Posts tagged ‘financial crisis’

Broken Record Repeats Itself

Article is an excerpt from previously released Sidoxia Capital Management’s complementary June 2012 newsletter. Subscribe on right side of page.

Traditional music records have been replaced with CDs (compact discs) and digital downloads. Although the problem of a broken record repeating itself is no longer an issue, our financial markets have not conquered the problem of repetition. More specifically, the timing of the -6.3% stock market decline during May (as measured by the S&P 500 index), coincides with the same broken sell-offs we have temporarily experienced over the last two summers. First, we had the “Flash Crash” in the summer of 2010, and then the debt ceiling debate and credit downgrade of 2011.

So far, the “Sell in May and go away” mantra has followed the textbook lessons over the last few years, but as you can see from the chart below, the short-lived seasonal sell-offs have been followed by significant advances (up +33% from 2010 lows and up +29% from the 2011 lows). Given the global challenges, a two-steps forward, one-step back pattern in equity markets should not be seen as overly surprising by investors.

Source: Yahoo Finance

Although the late-spring and summer doldrums have not been a joy-ride in recent years, these overly simplistic seasonal trading rules of thumb have not been exceedingly reliable either. For example, even though the months of May in 2010-2012 produced negative returns, the previous 25 Mays going back to 1985 produced positive returns more than 2/3 of the time. Rather than fiddle with these unreliable, unscientific trading rules, individuals would be better served by listening to famous Jedi Master Yoda from Star Wars, who so astutely noted, “Uncertain, the future is.”

Voting Machines and Scales

Given the spread of globalization and technology, the speed of news dissemination has never been faster. With the 2008-2009 financial crisis still burned into investors’ minds, the default response to any scary news item is to shoot first and ask questions later. Renowned long-term investing legend Ben Graham famously highlighted, “In the short run the market is a voting machine. In the long run it’s a weighing machine.”

As it relates to short-run current events, here are some of the items that investors were voting on (no pun intended) this month:

Europe, Europe, Europe: This problem has been with us for some time now, and there are no signs it will disappear anytime soon. In a game of chicken between the EU (European Union) and Greek legislators, fresh elections are taking place on June 17th, which will ultimately determine if Greece will exit the Euro monetary union or stick to the bitter medicine of austerity prescribed by the key European decision-makers in Germany. As Greece attempts to clean up its own mess, European politicians and G-20 leaders around the globe are scrambling to create plans that ring-fence countries like Spain and Italy from succumbing to a Greek-born contagion.

Presidential Politics: If you haven’t been living in a cave for the last six months, you probably know that 2012 is a presidential election year. Regardless of your politics, there are big questions surrounding the economy, jobs, deficits, debt, taxes, entitlements, defense, gay marriage, and other important issues. Answers to many of these questions will remain unclear until we get closer to the elections. The financial markets do not like uncertainty, so probabilities would indicate volatility will remain par for the course for the foreseeable future.

Facebook Folly: Despite my warnings, Facebook’s initial public offering (IPO) failed to live up to the social media giant’s hype – the share price has fallen -22% since the shares originally priced. Great companies do not always make great stocks, especially when a relatively new kid on the block has his company’s stock initially valued at a hefty price-tag of more than a $100 billion. Finger pointing is being spread liberally on the botched Facebook deal (e.g., Morgan Stanley, NASDAQ, Facebook), but no need to shed a tear for 28-year-old founder Mark Zuckerberg since his ownership stake in the company is still valued at around $15 billion – enough to cover a European trip to McDonald’s with his newlywed wife.

Dimon in a Rough Spot: Jamie Dimon, the poster child of the banking industry (and CEO of JP Morgan Chase – JPM), dropped a bomb on the investment community earlier in the month by explaining how a rogue “whale” trader racked up $2 billion in initial losses (and growing) by taking excessive risk and throwing controls into the wind.

Chinese Dragon Losing Steam: The #2 global economy has been losing some steam as witnessed by slowing industrial production and GDP growth (Gross Domestic Product). In turn, the self correcting economic forces of supply and demand have provided relief to consumers and corporations in the form of lower fuel, energy, and commodity prices. Chinese leaders are not sitting still – there are plans of accelerating infrastructure spending and assisting banks in the form of capital injections and lower reserve requirements.

