Wealth International, Limited

Finance Digest for Week of October 11, 2004


Why is it that people are so prone to buying high and selling low? Why was it that the flow of money pouring into dot-com stocks reached its apogee when the stocks were the most ludicrously overpriced? Nobel laureate Daniel Kahneman of Princeton and the late Amos Tversky of Stanford have given us a good sense of the phenomenon through what they called the Law of Small Numbers. This is the tendency of people to be unduly influenced by recent events or statistical outliers. Thus, if tech stocks had a burst of gains last year, the public raises its expectations for next year. Logically, you should expect the reverse.

Take the multitude of investors who followed one or two good calls of seemingly omniscient market timers like Joseph Granville, Elaine Garzarelli or Abby Joseph Cohen, only to fall into the abyss. By the same token investors typically rush to cash near a bear market’s end, when values are at their best and they should be buying bargain stocks. The Law of Small Numbers is in full force among mutual fund buyers. Many investors flock to funds with sizzling short-term performance. The media and the fund-ranking services fan the misbegotten enthusiasm by hyping current star performers and ranking these funds atop weekly lists.

The hot-hand syndrome is alive and well today. Once the bubble had burst, bond funds became the favorite flavor. Do not expect this to continue. Rising inflation and higher rates should dampen bond fund returns and investors’ spirits. Natural resource and commodity funds are other places not to be after recent sharp run-ups. They are very volatile, and over time their records are mediocre. For three years, until 2004, gold funds did brilliantly, then they dimmed. Nevertheless, you can find good funds with fine long-term track records and relatively low risks. They do not go for flashiness, just savvy stock picking that outdoes the S&P 500 by a comfortable margin.

Link here.


A big mistake investors make is spending too much time predicting the unpredictable -- like whether a company’s earnings next quarter are going to be 2 cents higher than the consensus -- while ignoring trends that are quite visible and that will have a huge impact on investment results. A prime example of such a trend: the rise of the consuming class in Asia and the dramatic increase in the quality of life that must inevitably follow. What with cell phones, cars, credit cards and houses within reach of millions of formerly impoverished Asians, this trend will not go away and will only grow stronger.

One way to capitalize on this underappreciated trend is to buy stocks in South Korea. A year ago I recommended Korean stocks as better values than Chinese issues. Since then the Korean Composite index, or Kospi, is up almost 14%, and China, depending on which index you use, is down between 4% and 8%. I am even more convinced today that the better bargains are on the peninsula. China’s need to recycle surplus dollars is creating a dangerous overvaluation in commercial real estate. Why are stocks cheap in South Korea? The primary reason is that consumer sentiment is weak. From a low of 280 in 1998, following the country’s near bankruptcy, the Kospi has recovered to 850. Yet in dollar terms Korean stocks are as cheap as they were 15 years ago.

One reason to look for a resumption in consumer confidence -- and spending -- is the strength of Korea’s export economy, due, in large part, to the deliberate undervaluing of the Korean won. Growing China and the consumption-happy U.S. are Korea’s largest export markets. As a result Korea enjoys solid job growth that puts cash in people’s pockets.

Link here.

Or is Korea the proverbial canary in the coal mine?

While financial markets have been relatively blasé about the unrelenting surge in oil prices, the global economy is not. Activity now seems to be sputtering in many segments of the world. That is true in Asia and Europe, although the US economy remains something of an outlier for now. But with oil prices at a flash point, resilience is likely to become an increasingly scarce commodity in a still-unbalanced and vulnerable global economy. The outlook for 2005 continues to darken.

Korea could be the “canary in the coal mine” -- an early warning sign of what lies ahead for an increasingly vulnerable Asian economy and an increasingly unbalanced global economy. The recent Korean data flow simply looks terrible. The data all smacks of an economy that is now on the brink of outright cyclical contraction. For the Korean stock market, which is now up 22% from its early-August lows, this could come as a rude awakening. Why dwell on Korea? For starters, Korea is Asia’s third-largest economy behind Japan and China. It has long been one of Asia’s most dynamic Tigers. Yet Korea now personifies all that is wrong with the Asian export-oriented growth strategy. To the extent that the China slowdown gathers force, additional weakening of Korean exports is likely. And that will only tip the risks of this externally dependent economy further to the downside. A further moderation in Chinese economic growth still seems like the best case to me. For the rest of externally dependent Asia, such an outcome would spell further deceleration in the months ahead.

Trends elsewhere in the world economy are hardly comforting. Germany, long the weak link in the Euroland growth chain, has taken yet another worrisome turn for the worst. Even the U.K. now seems to be slowing. Finally, in the US, while the GDP seems OK, the quality of the increase does not. That is especially the case for the increasingly beleaguered and oil-shocked American consumer. I do not think it is a coincidence that signs of weakness are now popping up all over the world. I continue to hold the view that the oil price has to remain around $50 for at least three months to qualify as a legitimate shock; so far, it has been only about two weeks. Meanwhile, the early warning signs of a cyclical downturn in the global economy are increasingly evident. A China-centric Asian economy is leading the way, and Korea appears to be first in line.

Link here.


With 2004 we have a forgettable year for investment returns but a vintage one for financial anniversaries. A half-dozen milestones in the stock and bond markets command our remembrance today. First light a candle for the 75th anniversary of the 1929 Crash. The actual killer was the postcrash bear market. Between the recovery highs in the spring of 1930 and low ebb in 1932, the Dow Jones industrials lost 86%.

In 1954, to commemorate the Dow’s return to the heights of Sept. 3, 1929, John Kenneth Galbraith published The Great Crash, a cautionary tale on stocks couched as popular history. With a little more foresight, Galbraith could have written a predictive work entitled The Great Bull Market, since the averages were, indeed, poised for liftoff. Famously, people are bullish at the top and bearish at the bottom. They were bearish to the point of revulsion 20 years later, in October 1974. The Dow had peaked in 1966. The Vietnam War, a dollar crisis, virulent inflation, a recession and a presidential resignation had conspired to make a multibillion-dollar gift to Warren Buffett. “How do you feel?” Forbes asked the Sage of Omaha as the Dow was making a final, sickening low. “Like an oversexed guy in a whorehouse,” the master replied. “This is the time to start investing.”

Monetary anniversaries also dot the 2004 calendar. Foremost among them is the Federal Reserve’s 90th. Have you sent Alan Green span a birthday card? Save the postage; don’t encourage him. The Fed is in the dubious business of price-fixing. Or rather, interest-rate-fixing. As well, this year marks the tenth anniversary of the 1994 Fed tightening campaign -- instigated in order to kill the sharks of inflation. Scroll forward now to 2003. Why did the Fed cut its rate? To kill the shark of deflation. By June 2003, when the bond market stopped rallying, the yield on the ten-year stood at 3.1%, the funds rate at 1%. Here were emergency yields, unseen in America for a half-century. But what was the emergency?

Because I view the early-2003 bond rally as a government manipulation, I doubt that the ten-year will soon return to 3.1%. In fact I believe that the bond bull market that began in 1981 (at a yield on the 30-year of almost 15%) ended in mid-2003. You could have lit another candle: June marked the first anniversary of the new bear market in bonds.

Link here.


