Wealth International, Limited

Finance Digest for Week of August 23, 2004


Rural hospitals, car insurers and furniture stores are not exactly the first businesses that come to mind when talking about growth stocks, but fund manager Richard Aster Jr., 64, picks through such sleepy industries to find growing companies that others have ignored. Aster’s growth strategy rarely includes Internet and biotechnology stocks. In the late-1990s tech bubble it was painful watching other fund managers make easy money. “When it all blew up, we looked pretty good,” says Aster, who manages $3.4 billion at Aster Investment Management in San Francisco.

Aster’s Meridian Growth Fund invests in companies with market values between $500 million and $2.5 billion. It has returned an annualized 14% during the past five years, twice the rate of the Russell 2000. Unlike many other growth managers, Aster pays a fair amount of attention to balance sheet ratios like that of debt to total capital. An expectation of 15% annual growth is good enough for him. He will hold for three to five years. Aster also looks for companies that can finance their own expansion, so he pays close attention to return on equity. For example, a company might not be able to finance its growth if profits are increasing at a 20% annual clip but its return on equity is only 10%.

Forbes rates the Meridian Growth Fund, which has $1.3 billion in assets, with a C in bull markets and an A in bear markets. The fund is also rated a Best Buy, based on its risk-adjusted performance and low costs. Whereas the median growth fund has annual expenses of $1.45 per $100 in assets, the figure at Meridian is just $0.95. This fund does not charge a sales fee.

Link here.


Whenever I am on edge about the stock market I take comfort in compartmentalizing the possible outcomes. The market can do any of four things: go up a lot, go up a little, go down a little or go down a lot. It is only in the last case that you should really regret not having gone to cash, and the last case occurs only rarely. Unless I think I see big, bad things others do not see, I cannot justify a down-a-lot forecast, since the market is a discounter of all known information. That means that bad stuff we already know (war, deficits, you name it) is already priced into stocks, so you gain nothing by selling. That fact helps explain why I almost always own stocks.

What should you do if you are persuaded that the market is destined to decline just a little? Nothing. It costs too much (taxes, commissions, price spreads) to move out and in for a brief interval. Remember, too, that a downward blip tends to be over before long. Also remember that you might be wrong. Much more of the time than not, stocks rise. Often they rise when there seems no good reason. Sometimes I am wildly bullish, expecting the up-a-lot outcome. That is, I think I see big, good factors others do not see. But again, the only basis for such an extreme view is if you think you see something others do not.

I remain optimistic for a big upward move ahead. Partly it is because economic sentiment is dour, while the economy progresses quite nicely. But just as important, I am bullish because I see a lot of great stocks to buy. But even if you are much less sanguine than I, you should be in stocks. Just look for unappreciated quality. That way, if stocks do sour, you are likely to lose less than the market as a whole. By quality I mean firms that are leaders in their fields. Maybe profits are down or margins are thin, but if the firm has a competitive advantage, it should be able to turn more of its sales dollars into profit dollars. Signs of market leadership: high market share, prestige customers, lower costs, unique distribution or regional dominance. The four stocks listed below have at least one of these qualities.

Link here.


In the past 12 months the price of oil rose 50% to $45. The price of oil company shares (measured by the S&P 500 Energy Index) is up only 27%. Why is Wall Street so cool on the sector? Apparently out of a belief that oil prices will collapse in the near future, making the current gusher of oil industry profits a very short-lived phenomenon.

Energy savant Daniel Tulis has a different view. He thinks high prices are going to stick around for a while. Not as high as they are now, but high enough and long enough to make the energy-producing sector of the market a terrific buy. Tulis, 66, has been covering the sector ever since the first OPEC embargo 31 years ago. With some apparent success: Elco Energy, founded by Tulis’s partner Paul Elliot in 1995, claims a 12.6% annual return since inception (after fees), besting the S&P 500’s 11%.

If not stock traders, at least oil traders are expecting a future close to the one Tulis envisions. The December 2008 futures price for light sweet crude is $35. From such expectations Tulis reasons that oil and gas stocks are undervalued, along with stocks throughout what he calls the “energy chain”, which starts with exploration and production and ends with power transmission. Below are some of Tulis’s favorites. By his estimates, the stocks trade below what they should, which is their intrinsic value.

Link here.


With the stock and bond markets not going much of anywhere, you may despair of finding any good liquid investment for your cash. For me, a good place for investment truffle hunters to start sniffing is the field of master limited partnerships, which have the twin advantages of high yields and tax benefits. These publicly traded securities are mostly concentrated in fuel storage and pipelines. Energy price zigzags do not affect MLPs much. They earn their money from the volume of oil and gas they handle. With growing demand and insufficient infrastructure for it, MLPs have big growth in their future.

Because people buy them for the fat yields, MLPs are unjustifiably tainted by the Federal Reserve’s rate-tightening. MLPs are down 3% in 2004 -- a buying opportunity. Since 1998 an index of MLPs created by Jerry V. Swank of the Cushing Fund has measured a 14.7% annual return versus 2.1% for the S&P 500 and 5.3% for the ten-year Treasury. Swank found the MLPs were not correlated to the S&P or any other major securities index, so they are a good way to diversify. Further, fads among institutional investors are not a factor since the big boys steer clear of MLPs. Open-end mutual funds are legally barred from buying them and pension plans fear that such a tax-advantaged investment would queer the plans’ tax-exempt status.

MLPs yield 6% to 8%, well over 10-year Treasurys’ 4.2% and energy titans such as ExxonMobil’s 2.4%. MLPs are exempt from corporate taxes and pass through almost all their distributable cash flow to investors. Typically only 10% to 20% of an MLP distribution is currently taxable (at up to 35%) to the unit holder -- the heavy depreciation charges these outfits can claim causes the IRS to deem a large part of their payouts as a return of capital rather than as taxable income. The return of capital lowers your tax basis in the stock and thus raises your capital gain down the road. In the meantime, you enjoy largely untaxed income. The downside is the complexity of your tax return. Attaching a K-1 form to your tax return is a hassle. And depending on how the MLP deals with depreciation, you could get thrown into the harrowing alternative minimum tax.

