Monday, March 30, 2009

Government Motors

Been away so long I hardly knew the place
Gee it's good to be back home
Leave it till tomorrow to unpack my case
Honey disconnect the phone
--The Beatles

President Obama provided a taste of what it's like under a socialist economic system when he spoke of stepped up measures to keep US auto makers afloat. Recall once more that the definition of socialism is state control of economic resources, production, and distribution. At the other end of the scale lies capitalism, where economic decisions are in private hands.

The new plan includes many provisions, including the mandated firing of GM CEO Rick Waggoner and some board members. But two lines in particular grabbed my attention. One was the president's statement that, to maintain confidence in domestic autos, that "the United States government will stand behind your warranty."

President Obama also highlighted his obligation to auto industry workers, promising that "I will fight for you. You are the reason I am here today."

Feel free to ponder those statements on your own...Meanwhile, this intervention is shaping into a textbook example of resource misallocation under the hand of the state. When economic resources are misallocated, standard of living declines.

As such, we're picking up the pace towards a destination of squalor.

no positions

Sunday, March 29, 2009

Lock and Load

"Come on, lock up, baby, lock up."
--Maverick (Top Gun)

I inked a contract to purchase a new house this past week. We're scheduled to close in early May. I'm doing a 15 yr fixed mortgage and my paperwork is done. However, I've yet to lock in my interest rate. Currently, price is 4 3/4% with a 45 day lock. If I could wait another week or so, a 30 day lock stands at 4 5/8%.

Mortgage rates are near generational lows, but the Fed is acting aggressively to buy rates lower in attempt to juice a housing-led economic recovery. There is no guarantee that rates will go lower because the Fed must print money in order to buy bonds (a.k.a. 'monetizing debt'). This is clearly inflationary and at some point rates are likely to reverse higher. Already, long bond rates have retraced about 50% of the move after the Fed's monetization announcement a couple weeks ago.

So, do I play it safe and lock in a quite respectable 4.75 on Monday, or do I roll the dice a bit longer hoping that the Fed's near term firepower shaves another eighth or quarter point in the next week or so?

I could always short some govies in the interim as a hedge...

Friday, March 27, 2009

Rock, Paper, Metal

I keep looking for something I can't get
Broken hearts lie all around me
And I don't see an easy way to get out of this
--Cutting Crew

Over the past month or so, I've been unwinding my 'paper' positions in the precious metals, namely my positions in GLD and SLV. A few reasons for this. One is that I'm stepping up to a nicer, more expensive house and as I sink more of my net worth into real estate, it felt prudent to take off some risk in a another 'hard asset' category.

There are some questions about counterparty risk with owning these precious metals ETFs. Although they purportedly buy physical gold, exactly where the physical stands related to 'long only' warehouse stock versus leased to others is confusing and...unaudited by the charter of these securities.

If metals prices really go crazy, there is some chance that the government would slap some controls on the bullion ETFs since they move such big volumes of metal. I don't want to be there for that.

Instead, I'll be more comfortable adding to my physical bullion stock over time. Should gold get hammered towards $600 or lower (as some predict), I'll look to step up my bullion purchases.

My metals ETF exposure has gone from 25-30% of liquid assets down to 4-5%. I'll likely be totally gone from GLD and SLV on any further liftage. Hopefully we'll get another pop here, although the technical set-up looks head-and-shouldersy just as GLD hits uptrend support.

Am getting that 'book 'em if you got 'em' feeling...

positions in GLD and SLV

Thursday, March 26, 2009

Save Haven

The news slows
People forget
The shares crash, hopes are dashed
People forget
Forget they're hiding
--The Who

Newsweek recently ran a cover story entitled "Stop Saving Now." The article draws on Keynesian 'Paradox of Thrift' theory, which postulates that during tough times, if individuals become risk averse and save, then the overall economy will decline and everyone will be worse off. The Keynes remedy is government sponsored intervention to motivate more risk taking and spending.

This theory is misguided in that it assumes that economic progress depends on consumption and spending. We've heard political leaders claim that 'credit is the lifeblood of our economy' and the like.

No. The lifeblood of an economy is capital formation. Capital is invested in processes that improve productivity and raise standard of living over time. Capital formation requires abstaining from the consumption of some resources in the present, and putting them aside for the future (read: saving).

During the past few years (decades), we've been consuming more resources than we've earned in income. By consuming more than we've earned, we've not only squandered capital that should have been invested in our future, but we've borrowed and consumed resources from others. Living large in the present has compromised our future: we're both under-invested plus we owe others. Consequentially, future standard of living is almost certain to decline.

Individuals are starting to figure this out, and they are correctly changing their behavior towards paying down debt and saving. While this results in a lower standard of living in the near term, it will help rebuild capital stock over time.

