Who Is John Galt?

And anytime your feel the pain, hey Jude, refrain
Don't carry the world upon your shoulders
--The Beatles

What happens if growing government intervention causes entrepreneurs and capitalists to exit the economic system in search of better opportunities? That is a central question in Ayn Rand's classic work Atlas Shrugged.

This is no hypothetical question, of course. Rand saw it in motion over 50 years ago. Government intervention that stifles free enterprise has been a significant factor in the decline of domestic manufacturing. Why would a producer want to cope with myriad governmental obstacles when it is easier to set up shop elsewhere?

Case in point is this situation in South Carolina. The National Labor Relations Board (NLRB), an agency of the federal government, is suing The Boeing Company (BA) for building a commerical aircraft factory in Charleston. The new facility will not be unionized.

The NLRB claims that BA is retaliating against the International Association of Machinists and Aerospace Workers (IAMAW) union for past strikes in Washington state. The NLRB is seeking a court order forcing BA to build the new factory (although the SC facility is nearly complete and will open this summer) back in Everett, WA--the historical (and unionized) home of BA's commerical airplane business.

The argument is so frivolous that it is difficult for me to type this wearing a straight face. But the fact that the issue is even on the table demonstrates how far we have strayed from the liberal (classically defined) principles of property rights and freedom of association.

In a free society, property owners decide how their assets are deployed. They are also free to associate with whomever they want to work in that regard. Good choices are rewarded on the free market, while bad decisions are penalized.

Whether BA is 'retaliating' against a union's past behavior makes no difference. The owners of BA should be free to associate with whomever they please. If they choose poorly, then the market will penalize them accordingly.

If government continues to intervene in this situation on behalf of special interest groups such as organized labor, then it provides additional recruiting fodder for John Galt.

no positions

Playing the Fool

How can you help it when the music starts to play?
And your ability to reason is swept away?
--Aaron Neville

If the moronic argument in this article prevails in policymaking (it already has to some degree), then US living standards will fall to very, very low levels. And the price of gold will rise to very, very high levels.

Essentially, the writer is presenting a variation of the Keynesian argument. Last year, a clever video contrasted the Keynesian argument to the Austrian view as championed by Hayek. Round II has recently arrived.

position in gold

Drug Store

Dr Jimmy and Mr Jim
When I'm pilled you don't notice him
--The Who

A couple weeks ago we noted the favorable near term technical set up in the Drug Index (DRG). The pattern indeed resolved bullishly. Nearly all large cap pharma stocks are currently under accumulation.

Pulling back the time frame, the DRG looks to be poking its nose thru a decade long down trend (there is also a multi-year flag pattern). When drawing the line w/ a crayon instead of a pencil, there has yet to be a technical resolution.

But current price action is most definitely bullish.

position in select pharma

Flirting With Disaster

I'm out of money, I'm out of hope
It looks like self-destruction
How much more can we take
With all of this corruption
--Molly Hatchet

The Fed continued to coo like a dove today. On the back of the accomodative FOMC statement, the dollar tanked. The Dollar Index (USD) appears destined to test its all time low of 72ish. A break below that, and it's a brave new world.

Gold, on the other hand, exploded higher on the news--and marked another all time high. (Silver, btw, rallied 5%).

Can't help but think that today marked a watershed event: the day the Fed sped past the "Stop--Cliff Dead Ahead" sign.

From where I sit, chances of a currency crisis have now ticked up considerably. While I have been working them lower, cash levels in my personal accounts still exceed 50% of total liquid assets.

I am growing increasingly uncomfortable w/ this position. Over the next week or so, I will be looking to swap out of a signficant fraction of my remaining dollars. 

Perhaps the entire world will need to see the problem before the Fed does...

position in gold 

Chicken Dance

Ramirez: The chicken is in the pot.
Clark: Cook it!
--Clear and Present Danger

Not sure anyone has analyzed the technical problem that the Fed faces here more than John Hussman. Dr J has examined the historical relationship between T-bill rates and monetary base per nominal dollar of GDP (a.k.a. 'liquidity preference').

