Wealth International, Limited

Finance Digest for Week of July 4, 2005

Note:  This week’s Offshore News Digest may be found here.


“It is hard to find and produce gold, easy to print money,” observes James Grant, editor of Grant’s Interest Rate Observer. “We [gold] bulls take comfort in the geological scarcity of our precious and beloved metal.” Unfortunately, geological scarcity functions very poorly as a market-timing tool. “Gold was scarce in each and every year of the 1980-99 bear market,” Grant admits. But happily – for those investors among us who get no thrills from owning a “precious” asset that falls in value - a couple of developing trends suggest that the nascent gold rally will gain momentum:

First, the structure of short-term interest rates in Europe and the U.S. may encourage rising gold prices, according to Paul Kasriel, the self-styled chief economist of Northern Trust Co. Second, the euro’s recent travails seem to be destabilizing the worldwide currency markets, a condition that should also encourage rising gold prices. “Gold really starts to glitter when you can’t get an ‘honest’ return on your money market investments in any major currency,” Kasriel explains. “That is, when the inflation rate is above money market rates in all major currencies, investors turn to gold as a store of value.”

For example, as the chart below illustrates, U.S. short-term rates began delivering a negative real return in the summer of 2002 and did not begin to deliver a positive real return until very recently. It is perhaps no accident, therefore, that the gold price rallied from about $300 an ounce in August of 2002 to more than $450 an ounce by the end of 2004. The metal has been languishing ever since, as the Fed’s rate-hike cycle has lifted short-term interest rates above the inflation rate.

In theory, therefore, short-term rates in the U.S. and Europe both provide competitive real returns versus the inert, non-yielding precious metal. Nevertheless, ever since the French vote, gold has been rallying against both the dollar and the euro … especially the euro. Since May 29th, gold has advanced only 1% against the dollar, but more than 8% against the euro. “I wonder if the gold market is beginning to reflect the expectation that an honest return on one’s money may be hard to come by in the not-too-distant future,” Kasriel muses. Kasriel believes that the real ECB rate and short-term U.S. rates could turn negative again soon.

If the quest for an “honest return” sets in motion the next leg of the gold bull market, monetary instability might keep it in motion. “The true prerequisite for a continued rally in the gold price is monetary disorder,” Grant asserts. “Motive power for the 1980-99 bear market was the lack of disorder (though there were many promising crises), in the absence of which financial assets produced outsized returns.” Therefore, the unfolding constitutional crisis in Europe, which is becoming a low-level monetary crisis, may provide ideal conditions for a sizeable gold rally. “Constant readers know that [we have] been keeping a bedside vigil for the international monetary system for as long as we’ve been publishing,” Grant continues. “We’re still at it. The arithmetic of the U.S. current account is – as it has been for decades – adverse; noting new there. New is the political and constitutional crisis in Europe.”

“There is $1 trillion or so worth of gold in the world, of which central banks hold half,” Grant concludes. “There is $369 billion of gold derivatives contracts outstanding (or was at year-end, up from $318 billion at midyear). There is $9.6 trillion in U.S. M-3 (i.e., money supply) and the equivalent of $8.3 trillion in euro M-3 … So relatively scarce is bullion that even a small reallocation of monetary assets to gold from paper, a small tweaking at the margin, could cause an inspirational pop in the gold price.”

Link here.


Another new theory has been concocted to rationalize unsustainable excesses. The notion of a “global saving glut” has been proposed – and quickly accepted – as a new and important excuse for mounting global imbalances. It is also thought to explain why interest rates are so low – resolving the great conundrum of our time by stressing the mismatch between excess capital and limited investment opportunities. Finally, this theory implies that global imbalances are more benign than malign – drawing into question the urgency for any rebalancing. I do not buy the global saving glut hypothesis, and here is why.

At the heart of this debate is America’s massive current account deficit. Both history and theory tell us that such outsize external imbalances are not sustainable. Yet, so far, the time-honored current-account adjustment has yet to play out. There have been many attempts in recent years to come up with new theories to explain why: The so-called Bretton Woods II hypothesis is one such strain of thinking – essentially arguing that a mercantilist Asia must now be seen as part of an expanded dollar bloc that is more than willing to provide the external funding for an income- and saving-short U.S. consumer. More recently, former Fed Governor Ben Bernanke has pushed the debate even further, famously suggesting that a global saving glut is a key factor behind America’s gaping current account deficit – the U.S. is effectively doing the world a favor by absorbing a surfeit of saving that is sloshing around increasingly integrated global capital markets.

The saving-glut hypothesis has quickly become the rage, endorsed by policymakers, a broad consensus of investors, and the popular media – the latest press endorsement being the July 11 cover story of Business Week. Experience tells us that new theories such as these almost always crop up during periods of financial market excess. Look no further than the New Paradigm thinking of five years ago. In this same vein, it pays to heed the everlasting wisdom of Graham and Dodd, who some 70 years ago looked back on the excesses of the Roaring 1920s and wrote, “…[T]hat new theories have been developed and later discredited, that unlimited optimism should have been succeeded by the deepest despair, are all in strict accord with the age-old tradition.”

Conjecture about a global savings glut would make Graham and Dodd cringe. In my view, not only is the notion of excess global saving hard to support with empirical evidence, it is also hard to support from a theoretical point of view. I have noted ad nauseum that the world is now beset by record disparities between those nations with current-account deficits (mainly the United Sates) and those with current-account surpluses (mainly Asia). The problem is not the overall state of global saving or investment, but the tensions that have opened up between deficit and surplus nations. The imperatives for a rebalancing of this disparity remain urgent, in my view. There may be a deeper and potentially more sinister meaning behind the saga of the global saving glut. In my view, it is being used as a foil to deflect attention from one of the world’s most serious imbalances – the excess consumption of America’s asset-dependent economy.

In his treatise on the saving glut, Ben Bernanke goes on at length to dismiss the connection between America’s saving shortfall and its current account deficit. He stresses, in particular, the seemingly incongruous relationship between America’s fiscal balance and its external shortfall – noting that the U.S. current account deficit widened in the late 1990s as the federal budget moved into a rare position of surplus. What Bernanke conveniently leaves out of this discourse is the plunge in the personal saving rate over this same period from 4% to 1% on the back of a powerful wealth effect brought about by the equity bubble. In a similar vein, he all but dismisses the even more worrisome substitution of property-based wealth effects for income-based saving in recent years. According to his line of reasoning, America’s asset bubbles are innocent victims of global circumstances rather than visible signs of domestic markets and U.S. consumers that have gone to excess.

That the leading apostle of this new theory – Ben Bernanke – was, until recently, a governor of the Federal Reserve is all the more curious. In my view, no one has a bigger stake in dismissing the perils of the Asset Economy than its architect, the Fed. This brings up an alternative explanation to the savings-glut thesis: It hinges on the role of the U.S. central bank. By condoning the equity bubble of the late 1990s, a case can be made that the Fed set in motion a post-bubble defense strategy of extraordinary monetary accommodation that all but insured a steady stream of “echo bubbles” – from bonds and credit to emerging-market debt and property. By focusing on the saving glut, Bernanke conveniently offers a revisionist history and theory that all but exonerates the Greenspan Fed from any culpability in spawning the world’s unprecedented imbalances. Such a mindset ignores the mounting pitfalls of yet another post-bubble shakeout – this one dominated by the downside of overvalued property markets and the concomitant unwinding of a potentially lethal debt cycle.

All this is not to deny one very important aspect of the global saving glut story – the surplus of saving that exists throughout Asia and parts of Europe. In my view, this is traceable to a seemingly chronic shortfall of domestic private consumption – from Japan and China to Korea and Germany. While the reasons behind this trend are as diverse as the economies themselves, the common thread is a lack of job and income security brought about by ongoing restructuring (Japan), reforms (China), or the threat of both on still rigid economies (Germany). But that raises the possibility of an even greater challenge for the U.S.: As restructuring and reforms run their course in nations with current account surpluses, their excess saving should eventually be absorbed and translated into renewed emphasis on consumption. That would then make it all the more difficult for America to fund its massive current account deficit at today’s asset prices and foreign exchange value of the dollar.

