Wealth International, Limited

Finance Digest for Week of August 2, 2004


The sponsors of the Sound Shore Fund, launched in 1985, do not brag in public, but they have reason to be proud of their achievements. Their large value fund’s 13% annual return over the last decade betters that of the S&P 500 by 1.6 points, and the fund has handily beaten the index every year since the market imploded in 2000. This ability to preserve capital in bear markets is why Forbes gives Sound Shore a down market score of B, along with a C for bull markets.

Sound Shore gets our highest grade for cost efficiency. We like its annual expenses of $0.98 per $100 in assets, no sales charges and no 12b-1 fees for promotional expenses. Word of mouth and performance have attracted its $1.3 billion in assets. “We started the fund because the board members of our institutional clients wanted us to manage their money. They’ve done our marketing for us,” says fund co-founder Harry Burn III.

Burn and his two partners call their investment style “disciplined value investing”. They look for companies that appear cheap relative to expected profits. Specifically: A company’s forward price/earnings multiple is no more than three-quarters of its historical P/E ratio, the latter being calculated as a weighted average of the trailing multiple over the past decade (recent years count more heavily). The stocks that turn up under that rule are out of favor, either because of bad news that is inconsequential to long-term performance or because of Wall Street’s whims. But they are not companies on the skids. “We’re not ambulance chasers,” Burn says.

Once he has identified stocks trading at such discounts, Burn makes sure that current profits are positive and projected earnings growth is at least 10% a year for the next three to five years. Burn does not mind how much debt a company carries, but he rarely winds up with those whose credit ratings are in the junk range. His biggest holdings include Berkshire Hathaway, Liberty Media and Devon Energy, all of them stocks that he has held for more than a year. Sound Shore is now buying insurer Cigna, a company that is winnowing its 12 million current subscribers to 9.7 million by the end of the year. Cigna sold a business that insures retirees for $1.7 billion, money it will use for stock buybacks. The stock, at a recent $65, trades at 11 times estimated earnings for 2004, against the S&P 500’s 18. Cigna’s trailing P/E for the past ten years averages 12.9. Health care firms are Sound Shore’s second-largest group of holdings, outstripped only by financial services firms, almost a fourth of the portfolio.

Link here.


The investment landscape with stocks and bonds is now “a vast wasteland”. Robert Rodriguez, quoted by the Wall Street Journal in early July, speaks for the value wing of the investment business. The manager of the FPA Capital Fund is seeking refuge in cash. Should you?

Yes, but be careful of what refuge you seek. Following is a cautionary look at a refuge-that-is-not: the two dozen (and counting) mutual funds that invest in speculative-grade bank loans. With these claims -- also known, a little confusingly, as leveraged loans -- Wall Street has created a kind of trifecta of unfavorable terms. The yields on offer are small. The opportunity for price appreciation is nil. And the risks to principal are clear and present. What less could you want?

Link here.


Much of what so-called experts say is pure bilge. A hard look at the last four decades calls into question their glib views on the stock market’s direction. There is much faux wisdom about how different sectors behave in recoveries. In reality they seldom follow any script. One group that is allegedly a late-market, late-economic-cycle group is the oil stocks. As the economy strengthens, the theory goes, demand picks up for manufactured products, which requires more energy. We found, however, that the oils outperform the bull markets in the first three months of a rally half the time. And in the last three months they underperform half the time.

In a bear market, a condition we hope not to see again for a while, it is impossible to gauge duration. False dawns occur often. Still, we found that the most wretched part of a bear market is the last 25% of it, when everything goes down a lot.

The market commentariat, the source of all the bilge, has a weather-vane mentality. These articulate, if unaccountable, experts do not fear to contradict themselves -- and hardly ever seem to be challenged in the press. When we tracked newspaper and magazine articles, a large bunch of market savants in summer 1982 were bemoaning the hopelessness of common stocks. But by fall they were articulating why the August-triggered rally was so strong and why it should continue higher.

On the other extreme are the permanent bears, whose consistency is for some reason acclaimed as a virtue. One academic economist made dark predictions about the market in 1995 [Robert Shiller, we presume], even darker ones in 1998, and finally was proved right in 2000, at which point he was anointed a guru. Today’s desultory, drifting market reminds me of 1991’s, though only to a degree. Still, then there was some activity, unlike today. In fact, now everything -- small caps, large ones, value names, even those with upgraded earnings -- is treading water. My feeling, based on no study or guru, is to stick around and await improvement. The market has not slumped, despite every reason to do so (war, terror, inflation concerns, slowdown forecasts). That is sufficient reason to be optimistic.

Link here.


Every president since Richard Nixon has asserted that we are running out of oil. Meaning: We are sitting ducks for those who brandish the oil weapon. Both George W. Bush and his challenger John Kerry worship at this altar. And why not? How many elections have been lost by blaming foreigners for an impending crisis and promising a quick fix? Despite their cynicism about politicians, most people actually believe that mineral resources, including oil, are doomed to disappear. It is obvious: Start with a given stock of provisions in the cupboard, subtract consumption and eventually the cupboard will be bare.

But what is obvious is often wrong. We never run out of minerals. At some point it just costs too much to produce them profitably. In the 19th century the big energy scare was in Europe. Most thought Europe was running out of coal. That doomsday scenario never materialized. Thanks to a plethora of substitutes, the prices that European coal could fetch today are far below its development and extraction costs. Consequently, Europe sits on top of billions of tons of worthless coal. Once economics enters the picture, the notion of fixed reserves becomes meaningless. Reserves are not fixed. Proven oil reserves, for example, represent a warehouse inventory of the expected cumulative profitable output, not a fixed stock of oil thought to be in the ground.

In 1971 the world’s proven oil reserves were 612 billion barrels. Since then the world has produced 767 billion barrels. We should have run out of reserves five years ago, but we did not. In fact, today’s proven reserves are 1,028 billion barrels, or 416 billion barrels more than in 1971. How could this be? Thanks to improved exploration and development techniques, costs have declined, investments have been made and reserves have been created. The sky is not falling.