The results show an asymptotic relationship. When rates are high, people have less desire to carry money around because of opportunity cost. When rates approach zero, however, people are increasingly prone to hold cash because there are few competing uses for it.

I like to think about this in terms of cash that I am holding in investment accounts. I would like to put this cash to work in short term vehicles, but alternatives such as 3 month T-bills or 3 month CDs are yielding next to nothing. Thus, I'm comfortable just staying in cash because at least I am in a flexible position to deploy it should opportunities arise. To me, that is worth more than the pathetic yields I would be getting by tying up cash in short term fixed income vehicles. Just as John's analysis shows, ultra low interest rates have me holding more cash than I otherwise would.

The problem for the Fed is that in order to press interest rates closer and closer to zero, the amount of base money that the Fed has to pump into the system via its asset purchase programs such as QE2 must grow exponentially. Any exogenous forces putting upward pressure on rates (e.g., perceptions about inflation, slow down in offshore Treasury buying) must be met with ever more money printing by the Fed, otherwise all of this money that has been created would quickly seek other uses, and prices of many things would explode higher.

Since the Fed is approaching the zero bound for interest rates, it stands to reason that at some point, perhaps soon, the Fed will be physically unable to suppress rates further in an environment where exogenous forces are pressuring people to reduce their liquidity preference.

Should we reach this point, the Fed faces one of two alternatives: a) it could sit back and watch prices rip higher as people swap out of cash perceived as a rapidly depreciating asset, or b) it could rapidly withdraw the funny money that it has been pumping into the system.

Remember the nonlinear relationship between money printing and interest rates, however. The Fed would have to remove a disproportionate chunk of stimulus in an attempt to normalize rates just a fraction higher than where they currently stand. Dr J estimates that, in order to normalize short rates at 0.25 - 0.50%, the Fed would have to reverse its entire $600 billion QE2 program.

The point is that, if the Fed tries to tame inflation at this point, it will have to suck gigantic amounts of liquidity from the system. If the Fed decides not to do this, then prices of most things are certainly headed much higher.

This is the box that the Fed is in.

This situation also goes a long way toward explaining the action in precious metals. Investors have sniffed the Fed's bind out, and are bidding gold and silver up on a bet that the Fed will choose option a) above.

Before us is a game of chicken of historical proportion.

position in gold, silver

Fed Front Running

When it gets too much
I need to feel your touch
I'm gonna run to you
--Bryan Adams

Pretty breakout above resistance from a multi-month inverse head-and-shoulders pattern in the S&P (SPX) today. New recovery highs once again.

Interestingly, this bullish action is occuring one day prior to the bimonthly FOMC policy statement. Seemingly, market participants are front-running the Fed, anticipating that the central bank will continue its money printing ways.

Should tomorrow's FOMC statement indeed be perceived as accomodative, then today's action may mark the beginning of another leg higher.

However, should Uncle Ben & Co surprise the masses with some hawkish FOMC verbage suggesting that the monetary spigots may be turned off, then today's break out might turn into tomorrow's fake out.

position in SPX

Anticipation

We can never know about the days to come
But we think about them anyway
--Carly Simon

FOMC meeting tomorrow. Can't shake the notion that the Fed heads will wax tougher than anticipated. Not because they want to. But because they are feeling increased pressure (from here and abroad) to chart a more reponsible policy course.

I've been wrong as rain on this for the past year, thinking that Uncle Ben would already have blinked by now.

But feels like it's getting cloase to the point of no return...

Look Again

You've been running and hiding much too long
You know it's just your foolish pride
--Derek & the Dominos

Interesting alternative to government Consumer Price Index (CPI) data. Check out the steepening slope over the last four months. Amounts to about 8% annualized.

Which is ~3x the increase suggested by official government stats.

Closing Walls

"We seem to be made to suffer. It's our lot in life."
--C3PO (Star Wars)

Remember that trash compactor scene from Star Wars? The federal government at large, well reflected in scene by lots of idle refuse, is on the verge of being crushed by two converging walls. One wall is the deflationary force of debt and leverage. The other wall is the inflationary force of money printing and rising prices.