By promoting another round of borrow-and-spend, bureaucrats are pointing us towards a state of irreversible squalor. Let's hope that individuals have the fortitude to overthrow this movement.

Wednesday, March 25, 2009

Death Certificate

Sara Sidle: "Clothing, $85. Earrings, $30. Latte, $4. Getting away with murder..."
Gil Grissom: "Priceless."
--CSI: Crime Scene Investigation

During commercial breaks from the box monster last nite, I surfed thru a couple of President Obama's press conference comments on the economy. The snippets I heard were downright laughable. One of them was that the US dollar is 'extraordinarily strong' because investors are confident in the economy.

Not quite. During fat times the entire globe was short trillions of dollars while engaging in a carry trade. Investors borrowed dollars at a cost held artificially low by the Fed. They then sold (read: shorted) the dollar to buy speculative assets of all shapes and sizes (stocks, bonds, real estate, derivatives). This was a great trade as long as prices increased. However, prices have been declining over the last 6-18 months, prompting investors to sell these speculative assets and then buy back dollars to cover their leveraged bets. It has been this massive short squeeze that has juiced the dollar higher.

For those in doubt of the ultimate consequence of all this government intervention, Mr P and Minyan Peter weigh in on this week's Private Public Investment Partnership (PPIP). Fil Zucchi sketches the downstream outcomes of last week's debt monetization scheme.

Don't take what politicians say at face value. Think it through. When you do, you may conclude that, while the dollar may rally more in weeks or months ahead, the crime scene suggests a case of premeditated murder.

position in USD

Tuesday, March 24, 2009

Monkey Business

Cover me, when I sleep
Cover me, when I breathe
You throw your pearls before the swine
Make the monkey blind
--Peter Gabriel

Current economic problems have unleashed calls for increased government regulation. Presumably, the penalty of economic loss levied on market participants for taking imprudent risk in free market systems is not enough. Some degree of control is deemed necessary. This control transfers authority for production and distribution decisions from private hands to the State. State ownership and control of economic resources and their allocation is known as socialism.

Cries for increased regulation always coincide with periods of dramatic declines in market prices and economic activity, which should tell us something about the behavioral motives behind regulatory campaigns. These cries are usually grounded in the argument that people are prone to irrational extremes when making economic decisions. Regulators are charged with clipping those extremes in order to temper boom and bust cycles.

Such arguments, of course, are quite circular, because individuals charged with oversight hail from the same species who purportedly makes foolish buying and selling decisions in market environments. Who oversees the regulators when pangs of foolishness taint their decision-making processes?

The fact is that we currently spend more on government oversight and regulation than at any time in our economic history. Yet, examples abound of regulatory 'failures' (e.g., Madoff, CDS, front running, etc.).

Regulation is a form of inspection. A fundamental axiom of Total Quality Management is that control programs dependent on high levels of inspection are rarely effective. Research suggests that inspectors generally miss about 20% of all defects present (Juran 1988: 18.86). Inspection errors may be due to cognitive constraints, or they may be more political in nature.

Meanwhile, market participants who think they are 'covered' by regulatory programs are prone to do less due diligence when making buying and selling decisions. Less due diligence means more risk taking. As such, regulation is a breeding ground for moral hazard.

Before blaming free markets for current problems, intellectually honest individuals should try testing a hypothesis that excessive regulation and accompanying moral hazard are root causes of our economic hardships.


Juran, J.M. 1988. Juran's quality control handbook, 4th ed. New York: McGraw-Hill.

Monday, March 23, 2009

Upwardly Mobile

What you need is a big strong hand
To lift you to your higher ground

News of a government plan to buy $1 trillion+ of distressed bank assets ignited a huge Monday rally, with the major indexes gaining about 7%. The bank index (BKX) rallied nearly 18%, which should be no surprise as this program would effectively take non-performing assets off bank balance sheets and replace them with 'safe' dollars.

Anyone with a brain can see that this plan is inflationary, and that it gives institutions that made a boatload of poor decisions a free pass to make more of the same. Even before today's announcement, financial institutions have been gorging on the bailout feast.

Just another in a long line of government interventions seeking to solve a debt and spending problem with more debt and spending.

Long term implications aside, markets appear ready to view this news as positive. Over the past two weeks, major indexes are up over 15%. While near term resistance looms, it appears to me that markets have room to run. SPX 975-1000 seems doable.

Keep in mind the ferocious nature of bear market rallies, as exemplified by the post-crash market action from 1929-1932.

no positions

Thursday, March 19, 2009

Let It Bleed

Well I'm talking about the midnight gambler
The one you never seen before
--Rolling Stones

Yesterday the Fed announced its intent to purchase over $1 trillion in treasuries and agencies. Their objective is to suppress interest rates and breathe some semblance of life into the housing market.