If oil reserves are not the problem, what is? The real problem is our oil policies. We inadvertently give aid and succor to OPEC, the world’s clumsy oil cartel. That has been especially true since Nov. 13, 2001, when President Bush announced that the U.S. would fill the Strategic Petroleum Reserve to capacity. When the President ordered the reserve to be filled, the spot and future oil prices were in rough balance. Since then the spot prices shot up and have exceeded future prices (until recently) by a wide margin, indicating scarce private inventories. Indeed, private oil inventories fell to a 29-year low on Jan. 23, 2004. Since Nov. 13, 2001 private companies have been forced to compete for inventories with the government. Fortunately, it appears that, barring “events”, the oil price surge has run its course.

On Jan. 16, 1991, the day the first Gulf war began, George H.W. Bush ordered a drawdown of the government’s reserve. The results were dramatic: The spot price of oil fell from $32.25 per barrel to $21.48 in one day. The lesson is clear: We have an oil weapon, too. The strategic reserve should be used to bloody OPEC’s nose, not to prop up a cartel.

Link here.

Crude oil rises to record on concern OPEC cannot meet demand.

Crude oil futures rose to a record in New York after OPEC President Purnomo Yusgiantoro said the group may not be able to increase production fast enough to lower prices, which have surged 39% in the past year. Purnomo told reporters that an expected output increase from Saudi Arabia cannot be done “immediately”. Oil pared some of its gains after a Saudi Arabian official later said the country can boost production by 500,000 barrels a day to 10 million barrels a day immediately, and more if needed.

Link here.


Watch out for scams from a typically reliable source -- your insurance agent -- warns the North American Securities Administrators Association. The NASAA reports annually on the top 10 scams. This year, according to Consumer Reports, several have been linked with insurance agents, who may receive a hefty commission for your investment, even if the deal turns out to be bogus. To avoid being scammed, ask for written information about the investment, including financial information about the company. Then research it and the associated companies thoroughly.

Link here.


To supporters of government regulation, nothing can apparently ever take place to falsify their beliefs. If the very evils regulation was framed to prevent nevertheless end up being realized, the crisis is met with a universal cry for more regulation. The idea that the regulatory project itself has been exposed as useless hardly crosses anybody’s mind. This was precisely the script played out after the 1990s bull market collapsed in the spring of 2000. One by one, corporate executives, directors, auditors, consultants, investment bankers and stock analysts were condemned for having exploited gaps in the regulatory structure to feed investors with misinformation that drove them to overpay for stocks. The result, two years ago, was the Sarbanes-Oxley Act, which sought to improve the information that investors receive.

Yet the events that led to Sarbanes-Oxley only confirmed what was already evident well before the bull market came along: Securities regulation does not work. Not only are the likes of the SEC and OSC superfluous; they are incapable of containing the market frenzy that arises whenever bad monetary policy mars investors’ judgments.

Spearheaded by the United States in the 1930s, securities regulation is founded on the fact that those involved in supplying equity shares, namely corporations and the investment firms that assist them, have better access to information than the investors buying the shares. More critically, it is assumed that were equity suppliers left to themselves, they would exploit their informational edge at the expense of investors by not adequately disclosing what is happening inside companies. To remedy this, the massive edifice of securities regulation is centered on the principle of mandated disclosure. This principle obligates firms to issue a detailed prospectus when first issuing securities and subsequently provide periodic financial reports. But just how many people would continually invite exploitation by dealing with parties that leave them in the dark? One would have to see investors as complete idiots in order to evade the conclusion that corporations have definite incentives to disclose relevant information on their own.

In 1964, George Stigler, the Nobel Prizewinning economist, was the first to document the futility of securities regulation. He discovered that the one-year market-adjusted returns of IPOs were no different after mandated disclosure than before. Investors buying new issues thus saw no benefits from securities regulation. George Benston later compared firms that were not reporting revenues prior to securities regulation to those that were. No significant difference in returns was found between stocks in the two groups both before and after regulation was instituted. Interestingly, most of these studies found the volatility of stock price movements declined after mandated disclosure came into play. Riskier, more entrepreneurial firms tend to have more volatile stocks. The implication is that regulation reduced market swings by shutting out these firms from publicly traded equities, hindering a key source of economic dynamism.

What is so revealing about the recent spate of corporate wrongdoing is that we have witnessed far more instances of financial fraud now than before the SEC ever existed. Over the last few years, misconduct has been somewhat more pronounced in the United States than in Europe or Canada, even though Americans have the toughest securities laws in the world. Mandated disclosure should also have been expected to maintain the quality of IPOs, where information is hardest to come by, yet it was precisely on Internet start-ups such as boo.com and pets.com that investors got colossally burned.

What happened was this: In the late 1990s, the U.S. Federal Reserve ran an overly easy monetary policy. With interest rates thus driven below what the market could truly bear, the demand for equities shot up to the point that investors were willing to entertain even the most dubious projects. Analysts who catered to this demand by writing up glowing reports on dicey companies were lavishly rewarded. Believing the regulatory framework offered protection, investors were all the more willing to assume inordinate risks. The excitement enticed a few top executives infected with weak moral fiber and shortsightedness to try to make a killing from this once-in-a-lifetime opportunity. To have spoiled the party would have incurred investors’ wrath, which meant regulators could do little -- just as they have done little since assuming the supervision of the markets.

Link here.


The Elliott wave patterns in the U.S. Dollar Index during the past year define the phrase, “textbook example”. And, at virtually each major high and low, the conventional wisdom reached emotional extremes that amounted to perfect contrary indicators: very bullish just before a down move, very bearish just before a rally.

Yet another episode unfolded just last month. The Dollar Index reached a five-month low on July 19, amidst widespread negative sentiment. And no one is convinced by the bounce up that prices have taken since that time. In a survey of 16 banks, only three expected the U.S. dollar to rise against the euro in the next six months. This small number of bulls is no surprise, given the all-too-typical track record of sentiment surveys like this one regarding the dollar. Yet this recent survey simply serves to confirm what the Elliott wave pattern clearly shows. The Dollar Index is near an important price level that is closely related to previous price action; if the index moves quickly through that level, we will not be “surprised” by how rapidly the trend accelerates from there.

Link here.


