presses, they’re never going to stop. Pandora’s Box has been opening, and you can’t un-invent the wheel. However, those numskulls in Washington aren’t going to bring the world to an end either.

Plenty of economists point to the hyperinflation that occurred during the fall of Weimar Republic in Germany or the current situation in Zimbabwe. They raise some valid points, but there are many more differences than similarities.

These countries, like all others, did and will continue to cycle. Life didn’t end in Weimar Germany, nor has it ended in Zimbabwe. Adjustments have and will be made, and the world goes on. Cycles like these may be so [unbearably] slow that they’re sometimes hard to see. But then, just because I can’t see my grass growing doesn’t mean I get to forget about cutting it.

Fortunately, we think this is just what’s happened in Washington. Americans got lazy about scrutinizing their elected officials. Now we’ve woken up to find the grass somehow much longer than we like, and with plenty of weeds that need pulling.

Friday, November 6, 2009

The Joys of [Careful] Giving

“Giving back to the community” means different things to different people. To some it means giving extensively of themselves, their time, and their skills for a vast number of causes. To others it might simply mean cutting a yearly check to Green Peace.

Philanthropy is not something to which all of us feel obliged. Some of us have trouble finding a cause whole-heartedly support; others simply lack the resources, be it time or money. We could all, most assuredly, do more. But then again, we could all just as easily do much, much less.

It’s no simple task to balance our obligations to our community with those to our family. We all work hard to provide a better life to those closest to us, at the same time trying to leave our community in better shape than as we found it.

We all have reasons to give. Many have organizations or causes of personal significance, or that have had particular impact on their lives. Others have the desire to build a longstanding legacy with the hopes of being remembered by the community they love.

When it comes to giving back, not everything can be monetary. Those who have particular skills have a responsibility to put those skills to work for the benefit of their community, not always for personal gain.

For some, especially those with heavy business obligations, time constraints, et cetera; money is a much more preferable way of giving back. Such gifts are certainly worth no less than gifts of time or skills, and they certainly come with their own benefits, namely tax deductions. However, they come with their own drawbacks as well.

Even those who lack the capability to give of themselves, preferring instead to share the spoils of their own labor – money – have an obligation to serve as a steward for those gifts, to follow that gift through to ensure that the gifts they grant or used in accordance with their wishes.

Now, friends, therein lies the rub.

For years stories have come out about different charities that donors have found not to be using gifted funds appropriately. Some have developed extremely high overhead costs, while others have been documented paying administrators ludicrous salaries.

In other instances the misgivings are much more subtle.

Most local organizations rely on the local community for support, both moral and, more importantly, financial. However, for years, in this region particularly, those same organizations that rely on the local community have failed to return the favor by using local businesses for goods and services.

Many think of themselves as major institutions and feel privileged as such, often using big-city firms out of New York, Chicago, or Los Angeles for services like accounting and asset management, and even construction work. They seem to have lost their own sense of obligation as organizations built by the local community for the benefit of the local community.

Now we have an array of local causes that are begging for funding but getting nothing, not that it should be any surprise. For years the local community supported these causes from the Museum to the Zoo, not to mention COSI.

Yet when the time came for these same causes to procure services, do you think they utilized those same local patrons that were footing the bill? Absolutely not. Instead these organizations have looked outside the region for the services they require, with absolutely no understanding that with every dollar that they pay to an outside vendor, that’s one less dollar that they will ever see back in a donation from a local supporter.

If there’s anything that can be said about the Northwest Ohio region, it’s that money follows the same trends as people: Once they leave, they don’t come back.

So, fortunately, it seems we all have something to learn when it comes to philanthropy. We in the general public need to give more freely of ourselves, including our time and our skills rather than just our wallets.

Likewise local charities, foundations, unions, et al need to understand that this giving is a two-way street. If they expect to be supported by the local community, they need to return the favor when they require goods or services by using local talent.

Monday, November 2, 2009

Experts Agree Correction Coming

Looking back over my past articles this morning, I have been calling for a pullback in the markets now for the last six weeks. Now, six weeks later, after some ups and downs, the stock market is essentially right where it started (the Dow is up less than 0.5%, while the S&P 500 is down about 1.5%).

After six weeks and little or no movement, investors in the broader stock market haven’t made a dime. And still, after six weeks, the markets still have us awaiting a correction.

But, oh how vindication can be sweet. After six weeks of telling investors that the economy hasn’t turned, and that this rally is built on nothing but air, finally we’re seeing more and more market technicians and other professionals on the markets follow our lead.

What’s more, they’ve been turning bearish for precisely the same reasons we’ve been harping on for more than a month. They say, as we have been, that the credit markets haven’t loosened. In aggregate, more debt is being paid off than taken on.

Credit cards are a prime example. In an industry built entirely on financing purchases – helping people pay for something today with money they’ll [hopefully] earn tomorrow – credit card companies, who have access to vast sums of credit through the Federal Reserve, have been raising rates to astronomically high levels (Citi Jacks Credit Card Rates…, Vince Veneziani).

What other experts are realizing is that with credit continuing to tighten, the flow of money through the global economy (velocity) has slowed incredibly. We would liken it to blood circulating through constricted veins. All this means that, in the short-term, deflation is still a very real threat in the United States.

Perhaps more importantly to investors, this means that the recent market rally is not based on economy, just added liquidity. Prices have been driven higher by money flowing into the market from the sidelines. Some of that money is from banks that were given bailout funds in the stimulus packages.

When they were given these stimulus funds, banks needed to do something with that money, but considered it too risky to loan it out. Instead, the vast majority of those funds were left in the Federal Reserve System, where the Fed pays interest on excess reserves. Some funds eventually made their way into global markets, and have contributed to supporting share prices.

While deflation is a serious threat in the immediate term, inflation is still a larger, more long-term worry. We believe, as we have for some time, that the United States may very well be on the road to more 1970’s-style inflation. In fact, we begin we are already beginning to see this on the horizon. Now, as in the ‘70’s, unions refused to make wage concessions (Opposition Builds to Ford Union Concessions, Jeff Bennett), and this later contributed to massive wage inflation, despite high unemployment.