Lest you were unaware, the Fed will create those trillion+ greenbacks out of thin air.

Our central bank has now put the destruction of our currency front and center. Foreign dollar holders are now on notice that the greenback is going down.

Predictably, the dollar was smoked on the news. Just like that, it fell now sits on intermediate term support.

Gold did an about face as well. Yesterday morning it was trading drekky around $880. Today it closed at $960.

If the dollar knifes thru USD 81-82 with relative ease, then things could unravel rather quickly.

position in gold

Tuesday, March 17, 2009

Make It Count

"I saw my whole life as if I had already lived it. An endless parade of parties and cotillions, yachts and polo matches. Always the same narrow people, the same mindless chatter. I felt like I was standing at a great precipice, with no one to pull me back, no one who cared... or even noticed."
--Rose Dawson (Titanic)

Today we suddenly lost someone who helped A LOT of people. At Minyanville, we like to say we're a community where people watch each other's back. When one of us goes down unexpectedly, it's especially painful.

I'm feeling it, Bennet.

I know your passing is reminding us to make it count. I intend not to let you down, my friend.

Monday, March 16, 2009

Hope Chest

When it will be right, I don't know
What it will be like, I don't know
We live in hope of deliverance from the darkness that surrounds us
--Paul McCartney

Fed chairman Ben Bernanke was on 60 Minutes claiming that the recession will be over inside of one year. This is making headlines this morning and markets are up nicely.

Perhaps the recession will end quickly and heaven knows markets have been looking for an excuse to rally.

If you're basing your investment decisions and outlook on the prognostications of Mr Bernanke, you'd be wise to first consider his track record. The Fed chief has presided over the largest credit bubble in the history of the world and its subsequent poppage. Not once did he foresee the problem--at least on the record.

Chances of his ability to suddenly be able to forecast accurately seem pretty small.

Friday, March 13, 2009

STARKe Attack

Meg Harper: "Joe, have you ever heard of manic depression?"
Joe Scheffer: "Huh? Yeah! [laughing hysterically]"

Meg Harper: "See, this...this is way out of my league."

--Joe Somebody

This past Monday Merck (MRK) announced a $40+ billion buyout of Schering Plough (SGP). For years, I held speculative positions in SGP with a potential takeout as part of the thesis. While waiting, however, previous SGP management ran the company into the ground (thx Dick Kogan), making this position one of the biggest losers of my investment career--and placing it on my 'personal restricted list.'

Moreover, one reason why I recently legged into Merck was the firm's historical tendency to stay away from big mergers. Mergers, you see, usually benefit the seller more than the buyer. Buyers nearly always overpay (why sell your company otherwise?), making it difficult to achieve superior returns on capital. Plus you have the integration issues...

So, I found the merger announcement to be ironic in more ways than one. Upon hearing the news pre-market on Monday, my initial reaction was, well, unfavorable. Others seemed to dislike it as well, as MRK stock was pounded
on Monday to the $20 level last seen in 1995.

Retrospectively, Monday was also a day of general market capitulation, as my FA contacts tell me that many of their clients threw in the towel on stocks in a brutal market sell-off.

Since then, however, pharma shares have done a big about face higher, with MRK closing the week up about 35% off its Monday lows.

These kind of moves make you wonder whether market participants aren't round tripping on Xanax and Zoloft which, I suppose, would be coolio for Pfizer (PFE).

positions in MRK, PFE

Thursday, March 12, 2009

Bottoms Up

It's time for the good times
Forget about the bad times, oh yeah
One day to come together
To release the pressure
We need a holiday

After 10%+ moves in the broad indexes over the past couple of days, the bottom callers are naturally out in force. A peek at the charts suggests little more than a rebound from deeply oversold conditions at the present time. Most indexes are approaching resistance defined by the November lows. Let's see how prices navigate this first hurdle.

While there seems to be a fair amount of bullish rhetoric out there, Prof Goepfert points out that actions suggest a bearish bent. Hoofy also has to be encouraged by the leadership exhibited by the banks. The Bank Index (BKX) is up more than 20% in the past few sessions.

As such, we may be set up for a rally that lasts more than a New York minute.

no positions

Wednesday, March 11, 2009

Breaking Away

It's been such a long time
I think I should be goin', yeah
And time doesn't wait for me, it keeps on rollin'

What word best describes my current level of attention to the markets? Detached. I'm less plugged into the flickering ticks than I've been for quite a while.

While many claim that the only way to play this market environment is to trade 'em, I've elongated my time horizon towards positions that have more 'destination' rather than 'path' thesis. While I still like to follow the granular events and trader thought processes, my investment posture leaves me less inclined to link my actions to the daily flow.