A major labor dispute is raging across Europe: Businesses are pushing to extend their employees’ work hours, often without the extra pay. Last week in Germany, DaimlerChrysler was the latest firm to win the battle with the labor unions and raise hours for many of its workers from 35 per week to 39. The French are joining the chorus, too. The Deutsche Welle reports the French president as saying: “Workers should be able to spend more than 35 hours on the job each week.” The French premier concurs: “The 35 hours have killed growth since 2000.”

The French politicians -- and politicians in general -- would be well served to look at their country’s progress from an Elliott wave perspective. They would see that the real culprit of the 2000 downturn was a collective downturn in social mood. And until it turns up again, no amount of new legislation will end France’s economic slump. When will the French feel more productive again? The French stock market holds the answer. In fact, in every country the stock market is an excellent indicator of the nation’s sentiment. Knowing where a country’s stock market is headed can tell politicians (and investors) what is next for their country’s collective psychology -- and as a result, for their economy.

Link here.


Money is created in two ways: First, money creation comes from borrowing it and spending it. (Money is literally borrowed and spent into existence.) Second, it can simply be printed up “out of thin air” by a central bank. The U.S. economy and other modern economies have central banks and fiat currencies. Central banks have two major powers. They can 1) “peg” the nominal level of short-term interest rates, and 2) purchase assets such as government debt, with newly printed money. When the central bank pegs short-term interest rates at a low level, it greatly encourages corporate and individual borrowing and spending.

For the past decade, most money has been created through private sector borrowing and spending. However, the day is fast approaching when the private sector’s new borrowing will not create enough new money to keep servicing the already massive level of old debt. Central banks will need to step up their efforts to “print money out of thin air”. Central bank printing of new money is accomplished by purchasing government debt or other assets.

There has been substantial money growth since 2000. Neither the crash of the NASDAQ stock market nor the last recession has slowed down money growth. The fact that the Fed cut interest rates 13 times since 2000 -- reducing them to a 46 year low -- has a lot to do with the massive amount of borrowing that has taken place in the United States. The amount of net borrowing in the United States is quite impressive, particularly when you consider the old economic model when borrowing was limited to simply recycling savings. In 2003, the savings rate was 2 percent of GDP, while net credit market borrowing was well in excess of 20% of GDP. There has been a whole lot of borrowing and spending of new money going on!

Certain asset classes, such as financial assets and housing, have benefited the most by this credit and money creation. For instance, because the mortgage market has been willing to finance any and all mortgages, the credit creation process has allowed both new mortgage debt and the ability to pay for higher housing prices. These higher housing prices have, in turn, allowed for the funding of larger mortgages. Money creation in the private sector tends to concentrate in certain asset classes that facilitate the creation of new credit. This new credit lends itself to new spending, leaving behind new money as the residual, and a growing mountain of debt. To say that this process has been left to run wild is an understatement.

Link here.

The case for a genuine gold dollar.

For nearly a half-century the United States and the rest of the world have experienced an unprecedented continuous and severe inflation. It has dawned on an increasing number of economists that the fact that over the same half-century the world has been on an equally unprecedented fiat paper standard is no mere coincidence. Never have the world’s moneys been so long cut off from their metallic roots. During the century of the gold standard from the end of the Napoleonic wars until World War I, on the other hand, prices generally fell year after year, except for such brief wartime interludes as the Civil War. During wartime, the central governments engaged in massive expansion of the money supply to finance the war effort. In peacetime, on the other hand, monetary expansion was small compared to the outpouring of goods and services attendant upon rapid industrial and economic development. Prices, therefore, were normally allowed to fall. The enormous expenditures of World War I forced all the warring governments to go off the gold standard, and unwillingness to return to a genuine gold standard eventually led to a radical shift to fiat paper money during the financial crisis of 1931-33.

There should be no mystery about the unusual chronic inflation plaguing the world since the 1930s. The dollar is the American currency unit (and the pound sterling, the franc, the mark, and the like, are equivalent national currency units), and since 1933, there have been no effective restrictions on the issue of these currencies by the various nation-states. In effect, each nation-state, since 1933, and especially since the end of all gold redemption in 1971, has had the unlimited right and power to create paper currency which will be legal tender in its own geographic area. It is my contention that if any person or organization ever obtains the monopoly right to create money, that person or organization will tend to use this right to the hilt. The reason is simple: Anyone or any group empowered to manufacture money virtually out of thin air will tend to exercise that right, and with considerable enthusiasm. For the power to create money is a heady and profitable privilege indeed.

In recent years an increasing number of economists have understandably become disillusioned by the inflationary record of fiat currencies. They have therefore concluded that leaving the government and its central bank power to fine tune the money supply, but abjuring them to use that power wisely in accordance with various rules, is simply leaving the fox in charge of the proverbial henhouse. They have come to the conclusion that only radical measures can remedy the problem, in essence the problem of the inherent tendency of government to inflate a money supply that it monopolizes and creates. That remedy is no less than the strict separation of money and its supply from the state.

Mises showed, as far back as 1912, that since no one will accept any entity as money unless it had been demanded and exchanged earlier, we must therefore logically go back (regress) to the first day when a commodity became used as money, a medium of exchange. Since by definition the commodity could not have been used as money before that first day, it could only be demanded because it had been used as a nonmonetary commodity, and therefore had a preexisting price, even in the era before it began to be used as a medium. In other words, for any commodity to become used as money, it must have originated as a commodity valued for some nonmonetary purpose, so that it had a stable demand and price before it began to be used as a medium of exchange. In short, money cannot be created out of thin air.

Americans have been used to using and reckoning in “dollars” for two centuries, and they will cling to the dollar for the foreseeable future. They will simply not shift away from the dollar to the gold ounce or gram as a currency unit. People will cling doggedly to their customary names for currency; even during runaway inflation and virtual destruction of the currency, the German people clung to the “mark” in 1923 and the Chinese to the “yen” in the 1940s. There is only one way to separate money from the state, to truly denationalize a nation’s money. And that is to denationalize the dollar (or the mark or franc) itself. Only privatization of the dollar can end the government’s inflationary dominance of the nation’s money supply. There is only one way to accomplish this: to link the dollar once again to a useful market commodity. Only by changing the definition of the dollar from fiat paper tickets issued by the government to a unit of weight of some market commodity, can the function of issuing money be permanently and totally shifted from government to private hands. I propose that the dollar be defined as a weight of a single commodity, and that that commodity be gold.

