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It is the kind of return investors crave and hedge fund managers are paid outrageous fees to deliver: 11% a year, unaffected by the gyrations of the stock and bond markets. But you do not have to hand some money manager enough cash to build a new wing on a Greenwich mansion to get this type of performance. Commodities futures have been grinding it out for decades, often seemingly independent of interest rates, market crashes and even the prices of commodities themselves.
You probably thought that commodities were nothing but a casino game. A place to double your money in copper if you are lucky or to get wiped out if you are not. Two finance professors, however, have evidence that commodity futures are not merely a form of gambling but an extremely useful tool in a diversified portfolio. Geert Rouwenhorst of the Yale School of Management and Gary Gorton of the University of Pennsylvania’s Wharton School pawed through 44 years of futures prices maintained by the Chicago-based Commodity Research Bureau. An important distinction: The profs were looking not at spot prices but at futures prices – contracts for delivery of commodities one to three months in the future. Spot prices have not done particularly well over long periods, barely keeping up with inflation. But futures contracts have delivered handsome returns, averaging almost 1% a month since 1959.
But don’t futures and spot prices eventually have to converge? They do, but there is a gain to be made (on average) in buying a portfolio of futures contracts and rolling them as they mature. Paradoxically, it is possible to make money investing this way even during a time when spot prices are falling. Between 1983 and 1994 the spot price of oil fell 53%. Yet someone hypothetically buying futures with short-term maturities during this bear market would have made a cumulative 87% return, the professors calculate. The reason for the positive result has to do with a strange phenomenon called backwardation. Backwardation occurs when the futures price is below the spot price. As of April 24 the spot price of crude was $75. But you could buy a barrel for delivery in December 2007 for only $70. If you buy the future barrel, and if the spot price does not budge over the next 20 months, then you will make $5 from the price gain. You will also, as we will explain, make $5 or so from interest income. Not bad: a $10 gain on a $70 investment, during a time when the commodity in question did not advance in price.
Why are sellers willing to sell future oil at a bargain price? In order to reduce risk. Think about who they are. Putting aside the speculators who step in the middle, the ultimate sellers of oil for delivery next year are oil producers. An oil company sinking money today into an offshore well needs to recover that investment in later years. What if the price of oil collapses? It has happened. By selling oil today that will not be extracted until the end of next year, the oil producer reduces its business risk. People on the buying side take on the risk. They should be compensated for doing so. Backwardation is rather uncommon in agricultural commodities and is almost never seen in gold. But it is common in industrial commodities, and it enriches futures buyers.
Now, about that interest. You can speculate in commodities with very little down, but in our hypothetical example you deposit the full contract amount with your broker. The $70 is invested in Treasury bills. You would pocket the interest earned on the bills as well as the $5 price appreciation. Your cumulative return on your $70 would be about 14%. Ignoring transaction costs, the two professors found that total returns over the 44-year period were 11% a year, compounded monthly, the same as the S&P 500 stock Index. Of that, about 5% came from the T bills, leaving a commodities “risk premium” of 6%, slightly less than the historic risk premium on stocks.Link here.
SHARES OWNED BY WALLY WEITZ’S FUNDS ARE NOT DOING SO WELL THESE DAYS. SO BUY THEM
Warren Buffett, that deity of value investing from Omaha, has long counseled patience in the stock market. Wallace Weitz, a lesser-known Omaha money manager and a Buffett acolyte, needs investors’ patience nowadays. Weitz’s largest mutual funds have been laggards recently. Since January 1, 2005 his two main funds, Weitz Value and Weitz Partners Value, have delivered cumulative returns of -0.5% and 0.8%, to the S&P 500’s 10.8%. Impatient investors have yanked $1.5 billion out of Weitz Value (now with $2.9 billion in assets) and $990 million out of Partners Value (now $1.9 billion). And that is on top of the $840 million they pulled from the funds in 2004.
Wally Weitz is philosophical. “It is impossible to earn above-average long-term returns without being willing to be out of step with the market from time to time,” says Weitz, 57, a plainspoken guy with a penchant for plaid shirts. “These are the times that set up the portfolios for superior long-term performance.” As Buffett has put it, “You cannot buy what is popular and do well.”