Rhyme and Dime

"Meet the new boss. Same as the old boss."
--The Who

Am slowly but surely chewing thru John T. Flynn's (1948) The Roosevelt Myth. I'm continually struck by the political parallels between the 1930s period and today.

A massive credit bubble expands during a free spending Republican administration. Things start to unravel, and the decline picks up speed as the presidential elections kick in. People subsequently vote out the Republicans in the midst of a credit meltdown and replace him w/ a Democrat who can croon w/ the best of them about 'change.'

The Democrat president then uses the crisis backdrop to spend, inflate, and violate the Constitution on a scale thentofore unseen.

The rhyme is certainly there, but it remains to be seen whether the American people will tolerate such despotic behavior this time around.

References

Flynn, J.T. 1948. The Roosevelt myth. New York: The Devin-Adair Company.

House of Mirrors

"Now, you must remember: the enemy has only images and illusions behind which he hides his true motives. Destroy the image and you will break the enemy."
--Shaolin Abbott (Enter the Dragon)

When President Obama announced yesterday that his administration would conduct a probe into whether oil and gas prices are being driven higher by illegal manipulation, I had to laugh. Is that as opposed to legal market manipulation as you've been engaging in, Mr President?

This administration has sanctioned the printing of $trillions of dollars. Consequently, asset prices have lifted higher on a rising tide of liquidity.

Now, as it is clear that the confetti-fest is jacking commodity prices higher, the government wants to look for causes other than itself.

Classic behavior, really.

Evidence suggests, however, that the people are become less prone to be duped by these diversionary tactics. As the shot of stimulus begins to lose its effect, polls once more suggest a trend in the number of people who think that we are headed in the wrong direction.

When looking for those to blame for this situation, Mr President, the mirror would be a good place to start.

position in commodities

Socialist Hubris

Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world
--Tears for Fears

Pondering some of the assumptions that underpin the socialist mindset.

People are not meant to be free. They are instead meant to work for the collective 'good.'

Superior insight into how resources should be allocated. Central planners think they know who should get what and how much. This includes how capital should be allocated toward investments.

Necessary force. Socialists know that individuals will not voluntarily comply with the plan. Force, also known as government, is necessary to get things done.

The sheer hubris baked into those assumptions is monumental. When operationalized, that hubris drives slavery, poverty, and despotism.

Vertical Leap

"He's going vertical. So am I."
--Maverick (Top Gun)

Silver got going late last summer about the time of the Fed's QE2 ruminations. It has looked back since.

Current action has that gappy, parabolic look of a blowoff. Various oscillators such as the relative strength index and slow stochastics are pretty much plastered against the ceiling.

There are, of course, plenty reasons why 'White Lightning' could continue to zap higher, not the least of which is the Fed's non stop printing press.

Action like this that demonstrates why it's so difficult to stay on board during a bull market. The moves higher seem too good to be true, and the corrections that follow seem too painful.

position in silver

For the Record

And the vision that was planted
In my brain remains
Within the sound of silence
--Simon & Garfunkel

Gold has crossed $1500/oz. Silver now stands above $45/oz.

Another milestone met largely with...quiet.

position in gold

Balanced Budget Amendment

Circumstance has forced my hand
To be a cut price person in a low budget land
--The Kinks

Think recent talk of a balanced budget amendment is a recent phenomenon perhaps linked to the Tea Party movement? Nope. Murray Rothbard discusses the pros and cons of the amendment as it gathered steam in the late 1970s.

While intuitively desirable, there are a number of negatives. Politicians may create loopholes that facilitate chronic evasion of the law. Moreover, it is possible that a balanced budget amendment could be balanced up, by increasing taxes to cover bloated spending, rather than down. Finally, the Fed can facilitate the transfer of wealth via inflation regardless of whether the budget is balanced.

Rothbard astutely observes that the real problem here is government spending, and that the real solution to this problem is to take away government access to resources. Specifically, this means that access to tax revenues and the monetary printing press must be denied. We have noted precisely this a few times in these pages.

As Rothbard notes, a balanced budget amendment is a well intentioned step in the direction of liberty. But it is likely to have minimal impact without measures that directly strip the federal government of capacity for confiscating wealth.