Link here.


Economists traditionally consider the economy to be in a recession if there are two consecutive quarters of contracting GDP. And until last Friday’s revisions, the U.S. met the qualification during 2001. Not anymore. The government now says the GDP did not really fall 0.6% in the second quarter of 2001 but actually rose 1.2%. So, the string of three losing quarters was suddenly broken up by a winner in the middle. How lucky!

I asked economists at the BEA how a GDP number could change so dramatically so many years later. One of the big reasons, I was told, is that the Commerce Department suddenly decided to use some seasonal adjustments for car sales that were already being employed by the Federal Reserve. The National Bureau of Economic Research, a private group, has the unofficial role of declaring recessions. It is unlikely that the group will change the historic record because of Friday’s changes. But the move could play well on the campaign trail.

Link here.


The SEC has fielded nearly 250,000 tips about possible securities-law violations so far this year, according to USA Today. In fact, the commission receives more than 1,300 emails each day through its online complaint service, according to the paper, citing John Stark of the SEC’s enforcement division. Most concern accounting problems at public companies. A likely reason for the increase is the provision of Sarbox that offers federal protection to whistle-blowers.

Link here.


For $25 million, you too can invest with Carl C. Icahn, the investor best known for battling companies like Texaco and RJR Nabisco. While such a combative public personality as Mr. Icahn's may run counter to the traditional image of hedge fund managers as secretive operators, he is simply the latest prominent financier who has looked to assemble a hedge fund in the last few months. The large amount that Mr. Icahn, 68, is looking to raise is “virtually unheard of,” said one investor in such portfolios, who declined to be identified because he was not familiar with all the details of Mr. Icahn’s new venture.

Mr. Icahn is planning to charge steeper fees than the average hedge fund operator, according to the marketing documents. He expects to charge 2.5% of assets under management, and 25% of net gains, after taking into account previous losses, the documents said. That compares with the 1% of assets and 20% of gains that are typical among hedge funds. And Mr. Icahn says in the marketing material that he may raise those fees further: to 3% of assets and 30% of gains for new investors who commit money after the hedge fund has opened for business.

Despite those daunting figures, Mr. Icahn is betting that investors will be drawn by his reputation for taking on the managements of large corporations and persuading them to take steps to improve their stock performance, like spinning off assets. Indeed, Mr. Icahn cites his activist role in the marketing material for his fund.

Mr. Icahn says in his marketing material that, based on an audit of his results from 1990 to 1995, he had a 48% compounded annualized return, taking into account borrowing to augment his investments. He had a 53% annualized return, again taking borrowing into account, from 1996 through May 2004, although he said those results had not been independently verified.

Link here.


If the Fed continues to print money at the rate they have done in the last couple of weeks, there is a chance -- given that the global economy is, while unbalanced, nevertheless in a strong synchronized growth mode -- that inflationary pressures could accelerate far more than is currently expected. In this instance, inflationary symptoms would show up in sharply rising wholesale and consumer prices and not necessarily in rising asset prices, such as real estate. In other words, inflation would migrate from the asset markets to consumer prices and lead to far higher interest rates and, possibly, to a rout in the bond market, as has already happened in Japan, where JGB bond yields have risen by more than 300% since June 2003 -- from 0.5% to 1.9%, knocking off bond prices!

In Japan the 300%+ increase in bond yields coincided with a strong recovery in the stock market (up from less than 8,000 in April to around 11,500 recently); therefore, one could argue that, in the United States, further weakness in bonds, or even a collapsing bond market, may not derail a bull market in equities. But there are numerous important differences between Japan and the United States. When Japanese stocks and interest rates bottomed out a year ago, expectations in Japan about future economic growth were extremely depressed, bearish sentiment was at an extreme, and Japanese institutional investors and individuals were very underweighted in equities compared to bonds. Otherwise, how could one explain that, at the time, the Japanese stock market had a dividend yield of more than 1.5%, while bonds were yielding less than 0.5%? In the 1940s, the Dow Jones Industrial Average had, at times, a dividend yield of 7%, while government bond yields fell to below 2%, indicating that growth expectations were then as low as they were last year in Japan. The 1940s represented the best short opportunity in one’s lifetime for U.S. bonds.

To put it in very simplistic terms, whereas rising global inflation and interest rates are likely to be beneficial for the Japanese economy, whose problem was asset deflation, this is unlikely to be the case for the United States, where excessive debt growth fuelled asset inflation and led to a highly leveraged consumer. In fact, my principal concern regarding the U.S. financial and real estate markets would be precisely that the economy is as strong as everyone is predicting. In this scenario, I would not be surprised to see a repetition not of 1994, as is popularly supposed, but of 1973/74, when corporate earnings expanded but stocks fell out of bed because of rising inflation and interest rates.

The Federal Reserve Board is caught in a very difficult position. In fact, it would seem that, regardless of future monetary policies, the economy will disappoint, as the market mechanism has begun to take away the Fed’s job by tightening monetary conditions.

Link here (scroll down to piece by Marc Faber).


There are many reasons to love price charts, not the least of which is that they give you a record of what has happened. To have a chart is to have facts at your disposal. Facts become especially useful when making comparisons that require analysis. Would you rather draw a conclusion by comparing two sets of facts, or by comparing two sets of speculation? Am I leading up to something? Yes: That the stock market was “tripped up” by “rapidly escalating oil prices” and “a sharper-than-expected slowdown in consumer spending.” Well. Here we have a mix of speculation, facts, and conclusions. Let us look at the charts, establish the facts, and do some comparing.

If rapidly escalating crude oil prices would trip up the stock market on just one day, can you imagine what would happen if oil prices climbed 50% in 11 months -- as they did from April 28 of last year ($25) through March 15 of this year ($38)? Surely the stock market would not just trip but fall flat on its face! Let us check the chart. On April 28, 2004, the Dow Industrials opened at 8472, and on March 15, 2004, it closed at 10103. Oops... that is not a loss; it’s a gain of more than 20%.

