Saturday, March 28, 2009

those long buyers

a few months ago, over a very nice zinfandel and overlooking a beautiful valley in the blue ridge, i was discussing the problems in the economy with my brother-in-law john, a perceptive fellow who always enjoys a touch of irony. during this time, there was great discussion afoot that many or all of the problems in the economy, particularly the problems at the big banks, were really the fault of the short sellers. they were driving the prices of the shares of the banks down artificially, it was said, thus making it difficult for the banks to raise capital, and so on. short sellers were reviled as being unpatriotic or worse, and there was a movement afoot to solve the problem by banning short selling.

"ya know," he said, "its really the fault of those long buyers."

well of course, i thought, but what a great turn of phrase. it was, after all, those long buyers who bid up the price of everything and created the bubble in the first place. and of course their co-conspiritors the banks and the fed, who provided all the money and the leverage which facilitated their doing so. those few of us who saw their folly and were selling short into the bubble were the true patriots, trying in vain to counteract the folly and deflate the bubble in an orderly fashion. imagine the pain of shorting lehman brothers, merrill lynch and citibank, and watching them double, against all reason.

furthermore, it was those same short sellers who were later able to provide a modest spurt of buying power just when it was needed. all those long buyers were the ones who were bailing out of their positions when the stocks came down into single digits, and it seems like the short sellers were the only ones buying.

there's a guy called cramer who has been writing all kinds of stuff about how bad short selling is. is he the guy that jumps up and down and wears funny hats on cnbc or one of those financial channels, or do i have him mixed up with somebody else? anyway, he should be that guy, because he seems to be quite the fool. in a bull market, you buy low, sell high. in a bear market, you sell high, buy low. either way, you're providing a balancing force and a vital service to the market, and should be shown a little respect. fugget about it.

thoughts on the bailout

howdy, y'all, i'm back after a modest hiatus. i've been watching with interest all the plans and machinations for trying to "fix" the economy, and you won't be surprised to learn that i don't think very highly of any of them. i don't want these posts to take on the character of a political rant, so i'll make this a short post before returning to what interests me more, which is the larger view of what the economy and the markets are doing, independent of any efforts to manipulate them by government or otherwise.

essentially, my objection to the bailouts is pragamatic; i don't think they will work. in fact, i am among those who think they will make the situation worse, in addition to costing the treasury an arm and a leg to carry them out. what i believe is that the markets, for stocks, bonds, real estate, commodities, instruments of mass destuction, you name it, all have to hit a real bottom before any recovery can begin. contrary to popular opinion, there are many folks who were not taken in by this massive bubble in all of these markets, who have kept their powder dry and are waiting for the opportunity to invest in real assets at realistic prices. (i would like to believe that some of my readers are among those). these people were willing to forego the potential profits which others were reaping during the bubble phase, in order to be in a position to purchase assets at lower prices after the inevitable crash. included in this category are quite a number of solid banks, who resisted the lure of highly leveraged high yield assets (ie. toxic assets) and kept their feet on the ground doing solid conventional banking (more on this subject below).

these people and institutions are not stupid, although many would have thought them so during the height of the bubble. if they were not taken in then, they surely will not be taken in now. they are waiting for the above-mentioned real bottom before they part with the cash which they have so patiently and carefully held on to during these troubled times. (if you are asking, when will this bottom occur and how will we know when we get there, i will be discussing this with great enthusisam in future posts, as it is the 64 trillion dollar question).

so, what does this have to do with the bailouts? it is my contention that the bailouts are merely delaying the inevitable collapse in the prices of the assets, and thus delaying the recovery. there is no avoiding the pain associated with a collapse in these assets, but there could be some benefit to shortening the period of time during which we have to endure this pain. every element of the various bailout plans is an attempt to prop up the prices of things by injecting liquidity (ie. money) into a system in which the very problem was too much liquidity in the first place. but the mood has changed, and people just aren't "buying it" any more. they've got all the crap they need, be it goodies from walmart, gas guzzlers, vacation condos, or stocks and mutual funds. they're selling, not buying, and it's not just the smart ones now, everyone's doing it. so it's all going down, and the sooner the better, says I, so that a real recovery may begin.

a couple of additional notes:
1. about those banks i mentioned above who acted prudently during the bubble, even though it meant lower profits and derision from the analysts at the time. they deserve the competitive advantage that such prudence confers. it is not right nor useful that their competitors who acted imprudently should be propped up by the government.
2. consider this irony: we hold that home ownership is a wonderful value in our society. what better news then, that home prices are falling, bringing the price of a home within the reach of so many more americans. instead, the bailout folks are doing everything they can to prop up the prices of homes, in direct conflict with our cherished values. i would hold that the real american dream, over the past 15 years or so, has not so much been home ownership, but home price appreciation, a wonderful way to riches without effort or sacrifice. this is pure bubble thinking, and must of course die out as the bubble deflates.