In the meantime, we continue to wait for the approaching market correction. The big question investors now need to be asking themselves [or their advisors] is where to weather the coming storm. Unfortunately, this correction is likely going to be very similar to the one that occurred last year; perhaps not in depth, but certainly in depth. In the coming correction, like last year, diversified portfolios are going to take a serious beating.

The market is overpriced across nearly all sectors, with few exceptions. However, more bank failures are almost a certainty. In addition, interest rates are so low right now that they simply can’t get much lower, meaning that bond positions are not likely to perform well.

However, looking past the storm, with election season coming up for many Congressman in just over a year, we can say beyond a doubt that the Fed is going to be getting quite a bit of political pressure to do something in order to get this economy going before voters go to the polls next year. We also know that changes in monetary policy by the Fed usually take at least six months to take effect.

With all this in mind we can construct a rough timeline of the way things will likely play out over the next six months, year, and two years, which are pretty good time horizons when considering investments.

First, with each passing day a major market correction draws nearer. Hopefully investors have been getting prepared to buckle down. If they haven’t, they certainly need to.

Second, once the market corrects the Fed is likely to work with the Treasury to make major shift in monetary policy in order to appease pressuring politicians. Knowing what we do about monetary policy, major changes will need to be made by the time it’s getting warm in spring, at the very latest.

Lastly, once the economy and the markets begin a sustainable recovery, inflation is likely to reach levels not seen in the US since the ‘70s. While this may alarm some investors, and inflation on the scale we see coming is certainly never fun, it’s nearly always better than the alternative.

Monday, October 26, 2009

US Laggard in Global Recovery

Well, perhaps apologies are in order. Apparently I’ve underestimated readers’ interest in political satire. It seems that last week’s article was not read with the same enjoyment that I got in writing it.

I will be the first to admit that my article last week was a bit more political than most. However, while I chose to present my case as a political satire – not to mention fantasy – the real objective was to get readers thinking about current economic circumstances, and how the economy could be turned around – if that was really the goal.

This week we’ll stay away from politics, but keep discussion broad. So this week let’s consider the following question: Why is rest of world recovering and the US isn’t? In other words, why are we lagging rather than leading?

First, let’s be clear. I’m not talking about a stock market recovery. I’ve stated repeatedly that we believe this rally is totally unjustified in fundamental terms. What we’re talking about is REAL economic recovery – sales, jobs, revenue, PROFITS.

The example we’ve seen thrown around repeatedly in the last week is the London real estate market. According to one Bloomberg article some agents there are nearly sold out of inventory (London Agents ‘Sold Out’ as Home Asking Prices…, Svenja O’Donnell). Even though unemployment is still high, construction had slowed down so much during the downturn that now inventory is extremely low.

Of course, mortgages are much more available there than they are here, and that is spurring demand from foreign buyers. That includes demand from several big banks, including at least one that was the recipient of a hefty taxpayer bailout. Goldman Sachs employees have reportedly been major buyers in UK real estate (The barefaced greed of bankers and their bonuses…, Boris Johnson).

All this demand on the far side of the pond has sparked recent increases in asking prices, which are now topping previous highs set in late 2007 (London Agents ‘Sold Out’…). All this while US housing prices remain at their lowest levels since the start of this recession, amid growing foreclosure figures, even among modified mortgages (the so-called “refault rate”).

What’s more, things aren’t expected to improve in the near future as another wave of trouble is expected, this time in commercial real estate and Alt-A mortgages, which could very well lead to even more bank failures (Commercial real estate to drive U.S. bank failures, Elinor Comlay).

And London is hardly the exception to the global recovery. Australia has rebounded so fast that the central bank there recently began raising rates in order to ensure the economy doesn’t overheat and inflation doesn’t take off (RBA Says Low Australian Rates Imprudent…, Jacob Greber).

The million dollar question, it seems, is this: What’s makes the United States so much different from most other developed nations? Why does credit continue to contract here as consumers pay off debt rather than take out loans – not that banks want to lend anyway?

We’ve been saying for some time now – especially since government bailouts started – that inflation would be a problem down the road. But we’ll readily admit that isn’t the case right now. In fact, deflation is a much more serious threat as credit continues to shrink.

In fact, right now the US dollar buys more than it did a year ago, according to CPI figures from the Bureau of Labor Statistics (Consumer Price Index – All Urban Consumers, Department of Labor).

To add to this history lesson, let’s take a quick look at the Dow. At just over 10,000, the first time the Dow was at these levels was in 1999, and most recently crossed these levels (while in an upward trend) was in April of 2005.

Thinking back to 1999 and 2005, I certainly can’t speak for readers, but I can say that personally today feels absolutely nothing like 1999, much less 2005. Not in economic terms like sales or unemployment.

It’s historical comparisons like this that have led us to believe that this recent run in stocks, while beneficial for helping to rebuild portfolios, is not supported by economics. Even though some big business have started loosening their purse strings (Business Spending Looks Up, Timothy Aeppel), the US still has a long way to go before we see a true economic recovery, one that would justify the kind of rally we’ve seen in stocks.

Monday, October 19, 2009

How Obama Saved the Economy

The following is, or could be, a transcript from a high school history teacher’s lecture in the year 2030 on Obama’s first term.

Having entered office in July of 2009, newly elected President Obama was put in a very tough spot. Presented with an economy plagued by recession, financial crisis, the threat of inflation, and calls for vast social reform, the Obama Administration was forced to prioritize.

After conferring with economic advisors, new Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke, the administration had good reason to believe that the tools possessed in the vast arsenals of these agencies had been strategically deployed, and would slowly guide the economy away from further calamity.

So, having received his mandate for social reform from the American people in the election of 2008, Obama and his team went to work on reshaping social policy in America, particularly with regard to climate change and healthcare, with the hope of letting the economy take care of itself, under the close supervision of Geithner, Bernanke, and others.

However, by the fall of 2009, it was evident that would not happen, that the economy would not right itself, and that the administration would be forced to reevaluate, knowing that the economy is always goal number one, and that social reform cannot be achieved in the absence of stable economic activity.