Another caution: MLP managers, who own a chunk of MLP shares and thus get the same nice dividends you do, also are entitled to increasing payouts as the distribution increases. Their take can reach as high as 50%. The idea is to motivate management to expand the business. Thus far the motivation has worked. Dividends have been going up.

Link here.

Another way to play the energy sector is to buy energy trusts from Canada.

Royalty trusts for natural resources can be fine investments, liquid securities that trade like stocks and give you double-digit yields and some tax breaks to boot. The most common are in oil and gas (coal and timber account for much of the rest), and their volatile prices discourage some investors -- unlike energy master limited partnerships, a steadier infrastructure play. The best of these energy trusts are from Canada.

In the U.S. a royalty trust is a financing entity that holds the extraction rights for resources, although not the acreage they are drawn from. Like real estate investment trusts, royalty trusts are not taxed at the corporate level if they pass most of their earnings on to investors by way of dividends, usually paid monthly. To maintain the trusts’ tax-free status, their managers are not allowed to issue fresh debt or equity. That crimps their ability to add to reserves. The upshot is that the reserves tend to shrink and the value of your investment constantly declines. Reflecting this depletion of the assets, tax law treats a portion of each year’s distributions as a return of capital not subject to income tax.The amount of capital returned simply reduces your cost, or “basis”, for the purpose of determining the capital gain or loss if you sell.

Canadian energy trusts are a better deal. Unlike their U.S. cousins, Canadian trusts can issue more shares and use debt to acquire production properties. They can be exploration and operating companies, not just passive royalty trusts. Thus, a well-managed trust may well exist in perpetuity. Like the U.S. variety, the Canadian trust pays no corporate income tax. It passes through income to its unit holders. As in the U.S., a portion of the payout is considered partly a return of capital. A bonus: Canadian trusts are treated as corporations whose dividends are eligible for the favored 15% dividend tax rate in the U.S., notwithstanding the lack of parent corporate income tax. A U.S. investor pays a special (unavailable to Canadians) 15% withholding tax to Canada but can get a full credit for this sum against his U.S. income tax bill. Hence, your dividend is effectively tax free. A risk is that either Canadian or U.S. tax authorities will crack down on this loophole.

The wonderfully high trust dividend yields, ranging from 10% to 14%, remind you that you are being paid for taking on considerable risk -- that now-high energy prices will plunge, causing a decline in the dividend. But if you think oil prices will stay fairly high, these trusts are extremely attractive.

Link here.


A school of prominent China watchers, led by Morgan Stanley strategist Andy Xie, warns that the domestic overheating could lead to a “hard landing” in sectors ranging from steel to real estate. The Chinese government, worried about that very thing, is trying to rein in the torrid expansion. If China’s growth does ease, recognize that Chinese exporters should keep on chugging by profiting from the country’s global competitiveness. With world economic growth at its highest in years and economic recovery gradually taking hold in the U.S., earnings at businesses exporting from China should be robust.

So says Hong Kong-based Peter Chau. Chau, 46, helps manage $400 million of Asian investments, mostly from institutional investors. One of the keys to Chau’s staying power: seeing China as an entity that includes Hong Kong and Taiwan. $Billions worth of trade and investments move monthly between the two smaller economies and the mainland’s, and he judges companies according to how well they find niches in this three-part economy. His approach has paid off. TAL’s Talvest China Plus Fund has increased by 19% annually since its 1998 inception, compared with a 2% decline in the Morgan Stanley Capital International Golden Dragon Index, a China benchmark. (The open-end $100 million Talvest China Plus Fund is aimed at Canadian investors, and Americans cannot buy it.)

Chau’s fund currently holds shares in Taiwanese technology companies, mostly component manufacturers, that he believes will benefit from a global rise in consumer and business spending this year. Among non-tech exporters he holds, Hong Kong-listed Weiqiao Textile makes denim used in Levi’s jeans. Its wares will be more competitive when global trade in textiles is liberalized next year. Then there is Hong Kong’s Techtronic, supplier of hand tools to Home Depot and Sears, Roebuck; it should benefit from the U.S. economic recovery, Chau says.

Link here.


Long-term consumers clearly do not believe that the oil price will fall much. When the spot price (i.e., for immediate delivery) has soared in the past, the forward price (for delivery in the future) has barely budged, because consumers expected the price to fall again. In October 2000 the spot price reached $38 but the forward price stayed at $20. This time, the forward price has climbed sharply too: the price of oil for delivery in ten years’ time has reached $35 a barrel. Perhaps buyers are willing to pay this apparently heady price because it is not so elevated after all. Since January 2000, the average price of oil has been about $30, points out Jeffrey Currie, head of commodity research at Goldman Sachs.

An unexpected increase in demand from a growing world economy, in particular from China, has helped push the oil price up. So have growing worries about supply from unstable regions of the world. But these supply worries reflect deeper problems of under-investment, argues Mr Currie. There has been no growth in pumping and refining capacity since the 1970s -- all the growth in output of the past three decades has come from squeezing more oil out of existing fields. The rise in the oil price is both a reflection of past under-investment and, of course, a spur to future investment. It will, however, need oil to stay above $30 a barrel for several years to solve these supply problems.

What a high and rising oil price might mean for the world economy is the subject of much debate among economists. The big question for financial markets is, who will pay the tax that a higher oil price represents? Clearly, America as a whole will fork out in some way because it is a net importer of oil, and the effects of the rise in the oil price are greater there because gasoline is taxed so lightly and oil is denominated in dollars, a currency that shows every sign of weakening further. If consumers do not pick up the full tab, companies will have to pick up some of it through lower margins. Falling profits are unlikely to help the stock market.

More on this story here.


Heavy trading by hedge funds in equity markets adds to the liquidity needed for accurate pricing, but they are not killing the volatility they need to make profits, analysts said. Prime brokers who deal with hedge funds estimate they have accounted for between 30-50 percent of daily share trading volumes in Europe this year. In the United States that figure is lower because of the dominance of mutual funds. Hedge funds manage only about $1 trillion of world assets, but they can leverage -- borrow a multiple of assets to take bigger positions, which amplifies their impact on the market, analysts said.