Implicit in the saga of the global saving glut is yet another effort at scapegoating – in effect, pinning the blame on the world’s savers while exonerating American consumers and the U.S. central bank from fostering mounting global imbalances. Unfortunately, by failing to face up to its own excesses, the U.S. does itself and the rest of the world a huge disservice. I have said it from the start: Global rebalancing is an urgent and shared responsibility. The sooner the world seeks a collective resolution of its problems, the less likely a disruptive endgame.

Link here.


As the “debate” over the existence of a housing bubble intensifies, both sides are likely to be proven wrong when it comes to predictions for housing declines should the bubble burst. Most bubble advocates believe that rather than collapsing, housing prices will either rise more slowly, fall slightly, or simply stop going up, thereby allowing stagnant incomes to catch up with surging prices. However, a closer look at the facts reveals it is far more likely to burst with as big a bang as did the NASDAQ five years ago.

One of the main arguments (more wishful thinking than reasoned perspective) against a precipitous drop is that homeowners will not quickly unload houses in the same manner stock investors bailed out of losing equity positions. For example, Treasury Secretary John Snow recently argued against the existence of a housing bubble by claiming, “houses are not like stocks, pork bellies, or gold, and are therefore not prone to bubbles.” He claimed that unlike buyers of those other assets, Americans are buying houses because everyone knows that houses are great investments. Setting aside the self-serving nature of his dismissal of even the possibility of a housing bubble, his comments ironically provided some of the most convincing evidence in support of a housing bubble that I have ever heard.

One reason few expect housing prices to collapse is the mentality that homeowners need to live somewhere and as such will be reluctant to sell their residences. This argument ignores that fact that so many of today’s homebuyers do not occupy their properties as primary residences, and that relatively attractive rentals provide homeowners with viable, none-ownership alternatives for shelter. However, a more in-depth analysis reveals that contrary to prevailing rhetoric, housing speculation is not only rampant, but also far more pervasive than the data suggests, perhaps even more widespread than was the case with tech stocks during the NASDAQ bubble.

According to a recent study by the National Association of Realtors, 23% of homebuyers specifically identified their purchases as investments. Another 13% identified their purchases as vacation properties. Since rental yields are so low, those buying properties as investments are by definition speculating. However, buyers of vacation homes, are also speculating, as inherent in the decision to buy such properties is the expectation of price appreciation. Absent such a forecast, it is far more economical to vacation in hotels. Further, as owners of rental or vacation properties do not occupy their properties as principal residences, a change in sentiment as to future price appreciation could easily cause such owners to sell, or worse, to walk away from mortgages in circumstances of negative equity.

However, the mere fact that owners occupy their houses as principal residences does not necessarily remove such properties from the category of speculative investments. For example, 58% of recent California homebuyers financed their purchases using ARMs (with percentages in pricier counties exceeding 80%). The primary reason given to justify such mortgages was owners’ intentions to resell the properties in relatively short periods of time. Such buying is clearly speculative, regardless of the speculator’s intention to occupy the property. Given high transaction costs and low relative rents available in markets where such mortgages are most pervasive, absent the expectation of rapid price appreciation, such short-term buyers would clearly be better off renting.

Also, the fact that so many buyers are using interest-only, or negative-amortization mortgages, suggests even greater degrees of speculation. Since none of the monthly payments on such loans reduce the principal of the mortgages, buyers utilizing them are no better off than renters. However, since they must also pay property taxes and maintenance, interest only buyers actually get the worst of both worlds. They rent property from lenders, yet get stuck with all the headaches associated with ownership. The only way interest-only buyers build equity is though price appreciation. In other words, they are the ultimate speculators.

The reasons for such unbridled, rampant speculation are clear. According to the Economist, a recent survey showed that the Los Angeles homebuyers expected an average 22% annual home price appreciation over the next 10 years. So intoxicating is the expected payoff from home ownership, that the incentives to lie to qualify for mortgages have never been greater, and, as it so conveniently happens, easier to do. Should we be amazed that when reckless lenders offer buyers can’t lose bets, with huge expected payoffs, that so many want a piece of the action? The fact that the majority of today’s homebuyers are actually speculators in disguise, suggests that when the trend turns, prices will drop precipitously.

Link here.

Real estate bubble: Does the public know what the news junkies know?

News junkies like me see a lot of “real estate bubble” stories, and since most so-called experts on the markets and the economy are also news junkies, they seem to think the man/woman on the street have likewise heard and read the bubble stories. Thus the argument the “experts” make against a real estate bubble, namely that there cannot be one with so many people worried about it. This pseudo-contrarian argument is probably what explains the recent issue of Business Week, in which a gang of economists was asked if housing prices are due to plunge – not one said “Yes”.

I guess the gang in question had not heard about the poll by the National Association of Realtors. The poll found that only 23% of respondents had heard of a housing bubble, and that lots of people did not even understand the “bubble” part of the question. I also have to wonder if your average economist knows of the recent data on homeowner equity, which stands at 56.3%, only a sliver above the lowest level on record.

It is obvious that no one likes to hear comparisons between home prices today and the stock market bubble that burst in 2000. The obvious differences between real estate and equity shares duly noted, there is one undeniable and disturbing similarity, to wit: During the stock market bubble, traditional valuations did not matter to shareholders. Valuation matters only if you believe that the stock’s price should reflect the worth (or value) of the company. But stock investors could have cared less about value. They were willing to pay outrageous prices because they believed a greater fool would pay a more outrageous price later on.

So too are homeowners now willing to convert every dollar of equity into debt: they believe the link between a home’s value and its selling price has been broken. They themselves and/or recent homebuyers in their neighborhood may pay a foolish price for a home today, but they believe greater fools and higher home prices will be just as abundant tomorrow.

Link here.

Mobile home madness: prices top $1 million.

A two-bedroom, two-bathroom mobile home perched on a lot in Malibu, California is selling for $1.4 million. This is not a greedy seller asking a ridiculous amount no one will pay. Two others sold in the area recently for $1.3 million and $1.1 million. Another, at $1.8 million, is in escrow. Nearby, another lists for $2.7 million. “Those are the hottest (prices) I’ve ever heard,” says Bruce Savage, spokesman for the Manufactured Housing Institute. He says prices in another hot spot, Key West, Florida, top $500,000.

As if the price is not tough enough to swallow, trailer buyers: 1.) Do not own the land. As with most mobile homes sold in Malibu, the land is owned by the proprietor of the trailer park. 2.) Still pay rent. Not owning the land means paying what is called “space rent” that is as high as or higher than many mortgages in other parts of the USA. On the $1.4 million trailer, space rent is $2,700 a month. 3.) Cannot get mortgages. Since the buyers do not own the land, most of the mobile homes are paid for in cash or with a personal property loan that usually amounts to $100,000 or less.

Why would anyone pay seven figures for a trailer? It gets you more than the typical mobile home. The $1.4 million trailer is in a gated, guarded community with a shared tennis court and panoramic views of the Pacific Ocean. It also is on a larger-than-usual “triple-wide” lot. Buyers are willing to pay such prices just to get into Malibu, where the average list price is $4.4 million, says Coldwell Banker broker Rick Wallace. But, it is still a trailer with a modest kitchen and faux wood floors. Many still have trailer hitches attached.

Link here.

Investors look to neighborhoods once considered a waste of time.

As home prices in hot markets across the nation continue to grow, it is getting harder and harder to find affordable opportunities. As a result, home buyers are looking in areas they would not have even considered five years ago. And even in such neighborhoods, cheap is not really all that cheap. Take, for example, Compton and Harlem. Houses in Compton are selling for up to 20% more than the asking price. And values in Harlem have jumped 4-fold in the past 8 years. Skyrocketing prices, bidding wars, lack of supply … but we are not talking about the red-hot housing market in Beverly Hills, 90210. This is Compton, 90220.