At that point, Obama and his team were faced with a decision, their first option to continue pursuing a socialist agenda, holding onto the naïve belief that the economy would fix itself. Had Obama taken this course of action and the economy not improved, the Democrats would have lost Congress at the next midterm election in 2010, leaving Obama a neutered, lame-duck President for the final two years of his term, at which point the Democrats would have most certainly lost the White House.

Obama’s second option, and the one we know from history that he [correctly] pursued, was to redirect the focus of his first term toward bolstering the American economy.

Now, at that time energy was a very controversial issue, between speculation, regulation, and carbon footprints. Many people, mostly in the US, were pushing very hard for new regulations that would force energy companies to become more environmentally friendly.

And take it from me, because I was there and I lived through it, when I tell you that at that point in time, global warming, as it was called back then, was a religion, not a science. Up until then everything, the economy included, had taken a backseat to the environment – until the Obama Administration led the change.

At that point, what will certainly go down as a tipping point in American history, some key members of the administration, in a magnificent change of direction, decided to take a hard line with environmental lobbyists, much of their work having come into question (Gore dodges questions at environmental journalist conference, Michael Krebs).

Obama and his staff began independently reviewing research conducted on the environment and found that, while there was a time when evidence of global warming abounded, by 2009 the case had changed. The polar ice cap summer melt rates had been falling for several years (Polar icecap is melting at slower rate…, Mike Swain), the Pacific Ocean had begun to cool (Whatever happened to global warming…, Daily Mail), and arctic polar bear populations, which were at the time a key indicator used by environmentally-conscious Americans, had actually been expanding (Federal Polar Bear Research Critically Flawed…, Institute for Operations Research and the Management Sciences).

Aside from the obvious environmental implications, energy was a major issue for still other reasons. By 2009, many Americans were growing upset that their country had been exporting so much money to conflict-regions – including the Middle East and Venezuela – in exchange for oil and other forms of fuel over the preceding decades.

In the first nine months of 2009 alone there had been over 200 major oil finds worldwide including several in the Gulf of Mexico, one of which may have been the largest deposit ever (The Oil Industry Sets a Brisk Pace…, Jad Mouawad). Meanwhile, the price of natural gas was ready to fall through the floor, not just due to the numerous finds, but the advent of technology allowing companies to more efficiently extract gas deposits.

One single natural gas discovery in northern Louisiana alone revealed enough natural gas that, with the new technology available, was equivalent to 33 BILLION barrels of oil, which was about 18 years worth of all oil production in the United States at that time (U.S. Gas Fields Go from Bust to Boom, Ben Casselman). Of course, there were also major finds in Texas, Arkansas, and Pennsylvania, making the supply of natural gas on – or under – American soil sufficient to fulfill demand in the US for nearly a century.

Now, we must remember that at the time – remember we’re talking about the fall of 2009, Obama has only been in office for 9 months and already the country is viscously divided – the U.S. economy had slowed to a near standstill. Consumers, who had carried the burden of excess debt for decades, simply were not capable of rescuing the economy through spending. Around mid-2009 statistics had showed a halt to the flow of consumer credit, due in small part to banks’ hesitations about lending, but even more-so to Americans’ lack of demand for loans.

American corporations, despite sitting on $14 trillion in early 2009 – I know it doesn’t seem like much now, but at the time that was a year’s worth of GDP – simply could not be convinced to tap into those funds, even to invest in future growth (Where Consumers Fail, Can Businesses Lead?, Gongloff).

Obama knew that despite all odds, he had no reasonable alternative but to take the bull by the horns and attempt to rescue the economy himself, using one of his most powerful tools to do so – policy. By late 2009, it was clear to Obama and most other Americans that the environmentalist crowd, despite their good intentions, simply would never be won over by the more economically-minded. With their lobbyist, celebrity advocates, and protest crowds, and despite ignoring a good deal of facts that weakened their arguments, environmentalists at that time had a much louder, more resounding voice than the silent majority.

As a student of history, Obama of course recognized that he faced a predicament frighteningly similar to that faced by President Jimmy Carter just thirty years before. Obama remembered the gas lines under Carter’s terrible energy policy, and knew that he could not go the way of his predecessor as a one-term President who took his party out of power for the next twenty years, while his successor would be remembered for fixing the problem.

Obama could not have his own equivalent of Ronald Reagan, who was given credit for quickly cutting the price of gasoline in half. Obama knew he could fix the mess himself, even reducing the cost of energy in the long-term, which would ultimately return the United States to its place of prominence among the world’s manufacturing nations.

With all this in mind, Obama – always the consummate politician – undertook a major shift in policy; one which ultimately saved the US economy, his administration, and his party. After some impeccably executed and carefully choreographed political maneuvering, Obama was able to make American energy independence goal number one for his administration, which they resolved to do using all means necessary, including so-called green energy, mostly wind and solar, as well as the not-so-green like oil, natural gas, coal, nuclear, and offshore drilling.

As an added bonus, Obama’s administration was able to shape numerous programs to incentivize technology innovations in the energy sector. Most noticeably, there were many tax breaks offered to companies that invested significant assets in lowering the environmental impact of their respective fuels, with particular focus going towards cleaner-burning coal.

Obama’s focus on energy was simply brilliant, as was his ability to work out an acceptable solution for everyone. He knew that if he could loosen restrictions on the energy sector – even for just a few years – to give companies and individuals the leeway and incentives to expand the industry and achieve energy independence that more money would follow, flowing into investments designed to improve technology and curtail carbon emissions.

Under Obama’s supervening plan of action, job number one was the economy, since without a strong economy there simply would be no money – much less incentive – to invest in green technology. By holding off on social reform, the administration knew they could save the economy, which would give them time to garner support and credibility to be used later on to achieve their objectives of shaping social policy.

Furthermore, Obama and his administration realized just how many peripheral industries would be helped by a massive expansion in the energy sector. Resolving to build five new nuclear plants across the country, encouraging offshore drilling, and loosening restrictions on coal, natural gas, and oil refineries – temporarily – all combined with the already burgeoning areas of wind and solar power, had an immediate impact.