U.S. Federal Reserve Chairman Alan Greenspan has said attempts by the U.S. Securities and Exchange Commission to regulate hedge funds would limit their flexibility “to the detriment of our economy.” Part of that flexibility comes from hedge funds’ ability to short -- sell securities they do not own on the expectation of buying them back cheaper at a later date -- and use derivatives.

Link here.

Towry Law agrees to compensate investors in failed Cayman Islands hedge funds.

The deal, agreed with the Hong Kong Securities and Futures Commission (SFC), is one of the biggest voluntary compensation payments made in Hong Kong. Towry Law (Asia) handled investments in Global Opportunities Trading and Global Diversified Trading, both registered in the Cayman Islands, until they were suspended from trading in September 2002. It has been estimated that losses to investors in the two funds amounted to over US$50 million. Towry Law agreed this week to make ex-gratia payments of 90 per cent of capital to customers who invested in Global Opportunities, plus compound interest at 1 per cent. Global Diversified investors will receive 80 per cent, plus 1 per cent compound interest, from the date of investment. In March, The Standard revealed a web of confusion and deceit involving the two funds, which extended well beyond Hong Kong.

In what it termed a severe reprimand against Towry Law, the SFC said the investment adviser had:“Conducted insufficient due diligence into the two funds before recommending them to clients; Failed to conduct proper inquiries into circumstances surrounding the two funds which indicated problems with the funds; Failed to advise clients when it became clear that the funds had problems”. However, the SFC said it planned no further action against Towry Law in view of what it termed the mitigation of the payout offer, the removal of senior management at Towry Law responsible for the involvement with the two funds, and the “high degree of co-operation” since shown by current management.

Link here.

Hedge funds growing in popularity with UK pension funds.

Almost half of the UK’s largest pension funds have invested in hedge funds or are considering doing so, according to a new survey, commissioned by global fund-management group Pioneer Investments. 16% of the pensions polled have already placed assets into hedge funds, while one-third are actively studying the possibility. The majority of the pension funds, 73%, were hoping to improve performance through participation in hedge funds, while the remainder did so for defensive reasons.

Of the pension funds that have avoided hedge funds the poll found the 35% cited a high level of undefined risk as the main reason, while 26% blamed high fees and 12% believed hedge fund growth was a short term “fad”. Meanwhile, 38% of pension funds saw a perceived lack of transparency as the greatest obstacle to hedge fund investing.

Link here.


Is art a good investment? Despite the stratospheric prices recently achieved by some paintings, notably Pablo Picasso’s “Boy with a Pipe”, which sold for a record $104 million in May, many art market advisers concur that the answer is, regretfully, “No.” That is despite some evidence of a number of well-publicized art market indexes, notably the Mei Moses all art annual index, which tracks 6,000 artworks, including old masters, 19th century masters, Impressionists and pre-1950 American paintings. The index has recorded an annualized compound return of 12.6% over the past 50 years, compared with 11.7% for the Standard Poor’s 500-stock index.

The indexes are misleading, investment professionals say, in part because they typically fail to take transaction costs into account. And in the art market, transaction costs, whether levied by dealers or auctioneers, can be very high. Works of art sold at auction normally attract both buyers’ and sellers’ premiums of 10% or more, and dealers can charge as much as 50%. Money is almost always convertible into art, but the reverse convertibility -- art into money, or at least more money than you paid for it -- can rarely be predicted with confidence.

The narrower the collecting category, the more volatile the returns over time. An even bigger problem with the broad art market price indexes like Mei Moses is that they represent the aggregate performance of an array of art categories. Individual works by equally respected artists can fare very differently at auction. “Boy with a Pipe” earned a 16.05% compound return, once the auction house’s commission had been deducted, from 1950, when it was acquired for $30,000 by Betsey and John Hay Whitney. But what of Vincent van Gogh’s “Portrait of Dr. Gachet”, which was bought by a Japanese collector for $82.5 million in 1990 and has since been sold again for an eighth of that price?

Link here.


Hudson’s Bay Co. is a 334-year-old department store chain. It is Canada’s oldest company. While this advanced age certainly deserves respect and inspires wonder, it seems to buy you no quarter in the rough-and-tumble world of making money. Hudson’s Bay is struggling these days, and the papers report that the tired old merchant has had enough and may be sold. Target and investor Jerry Zucker are competing suitors to buy the company. Some Canadians lament the passing of such a venerable institution -- Hudson’s Bay is the last domestic department store since 133-year-old Eatons failed in 1999 -- while others are less sentimental. Markets change, though, and while Hudson’s has been a loser, such things do not usually persist forever. Just as periods of high returns invite competition and put pressure on future returns, so, too, do poor returns tend to rebound as market forces correct the error. Target may be able to do better with Hudson’s assets.

Most people want to buy strong companies with growing sales and expanding markets and a bright future. No one wants to buy a company that has problems to work through, that has been hit with one setback or another and where the near-term outlook is murky and uninviting. Yet it is in these latter opportunities where the greatest investors have plied their trade and milled their fortunes. Warren Buffett bought The Washington Post in the throes of the 1973-74 bear market, when it was struggling. He bought 10% of the company for about $10 million. At the time, the company had revenues of over $200 million. Ten years later, his stake was worth a quarter of a billion dollars.

He bought GEICO when, in his words, “It wasn’t essentially bankrupt, but it was heading there.” It was one his greatest acquisitions. Not just Buffett, but scores of wealthy investors have enjoyed incredible returns by buying when other investors were fearful, by seeing through the temporary setbacks. The greatest investors did not fear to go against the consensus. As writer Malcolm Muggeridge used to say, “Only dead fish swim with the stream.”

A just-completed, titled Capital Account: A Money Manager’s Reports on a Turbulent Decade 1993-2002 collects financial reports written by Marathon Asset Management’s partners and delivered to its clients over the boom years. Marathon is an investment advisory firm based in London that manages over $24 billion in assets for institutional investors. The book was interesting because it illustrates Marathon’s unconventional investment style and provides a number of useful ideas and examples of investments that succeeded by bucking consensus opinion.