As I discussed in a previous Investing Caffeine article (see The European Dog Ate My Homework), although the current headlines remain gloomy, that will always be the case. Just a few years ago, Bear Stearns, Lehman Brothers, AIG, CDS (credit default swaps), and subprime mortgages were the boogeymen. In the 1980s, we had the Savings & Loan financial crisis and the infamous 1987 Crash. During the 1970s, the Vietnam War, Nixon’s impeachment proceedings, and rising inflation were the dominating issues. Since then, the equity markets are up over 20x-fold – time will always reward those patient long-term investors. Despite all the doom and gloom, stock markets have roughly doubled over the last three years and all the major indexes remain solidly in the black for the year. Choppy waters are likely to remain as we approach this year’s elections, but for those who understand broken records often repeat themselves, there’s a good chance the music will eventually sound much better.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including commodities, inflation protection, floating rate bonds, real estate, dividend, and alternative investment ETFs), but at the time of publishing SCM had no direct position in FB, MCD, JPM, MS, NDAQ, AIG, Lehman Brothers, Bear Stearns, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

June 2, 2012 at 6:51 pm Leave a comment

Investing with the Sentiment Pendulum

Article is an excerpt from Sidoxia Capital Management’s complementary May 2012 newsletter. Subscribe on right side of page.

The last five years have been historic in many respects. Not only have governments and central banks around the world undertaken unprecedented actions in response to the global financial crisis, but investors have ridden an emotional rollercoaster in response to historically unparalleled uncertainties.

While the nature of this past crisis has been unique, experienced investors know these fears continually manifest themselves in different forms over various cycles in time. Despite the more than doubling in equity market values over the last few years, as measured by the S&P 500 index, the emotional pendulum of investor sentiment has only partially corrected. Investor temperament has thankfully swung away from “Panic,” but has only moved closer to “Fear” and “Skepticism.” Here are some of the issues contributing to investors’ current sour mood:

The Next European Domino: The fear of the Greek domino toppling the larger Spanish and Italian economies has investors nervously chewing their finger-nails, and political turmoil in France and the Netherlands isn’t creating any additional warm and fuzzies.

Job Additions Losing Steam: New job creation here in the U.S. weakened to a lethargic monthly rate of +120,000 new jobs in March, while the unemployment rate remains stubbornly high at an 8.2% level.

Domestic Growth Losing Mojo: GDP (Gross Domestic Product) growth of +2.2% during the first quarter of 2012 also opened the door for the pessimists. Consumers are still spending (+2.9% growth), but government spending, business investment, and housing are taking wind out of the economy’s sails.

Emerging Markets Submerging: Unspectacular growth in the U.S. is not receiving any favors from slowing emerging markets like China and Brazil, which took fiscal and monetary actions to slow inflation and housing speculation in 2011.

Humpty Dumpty Politics: Presidential elections, tax policy, and deficit reduction are all concerns that carry the possibility of pushing the economic Humpty Dumpty off the wall, and as a result potentially lead to a great fall. The determination of Humpty Dumpty’s fate will likely have to wait until year-end or 2013.

Any student of history knows these fears and other concerns never go away – they simply change. But like supply and demand, gravitational forces eventually swing the emotional pendulum in the opposite direction. As Sir John Templeton so aptly stated, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” Or in other words, escalating bull markets must climb the proverbial “Wall of Worry” in order to sustain upward momentum. If there was nothing to worry about, then all the buyers would already be in the markets. We are nowhere close to experiencing “Euphoria” like we saw in stocks during the late-1990s or in the housing market around 2005.

Positively Climbing the “Wall of Worry”

With all this bad news out there, surprisingly there are some glimmers of hope chipping away at the “Wall of Worry.” Here are some of the positive factors helping turn pessimist frowns upside down:

Slow & Steady Wins the Race: The economic recovery has been weaker than hoped, but I can think of worse scenarios than 11 consecutive quarters of GDP growth and 25 straight months of private job creation, which has reduced the unemployment rate from 10.0% in October 2009 to 8.2% last month.

Earnings Machine Keeps Chugging Along: With the majority of S&P 500 companies having reported their quarterly results for the first quarter, three-fourths of the companies are beating forecasted earnings, which are currently registering in at a respectable +7.1% rate (Thomson Reuters). One company epitomizing this trend is Apple Inc. (AAPL). The near doubling in Apple’s profits during the quarter, thanks to explosive iPhone sales, pushed Apple’s shares over $600 and helped drive the NASDAQ index to its best day of the year.

Super Ben to the Rescue: The Federal Reserve has already stated their intention of keeping interest rates near 0% until 2014. The potential of additional monetary stimulus spearheaded by Federal Reserve Chairman Ben Bernanke, in the form of QE3 (Quantitative Easing Part III), may provide further needed support to the stock market (a.k.a., the “Bernanke Put”).