As a result, due solely to a temporary loosening of the leash, Obama and his team created a sudden and incredible demand for raw materials that would be needed for construction, engineers to design new facilities, construction crews to build them, not to mention ancillary companies required to feed and house those construction crews.

Once facilities started opening there was still more job demand to staff new plants, and all these new employees needed food, homes, and health insurance. As plants got up and running successfully those same employees found themselves with disposable income, which meant new demand for major purchases like flat-screen TV’s and new cars.

Of course, we can’t forget that now transportation companies were needed to help move and manage these fuels around the country, whether it was oil that needed to be moved cross-country by truck or rail, new pipelines that needed building to handle increased flow of natural gas, or companies managing the flow of electricity generated by nuclear plants, solar panels, and wind farms placed strategically across the country.

And so it went that through the single action of temporarily loosening environmental restrictions that President Obama was able to manufacture a massive trickle-down effect, by which he single-handedly saved the US and perhaps the global economy. Obama later went on to mold social reform later with new support and added credibility, earning the Nobel Peace Prize that was bestowed on him somewhat prematurely and shaking off his haunting image as a glorified community organizer and reserve his place among the greatest presidents in U.S. history.

OK, class, that’s all for today.

Monday, October 12, 2009

Traders put cart before horse

In our business, timing is absolutely everything. And while there is a big, big difference between being wrong and being early, waiting is rarely fun. But such is life for a contrarian.

Most readers will undoubtedly understand my frustration, as I have been calling for a downturn in the stock market for about a month now. So for the last month life around the office has been characterized by the old adage “Patience is a virtue.”

After all, we know that a market correction WILL come. There’s simply no doubt about it. Markets always – ALWAYS – correct, sooner or later. The only questions are (1) when, (2) how long it will last, and (3) how severe it will be. And once it starts, everyone who has been calling for a correction – us included – will look like geniuses.

Until then we must endure our current status as nitwits who obviously do not understand the dynamics of a bull market such as this (pardon my sarcasm).

In 2006, Euro Pacific President Peter Schiff stood up at a mortgage brokers’ conference and told all in attendance that the real estate market was going to crash. At that point, people laughed, having firmly grasped the belief that property values never went down. However, by early 2008, no one was laughing anymore. Many were looking for new jobs.

When we first started buying gold back in 1999, we did so in light of booming dot-com’s and tech stocks. For years people thought us cooks for ignoring such an obvious opportunity for easy money. Once the bubble burst and the market crashed, people wondered why we didn’t warn them sooner.

Last year crude oil ran to $140 per barrel, and even then analyst reports projected advances to $200 and beyond. We argued that the fundamentals didn’t support $140/barrel, much less $200. We argued then that oil and been pushed up to $140 by individuals speculating in the market, and that those the market would crash when there was no more money to push it higher – in other words, when everyone got on one side of the trade, the long side.

At the time we had been forecasting a major spike in inflation, a spike that has not yet materialized, but certainly will once the real recovery in the economy begins. However, we still took a negative opinion of oil, taking a step back from the sector and later watching crude fall to $33/barrel.

You can’t argue with facts, folks. And the simple facts are that the market is overdone. Right now inflation numbers are lower than they were in March of last year when Gold was setting new highs. And yet Gold is again moving to new all-time highs, propelled mostly by excited buying from individuals who know somewhere between very little and nothing about gold and how it is traded.

One argument that has come up repeatedly is that the US dollar is crashing and that investors should be buying gold and other commodities as a hedge. This argument doesn’t exactly hold water, since the dollar is currently higher than it was last March when gold peaked, as measured against a basket of global currencies (NYBOT:DX). In fact, based on global exchange rates, it has been projected that Gold should actually be just shy of $800/ounce (Nadler, Buy the Rumour, Buy the Fact).

The facts are that the stock market is currently at levels seen around 2002, a time which was NOT characterized by rampant unemployment and a recession that economists have claimed is over, but is starting to feel more like a depression, unlike today.

The picture being painted by the markets is that the economy has bottomed and the U.S. is back on the road to prosperity. But the facts are that this economy has NOT recovered as the market suggests, and that it probably won’t anytime soon with the current policies coming out of Washington.

Successful investors must make decisions based on facts rather than emotions. Lately one report after another encourages buying of gold. With gold hitting new highs, analysts argue that it has risen above any kind of resistance, so there’s no reason NOT to buy. In reality, at this point gold feels eerily similar to dot-com’s near their peak in 1999 and 2000.

Unfortunately, gold hitting new highs does not have any affect whatsoever on the fundamentals. Instead, this event is the consequence of emotion in the markets, and it’s extremely important that investors not get caught up in that emotion. Instead, take a step back and separate emotion from truth and fact from fiction.

Monday, October 5, 2009

Earnings estimates fill markets with hot air

With this week marking the end of the quarter, it isn’t unreasonable to expect some screwy market activity. Between investors’ profit-taking and advisors’ window-dressing, the market can get so confused it forgets which way is up.

All-in-all, this past week has been relatively calm, considering the forces at work. After a brief pop to the upside, stocks seem to be settling back at last week’s levels. Fundamentals, however, rarely change from week to week.

The fact is that when we look at recent moves in the stock market, volume and sentiment numbers, and price-to-earnings ratio (considering our own estimates for realistic earnings), the stock market remains extremely overbought.

Of course, this is based on our opinion that the economy simply has not significantly improved, and that more likely than not, earnings reports are going to disappoint investors. At this point the market is fundamentally overbought, but other indicators suggest that many investors simply have a hard time taking a position against the current trend.

Our contention at this point is that stocks appear to be running out of steam on the upside. Trading volume around the peaks has been declining recently, indicating that a good deal of demand has been absorbed. Even with the window-dressing typical in the last week of a quarter, this market has made no substantial move to the upside.

Instead, Treasury yields have continued their decline that started back in August. This could mean that we aren’t alone in thinking this is a pretty good time for investors to be taking profits. It seems there are others who are content to book their gains on the year and take a breather on the sidelines.