A longer term market frame has likely spared me considerable angst during the market melt over the past year. Ms Market has chewed up traders and spit them out in droves during the past 18 months.

The flip side is that I may be less sensitive to shifts that could materially impact my investment theses. For example, I've taken little action in my positions in select pharma such as Merck (MRK) and Pfizer (PFE) despite recent events (health care reform that appears more eminent w/ the new administration, recent mergers, etc) that may very well impair long term returns on capital with these firms.

That's the risk with an investment posture. You're less likely to react quickly to game changing news, which challenges effective risk management. Compared to traders, investors are likely to suffer significant drawdowns as they piece together emerging info and compare it to their investment story. However, the potential payoff if (big if) 'patient capital' gets it right can be significant.

Maintaining an investment posture in this environment certainly seems less crowded. The book is still out on its value-generating properties...

positions in MRK, PFE

Monday, March 9, 2009

Out for Blood

I can't believe the news today
Oh, I can't close my eyes and make it go away
How long
How long must we sing this song?

Bureaucrats have been chanting that credit is the 'lifeblood' of our economy. After Prof Depew points out the absurdity of this claim, Prof Shedlock carries the ball the rest of the way in his excellent follow-up piece.

Another name for credit is debt. An economy cannot thrive on a long term diet of debt. Instead, the lifeblood of an economy is savings. Savings permits capital formation, some of which may be prudently loaned out to improve productivity.

Given our low savings rate, where did all the lending and leverage come from? From fractional reserve banking. This gigantic Ponzi scheme permitted credit to be extended with no savings to back it up. As with all pyramid schemes, this one was certain to fail. Pinpointing the timing of the collapse, and from what height it would ultimately plummet, was the difficult thing.

Now we are seeking to rebuild the pyramid with another round of lending with no savings to support it.

A lifeblood of leverage leads to certain death. Time for a transfusion.

Thursday, March 5, 2009

Tea & Crumpets

You say you'll change the constitution
Well you know
We all want to change your head
You tell me it's the institution
Well you know
You better free your mind instead
--The Beatles

Away from mainstream media, thought that opposes government interventionary efforts has been swelling. Jim Rogers is pounding the audio and video waves. Lew Rockwell penned a nice piece describing the loss of standard of living when government appropriates capital from private hands.

I view this groundswell movement as a positive. It could precipitate a movement similar to the one that preceded our original battle for liberty more than 200 yrs ago.

Active Agency

We are matching spark and flame
Caught in endless repetition
Life for life we'll be the same
--The Fixx

Jeff Macke and other commentators have been banging the drum to eliminate the credit rating agencies. The thinking is that, because so many money managers pin their actions on the credit ratings supplied by Moody's and S&P, a downgrade to, say, General Electric (GE), in a 'down' market sparks a selling stampede.

The ratings agency witch hunt seems misplaced. We should ponder instead why money managers have become so dependent on agency-sponsored ratings rather than doing their own homework.

It's not the rating agency's fault that managers mindlessly follow credit rater actions. Agency problems are not solved until principals take responsibility for their own actions.

no positions

Monday, March 2, 2009

Long and Wrong

"On any other day, that might seem strange."
--Cameron Poe (Con Air)

In his annual Letter to Shareholders, Berkshire Hathaway chairman Warren Buffett often discusses a 'mistake du jour'--an investment error that he made during the previous year.

My mistake du jour in 2009 is shaping up to be getting involved in select pharma names ahead of this market meltdown. I liked the valuation of drugmakers Merck (MRK) and Pfizer (PFE) along with their nice dividends in a low yield world. I also thought that chances were high that the new administration would keep hands off this sector during the weak economy likely to persist over the next few years.

Since President Obama's speech to Congress last week, health care sectors have been leading markets to the downside. Given the president's rhetoric, many believe that health care reforms will now begin sooner rather than later. Should these reforms occur as specified by the new administration, then returns on capital are likely to suffer among the drugmakers (as, of course, will standard of living as innovation and efficiency exits this sector).

Previously, my time horizon (5+ yrs) had me insensitive to near term price fluctuations in these names. But now I wonder whether the long term fundamentals of this sector will not be impaired for many years.

As such, I'm considering an exit strategy for at least part of my position.

positions in MRK, PFE

Pin Action

"Do you think, if I called up Shute, that he'd come over and wrestle me in one of the banquet rooms? I'm not sure I can take it very much longer."
--Louden Swain (Vision Quest)

If you wondered what markets feel like in meltdown mode, this is it. Shedding a couple of percent daily, rampant pessimism, longstanding stalwarts getting sold. The Dow is now printing a 6 handle.

Lots of folks dialing 1-800-Get Me Out Now to relieve the pain.

As the news flow heads from dark to darker, it's hard for the contrarian in me not to wonder whether we're close to a bottom.