Proof that a rising tide lifts all boats, Compton is going through much of the same real-estate mania as everywhere else. But it is also getting a new look from investors who have overcome qualms about its reputation, seeing it as one of the last affordable places to invest in Los Angeles. But affordability is a relative term. The national median home price is about $210,000. That will get you absolutely nothing in Compton.

Link here.

Risky mortgage business.

By any measure, the housing boom – now almost 4 years old – is one for the record books. A recent study by The Wall Street Journal found that in 55 places, housing prices had risen by at least 30% in three years, after inflation. Together, those 55 markets now account for an unprecedented 40% of all housing value in the U.S. What makes this boom particularly unnerving is that it owes much of its longevity to the explosion in the number of risky mortgages. Many borrowers are likely to be pinched, if not creamed, when interest rates rise or housing cools, leaving them unable to make payments, refinance on favorable terms or sell at a profit. Lenders may be even more vulnerable than borrowers, which may mean an economywide disruption if – or when – housing prices stagnate or decline.

The traditional mortgage – 20% down with a fixed interest rate – is being eclipsed by loans with low down payments or none at all, many with adjustable interest rates. These inherently risky mortgages are now routinely offered with features that allow a borrower to pay only the interest due for an extended period, or, even more dicey, with the “option” to pay less than the interest due each month while adding the unpaid portion to the loan balance. One-fourth of all home buyers – including 42% of first-time buyers – made no down payment in 2004, according to the National Association of Realtors. Nearly one-third of all new mortgages this year call for interest-only payments (in California, it is almost half), according to Loan Performance, a mortgage data firm.

Another risky aspect of these sorts of mortgages is that they attract relatively hard-pressed borrowers. Egged on by lenders where mortgage-making has been the one consistent profit center, they tend to be people who cannot afford a traditional fixed-rate loan – even at the current low rates. It is a safe bet that lenders would not be so freewheeling if they had to worry about being paid back in full. But i is unusual for lenders to bear the entire risk of the loans they make: they sell many mortgages to private investment banks, which slice and dice them into various securities – an interest-only portion, say, and a principal-only portion. Those securities are then sold to other investors, like mutual funds, pension funds, hedge funds, European insurance companies and the central bank of China, to name a few. Investors now hold $4.6 trillion in mortgage-backed securities. That is more than the outstanding value of U.S. Treasuries.

So far, the mortgage-backed market has generated cash and profits galore. Someday, however, someone will lose money. …

Link here.

Soaring numbers of rentals go condo.

Tens of thousands of renters around the nation are facing a choice: Buy their apartments or move out as a wave of condominium conversions picks up speed. The number of apartments being renovated and sold as condos is escalating at a time when single-family homes are beyond the means of many Americans. At least 70,800 apartment units were sold to condominium developers nationwide in 2004, up from 7,800 in 2002, according to Real Capital Analytics, a New York consulting firm. As of June 1 this year, at least 43,900 units have been sold to developers, says Dan Fasulo, director of market analysis for the firm. There are about 19 million rental apartments in the USA. The conversions are occurring most rapidly in Southern California, Northern Virginia and the Miami and Las Vegas areas.

Though a record 69% of households owned their homes last year, lower-cost rentals are dwindling, according to a study released last month by Harvard University’s Joint Center for Housing Studies. About 43% of rental units built in the past five years are renting for above $800 a month, compared with 25% of the units built before then. Some real estate analysts say conversions are not significantly depleting the supply of apartments. “There’s no question converting rental units in large numbers to condominium ownership units is going to reduce the stock of rental units, but it’s not going to reduce it by as much as first cast,” says Mark Obrinsky of the National Multi Housing Council in Washington, a trade association for the apartment rental industry.

Though rents may rise temporarily on apartments that remain, they are likely to level off because many converted condos return to the marketplace as rentals, says Hessam Nadji of Marcus & Millichap, a real estate investment firm in Encino, California.

Link here.

Housing price flattening may sting more than dot.com bust.

Whether it is a national bubble or just pockets of regional froth, an end to surge in home prices could inflict economic harm that would make the 2000 tech bust look tame in comparison. Even if the market cools in only those parts of the country that Alan Greenspan describes as “frothy”, the U.S. has a serious problem. If prices were merely to level off, it could subdue the property-linked activity that has stimulated spending and job growth – crucial supports for the U.S. economy.

Based on benchmarks from a recent IMF study comparing the stock and housing market bubbles, there are about 15 states that are vulnerable to a housing market correction. These represent about 35% of GDP, the broadest measure of the nation’s economy. “A significant correction in consumption spending in these states is bound to have significant effects on national growth,” said Thomas Helbling, an economist at the IMF in Washington. Merrill Lynch estimates the impact on growth could be as much as one percentage point of GDP.

Add the knock-on effects to the rest of the economy to any initial spending hit and the situation looks worse. The IMF study found that while stock market collapses are more frequent, housing busts do a lot more damage. “The output loss associated with the typical housing price bust (about 8 percent of GDP) was twice as large as that associated with a typical equity price bust,” the study said.

The Federal Reserve understands these risks, which is why its top officials have talked of revamping lending guidelines to reduce speculation. When it raised rates for the 9th straight time in a year, the Fed, the nation’s central bank, gave no indication it was prepared to stop in the near future. A look at the U.S. economy’s reliance on the housing sector in recent years is helpful in gauging the impact of a serious market upset. American households have enjoyed a $4 trillion rise in wealth, thanks to a 40% gain in house prices since early 2001, according to Merrill Lynch. Assuming they spend 6 cents of every extra dollar, this adds up to $50 billion in additional spending each year, contributing about half a percentage point to annual GDP since 2000.

Link here.

Beware of property bubbles.

Pondering the U.S. economy’s prospects, the dramatic aggravation of the economic and financial imbalances is most critical. With them, there can never be normal economic growth. The other crucial aspect is the obvious fact that U.S. economic growth depends entirely on the continuation of the frenetic housing bubble. All bubbles essentially end painfully, housing bubbles in particular. They are an especially dangerous sort of asset bubble, because of their extraordinary debt intensity. The debt numbers speak for themselves: In 1996, U.S. private households borrowed $332.2 billion; in 2000, their borrowing was up to $558.6 billion. With the housing bubble in full force, it hit $1,017.9 billion in 2004.

This debt intensity has its compelling reason in the particular way that accruing “wealth” has to be converted into cash. In the case of an equity bubble, in general, the owner realizes capital gains simply through selling a part of his stock holdings. No bank and no debt are involved. He directly exchanges stock for cash. In this respect, a property bubble is a totally different animal. Since homeowners normally want to stay in their house, “wealth effects” have to be extracted through additional borrowing against the inflating property value; that is, through mortgage refinancing. In essence, twofold borrowing is needed: first, to boost housing prices; and second, to withdraw equity.

But this debt intensity finds very little or no attention at all. Yet there is a second, even more dangerous, aspect to housing bubbles: They heavily entangle banks and the whole financial system as lenders. For this reason, as a matter of fact, property bubbles have historically been the regular main cause of major financial crises.

During its bubble years in the late 1980s, Japan had rampant bubbles both in stocks and property. While the focus is always on the more spectacular equity bubble, hindsight leaves no doubt that the following economic disaster was mainly rooted in the property bubble. Both bubbles burst in the end, but the property deflation has continued for 13 years now, with calamitous effects on the banking system through a horrendous legacy of bad loans. As a result, Japan has been struggling for years with two kinds of endless price deflation: gradually in the prices of goods and services and savagely in asset prices. The main culprit in keeping the economy locked in chronic stagnation is the evil concurrence of protracted property and debt deflation plainly strangling the banking system.