See It

"No dream is ever just a dream."
--Dr Bill Harford (Eyes Wide Shut)

Last fall, a video that explained QE2 went viral. A brilliant piece.

Now, the creator has developed a video that explains inflation. Another homerun.

Those scratching their heads over the widening chasm between rich and poor should make sure they understand what is being said here.

Breaking Away

And I think it's gonna be a long long time
Till touch down brings me round again to find
--Elton John

For the past week or so I've been wanting to add to a 'starter' position in Johnson & Johnson (JNJ). My valuation work has me liking it below $60, and last week I had limit orders in at about $59.50.

As the chart indicates, price never came in for a fill, and today the stock gapped higher on big volume on positive earnings news. Technically, previous resistance at $61.50ish has now become support. Seemingly the stock is now significantly out of range.

It can be hard to keep emotions in check in such situations. "I knew that price was heading higher!" "Why didn't I raise my limit price a dime or so last week?" "You're letting the stock get away from you--better grab some up here at these higher levels in case it's never going to come back down now." "Way to go doofus...another example of being penny wise and pound foolish."

After that bout of second guessing, I remind myself that I am building this JNJ position on an investment thesis rather than on a trading thesis. And investment performance depends on finding attractive gaps between intrinsic value and market price. My work has identified a price that provides a comfortable margin for error.

If I give up on that analysis, and blindly chase the stock higher, then my margin for error goes down and my risk goes up.

So I'll sit on my hands, revaluate the story in the context of the ongoing information flow, and keep an eye out for a price point that I deem more favorable to long term investment returns.

position in JNJ

Unpaid Downgrade

Welcome to the grand illusion
Come on in and see what's happening
--Styx

Today, S&P put the AAA credit rating of the US on 'negative outlook.' Credit default swaps on Treasury debt have widened. Current spreads suggest 1/3 chance that the US credit rating will be downgraded within two years.

Politicians who previously claimed that the credit rating agencies were reactionary (which they were are still are) in their ratings during the credit market meltdown are crying foul today.

We've noted it many times before. If we are not proactive in dealing w/ our financial situation, then market forces will put us into a reactionary position.

If (when) credit market confidence sinks, then the emperor wears no clothes.

Texas Hold 'Em

Now I'm towing my car
There's a hole in the roof
My possessions are causing me suspicion
But there's no proof
--Crowded House

The University of Texas endowment has taken delivery of $1 billion in physical gold. That's about 5% of the endowment. Hadn't realized that the UT endowment was so large, but it apparently manages the endowment of the entire UT system (among the largest public university systems) plus Texas A&M.

What I find most interesting is the choice to buy the physical metal rather than a securitized proxy such as GLD (although the fund may in fact own such instruments as well).

The impetus to buy gold looks to have come from board member Kyle Bass, a most savvy fund manager.

position in gold, GLD

Gimme Drugs

Dr Jimmy and Mr Jim
When I'm pilled
You don't notice him
--The Who

One chart pattern that jumped out at me today was the inverse head and shoulders pattern in the Pharmaceutical Index (DRG).

The pattern is right up at resistance here. Will be interesting to monitor price behavior over next few days.

position in select pharma

Child's Play

Randy Cellini: He started it!
Mr Horn: If that's true kid, you have less brains than a woodpecker on an aluminum telephone pole.
--Sidekicks

Heard a Republican congressman explain last night that he voted for the 2011 budget bill only because Democrats were standing pat with the goal of shutting govt down and then blaming Republicans.

Truly, the twisted logic of juveniles seems to totally dominate Washington thought process.

Should it surprise that gold and silver have been marking new highs daily as this saga unfolds? The metals are bets on disorder--economic, social, political.

With spineless bureaucrats populating DC, disorder is the odds on bet.

position in gold, silver

Green Eggs and Scam

Those one track minds
They took you for a working boy
Kiss them goodbye
You shouldn't have to jump for joy
--Tears for Fears

As folks look under the hood at the pending budget bill w/ the pathetic $38 billion in spending cuts, we learn that even that number is an illusion. I've seen estimates suggesting less than $1 billion in real cuts.