Michael Winer, manager of the Third Avenue Real Estate Value Fund (assets: $1.3 billion), sees something better for investors than real estate investment trusts: real estate operating companies. Real estate operators differ from the more familiar REITs in that they pay taxes (albeit not much, thanks to depreciation). The operators are exempt from the rule demanding that REITs pay out 90% of income. So the operating companies need not borrow or dilutively sell more stock to raise capital for new investments. To Winer, this makes them the better bet for long-term capital gain. The payoff for his fund: a five-year annualized return of 20% versus -2% for the S&P 500.

Winer, who previously worked in real estate development, says his favorite investments lie where the opportunity for growth extends far into the future. That is why he likes St. Joe Co., which owns 820,000 acres in northwest Florida, 2.4% of the land in the state. “This is a company that will be developing this land for the next generation or two,” says Winer. A good buy, he says, even at 39 times expected 2005 profits. Winer also likes Forest City Enterprises, a real estate operating company which focuses on large mixed-use urban developments such as the new Atlantic Yards project in Brooklyn. Winer also invests in financially troubled companies with a real estate angle, such as Kmart Holding. Even if the retailing business craters, Kmart still has valuable real estate, which Deutsche Bank analyst Louis Taylor estimates is worth $150 a share, vs. its recent price of $86.

Link here.


The benchmark S&P 500 has barely budged in 2004. How can you make money in the market if stocks sit idle for the balance of the year? Max G. Ansbacher has an answer, albeit a risky one: Sell option contracts on the S&P 500 and collect the purchase price (called the premium), expecting the options to expire worthless in a gridlocked market. Yes, you can make money doing this. But it is definitely not one of those investment strategies to bet your kid’s college tuition on.

Ansbacher sells only short-term calls and puts -- expiring in six weeks or less -- that are out of the money. Ansbacher, 68, thinks the investment climate is so iffy that the flat market will persist for the next few years. His gamble is far from unreasonable. Three-fourths of option contracts expire worthless. That is why, if you are selling options, you are likely to wind up with a succession of small profits punctuated by the occasional big loss. For individual investors, Ansbacher’s strategy is doable but hazardous.

Ansbacher’s options are not covered. They are, in the lingo of Wall Street, naked. When he loses a bet, he buys back the option at a loss. Big market moves do truly horrible things to naked sellers. If the market takes off and they sold calls, they get stuck having to buy expensive shares to hand over to the buyers. If the market tanks, sellers of naked puts wind up losing the difference between the strike price and the spot price. That is what happened to many giddy put sellers in the 1987 crash.

Link here.


There is more to corporate performance than what you see in the earnings reports. Could an investor have anticipated the trouble at companies like Enron, Adelphia, WorldCom and Tyco by looking more closely at how they were governed and how they kept their books? Their problems, to be sure, are far more visible in hindsight, but nonetheless each left telltale signs that all was not well. Robust reported earnings growth at both Enron and WorldCom was not supported by hard cash. The Adelphia board was stacked with company insiders who turned a blind eye to self-dealing by company executives. Tyco’s chief executive raided the company’s coffers, and its P&L statement was plagued by constant writeoffs. In this, the third report in our Beyond the Balance Sheet series, we provide shareholders with scorecards on corporate integrity and earnings quality for the 30 largest U.S. companies based on market capitalization.

The integrity measure rewards companies with underpaid bosses, outsider-dominated boards and a history of responsiveness to governance proposals from shareholders. It docks those with antitakeover defenses, problem directors and legal or regulatory problems. The earnings-quality grade rewards companies for having high sums of operating and investing cash flow relative to reported earnings. It penalizes those with lots of nonrecurring charges or a habit of falling short of Wall Street earnings expectations. As the recent accounting debacle at Fannie Mae shows, how a company keeps its books is just as important as how it is governed.

Link here.


William (Mickey) Harley III is a vulture, investing in troubled companies that are in Chapter 11 or are trying to avoid it with an out-of-court restructuring. Unlike the average investor, money manager Harley has enough weight to influence a company’s reorganization. Running the $1.2 billion Mellon HBV hedge fund, he has the clout to push negotiations his way. You cannot easily duplicate his moves, but you can pick at some of the carcasses he has found.

In 1999 Harley founded the hedge fund, which he sold in 2002 to Mellon Financial. He puts 10% or so of the portfolio in distressed equities. The rest is in merger arbitrage, convertible bond arbitrage and what he terms “special event investments”, basically any opportunity Harley sees to make money. Like all hedge funds, this one is expensive: Mellon takes 1% of assets annually plus 20% of gains (minimum investment, $1 million). Also, it does not reveal performance data. But who says vulture investing is just for hedge funds? A handful of mutual funds specialize in distressed securities. The difference between a hedge fund and a mutual fund is the latter has lower fees, must publish its performance data and must offer easy redemption. Some tips for would-be vulture investors follow.

Link here.


The bad news for oil consumers is that global demand has been growing at 1.5% a year over the past five years, while production capacity has been inching ahead at 0.2%. That squeeze all but wiped out the industry’s spare capacity and caused a spike in prices. The good news is that the zooming prices have gotten the attention of oil producers. It is preposterous to say that the world is running out of energy. It is only running out of cheap energy. There is plenty of the expensive stuff.

Link here.

US developers see hope in abandoned oil wells.

The US sits on 3% of the world’s proved oil reserves and accounts for more than a fifth of global consumption, making nonsense of the “energy independence” stances of both presidential candidates. But it has spare oil a-begging. While no large discoveries have been made outside Alaska and the deep waters of the Gulf of Mexico for decades, there is a rich resource to be tapped in the form of abandoned wells, which experts estimate could hold 377 billion barrels -- more than double the cumulative US production to date.

Professor Kishore Mohanty at the University of Houston estimates that as much of two-thirds of the oil contained in mainland US reservoirs has been left behind because it has proved too difficult or expensive to extract. But technological advances and a sustained run of high oil prices has attracted smaller companies to develop assets dropped and sold by the majors in states such as Texas, Oklahoma and Kansas. “What is left behind would be their crumbs, but our seven-course meal,” says Jeff Johnson, chairman and chief executive of Cano Petroleum, a small Texas-based independent that develops mature fields.

Oil is held within porous rocks rather than in convenient pools. Traditional flushing with water leaves much of the oil behind, stuck to fractured rocks. The technology to improve extraction rates has been around since the 1960s. Heavier oils can be dislodged through heating, while gases such as carbon dioxide can be used to flush out oil more effectively than water. And chemical polymers can help seal rock fissures and allow oil to be pumped. Mr. Mohanty suggests it could make sense to site power stations in such mature fields, with greenhouse gases such as CO2 pumped into the ground to extract oil rather than into the atmosphere.

Link here.

When it comes to investing in energy companies, there is no place like home.

In a world of increasingly volatile geopolitical tensions, we have argued for months that domestic supplies of oil and gas will become increasingly vital to the well being of the U.S. economy. That is why we recommend stocks like Suncor Energy, a company that literally “mines” oil from tar sands in Alberta, Canada. Despite the unusual geological nature of Suncor’s reserves, its “syncrude” refines into gasoline and jet fuel just as well as Saudi oil. The one important difference between these two versions of crude oil is that Suncor’s sits right next door in Canada, not halfway around the world in the middle of the Arabian geopolitical tinderbox. Moreover, Suncor’s reserves are not inconsiderable.