Return of the IPO: Initial Public Offerings (IPOs) have gained steam versus last year with more than 53 already coming to market in the first four months of 2012. This is no 1999, but a good number of deals have done quite well over the last month. For example, data analysis company Splunk Inc. (SPLK) share price is already up around 100% and the value of leisure luggage company TUMI Holdings (TUMI) has climbed over +40%. In a few weeks, the highly anticipated blockbuster Facebook (FB) IPO is expected to begin trading its shares, so we can see if the chronicled deal can live up to all the hype.

Dividends Galore: Dividend payments to stockholders are flowing at an extraordinary rate so far in 2012. Companies like IBM (increased its dividend by +13%), Exxon Mobil – (XOM +21%); Goldman Sachs – (GS +31%) are but just a few of the dividend raisers this year. Through the first three months of the year, the number of companies increasing their dividend payments was up +45% as compared to the comparable number for all of 2011.

Emerging Growth Not Dead: While worriers fret over slowing growth in China, companies like Apple grew by more than +100% in this region and collected nearly 20% of its revenues from this Asian country (~$8 billion). Coincidentally, China is expected to surpass an incredible one billion mobile connections in May – many of those iPhones. In other related news, Starbucks Corp. (SBUX) plans to triple its workforce and number of stores in China over the next three years. China has also helped fuel a backlog of Caterpillar Inc. (CAT) that is more than triple the level of 2009. Emerging markets may have slowed down in 2011, but with inflation beginning to stabilize, emerging market central banks and governments are now beginning to ease policies and reduce red-tape. For example, Brazil and India have started to lower key benchmark interest rates, and China has started to reverse capital flow restrictions.

Stay Off the Trampled Path

The mantra of “Sell in May and go away” always gets a lot of playtime around this period of the year. Over the last few years, the temporary spring/summer sell-offs have only been followed by stronger price appreciation. Individuals attempting to time the market (see also Getting Off the Treadmill) generally end up in tears. And for those traders who boast about their excellent timing (like those suspicious friends who brag about always winning in Las Vegas), we all know the truth – nobody buys at the lows and sells at the highs…except for liars.

With all the noise and cross-currents flooding the airwaves, investing for individuals without assistance has never been so difficult. But before hiding in your cave or reacting to the next scary headline about Europe, the economy, or politics, do yourself a favor by reminding yourself these chilling news items are nothing new and are often great contrarian indicators (see also Back to the Future). The emotional pendulum is constantly swinging from fear to greed and investors stand to prosper by adjusting sentiment and actions in the opposite direction. To survive in the investing wild, it is best to realize that the grass is greener and the eating more abundant when you stay off the trampled path of the herd.    

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct position in SPLK, TUMI, IBM, XOM, GS, SBUX, CAT, FB, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

May 1, 2012 at 12:08 am 1 comment

Markets Race Out of 2012 Gate

Article includes excerpts from Sidoxia Capital Management’s 2/1/2012 newsletter. Subscribe on right side of page.

Equity markets largely remained caged in during 2011, but U.S. stocks came racing out of the gate at the beginning of 2012. The S&P 500 index rose +4.4% in January; the Dow Jones Industrials climbed +3.4%; and the NASDAQ index sprinted out to a +8.0% return. Broader concerns have not disappeared over a European financial meltdown, high U.S. unemployment, and large unsustainable debts and deficits, but several key factors are providing firmer footing for financial race horses in 2012:

•  Record Corporate Profits: 2012 S&P operating profits were recently forecasted to reach a record level of $106, or +9% versus a year ago. Accelerating GDP (Gross Domestic Product Growth) to +2.8% in the fourth quarter also provided a tailwind to corporations.

•   Mountains of Cash: Companies are sitting on record levels of cash. In late 2011, U.S. non-financial corporations were sitting on $1.73 trillion in cash, which was +50% higher as a percentage of assets relative to 2007 when the credit crunch began in earnest.

•  Employment Trends Improving: It’s difficult to fall off the floor, but since the unemployment rate peaked at 10.2% in October 2009, the rate has slowly improved to 8.5% today. Data junkies need not fret – we have fresh new employment numbers to look at this Friday.

•   Consumer Optimism on Rise: The University of Michigan’s consumer sentiment index showed optimism improved in January to the highest level in almost a year, increasing to 75.0 from 69.9 in December.