We should expect no less from the flim flammers in Washington.

Perhaps the only positive out of this debacle is that it is getting more and more difficult for DC politicians to pull the wool over people's eyes.

Popular opinion is quickly turning on this one. How fine would it be to see a come from behind thumbs down vote?

Screen Test

I'm gonna run to you
Yeah, I'm gonna run to you
'Cause when the feeling's right, I'm gonna run all night
I'm gonna run to you
--Bryan Adams

At the RISE conference two weeks ago, many portfolio managers and analysts noted that they employed 'stock screens' to whittle the universe of possibilities into a subset more conducive to in-depth analyses. Most of the screens employed by these people are software algorithms that scour databases and identify stocks with attractive characteristics such as high return return on equity, low dividend payout ratios, or strong price momentum.

Many brokers (like Schwab) and investment info sites (like Morningstar) possess screening capability.

When looking for equity investments (not short term trades but long term investment), there is a screen that I like to employ. However, it is a low tech, non-mechanical screen--one that builds on my analytical strengths and personal taste preferences. One 'edge' that I may have over some market participants is skill in industry analysis and knowledge of factors that drive sustainable competitive advantage. I also have a taste for value, and believe that lower prices reduce risk and provide margin for error.

As such, I like to use that following criteria when looking for potential equity candidates:

Favorable industry structure. Think Porter's (1980) five forces. I like industries where the forces are favorable for industry profits over time. A pile of research suggests that choice of industry explains more variance in company profits than company-specific factors. Thus, I would rather consider stocks where the industry forces are blowing at the propsective company's back rather than in its face. It has become harder and harder, btw, to locate such favorable industry contexts.

Organizational factors. Research (e.g., Collins & Porras, 1994) suggests a number of factors that relate to sustainable competitive advantage over time, such as home grown experienced management, ideosyncratic cultures, demonstrated track records at coping with disruptive change. To evaluate these factors I need access to the inner workings of organizations. This can be obtained by personal contact, or (more frequently) by devouring what has been written about potential candidates by the media. You might be surprised at how much you can learn about organizations thru secondary sources.

Strong, dominant brands. I prefer firms that have gained mindshare with customers and marketshare from competitors. Strong brands drive higher profit margins as customers are willing to pay more for a branded goods relative to me-too generics. Moreover, large market share increases bargaining power and helps companies be a price maker rather than price taker.

High profit margins. I like enterprises that consistently produce gross profit margins north of 50% and net margins of at least 10%.

High cash/low debt. Debt reduces strategic freedom, even when the cost of credit is low. As an investor, I like my companies to have piles of cash since it is likely come back to me either directly or indirectly. As a general rule, I like to see balance sheet cash of at least 2x debt. Conceptually, I like to know that companies I own can extinguish all their debt overnight while still having a nice cash stash left over.

Free cash flow. Cash flow is the lifeblood of a business. Cash flow is also the theoretical basis for securities analysis and valuation. I am attracted to firms that generate gobs of free cash flow (FCF).

Valuation. While I review tradional valuation metrics such as P/E, I prefer valuation metrics directly employ FCF. Lots of FCF alone does not suffice--the price that you pay for the FCF is really what matters. When using my 'quick and dirty' comparison of enterprise value:FCF perpetuity, I like to see ratios of 1.0 or less. The lower the ratio, the greater the potential discount I am getting. Stated another way, cheap valuations provide higher 'margin for error' in my decisions.

Once I have a list of candidates, I can conduct more in-depth assessment. I can also overlay my macro view on candidates to more completely evaluate risk and reward.

Currently, my screen whittles down the universe of stocks into a pretty small list.

References

Collins, J.C. & Porras, J.I. 1994. Built to last. New York: Harper Business.

Porter, M.E. 1980. Competitive strategy. New York: Free Press.

NKU Endowment AA

The NKU Foundation manages the university's endowment. The definition of an endowment is a gift given by a donor that restricts what can be done with the resources. Usually, the principle is not to be touched.

At the recent RISE conference, I attended an interesting session on endowment management and learned some specifics about the Rutgers endowment and how its investment portfolio was allocated.