Most financial advisors are content to hold until the market shows some sign of weakness, while our argument is that this market, lacking any fundamental support, is being driven higher each day by unrealistically hopeful investors. Once they run out of buying power – and they WILL run out of buying power – the market will descend back to reasonable levels, and there will be few buyers as everyone rushes for the exit at once.

This concept couldn’t be more evident than in the gold market. Recent market activity reflects sporadic buying likely to be central banks building positions. Why, do you ask? Well, quite simply, this buying is likely to be central bankers because they aren’t getting a good price.

Any investor who has bet against central bankers would likely have pretty astounding returns over the past several decades. Remember when Gordon Brown sold over half of Britain’s gold nearly a decade ago, right around $300/oz?

At this point there’s just way to much excitement surrounding gold for it to be a good buy. Being the contrarians that we are, we expect the demand seen lately buy uneducated investors will soon dry up. From there we see a forthcoming correction in commodities that will represent a great buying opportunity.

After its correction, commodities are likely to move higher to levels never before seen as the Federal Reserve is forced to inflate away debt accumulated by the U.S. government. We listen when representatives of the Fed claim they have the ability to inject enough liquidity to avoid a depression, but without causing runaway inflation. But we don’t believe a word.

One day in the near future, probably when election season draws near and campaigns kick into high gear, we believe that the Treasury and the Fed will be forced to make the difficult decision between a double-dip recession and inflation, and we all know which they’ll choose.

Monday, September 28, 2009

Bull market set to buck investors

Lately I’ve been watching a little more CNBC than usual, trying to keep my finger on the pulse of this market. In doing so, I’ve noticed a recent trend, one that, sadly, isn’t all too unusual. As guests and commentators discuss market action, prices continue to climb, particularly for stocks and commodities, especially gold.

And yet, predictions and price targets keep moving higher and higher. It occurs to me, after having been raised to be a contrarian investor, that when absolutely no one thinks there’s a top in sight, quite often they’re standing frighteningly close to the edge of a cliff.

My point is this: lately the general public has been getting increasingly excited about where this market might be headed, and all the “dumb money” — those funds not managed by professional investors — has been piling onto the long side of the market

Meanwhile, the smart money has gone in exactly the opposite direction. Wednesday morning we saw the OEX put/call ratio hit the highest levels we can recall. That means that the professionals – fund managers, investment advisors, on down – are all betting that the market is poised for a major correction, one worth hedging against in a big, big way.

So, to recap: Dumb money, which is almost always wrong, depending on time horizon, is decidedly long the stock market, despite its gains year to date. Smart money, which has a much better batting average, is short, and short BIG.

The question for investors is what to do now. After seeing portfolios, on average, cut in half during 2008, most investors have made back at least some of their money, as typically growth funds are up anywhere between 15-30% on the year.

Despite their gains, many investors are happy to sit tight and “let it ride.” There seems to be some sort of sense of entitlement on the part of individual investors that they are still owed the remainder of what they lost. It would appear that a large number of investors have forgotten one of the most important tenets of investing: the market doesn’t care about you.

The sad fact is that the market could care less how much John Q. Public lost in his IRA last year. So if John thinks making it all back is as simple as sitting tight and waiting, he likely has another thing coming.

While most stock funds have made strong gains so far this year, they have done so mostly on blind luck. Recent economic numbers simply do not support current price levels in stocks. So with the S&P 500 P/E ratio currently well over 100, and no truly positive economic news in recent memory, investors need to think long and hard about what to do now.

If you haven’t guessed it, we are currently pushing investors to take their gains and step out of the market for a breather. The coming correction will likely allow investors to buy back into choice sectors at much lower levels, rather than having to ride the market down.

While many investors might protest this argument, the simple fact is that most have taken a beating over the past two years, and need to book their gains and take a little time to regroup. Even rodeo riders get off the bull when their eight seconds are up.

In our view, anyone who sticks around now is just a glutton for pain. They’re more than welcome to ride the market through the storm ahead. But as for us, we’ll be on the sidelines where it’s warm and dry.

Monday, September 21, 2009

Market poised for dive as deflation odds rise

Sometimes life is a waiting game, and such is certainly the case with the coming correction in the stock market. Day after day, week after week, this market continues higher in a trend built entirely on thin air.

With few fundamentals to support this market recovery, investor sentiment is nearing levels of bullishness, typically associated with bubbles. In the late 1990s, sentiment reached all-time highs for tech stocks, and surged late last year for 30-year Treasury bonds as investors fled stocks. The global real estate market saw unprecedented positive sentiment for years as the housing market boomed, finally coming to a peak about two years ago.

Investor sentiment essentially measures the popularity of a given investment. The higher it trends, the more likely the investment is near a major peak. Investments can’t go up forever; at some point, they simply have to correct. The further an investment gets away from rational levels, the more likely it is to snap back in the other direction. This is reflected in market sentiment.

Today, we can see this not just in most of the stock market, but also in several commodities, particularly precious metals. Gold, which we typically love, has lately enjoyed a run that is extremely overdone on the upside, and it is poised to see a major correction within the next two to six weeks.

Likewise, silver is also overpriced given current conditions. Unlike gold, silver is much more closely linked to manufacturing – that’s where it’s most commonly used — and the economy simply has not recovered sufficiently to support the current price.

While we have been on the path for high inflation for a long time — we still haven’t seen the consequences of the trillions of dollars created in government bailouts — the sad reality is that it is becoming increasingly likely that the United States may enter a deflationary environment in the near future.

Deflation hasn’t been a major issue since the Great Depression, but it is typically characterized by falling prices that result from the slowing of credit, a general deleveraging (e.g. American paying off debt) and, unfortunately, rising unemployment.

These characteristics describe the current situation in the United States frighteningly well. What that means is that Fed Chairman Ben Bernanke, the self-proclaimed expert on the Great Depression — and avoiding a repeat — is looking at the real possibility of a double-dip recession that would cause massive unemployment and nasty deflation.

The problem now, and the reason that deflation is becoming feasible, is even though the Fed, in conjunction with the Treasury, created trillions of dollars last year out of thin air, all that new money simply isn’t circulating because the economy is so terribly slow.