Sunday, April 20, 2008

i'm back

sorry for the hiatus, but tax time intervened, and there was a mountain of k-1's and 1099's to attend to. i hope now to be more regular, except when traveling.

thanks for the encouraging comments, it makes me feel like the effort is worth it. the feeling i'm getting is that everyone wants me to cut to the chase and tell them what to do! i'm torn here, because i'm not sure that's really what i want to do. my real purpose in writing was to educate, to try to bring some light to the world of investing, trying to look at it from some unique and unusual angles, say some of the things that are not being said by the talking heads. also, i am not a "registered investment advisor" and thus cannot presume to give actual individual investment advice. furthermore, if i'm wrong, i don't want people getting pissed off at me. people have a way of remembering that the good decisions were their own idea, and the bad ones they got from somebody else; present company excepted of course! and of course i do have some ideas about what to do, so there's that, too...

for now, let me say that if you read me saying that something is in a bubble, then by definition i think it is overpriced, that it is one of the trains (ie. investments; see "we're all gamblers") that has gotten ahead of itself, and is due to move backward, perhaps a lot backward, relative to the other trains. therefore, it is something which i think you should SELL, jump out of, onto another train. maybe even sell short if you like to gamble. (if you don't know what that is, that's ok, because in that case you shouldn't do it, anyway.) at present, i believe that stocks, real estate, and high yield bonds are in a bubble that is just beginning to collapse. some of the other trains, like gold, commodities, and money are more complicated, and i hope to write more about them in the future.

in addition to the nice comments, some good questions were posed by steven newcomb and by someone named suntrinsic. so rather than ramble on, i'm going to try to present my opinion about these questions.

Suntrinsic said...
Hi Jim! What's your take on these often-heard opinions? (1) Since its inception, the U.S. stock market has had some spectacular ups and downs, but its overall trajectory has always been up. Therefore, a prudent, well-chosen and -diversified mix of equities, bonds, and cash--and a willingness to stay invested over the long haul--is the best hedge against inflation and against such alleged facts as that even returns of U.S. Treasury bonds rise and fall over time. (2) Huge stock-market crashes and long economic depressions are less likely to happen in the "developed" world than in, say, the late 1920s and 30s, because of how alertly the economy is now managed. (3) Money is a social construct, a mutual agreement on a standard medium of exchange. In some cultures and at some times, value has been tied to gold, in others to cowrie shells. The fact that it is now plastic, or stipulated by the World Bank or whatever, does not perhaps mean it is any less real or stable than it has always been.I'm really interested in hearing all points of view on these matters. Thanks for blogging! I want to read Prechter, for instance.

ok, in order: (1) YES! i believe this, (the first part, about stocks, not necessarily the "mix"). a couple of weeks ago, i started writing a post which was to be a summary of what each of the major "trains" was and what i thought of them as an investment vehicle in general. (it was too boring to post). regarding stocks, i point out that they represent the one investment where you own a piece of something that is (hopefully) growing and increasing in and of itself, an actual business. the others pretty much just sit there, perhaps earning interest or rents, and you hope they somehow become scarce and that people will want to pay more for them at some point. but that's in the "long haul." remember that stocks lost over 90% of their value between 1929 and 1933, and that it took over 20 years for you just to get back to where you started if you invested in 1929. ouch. my premise is that there are indicators and measures which you can use to see if an investment is overvalued, and when that is the case, you have to jump off. you might not live long enough to benefit from the long haul. also, many companies went bankrupt in the 30's, so if you happened to own the wrong ones, you never got even.

(2)i believe just the opposite. all of the central bank interventions, financial innovations, and so on have only conspired to create a much more unstable environment. there are so many layers of financial products, each some sort of derivative of the layer below, it's like one of those cheerleader pyramids 20 persons high. insiders now refer to these products collectively as "financial instruments of mass destruction." when the pyramid collapses, it will be much worse than a simple collapse of the underlying financial instruments (mostly mortgages and corporate loans) would have been, and no amount of "management" will save the day. when bear stearns collapsed recently, everyone complained about the "bailout." but the stockholders, whose stock was worth $150 not that long ago ended up with ten bucks, a 93% loss in short period of time. how long will it take for them to get back to where they were?