What about consumer spending? The report for June 2004 (-0.7%) showed the largest monthly decline since the report for September 2001 (-1.8%). If today’s “news” made the market trip, what do you suppose happened to the stock market when the report for September 2001 came out on November 1, 2001? Check the charts, do the math, get the facts ... the Dow Industrials opened at 9087 on November 1, 2001, and closed that session at 9264, a one-day gain of nearly 180 points.

Yes, there are lots of reasons to love price charts. There is NO better way to expose the fallacy of the notion that external “news” has anything to do with the internal patterns of the market. The charts speak for themselves, and so do the facts.

Link here.


Warren Buffett is now holding $34 billion in cash -- with most of it in foreign currencies. In his previous 50 years as an investor, he had never bought foreign stocks or currencies. Now he owns billions of both. He did not suddenly see the advantages of global asset allocation. He is just doing his best to protect his assets from the policies of the Fed. Other notable money managers -- the best in the business -- have allocated heavily into cash and foreign securities too. Mason Hawkins of Longleaf Partners is the best mutual fund manager in the United States. He is holding 25% of his fund’s assets in cash now, and his largest equity holding is Vivendi, a French media conglomerate. Bill Gross, “the bond king”, who manages $400 billion in bonds for PIMCO, says he would own more foreign bonds if he could, but his fund’s charter prevents him. Meanwhile, he personally sold his own flagship bond fund and is buying commodities and, more recently, tax-free municipal bonds, another way of holding a cash-like asset.

Ironically, as the world’s best investors get out of stocks, move out of U.S. bonds, and move heavily into cash and foreign securities, Mr. and Mrs. Mutual Fund are still piling in. But that is par for the course. Mutual fund buyers tend to have all their money in stocks and bonds at the market top and all their money in cash at the market bottom. They are right on track once again.

In 1981, just before the stock market took off, Mr. and Mrs. Mutual Fund only held 22.9% of their investable assets in stocks and bonds. Today the average mutual fund buyer holds 72.3% of his investable assets in stocks and bonds. Only 27.7% of his mutual fund assets are in cash. In their own ways, the world’s best investors and the world’s patsies are telling us it is time to be cautious in stocks and bonds. Why? Expensive stocks and inflation do not mix. And last month, I saw two things that make me think inflation is going to continue to grow and be a much bigger factor this year and next than most people realize.

I am not bearish by nature or philosophy. But I cannot imagine a worse scenario for investors than the one I see developing right now. Inflation is moving higher. But interest rates are still at near record lows. Prices for financial assets, real estate, stocks, and now commodities are at record levels. Yields on fixed income investments are not attractive, given the rate of inflation and the likelihood of it increasing. There is almost nothing safe to do with your money... or anything to buy that is likely to garner a good return.

Link here (scroll down to piece by Porter Stansberry).


For four years in a row, gold and gold stocks have consistently outperformed the major indices (believe or not). Better performing gold funds have produced a 3 to 5 fold return since 2000. However, this year it seems that nothing is working. The major stock indices are flat and failing. The bond market is not to be touched with rates expected to rise further. And, gold and commodities have been savagely “hammered” in the biggest correction since the bull market in gold started. Where is an investor to put money nowadays?

I believe the answer at least in part lies in the value of the dollar. The dollar index has virtually collapsed in the last two years losing 30% of its value. No wonder we are paying more for food and gasoline. One would think that this would be good for gold’s price. Well, it has been and will be again in the future, but it is not the only factor to consider.

Everyone in the world who holds dollars and does business with us has lost about 30% of their purchasing power by holding those dollars the last two years. Can they be expected to continue to lose more -- indefinitely? I don’t think so. Foreign governments have devalued their own currencies in order to attempt to adjust to the “de facto dollar devaluation” so that they may sell us their goods more cheaply than we can make them for domestically. This is a deflationary not inflationary problem by which generally the lowest cost producer wins -- every time! And that winner is Asia, specifically China.

So, what I believe is happening is that the deflationary global forces are taking over in the world in spite of massive U.S. government (and other) expenditures designed to ward off an economic collapse in this election year. Ultimately we will see the next up leg of gold’s rise due to the perception of gold primarily being a safe-haven “store of wealth” as a result of the loss of credit-worthiness of conventional investments, and secondarily a hedge against the price inflation that is being created by governments simply printing more money to fight the deflation in the first place. As this perception takes hold, I expect the “real” value of gold to be realized, and the gold price to catapult to its highest level in decades.

Link here.


In what might be called the “Financial/Political/Economic/Masters of the Universe/Conventional Wisdom Universe”, a fascinating Garden of Eden universe populated by all acolytes of published financial wisdom, U.S government minions, anyone remotely connected with Wall Street or the various elements of money and banking domestic and international and, seemingly, most of the population of the U.S. along with a plethora of Central Bank heads abroad. This universe has a global economic expansion of considerable vigor underway, led and driven by the resurgent U.S. entrepreneurial miracle, aided and abetted by a deity-ized Fed Head and bolstered by a New World/Age financial system itself bolstered by the twin miracles of structured finance and derivatives. Through Alchemy inflation remains (reportedly) modest, job growth is soaring (with a small hiccup), equity markets expect a continuing bull market in new age of price/earnings ratios historically high but new age warranted, and debt markets respond joyously to Fed-Head direction. Virtually all media, telecom and internet providers of financial information seem to completely or partially subscribe to and live in this universe!

Barely noticeable, ephemeral contrary manifestations are situated in the “Perverse/Cultist/Pessimistic/Anti-cultural/Alarmist/Unconventional Wisdom Universe”. As an entrée into this universe, we would initially mention the net international deficit position of the United States to the “rest of the world” increasing year over year as of 2004-03-31 to $5.2 trillion. The rate of expansion in this number continues to increase. It receives virtually no attention. Some day, some time, it may become more noticeable since a sizeable portion of the foreign net position is invested in debt instruments. Only in the recent past has this grown to the point that the U.S. not only has the net deficit position but also now has a net payable of income to foreigners. This will continue to compound, exacerbated by any increase in interest rates. Not only will the seemingly impossible to diminish trade deficit contribute to the increasing net deficit position, but also now an increasing net income payout. The amount of the net negative is now approaching the combined GDP’s of Japan, China and India as an illustration of the magnitude!

