Entries from December 2008 ↓

Predictions are probably the best Rorschach tests for bloggers and investors. Everyone is in the prediction business, because every act of investment (including sitting on cash in the sidelines) is an implicit prediction about the future.

Writing down my predictions for the year has proven itself to be a great tool for me to become explicitly aware of my cognitive biases. Because if there’s one thing I’ve learnt in investing, its this - It’s not what you don’t know that kills you, but instead its what you know that’s wrong. (Can’t seem to find the original source for this quote).

So here’s the top 10 predictions on my mind as of today:

1. Stock market - The Obamarama stock market rally will be mostly over by Obama’s first quarter as President. By late 2009, it will be obvious that all of the government bailout and spending efforts are like holding an umbrella in a hurricane. The nation will finally resign to the reality of a longer term depression. This realization alongwith a few shocking municipal bankruptcies will cause the stock market to finally bottom in early 2010.
2. Bond bubble - The treasury bond bubble will continue to inflate, pushing yields to even lower levels than today. Bond bears will get clobbered in 2009 by being too early and too aggressive. The only thing that can burst the treasury bond bubble is a “growth scare”, which will not occur until 2010.
3. Obama - Barack Obama will not have the courage to give the economy the bitter pill it needs to quickly get rid of the mal-investments and excessive leverage that led to the current crisis. Nor will Obama have the courage to suggest that the government needs to be a referee in the market, rather than the dominant player it has become thanks to Paulson and Bernanke. The high of “Yes we can” will slowly morph into a hangover of “Yes we could have.”
4. Economy - By the end of 2009, almost everyone in the country will continue to believe in the perpetual motion machine that is Keynesian economics and fractional reserve banking. The Keynesians, led by Paul Krugman will still propagate the “free lunch” myth: Deficit spending and huge amounts of bad credit can cure all the problems created by deficit spending and huge amounts of bad credit.
5. Suburbia - 2008 will be seen in 2009 to have been the last year of the techno-triumphalist era. By the end of 2009, it will be apparent that technology (software, finance, green technology) alone cannot indefinitely sustain the now defunct credit-driven consumerist suburban SUV lifestyle. Austerity will be the new black.
6. Real estate - Real estate will overcorrect on the way down, and “fortress areas” like Cupertino in the Bay Area will also experience severe price reductions as IPO/options wealth, jumbo mortgage financing and the hope for a quick recovery dries up. It will be finally realized that encouraging excessive home ownership tends to hurt the economy by making it harder for workers to relocate to where the jobs are.
7. Alternative energy - Alternative energy and OPEC countries will ironically find themselves on the same side, hoping for higher oil prices so that their respective industries and  economies become viable. Oil prices will continue to disappoint them by being stagnant, and this will be a silver lining for the middle-class consumers.
8. Pakistan - The world will again be fashionably outraged for a few days in the Fall of 2009, when it becomes clear that new attacks were being planned against Indian targets even while Pakistan was condemning the recent 26/11 Mumbai attacks. India and Pakistan will again lurch towards war after the next terror attack. The US will once again force India to back down by essentially telling India: “not tonight dear, I have a headache”.
9. Microsoft - Microsoft will realize (if it has not already) that there is no point going after has-been giants like Yahoo, and will instead (correctly) acquire Facebook and/or Twitter at bargain prices. For the first time in its history Google misses out on the obvious due to the “not built here” syndrome.
10. Google - Google revenue will surprise to the upside, but it will be at the cost of cutting down on other expenses, including payroll/bonuses, bandwidth bills for Youtube and possibly even Gmail and other Google apps.

Never intended as investment advice. Read my disclaimer.

Image by Getty Images via Daylife

Today we face the ironic situation of the US government abandoning free market principles to save the free market.

Whether or not the Government will succeed remains to be seen. But in the mean time, there are some fascinating unintended consequences going on (fascinating in a morbid sort of way).

It seems like every generation learns the hard way that central planning does not work, and indeed often worsens the situation that it claims to cure.

So here are just a few examples of how the current US government actions often worsen the situation that they are trying to solve:

1. Lowering interest rates reduces credit to companies

People who invest their money in CDs and money markets are (sometimes unknowingly) lending this money to companies who need the money and are willing to pay interest for short-term loans.

By driving interest rates so low, the Federal Reserve risks a perverse side effect - many money markets will have an expense ratio that’s higher than their interest rate! This means that many money market investors will have a negative return on investment. If this causes investors to withdraw from the money market (and invest into, say treasuries), it lessens the amount of money available for companies to borrow. This is already happening, as evidenced by the huge demand for treasuries (even at near-zero interest rates).