Suncor is but one example, albeit a unique one, of a company possessing large North American oil reserves. Finding companies with domestic oil reserves is not too difficult, but finding companies with considerable and/or growing reserves is very difficult indeed. Here is why: North America has been “drilled out” and substantial finds have become virtually impossible to find. More exploratory holes have been drilled in the continental United States than in the rest of the world combined. The Lower 48 United States oil discovery rate hit its maximum in 1957; proven oil reserves peaked five years later in 1962 and have been diminishing ever since.

Because high-quality companies in the oil stock sector have been lagging behind the strong rallies in both oil and gas, we think the timing has never been better to snap up the shares of companies with large North American reserves. E.g., natural gas prices have soared more than 260% over the past year and a half. Meanwhile, the XNG Index of natural gas stocks -- which consists of 15 major gas producers -- has actually declined over 8% over the same period!

Over the last few months, we have tipped off our subscribers to several opportunities in the North American oil and gas sector. One example is Petro-Canada, a company that is set to become Canada’s largest petroleum producer. Talisman Energy is a different sort of play on domestic oil. The company recently unloaded its problematic oil properties in the Sudan, to re-focus its efforts on properties back home in North America. At the beginning of 2002, Talisman had proven reserves of 1.5 billion barrels of oil equivalent (boe), up 26% from the year before. More of it is tucked safely beneath the Western Canadian foothills and prairies. When it comes to investing in energy companies, we strongly believe that there is no place like home.

Link here.


Faced with desperate times for investment returns, buyers of stocks and stock mutual funds might turn to a desperate remedy -- growth of dividends. It is a creaky old idea, hopelessly unsuited to a world of short attention spans. Yet circumstances may force a revival of interest in it among investors. Prospects for growth via rising stock prices are certainly open to question. At about 20 times the latest 12 months’ earnings, doubters say stock prices as represented by the Standard & Poor’s 500 Index are still too high to offer more than sketchy hopes for capital gains. With an aggregate yield of about 1.7%, current income from the stock market is also scarce.

The main alternative asset classes do not look much better. A check shows taxable money-fund yields averaging 1.13%.Bond market yields remain stubbornly low: Early this week the yield on the 10-year Treasury note stood at 4.13%, down from 4.87% in mid-June. Let’s not even talk about real estate, where years of soaring prices can give anyone mean-reversion nightmares. “One of the primary rules of investing is that the returns on capital are highest where capital is scarce,” said Richard Bernstein, chief U.S. strategist at Merrill Lynch & Co. “However, because of the Federal Reserve’s repeated encouragement to investors to take more and more risk, there is no asset class today that is starved for capital.”

Amid all the inflated figures, one number stands out as lower than usual. That is the dividend-payout ratio, or the percentage of corporate earnings being passed along to stockowners. Companies of the S&P 500 are paying out about 34% of their earnings in dividends, which is rock-bottom by historical standards. Typically in the six decades since World War II, the ratio has hovered between 50% and 60%. Dividends would increase almost 50% -- and yields rise to about 2.55% -- if companies merely went back to the old practice of paying out half their earnings. Recent changes in the U.S. tax laws have accorded the same favorable tax treatment to most dividends that capital gains enjoy.

This is slow-motion stuff, and we are unlikely ever to see a mania over rising stock payouts. Then again, the investment world is probably due for a good long respite from manias anyway. Dividend growth is worth more attention than it gets.

Link here.


Concorde America soared on the wings of a misleading press release to a market value of roughly $1 billion even though the company itself consisted of nothing but an answering machine in the Boca Raton, Florida home of a 75-year-old ex-stockbroker who had been barred from the industry for the past 30 years. Just so you know how the SEC is spending your tax dollars, the agency promptly, and dutifully, opened an “investigation” into trading in Concorde America’s uber-hyped shares, while bizarrely permitting the shares themselves to continue to trade -- an arrangement not terribly different from walking into a liquor store in the process of being robbed, and dealing with it by launching an investigation into whether a robbery was in fact taking place.

Eight weeks later and, predictably enough, nothing has happened -- except of course that the price of Concorde’s stock, the target of an apparent pump-and-dump effort by somebody, somewhere, has collapsed from $10 to $2.42, while the SEC has retreated behind that smothering wall of “no comment” that descends every time the agency begins one of its so-called investigations.

Nowhere is over sight more needed -- and less actually being provided -- than in the penny stock market, where promoters can legally sell stock to the public from companies so small, obscure and financially troubled that they never issue information about themselves, financial or otherwise, to the SEC, the public, or anyone else. The hyping is done by promoters who are typically paid thousands of shares of stock to write up “research reports” on one company or another, praising its prospects to the moon. Then the stock starts to climb, and the insiders start to sell out, eventually causing the price to collapse, which is why the scam is referred to as a “pump and dump”.

Link here.


The image of investment clubs is about as down-to-earth as they come. Think grandmas, or the once hugely popular Beardstown Ladies, gathering in a living room to pool their money and buy shares in favorite products or stores, like Hershey Foods or Costco. But the top executives of a group that promotes stock ownership and investment clubs now finds itself in a steamy mess of charges involving whistleblowers, a Senate committee investigation into six-figure salaries and country club memberships for executives. The U.S. Senate Committee on Finance began investigating the NAIC after being contacted by a whistleblower at the group last spring. The committee is looking into other tax-exempt groups nationwide. Key concerns: Are pay and benefits for top NAIC officers out of whack? Are contracts being offered to old friends without competitive bidding? And do many of the costs make sense in the post-bear market world? Another concern: The NAIC was granted not-for-profit, tax-exempt status only in 1997. It had been a for-profit operation.

Making a lot of money and driving a fancy SUV alone are not criminal acts, but this news is troubling, especially after the big scandal in mutual funds, which also claimed to look out for little investors. The NAIC has been around since the 1950s, and chairman emeritus Thomas O’Hara Sr. practically had cult status among regular investors. What makes the picture look even worse is that the financial picture for the NAIC has not been all that great. Revenues and membership have been falling.

The investment club has served as an introductory course to stocks, sort of Stock Picking 101. Individuals pay $19 to $44 a year to belong, depending on the type of membership. The NAIC then provides investment guidance through software, a monthly magazine, annual conventions and other resources. But the reality is that many people, whether they had a broker or picked stocks on their own, soured on stocks after losing money in 2000, 2001 and 2002. The NAIC had more than 550,000 members, including people belonging to investment clubs and individuals, just five years ago. It has about 250,000 now.

Link here.


Bill Miller, one of the most successful US stock investors, is teetering on the brink of breaking the longest winning streak that the investment world has seen in recent decades -- his own. The 54-year-old former research analyst has achieved fame as the only money manager ever to have beaten the Standard & Poor’s 500 index for 13 years in a row. Few funds beat their benchmark index over even short periods of time. With only three months of the year left, Mr. Miller, a longtime value investor who heads the fund management division of Legg Mason and also manages the $15 billion Value Trust, is trailing the index by about 4%. However, he has been badly trailing before, and pulled through.

In some characteristically big plays, Mr. Miller last week revealed he had bought 12% of the stock sold in the recent Google IPO. That holding, the biggest IPO investment he has ever made, is up by 60%. And he forcefully called on another of his big holdings, Barry Diller’s InterActiveCorp, the internet company, to undertake a stock buyback to lift its lagging share price -- to no avail so far.