•   Federal Reserve to the Rescue: Federal Reserve Chairman, Ben Bernanke, and the Fed recently announced the extension of their 0% interest rate policy, designed to assist economic expansion, through the end of 2014. In addition, Bernanke did not rule out further stimulative asset purchases (a.k.a., QE3 or quantitative easing) if necessary. If executed as planned, this dovish stance will extend for an unprecedented six year period (2008 -2014).

Europe on the Comeback Trail?

Source: Calafia Beach Pundit

Europe is by no means out of the woods and tracking the day to day volatility of the happenings overseas can be a difficult chore. One fairly easy way to track the European progress (or lack thereof) is by following the interest rate trends in the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). Quite simply, higher interest rates generally mean more uncertainty and risk, while lower interest rates mean more confidence and certainty. The bad news is that Greece is still in the midst of a very complex restructuring of its debt, which means Greek interest rates have been exploding upwards and investors are bracing for significant losses on their sovereign debt investments. Portugal is not in as bad shape as Greece, but the trends have been moving in a negative direction. The good news, as you can see from the chart above (Calafia Beach Pundit), is that interest rates in Ireland, Italy and Spain have been constructively moving lower thanks to austerity measures, European Central Bank (ECB) actions, and coordination of eurozone policies to create more unity and fiscal accountability.

Political Horse Race

Source: Real Clear Politics via The Financial Times

The other horse race going on now is the battle for the Republican presidential nomination between former Massachusetts governor Mitt Romney and former House of Representatives Speaker Newt Gingrich. Some increased feistiness mixed with a little Super-Pac TV smear campaigns helped whip Romney’s horse to a decisive victory in Florida – Gingrich ended up losing by a whopping 14%. Unlike traditional horse races, we don’t know how long this Republican primary race will last, but chances are this thing should be wrapped up by “Super Tuesday” on March 6th when there will be 10 simultaneous primaries and caucuses. Romney may be the lead horse now, but we are likely to see a few more horses drop out before all is said and done.

Flies in the Ointment

As indicated previously, although 2012 has gotten off to a strong start, there are still some flies in the ointment:

•   European Crisis Not Over: Many European countries are at or near recessionary levels. The U.S. may be insulated from some of the weakness, but is not completely immune from the European financial crisis. Weaker fourth quarter revenue growth was suffered by companies like Exxon Mobil Corp (XOM), Citigroup Inc. (C), JP Morgan Chase & Co (JPM), Microsoft Corp (MSFT), and IBM, in part because of European exposure.

•   Slowing Profit Growth: Although at record levels, profit growth is slowing and peak profit margins are starting to feel the pressure. Only so much cost-cutting can be done before growth initiatives, such as hiring, must be implemented to boost profits.

•   Election Uncertainty: As mentioned earlier, 2012 is a presidential election year, and policy uncertainty and political gridlock have the potential of further spooking investors. Much of these issues is not new news to the financial markets. Rather than reading stale, old headlines of the multi-year financial crisis, determining what happens next and ascertaining how much uncertainty is already factored into current asset prices is a much more constructive exercise.

Stocks on Sale for a Discount

Source: Calafia Beach Pundit

A lot of the previous concerns (flies) mentioned is not new news to investors and many of these worries are already factored into the cheap equity prices we are witnessing. If everything was all roses, stocks would not be selling for a significant discount to the long-term averages.

A key ratio measuring the priceyness of the stock market is the Price/Earnings (P/E) ratio. History has taught us the best long-term returns have been earned when purchases were made at lower P/E ratio levels. As you can see from the 60-year chart above (Calafia Beach Pundit), stocks can become cheaper (resulting in lower P/Es) for many years, similar to the challenging period experienced through the early 1980s and somewhat analogous to the lower P/E ratios we are presently witnessing (estimated 2012 P/E of approximately 12.4). However, the major difference between then and now is that the Federal Funds interest rate was about 20% back in the early-’80s, while the same rate is closer to 0% currently. Simple math and logic tell us that stocks and other asset-based earnings streams deserve higher prices in periods of low interest rates like today.