The challenge facing the Fed is how to get all of that new money, currently held by banks as excess reserves in the Federal Reserve System accumulating minute interest, into the hands of American citizens and companies for spending.

At this point, with banks fearing losses from defaults, most banking institutions are happy to leave all that bailout money in the Federal Reserve System earning interest — no matter how small — rather than take the risk of lending.

Just as significantly, there simply isn’t demand for loans on the part of American consumers. The Fed seems to be expecting the consumer to turn around and create demand for credit which will get all their new money circulating. Unfortunately, this is unlikely.

During the past year, the United States has seen a drastic increase in the savings rate, which indicates that most Americans are much more interested in saving as opposed to consuming, much less taking on debt in order to make major purchases.

For years this rate was negative, meaning that Americans borrowed more than they saved. Now, it seems that trend has changed, and with unemployment moving higher and no truly positive economic news to be found (less bad will not suffice), Americans are cutting back on spending and building up reserves of their own.

When it comes to consuming, at this point, companies are much more likely to have any kind of demand for credit. In fact, right now they’re sitting on record cash reserves that could be used to service such debt.

The government’s best course of action would be to offer corporations incentives to loosen their purse strings to invest in expansion projects. This would most likely be done through tax credits for corporations. The current political climate makes this highly unlikely.

Instead, with its outdated fixation on the U.S. consumer, the government is much more likely to try everything in its power to stimulate American citizens into taking on additional debt to make unnecessary purchases. This would most likely be achieved through the expansion of homebuyer tax credits as well as rebate programs like cash for clunkers.

What the government fails to realize is that at this point trying to stimulate American citizens to take on debt and buy things they don’t need is akin to beating a dead horse.

The balance sheets of most Americans have been decimated during the past two years and it should be abundantly clear that the demand for new debt simply does not exist. It’s time the Fed realized this, and looked for another way to rescue the American economy from the brink of disaster.

Monday, September 14, 2009

Gold hits $1,000 an ounce – but can it last?

It recently has been relatively quiet in the markets, with the biggest news being gold’s fifth test of the $1,000 mark in the past year and a half.

While gold’s recent strength is certainly no surprise — we have been singing its praises for a decade — it is worth noting that this most recent advance towards $1,000 has taken place as money supply numbers released by the Federal Reserve (especially M2 and MZM) have actually been falling.

What this seems to indicate is that the Fed has taken action the past month to begin removing excess liquidity from the system that it injected last fall. It is doing so with the hopes of avoiding massive inflation once credit begins to loosen again and all that new money starts making its way through the global financial system.

So far, the Fed’s efforts to remove excess liquidity have not been totally successful, as gold has marched higher since this time last year, nearing $1,000 for the third time since then. It has done so as the dollar has fallen sharply on worries that the international community will make good on its promise to abandon the U.S. dollar as the world reserve currency.

This concept has been picking up steam since the financial crisis erupted in the United States last year, with the rest of the world being dragged into the pit thanks in large part to their substantial reserves in dollar-denominated holdings. During the past year, the reserve currency status of the dollar has been called into question by the likes of the G-8, the International Monetary Fund and, most recently, the United Nations.

The varying dynamics of this year and last have sparked an interesting debate about whether gold or United States Treasury bonds provide a better “disaster hedge.” In a Sept. 9 Wall Street Journal article (“Is Gold the Right Recipe for Disaster”), Peter Eavis addresses both sides of this argument.

Frequent readers will undoubtedly guess where we tend to stand on this issue. And for those who call us fatalists for preferring gold, I’ll point to the 38 percent decline in the value of 30-year Treasury bonds year-to-date, versus the 14 percent advance in the price of gold bullion.

Strangely, other commodities seem to lack the luster in gold’s recent performance. Crude oil has been trading at $70/barrel lately after dipping briefly into the upper 60s.

This is likely because of the relatively slow summer travel season this year, as well as decreased speculation, which played a major role in oil trading more than $120 a barrel this time last year.

Even more significantly, natural gas remains very cheap, trading at slightly more than a third of its price this time last year. This is even more remarkable considering that we are heading into what has been predicted by “Farmers’ Almanac” to be an extremely cold winter. Some may remember that even last year, which was not as bad as this year has been forecasted, saw Russia cut off the flow of natural gas into the Ukraine due to shortages in Eastern Europe.

As we head into fall, a historically weak period of stocks and strong time for gold bullion, all of these developments have set the stage for what should be an exciting six months.

Between now and Christmas, the world markets will reveal a lot in the way of collective expectations about where our global economy is headed, and how it intends to get there.

Tuesday, September 8, 2009

Recession’s impact magnified by credit crunch

Debt. The very word by now should make your eyes water and the hair on the back of your neck stand on end.

We all know how it works; buying something today and paying for it tomorrow rather than saving today to buy tomorrow. And, most importantly, we know the disastrous effects it can have on a nation and a global economy.

For years leading up to the financial crisis of 2008, the United States’ consumer savings rate had been negative. That means that, in aggregate, more money was borrowed by Americans than was saved. It means that our country, from sea to shining sea, was running completely and totally on borrowed money — and borrowed time, as the saying goes.

The bill for all that debt finally came due in 2008, and in the blink of an eye credit tightened up tighter than a snare drum. When that happened, when the system couldn’t even get the credit to run on a day-to-day basis, the whole thing came crashing down.

Depressed yet? Well, don’t be. Despite the double-digit unemployment and daily headlines about protest after protest, topped off with a wave of bankruptcies, the truth is that this recession hasn’t been all that bad. Unfortunately, it has been magnified immensely by the credit crunch we experienced in the fall, and the ensuing financial crisis.

Now, months later, with the market having staged an excellent rally and the economic numbers starting to turn up, it has become apparent that the system is stabilizing.

After such a sharp decline, the U.S. economy and stock market are simply resetting, but at lower levels, since there isn’t enough debt left in the system to support the old highs in the market. The destruction of all that debt over the past year has just proven extremely … messy.