Similar info can be found for NKU's endowment, as the foundation produces a variety of reports for stakeholders.

The last annual report for the endowment was issued 6/30/10. In terms of financial securities (cash and investments, but not counting loans, land, and promised donations), the endowment manages about $65 million. That includes about $9 million that the Foundation manages for NKU at large, so the actual endowment part of the portfolio is more like $55-56 million.

The endowment breaks down its $55 investment portfolio (page 14), but that does not include the bulk of its $10.7 million in cash shown on the balance sheet. It appears that the reporting convention is that cash is not an investment class.

To get a feel for overall asset allocation, I added that cash to the investment portfolio. Here's how the asset allocation (cash plus investments) maths out (in $ thousands):

cash $10,754 (16.4%)
fixed income $11,264 (17.2%)
equities $28,313 (43.1%)
hedge funds $8,531 (13.0%)
alternative assets $6,015 (9.2%)
other $795 (1.2%)
total $65,672

Alternative assets are said to include private equity, venture capital, real estate, and real assets. Would guess 'other' includes these as well--and perhaps some credit instruments as well. If we add, hedge funds, alt investments, and other, we get a total of 23.4% allocated to broad 'alternative investments.'

At the end of 2010, the foundation issued this report that summarized overall investment fund performance on a percentage basis. It also reports annual portfolio performance for the past decade. Not surprisingly, the fund experienced some losses in 2008, 2009.

It also reports an allocation toward equites of about 68%--much higher than the 6/30/10 annual report. This suggests that either the investment managers increased commitment to stocks in late 2010, or something's getting lost in the translation.

Going for Gold

Yeah, there's a storm on the loose, sirens in my head
Wrapped up in silence, all circuits are dead
Cannot decode, my whole life spins into a frenzy
--Golden Earring

Bot some physical gold today. First physical purchase of the year. It's difficult for me to buy in a rising market. Plus, selection on venues like ebay has not been all that great.

Given the macro state of affairs, however, gold could be strong for quite some time.

My 2011 goal is to add 3-5% by weight. If prices stay strong, then perhaps I'll try to 'dollar cost average' some coins each quarter.

Should gold price take a significant dive, then I might get more aggressive.

position in gold

Dollar Squalor

Right here, right now
Watching the world wake up from history
--Jesus Jones

The US dollar is at key support right here.

If the 75 level gives way, then 71 becomes quite literally the last line of support.

Budget Line With No Spine

"You want to know about politics in Washington? Four words. Watch your back, Jack."
--Admiral Jim Greer (Clear and Present Danger)

In FY 2010 the federal govt spent $3.5 trillion--a deficit of $1.3 trillion over receipts. Last night the Congressional leadership came to terms on a 2011 budget, a budget that was due last October, that forecasts a paltry $38 billion in reduced spending vs 2010.

Today, the president and house/senate leaders are talking about what a grueling process it has been, with both sides have to make serious compromise.

All for a 1% reduction--a forecast reduction at that. Laughably sad.

Clearly driving this process was fear on both sides of being associated with a govt shutdown.

If politicians will not make the necessary reduction out of fear of taking govt apart, then we face certain economic dislocation ahead.

Ignore and Get Poor

"You know, I know this steak doesn't exist. I know that when I put it in my mouth, the Matrix is telling my brain that it is juicy and delicious. After nine years, you know what I realize? Ignorance is bliss."
--Cypher (The Matrix)

As noted in this article, the following chart says it all:

Bernanke and other Fed heads have been claiming that their actions have not been stoking inflation.

Today, gold is again marking all time highs, silver is at generational highs, and oil is north of $110/barrel.

Of course, those who slurp down such drivel will be first in line for the next bailout...

position in gold

The Great Gold Robbery

There's a room where the light won't find you
Holding hands while
The walls come tumbling down
When they do, we'll be right behind you
--Tears for Fears

Interesting review of the relationship between the banks runs of the early 1930s and FDR's ban on gold. One insight is that the bank runs in late 1932 were people seeking to front run the US going off the gold standard--something that FDR had publicly hinted in the months leading up to his inauguration.