Mr. Miller has left many value investors, who traditionally cling to out-of-favor industrial sectors such as paper and chemicals, aghast at his enthusiasm for technology stocks. His portfolio, which at only 34 stocks is unusually small for such a large pot of money, is heavy with holdings in Amazon.com, which has also slumped this year, Nextel and eBay. He began buying companies such as IBM, Dell and AOL in the early to mid-1990s. But Mr. Miller is in the traditional value investors’ mold in his strict adherence to a lengthy research process.

He hardly buys any stocks, and holds them for years. He has only bought three companies this year: Google, Electronic Arts and Countrywide Mortgage. He sees few valuation anomalies in the market at present, making for few good opportunities. However, he believes the bear market ended in March 2003 and we are in the early stages of a bull market. He believes that an area that jumps out now in terms of value is the big financials -- JPMorgan Chase, Citigroup, etc. Hedge funds form one asset class he does not consider great value. “It’s not an investment strategy. It’s a compensation strategy,” he says, referring to hedge fund managers’ high fees.

Mr. Miller has an academic’s dispassionate rigour for assessing his mistakes. “Our most significant mistake in the past year was not getting any energy stocks. We looked at it, but didn’t act. Also, we thought the market would consolidate this year, and we decided to sit tight instead of cutting back on some of our big names like Amazon and Nextel. That was a mistake because they went down. But generally speaking, our mistakes are that we stick too long with companies whose economics may not be as good as we originally thought. It’s a strength and a weakness of value investing, to be patient.”

Link here.


For the last few months, we have argued that U.S. economic growth was more likely to disappoint on the downside than surprise on the upside. We therefore recommended initiating trading positions in long-term U.S. government bonds, which were at the time oversold and almost totally out of favor. We also felt that, contrary to expectations, a weakening U.S. economy was likely to strengthen the dollar, as the foreign exchange market would begin to discount trade and current account deficits, which were likely to be less ominous than was widely expected. Our view was largely based on the sharp deceleration in the growth of U.S. monetary aggregates.

The 12-month rate of growth in M2 is, at 3.6% year over year, at the lowest level since 1995. As a result of the decline in the rate of growth of money supply, “excess money”, as defined by the growth in money supply in excess of nominal GDP, has also plunged over the last 18 months. The impact of decelerating money supply growth is not only leading to disappointing economic growth figures, but usually also precedes a poor, or at least indifferent, environment for equities. But as long as money supply growth continues to be muted and, ideally, decelerates, the U.S. dollar has further recovery potential. And while I admit that I cannot see anything particularly positive about the U.S. dollar, I feel that the euro has, for now, even worse fundamentals and could, as a result, break down against the dollar.

With regard to bonds, we continue to be reluctant holders of U.S. dollar bonds. Bonds are no longer oversold the way they were two months ago, but should the economic news continue to deteriorate, as we expect, a further simultaneous advance with the U.S. dollar seems likely. In addition, weakness in consumer durable stocks, such as General Motors, and the ultimate discretionary spending beneficiaries, such as Coca-Cola and Starbucks, do not augur well for consumers’ staying power or for the entire stock market. What I find most remarkable about the most recent weakness in consumption is that this weakness coincided with another upside explosion in consumer loans. To me this smells like desperation!

Given these unattractive fundamentals, I would use any strength in equities as a selling opportunity. Still, I am also reluctant to be overly negative about equities and to sell them short too aggressively. Turning to commodities, we note that some prices have come off rather abruptly. Soybeans are a good example of what happens when the Chinese suddenly step aside from their normal buying pattern. Of our recommended breakfast commodities, sugar and coffee have recently entered a correction phase. (Coffee, however, seems to have again stabilized and is likely to resume its bull market.) In the meantime, it looks as if orange juice has made a major low and we would use any weakness to add to positions.

We still remain confident that oil prices will rise in the long run, as demand is likely to continue to increase, while supplies will level off or decline. However, prices may have temporarily overshot, and some caution is in order. Oil shares have not confirmed the most recent strength in oil prices, and this negative divergence should raise some concerns about the potential for immediate further price gains. In general, I see limited opportunities for large capital gains with low risks.

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


On October 2, some 200,000 Dutchmen poured into the streets of Amsterdam to protest against cutbacks in welfare benefits. The government, they claimed, violated the “Dutch model” which dictates that any big social reforms must be first negotiated between the government, trade unions and employers, and then implemented only if there is a consensus. The protests were the biggest show of public dissatisfaction in two decades. And here is where it gets interesting. A month-and-a-half earlier, the Dutch AEX hit a new low for the year. It had also been falling in the two weeks leading up to the demonstration, finally bottoming on September 28, just four days before the protests.

Coincidence? Not likely. Our regular readers know that Elliott waves are much more than just a chart pattern. The ups and downs (or waves, as we call them) that make up any market chart actually represent something: changes in social mood. When a society’s mood is optimistic, investors buy stocks -- and charts turn up. When collective optimism recedes, investors sell -- and the charts reverse direction. A chart of the AEX, for example, tracks changes of a very broad collective psychology -- perhaps that of the entire Dutch society. And the falling trend in the AEX for most of 2004 indicates that the Netherlands as a whole had not been feeling very happy. Those collective emotions were literally on the streets during the October 2 protests.

Moreover, the stock market is also the most sensitive indicator of the changes in social mood. When the broad mood deteriorates, stocks fall first -- before the same negative collective mindset begins to translate into “bad” events and news headlines.

Link here.


As the odds of a full-blown oil shock rise, we have little choice other than to cut our global growth forecast. Our first revision is a relatively small one: We are reducing our 3.9% estimate of world GDP growth for 2005 by 0.3 percentage point to 3.6%. Yet there is more to this revision than meets the eye. This relatively modest cut to our annual growth numbers masks a worrisome shortfall we now anticipate in early 2005 -- a shortfall that pushes the global growth rate down to its “stall speed”. History tells us that is a very precarious place to be -- it does not take much to tip a stalling global economy into outright recession. As I see it, that remains the major risk as we peer into 2005. By region, our forecast cuts are pretty much across the board.

With the growth dynamic of an increasingly precarious world veering toward its stall speed in early 2005, recession looms as a distinct possibility, in my view. The recession call is always the toughest call for any forecaster. Turning points in the oft-fickle business cycle can arise for any one of a number of reasons. Economies that are growing rapidly possess a cushion of resilience that enables them to ward off the unexpected blow. By contrast, economies that are inching ahead at their stall speed lack such a cushion and, as a result, are far more vulnerable to even the slightest of shocks. The precondition of vulnerability is invariably the decisive ingredient of any recession call -- precisely the reason I am so worried today. As the odds of a full-blown oil shock rise, the prospects of outright global recession in 2005 loom more and more likely, in my view. Our forecast revision is a nod in that direction. The risk is there will be more cuts to come. An unbalanced global economy is now in the danger zone.

Link here.

In danger of a global recession?

Remember the theme song to Top Gun? Morgan Stanley’s chief economist Stephen Roach titled his latest missive “Danger Zone”, and now I cannot get the darn tune out of my head. Unfortunately, no other title is more befitting a report on the tenuous state of the global economy. The main catalyst for his downward growth revisions is energy. Mr. Roach expects toda’qs $50-plus-a-barrel oil to drag down growth in early 2005.