We are only one month through the 2012 financial market race, so it much too early to declare a Triple Crown victory, but we are off to a nice start. As I’ve said before, investing has arguably never been as difficult as it is today, but investing has also never been as important. Inflation, whether you are talking about food, energy, healthcare, leisure, or educational costs continue to grind higher. Burying your head in the sand or stuffing your money in low yielding assets may work for a wealthy few and feel good in the short-run, but for much of the masses the destructive inflation-eroding characteristics of purported “safe investments” will likely do more damage than good in the long-run. A low-cost diversified global portfolio of thoroughbred investments that balances income and growth with your risk tolerance and time horizon is a better way to maneuver yourself to the investment winner’s circle.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in XOM, MSFT, JPM, IBM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 3, 2012 at 2:25 pm 4 comments

Solving Europe and Your Deadbeat Cousin

The fall holidays are quickly approaching, and almost every family has at least one black-sheep member among the bunch. You know, the unemployed second cousin who shows up for Thanksgiving dinner intoxicated – who then proceeds to pull you aside after a full meal to ask you for some money because of an unlucky trip to Las Vegas. For simplicity purposes, let’s name our deadbeat cousin Joe.

Right now the European union (EU) is dealing with a similar situation, but rather than being forced to deal with money-begging cousin named Joe, the EU is being forced to confront the irresponsible debt-binging practices of its own relatives – the PIIGS (Portugal, Ireland, Italy, Greece, and Spain). The European troika (International Monetary Fund/IMF; European Union/EU; and European Central Bank/ECB), spearheaded by German and French persuasion, is contemplating everything from prescribing direct bank recapitalization, bailouts via the leveraging of the EFSF (European Financial Stability Facility), ECB bond purchases, debt guarantees, unlimited central bank loans, and more.

New stress tests are being reevaluated as we speak. Previous tests failed in gaining the necessary credibility because inadequate haircuts were applied to the values of PIIGS debt held by European banks. European Leaders are beginning to gain some religion as to the urgency and intensity of the financial crisis. Just today, Germany’s chancellor (Angela Merkel) and France’s President (Nicolas Sarkozy) announced that they will introduce a comprehensive package of measures to stabilize the eurozone by the end of this month, right before the summit of the G20 leading global economies in Cannes, France.

Pick Your Poison

Whatever the path used to mop up debt excesses, the options for solving the financial mess can be lumped together in the following categories:

1. Austerity: Plain, unadulterated spending cuts is one prescription being administerd in hopes of curing bloated European sovereign debt issues. Negatives: Slowing economic growth, slowing tax receipts, potentially widening deficits (reference Greece), and political reelection self interests call into question the feasibility of the austerity option. Positives: Austerity is a morally correct fiscal response, which has the potential of placing a country’s financial situation back on a sustainable path.

2. Bailouts: The troika is also talking about infusing the troubled banks with new capital. Negatives: This action could result in more debt placed on country balance sheets, a potentially lower credit rating, higher costs of borrowing, higher tax burden for blameless taxpayers, and often an impossible political path of success. Positives: Financial markets may respond constructively in the short-run, but providing an alcoholic more alcohol doesn’t solve long-term fiscal responsibility, and also introduces the problem of moral hazard.

3. Haircuts: Voluntary or involuntary haircuts to principal debt obligations may occur in conjunction with previously described bailout efforts, depending on the severity of debt levels. Negatives: There are many different sets of constituents and investors, which can make voluntary haircut/debt restructuring terms difficult to agree upon. If the haircuts are too severe, banking reserves across the EU will become decimated, which will only lead to more austerity, bailouts, and potential credit downgrades. Such actions could hamper or eliminated future access to capital, and the cost of access to future capital could be cost prohibitive for the borrowing countries that defaulted/restructured. Positives: Haircuts eliminate or lessen the need for other more painful austerity or restructuring measures, and force borrowers to become more fiscally responsible, not to mention, investors are forced to conduct more thorough due diligence.

4. Printing Press: Buying back debt with freshly printed euros hot off the press is another strategy. Negatives: Inflation is an invisible tax on everyone, including those constituents who are behaving in a fiscally responsible manner. Positives: Not only is this strategy more politically palatable because the inflation tax is spread across the whole union, but this path to debt reduction also does not require as painful and unpopular cuts in spending as experienced in other options.

The Costs

What is the cost for this massive European debt-binging rehabilitation? Estimates vary widely, but a JP Morgan analyst sized it up this way as explained in the The Financial Times:

“In a worst-case, severe recession scenario, €230bn in new capital is needed to meet Basel III requirements, assuming a 60 per cent debt writedown on Greece, 40 per cent on Ireland and Portugal and 20 per cent on Italy and Spain, and that banks withhold dividends.”

 

More bearish estimates with larger bond loss haircuts, stricter regulatory guidelines, and harsher austerity measures have generated recapitalization numbers north of €1 trillion euros. Regardless of the estimates, European governments, regulators, and central banks are likely to select a combination of the poisons listed above. There is no silver bullet solution, and any of the chosen paths come with their own unique set of consequences.