In 1933 a NYC lawyer with unsurrendered gold holdings challenged the confiscation order. A Federal judge upheld the order, saying that the government was justified in compelling individuals to surrender their gold, and declared 'the right of the government to take private property of any kind when it is deemed necessary by the appropriate authority for the public good.'

A shot across the bow of Liberty, to say the least...

position in gold

Democratic Liberty

"You're walking around blind without a cane, pal."
--Gordon Gekko (Wall Street)

Periodically these pages have discussed the inherent disconnect between democracy and liberty (stream here). The late F.A. Harper writes about the contrast much more elegantly than I.

One particularly insightful passage:

"Strange indeed is this concept of 'democratic liberty,' which has gained such widespread approval! Strange is a concept of 'liberty' which allows you to be forced to pay the costs of promoting acts of which you disapprove or ideas with which you disagree, or which forces you to subsidize that which you consider to be slothful and negligence. Your 'liberty' in the process is that you enjoy the right to be forced to bow to the dictates of others, against your wisdom and conscience."

The word that appears multiple times in the above passage is force. Indeed, democracy can be viewed as a mechanism of force.

So, why do politicians today frequently espouse the merits of democracy in the context of liberty? As Harper observes,

"This illusion, that the democratic process is the same as liberty, is an ideal weapon for those few who may desire to destroy liberty and to replace it with some form of authoritarian society; innocent but ignorant persons are thereby made their dupes."

Engage your brain, and don't be duped by the pied pipers' tune of democracy.

The CSCO Disco

"You've done a lot of solid work here. But it's just not Ivy League, now, is it?"
--Rutherford (Risky Business)

Calling a bottom in Cisco (CSCO) has been a risky endeavor recently. Three times in the past year, CSCO has gapped lower after disappointing earnings reports.  Previous gaps lower have been followed by upward price movement to fill the gaps.

The most recent gap lower in Feb, however, was followed by further price weakness. After meandering lower for weeks, CSCO stormed some 5% higher--thought to be linked to an internal company memo issued yesterday by CEO John Chambers stating that the company had to make some changes.

Note the chunky volume on today's move higher. Note also the possibility of a 'double bottom at $17ish.

Perhaps this will turn out to be another false signal. But one factor that is providing tailwinds rather than headwinds at this level is valuation. CSCO generates $9-10 billion in free cash flow. As a perpetuity, $9 billion in annual cash amounts to $9 / .1 = $90 billion.

CSCO has $40 billion (!) in cash and $15 billion in debt. That's $40 - $15 = $25 billion in net cash. Market cap is currently $100 billion, meaning that enterprise value is $100 - $25 = $75 billion.

So the way I see it, I can currently buy a cash rich large cap stalwart with a dominant position in its sector and strong brand for about a 17% discount from list price. Is this discount warranted because CSCO is losing its edge like some market participants fear? I don't think so. CSCO operates in an industry that is attractive for profits. Moreover, it has a strong franchise and some of the most capable managers in industry.

My only reservation is my bearish macro view--which keeps me from getting really aggressive in a situation like this.  That said, I added to my position last week and will look to add more now that the technicals have perked up.

I'll be watching for pullbacks below $18.

position in CSCO

Golden Breakout

The time has come to make or break
Move on, don't hesitate
Breakout
--Swing Out Sister

Last weekend we noted the bullish technical set up in gold. Today the pattern resolved itself to the upside in classic 'breakout' fashion. The move once again finds gold in price discovery, exploring time highs.

Whenever one of these upside resolutions occurs after you were watching it form, there will always be some regret that you weren't long enough ahead of the move. But then remind yourself about the prudence of risk management, and that opportunities can be made up easier than losses.

That's what I was telling myself today ;-)

Besides, past resistance at 140ish GLD has now become support. A pull back in price toward that 140 level may present a nice opportunity to add to a position...

position in GLD

Real Risk

The ice we skate is getting pretty thin
The waters' getting warm you might as well swim
My world's on fire, how about yours?
That's the way I like it 'cause I never get bored
--Smash Mouth

Last week's RISE conference reiterated my sense that portfolio managers just do not manage tail risk well. They have been raised on the portfolio theory concept and know how to manage idiosyncratic, security specific risk. But they are largely unprepared for systemic risk that takes all risky assets down in a correlated fashion.