(3) great observation, and the crux of what i plan to examine carefully, because it's very complicated. i do believe that money, when not tied to something concrete, such as gold or cowrie shells, has the potential to be debased, as in the famous inflation of postwar germany, the italian lire, or myriad south american countries over the years. however, these were examples of currency inflation, where the government simply printed huge amounts of money and put that money into circulation by spending it for its own purposes. our current expansion of the money supply is primarily caused by an explosion of debt. its the old economics 101 lesson (where the banking system creates money by lending it to people who then deposit it in accounts where the bank can lend it out again, and so on) on steroids. all those financial instruments mentioned in the previous paragraph increase the flow of money. the question is: what happens when the pyramid starts to collapse? one school of thought is that the fed will try to stop the collapse by somehow flooding the system with money, causing great inflation. the other school says that the collapse will be deflationary (meaning that money will become worth more) because money disappears in the collapse in the same way that it is created in the bubble, and the fed will not be able to do anything to stop it. i belong to this latter camp. lets look at the clearest example i can find for this, the bear stearns collapse and bailout. people are saying, oh this is inflationary, the fed put up all these guarantees and kept the whole thing from collapsing, that's just more money in the system. what i see is the evaporation of an enormous amount of wealth. all those stockholders have a lot less "money" than they used to (actually, they don't have less money, but they have less wealth, less that they can convert to money and spend), and many jobs were lost, also. the net effect is very deflationary, despite the fed's inflationary attempt to prop things up. look at the mortgage fiasco. people are losing their homes and investment properties, that wealth is going up in smoke. and they're not the only ones to suffer. the ones who issued or bought those mortgages (like bear stearns!) are going broke, too. all sorts of bailout ideas have been kicked around, but even if some of them were to be implemented, they would merely reduce the degree of deflation, not create inflation.

Steven Newcomb says: OK, you got my attention. At a moment when the forward/backward/relative motion of the trains is less predictable than at any time in my almost 60 years of life, I need all the help I can get. I see lots of things I want to take my money *out* of, but not too many that I want to be *in*. I want to get out of U.S. dollars, for example, but I should have thought of that earlier than now, and Euros are looking pretty expensive.

this brings up a number of thoughts, steven. first of all, we have to fess up to the fact that there are not just eight or ten possible investments, there are a jillion. there aren't just "stocks," there's each and every stock traded on all the stock exchanges in the world, and one or two of these can be going up while all the others are going down, and vice versa. and so on for each of the other trains. in the case of money, there are US dollars, and then all the other currencies such as the euro, the yen, the swiss franc, and so on. so even if you've made the decision to keep a part of your investments in "money," you have the option to choose from all these different kinds of money. you rightly point out that the euro train has pulled out smartly ahead of the dollar train, meaning that you wish you'd gotten onto it back when it was behind (which was the case not so many years ago). i like to look at things as much as possible from the point of view of what i figure their fundamental value to be, and then see if the price of that thing is in line. if so, i figure the train is right where it should be. if the price is too high, i figure the train has gotten ahead of itself and it might be time to jump off. if the price is too low, we want to jump on. so how do we figure this "fundamental value?" well for a stock, it has to do with the profits and dividends, and one's analysis of the future prospects for the particular business. for currencies, i think the "hamburger test" is a good one. what does a hamburger cost in a particular country, compared to all the others? or a suit of clothes or a cup of coffee in a restaurant, or some other common item. if the cost is high, then that currency might be considered to be overvalued, and thus due to correct at some point. right now, it's very expensive for an american to travel in europe, and the europeans are all flocking to take their vacations here in the US because it's so cheap. this tells me that the euro is overvalued relative to the dollar, so i wouldn't be investing my money there at this point. that is not to say that the euro will not continue to go up in relation to the dollar, but i feel that in the long run it will probaby come back down.

thanks, everybody, more later.

Monday, April 7, 2008

is this a bubble?

in my previous post "we're all gamblers," i made up an analogy using trains moving at different speeds to represent the different kinds of investments you can make. each train is a different thing you can be invested in, and you want to be riding on one which is moving briskly forward, not sitting still or, as is too often the case these days, going backward. the point i was trying to make is that, unless you are completely broke, as in homeless or thereabout, you are always riding on one or another of the trains. there is no "safe" position on the platform, as there was in the good old days. at some point in the future, i hope to sit down and look at each of the different kinds of investments and some of the ways to value them, to figure out what they are worth based on some quantitative measure, such as the interest or dividend or rental income which they earn. but there is a much more interesting element to all of this, and that is the psychological element.