Many analysts dismiss oil as “shocking” because it has yet to reach the levels of the early 1980s in inflation-adjusted terms. “Macro tells us that price changes matter more than levels,” Mr. Roach says. “At $50, the real oil price is fully 66 percent above the average that has prevailed since early 2000. Tha’qs a shock in my book”q

Link here.


There are bunches and bunches of quantitative measures used, and abused, to gauge the health of the Silicon Valley economy. Tech stock prices, local real estate sales prices and volume, mortgage rates, local employment opportunities, latest retail prices for electronic gadgets, etc. are all readily available. There is even a monthly table showing a broad array of Santa Clara County’s local statistics. A couple weeks ago, local pundits raised their cheerleading profile by reprising the “traffic is up”, therefore the economy must be “better” mantra. Unfortunately, there are no real-time (or even near-time) quantitative measures of local traffic.

Actually, I have developed my own system. I go around asking people, “So how’s business?” Overlooking my grammatical imperfection, the results are often interesting. It appears real estate still sells briskly in the Palo Alto area. With real estate sales strong, you would think moving companies are slammed. Back in late June, one major moving company told us they were “sold out” for July. More recently, they were only too happy to compete for our business. We then went shopping for a new desk at a local office supply store. How was business? “Really slow, the warehouse guy said. The CableTV technician said his activity level has really slowed down.

The final poll results: Real estate is still strong. Auto maintenance is steady. Moving companies, office supplies, the cable company, the phone company and local tire store are all slow. How long this divergence can last is anybody’s guess. How it will end is a little easier to imagine....

Link here.


The first big city to boom was London, starting around 1996. Boom mentality spread to Los Angeles, New York and Sydney around 1997, to Paris in 1998, to Miami, Moscow and Shanghai in 2001, and Vancouver around 2002. These and other cities have been booming pretty much ever since; real estate prices in most are up at least 50% in real terms since 2000. This has been a big windfall to homeowners, but has hurt anyone planning to buy.

But growth in home prices is now weakening in some of these cities. The rate of price growth in London and New York slowed sharply over the past year -- to only about a 1 percent real increase in the second quarter of this year. In Sydney, home prices actually fell in the second quarter. Has the boom ended? Will no other cities benefit? Worse still, could the mood in housing markets soon lead prices downward?

No one predicted this boom, so predicting its end is risky. Housing prices have shown tremendous upward momentum in the face of previous warnings that the party is over. Any prediction concerning the boom’s end requires understanding why it occurred in so many places. Surprisingly, there is no well-received explanation, because this boom’s ultimate causes are mostly psychological. Regular economic factors like interest rates are simply not adequate to account for the recent booms.

Three psychological causes stand out: first, a change in people’s perceptions about the source of value in a changing world economy; second, increasing public faith in “glamo”q cities with international name recognition; and third, the plain giddy dynamics of speculative bubbles. Each factor deserves greater attention if we are to understand current housing market conditions and discern future price trends.

In contrast to the other two psychological causes, speculative contagion has a natural end. A speculative bubble, sustaining itself solely by reaction to price increases, cannot go on forever. So, where does this leave us? I am betting that some high-flying glamor cities will continue to see decelerating growth in home prices -- and eventually decreases. Prices in glamor cities are likely to drop sharply the next time there is a serious recession, or if the local economy suffers a severe shock, or if interest rates rise too fast. Then, contagion within and across markets can work in a downward direction, propelling prices lower for years.

Link here.


The Daily Reckoning wrote this week, “Greenspan’s low rates lured consumers to buy bigger houses and bigger cars. Now they’re paying nearly $2 for gasoline... and hoping the winter is not too cold.” Consumers had better do more than hope. They had better get some religion and start praying. I had a gas-driller in the office today to sign a few documents. We started talking oil patch. In his own words...

“... Yes, we are being paid more for the gas we sell, but it is costing us more in every way to get it out of the ground and to the wellhead. And then, it goes into the gathering system and a lot of our gas is piped directly to an electric utility for base-load power production. Unbelievable! We go to all that work and expense to find, drill, and produce that gas, and then it gets burned up to spin a turbine to push electrons through a power line, with all the net-energy loss that occurs along the way. And then people use the electricity to keep the lights on in empty rooms. Our economy is just chock-a-block with the wrong economic incentives. And most people don’t even have a clue. Our grandchildren will hate us.”

And, predicts your man in Pittsburgh, our grandchildren will hate Alan Greenspan. As the yoga teacher says... “Think of a happy place.”

Link here.


Renewed weakness in the U.S. economy has hardly come as a surprise to us. It is the inexorable outgrowth of an economic recovery that has been of highly dubious quality right from the start. The U.S. economy is plagued by an extraordinary array of growth-impairing imbalances: a record-high trade deficit, a record-high budget deficit, record-high household indebtedness, record-low national saving and asset price bubbles supporting record-high consumer spending.

Any other country faced with these monstrous domestic and external imbalances would have endured panicky capital flight and a collapsing currency, forcing its central bank to drastic monetary tightening. But the U.S. central bank and the dollar were spared this fate because the central banks of the Asian surplus countries stepped in, accumulating any amount of dollars needed to avoid an undesired rise of their currencies. These huge and soaring dollar purchases by foreign central banks were crucial in allowing the U.S. Federal Reserve to pursue its ultra-loose monetary policy with ultra-low interest rates.

In our view, it is bad policy on both sides. The Asian central banks accommodate the credit excesses in the United States, and in doing so, fuel rampant credit excesses in their own countries. Japan’s horrible aftermath over more than a decade after its credit excesses in the late 1980s does not seem to deter anybody. The United States, on the other hand, is losing jobs to Asia. The result is an unprecedented symbiosis between the two continents: The Americans borrow and consume, and the Asians produce.

The success or failure of the massive monetary and fiscal stimuli over the past few years is one of the most controversial questions about the U.S. economy. Using the previous six postwar U.S. business cycles as a measure, the U.S. economy’s performance during the last two to three years has been by far the poorest ever, despite the unprecedented amount of fiscal and monetary stimuli. Even more important is the further question of whether or not the economy has gained the “traction” it needs for the recovery to become self-sustaining and self-reinforcing without further artificial monetary and fiscal stimuli. In past cycles, the usual vigorous traction used to come mainly from pent-up demand that had accumulated during the recession. Key to the present subpar recovery has been the exact opposite -- heavy consumer borrowing from the future. And a growing part of domestic spending exits to foreign producers, fueling the U.S. trade deficit, instead of U.S. domestic production.

Link here.


Years ago there was a controversy with respect to a game show where the host offers you the opportunity to win what is behind one of three doors. Typically there was a really nice prize (e.g., a car) behind one of the doors and a not-so-nice prize (e.g., a goat) behind the other two. After selecting a door, the host would then proceed to open one of the doors you did not select. It is important to note that the host would NOT open the door that concealed the car. At this point, he would then ask you if you wanted to switch to the other door before revealing what you had won. Apparently, in response to a newspaper column written about the show, a reader posed the following question: “Is it to your advantage to take the switch?”

This problem was given the name The Monty Hall Paradox in honor of the long time host of the television game show “Let’s Make a Deal”. The columnist’s answer to the reader was that the contestant should switch doors and she received nearly 10,000 responses from readers, most of them disagreeing with her. Several were from mathematicians and scientists whose responses ranged from hostility to disappointment at the nation’s lack of mathematical skills. [Ed: The columnist is, in fact, correct.] In the real world, of course, the Monty Hall Paradox is even worse because while behind one door there is nothing, and behind another door there is a nice prize, behind the final door is an absolute ogre who will devour both you and your investments.