Working for Omaha brokerage Chiles, Heider in the 1970s, Weitz met Buffett at a bridge game and attended annual meetings of Buffett’s holding company, Berkshire Hathaway, where he drank in the great man’s wisdom. “I was fortunate enough to have caught on to it early,” Weitz says, referring to the art of value investing. He bought Berkshire shares at $270 in 1979. Weitz started his own firm in 1983. As you would expect, both men revere Benjamin Graham (1894-1976), whose philosophy, as Buffett says, teaches the virtue of “buying $1 for 40 cents.” Since Weitz and Buffett have similar investment styles, they are both in a slump of late. Berkshire Hathaway, a mutual-fund-like assortment of insurance, candy, jewelry and lots of other companies’ stocks, happens to be one of Weitz’s largest investments. It is down 9% from its high two years ago.
Weitz and Buffett made some similar purchases recently. Both Nebraskans added new positions in drooping Wal-Mart Stores and Tyco International. Just as Buffett does, Weitz buys what he understands, not what is hot. You will find Google in his portfolios. Nor any hot energy names. Instead you will see some rather cold financial and media stocks and a big wad of cash (now 13% of assets at Value and 10% at Partners Value, down from as high as 34% and 30%, respectively, last year). Buffett, to the vexation of some investors, also is sitting on a mountain of cash and bonds (50% of Berkshire’s market value), waiting for better opportunities, and Weitz notes that it rarely pays to bet against Buffett. Over time Weitz has proved his own doubters wrong. He has logged an impressive 14% annual return over the past ten years in each fund, 4.8 percentage points better than the S&P. One or both of the funds have appeared on the Forbes Honor Roll for each of the last six years.
Like Buffett or Graham, Weitz aims to buy parts of companies at a discount to what an informed, rational acquirer would pay for the whole thing if he were planning to keep it forever and wanted to earn a 12%-to-15% annual return. What keeps Weitz out of the energy sector, which has been the place to be over the last couple of years? An unwillingness to compromise his price discipline. Weitz is also wary of tech names in a Buffettesque way because he thinks it is difficult to predict the consistency and stability of their cash flows.
Financial services make up 35% of Weitz’s assets. One of his largest holdings is scandal-ridden Fannie Mae. To Weitz its troubles are “fixable”. Mortgage company Countrywide Financial is another unloved stock. This time the culprit is the end of the refinancing boom that will presumably come as interest rates climb. Overlooked, says Weitz, is that Countrywide has a sizable business servicing the loans and that this business is countercyclical to mortgage origination. Value investors pounce on stocks beaten down by bad news. Last year Weitz bought into American International Group after New York Attorney General Eliot Spitzer chased Maurice Greenberg out of the chairman’s office. “Old media”, at 17% of Weitz’s assets, constitute his second-largest sector. He recognizes that ad dollars are moving to the Internet but believes that investors have overreacted. “[T]hey generate mass quantities of free cash flow,” says Weitz.
Weitz funds do not charge sales loads. Annual expenses are moderately low at 1.1% and yearly portfolio turnover is on the low side – 40% for the Value Fund, 36% for Partners Value.Link here.
We all like money, but not all of us like the U.S. dollar. Understandably so. There are too many dollars in circulation. If there were not, why would the world’s central banks feel obliged to keep scooping up the excess? Dollar-denominated assets held by non-U.S. central banks top $1 trillion. Maybe you – Republican, Democrat or neither – share some of these doubts. You would like to hedge your monetary bets. What are your options? One course of action is to open a bank account in euros, yen, Swiss francs or another foreign currency. But this is not easy to do. Apply to one of the presumably cosmopolitan New York banks and most will tell you it is not on the menu.