Consider General Dynamics, a company that Marathon backed in the early 1990s. General Dynamics was in bad shape at the time, suffering from a declining backlog of business in the wake of the Soviet Union’s demise. New management took the company in a different direction in 1991 -- by closing or selling unprofitable businesses and buying back its own depressed shares. The stock of General Dynamics increased six fold between 1990 and 1993, even though its sales were reduced by half. Yes, sales declined by 50% and the stock rose six fold! Marathon used the example to highlight a couple of key points regarding their “capital cycle approach”. First, investment returns can have less to do with sales and growing markets than they have to do with the efficient allocation of resources. Secondly, Marathon reinforced the idea that “It is better to invest in a mature industry where competition is declining than in a growing industry where competition is expanding.”

The “capital cycle approach” is based on a simple yet compelling idea. High returns on capital, or the prospect of high returns on capital in one area of the market, will attract additional investment. This additional investment will put downward pressure on returns in that market. Using the capital cycle approach, you would become suspicious when shares are priced on the assumption that existing returns are going to be maintained or improved in light of rapidly expanding new investment and growing capacity in a business or industry. The process works in reverse as well. As share prices decline, investment capital moves off to find greener pastures and competition declines. As excess capacity is sweated off, though, returns are likely to improve.

Link here.


The Federal Reserve Chairman the available data on home prices are inadequate to determine if there is a potential bubble in housing prices. “Taking a firm stand on the appropriateness of real estate prices is not possible,” due to data limitations, Greenspan said in written answers to questions submitted by Senate Banking Chairman Richard Shelby, R.-Alabama, in conjunction with Greenspan’s report to Congress on monetary policy July 20. A Fed report to Congress on economic developments in the last six months noted that house price increases have outstripped income as well as rents in recent years. “This observation raises the possibility that real estate prices, at least in some markets, could be out of alignment with fundamentals, but that conclusion ... cannot be reached with any confidence,” Greenspan said. He said the rise in house prices has been influenced by the low level of mortgage interest rates “in ways that can’t be gauged precisely.”

Links here and here.


The deed is done. The time has come to pay serious money for your fun. Bubbles has accomplished his mission, and the inflationary beast may be loose again. Does anyone remember President Ford’s Whip Inflation Now buttons? Get ready for a price control nightmare created by Washington. Soviet style ration books may be on the way. Why else has the government created WIC stores? We have a great bull market in oil. This is a verifiable fact. The money bubble has caught up with us. The question is what now?

We can say the cost of all energy is going up. Gasoline, diesel, fuel oil, natural gas, coal, and electric must go up. The entire hydrocarbon group must raise their prices, or cease operating. The downstream products such as chemicals, plastics, tires, and other products must increase their prices. There will be the usual wailing and gnashing of teeth, as reformers and politicians attempt to prevent price increases to the consumer, but ultimately prices will rise. Process industries such as steel, copper, and aluminum will have large increases in their energy costs. Therefore, they must have large increases in price, or shut down production. The airline industry is already buckling under the new energy costs. Local truck operators in California have already begun parking their trucks, rather than operate at a loss. The impact in retailing is already being seen. Wal-Mart has already mentioned that higher gasoline prices were affecting sales. Retail sales will be affected across the board. SUV sales will drop further. The travel industry must be affected. Every sector in the economy is involved.

The big question is the stock market. Unfortunately, we have a precedent to use a guide. The combination of the Vietnam War and the massive social spending of the Great Society had created a massive inflationary wave that culminated on January 21, 1980. The economy contracted massively after that. Who remembers that President Ronald Reagan appointed Alan Greenspan as Chairman of the Federal Reserve Board? Who remembers that Reagan claimed that Greenspan was an inflation fighter? The truth is that Alan Greenspan did everything in his power to reflate the US economy, and he destroyed the value of the US dollar in his quest for reinflation. The stock market was a bad investment from the mid-1960s until the early 1980s.

We now begin a new era in economics. Cheap energy is over. We have a hyperinflated economy. Real estate has joined the tulip bulb craze in historic terms. All asset groups have risen in the last two years, which is a consequence of the Federal Reserve’s decision to break all historical norms in money creation. This is unique in modern financial history. We must be prepared to throw out our comfortable assumptions, and deal with the reality in front of us. We have an overheated economy at the beginning of this cycle. There is so much liquidity floating the world that the beast is fueling itself. It will collapse, but not in way we are expecting! We need to understand that this is global in scope at this time.

Historically, financial assets tend to under perform during periods of real asset inflation. John Templeton has forecasted a negative environment for the next decade. The greatest threat to the US is the impairment of its credit mechanisms. If inflation gets too high, the entire credit business will collapse. Greenspan will not let this occur, for it would be the end of the giant consumer bubble. How long do you think the US economy would last with a collapse of its consumer credit mechanisms? Scary thought, no? Remember, there has never been an economy in history that has based solely on credit. Neither earning power, nor asset wealth is driving this economy! No one has ever seen anything like this before.

Link here.

Or is it?

Until recently, a revival of inflation in the United States was a major concern for investors. The spotlight was on employment and consumer commodities, but the recent slump in payroll jobs convinced many that perhaps the inflation scare was overblown. Now, even though inflation worries have receded, along with the consumer price index, can investors forget about inflation? Keep in mind that the price of gasoline leaped by more than 40% since December 2003 to its summer peak, and the price of milk -- another frequently purchased item -- has risen more than 10% in the past year.

The price spikes in these items -- necessities for most households -- have convinced many commentators that despite June’s soft patch, inflation in general is spiraling upward. We disagree: Even if some prices have risen sharply, investors should not position themselves for inflation. Here is one reason why. Gasoline only accounts for 2.7% of consumer outlays, while milk accounts for even less, 0.2%. This concentration on small purchases neglects the big price declines in big-ticket, infrequently purchased items. These items are often discretionary, and purchase can be postponed if price increases appear temporary -- or delayed if further price drops are expected. New and used vehicles are in this category; outlays for autos and parts account for 5.2% of consumer spending. Computers are another example and, adjusted for the rise in computing power, their cost to consumers has dropped spectacularly.