During the four years 2000-04, total indebtedness ballooned by $9.7 trillion, against a simultaneous increase in national income. For each dollar added to national income, there was almost $6.40 added to overall indebtedness. Implicitly, the smallest part of this horrendous borrowing binge was spent inside the economy, as reflected in the poor growth of national income. Overwhelmingly, it financed leveraged asset purchases and soaring imports. The former involve no income creation; the latter involve income destruction. By implication, this borrowing represents entirely unproductive, or dead-weight, debt, yielding to the debtors no future flow of income from which to pay their debt services. Business investment, the sole source of productive debt, was no higher in 2004 than in 2000.

Link here.


A survey from BNP Paribas suggests that whereas investors used to demand products which offered full principal protection, they are now sacrificing these guarantees to seek out higher returns. “Throughout 2004 and into 2005 investors were keen to take on more risk,” it says. This has supported retail demand for these products: the total level of retail savings invested in European structured products totalled about €80 billion last year, comparable to the previous year, according to the survey.

BNP Paribas predicts that issuance will remain strong this year. However, it also suggests that a subtle shift is now underway in investor appetite for risk: whereas in the past they have opted for exotic products, many are now seeking simpler structures – but with more exotic underlying assets. “Commodities, real estate and emerging market stock should remain in demand in the second half of 2005,” the bank predicts.

Link here.


Since credit cards were first issued and automobiles were first financed, bankers and car salesman have been more than happy to assist individuals in realizing their full borrowing potential. Realizing their full potential, that is, by borrowing more money than they really should. For young adults, perhaps living independently and with their first full-time job, this could lead to important life lessons about managing debt and living within their means. After many months or years of credit card and automobile payments, the initial thrill having long since worn off leaving only the payments, valuable lessons about borrowing too much money have often been learned – lessons that are not quickly forgotten.

When purchasing homes, on the other hand, it used to be quite difficult to take on more debt than would seem reasonable – there, the bar was set higher. Years ago, couples would walk out of their mortgage broker’s office disappointed and dejected because their dreams had been thwarted by a loan officer without a heart. These too were valuable lessons about debt. Maybe it seemed unfair, but someone who was presumably older and wiser had determined that the dream home so coveted by the young couple was simply beyond their means. Maybe when the couple later reflected on their denied attempt to purchase their dream home, they realized that the lender probably knew best.

But, the financing of real estate purchases has changed dramatically in recent years. Now that home financing has become as easy as getting a credit card or buying a car, valuable lessons about debt learned early on, are being unlearned later in life – this is probably not a good thing.

Link here.


Even for a Wall Street legend, it pays to be average. John J. Mack, who was named Morgan Stanley’s chairman and chief executive last Thursday, has agreed to a 5-year contract that will pay him as much as $25 million a year for the next year and a half – or in the me-too meritocracy of Wall Street, at least as much as the average of his high-paid peers. The compensation package is expected to vault him ahead of the $22.5 million pay package that his predecessor, Philip J. Purcell, took home last year. Still, it is about the same that the average chief executive of a big investment bank has received over the last three years. It is also less than the $27.8 million Mr. Mack was paid as president of Morgan Stanley in 2000 – near the height of the dot-com boom – his last full year at the company, before he was forced out in a power struggle with Mr. Purcell.

Executive compensation specialists said the pay package reflected the unusual circumstances of his return to Morgan Stanley. The board determined that Mr. Mack, 60, was the executive best qualified to calm the turmoil in the firm, stabilize the business and revive the stock price. So the compensation may reflect Mr. Mack’s leverage at the negotiating table as much as anything else. Even if he fails over the next two years, he is guaranteed to make at least as much as his peers.

Link here.


Looking at a recent magazine covers one is left with the impression that the whole world is concerned about U.S. real estate prices. This is borne out by the fact that if you go to Google and type in sex you get 78 million hits. If you type in real estate you get 110 million hits, which makes housing about 40% more interesting than sex. Is there a greater sign of a bubble? But if you type in housing bubble you get “only” 1,120,000, so there is not much worrying going on. A UBS/Gallup poll shows that only 13% foresee a decline in housing prices over the next 6 months. 67% of investors see real estate investments as more profitable, and 77% see such investments as safer than the stock market.

There are clearly bubbles in some areas of the country. That being said, the average home is still affordable by the average person, according to the housing affordability index. But not in the bubble areas. Only 17% of the U.S. can qualify for a mortgage on a median priced home in California. In certain areas it is much worse. This is not surprising for certain wealthy enclaves, but this is for an entire state! But if much of the growth in housing values has been in a few select areas, and data suggests that is the case, then it also means that much of the ability of homeowners to use their homes for refinancing is also in those areas. So much of the U.S. economic growth that was created by the asset bubble in housing is coming from a small (yet significant) number of areas in the country. Various estimates are that this adds as much as 2% to overall GDP. Further, economists at the Fed estimate that the economy would slow by 0.2% for every 1% drop in housing values. A softening in housing values in those bubble areas would significantly affect the whole country in a negative way just as their growth influenced a positive growth.

Last year, we built 2 million new homes. Yet we added only 1.2 million new households. That means we absorbed about 800,000 homes either as second homes or for investments. Given various studies, it is probable that around 500,000 homes were bought for investment over and above the number of new households. That is a major part of the bubble. If new homes were rising in line with the growth in households, there would not be the potential for supply to outstrip demand. When, not if, we enter a recession with a significant overlap of excess supply while unemployment is rising, that could cause a sharp break in housing values in certain areas.

We live in a cash flow society. We look at our income and then judge how much we can afford to spend. Rents are actually falling while prices rise. When home prices fail to rise every year, when investor confidence breaks, households will look at their cash flow and realize that they might be better off renting. But that may not be for some time. I remember writing about how the NASDAQ was overpriced in the 4th quarter of 1998. I watched the stock market take wings after that. Bubbles which are caused by investor expectations and irrational exuberance can last a long time. This is especially true if interest rates stay low. It goes double if mortgage rates drop from here.

Let me outline a very plausible scenario, and one which will illustrate why the Fed is in such a bind. Low inflation, excess world savings coming to the U.S. (for whatever reason) and a flat Fed policy is a prescription for lower long-term rates. This means the environment for housing prices could be quite good for some time to come. But let us say the Fed is worried about the housing bubble and wants to slow it down, as well as create a more classically normalized interest rate scheme. So they signal they will continue to raise rates. The market fears the Fed will continue until they cause a recession (as they historically have) and in anticipation they begin to buy long bonds, dropping long rates. Either way, I think the chance of significantly rising long-term rates, which would kill the housing market is less than 20% in today’s environment.

Bill Gross and others speculate about a 3% ten-year note, which would roughly mean a 4% 30-year mortgage. Can you imagine the wave of re-financing? Every mortgage in America would be re-financed. I think that could easily happen in the next recession. It would certainly soften the usual recession cycle again; postponing the ultimate day we hit the debt re-set button. It would trigger what Roach calls another round of Bad Growth (growth based on debt).

That is just another reason why I think it will probably take two recessions (and thus a long time) to get to the ultimate bottom of the stock market (in terms of valuation) and to hit the re-set button on debt. It is also why I think the Muddle Through Economy will be the paradigm for the rest of this decade, at the least. And this worries me. Because the above scenario is a prescription for deflation. Staving off deflation, which is evidently part of the programmed DNA transfer that is required when you become a member of the Fed, will not be as easy the next time as it was last time.

The die was cast when the Fed decided to use housing asset inflation to offset the bursting of the stock market asset inflation bubble. The fact that it became a bubble was not helpful. In hindsight, Stephen Roach is probably right. They should have raised rates faster and kept a lid on the housing bubble developing in certain parts of the country. But that is water under the bridge. Now, their choices are fewer, and their weapons are less. Get ready to get the lowest mortgage rate of your lifetime in a few years. But it will not be a sign of a healthy economy. While 4% will be good for us as individuals, we will not like the overall economy and the stock market. Can we hear it for Muddle Through?