In this other universe the reported inflation numbers in the U.S. are regarded as fictitious and “real” numbers in the 5-7% range are bandied about. The insurrection economists and commentators purporting such numbers argue that the measured future rise in rates from the current 1.25% will never bring about the “neutral” position the Fed is traveling towards but simply inflame an already serious inflation problem. Other rowdies argue that the expansion is flawed by malinvestment, particularly in residential. A pitiful few see potential for a massive increase in bad loans, particularly in the consumer arena. A minority believe equities at present P/E’s would be an abomination to Benjamin Graham. Collectively, this fringe population is little noticed.

If, after perusal of the above, the reader accepts the concept of these two antithetical universes, arrival at the question of their ability to persist becomes of paramount importance.

Link here.


The IRS has issued regulations on incentive stock options (ISOs) which finalize, with some changes, regulations proposed in 2003. ISOs provide employees with the ability to acquire employer stock without realizing income when the option is exercised. If the employee holds the stock for a required period, any gains on the sale of the stock are capital gains. The exercise price for an ISO must be no less than the fair market value of the underlying stock on the date the ISO is granted. In addition, an ISO plan must be approved by shareholders, and the amount of ISOs that can be granted to an employee is limited. If the employee meets the holding period requirements for capital gains treatment on the sale of the stock, the employer is not entitled to a deduction with respect to the ISO.

The final regulations include a number of minor changes from the proposed regulations put forward last year. These include revisions to the rules regarding maximum aggregate number of shares in an ISO plan, substitution and assumption of ISOs and modification of ISOs. The final regulations are intended to come into force on the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after the publication of the final regulations.

Link here.


You have no doubt noticed it by now -- any bit of news can move the market up or down a few hundred points. Then it suddenly heads in the other direction because of another bit of news. For normal investors, it is a nightmare. I do not believe the same is true for value investors. The very definition of value investing is tied up with value, not current price movements. We know there is a lot of fear behind the impulse buying and selling. That means unpredictability... and value investing is not about unpredictability. Even if the market price is jumping around like a headless chicken, we are not lost, because we buy on the basis of the company’s value, which does not fluctuate rapidly.

But even if you only buy undervalued companies, your portfolio is still not bulletproof. Even good companies can go soft. Their products can lose appeal; their production and sales costs can go up while their ability to raise prices does not. New technologies and new services erode old favorites; once-lesser competitors revamp and start stealing customers. CEOs change, commodity prices change... Few people remember to get out when things change, and sometimes they do not even notice. This is fatal.

Value investors are realists. I find most of them are good business people. So they understand that missing an earnings forecast for a quarter may be reasonable. You should not overreact, but you should know why you bought every stock in your portfolio. And if any of them are not still doing what you originally hoped, it is time to reassess. Of course, it always helps to stay out of bad markets. This requires timing. Go away and come back when it is better, in other words. That would work if you could distinguish between the rallies that are going to succeed and the duds. I can’t, can you? Nobody does it well.

There is something that is very close to timing that you can do, however. Get there first. If you look for values and exceptional companies, you tend to land in the right places. The clue is when your list of good stocks to consider seems to be heavy with clusters of stocks from the same industry or sector. As a value investor, you do not have to follow a trend... you can discover one. Last year, in searching for winning companies last year -- the sorts of companies with particularly strong and predictable growth, leadership in at least part of their industry and good profit margins -- I came across more small-cap companies than usual. In 1999, it was a handful of transportation companies that passed the test. In 2001, it was midcaps. In late 2002 and early 2003, it was dividend payers.

Ehen weighing the future, I never predict earnings. Instead, I look at the industry, the competition, the economy, the profit margins and estimate reasonable growth rates and the ability to increase or at least hold on to market position. Uncertain markets always have an upside. You just might have to look a little harder. When the other investors are being indecisive, you can be decisive... make tough choices and find bargains.

More on this story here (scroll down to piece by Lynn Carpenter).


Data showing foreigners own half the U.S. debt has raised concerns about a possible tipping point for America’s reliance on foreign capital, though the U.S. Treasury Department sees little risk from the holdings. A graph in a Treasury Department report this week on borrowing needs showed foreign holdings made up 50% of total privately held U.S. public debt, which excludes Federal Reserve holdings, as of May 31. Foreign holdings accounted for just 20% of U.S. debt in 1993 but they have swelled in recent years as Asian banks loaded up on U.S. Treasuries, seeking to depress their currencies against the dollar to boost exports.

Economists say the influx of offshore capital has helped support the U.S. economy by lowering market interest rates and bridging the country’s large budget and trade deficits. Some, however, see the high foreign holdings level as a vulnerability. With the presidential election less than three months away, the high foreign debt level has also bled into politics. “Sure, they’re competing with us for good jobs but can we enforce our trade laws against our bankers?”, Former President Bill Clinton said in an address to the Democratic National Convention.

Stephen Stanley, chief economist at RBS Greenwich Capital Markets, said while the current foreign holdings level is not a problem in and of itself, “you’d like to think it’s not going to go too far above 50 (percent).” However, Stanley did not anticipate a run on Treasuries. “Obviously there may come a point in time when foreigners are less willing to hold our debt, but it’s not like a light switch that gets turned from on to off,” he said.

Link here.


In the next 30 days, the board of Bob Trailers will vote on whether to relocate the entire company and staff -- from service rep to president -- from San Luis Obispo, California, to Bend, Oregon. Co-founder and President Roger Malinowski has no bad things to say about “San Luis”. The 44,000-person town, midway between San Francisco and Los Angeles, has been home to the bicycle-trailer and baby-stroller designer for 10 years. Its outdoor-oriented staff likes biking in the hills and along the coast. But he has few kind words for its real estate market. The tech boom and the town’s physical constraints made it hard to find a suitable commercial space. Then, with the median price of a home at $510,000 in May, “every time you would talk to people, the cost of living would come up. We’re not a business that can buy our way out of the problem,” he explains. “We can’t raise salaries to the point that people could afford to buy homes.”