it is my belief that people are not always rational when making investment decisions. they do not always assess the prospects for their choice with a cold and impartial analysis. there is a tendency to get caught up in some fad or hot investment, something which everyone is talking about around the watercooler or at parties. back in 2000, you couldn't go into a bar or restaurant without overhearing someone talking about their stock portfolio and subltly bragging about how well it was doing. six years later, everyone was flipping condos and discussing their latest deals.

once in a while, one of these fads can get completely out of hand and it becomes a bubble, or as it used to be called, a mania. there are stories that in the late 20's during the big stock market mania people were getting stock tips from the elevator operators and shoe-shiners. everyone was coming up with reasons why the world had changed in some fundamantal way to accomodate their view that stocks would continue to rise indefinitely. at times like this, when there is great excitement and everyone is making a lot of money, it is difficult to be a contrarian and to resist the urge to throw your money in as well. just about everyone knows that this big bubble ended with the great crash of 1929, and most of the people who made money in the bubble lost it all and more in the crash. i believe that our situation today is very similar to that of the twenties, and i plan to use it as a model in discussing some of the things which might happen in our future. of course there are differences, and i shall try to look at those as well.

returning to the present, we are in an interesting period, a sort of limbo. it seems clear that the real estate bubble has begun to burst. one way to see this is because everyone is now acknowledging that we have had a bubble, you can read about it in the daily paper or hear about it on tv, and you do not get that kind of insight when the bubble is still inflating. foreclosures are increasing at an alarming rate and people are losing their homes as well as their investment properties. i'm starting to read articles that say that things are so bad that we must be at a bottom, and that this is the time to start buying again for the next upturn. this certainly makes more sense than buying a year or two ago at the top, but is it a good idea?

if we return our attention to the 1920's and 30's, we may be able to gain some insight. we know there was a great crash in october 1929, in which stocks lost 30 to 40 percent of their value in just a few days. because of margin (the use of leverage to buy stocks with only 10 to 20 percent down), many people were wiped out then and there. in fact, part of the reason that the market fell so fast was that forced margin sales drove it down further than it might otherwise have gone. at that point, many people argued that this was a fantastic buying opportunity, that the conditions for stocks to keep climbing were still intact, and that there were great bargains available. and the market did rally from there, gaining back a good part of the loss over the next few months. after a while, though, the market started to go down again, passing the point of the original decline to a new bottom. again, the bargain hunters jumped back into the market and it went up again, but not so far as the previous time. this process went on, over and over, for a period of four years until, by 1933 the market had lost not 40 percent, but 95 percent of its value. yes, a thousand dollars worth of stocks was worth 50 dollars by the time the real bottom was reached. many companies went out of business and their stock went to zero, so there was no recovery for those stocks, ever. this was the start of the great depression, which made the great crash seem mild indeed.

i realize that i have not made a convincing case yet that our current situation is close to that of the 20's and 30's, but i will try to draw more parallels in future posts. in fact, i started out trying to do that, and i found it getting ponderous and boring, and never really getting to the important point i want to make. but i want to state clearly that i do believe that these situations are similar and that we may be facing an economic collapse which could be as serious as that of the great depression. and i do have a number of ideas about how one can protect oneself, and they don't all involve buying guns and burying gold in your backyard.

reader steven is justifiably impatient, wanting to know what to do about all this. and he asks, indirectly, the 64 million dollar question: can we expect the collapse to be inflationary or deflationary. i am still pondering this issue and thus will give it a lot of attention in future posts, as i reason it out as i go. but a quick answer is: i'm leaning toward deflation, so it might not be a bad idea to hold onto your cash. cash is, of course, one of the trains, and it hasn't done very well while everything else has been going up in the bubble. and US dollar cash has not done well of late versus other kinds of cash such as the euro and yen. tough question, but remember that when one of the trains lags behind the others for a while, it will often play catchup as the others slow down.

if you're interested in more information on bubbles and crashes, please read one of the books on my recommended reading list to get a more complete description of these phenomena.

Saturday, April 5, 2008

recommended reading

i will be updating this list frequently, as i think of a good book or article while composing my posts, so the list is a work in process. i will try to give reasons why i like the particular book, so you will have some idea if it might appeal to you. several are wonderfully written, and i can recommend them on that basis alone, while others may be heavier reading, but contain valuable information which is worth slogging through. also, i'll try to create some categories.

A Short History of Financial Euphoria by John Kenneth Galbraith. this is a wonderful little book, full of wry humor, which gives a very brief summary of various financial bubbles and is full of anecdotes and observations of the various characters involved. you can buy it used on amazon for less than five dollars, and read it in a couple of hours. a delightful read, highly recommended.