Link here (scroll down to piece by John Mauldin).


I studied music in college. I was a classical guitarist. When I first started studying, I was familiar with Bach’s work, but I thought it was terribly boring. For me, the music of Bach was like an infallible sleeping pill. When they played Bach in my music classes, I would begin to nod off in a few short minutes, almost without fail. But one day – I remember it vividly – I was in the hallway of the music building. That day in the hall, I decided that, if all these experts and music teachers thought Bach was great, I would just keep listening to the music, and try to stay awake. I would try to hear what they heard. I consciously decided to expand my horizons. And it worked. Today, I am a huge fan of Bach’s music. When I hear it, it does not put me to sleep. On the contrary, it actually energizes me. I have recommended Bach’s works as energizing background music to several people.

It is hard to say what caused me to go from bored student to passionate advocate on the subject of Bach. All I know for sure is that I willingly suspended judgment and immersed myself in the music. I just played it day after day after day. One day, I realized that I loved it. I was bored at first. But then I just could not get enough of it. The music did all the work. It got me. I have done something similar with investing.

There is possibly no piece of writing more sleep-inducing than a form 10-K, the financial report that every public company must file with the SEC once a year. There are no stories. No pictures (except the odd graph here and there). Nothing visually stimulating in the least … and everything reads like it was written by lawyers and accountants. When I started reading these documents about ten years ago, I could not make it through them. I would literally fall dead asleep, with my head on my desk. But I decided that there must be something to reading them, since that is how investors with real money spent their time. So I would wake up and keep reading. Sometimes, I would fall asleep again. Then I would wake up again and keep reading. No kidding. That really happened. Every once in awhile, you can still find me nodding off in my chair at around 3 or 4 in the afternoon, with some boring piece of SEC filing in front of me.

Part of the reason I persisted is because I had read somewhere that people who are going through something emotionally frustrating or difficult will often say, “I’m tired,” as a kind of defense mechanism, an excuse for not being up to the task at hand. I took my boredom with SEC filings as a sign of my ignorance. I did not want to be ignorant, so I pressed on. With Bach, I submitted to the apparent wisdom of my teachers, and I learned to love that which I had previously disliked. With investing, I have submitted to the proven wisdom of the great investors, especially Warren Buffett: on page 217 of J. Pardoe’s collection of quotations titled, Warren Buffett Has Spoken, Buffett says, “I spend an inordinate amount of time reading. I probably read at least six hours a day, maybe more.”

Plenty of time spent reading is all well and good, but surely the chairman and CEO of a company that produces $100 million a week (no typo) in free cash flow does not just read all day. He must spend plenty of time in meetings. All corporations have lots of meetings … right? Yes, they do, but not Buffett’s corporation, Berkshire Hathaway. None of his time is spent that way. Buffett says, “We have no meetings at Berkshire. I hate meetings.” So what does he do besides read? The quote from the Pardoe book continues, “I spend an hour or two on the telephone…” – probably to the CEOs of the companies he owns, maybe his partner Charlie Munger, and a bunch of folks in the financial world.

After reading and talking on the phone, then the activity level really kicks into overdrive. “… and then the rest of the time,” says Buffett, “I think.” Reading, conversing with people who know what you would like to know, and thinking. Those are the three things rich people do all day.

Link here.


According to Wall Street, the introduction of an Exchange Traded Fund from a major commodity market is akin to dropping a Chevy 454 engine into a Mini Cooper. Meaning: the ETF will turn a financial fast car into a financial NASCAR in 0 to 60 seconds flat. We, on the other hand, take a vvvrrroooom with a very different view – one that recent historical data happens to hold up with great ease. Backing up in reverse, we recall the late 2004 launch of the very first U.S. gold ETF, right alongside an 18-year high in the precious metal’s price.

At the time, every “expert” analyst and their great aunt “B” saw the bull charging horn-first into the BULLion backed ETF. “This is going to go gangbusters,” predicted a well-known financial Web site. “The ETF will offer average investors a chance to cash in on the gold rush,” added CNN Money. In a world apart, though, the December 2004 Elliott Wave Financial Forecast was slamming the brakes on a bullish gold forecast. In our words: With the “most overbought condition in a quarter of a century… a major decline in prices” is on its way. Gold prices hit top on December 3 to initiate a 10%, two-month long sell-off. Six months later to today (July 2005), the market still stands $30 below its December high.

Current developments in the silver market have a very familiar ring: 1.) In 2004, the white metal surged 36.5% to hit a 17-year high; 2.) In the first five months of 2005, silver outperformed its blonder big brother; AND 3.) On June 20, Barclay’s Global Investor submitted an application to the SEC for – you guessed it – an ETF that tracks silver. And, at turbo speed, popular press headlines were born with silver swoons in their mouths: “The ETF could exert great upward pressure on the silver price. It looks as though silver is in a new bull market,” writes one June 20 Associated Press article.

Again, our analysis suggested the opposite was set to occur, as this excerpt from the June 20 Short Term Update makes clear: “Today’s high should mark the top [of the current rally]. If our wave count is correct, expect $7.00 to be swept aside in short order as silver makes its way towards significantly lower levels.” On June 20, silver prices topped and have plunged 9% since. Time and again, the establishment of an ETF has been anything but the positive fundamental Wall Street purports. Relying on outside events to drive your market strategy is NOT safe or smart.

Elliott Wave International July 6 lead article.


Oil prices hit new record highs above $61 a barrel on Thursday, driven by short-term supply fears as the first hurricane of the season threatened crude production and refinery operations in the Gulf of Mexico. But private warnings also point to a worsening long-term outlook, with Saudi officials saying that OPEC will be unable to meet projected western demand in 10 to 15 years. At today’s prices, the world will need the cartel to boost its production from 30 million to 50 million barrels a day by 2020 to meet rapidly rising demand, according to the International Energy Agency, the energy watchdog for consuming countries.

But senior Saudi energy officials have privately warned U.S. and European counterparts that OPEC would have an “extremely difficult time” meeting that demand. Saudi Arabia calculates there is a 4.5 million b/d gap between what the world needs and what the kingdom can provide. Saudi Arabia has the world’s largest oil reserves and will need to bear up to half OPEC’s production growth in the next 10 to 20 years, with the rest mainly coming from Kuwait and the United Arab Emirates. Saudi Arabia pumps 9.5 million b/d and has assured consumer countries that it could reach 12.5 million b/d in 2009 and probably 15 million b/d eventually. But a senior western energy official said: “They said it would be extremely difficult to move above that figure.”

But European officials hope that energy saving measures could curb oil demand. They believe OPEC could produce the 44 million b/d the world would need if consumers adopted efficiency measures under discussion by governments in the U.S. and Europe.

Link here.


Watching the U.S. Congress miss the big picture in the age of globalization has become a common occurrence. The latest example: Its tantrum over China’s push to buy Unocal Corp. There is no convincing reason to block Cnooc Ltd.’s $18.5 billion bid for the No. 8 U.S. oil company. Sure, there may be some national security issues at the margin. It is also a bit dodgy for China’s state-owned banks to subsidize the deal. Yet steps like divestiture can deal with such concerns.

Here is an even bigger problem: The dustup is distracting Congress from the real threat to their nation’s economic future – fiscal irresponsibility. And China’s role in enabling that trend should keep politicians up at night. China is not hoarding Treasuries conspiratorially. Its $230 billion of U.S. debt holdings are not the financial Trojan horse some fear – a way for China to attack the U.S. economy from within. Those holdings have everything to do with maintaining China’s 8.3 yuan peg to the dollar. The upshot is that Asia’s No. 2 economy has a disturbing amount of leverage over the U.S. If U.S. politicians want to protect national security, they should be looking at how much their government is becoming indebted to China.