It is, however, on EverBank’s. EverBank, of Jacksonville, Florida, does a brisk business in foreign exchange. It claims $900 million in nondollar deposits, including no less than $50 million in the Icelandic krona (whose 15 minutes of monetary fame appears to be ending amid concerns that Iceland’s economy is overheating). The EverBank depositor can choose among certificates of deposit in 15 currencies and deposit accounts in 18. Specialty CDs are also available, including an “Asian Advantage CD”, backed by the New Zealand dollar (40%) and the Japanese yen, Singapore dollar and Thai baht (20% each). EverBank does most of its business online or over the telephone.
If euros are your idea of a store of value, you can buy them on the New York Stock Exchange. The Euro Currency Trust (125, FXE) was listed in December as an exchange-traded fund (ETF). Each share is backed by 100 euros. Net asset value fluctuates with the euro-dollar exchange rate as well as with the interplay between interest earned and fees paid. A pair of principal-protected Asian currency notes, issued and administered by Citigroup, trade on the American Stock Exchange. Behind the notes is an equal conflation of the South Korean won, Thai baht, Indian rupee, Taiwanese dollar and Australian dollar. At maturity they earn the appreciation (if any) of the five relevant exchange rates, plus the $10 guaranteed principal.
For the U.S. dollar bear with convictions so deeply held that only a leveraged bet will do, Rydex offers a Weakening Dollar fund (or funds, as there are three subspecies, the differences having to do with loads and fees). The object of the fund is to produce 200% of the daily movement in the dollar against a basket of six currencies. Impartially, Rydex also offers a Strengthening Dollar fund, a mirror image of the other. Franklin Templeton offers a Hard Currency fund, with “hard” meaning, according to the prospectus, “currencies in which investors have confidence and are typically currencies of economically and politically stable industrialized countries.” The dollars of Canada, Australia and Singapore are the fund’s idea of hard – those plus the euro and the Swedish krona. Franklin Templeton levies a 2.25% sales charge on investments of less than $100,000 as well as a management fee (the portfolio is actively managed) of 1.2% a year.
The assets of the currency diversification options just enumerated could fit in the corner of your eye. That is another sign that the dollar bear market has much further to run.Link here.
RISING RATE STRATEGIES
While the Federal Reserve has signaled that it likely will stop tightening soon, new Fed Chairman Ben S. Bernanke does not want to be seen as soft on the war against inflation. So there is no solid assurance the Fed will be done if it raises the short-term rate another quarter-point, to 5%, at its May 10 meeting. Besides, long-term rates today do not depend on Fed policy. When foreign holders of U.S. debt dump even a small portion of their Treasurys, bond and mortgage rates rise. Low rates in Europe used to help keep our rates down. Now Britain and the European Union are moving rates up, making their debt more attractive.
How do you, as a fixed-income investor, protect yourself? You can park money in those old standbys: money market funds or certificates of deposit. With today’s flat yield curve, you do not give up a lot by shifting into them. They yield around 4.7%, pretty much tracking the federal funds rate. Just the same, you surely can do better than this. The best-known options for protecting against inflation-driven rate increases are Treasury Inflation Protected Securities (TIPS). Right now they are not such a good idea, although that may change if inflation cooks up. TIPS pay you a cash yield, now 2.5% for a 10-year bond, and an inflation adjustment to the principal, which is payable at maturity. With the core (that is, not including energy) CPI running at an annual 2% clip, you would fare better with an unprotected 10-year Treasury, yielding 5.1%. In other words [measured] inflation would need to be running at 2.6% for TIPS to make sense. That could well happen, but it has not quite yet.
TIPS is that principal can only be pegged up, but not down, so you are protected against deflation. But you are taxed on that each year on TIPS principal adjustment, at regular rates up to 35%, the same as you are on the cash interest payouts, even though you do not get your hands on it until you redeem or sell the bond. With Treasurys, as with all bonds, capital gains coming from so-called market discounts are taxed, when you sell or redeem, at ordinary rates of up to 35%. Capital gains due to falling rates are taxed at a maximum 15%. Thus, if you buy a bond at $900 and redeem it at $1,000, the $100 is considered ordinary income. If you buy at $1,000 and sell more than a year later at $1,100, the $100 is a favorably taxed capital gain.