Living on a prayer

But have ye faith. The economy and the stock market — and your 401(k) — will return to their old highs. It may not happen for some time, so if you’re waiting for the Dow to get back to 12,000 so you can sell everything and move to Tanzania, you might not want to hold your breath.

The economy will recover — in time. And we can add a third line to that short list of things we know in life that are absolutely certain, right under death and taxes. That is this recovery will most definitely not be built on credit.

It may not even be consumer-led. With American consumers still in the process of getting back on their feet, it’s quite likely that, in this economy, consumers are going to take a backseat for a while, and let business drive. As discussed in the article, “Recovery in the making but danger still abounds,” nonfinancial U.S. companies are sitting on (hoarding) and unprecedented $14 trillion in liquid assets.

With a year’s worth of U.S. Gross Domestic Product in cash, this economy could be turned around in remarkably little time. Of course, that turnaround would be predicated on the right policies coming out of Washington and providing the necessary incentives – not penalties – for companies to invest some of that cash in expansion projects.

Those policies would include tax cuts (abatements at the local level simply won’t cut it), general deregulation (e.g. employment rules) and cheaper energy. Cheaper energy is a hot issue, especially with cap and trade coming up for a vote.


Focusing for a moment on the economic climate, the most important objective in Washington should be making the United States self-sufficient for all its energy needs. This would contribute to the ultimate goal of keeping energy affordable, since energy dependence leaves this country at the mercy of energy providers, OPEC and the like.

Lately, it seems nearly impossible to check the headlines without noticing political turmoil, especially within this country. Between cap and trade and now health care reform, there seems to be a growing tension that there is somehow a battle waging between good and evil in this country. That President Barack Obama and Speaker of the House Nancy Pelosi want to bankrupt America, or that Rush Limbaugh and Glenn Beck want to burn down D.C. Neither of these could be further from the truth.

The bottom line is that liberal or conservative, Republican or Democrat, no group cares any more about America than the other. It’s just that when it comes to this country, each has a totally different vision of what the finished product looks like.

Conservatives want to save the economy through pro-business policies. The general feeling is that in order to allow the American working man to pull himself up by his bootstraps; the government needs to kindly step off his back.

Likewise, liberals tend to want desperately to help out the less fortunate, who have been made even more so by the current economy. They hope to capitalize on this opportunity to radically reform the role of U.S. government; to put systems in place to keep the little guy well-stocked on fish, rather than lifting regulations that make a rod and reel overly expensive.

Bottom line

The fact is that after the events of the last year, the current landscape — political, economic, and investment — is totally different from before. As an investment adviser, I can tell you with complete confidence that there are certain ideas, previously accepted truths that have been completely discredited over the past year.

First and foremost, the theory of buy and hold simply doesn’t work anymore. Today’s world sees major changes on a daily basis in both domestic and international politics, various sectors of the economy on various scales and with conditions constantly changing, the market is simply too dynamic for this system to work.

If that doesn’t throw enough of a wrench into your portfolio, the second change finally being acknowledged by the financial community is that diversification doesn’t work. Why this is a surprise, I simply will never know. Even the academics who conceived the idea of diversification stated that it was never meant for real-world implementation (Markowitz, Portfolio Selection: Efficient Diversification of Investments, page 275). As Warren Buffett once said, “Diversification is a hedge against ignorance.”

As you are undoubtedly aware, the world we live in today is vastly different from what it was a year ago. If you don’t understand how this impacts your investments, you better make sure your adviser does.

Monday, August 31, 2009

Recovery in the making but danger still abounds

Each week goes by and the same question remains: How much higher can this market go? After rallying nearly 50% from its bottom in March, the stock market must be nearly out of steam.

Despite economic numbers beginning to show what looks like the beginning of a mild recovery, we simply can’t believe that this market can go much higher. Especially since there isn’t as much money supporting prices as there was at the old highs. Not after so much leverage was wiped out of the system during the collapse.

And yet, with each passing week, the market continues higher.

Looking at the current economic situation and the fundamentals driving this market, we firmly believe that there is a correction on the way. One that may not take the market back to lows set in March, but undoubtedly one that will cause investors sufficient alarm to throw up their hands and walk away, turning instead to “safer” bonds.

These folks, the unfortunate few who lack necessary preparation and lose their heads (and a good portion of their portfolio), will without question be stepping out of the frying pan and into the fire. This is because bonds, those old bastions of safety, are set to decimate investors in coming years, for two reasons.

First, with interest rates so low right now, there is really only one direction they can go. Of course, readers who have a grasp of basic tenets of finance – or remember the 1970s – will remember that rising interest rates decrease the value of existing bonds.

Second, even those bondholders who are willing to ride out it out through rising interest rates and hold their bonds until maturity will not fair much better. In a time of rising interest rates, inflation tends to run like crazy because consumers take out loans to make purchases sooner rather than later, since they know it will be more expensive later.

Inflation is that tax for which none of us get a bill, but all of us pay. To holders of long-term bonds, it means a crushing blow to purchasing power.

When it comes to the possible dangers of bonds, take the following example. In December of 2008 we made our predictions for 2009. One of which was that the 30-year Treasury bond would be among the worst investments for 2009. At the time the bond was yielding about 2.6%. Now that same bond is yielding about 4.24%.

Therefore, that “safe” bond has caused anyone who bought in around New Years to lose more than 36% of their principal. In other words, if they tried to sell that bond in today’s market, they couldn’t even get 64 cents on the dollar for it.

The bottom line is that in this market, despite the volatility, bonds simply aren’t the answer. In fact, right now the stock market is just nearing the end of a 10-year bear secular market in equities, based on inflation-adjusted returns.

After the correction that we see coming in the near term, stocks will likely trade sideways for another four years or so while stagflation runs its ugly course in the United States economy (stagflation indicates a period of inflation that coincides with economic stagnation, and last appeared during the 1970s). After that, look for the start of something big. After the market moves sideways for awhile, a big bull run is on way in stocks.

Even while the market trades sideways in coming years that hardly means that there won’t be any money to be made. Even sideways markets have very trade-able rallies.