What if China began dumping U.S. debt? It would not even have to be about politics. Such a move might come if China decided to float its currency or it thought U.S. yields would rise, forcing it to accept losses on dollar holdings. That might happen if record U.S. budget and current-account deficits send the dollar lower. The budget deficit was a record $412.6 billion in the fiscal year ended Sept. 30, and a current-account deficit is 6.4% of the economy.

All this may sound a bit hyperbolic, especially when you consider China may have much to lose by letting the yuan surge or precipitating a massive drop in U.S. bond prices. Yet it is still an option for a nation that may want to flex its muscles in Washington. The U.S. used to fear Japan, the biggest holder of U.S. debt, in this regard. Japanese officials in the past have made not-so-veiled threats about pulling the plug on U.S. debt. In June 1997, for example, Prime Minister Ryutaro Hashimoto said “actually, several times in the past, we have been tempted to sell large lots of U.S. Treasuries.” The inference, which slammed markets, was clear. The prime minister had just come from a Group of Eight summit in Denver that featured considerable U.S. chest thumping about its booming economy. Japan’s leader was merely reminding Washington that while it had created a robust, productive and innovative economy, Asia holds the deed.

Whether China or others in Asia would suddenly dump their $1.1 trillion of U.S. Treasury holdings is anyone’s guess. Yet it would be a mistake to ignore the risk. The U.S. likes to claim its profligate ways are a matter of necessity amid weak demand in Europe and Asia. Such arguments ignore how the Bush administration peddled dodgy financial intelligence in order to push through huge tax cuts. This is less about the U.S. borrowing to bail out the global economy than its own fiscal policies. For better or worse, China and other Asia nations have made it possible for the U.S. to live far beyond its means. This region ships vast amounts of its savings to the West, holding down U.S. bond yields and supporting the dollar.

Yet there is a big flaw in U.S. arguments that deficits do not matter: They will matter if Asian central banks helping the U.S. paper over them change their minds. All it would take for the whole arrangement to come undone is for some of them to shift currency reserves into euros or yen. Granted, that has not happened. Those predicting a dollar crash have been humbled by its resilience. Remember, though, that the support of Asia’s monetary authorities is what is allowing the U.S. to confound its critics. If Asians reverse course, look out. It is here where Congress’s efforts on Unocal seem so perplexing. Rather than hyperventilating over Chinese companies buying up household-name U.S. ones, Congress should be panicking over fiscal realities.

Perhaps what bothers Congress is that a developing nation like China is managing to shake up the world’s wealthiest. Just as U.S. officials lost sleep over Japan’s rise 20 years ago, they worry about how China may alter the global status quo and exert influence over the U.S. China will indeed do that, yet not for the reasons some in Congress think. It is not China’s ownership of companies that is a problem – it is the IOUs.

Link here.


When the Long Term Capital Management hedge fund was sinking in 1998, leaders of the Federal Reserve were worried. They feared that if the fund failed, a major disruption could be set off in financial markets, with dire consequences for the global economy. Indeed, that worry was the impetus for the hastily arranged bailout of the fund. Since then, the financial system has not faced a similar test. At least not so far. Lately, though, there have been signs that hedge funds are again taking on big risks. That is not to suggest that a crisis is imminent, but the situation does raise important questions: While the rewards of hedge fund investing are well known, what about the downside? Could the actions of hedge funds again threaten the economy?

The numbers involved are enormous. At its near-collapse in 1998, Long Term Capital Management held $5 billion of its investors’ money. In the seven years since then, the hedge fund industry as a whole has nearly tripled in size, now wielding more than $1 trillion in invested funds. With so many more funds and so much more money, it is becoming a lot harder to be confident that the industry is being responsible. And the incentive to take risks with all that money is huge. A typical fee structure, called “2 and 20”, gives managers 2% of the assets under management and 20% of gains realized by the fund. At large funds, this means that a single year’s winnings can set up the managers for life. But as more funds pile into the winning strategies of the past, competition inevitably shrinks profit margins. And that has tempted managers to find new, sometimes riskier ways to maintain their spectacular returns.

The crowding effect is visible in some markets, particularly fixed income and convertible arbitrage, which hedge funds have come to dominate. In May, in its latest report on global financial security, the I.M.F. found that hedge funds might account for 80 to 90% of all participants in those markets. Because of that high concentration of hedge funds, the I.M.F. warns of trouble. It found that those funds, if stressed, might find themselves all selling at once, putting a strain on the entire financial system.

LTCM started with just $5 billion in capital. The fund was able to get $125 billion in additional funds. Using that leverage, it took on trading positions with an estimated potential value of $1.25 trillion. Despite the fund’s seemingly brilliant strategy, the high leverage meant that it did not take much of a setback to wipe out the fund’s underlying capital. And the potential freezing of $1 trillion worth of positions, even temporarily, was seen as a major risk to the system. What is happening to leverage today? Timothy F. Geithner, president of the Federal Reserve Bank of New York, discussed the issue in a recent speech. In his view, leverage in the industry has decreased, on average, since the 1998 bailout. Over the last year, though, the Federal Reserve and the I.M.F. have noticed that leverage is creeping back in some areas, probably because of heightened competitive pressure.

The trouble is that average leverage is not really a good indication of the risks involved. Even if the industry is generally healthy, a couple of very bad apples could spoil everything. After all, the LTCM crisis started with just one fund, not the whole industry. On that score, there has been talk on Wall Street about risky hedge funds. In particular, some traders who deal with hedge funds suspect that leverage in some cases today exceeds that of LTCM. Besides borrowed money, traders concern themselves with a broader measure called economic leverage, which takes borrowing into account but also includes risks like those arising from derivatives and other complex financial arrangements. Economic leverage can be high even when borrowing, or balance-sheet leverage, is moderate.

True economic leverage is nearly impossible to understand without full disclosure of all of a hedge fund’s commitments. This means that many decision makers – at banks, in government and on Wall Street – are merely guessing at the risk components they cannot see. Individual funds have all the relevant facts pertaining to themselves, but nobody has the complete picture. And that may be the biggest risk of all.

Link here.


Almost half of this year is already behind us. The biggest surprise, certainly, is the suddenly disappointing economic data about the U.S. economy. Whether this will be just another brief soft patch or a longer-lasting, rather serious, slowdown – if not worse – is the most important question for the whole world. For the “soft-patch” crowd, some recent spots of weakness in the U.S. economy have their main culprit in the jump in energy prices and its temporary impact on inflation rates. Other optimistic arguments are contained inflation expectations and still-considerable slack in the product and labor markets. Last but not least, Fed officials stress the fact that monetary policy is still “accommodative” and, therefore, supportive to economic growth.

We must admit to finding the singular focus on higher energy prices as the troublemaker in the U.S. economy more than simplistic. In our view, the world economy – and also the U.S. economy – is struggling with a lot of far bigger problems than higher oil prices. Besides, while these may have overshot, they could still stay high, and even rise further. They might even fall if the world economy, or large parts of it, turns significantly weaker. We see the economic and financial development through a very different lens, and judging from the behavior of the financial markets, we have the impression that we are by no means alone in assuming more permanent and pronounced economic softness in the U.S.

In hindsight, Alan Greenspan and his consorts take pride in having managed the U.S. economy’s mildest recession in the whole postwar period with their prompt policy responses, even though the stock market collapsed. For sure, this was another incident that immensely enhanced Mr. Greenspan’s reputation as the world’s greatest central banker. Two years ago, he summed up the Fed view about this policy by declaring, “Our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful.”

We have never agreed with this complacent assessment. What remains manifestly missing in this scenario is the V-shaped recovery that has been typical of all postwar recoveries but that has grossly failed to materialize this time. The final judgment has to weigh the earlier gains from the milder recession against the comparative later losses in the growth of GDP, employment and income from the unusually weak recovery over the three years since 2001. For sure, the latter losses vastly outweigh the earlier, minor gains. However, that is only one reason why we have always regarded the story of the “mildest recession” as a great delusion. But this raises a second crucial question: Why has the unusually aggressive combination of monetary and fiscal policy so lamentably failed to generate a recovery of the vigor that had been standard in postwar periods?