As time passes and the European crisis matures, I am confident that you will be hearing more about ECB involvement and the firing-up of the printing presses. Perhaps the ECB will fund and work jointly with the EFSF to soak up debt and/or capitalize weak banks. Alternatively, and more simply, the ECB is likely to follow the path of the U.S. and implement significant amounts of quantitative easing (i.e., provide liquidity to the financial system via sovereign debt purchases and guarantees).

Dealing with irresponsible and intoxicated deadbeat second cousins (or European countries) fishing for money is never a pleasurable experience. There are many ways to address the problem, but ignoring the issue will only make the situation worse. Fortunately, our European friends on the other side of the pond appear to be taking notice. As in the U.S., if government officials delay or ignore the immediate problems, the financial market cops (a.k.a., “bond vigilantes”) will force them into action. In the recent past, European officials have used a strategy of sober talking “tough love,” but signs that the ECB printing presses are now beginning to warm up are evident. Once the euros come flying off the presses to detoxify the debt binging banks, perhaps the ECB can print a few extra euros for my cousin Joe.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

October 9, 2011 at 4:36 pm 2 comments

Shoot First and Ask Later?

The financial markets have been hit by a tsunami on the heels of idiotic debt negotiations, a head-scratching credit downgrade, and slowing economic data after a wallet-emptying spending binge by the government. These chain of events have forced many investors and speculators alike to shoot first, and ask questions later. Is this the right strategy? Well, if you think the world is going to end and we are in a global secular bear market stifled by a choking pile of sovereign debt, then the answer is a resounding “yes.” If however, you believe the blood curdling screams from an angered electorate will eventually influence existing or soon-to-be elected politicians in dealing with the obvious, then the answer is probably “no.”

Plug Your Ears

Anybody that says they confidently know what is really going to happen over the next six months is a moron. You can ask those same so-called talking head experts seen over the airwaves if they predicted the raging +35% upward surge last summer, right after the market tanked -17% on “double-dip” concerns and Fed Chairman Ben Bernanke gave his noted quantitative easing speech in Jackson Hole, Wyoming. I’m still flicking through the channels looking for the professionals who perfectly envisaged the panicked buying of the same downgraded Treasuries Standard and Poor’s pooped on. Oh sure, it makes perfect sense that trillions of dollars would flock to the warmth and coziness of sub-2% yielding debt in a country exploding with unsustainable obligations and deficits, fueled by a Congress that can barely blows its nose to a successful negotiation.

The moral of the story is that nobody knows the future with certainty – no matter how much CNBC producers would like you to believe the opposite is true. Some of the arguably smartest people in the world have single handedly triggered financial market implosions. Consider Robert Merton and Myron Scholes, both renowned Nobel Prize winners, who brought global financial markets to its knees in 1998 when Merton and Scholes’s firm (Long Term Capital Management) lost $500 million in one day and required a $3.6 billion bailout from a consortium of banks. Or ask yourself how well Fed Chairmen Alan Greenspan and Ben Bernanke did in predicting the credit crisis and housing bubble.

If the strategist or trader du jour squawking on the boob-tube was really honest, he or she would steal the sage words of wisdom from the television series secret agent Angus MacGyver who articulated, “Only a fool is sure of anything, a wise man keeps on guessing.”

Listen to the “E”-Word

If you can’t trust all the squawkers, then whom can you trust (besides me of course…cough, cough)? The answer is no different than the person you would look for in other life-important decisions. If you needed a serious heart by-pass surgery, would you get advice from a nurse or medical professor, or would you listen more closely to the top cardiologist at the Mayo Clinic who performed over 2,000 successful surgeries? If you were looking for a pilot to fly your plane, would you prefer a 25-year-old flight attendant, or a 55-year old steely veteran who has 10 million miles of flight experience? OK, I think you get the point…legitimate experience with a track record is key.

Unfortunately, most of the slick, articulate people we see on television may look experienced and have some gray hair, but the only thing they are experienced at is giving opinions. As my great, great grandmother once told me, “Opinions are a dime a dozen, but experience is much more valuable” (embellished for dramatic effect). You are better off listening to experienced professionals like Warren Buffett (listen to his recent Charlie Rose interview), who have lived through dozens of crises and profited from them – Buffett becoming the richest person on the planet doesn’t just come from dumb luck.