Despite the widespread belief that inflation is much higher than reported, the evidence is that the consumer price index is overstated. A congressional study found that the CPI is biased upward in four areas. First, since the index has fixed weights, it does not account for the tendency to buy more of what is cheap and less of what is expensive. Second, the group of retail stores sampled monthly in the survey of selling prices changes slowly over time. As a result, rapidly expanding discounters like Wal-Mart are underreported, while those stores selling at full price are overweighted. Third, quality improvements are understated. Fourth, in the fixed-weight base period, currently 1982-1984, DVD players, wireless phones and lots of other new tech items did not exist 20 years ago, but now account for significant portions of consumer spending. Their prices have fallen dramatically, so the CPI is overstated, since it does not include them.

This study estimated that the annual increase in the CPI was overstated by 1.1%. In fact, the U.S. government has begun issuing chain- weighted CPI figures along with the 1982-1984 official numbers. The chained indexes correct for the substitution and new products problems and consistently show lower inflation rates. But inflationary fears are so deeply embedded in most Americans that even if they were able to set aside all of their convictions that inflation is being vastly underestimated, they would still believe that the Federal Reserve is oblivious to the threat and is even promoting it with rapid monetary expansion, especially since the beginning of 2003. But besides the traditional monetary measures, there are numerous other measures of money, like credit cards, which many consumers use to buy everything from groceries to gasoline to clothing. In any event, the money supply in the past year has grown less than nominal GDP and has been far from inflationary.

I see the rise in inflation fears as being one more brief uptick within the disinflationary trend of the past 23 years. And so far, the Federal Reserve apparently agrees. And then, as concerns about inflation turn to renewed worries about deflation, the Federal Reserve will switch from raising to cutting interest rates. How is that for contrarian?

Link here (scroll down to piece by Gary Shilling).


A key message of Benoit Mandelbrot’s book The (Mis)behavior of Markets (co-written by Richard L. Hudson), is that investment markets in general and the stock market in particular are riskier and more dangerous than people know. Investors should therefore be more cautious. Indeed, the last sentence in his book is: “Like the weather, markets are turbulent. We must learn to recognize that, and better cope.” His argument runs counter to the popular view that stocks long-term are not just the most profitable investment, but the safest -- a view given prominence several years back in the best-selling book Stocks for the Long Run by Jeremy Siegel.

Mandelbrot, 80, is a mathematician at Yale and the creator of “fractal” geometry, which focuses on the regularities in various irregular systems, from wind tunnels to coastlines. If mathematicians received Nobel Prizes, he probably would be first in line. His book is difficult. Sometimes I had trouble understanding him, especially when he is writing about fractals and not about investing, which is much too often. But he is not afraid to argue that the emperor has no clothes, that most of the leading financial theories accepted today are -- if not exactly hogwash -- badly flawed.

His arguments are persuasive, and sometimes, he expresses himself in memorable prose. The stock market, he says, is more dangerous than people know because it is not stable and peaceful, but turbulent. (Think of the bear markets of 1987, 1997 and 2000.) Think of all the investors who lost their shirts, and their early, comfortable retirements, when the Internet bubble burst because they were not sufficiently aware, as Mandelbrot is, of how treacherous the stock market is. Too many people, Mandelbrot argues, think that the “bell curve” is found everywhere in nature, that most things congregate in the middle, and that the relatively few exceptions peter out on the left and the right. (Hence the shape of a bell.) But the bell curve, Mandelbrot argues, does not apply to the stock market, the cotton market or to markets in general. “The seemingly improbable happens all the time in financial markets,” he writes.

Link here.


So you are a Googler, suddenly worth millions, fighting the hangover of your life and feeling the pull of the Lamborghini showroom. Before you do something you may regret, consider what steps you should take to protect your newfound wealth. Financial advisers offer several tips:

“Take it slowly,” said Jon Gallo, a tax lawyer and co-director of the Gallo Institute, which helps wealthy families plan how to use their money. “Let the money sit there earning interest for a while, before you make major decisions that will affect your life.” If the current stock price holds until their options become exerciseable, 950 to 1,050 Googlers will be millionaires

Link here.

Making sure Hollywood’s nouveau riche stay riche.

To the average viewer of HBO’s “Entourage”, the profligate spending of the suddenly rich young movie star protagonist and his pot-smoking hanger-on pals -- $1,500 cellphone bills, $2,500 monthly for vitamin supplements, the spontaneous leasing of a $300,000 Rolls-Royce Phantom -- probably seems like so many familiar real-life examples of celebrity excess, which as often as not lead to pathetic, real-life tales of financial ruin, amusing for their inevitability.

But there is one group of viewers incapable of finding humor in the self-induced financial wreckage of free-spending stars. No matter how absurd, they view such tales with grim disapproval. They are the men and women with the thankless task of keeping stars from spending themselves blind -- celebrity business managers.

In a culture of constant affirmation -- from friends, fans and of course talent agents — business managers stand out as Hollywood’s doomsayers. For them, a rainy day is always just around the corner and every role is as likely as not an actor’s last. While freshly minted stars may see an entourage of family and friends as a barrier against the intimidating maw of the entertainment industry, the business manager is likely to view them as income-sucking mooches.

Holding celebrities to their budgets -- never easy -- has gotten tougher recently for business managers like Mr. Bell because of a glut in the number of stars who have attained wealth quite young, including many whose financial training was limited to sliding the occasional coin into a piggy bank. “These kids are making serious money,” said Scott Feinstein, a Los Angeles business manager who specializes in young clients, including Hilary Duff. “They don’t realize the pressure that friends and family will put on them. They don’t have the maturity to say no.”

Manhattan accountant Marvin Ellin and business managers who watch the show said its central tension derives from a dilemma faced by many young stars who go from average backgrounds to sudden riches in Hollywood: squaring one’s new lifestyle with one’s old friends.

Link here.