Our short answer: The Greenspan Fed deliberately pursued a policy to instantly replace the bursting equity bubble with another, even greater, housing bubble. By rapidly slashing interest rates to rock-bottom levels, it succeeded in generating the housing bubble and also in provoking the consumer to sustain and accelerate his borrowing-and-spending binge, now against the soaring collateral of rising house prices. The consensus sees a tremendous success. In reality, it was by far the U.S. economy’s weakest recovery in the whole postwar period, with grossly lacking employment and income growth. That is a decisive failure. Moreover, at the same time, the aggressive policies and the resulting unbalanced recovery vastly aggravated the existing imbalances in the economy.

Could it be that these imbalances are damaging to economic growth and general prosperity? You bet they are. The greatest and most obvious damage derives from the escalating trade deficit in the U.S. manufacturing sector. The U.S. economy is being virtually deindustrialized. The sector has lost 3 million jobs since 2000 and keeps losing them month after month. Yet American policymakers and most economists do not appear to be worrying about any damages to the economy. From their public talk, we must presume a complete lack of grasp. Recently, a Fed governor spoke of the minimal savings rate as a sign of optimism. The soaring trade deficit, on the other hand, is generally put into a positive light with the argument that the flood of imports of both foreign capital and foreign goods reflects America’s dynamism.

The truth, rather, is that at 15% (measured as a share of GDP), U.S. import penetration of goods and services is unusually low in comparison to other major industrialized countries. For instance, it is 33% for Germany and 28% for the United Kingdom. In reality, what America grossly lacks compared to other major industrialized countries is competitive export capacity, and this, for sure, is primarily a problem of underinvestment in manufacturing.

Link here (scroll down to piece by Dr. Kurt Richebächer).


The average American consumer may be cash-poor, but the average American corporation is not. A few of these cash-rich corporations are spending their money very wisely … by investing in their own shares. America’s corporate titans are flush with cash. The S&P 500 companies alone hold about $22 trillion in cash equivalents, which represents about 10% of their total assets. Increasingly, many corporations are using their liquid funds to buy back stock. The top 25 S&P 500 companies bought back about 1.6% of their shares last year, at a cost of $60 billion. About half of all S&P 500 companies reduced their share count from the prior year – the highest total we have seen in four years.

For mature, cash-spinning business, the “plain vanilla” stock buyback can be an exceptional way to boost shareholder value. Author Louis Lowenstein calls it a “form of financial humility”, because when a management team adopts a regular and significant buyback program, it is essentially admitting that it has no better way to invest the cash – not even in the expansion of its business. Likewise, boosting dividend payouts represents another form of financial humility. By paying dividends, corporate managements implicitly admit that they can envision no better use of company cash. We like financial humility … especially in a company whose core operations are performing well.

Sometimes managements try too hard. Over the years, many of the management teams that were blessed with extra cash have devised clever ways of squandering it. They have embarked, for example, on ill-fated plans to acquire flawed competitors or to diversify into unrelated businesses. In the process these managements have wasted money that could have produced a higher return in the service of much less creative endeavors: Buying back stock or paying dividends. Stock buybacks can be a firm’s best investment, in particular if its shares are trading cheaply. It is an investment in a business that management already knows very well.

Investors ought to remember the point about acquisitions. Michael Porter, an accomplished corporate strategist, studied acquisitions between 1950 and 1986 (a universe of over 2,000 acquisitions). The results showed that most acquisitions failed to produce satisfactory returns. Of these acquisitions, about 53% of the acquired businesses were subsequently divested or shutdown. Porter noted that the results were conservative, because corporate honchos quietly buried a number of their failures.

Buy backs are easier to execute well than acquisitions. Nevertheless, insiders often buy their stock at inopportune times. The trick, of course, is to buy the shares when they are cheap. In this, corporate America seems to have used poor judgment at times. In 1982, for example, when U.S. stocks were dirt-cheap, American corporations purchased only 0.10% of their shares outstanding, or about $2.2 billion worth of stock. Five years later, corporations spent 30 times as much money buying stocks, only to watch their prices crash in October of that year. The chart below shows the bad timing of the last few years; heavy buying in the late 1990s bubble years and a slowdown in years where it would have been profitable.

The difficult question to answer is this: Are corporations buying back stock because they believe the stock is cheap, or is it simply an exercise in bad timing? Hard to know for sure, but the market’s valuations seem to indicate that in most cases, corporations are tossing shareholder money in the wind. Happily, some companies still conduct “plain vanilla” share buybacks – the type that increases shareholder value. Hudson City Savings is one such company. Public since 1999, the company has repurchased 55 million shares over the last six years, or about half the stock sold in its initial offering! The stock has surged from a split-adjusted $6 to about $35 today! Sometimes it pays to be humble.

Link here.


The July 7, 2005 terrorist bombings of London’s subway and bus network wreaked untold havoc to our friends across the pond, exacting hundreds of casualties, 40 (and counting) fatalities, and unimaginable loss to the spirit of a country that, just 24 hours earlier, rejoiced at having won the 2012 Olympic Summer Games. We grieve over this tragedy, and offer our heartfelt condolences to its victims. That said, the one solace we offer is understanding via the lens of socionomics – namely why such a murderous act of violence has happened at all.

The premise of the Wave Principle in brief: 1.) Mass social mood unfolds in clear and predictable wave patterns. 2.) The stock market is the primary measure of trend changes in social mood. 3.) The character of social events can be anticipated by tracking these patterns (13 in all) as they unfold in the price charts of major financial markets.

For example: Throughout 1978-1983, the Elliott Wave Theorist issued a series of forecasts for the coming social mood based on the fact that mass psychology was set to surge in a positive direction. We foresaw a “period of peace and political cooperation, a rising stock market, boom times, and no war for at least ten years.” For at least 10 years, the U.S. enjoyed an uninterrupted economic and cultural bull market until the Persian Gulf War erupted in 1991.

Then in 1995, Bob Prechter’s At the Crest of the Tidal Wave made the long-term case for a dramatic turn in the tenor of social mood that would precipitate these (and more) dismal changes to the cultural landscape: “Dramatic social upheaval and political turmoil, a net trend toward anger, fear, intolerance, disagreement, exclusion and most specifically, foreigners will commit terror acts on U.S. soil.” The events of September 11, 2001 are a haunting reminder of the power of such insight.

After enjoying a brief rebound in stocks and national unity, the October 2003 EWT recognized the imminent onset of the same pattern in stocks from 2001. Knowing this, we presented specific forecasts for the years ahead in the categories of finance, politics, and more: The escalation of polarization, opposition, terrorism, separatism, etc… would occur. Since then, the pattern in stocks has only become clearer, and our insight into how this change would affect the nation and the world more compelling each day. In fact, on July 6, 2005, one of EWI’s very own subscribers emailed this forecast to our message board – based on the personality of the current wave form unfolding in social mood and stocks: “I expect any kind of very bad news anytime now.

And, in the blink of an eye, the mainstream financial press jumped on the bad news/bad for stocks bandwagon, flooding the front pages with this overall message: “US stocks are projected to fall steeply after explosions in London.” (AFP) … “US stocks are set for sustained selling throughout the session.” (Market Watch) … “Attacks will keep stocks under pressure.” (ABC News)

Investors who sold on the morning news were out of luck by the day’s end, as all three major U.S. stock indexes ended slightly higher. Even London’s FTSE index recovered over half of its losses following word on the explosions. Truth be told, any immediate reaction stock prices have to breaking news events is temporary. The dominant trend is inalterable and plain to see with the help of Elliott wave analysis.

Elliott Wave International July 7 lead article.

Terrorism and stocks: “No inconsistency is too far fetched.”