If our nation’s lack of mathematical skills were evident back then, why should it not surprise us that behind today’s Door #1, Gift Giving by the Government, it is hard to resist as policy even though the “gift” comes from taxpayer money. However, the really big money gifts, behind Door #2, are handed out by the world’s central banks. In the financial markets, this money is gifted to those participants who are bright enough to take it when it is offered (savvy investors who don’t bother to listen to Wall Street’s relentless sales pitch). With this really big money behind Door #2, individual investors should take the money, lock Door #3, and run for their lives. In other words, selling your stock and bond portfolios and getting out is a wise thing to do. Opening Door #3 is what will happen when the foreign central banks stop buying dollar denominated assets. Behind that door is a crash, not a gift. As a prudent investor, opening the right door is as vitally important as not opening the wrong door.

Life was much simpler when investing offered a prize behind a door, and no loss behind the other two doors. Today, your Monty Hall choices are: Door #1 -- Stocks and Bonds that will give you a big loss; Door #2 -- Cash which looks like it will not give you a loss but actually will, as the dollar devalues; and Door #3 -- Foreign currency, precious metals and short positions in bonds and stocks that can offer large gains. Listen to Monty Hall but watch the activity of the world’s central banks carefully before contemplating which door to pick.

Link here.


PIMCO bond-fund manager Bill Gross has done it again. With his October investment outlook, titled “Haute Con Job”, Gross has taken on the government’s statisticians and Fed Chairman Alan Greenspan. He accuses them of purposefully underestimating inflation to make the economy look stronger than it is and keep Uncle Sam’s costs artificially low. In the two weeks since Gross’s thesis appeared, critics have roared, government statisticians have laughed out loud, academics have expressed disbelief, and portfolio managers have scratched their heads. But everyone has read it.

Gross struck a nerve because he offers an explanation for what seems to be a growing point of confusion among the general public: Why are personal expenses rising so quickly when the government’s consumer price index is rising at just 2% to 3% a year? According to Gross, the government is “fudging on inflation” by adjusting many of the prices that go into its calculation for improvements in quality. Gross also says the feds are adjusting for the fact that if the price of beef goes up, people eat more chicken. Due to these adjustments, Gross figures inflation is really about a percentage point higher and GDP about a percentage point lower than official statistics.

For most economists and portfolio managers, however, Gross’s arguments are pure heresy. While Gross has raised wrath and even ridicule, he deserves credit for addressing head-on a central economic paradox that many ordinary folks are wondering about.

Link here.


The number of pre-announcements over the past couple weeks has accelerated. The ratio of negative pre-announcements over positive announcements has increased to 2.1 from 2.0 at the beginning of the month and only 1.8 at the beginning of August. Earnings growth estimates have slipped to 13.0%, down from 13.8% at the beginning of October. Only about 10% of the S&P 500 has reported third quarter earnings. As the rest of the companies report earning over the next two weeks, investors should gain more clarity on business conditions and the prospects for the rest of the year.

Link here.


Last week the EC took an historic decision that will fundamentally transform the EU, when it recommended that the 25 nation body begin membership talks with Turkey. A final decision needs to be taken by member states on December 17, but the unanimous recommendation of the Commission, coupled with the stiff conditions for membership (which in any case will take years to resolve) means that approval by existing members is almost a foregone conclusion. The accession of such a large, poor, and predominantly Islamic country will fundamentally change the character of the EU, and it would extend the EU’s borders into one of the world’s most unstable and dangerous regions.

The manner in which the EU functions economically will also have to alter significantly, especially in the area of farm policies (33% of all Turkish workers are in agriculturally-based industries, versus 5% in the EU as a whole), fiscal policy, and indeed, the newly promulgated Constitution. If accession talks prove successful for Turkey, one of the first casualties -- which should be celebrated by supporters of a multi-speed Europe -- will be the end of the centralising impulse toward “ever closer Union”. This tendency, pushed by political elites of the EU, has increasingly generated political backlash, manifesting itself throughout Europe through the growth of extreme nationalist, quasi-fascist parties.

The euro was launched in the face of substantial regional disparities amongst the 12 founding member countries (both in terms of unemployment rates and per capita income levels). The problems would increase 100-fold in the event that a country like Turkey was involved in monetary union. Some of the original member states, such as Germany and France, who long saw themselves as the apex of the EU, but now find their influence dissipated through the recent entry of 10 new Eastern European nations, are now likely to embrace a more flexible political structure, which would allow some countries to deepen economic and political co-ordination. All to the good for the euro, we would argue, since it reduces the likely introduction of more members to the euro bloc (particularly those from the East), an entry which could have proved highly destabilizing to the currency union.

If the Turks had better secular education and more incentives to lead secular modern lives, as they undoubtedly would do as part of the EU, they would be less susceptible to the fundamentalist mosques that infect other parts of the Middle East such as Saudi Arabia. From Europe’s perspective, the negotiations will undoubtedly force the EU to lance the boil in terms of confronting inefficient or unworkable structures, such as the Common Agricultural Policy, the proposed constitution and the Stability and Growth Pact, all of which threaten the long term viability of the European Monetary Union. The risks must be measured against the benefits cited above and most importantly, the ultimate hope that a tolerant and democratic Turkey really could become a beacon for rational, moderate Muslims around the world, the ultimate way of winning the so-called war on terror and avoiding a genuine clash of civilisations.

Link here.


“Forgive me if this sounds crass, but it’s true. Disasters like Hurricane Andrew and 9/11 are exactly the type of big, ugly misfortune that creates Extreme Value opportunities.” Those words appeared in the letter I wrote to subscribers in January of this year. I went on to describe how an opportunity to safely double your money over the next few years was created by some of the worst catastrophes in history.

Hurricane Andrew struck in 1992, causing record insurance losses of approximately $22 billion. That record stood until 9/11, estimates for which top $50 billion. Then came the summer of 2004. Hurricanes Charley, Frances, Ivan, Jeanne and Tropical Storm Bonnie all hit Florida in a 48-day span. More than one in every five Florida homes has sustained some type of storm damage. Bob Hartwig, chief economist for the Insurance Information Institute, estimates the four hurricanes that made all the headlines cost $21.7 billion in insured losses -- 7 1/2 times the mean loss for hurricanes striking the continental United States between 1900-2002.

But $21.7 billion is not the whole story. The storms that have made headlines are not half of what took place this year. Jay Fishman, CEO of St. Paul Travelers Companies, says losses from this year’s hurricane season now rival those seen after 9/11 -- in all about 15% of one year’s premiums for the entire U.S. insurance market ($300 billion), wiped out in just 48 days.

Catastrophes are hard on insurance companies. In the aftermath of Hurricane Andrew, 12 insurance companies went out of business. The events of 9/11 put 38 companies out of business, including Kemper, then the seventh-largest insurer in the U.S. So far, the 2004 hurricane season has not put anyone out of business, but it is an easy bet that it will. About $20 billion of new capital entered the reinsurance business in the four months following 9/11 -- less than half of the estimates for that day’s tragic losses. Now the 2004 hurricane season has already obliterated all the new capital that rushed into insurance markets in the wake of 9/11. International Finance Corporation reports, “All told, 10% of the world’s insurance capacity -- the amount of money available for insurance -- was wiped out by the [9/11] terrorist attacks.”