The long-term bull market that we see coming down the line in stocks is deeply rooted in fundamentals and may well lead the United States back to prominence as THE global economic power. The major sector that we see leading the economy back to glory will be – try not to laugh – manufacturing.

It’s no secret that manufacturing has been shifting abroad for the past 15 years or longer. Now companies are finding themselves unable to control the productivity of employees or the quality of their products; and while cheap labor is nice, they simply can’t sacrifice quality.

With technology, resources and labor becoming cheaper here due to high unemployment and lack of demand for raw materials, what we see coming is a very gradual shift over the next several decades that will bring a significant amount of global manufacturing from Mexico and China back to the United States.

The following are several examples of this trend already developing.

  • Several months ago a Chinese industrial company made a bid to buy Hummer from GM, with the intention of leaving manufacturing in the United States, and even expanding production by opening other plans, all within the U.S.
  • Carlisle Tire & Wheel is closing down its production plant in China and bringing it back state-side, and consolidating that plant with others from Pennsylvania and Georgia all under one roof in Tennessee.
  • Hair iron producer Farouk Systems is consolidating all foreign production in Houston, Texas, according to an article in the Wall Street Journal on August 24th (Coming Home: Appliance Maker Drops China to Produce in Texas, Aeppel). According to the article, the company spends about $500,000 each month battling counterfeit versions of its products, most of which come out of China.

While this trend is obviously beginning to form, it unquestionably has hurdles to overcome. Policies in Washington need to encourage cheap manufacturing and provide incentives to businesses that relocate here, either through tax abatements or government grants.

The attitude that Americans have towards foreign firms also needs to change. No longer can Americans consider the Chinese or Japanese the enemy. Instead, they need to be seen as collaborative business partners. Americans cannot maintain the current “us versus them” mentality if they want to see see jobs move back here.

Recovery doesn’t always come from the usual sources. Right now consumer spending is still extremely tight because of high unemployment. Meanwhile, according to Federal Reserve Data cited in a Wall Street Journal article on August 26th, American nonfinancial companies are sitting on $14 trillion in liquid assets (Where Consumers Fail, Can Businesses Lead?, Gongloff). That’s equal to about a year’s worth of GDP. A simple loosening of their purse-strings to invest a fraction of those funds in future growth is more than enough to cause a serious economic recovery in this country.

Monday, August 24, 2009

Market fizzle likely on lackluster data

For last three or four weeks, the stock market has been trading sideways, more or less, on economic news that has seen no substantial improvement. While obviously this has put many investors’ minds at ease, we may not be out of the woods just yet.

First off, at this point there are no economic fundamentals supporting this market. The numbers show no substantial improvement, and certainly not enough to warrant the kind of market recovery we’ve seen so far. At some point, the numbers we’re seeing on the economy need to improve, or else the market will turn, but for the worse.

This is especially true with unemployment. With the consumer-dominated economy of the US, there is really no possibility of any substantial recovery with unemployment so high. Americans simply don’t have the money to spend in order to turn this economy around.

Meanwhile, so far the new Administration and the Federal Reserve have released only a small fraction of the funds authorized through the stimulus bills. The government is also dragging its feet when it comes to paying back rebates auto dealers have accrued through Cash for Clunkers.

These issues make little since. Why did the government push through stimulus bills that were so unpopular, just to sit on the money? Why are they holding back money owed to car dealers, rather than making good on their promise and allowing that money to make its way through the economy? Finally, why does this White House seem to care so little about turning the economy around?

But, since economic numbers don’t show any signs of improving, a correction in stocks seems imminent. The question is how big it will be. While it certainly could put the Dow back around its previous lows, the chances seem higher than it could simply catch its breath after retreating to the 7500-8000 level.

To give some historical perspective, consider the recovery after the 1929 crash. After finally bottoming in July of 1932, the stock market rallied for just two months before topping out in early September. It then traded sideways for more than six months before it finally broke out in May of ’33.

Market action from the mid-1970s tells a similar story. After putting in a second and final bottom in December of 1974, stocks rallied for seven months, then went into a holding pattern through the end of the year.

As it stands, we’ve been rallying since March, and the market appears to be losing steam. In fact, it’s overbought according to multiple indicators. Not only that, but we are now nearing September and October, which historically tend to be the weakest months for stocks.

With all this in mind, chances are better than average that the market won’t move substantial higher in the next several months. And while an end of the year rally isn’t out of the question, I certainly wouldn’t hold my breath. Especially not after seeing the Dow Jones Industrials rally more than 40% off its bottom and tracing nearly 40% of its decline since October of 2007.

The real question for investors is whether they have a plan that will stand up to either a violent correction or a market fizzle. And while many Americans put that responsibility off on their broker, it’s important to understand that the financial industry is one of several that are still suffering, and it may have a largest impact on investment portfolios.

While the auto industry has suffered lately due to lower demand, increasing inventory, unemployment, and the like, and the slowdown in real estate over the past year or two has caused the cash flow for many to dry up, the turmoil in the financial industry impacts many Americans even more significantly.

Since last year, major brokerage houses have obviously taken a huge hit, and after a wave of failure and mergers, there has been a massive consolidation in the industry. This has left brokers worrying about their own jobs, and spending less time focusing on client portfolios. For this reason, as outlined in a Wall Street Journal article last week (Wall Street’s B-List Firms Trade on Bigger Rival’s Woes, August 11, 2009), smaller firms are growing to fill the void being left as the formerly-dominant firms struggle.

Americans need to understand that there is major shift occurring in this country, one very different from the changes we saw occurring for decades leading up to the collapse last year. We’re seeing it in politics, manufacturing and consuming; and the financial industry is no different.

Americans used to commit considerable time to researching their own investments, before they started delegating that responsibility to advisors. Of course, initially they wanted to get to know their advisor and understand the person’s strategy for managing money, as well as their personal character. Unfortunately, now we are seeing fewer and fewer people taking the time to do their due diligence and get to know what they are buying and who is selling it to them.

The bottom line is this: Investors need to know who they are entrusting with their life savings. If they can’t take the time to do their homework, they shouldn’t be surprised when they find they’ve been caught up in the next big swindle.