If the government wants more money to be available for lending to companies, it needs to increase interest that people earn on savings. This will provide incentives for people to save, which causes more money to flow into money markets and CDs, and hence increases the pool of money to be lent to companies! Right now the very opposite is happening.

2. Lower interest rates reduces lending to individual borrowers

If you are a bank, here is an easy way for you to get almost free money with virtually no risk:

1. Borrow nearly unlimited amounts of short-term money from the Fed (at the 0.5% “discount rate”)
2. Buy longer term treasuries with this money (earn >2%)
3. Hold to maturity if necessary
4. Repeat

Note that the above does not include having to lend to flaky retail borrowers! So this rate cut actually has an unintended consequence of making retail borrowers even less attractive to banks!

3. Helping defaulting homeowners encourages more to default

If the government provides relief to homeowners who are behind on their payments, it creates incentives for even more homeowners to fall behind, so that they too can get lower interest rates and hopefully even principal reductions!

Surely not what is intended.

4. Guaranteeing deposits causes money to leave good banks

By providing strong guarantees to money deposited in unhealthy banks, it creates an incentive for people to withdraw their funds  from otherwise healthy (but not government-backed) institutions into bad banks that are guaranteed by the government!

5. Lesson learned by bankers - take even bigger risks next time

This is probably the worst of the unintended consequences. An entire generation (and probably more) of bankers and traders have now learned - that if you take risks, make sure you take huge ones. So that if you fail, you are more likely to be bailed out in the long run. The moral hazard being created by this bailout is just staggering.

The financial, mortgage, insurance and auto bailouts almost guarantee that the next bubble will be even bigger and even more disastrous when it bursts.

Even deflationists like me agree that there will be inflation - but its all about the timing. But while we wait for the mother of all monetary tsunamis, why not nibble on oil, gold while they are still relatively cheap ?

In my quest to find a good entry point for oil, I broke one of my rules of not making any trades on Fed days. I used the “sell the news” on Oil to pick up a position in the OIL ETF at $25.74, which corresponds to a Crude Oil price of approximately $44.51. I intend to add to this position if Oil dips further from here (a visit to $40 is not entirely unlikely).

(Click on chart to zoom)

NEVER intended as investment advice. Read my disclaimer.

Ever wonder who would invest in 0% interest treasury securities ?

While regular folks like you and me can invest in treasury securities, we aren’t driving the market. Treasuries are where institutions play. When it comes to big money market funds, and cash/income components of various mutual funds or other investments, these institutions are usually buying up treasuries. Especially with money market funds, since safety is paramount, these securities are the go-to place to find safety. That being said, this is where billions of dollars are traded. Yield, or rate of return isn’t as much of a concern as protection of principal, so the 0% rate is of little concern.

In addition to institutional investors, foreign banks are the other major player. In fact, the government reports that about half of the over $5 trillion in publicly traded debt is owned by foreign nations — namely China. Even with the economic turmoil here and abroad, U.S. debt is still viewed as one of the safest investments around the globe. So, when yields are down, it doesn’t matter when you’re looking for absolute safety on a global scale.

And finally, you have many pension funds investing heavily in safe investments like treasury securities. Just like money market mutual funds that seek safety, you have plenty of pension funds worth billions that need to be able to keep up with paying current retirees, and to allocate investments in this economic climate to protect what assets they do have.

Who Invests in 0% Interest Treasury Securities and Why? : Generation X Finance.

Image via Wikipedia

A friend asked me at a party the other day - “What can those of us who are not economic news junkies like you learn from this crisis ?”

There is only one answer to this question - “No matter how you create your wealth - you need to have a well thought-out strategy to help you 1) identify the dangers to your wealth, and 2) to select the steps you will take to protect your wealth. Without this strategy, you will become easy prey for the bigger animals in the economic food chain.”

And for those of us who are lucky enough to be economic news junkies in this environment, every day brings rewards and new lessons that can be learned.

Consider - today for the first time in history - US 3 month treasury bill rates went negative:

If you invested $1 million in three-month bills at todays negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56.

Bloomberg.com: Bonds

The bond market is pricing in a deflationary depression, and the stock market is optimistic. My money is on the bond market getting it right.