Think about that last sentence for just a minute. If 10% of the world’s oil supply suddenly went up in smoke, you would want to be long oil in a big way. But for some reason, that has not happened in the insurance stocks. No CNBC. No magazine covers. No headlines. Nothing. Capital has avoided this sector for years. Lots of people are interested in oil now, even though oil prices are already at 450% of their level at the bottom in late 1998. When people talk about reinsurance the way they are talking about oil today, then I will know it is time to sell. It feels right to be interested in the reinsurance business at a time when the fundamentals are improving and nobody else seems to care about it.

As a result of the laziness born of the easy money they have earned on their stock and bond portfolios, the property/casualty and reinsurance industries have done a miserable job of pricing risk over the last two decades or so. Since 1975, the entire property/casualty industry took in more premiums than it paid out in losses in only two years. Pathetic. The property/casualty companies are the ones who buy catastrophe reinsurance, the type of coverage an insurance company needs to handle events like hurricanes and 9/11. On average, the reinsurance industry as a whole paid out 11.6% more than it received in premiums over the 1981-2002 period.

This situation has Extreme Value written all over it. Capital is scarce. Performance has been miserable for decades. And reinsurance prices are likely to remain strong in the wake of yet another record year for catastrophes. The time is still right to make money in stocks of disciplined, financially strong reinsurance companies.

Link here (scroll down to piece by Dan Ferris).

Spitzer Sues Marsh & McLennan, names AIG, others in insurance broker probe.

New York Attorney General Eliot Spitzer sued Marsh & McLennan Cos. and arrested two American International Group executives in his first prosecution of the insurance industry. Spitzer alleged that Marsh & McLennan, the world’s largest insurance brokerage, took “lucrative payoffs” for steering unsuspecting clients to certain insurers. Spitzer also said AIG, Hartford Financial Services Group, Ace Ltd. and Munich Re participated in “steering and bid rigging.” Shares of Marsh & McLennan fell $10.83 to $35.30, AIG fell $6.97 to $60.02, Hartford declined $4.02 to $58.16 and Ace declined $3.86 to $36.45, all as of 2:42 p.m. Thursday in NYSE composite trading.

The allegations mark the third leg of Spitzer’s push to rid financial-services companies of corruption. Since June 2003, Spitzer and other regulators have imposed about $3 billion in fines for improper trading in the mutual-fund industry. Last year, he wrested $1.4 billion in settlements from securities firms he said were issuing biased stock research. Spitzer’s insurance investigation became public in April after the Washington Legal Foundation, an advocacy group and law firm, said earlier that it was concerned that the fees from insurers compromise the brokers “fiduciary duty represent the best interests of their clients.” Spitzer said Marsh, AIG and others were involved in rigging bids so that companies buying insurance would think there was a competitive process. The guilty pleas by AIG executives will “permit this case to run higher at AIG” and other insurance carriers, he said. He has subpoenaed Aon Corp., Willis Group Holdings Ltd., Hub International Ltd., Chubb Corp. and others and said “numerous civil and criminal cases” are to come.

Link here.

Munich Re and other insurers pounded in European trading.

The insurance sector reeled to 2-week lows after New York Attorney General Eliot Spitzer sued Marsh & McLennan, the world’s No. 1 insurance broker, for steering unsuspecting clients to certain insurers in exchange for lucrative payoffs. The lawsuit, which says the manipulation has occurred since the late 1990s, implicated a number of U.S. insurers as well as a Munich Re unit. Traders said there was concern among investors that other big European names could be involved. Munich Re shares slid 5%, with Zurich Financial and Swiss Re down about 4%.

Link here.


Unexpected events are the ones that have a propensity to really jolt the financial markets. The reason? Exactly because they are “unexpected”. When you think about it, there really are very few things that genuinely sneak up on markets. Almost all coming events cast a shadow in advance of their arrival. However, the shadows are often very faint, and they surely do not broadcast their timing at all well. For instance, with the benefit of hindsight aided by an expanding body of historical information, Pearl Harbor was not a major surprise. That it occurred on 12/7/1941 was. When you examine the long list of events leading up to what occurred in the United States on 9/11/2001, they or something like them were not surprises, either. However, the specific timing and the nature of the events certainly were.

As I noted on my website last week, “There’s the continuing threat of domestic terrorism, of course, ... Considering where the major sentiment measures are at present, the stock market is ill-prepared for such an event ... But is it possible the ingredients for another kind of terrorism of sorts are beginning to coalesce. Suppose, for instance, the Presidential election segued into out-and-out chaos? I sense this as a growing possibility.

“Something is up with the huge quantity of new voter registration throughout the country. Where I suspect this is leading is massive voter fraud on 11/2, or at least what will appear as such -- something akin to what Florida-2000 spawned, but on a much, much grander scale! Taken to an extreme -- something not to be ruled out, in my view -- it could leave the United States in political chaos on the morning of 11/3.”

I went on to conclude that such an outcome would not be at all charitable to the US financial markets. I certainly have not changed my view on this since last week. The ingredients are now very much in place for a high level of either actual or perceived election fraud. I can envision, and quite realistically, wholesale allegations coming from both sides leading to numerous petitions to federal judges in more than one state for extensions of voting hours, thousands of impounded voting machines, cries heard ‘round the globe of “disenfranchised voters” in huge numbers, ad infinitum, ad nauseam. Both the DNC and RNC claim to have legal SWAT teams in place. So at minimum, there will be thousands of lawyers who are very busy people on 11/2. And well after 11/2, I suspect and fear!

Link here.


One reason for the paucity of returns the world over comes from the inflation-adjusted level of short-term interest rates in America, which, despite three rises this year, are still abnormally low by historical standards. Thus have investors plonked their money in anything else that might earn a decent return: longer-term Treasuries, corporate debt, emerging markets, you name it. So much money has found its way into riskier assets of one sort or another that there are now only paltry returns to be had over and above the meagre risk-free rate (i.e., government bonds), a rate which has become steadily more meagre even as oil prices have risen sharply. The poverty of Treasury yields says a lot about the outlook for the American economy. It might also say a lot about the unwillingness of investors in emerging markets to invest in their own countries, suggests David Goldman, head of global markets at Banc of America Securities.

Economic theory would suggest that capital should flow from developed to developing countries, for the simple reason that the latter need the money and the former need the returns. And investors from rich countries have indeed increasingly invested their savings in emerging markets in recent years. Intriguingly, however, the wave of money flowing in will be more than matched by a veritable tsunami of money flowing out: Emerging countries will lend a net $74 billion this year, 90% more than last year. But the main way in which emerging countries are in effect lending to rich countries -- or rather one rich country, America -- is by amassing foreign reserves, which are then invested mainly in Treasuries.

The export of capital from young, growing economies to old, mature ones is a recent and unusual phenomenon. The IMF, for one, thinks it unlikely to last, in part because there are costs to accumulating such huge foreign-exchange reserves, since they are likely to be inflationary. Perhaps so, but the causes of this export of capital are deep-seated: the trend can be traced back to the Asian financial crisis of 1997, which destroyed the savings of many investors there. The result is that Asian investors are content to lend money to the American government at 4% or thereabouts because they are confident of getting it back. The accumulation of foreign-exchange reserves and generally better economic policies have presumably made emerging economies more stable than they were. That is why the credit ratings of such countries have improved a bit in recent years.