Great Crash 1929 by John Kenneth Galbraith. this is more galbraith the economist, disecting the great crash more deeply and analytically. for those who want to delve more deeply into the subject. well written, but not nearly so entertaining as "short history."

Extraordinary Popular Delusions: And the Madness of Crowds by Charles MacKay. written in 1841 and reprinted countless times, this book describes three major financial bubbles and quite a number of other manifestations of social mania, such as the salem witch trials. in lumping them together, mckay reveals his notion that all these phenomena are rooted in the same psychological causes. mckay was a poet and a songwriter, and the book is a joy to read. note that some of the modern editions contain only the financial portion (which might be all you want). highly recommended.

At the Crest of the Tidal Wave by Robert R. Prechter Jr. the best description i've found of our current bubble, and its likely outcome. written in 1995 while the stock market tech bubble was still under way and before the real estate bubble really came into being, the book anticipates our current crisis and much more to come. a must read if you're serious about understanding how things might play out.

Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression by Robert R. Prechter Jr. this is the companion book to "at the crest," a step by step guide to what to actually do to prepare for a crash. in a word: "SELL!"

Wednesday, April 2, 2008

we're all gamblers

ever watch one of those old english movies, or the new ones about old england? you'll often hear a phrase like "he has 200 pounds," or "she has 500 pounds," uttered in reverent or admiring tones. this of course did not mean that the person had that amount of folding cash in their pocket, nor even that they had that sum stashed away somewhere to live on. the sum in question was the amount of interest which he or she received anually from their wealth, which would be invested in gilt-edged bonds issued by the bank of england. you could of course compute the actual amount of wealth by dividing by 2% or thereabout, the prevailing interest rate at the time, but that was not the point. the point was that the person had that 200 pounds to live on per year, in perpetuity, in an absolutely safe and secure investment. and the value of that 200 pounds was likewise secure, as the pound was a fixed amount of gold, and for centuries that 200 pounds had bought the same amount of bread, cheese, ale, clothing, servants, and so on. these stores of wealth, whether large or small, were handed down generation after generation, and they maintained their value over long periods of time.

contrast that situation to today. let's say you've got a million bucks, and you're not the gambling sort, and you're trying to figure out what to do. you've probably got about the same amount of capital as the 200 pound guy above, who actually had around 10,000 pounds invested in bonds. can you do what he does? you might say "sure, i'll buy t-bills, absolutely safe, and be one up on the old brit, since i can get 5% instead of his measly 2%." but wait, we all know that $50,000 won't be worth nearly as much in 10 years, let alone 100 or 300 years. ok, you say, i'll do like him and just spend 2%, and i'll leave the other 3% in the pot, so the million dollars will grow by 30k this year, a bit more the next, and so on. but there are complications to this. first off, leaving aside the question of whether you can live on $20,000 a year, you probably have to pay taxes on the 5ok of interest, maybe around 15%, so now you've only got $12,500 to live on. more important, how do you know that leaving 3% in the pot will be enough to stay even? right now the dollar is especially weak, and you might think you can solve the problem buy buying your bonds in euros or yen or swiss francs. but tomorrow, those currencies might be the weak ones, for none of them are truly backed by any real standard such as gold or silver. and what happens if you buy gold? first off, you've got no income; now you have to sell off part of your holdings every year in order to live, the very thing you're trying to avoid. also, since gold and silver are no longer the recognized standard for money and value, their value in terms of dollars and other currencies fluctuates up and down like everything else.

by now, i hope you've got my point, the title of this post. there isn't anything you can do to solve your problem, because we no longer live in the world described in paragraph one. (i was going to title this post "the good old days" in order to emphasize this). whatever you do, you're gambling. there is nothing which i can think of which is fixed in value, and the value of each possible investment is constantly fluctuating in relation to all others. so your task, at any particular moment in time, is to try to pick the one which is is moving the fastest in the right direction, or i should say, which is going to move fastest in the right direction. imagine about ten train tracks running in parallel next to each other, each with a really long train on it. the trains are speeding up and slowing down and sometimes even going backwards, all independently of each other, kind of like the boats or streetcars in those little races on the scoreboard at the ballgame between innings. you're on one of the trains and you can jump over onto any one you want at any time. your mission, should you choose to accept, is always to try to be on the train that is moving forward the fastest. if you are mostly successful, you will be working yourself toward the front of the trains, and one day might actually arrive there, if indeed the trains have a front. the purpose of this blog is to present sensible, perhaps provocative ideas as to how this might be accomplished. as always, should you or any member of your team be killed or captured, the secretary will disavow all knowledge of your activities.