Image by Qiao-Da-Ye賽門喬大爺 via Flickr

The following could be written about any real estate market over the last decade, but is especially stunning coming out of Dubai:

For the past decade at least, real-estate speculation has been the national sport. The price of houses and apartments, many not yet built, rose by 43 percent in the first quarter of this year alone. Mortgage money was easy to get and speculators commonly flipped properties for substantial profits in a matter of weeks, sometimes even days, before the first monthly payments came due. Everybody wanted in on the game. “Employees didn’t focus on their work anymore,” complains the chairman of a regional transport company. “They all wanted to go buying property for 10 percent down, if that.” As of June, Dubai had 42 million square feet of office space under construction, more than any other city in the world, even Shanghai.

Image via Wikipedia

What was a flat desert 20 years ago is today an urban canyon. Such is the frenzy that the Hard Rock Café, built among vacant lots in 1997, is now surrounded by skyscrapers and plans to tear it down for another high-rise are being debated as if the Hard Rock were a heritage site.

Dubai’s Last Hurrah | Newsweek Project Green | Newsweek.com

What if all that investment had gone towards building world-class universities instead of ultra-luxury condos ?

Image via Wikipedia

A common misconception amongst novice home buyers is - “its a great time to buy - the rates are so low!”

In fact, as Calculated Risk explains, a rational buyer should be doing exactly the opposite:

A rational buyer wouldn’t pay more just because the interest rate is lower - although they might have to pay more because the demand is greater. But the current buyer wouldn’t pay much more, because the rational buyer would realize interest rates will probably not be artificially low when they try to sell, and their future buyer would have a higher interest rate and a lower price.

Calculated Risk: House Prices and Interest Rates

So is it possible to have falling mortgage interest rates and falling real estate prices ? Absolutely, and that is exactly what’s happening now!

Image via Wikipedia

There is no doubt that the media was totally unrestrained during the Mumbai attacks - they revealed the military actions in real-time, spoke to hostages even before the police in some cases, and also caused several false rumors.

But here is a misguided attempt to "legalize" a good code of conduct:

Just like the rest of the world, from the moment I learnt of the attacks, I stayed up watching television. I saw our local Police try to figure things out, I watched our valiant Officers Karkare, Salaskar and Kamte arrive, and almost immediately, lose their lives. I saw the NSG and Marcos arrive and started to watch each step of their operation, when suddenly, realization dawned! Over the next thirty or forty hours, I watched, helpless and frustrated, as our very own electronic media did things that seemed blatantly wrong to me.

What they were broadcasting in the name of the news, were in fact the exact operational procedures, locations, and actions of our anti-insurgency forces! Minute-by-minute!

Small Change » Blog Archive » The Petition

Sounds reasonable enough. But then here comes the petition that is being requested:

3. That this Hon’ble Court make and issue such other Writ, Order and Direction as it may deem appropriate directing the Authorities to formulate a model Code-of-Conduct within a fixed time frame; that be made mandatory to the TV News Channels, to regulate the ‘Live’ broadcast of such and similar eventualities and operations.

I share the outrage, but this can never become law because its too vague and impossible to implement. Most importantly, the determination of guilt/penalty will be after the fact, when it is too late.

Instead, here is what was required:

1. The media should not have been able to get close enough for live TV in the first place! Where were the riot police ?
2. Cell phone towers needed to be configured so that hotel calls get redirected to a safe number (see next point).
3. What scares me is not just that hotel guests were calling the media, but that the terrorists could have picked up any cell phone and talked to anyone in the world!

The media and public will always have a gawker mentality (live police car chases in LA/FL come to mind). But rather than an impotent code of conduct, it should be physically impossible for the media to damage the counter-terrorist operation!

I have been very bearish on the overall equity market since 2006 (yes, too early as usual). But I have begun to reconsider my bearish stance after seeing both the magnitude of this decline and the unprecedented levels of “quantitative easing” (a.k.a. money printing) by the Fed.

Right now the biggest worry for bears like me is that the government will overdo the printing (just like in 2001) - and let the inflation monster loose.

Since all asset classes have been subject to rampant speculation and margin calls, it was no surprise that Gold has declined sharply with the rest of the market so far.

However - since the last few weeks I started noticing gold showing strength vs the overall market.

Today Jeff Miller’s system also flagged the Gold Miners ETF (GDX) as the only buy in their universe.

The only new buy in our ETF universe is the Market Vectors Gold Miners ETF, (GDX). The concentration is pretty good, with 34 total companies and the top five representing about 37% of the total. Canadian companies make up 65% of the group. There is little correlation to the S&P 500, and a beta relative to gold bullion of 1.57.

We also featured GDX last July, but the sector has been difficult to forecast.

A Dash of Insight: ETF Update: A New Look at Gold.

I’m currently researching the pros and cons of holding GDX vs GLD over a 3-5 year period, and I’ll write more about this when my thinking clarifies.