A Bloomberg wire story about the terrorist bombing in London, which called it the city’s “deadliest attack since World War II.” That is a depressing perspective to an already-ghastly story, though I pass it along with some reservation – because the same news article said the UK’s “FTSE 100 Index tumbled 2 percent.” That was incorrect. The FTSE closed down 1.36%. In fact, prices rallied nearly 2.5% off the morning low. The Bloomberg article had a time stamp of 1:35 p.m. eastern, long after the FTSE had closed. This example of sloppiness only hints at how, when it comes to the way the media “covers” the stock market, no inconsistency is too far fetched.

At 7:14 a.m. eastern, a Reuters news article ran under the headline, “Stocks seen sharply lower after blasts,” complete with a quote from a stock trader who declared, “people are assuming the worst.” Yet U.S. stocks were in an uptrend by 1:39 p.m. eastern, at which time a Reuters news article proclaimed that the “World can absorb jolt from London blasts,” and this time found an economist and amateur philosopher to remind us that despite terrorism, people “continue going on about their daily lives.”

Amateurs aside, there is a broader meaning in what seems like so much mayhem and chaos. The act of mass murder in London was not an isolated event, nor was it random, though I do not say this in reference to the schemes of the terrorists. In his September 11, 2001 Elliott Wave Theorist, Bob Prechter explains the context of what had happened, as part of “a developing worldwide tragedy that will last for years.” There had been a profound change in long-term social mood that helped produce that bloody act of terrorism, not vice-versa. Terrorism may accelerate this mood, but the psychological trend was already in progress.

The media’s “analysis” has it exactly backwards. They see the event and wonder what it will do to the long-term psychology. It is the same habitual, flawed perspective we read every day. It is a mindset that dooms your decisions always to reacting, never to anticipating. That change in social mood is not for the better, as Bob explains so eloquently, and as the terror in London today once more makes clear. It is still soon enough for most of us to prepare for what the long-term mood will bring; it is not a future I want to have to react to.

Link here.

Why did European stocks not stay down?

For most investors, the biggest surprise about the market action after the July 7th London bombing was how quickly European markets recovered after the initial shock. The first blast went off at 8:51 local time on Thursday morning, 9 minutes before the London Stock Exchange opened. The FTSE-100 gapped down at the open and plunged from 5,229 down to 5,022 – nearly 4%. But by mid-day, the index reversed and finished trading only 71 points lower. And on Friday morning, July 8, British stocks opened with a gap up and closed at 5232, completely erasing Thursday’s losses. Like it never happened.

All of media’s explanations for such remarkable resiliency have boiled down to one: Traders and investors have been expecting a terrorist attack, and they simply brushed it off saying that, “any market decline was likely to be short-lived” (BBC). In the words of one well-known analyst, “I hate to sound cold hearted, but investors, to a large extent, have become immune to terrorist attacks” (New York Times). Have we really gotten so used to a terrorist threat that when an actual strike occurs, we dismiss it and move on about our business? Perhaps, but are you truly willing to bet that another terrorist attack, if it ever comes, will also leave the markets unscathed? I would not. Trying to estimate the market’s reaction to an unknown future event is futile. We all have seen cases when the markets take a completely irrational path, opposite to the one they “should have” taken.

There is another explanation as to why British stocks erased their losses so quickly. The Elliot Wave Principle teaches that the market moves in a basic pattern of 5 waves up and 3 waves down. By identifying which wave the market is in now, Elliotticians can forecast which way the market will likely go next. Market action on July 7th is a good example of how dramatic external events do not change Elliott wave patterns. On the contrary, events fit into wave patterns. That is why by studying them you can do more than just forecast the markets. You can also anticipate social trends.

Link here.

A terror premium in gold?

On a day when London was reeling from a series of terrorist attacks against its subway and bus riders, the price of gold went up in early trading. Most commentators predictably called it a “flight to safety”. It is a natural reaction to turn to the safest investment when the world feels decidedly more dangerous, thanks to coordinated attacks like that in London, Madrid, and New York and Washington, D.C. In fact, Bloomberg points out that the price of gold rose 4.4% after the 9/11 attacks, and despite first falling 1.6% after the Madrid attack last year, it rose 6.2% over the next week.

But if you bought gold in the morning just after news of the London attacks, you would have lost money. It closed down 30 cents at $424.20 an ounce – which goes to prove that the flight to safety is too often fleeting, and does not change the dominant trend in gold or in any major financial market. In fact, gold has been headed down since its high of $457.63 (spot price) last December. Your investment decisions can be more than a natural reaction to tragedies around the world. Our forecasts are founded on technical analysis and wave patterns that have shown over and over again the ordered movements in the markets.

Link here.


Some psychopaths occupy a prison cell. Others occupy a corner office. Both are dangerous. Psychopaths possess a profound lack of empathy. They use other people callously and remorselessly for their own ends. Psychopathic CEOs are no different. By advancing their own interests, with little regard for the agony they might inflict on others, they jeopardize the welfare of employees and investors alike. In short, psychopathy is bad business. It is true that heartless managers can achieve statistically heroic corporate triumphs. But it is also true that the garlands of such victories often contain the pink slips (and sufferings) of thousands of employees.

But before we proceed to condemn America’s self-serving CEOs, allow us to give credit where credit is due, both to Prof. Robert Hare for linking psychopathy to corporate behavior and to Alan Deutscheman for explaining the topic in a fascinating essay. “One day in 2002,” Mr. Deutscheman begins, “a 71-year-old professor emeritus from the University of British Columbia, Robert Hare, gave a talk on psychopathy to about 150 police and law-enforcement officials. He was a legendary figure to that crowd. The FBI and the British justice system had long relied on his advice. According to the Canadian Press and Toronto Sun reporters who rescued the moment from obscurity, Hare began by talking about Mafia hit men and sex offenders, whose photos were projected on a large screen behind him. But then those images were replaced by pictures of top executives from WorldCom, which had just declared bankruptcy, and Enron, which imploded only months earlier.”

“These are callous, cold-blooded individuals,” Hare scowled. “They don’t care that you have thoughts and feelings. They have no sense of guilt or remorse … I always said that if I wasn’t studying psychopaths in prison, I’d do it at the stock exchange.” Collectively, corporate psychopaths inflict pain on hundreds of thousands – if not millions – of employees and shareholders. The senseless sufferings include lost livelihoods, lost life savings and sometimes even broken families or suicides. And all the while that these CEOs sow agony, they reap riches for themselves.

But these highly compensated – and sometimes brutal – corporate executives, as implements of financial Darwinism, can produce a greater good, according to Robert J. Samuelson in a recent article for the Washington Post. Maybe so, or maybe we have simply baptized a social evil, in the process canonizing villains. But even from a rabidly capitalistic perspective, investing in psychopathic management can be very bad business. Folks like Enron’s Andrew Fastow, Sunbeam’s “Chainsaw” Al Dunlap and Worldcom’s Bernie Ebbers have demonstrated the destructive capacity of corporate psychopathy. When in doubt, therefore, the prudent investor might opt to invest in companies that do NOT promote psychopaths to positions of influence.

We cannot always know, of course, who is psychopathic and who is merely “tough”. But perhaps the time has come to attempt to discern the difference. For too long, we have revered executives who seemed charismatic, visionary, and tough … as long as they were lifting profits and share prices. We did not care about mass job layoffs, provided that they occurred as remotely and silently as a lethal injection. But we individual investors seem to be repenting of our complicity. In general, we no longer revere “tough CEOs”, and we no longer look the other way while psychopathic corporate managers abuse the companies they purport to lead. Morgan Stanley’s Philip Purcell was recently “shown the door”, mostly because he excelled at producing vitriol, rather then profitability. We will not miss Philip J. Purcell, and neither will Morgan Stanley Deane Whitter’s shareholders. Psychopathy is destructive, no matter whether it roams the back streets or roams on Wall Street.

Link here.
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