Bend seems to fit the small firm’s needs. Though inland, it is about the same distance from the Port of Portland as San Luis is from the Port of Los Angeles. That is key because Bob’s trailers come from Asia. Bikers, hikers and skiers -- many of them California tourists or emigres -- flock to the nearby Cascade Mountains. Better yet, the median home in Bend costs $217,500. One in nearby Redmond costs $154,547.

Bob Trailers is not alone. Rocketing housing and commercial real estate prices on both U.S. coasts are causing companies and individuals to think about moving. Relocations are, in turn, swelling populations and prices in towns like Bend, a decade ago seen as too far off the beaten path for anyone but backpackers. Not every “cheap” town needs to brace itself for a relocation wave. Lifestyle, usually meaning access to cultural activities, good weather, short commutes and an educated work force, often counts for more than prices. Real estate prices are not the only reason folks are moving -- but they are a big one. It is easy to see why.

Link here.


One investing rule can guide you through the market’s wilds, even if you forget all your other rules. Selling a stock immediately if it falls 7% to 8% from your buy point will keep you safe. Cutting losses quickly lets you overcome all sorts of mistakes. Did you buy a stock that broke out in weak volume? No problem. Just chuck it quickly and move on to something better. Did you buy in a bad market? Piece of cake. Just eject and wait for a new rally to begin.

IBD market research shows that 40% of all big winners return to or near their pivot points after breaking out. Far fewer go on to big gains once down 7% to 8% from the pivot, however. Don’t sweat the few that do bounce back. In the long run, you will do better by consistently keeping your losses small. A quick math lesson shows the impact of escalating losses. Say you sell a stock down 7% from your buy point. You need only make 7.5% on your next trade to get back to even. Let it mount to 25%, and you need a 33% gain to return to square one. If it tumbles to a 50% loss, you need to double your money just to start from scratch. Given how rare gains of 100% or more can be, that is a valuable lesson in keeping losses small.

Link here.


Almost as surely as war takes casualties, Fed rate hikes in recent decades have triggered disasters of one kind or another in global financial markets. But many analysts believe that the Federal Reserve’s string of victims, from Franklin National Bank in the 1970s to Orange County in the 1990s and the flattened tech bubble of the year 2000, might not grow much longer in the current tightening campaign. Other observers worry that the next victim could be a pretty big one: the U.S. consumer.

After taking its key overnight lending rate, the fed funds rate, to 1 percent, the lowest level in more than 40 years, the U.S. central bank this summer has started ratcheting rates back up. It is widely expected to throw another quarter-point hike on the stack next Tuesday and could add several more hikes in the next year, in an effort to take the overnight rate to a mythical “neutral” level, from its current red-alert emergency level.

What is neutral? “When we arrive at neutral, we will know it,” Fed Chairman Alan Greenspan said last month, in typically Delphic fashion. David Rosenberg, chief North American economist at Merrill Lynch, suggested one possible landmark to let us know when neutrality has been achieved: “Maybe we only know when ‘you are there’ when we get the first financial calamity, which has been part and parcel of every tightening cycle over the past three decades,” Rosenberg wrote in a recent note, helpfully providing a list of the victims, including Penn Square Bank in 1982, Continental Illinois in 1984, Askin Capital Management in 1994 and Long Term Capital Management in 1998.

As long as rates rise gently and the labor market improves steadily, most economists agree, most consumers should survive. Fiddle with either of those variables, and you could have trouble. But James Grant, a vocal critic of Greenspan, suggested that, despite the pain, rates should rise, and relatively dramatically, to stifle the potentially dangerous speculation that super-low rates have encouraged.

Link here.


Oil prices could rise as high as $50 per barrel before the year is up, analysts say, as the world’s growing thirst for crude stretches supplies thin and uncertainty abounds in petroleum-producing nations. Prices might leap even higher if there was a major supply disruption, analysts said. Even at $50 per barrel, prices would be about 12% less expensive than they were leading up to the first Gulf War, and more than 40% below the levels reached during the oil crisis of the early 1980s, when inflation is taken into account.

Of course, current high prices could begin to sap demand for gasoline and weaken the broader economy -- both of which would cool today’s red-hot oil markets. And while a terrorist attack in the United States would cause a brief run-up in the cost of oil, analysts said that would likely be followed by a longer-term decline in prices because of the negative impact such an event would have on the economy.

Link here.


Dollar pessimists fail to take this into account, says study.

Money laundering, tax and exchange control evasion, and other irregular capital flows are buoying the US dollar and financing a substantial portion of the US current account deficit. A study by Brendan Brown, London-based head of research at Mitsubishi Securities International, estimates that these “grey capital inflows” could be accounting for 30-40% of the capital flows that offset the US trade and services deficit.

“Dollar pessimists sounding a state of alarm about the US current account deficit fail to acknowledge the huge flows of funds into the US dollar from grey areas of the world financial system,” he says. “A proportion of these funds are placed in euro, yen, sterling and Swiss francs, but the bulk remain in dollars and each year steadily finance the American current account deficit.” In 2003, he says there was a net flow of funds from the rest of the world to the US of $550 billion, and estimates the number will be $580 billion this year.

Around 30-40%, or up to $240 billion of these flows are classified as “errors and omissions” since they cannot be traced from official sources. “These huge amounts are ‘grey money’ from continents such as South and Central America, Africa, parts of Asia and offshore tax havens,” says Mr. Brown, who regularly estimates global capital flows. “[T]hey should be considered by economists and market strategists because the amounts are so large.”

The unidentified flows include corrupt African and other Third World governments that siphon off tax, international aid and bribes and invest the money with unscrupulous banks. Then, there are the flows that emanate from drugs, other money laundered funds and false invoicing to mask tax evasion and capital movements from nations with exchange controls. There are also substantial cash payments for black market trade. Bank notes are generally dollars deposited in secret bank accounts in Switzerland and offshore banking sectors.

Link here.


German investors have had it with stocks. The short-lived Internet stocks boom that began in 1996 ended infamously in 2002 with the bust of Neuer Markt (the German equivalent of the NASDAQ.) Since then, Germans have owned fewer and fewer stocks. The latest figures show that now only 16.4% of Germans own equities, down from the peak of 21% in early 2001. Many German market analysts do not see the situation improving any time soon. “Stocks have a bad image,” they say. And as one of them said, “As long as German shares continue to move sideways, investor interest will stay limited.”