If you are having trouble sleeping, you either are taking too much risk, or do not understand the nature of the risk you are taking (see Sleeping like a Baby). Things can always get worse, and the risk of a self-fulfilling further decline is a possibility (read about Soros and Reflexivity). If you are determined to make changes to your portfolio, use a scalpel, and not an axe. The recent extreme volatility makes times like these ideal for reviewing your financial position, goals, and risk tolerance. But before you shoot your portfolio first, and ask questions later, prevent a prison sentence of panic, or your financial situation may end up behind bars.
[tweetmeme source=”WadeSlome” only_single=false https://investingcaffeine.com/2011/08/20/shoot-first-and-ask-later/%5D
Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MHP, CMCSA, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 20, 2011 at 2:53 pm 1 comment

Reality More Fascinating than Fiction

Make-believe is fun, but reality is often more fascinating than fiction. The same can be said for the books I read. Actually, all the books reviewed at Investing Caffeine have been non-fiction. My movie-viewing preferences happen to be quite similar – comedies and dramas are terrific, but I’m also a documentary fanatic. As a matter of fact, I have rented or watched more than 125 documentaries (and mockumentary, This is Spinal Tap) over the last six years.

There have been a slew of non-fiction books written about the recent global financial crisis, including the ones I reviewed: Too Big to Fail, The Greatest Trade Ever, and The Big Short. When it comes to videos, I have seen several TV-based documentaries covering various aspects of the global meltdown, but the Inside Job did an exceptionally good job of providing a global perspective of the financial collapse. The film was produced, written, and directed by Charles Ferguson (you can call him “doctor” thanks to the Ph.D he earned at MIT) and also narrated by Academy Award winner Matt Damon. The Inside Job provided a comprehensive worldly view by filming on location in the United States, Iceland, England, France, Singapore, and China. Not only did Ferguson break down the complex facets of the crisis into easily digestible pieces for the audience, but he also features prominent journalists, politicians, and academics who describe the complicated global events from a birds-eye view. Hedge fund manager George Soros,  former Federal Reserve Chairman Paul Volcker, former New York Governor Eliot Spitzer, and economist Nouriel Roubini, are a small subset of the heavy-hitters interviewed in the movie.

A wide range of causes and effects were explored – everything from derivatives, lack of regulation, excessive banker compensation, and the pervasive conflicts of interest throughout the financial system. Bankers and politicians shoulder much of the blame for the global crisis, and Ferguson does not go out of his way to present their side of the story.  Ferguson does a fairly decent job of keeping his direct personal political views out of the film, but based on his undergraduate Berkeley degree and his non-stop Goldman Sachs (GS) bashing, I think someone could profitably prevail in wagering on which side of the political fence Ferguson resides.

Although I give Inside Job a “thumbs-up,” I wasn’t the only person who liked the movie. The Inside Job in fact won numerous awards, including the 2010 Academy Award for Best Documentary, Best Documentary from the New York Film Critics Circle, and the Best Documentary Screenplay from the Writers Guild.

Slome’s Oscar Nominees

As I mentioned previously, I am somewhat fanatical when it comes to documentaries, although I have yet to see Justin Bieber’s Never Say Never. Besides the Inside Job, here is a varied list of must-see documentaries. There may be a conflict of personal tastes on a few of these, but I will provide you a hand-written apology for anybody that falls asleep to more than one of my top 15:

1)      Murderball

2)      A Crude Awakening  

3)      Touching the Void

4)      It Might Get Loud

5)      Hoop Dreams

6)      Lewis and Clark: The Journey (Ken Burns)

7)       The Staircase

8)      Enron: The Smartest Guys in the Room

9)      Cracking the Code of Life  

10)   Paradise Lost

11)   The Endurance

12)   Devil’s Playground  

13)   Everest: Beyond the Limit

14)   The Devil Came on Horseback

15)   Emmanuel’s Gift

I’m obviously biased about the quality of my recommended documentaries, but you can even the score by sharing some of your favorite documentaries in the comment section below or by emailing me directly. I will be greatly indebted for any suggestions offered. Regardless, whether watching a truth-revealing thought-piece like the Inside Job or A Crude awakening, or an inspirational story like Murderball or Touching the Void, I’m convinced that these reality based stories are much more fascinating than the vast majority of recycled fiction continually shoveled out by Hollywood. For those adventurous movie-watchers, check out a documentary or two – who knows…there may be an inner-documentary fanatic in you too?