A question mark also hangs over such things as property rights and robust legal frameworks. The absence of these is the reason why many emerging markets remain just thatand why people in them want to salt their money away in more stable places. Think, for example, of the immediate reaction of Russians to the travails of Yukos, a Russian oil company, which the government is taking away from its owners: capital flight. Such countries are unlikely to become stable, western-style democracies overnight; indeed, many may never do so. On the other hand, there comes a point where the opportunity cost for those in emerging markets of investing in US Treasuries -- issued by a country which has the economics, perhaps even the politics, of an emerging market -- becomes too great; and the risks of keeping so many of their eggs in this particular basket become similarly discomforting.

Link here.


There is something dissonant about the latest U.S. trade deficit news. Every respected financial newspaper or website is echoing the same set of verses, but if you listen closely, the lyrics leave something to be desired. The U.S. Commerce Department reported that the trade deficit deepened 6.9% in August to $54 billion, just shy of the $55 billion record set in June. Not surprisingly, the financial media have seized on the news to explain the dollar’s latest woes. As usual, the seemingly plausible explanation falls a few notes short. The relationship between the two just is not that simple, as can be seen in this chart.

Link here.


I have read several articles lately pointing out the risks homebuyers assume when purchasing homes using zero-down, interest-only Adjustable Rate Mortgages (ARM’s). Although the writers of these pieces are right to discern risks in these loans, they do not properly identify where the actual exposure lies. One reason that zero-down payment loans are so popular is that buyers realize that since they put nothing down, they have nothing to lose. When interest rates ultimately rise and home values decline (as they eventually must), the zero-down ARM borrower will be able to walk away from his overpriced home none the worse for wear. The real sufferers will be: 1.) lending institutions and private investors left holding the defaulted mortgages, 2.) U.S. tax payers who ultimately stand behind the government-sponsored enterprises guaranteeing those mortgages, and 3.) home owners with traditional mortgages, who will lose their equity as rising interest rates, contracting mortgage credit, and increased foreclosures result in falling real estate prices.

Given the no-risk scenario for these borrowers, it is should be no surprise that more and more renters have become buyers in recent years. To give you a better idea of how the current lending conditions are sucking buyers into the market place at unsustainable rates, below are 10 reasons why buying a house using a zero down, interest-only, five-year ARM, with the intention of defaulting on the loan after the fifth year, is better than renting. All things considered, buying with a zero-down, interest-only, five-year ARM, with the intention of defaulting after the fifth year, is hands-down the best way to rent a house.

While it may be true that most zero-down, interest-only ARM buyers do not actually intend to default, it is inevitable that the availability of this option factors into their decision making process. The fact that no down payment is required makes tangible the lack of downside risk. With no risk, why not take a chance to live cheap and possibly make some easy money? As is the case with any mania, most buyers expect to be able to quickly sell for a profit (before the higher payments kick in). However, if it does not work out that way, it is the bank’s problem, not theirs. Today, lenders are gambling that the desire to maintain a good credit rating will be as effective in preventing defaults as the desire not to lose hard-earned cash. It doesn’t take Jimmy the Greek see this as a sucker’s bet.

Link here.


American businesses are not holding up their end of the bargain. The way the bulls have the plan drawn up is that just as consumers slow down their buying of cars, new kitchens and carpet, businesses will step in with hands on hips and checkbooks held high ... and spend like crazy. Oh sure, capital spending has been on the march for awhile, but folks who watch this sort of thing figure that compared to the profits and cash flow being churned out, businesses generally are “under-investing”. Or are they?

Based on the corporate tax bill passed this week by the Senate, and slated as a slam dunk for a presidential signature, it looks like corporations have been investing plenty -- in lobbyists. It also appears that such an alternative investment will crank out a much higher ROI than building a factory or buying a bunch of noisy machine tools. And that is what is so great about the New Financial Era (NFE) -- it is as clean and quiet as a new Hummer slipping into three parking spaces at the mall.

For their investment, American manufacturers get a tax rate cut of 3%, which doe not sound like much unless you are talking about 3% on a money market fund, or 3% on a CD that matures before the sun turns into a supernova. But many a corporate treasurer will remind you that a 3% rate cut equates to about a 10% cut in the total tax bill.

However, to qualify you must be a manufacturer who engages in “domestic production”. You know, like the bakery at Kroger’s. If you are surprised that in-store bakers are manufacturers, then your brain is still thinking Old Financial Era Thoughts (OFET). Today, timber companies, farmers and companies that make movies and print newspapers are all manufacturers. Who knew there were so many manufacturing jobs left in America?

Link here.


I recently read and reviewed The Great Swindle — The Story of the South Sea Bubble by Virginia Cowles. The book deals with the rise and fall of the South Sea Company and John Law’s Mississippi Company in the early part of the 18th century. As I read this entertaining book, I became more and more fascinated by the many parallels between this early period of speculation in our capitalistic age and today’s financial environment. In particular, I was astounded by the similar role that paper money, excessive credit creation and highly questionable practices -- by governments as well as businesses -- played in fuelling the financial excesses in both periods.

From time to time, a wave of optimism spreads around the world like a bushfire. People believe they are seeing the dawn of a new era, which will bring unimaginable riches and prosperity to all. Waves of new-era thinking are usually associated with discoveries, the application of new inventions, etc. A typical feature of “new era” thinking is that it usually engulfs a country or the world not at the beginning of an era of prosperity, but toward the end of such a period and is associated with some sort of a “rush” or investment mania.

The Great Swindle is an excellent account of the events that surrounded the South Sea Bubble and the Mississippi Scheme. Although over the following 300 or so years the stage of investment manias repeatedly changed, the script, the accessories and the nature of the actors participating in the bubble have largely remained the same. In each bubble, excessive monetary stimulus and the use of credit fuel the flames of irrational speculation and public participation, which involve a larger and larger group of people seeking to become rich without any understanding of the object of speculation. All manias feature shady characters, corruption, fraud, dubious practices, the creation of money and the extension of risky loans in order to keep the speculative orgy going, the catalyst which leads to the initial collapse, the revelation that insiders cashed out, or some adverse economic or political news -- and then the panic during which greed and euphoria are replaced by fear and the speculators’ desire to get out at any price.

What is also important to understand is that both the promoters of the South Sea Company and John Law attempted to support the market at any cost. At some point, however, market forces proved to be far more powerful than any price-supporting measures they could ever have taken. The Mississippi Scheme in particular provides a relevant example of the ineffectiveness of printing money to stimulate the economy and lighten its debt load. John Law’s policies of the day are reminiscent of those of the current U.S. central bank, the aim of which is to solve any problem the same way Law tried to solve the Mississippi Company’s problem -- simply by increasing the money supply. That such monetary policies will lead to the same price increases, which, at the time of Law’s Mississippi Scheme, destroyed people’s faith in paper money, ought to be clear.

A financial system based on paper money depends almost entirely on the confidence of the public in the currency that is issued by the monetary authorities, and that once confidence in a currency is badly shaken, painful consequences are inevitable. Therefore, the reader should ask himself the question: For how much longer will foreign investors, who are financing the U.S. trade and current account deficits, be willing buyers and holders of American stocks, bonds and the dollar?

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