A better alternative, and one implicitly backed by the federal government, is a perpetual preferred offered by home mortgage provider Freddie Mac, with an AA- credit score. This security’s payout is tied to a 5-year Treasury yield index and is reset only once every five years. Gains here are never treated as “market discounts” deserving of the punitive tax rate. A preferred from the student loan people SLM Corp. – known as Sallie Mae – is rated BBB+ and is linked to the 3-month Libor plus 0.7 points. The payout is reset every three months and, at a price of 102, yields 5.6%. Once again, income is taxed at 15%. Two perpetual preferreds are among my favorites: Goldman Sachs GS A and GS C. They are rated A- and at current prices yield 5.3% and 5.2%. Next reset is June 1.Link here.
BUFFETT SAYS HE IS KEEN ON INVESTMENTS OVERSEAS AT BERKSHIRE ANNUAL MEETING
Warren Buffett said that he wants Berkshire Hathaway to make more investments overseas, as he pinpointed areas such as Europe and Japan as having potential. The billionaire investment legend is trying to put Berkshire’s cash pile to more profitable use, and said he would ideally like to shrink the company’s cash to about $10 billion, from about $40 billion currently. Buffett, Berkshire’s chairman and chief executive, said he has concerns about the dollar, which he sees weakening further, and he also said he does not find “screaming bargains” in the U.S. in big companies at present.
Berkshire made its first acquisition of a non-U.S. based company last week, with a deal to buy 80% of Israel’s Iscar Metalworking Cos. in a transaction valuing the closely held tool firm at $5 billion. Buffett said that while Berkshire had always been willing to do things outside the U.S., it was not offered many opportunities in the past, though more might now come after the Iscar buy. He told Berkshire’s annual meeting on Saturday he was eyeing a possible $15 billion acquisition, but said there was only a small chance of that happening, and gave no further details.
Some 24,000 shareholders packed Omaha’s Qwest center to hear Buffet speak. Many have made healthy gains from Berkshire stock, which has far outperformed benchmark indexes since Buffett took over the company in 1965. Buffet, speaking at a news conference held on Sunday, said he sees opportunity for investments in Europe and Britain, which looked a “fertile field”, and sees potential for buying whole companies in Japan, partly because of a rise in shareholder activism that could encourage firms to find a home at Berkshire.Link here.
With more than a touch of irony, our politicians in Washington have been sounding protectionist alarms to keep out foreign goods and capital, while investors in U.S.-run stock funds are rushing to send their capital abroad. During the 12 months through February net purchases of international and global U.S. mutual funds were $117 billion versus $103 billion for funds that invest in domestic equities. Might there be an element of rearview-mirror investing here? The markets of Japan and emerging economies have been hot for the past three years. That does not make them a bargain now.Link here.
WILL WE HAVE “FANTASIA” AT THE FED?
The changing of the Fed chairman has been a traumatic event in my lifetime. Black Monday of 1987 happened two months after Alan Greenspan took office. Paul Volcker brought about interest rates near 20% by initiating a policy of monetary control in 1979. Arthur Burns, in 1970, stepped up to the plate right before the 1971 unpegging of the dollar from the gold standard, and its de facto devaluation. (I was not around for the ascension of William McChesney Martin in 1951, but believe even that was eventful.) The one major exception to the rule was the uneventful and largely forgotten 10-month tenure of G. William Miller in 1978-1979, but I expect this transition to represent a more than 10-month appointment, hence the rule, not the exception.
The hallmark of Greenspan’s tenure has been crisis management. He led the way for “circuit breaker” rules after the 1987 crash. He also generated a steep yield curve in the early 1990s that allowed banks and other financial institutions to “clean up” their default-ridden balance sheets by making new loans at record spreads. More recently, he provided liquidity (and confidence) to the markets in the late 1990s in anticipation of a Y2K crisis, and mitigated the 2001 recession by cutting the discount rate to 1.0%.