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 4, 2011 at 11:10 pm 3 comments

Banking Crisis Broken Record (1907 vs. 2007)

Like a spinning and skipping broken record, our history has been filled with an endless number of banking crises. And unfortunately, the financial crisis of 2008-2009 will not be our last (read more about rhyming history). Robert F. Bruner, professor and Dean at the Darden Graduate School of Business Administration, has studied the repetitive nature of banking crises and identified core foundational aspects present in these vicious financial events.

In a period spanning 105 years (1900 – 2005) Bruner references 31 separate crises occurring across the world in various countries. Just in the last handful of decades, Americans have experienced the seizure of the Continental Illinois National Bank and Trust Company (1984), the S&L crisis (Savings & Loan – late 1980s), the disintegration of Long-Term Capital Management (1998), followed by the recent falling of dominoes in the first decade of the 21st Century (Bear Stearns, Lehman Brothers, Wamu, AIG, etc.).  What do many of these crises have in common?

In comparing the recent global financial crisis, Bruner compares the recent events to the “Panic of 1907” – the last financial crisis before the creation of the Federal Reserve System in 1913. The last few years have been rough, but a century ago San Franciscans endured the mother of all crises. This is how Bruner described the time period:

“The San Francisco earthquake of 18 April 1906 triggered a massive call on global gold reserves and a liquidity crunch in the United States. A recession commenced in June 1907. Security prices declined. In September, New York City narrowly averted a failure to refinance outstanding bonds. Then, on 16 October, a “bear squeeze” speculation failed and rendered two brokerage firms insolvent. The next day, depositors began a run on Knickerbocker Trust Company…Runs spread to other trust companies and banks in New York City. And the panic rippled across the United States.”

Bruner highlights four key factors inherent in these, and other, financial crises. Here is a summary of the four elements:

Existence of Systemic Structure:  In order for a crisis to occur, an economy needs a collection of linked financial intermediaries to form a system. Throughout history, transactions and deposits have connected to multiple systems around the globe.

Systemic Instability: Hyman Minsk, a renowned 20th Century economist, was known for his thoughts on his “Financial Instability Hypothesis.” At the core of Minsky’s crisis beliefs was the idea that economic slumps were caused by the credit cycle. At the late stages of an economic cycle there is a larger appetite to assume additional risk and debt. A spiraling vortex can occur as “Easy credit amplifies the boom, and tight credit amplifies the contraction,” Minsky states.

Systemic Shock: Beyond an unstable system, a crisis needs a spark. For Bruner that spark must have four characteristics:

  • Real, Not Apparent: The shock must be “real, not apparent.” The disturbance must be disruptive enough to shake the trust of the financial system and be large enough to have a real economic impact (e.g., new technologies, massive labor strike, deregulation, or even an earthquake). 
  • Large:  The trigger of a financial crisis must be large enough to shift the outlook of investors.
  • Unambiguous and Difficult to Repeat: The shock must unambiguously stand out from the standard marketplace news.
  • Surprising: The event must be unanticipated and cause a shift in thinking.

Response and Intervention: Effectively, the response to a shock converts an overconfident boom into fear and pessimism. The reply can often be an overreaction to the existing fundamentals, which flies in the face of efficient markets and rational decision making.

According to Bruner, crises including the one triggered by the earthquake of 1906 carry the four previously mentioned elements.

Solution = Leadership

At the vortex of any financial crisis lies fear and panic, which require leadership to mitigate the damage. John Pierpont “J.P.” Morgan, semi-retired banking executive, orchestrated leadership in 1907 by organizing a rescue of “trust companies, banks, the New York Stock Exchange, New York City, and the brokerage firm of Moore and Schley.”

Time will tell and history will judge whether Federal Reserve Chairman Ben Bernanke and Treasury Secretaries Hank Paulson and Timothy Geithner provided the necessary leadership to sustainably lead us out of the financial crisis. Of course, decisions made by the key U.S. leadership figures are not made in a vacuum, so choices made by our international brethren can impact the success of our monetary and fiscal policies too.

There have been 18 substantial global bank crises since World War II and the recent credit-induced collapse will not be the last as long as Bruner’s four elements of a crisis exist (structure, instability, shock, and intervention). The ultimate outcome of a crisis will be dependent on the nature of leadership, coordinated government intervention, and regulation. The global economic record will continue spinning, but with Robert Bruner’s lessons learned from the Panic of 1907, hopefully the music will last for a very long time before skipping on a crisis again.

Read the whole Bruner article

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and a derivative security of an AIG insurance subsidiary, but at time of publishing had no direct positions in JPM. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 11, 2010 at 11:00 pm 2 comments

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