Coincidently, this morning I happened across this article on John Mauldin's fine site. The author distinguishes between trivial risk and real risk. Real risk is the risk that can wipe you out. He argues that many measures of risk in the mainstream finance demand (e.g., beta, standard deviation, VaR) do not capture real risk.

He includes the above chart to demonstrate that severe stock market losses occur much more frequently than predicted by normally distributed models.

I also like his concept of birthday risk. Most people have a 15-20 year window for serious investing. Depending on when you were born, this window fall over a 15-20 year period where risky investments go thru the roof (e.g., 1981-2000), or when risky assets tread water at best (e.g., 1966-1980).

He suggests that the argument that 'stocks always go up in the long run' is an impractical one. It won't matter for investors who by chance are dealing with the wrong investment window and who may not be able to stick around for the 'up' cycle.

He concludes with some ideas on how to manage tail risk, including the potential value of market timing and considering asset allocation in terms of assets that are truly uncorrelated.

Overall, an interesting and recommended read.

position in SPX

Wealth vs Money

Money, it's a gas
Grab that cash with both hands and make a stash
--Pink Floyd

People often equate weath with money. Wealth and money are not the same.

Wealth is created by productive work. Productive work combines labor with other factors of production to create economic resources of value. If I am a baker, then my labor in concert with capital equipment (stove) and raw materials (flour, water, etc) creates bread. The bread is wealth, as it is an economic resource that can add to standard of living.

Money is not an economic resource. It is merely a piece of paper or a digital accounting entry. Save for the effort required to create the money, there is no productive work or value creating outcomes.

Envision a world where all people are sloths. Everyone sits around all day engaging in leisure; no one engages in productive work. The only 'worker' is someone who prints money and distributes it to the masses. Everyone receives a pile of dollars adding up to $1 million.

Is this a wealthy people? Of course not. There has been no productive work. Valuable economic resources have not been created. The standard of living of all those paper millionaires will be primitive.

While money does not create wealth, what it does do in modern economies, however, is facilitate wealth transfer. Society currently treats fiat currency as a legitimate claim on wealth. Thus, if someone who does not engage in productive work can procure dollars from the 'money printers,' then they can use those dollars to obtain the bread baked by others.

Those who engage in productive work to accumulate real wealth lose some to those people who hold the freshly printed dollars.

People who equate the massive money printing programs of central banks with general increases in economic activity, i.e., productive work and real wealth creation, are disillusioned. General standard of living does not increase with more money.

Money printing can at best transfer wealth--meaning that some will gain economic resources at the expense of others.

Gross Problem

I don't want to wait for our lives to be over
Will it be yes or will it be sorry?
--Paula Cole

Am not a huge fan of Bill Gross of Pimco, but he captures our problem pretty well. If we suppose that future entitlement liabilities were in fact fully funded via the infamous 'lockbox' by borrowing, then the interest expense on the $75 trillion in total debt required to fund these liabilities would be about $2.6 trillion. We currently pay about $250 billion in interest expense. 

As such, the total debt burden of the US approaches 500% of GDP. This is higher than Greece.

Gross posits that absent large entitlement cuts (which the federal government seems reluctant to do), then the US is likely to default on its debt. Rather than a 'conventional' default, which entails outright failure to uphold contractual obligations, the US would be more likely to default by printing money to pay the bills (i.e., inflation).

Perhaps the strength of gold can be explained in part by the possibility that increasing numbers of investors are factoring this scenario into their asset allocation decisions.

position in gold 

Bullish Bullion

Man we were killing time
We were young and restless
We needed to unwind
I guess nothing can last forever
--Bryan Adams

While catching up on some chart gazing, the gold chart stood out right away. Multiple reverse head and shoulder patterns are evident, as demand seems to be absorbing any price weakness.

Had an order in Fri after the morning sell off but price never came in. Will be looking to add to my position early in the week.

position in GLD