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.

Wednesday, February 17, 2010

Asinine Assumptions Abound in Turbulent Times

Friends, it may come as a shock, but there is a war being waged under our very noses. This war is not fought with guns, tanks, or bombs; its casualties are hardly noticeable. In fact, many haven’t even been born yet.

The war being fought this very day is an economic war. Its trenches are stock exchanges and trading pits around the world. Its weapons, from foreign exchange and repurchase agreements to credit default swaps and collateralized debt obligations, are being deployed by troops, Goldman Sachs and JP Morgan Chase among them, worldwide.

While the war wages on and opposing forces shoot it out at trading posts across the globe, little thought is given to collateral damage or innocent casualties, mostly because many of the casualties are our grandchildren’s grandchildren. They will bear brunt of the goings-on in today’s markets, not us.

Even after all we’ve been through over the past two years, the trend of today remains excess: Excess spending financed by massive debt. The only difference is who is borrowing. Instead of individuals taking out mortgages with no-doc loans, the biggest borrowers now are governments, not consumers.

Rest assured, in the long-run the effect will be the same. The bill will come due, someday; just as it did two years ago for spending that began with baby boomers.

The biggest concern to investors today is, or should be, sovereign debt. Greece has been making headlines lately because of its own crisis, but that hardly skims the surface.

Far away from the euro zone, a grand experiment which may or may not survive this turbulent time, there are countless municipalities that have racked up considerable debt, only to see their tax revenues dry up as a result of high unemployment, falling property values, and tightening consumer spending.

Like corporations and consumers, governments on all levels must also rein in their excess spending and make every attempt to relieve themselves of debt burdens. Some will ultimately fail, just as Americans who filed for bankruptcy and Lehman Brothers before them. There are always casualties in war.

However, most governments possess tools unavailable to the private sector. Whether towns are forced into receivership or states must halt tax refunds, as California did last year, the tools available to the public sector are always more abundant. However, the decisions that have to be made are not easy.

It takes a lot of discipline for politicians to rein in spending and cut government programs, rather than playing the usual ‘blame game.’ The fact is that governments could very easily fix many of the problems they face, but not with gutless ‘leadership’ so common today.

That doesn’t mean it’s impossible for governments to change their ways. The world today is free of many long-held assumptions. Until 2008 who ever thought that Bear Stearns would cease to exist, or that GM could go into bankruptcy? Did anyone ever think that they could see home values cut in half?

Unfortunately, in the place of these abandoned beliefs, new assumptions are forming. The new idea quickly gaining popularity is that the US must be on the gold standard, or else the dollar will become worthless, that the price of gold is going to the moon on an Iranian shuttle, and, lastly, since the recession is finally over, that the markets will keep going up.

Unfortunately, these and other assumptions will certainly be proven wrong, as sure as the Earth is round. Among the most deeply-imbedded assumptions in popular thinking, with the most far-reaching consequences for people around the world, is that governments can’t go broke.

The United States’ AAA credit rating was not pre-ordained, it was earned after decades of financial responsibility; and Treasury bonds are not riskless securities. Just ask anyone who purchased a 30-year bond at the beginning of last year, only to see their bonds fall by more than 30% by the end of 2009.

The world is constantly changing. Assumptions can prove to be very, very dangerous to investors. Those who fail to adapt will go the way of the Dodo, as will their chances for retirement.

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