There has been a series of speculative price spikes since the first of the year, in markets such as nickel, silver, and the shipping rates. In each case, the play became impetuous and was followed by a substantial plunge in price. Now the zoom in crude seems to be answering our question asked in April, “What’s Next?”. At times of significant market excitement, we try to be impartial and our “Checklist For A Top” (or bottom) provides some discipline. Applying it to the crude oil market:

The XOI index of oil stocks is presenting a significant divergence with the crude oil rally of the past few weeks. There are thirteen previous examples (since 1983) where stocks failed to confirm the rally in oil. Crude oil is in the process of making a top in the order of those made in 1980 and 1974. This would also fit with the sequence of speculative failures that have been so evident since the first of the year. While most would celebrate a cyclical decline in energy prices, it may not be a complete blessing. The plunge after 1980 created the rubble of a number of banking failures and this time around the ripple effect could be equally interesting.

Link here.

The key word in the headline is “despite”.

“Crude Futures’ Losses Widen Despite Fresh Terror Fears”

The key word in the headline (referring to Wednesday’s 3.9% drop in crude) is “despite”. We have come quite a way since just last Thursday (August 19), when the headlines blared a different tune: “Riding a wave of strong demand and continuing risks of supply disruptions, oil prices are bound for $50 a barrel”. Not only have prices failed to reach $50 a barrel -- they have actually declined over the past four sessions.

Yet let’s get back to the “despite” part, since “Fresh Terror Fears” tells only part of the tale. Overnight stories from Iraq included reports of a pipeline attack in the central region of the country; there was also a wealth of speculation that terrorism was behind the near-simultaneous crash of two commercial airliners in Russia. Finally, data from the Energy Department this morning showed a fourth consecutive week of decline in the inventory of crude oil -- the size of the decline was double what analysts expected. “Inventory” is synonymous with “supply”, and when supply goes down price goes up -- right?

Wrong. When you imagine that “news” drives the trend in crude oil, facts like these virtually force themselves into your story. Yet, when the trend goes the other way, words like “despite” show up in your headline.

Link here.


A headline in Tuesday’s New York Times declared, “Older Investors Jittery as U.S. Markets Disappoint”. Yet the story itself offered nothing but anecdotes to support the headline claim. In the broader measures of investor sentiment and 401(k) plan activity described in the article, there was not a shred of evidence that older investors are any more jittery or disappointed than other investor groups. What the evidence in the Times piece actually shows is that investors remain bullish, in both their expectations and their asset allocations.

The anecdotes are disturbing, of course. A Staten Island widow sold her home in 2001 and put $90,000 of the proceeds in the stock market. Today her account is down to $28,000. A 70-year old retiree in Boynton Beach, Florida has seen the share value of her former employer’s stock (AT&T) holdings dwindle from $25,000 to $6,000.

But are (401)k shareholders bailing out of stocks, given that the S&P 500 has declined in three of the past six full calendar years? Not even close. The Times article cites a recent survey of plan activity among 4.5 million 401(k) participants, showing that 67% of the assets invested in such plans went into stocks last year, up from 62% in 2002 -- only slightly lower than the stock allocation in 2000, the year of the all-time highs.

Link here.


If you follow world events, you have hardly seen any good news coming out of Germany lately. The country’s headlines are dominated by disturbing reports of record-high unemployment, falling consumer confidence, massive protests against cuts in social spending, a contracting economy... the list of Germany’s troubles is long. Now this. “Germany breaks the Hitler taboo,” reads the headline on Telegraph.co.uk. A new film by a respected German director, set to open next month, breaks new ground and violates the decades-long unspoken rule of German filmmakers to only show Hitler as a “background figure”.

Many German films have avoided showing Hitler altogether. By contrast, in The Downfall, the Fuhrer is the center of attention. The film focuses on Hitler’s last days and depicts him as a “soft-spoken dreamer, an avuncular character with a penchant for chocolate cake”. The movie has already sparked a controversy, and for a good reason. “Should a monster be portrayed as a human being?” is a question worthy of intense debate. But for an Elliott wave thinker, a more important question may be “Why now?”. That is, after deliberately keeping Hitler’s likeness literally off camera for almost sixty years, why drag this skeleton out of the closet today?

“It is just the time for this kind of film to come out,” a German art historian tells The BBC. German film critics agree and praise the movie for finally “bringing Germany’s evaluation of its history into ‘a new phase’.” Yes, the timing is right, and it is definitely a new phase: It is called a bear market. During bear markets, “hero” images become mixed. In movies, “good guys” no longer win. Often, it is even hard to tell the good guy from the bad one. Germany’s bear market in social mood began in 2000, so this is a logical moment for the softening of Hitler’s image. Germany’s economic woes are the result of the same downturn in social mood.

Link here.


I have said a lot recently about the market psychology regarding crude oil, mostly how (as usual) the sentiment extremes served as a contrary indicator. Just as everyone was certain that a barrel of crude would break $50, prices began to fall. This particular obsession will pass, eventually, and another will take its place. Yet in the meantime, being wrong is not the only hazard of following the conventional wisdom. The other danger is literally less visible. While the media and far too many investors act like the financial universe revolves around just one market, other real opportunities in other markets go unnoticed.

Like the Treasuries market, for example. Data released this week shows that two different groups of traders have taken very large positions in Treasuries; one is short, the other long. In fact, one of the groups now holds the largest position in nearly six years. This is exactly the sort of extreme that often precedes a large move.

Then there is the Dollar Index. The Elliott wave pattern in this market has unfolded beautifully throughout 2004, for both the February lows and the May highs. Prices seem to have gone sideways through much of the summer, yet this movement, too, is in keeping with what the pattern called for. This leg of the pattern is about to end, and the next move should be anything but “sideways”. These opportunities will continue to be overlooked, that is until they have got the word “missed” in front of them.

Link here.


The U.S. GDP increased at a 2.8% annual rate in the second quarter (Q2) of this year, according to this morning’s report from the Commerce Department. So said all the news reports I read today, yet they also unanimously managed to point out that 2.8% was “slightly better than the 2.7% growth rate that some economists had forecast.” What a crock. This was down from a previous early estimate, a lot lower than the previous quarter, and actually the slowest GDP growth since Q1 of 2003.