Not to go off on a rant here, but I can’t help it. This statement about investor interest is a classic example of the kind of reversed cause-and-effect thinking that we hear so often from the financial media and conventional analysts. This point of view -- just think about it -- implies that a stock market is an entity that exists somewhere separate from this world. And while the stock market hangs out there in a vacuum and acts as it pleases, its erratic behavior makes investors gain or lose optimism here on Earth.

But what is a stock market if not a large group of investors buying and selling shares? “Stock market” and “investors” are one and the same! So how can the “sideways movement of German shares limit investor interest?” It is the other way around! “Investor interest” is what moves the market -- up, if investors are interested, and down, if they are not. So the only force that can knock “German shares” out of their recent sideways drift is a renewed confidence of German investors. Of course, if their confidence continues to decline, the German DAX has further to drop...

Link here.


“Buyers fled Wall Street Friday after a new report showed hiring in the U.S. decelerated last month, rising at the slowest pace in eight months.” This sentence -- from an afternoon story in the Wall Street Journal online -- summarizes all you need to know about the media’s coverage of today’s stock market. Here is what that remark (and the rest of the coverage) failed to consider: U.S. stock markets were down yesterday, this week, and over the past month. Asian and European stock markets were lower in their Friday sessions before the release of this morning’s U.S. job figures; the most those numbers did was accelerate a trend that was already firmly in place. Yet even after you separate the fiction out, the job growth facts do tell a vitally important if bleak story. The “consensus forecast” among economists was for an increase of some 240,000 jobs in July; the initial figure (jobs data is often revised) was 32,000.

Most of the news stories said that economists and forecasters were “surprised” by the jobs data, yet nothing that I read delved as deeply as it could have to explain why the establishment was surprised. Here is a hint: note that the consensus forecast for June and July was in the 250,000 range, which has actually been the same estimate for about the past five months. When the monthly job growth numbers exceeded 300,000 in March & April, the economic establishment was convinced that we were no longer in a “jobless” recovery. They believed this recovery would finally do what previous recoveries have done at this stage, namely produce job growth at an annual rate of about 3%. Long story short, that should mean a monthly figure of at least 250,000.

It is not that their assumptions were unreasonable; again, their models were based on previous recovery periods. This is why their “surprise"” runs deeper than the news stories reveal. Can you know something that the economists do not? Yes, because there is indeed a flaw in their models. The stock market and economy are not linear; growth and contraction DO NOT move in straight lines. Instead, they move in recognizable patterns -- “recognizable”, that is, if you know what you are looking for.

Link here.


By any measure, the late 1990s was a time of extraordinary growth and prosperity in much of the world -- and yet, the global financial system still managed to lurch through six crises: Mexico in 1995; Thailand, Indonesia, and South Korea in 1997 and 1998; Russia in 1998; and Brazil from 1998 to 1999. The Indonesian crisis was especially severe: The country’s quarterly real GDP plummeted 18.9 percent, and its currency fell into a hole 526 percent deep. Each of these upheavals spread to most parts of the globe, destabilizing currencies, knocking gaping holes in bank balance sheets and, in many cases, causing a wave of bankruptcies. The fact that each country recovered and the global economy roared on again is testament not to good financial management but to good luck.

Fortunately, bankers and regulators now realize the system is flawed. The world’s central banks have been pushing for more sophisticated risk models -- but what they need is one that takes into account long-term dependency, or the tendency of bad news to come in waves. A bank that weathers one crisis may not survive a second or a third. I thus urge the regulators, now drafting the New Basel Capital Accord, to regulate global bank reserves, to encourage the study and adoption of more-realistic risk models. If they do not, the number of crises will just keep growing.

Even the most cursory glance at the economics literature will yield a perplexing cacophony of opinions -- and, more invidious, contradictory “facts.” Consider one example. Proposition: Share prices are dependent over (a) a day, (b) a quarter, (c) three years, (d) an infinite span, or (e) none of the above. All these views have been presented as unassailable in countless articles reviewed by countless worthy peers, and supported by countless computer runs, probability tables, and analytical charts. Wassily Leontief, a Harvard economist and 1973 Nobel winner in economic sciences, once observed: “In no field of empirical enquiry has so massive and sophisticated a statistical machinery been used with such indifferent results.” ...

Link here.


Wall Street is rooting for Google’s anticipated initial public stock offering ... to fail miserably. Investment bankers fear the “Dutch auction” IPO, if successful, could severely diminish their power and influence, and that has a lot of people on Wall Street worried and more than a little angry. In just about every interview they give, Wall Street sources are actively campaigning to undercut the IPO, warning the public that the stock will be overpriced, and instead of appreciating in value after the offering, will actually retreat. Investment bankers have a lot to be unhappy about.

To start with, Google’s underwriters have been told not to expect the typical 7% commission they generally pocket for acting as the middleman between the company and the stock-buying public. Instead, the underwriters, led by Morgan Stanley and Credit Suisse First Boston, will get 3%. If the offering generates $3.4 billion as expected, that means the underwriters will earn $103 million -- not bad, but still far less than the $241 million they would net with the normal commission fee. But Wall Street has survived low commissions on high-profile IPOs before. What really bothers the investment bankers is the worry that this deal might spell the end of the very lucrative IPO pricing and allocation game.

If Google’s offering works for the company -- that is, if it raises money at a good price and at a low commission to boot -- then this IPO would legitimize an alternative to the traditional IPO that will diminish the power of Wall Street investment banks. Other companies, companies with lower profiles than Google, will have a new alternative for raising money. Wall Street does not even like to think about that possibility. If, on the other hand, Google’s IPO fails -- if not enough investors bid, or if the price is too low, or if the IPO sinks, leaving hordes of angry individual investors and the company with egg on its face -- then the auction model will go back on the shelf and Wall Street investment banking will go back to business as usual. Of course, just because Wall Street hates this deal does not mean you should jump at the chance to invest.

Link here.
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