Yes, some of the news coverage did report the downward revision, but here is what NONE of them saw fit to discuss: A 2.8% GDP is way below what economists were forecasting at the start of the year -- the “consensus estimate” for Q2 was in the 4.5% range, according to The Wall Street Journal’s Monthly Survey. Many economists were predicting a GDP growth rate above 6%; this consensus held as late as May. Then, however, June and July saw one economic report after another showing a poorer-than-expected performance. Now, nearly two months after the end of Q2, these folks have had plenty of time to backpedal, knowing full well that in some cases their estimate was off by half. And just because the media did not report it does not mean it did not happen.

One other thing no one seemed willing to consider: After an upward spike in Q3 of 2003, the trend in GDP growth has clearly been trending lower. Is this supposed to happen in an economy that -- according to the establishment economists -- has not only “recovered” but is now in an “expansion” phase? The issue is the difference between reality and perception; that gap will define the success or failure for most investors, whether they realize it or not.

Link here.


Never before has the world’s leading economy been saddled with such a severe shortfall of saving. Ironically, America has not had to pay a price for its extraordinary profligacy -- at least not yet. The US has borrowed freely from abroad and converted asset-based saving into newfound purchasing power. In my view, this cannot continue. There is nothing sustainable about the growth dynamic of an increasingly saving-short US economy.

In a world where saving must always equal investment, America’s saving shortfall has profound implications. Lacking in domestic saving, the US had had to import surplus saving from abroad in order to keep its economy growing. And the only way it can attract such capital inflows from abroad is to run massive current account and trade deficits. America’s outsize claim on the rest of the world’s pool of surplus saving has, in effect, become the sustenance of the global economy’s US-centric growth dynamic.

The key issue for the economy and financial markets is sustainability -- namely, whether a saving-short growth dynamic can persist indefinitely. The argument against that conclusion is a classic “current account adjustment” -- a scenario that typically involves a weaker dollar, an increase in real interest rates, a suppression of the interest-rate-sensitive components of domestic demand, and a concomitant rebuilding of domestic saving. Whether the investment flows are driven by perceptions of superior returns on US securities, by currency targeting of foreign officials (especially Asians), or by some combination of both, it really does not matter as long as the flows hold up. For the time being, the flows certainly have the upper hand. That could always change, but it would undoubtedly take some type of a shock to reverse the powerful momentum of foreign demand for dollar-based assets.

But there is more to the sustainability argument than the possibility of a trend-reversing exogenous shock. It turns out that there are several endogenous features to the US and global economy that have been quite supportive of a saving-short growth US dynamic. Should the conditions giving rise to this outcome be drawn into question, then all bets would be off. In my view, three such possibilities loom as particularly important in that regard.

Saving is the sustenance of long-term growth for any economy. And yet America is lacking in saving as never before. It has finessed that shortfall by consuming the wealth generated by asset appreciation and by drawing heavily on the world’s pool of surplus saving. In my view, there is nothing stable about this arrangement. In fact, there is a growing risk that America’s saving shortfall will only intensify in the years ahead -- especially given Washington’s total lack of fiscal integrity. As always, the flows will give the impression that this outcome is sustainable. In the end, nothing could be further from the truth.

Link here.


The United States faces a shortage of 35 million workers over the next three decades, especially those with specialized skills, according to a report by the Employment Policy Foundation, a business-funded research organization. With the retirement of workers born during the baby boom after World War II, the U.S. economy must boost the productivity of its workers or admit more immigrants to cope with the expected shortfall, said the group, which represents companies such as General Motors, Pfizer and Boeing.

The employers’ group says the current political debate over the lack of U.S. job growth and the fears of outsourcing of technology jobs to India and manufacturing jobs to China may be set against a longer-term trend running in the opposite direction. The U.S. population aged 65 and older will increase from 12.4% in 2002 to 20% over the next two decades, the report said, so if productivity growth is limited to the long-term average increase of 1.8% annually, by 2032 America will experience a shortage of 35 million workers. The crunch will come because of both the number of workers and those workers’ skills and education.

Link here.


Two things happened this week that might lead you to conclude that California and New Jersey were on two different escalators, one going up, the other down. Think again. California's credit rating was raised three levels by Standard & Poor’s, to A from BBB. New Jersey, meanwhile, is looking at a $4.4 billion hole in its budget for next year, far larger than had been expected, according to a memo written by David J. Rosen, the legislature’s budget and finance officer, and first reported upon this week. California’s on the way up, New Jersey (now rated AA- by Standard & Poor’s) down, then, right?

Not so fast. Both of these states have a lot of work to do on their future budgets, as a close reading of the S&P upgrade and the New Jersey memo shows. They are really both heading in the same direction. If you are from California or New Jersey, this is not happy reading. It is not too cheery or reassuring if you hold the bonds of these states, either. California and New Jersey have not fixed their budget problems. A wise man once said, “You are not going to grow your way out of a deficit.” Someone should tell California and New Jersey.

Link here.


It was just an online classified ad, under Collectibles for Sale, but it sounded like a cry from the heart: “I’m tired of these things now. Please save me from them.” Years earlier, there were days when Kelly Cabral and her husband, Dan, would join the early-morning crowds laying siege to gift shops that were expecting shipments of Beanies. Now, she says, “My husband’s like, ‘Where did we get all these?’ Then you realize you spent way too much time on this insanity.”

Some former collectors cringe when they think of the plush critters, just as certain investors do when they recall Internet crash-and-burns such as Webvan or Pets.com. In many ways, in fact, the Beanie Baby mania was the dot-com stock bubble writ small. Both were creatures of a frothy, peacetime economy with low unemployment and towering consumer confidence. Both were abetted by the advent of online trading and the explosive growth of the Internet. Both gave rise to celebrity oracles who seemed able to decode the mysteries of the market. Both spawned fraud and even episodes of violence. And, finally, both flouted all classical notions of investment value. Until they didn’t.

Beanie Babies, as aficionados know, are the brainchild of H. Ty Warner, 59, chairman and owner of Ty Inc., based in the Chicago suburb of Westmont, Illinois. Forbes magazine ranks Warner as the 65th richest person on Earth, worth an estimated $6 billion, ahead of Los Angeles insurance and real estate tycoon Eli Broad, Staples Center owner Philip Anschutz and Amazon.com founder Jeffrey Bezos. Nowadays, Warner is intensely private. He does not give interviews and declined to comment for this article. Warner’s killer insight was that the world needed an attractive plush toy that a kid could afford. He designed it himself and brought it to market in 1994. Having produced a lovable item at a popular price, Warner then stumbled upon -- or cunningly executed, depending on whom you believe -- a series of moves that made Beanie Baby sales go nuclear.

By accident or design, these actions all helped foster an aura of scarcity around the Beanies, even as Ty Inc. factories in China were pumping them out by the hundreds of millions. And the parallels with the contemporaneous dot-com bubble? Initial public offerings of stock in the most hyped Internet companies created a mad rush for shares. Investors pleaded with brokers for allocations of stock at the IPO price, in hopes of a first-day “pop” that would let them unload their shares at double or triple their money. New-character introductions were the IPOs of the Beanie Baby market. If you could grab one at retail for $5.99, who knew if it might be the next royal-blue Peanut the Elephant and fetch $3,000 on EBay?

Both the dot-com and Beanie crazes thrived in an atmosphere of uncertainty. Nobody could say whether the Internet might actually live up to its hype as a transforming technology. As for Beanie Babies, Ty Inc. did not advertise and provided almost no information about the toys, so nobody knew for sure how many characters existed or in what numbers or even where you could buy them. That is where the gurus came in.

Ty Inc.’s market maneuverings helped make Beanie mania one of the longest-running toy fads in U.S. history. Still, the fate of a bubble is to burst. In August 1999, Ty shocked the collecting world by announcing that it would stop making Beanie Babies on Dec. 31, 1999. The company never publicly explained its reasons, but Beanies auction prices had begun to stagnate, so skeptical collectors saw the move as a desperate effort to stoke the fervor. It backfired. Prices plummeted on the resale market as people sold their collections or, like Kelly and Dan Cabral, stopped buying Beanies and packed away what they owned. Ty soon relented and announced that by popular demand it would resume production in early 2000, but it did not reverse the slide. Beanies peaked just about when the NASDAQ did.

Today, a rare Beanie -- perhaps with a Ty Warner autograph -- may still fetch more than $1,000 at auction. The toy is still a good seller at retail, but people no longer line up to buy them. Business researcher Hoover’s estimated Ty Inc.’s 2003 sales of Beanies and its other plush toys at $750 million, down from $1.25 billion in 1999.

Link here.


Visitors to modern Egypt scratch their heads. All along the muddy waters of the Nile, nothing seems to work quite the way it is supposed to. Egyptians are interesting and enterprising people, say travelers, but organization is not their thing. In fact, state administrators seem bent on preventing anything from getting done. For example, if you wanted to buy a piece of desert in order to build a factory, Hernando de Soto [in his book, The Mystery of Capital] found that it took 77 administrative steps, involving 31 different government agencies -- a process that would take between six and 14 years to accomplish. How did these people ever build the pyramids, one wonders?

So, too, do visits to modern-day Greece and Rome bring question marks. Our recent visit to North America left us wondering, too. We are the “conquerors” now, says Michael Ledeen. “The French Revolution produced massive bloodshed, a world war, and then failure,” Ledeen opines. “The Russian Revolution produced bloodshed, then organized terror for three quarters of a century, then failure. The fascist revolutions in Italy and Germany produced a world war, the Holocaust, and then humiliating defeat. The Chinese Revolution killed more people than all the others combined, and China is still looking for a workable solution to its enormous problems. The American Revolution produced a great success, and we are still succeeding more than two centuries later.”

Americans believe they are pioneers forever... the same people who crossed the prairie in covered wagons, beat the British in 1814, and wrote the Declaration of Independence. Every man with a social security number believes he has the blood of Jefferson and Franklin somewhere in his veins...he sees no difference between himself and Daniel Boone, save the coonskin cap, and he imagines he is as ready as a Roosevelt to charge up San Juan Hill. “The things that will destroy America,” remarked this first Roosevelt, “are prosperity-at-any-price, peace-at-any- price, safety-first instead of duty-first, the love of soft living and get-rich-quick theory of life.”

On our trip across the lower 48 we found few of the lean, hard men cast in the mold of the pioneers -- at least, not in public life. America has moved beyond its founders, its visionaries and its grabby extenders. In their place is a race of flabby pretenders; as high-minded as modern Romans, energetic as modern Egyptians, and as disciplined as modern Greeks. Americans still value their independence; they are beholden to no one, unless he offers easy credit terms. In their unbecoming desperation to preserve their own soft lives Americans go along with almost anything. They stand in line while grandmothers are patted down at airport terminals and pretend it makes them safer... meanwhile, they squander the wealth, institutions and customs that took generations to build.

Now it is the century after the American Century. It is time for real challenges tossed by Fate in our path, like banana peels on the steps at twilight. Markets make opinions. But the bull market that so flattered Americans’ opinion of themselves and their prospects has come to an end. Since the U.S. stock market went mostly up from 1975 until 2000, it is a decent bet that it will go mostly down from 2000 until many of us are dead.

But if that were all there were to it -- that is, if we only faced a normal, regular, run-of-the-mill bear market cycle, we could sell our stocks, put our money in short-term Treasury paper, and relax. Unfortunately, this new cycle comes at a bad time...when a number of other longer-term cycles seem to have turned against us. As our friend Byron King puts it: “Debt, resource depletion, industrial decline and adverse demographics -- we are...on the cusp of a major set of changes in the world that will be as significant as the events of 1914-1918. ... What will be the trigger for things? Somebody will do something stupid and upset the whole matter...

Almost inevitably, living standards in America will fall -- relative to those of other nations. It is one of the safest, surest predictions we could make. Standards of living may fall, yes, but not necessarily quality of life. In the years ahead, Americans will be broken, buckled and bent -- but into a better shape.

Link here (scroll down to piece by Bill Bonner).
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