All this took place at the cost of creating “legacy” issues. These include the twin budget and trade deficits, a housing bubble (which replaced the turn of the century stock market bubble) and an indebted (or indentured) consumer living in what Warren Buffett has termed “a sharecropper society.” Meanwhile, major developing countries like China and India are experiencing massive growing pains that are being aggravated by the unprecedented injection of global liquidity by the American Fed. Even so, Greenspan’s questionable policies have so far been redeemed by masterly execution. It was the kind of thing that George H.W. Bush (Sr.) might have referred to, in one of his more lucid moments, as “voodoo economics”.
This is no time to be sending a rookie “pitcher” to the mound with the bases loaded and none out. Ben Bernanke has Greenspan’s educational level and intellect, but not his Washington experience or deft touch. In the Walt Disney movie, Fantasia, the Sorcerer’s Apprentice said the wrong words and opened up the floodgates. I am not at all sure that Greenspan would be able to head off the coming financial storm if he were still in charge. And in my heart of hearts, I do not believe that the Apprentice is up to the job.Link here.
LACK OF LOCUSTS BOOSTS STOCKS
Consumers have lost their swagger and are instead feeling jumpy and digging spider holes in the backyard next to where they were going to install the Outdoor Kitchen and Barbeque Complex with all that cash out refi money. At least that is according to RBC Financial Group, a company, that among other things, quantifies America’s level of giddiness with its RBC CASH Index. CASH is short for Consumer Attitudes and Spending by Households (and not Crazy About Shopping for Hummers as was originally suggested).
When RBC released its latest measure of consumer confidence last week, it came in at a paltry 67.1 for May. Whatever “67.1” actually means, that is miles below the April 89.4 reading. But while a stinker, the number was no surprise to the number crunchers at RBC who, in a press release, ticked off several confidence killers, including sky high gas prices, spiking mortgage rates, a rancorous immigration debate, and the implications of a potential Iran conflict. The RBC CASH Index comes from a survey of 1,000 Americans. All of the sub-indices lost ground in May, but the Expectations (sub-)Index sank like a shot put in a swimming pool. This index of feelings about the economy plunged to 6.3 – the second lowest mark in at least four years – from 56.9 the month before. But things could be worse. Nowhere in RBC’s press release was there mention of plague or locusts, and that was as good a reason as any for the Dow to rally triple digits on Friday.Link here.
HOUSING BUBBLE IS BURSTING ON ALL FRONTS
The evidence of a deflating housing bubble is spreading to places less visible to the naked eye. We are not just talking record, and fast-escalating, inventories – one of the most glaring red, flashing lights and harbingers of falling prices. Or things such as Ameriquest laying off 3,800 workers and closing 229 branches in its mortgage-lending unit. No, the evidence has segued to the subtle in three ways – mounting mortgage interest expenses, a declining homeownership rate, and a rising owner-occupied vacancy rate.
According to research by Moody’s Investors Service chief economist John Lonski, the yearly increase in mortgage interest paid by households rose to 15.8% in the first quarter – a 24-year high – from 2005’s annual growth rate of 14%. So, you are asking, interest rates are not soaring. How can households’ interest payments rise that much? As Mr. Lonski put it, “The steep advance by household interest costs amid relatively low fixed-rate borrowing costs is unusual and reflects an earlier atypical reliance on variable-rate mortgage debt for the purpose of affording costlier housing.” In other words, the chickens are coming home to roost on the variable-rate mortgages.
You may not recall the last time mortgage interest expenses happened to be growing this fast, in 1982. The yield on the 10-year benchmark Treasury, which determines mortgage rates, happened to be about three times what it is today and set to fall – an important distinction. And then there is the homeownership rate. After more than a decade of rising to the highest levels on record, the homeownership rate declined to 68.5% in the first quarter of 2006 from 69.1% in the same quarter last year. The obvious explanation is that affordability is at a 20-year low. But, according to Goldman Sachs chief economist Jan Hatzius, “The decline in homeownership is particularly interesting because it has occurred in the face of strong rental-to-condo conversions of apartment buildings, which have expanded the supply of owner-occupied units. Thus, declining homeownership is very likely due to a decline in demand, not a decline in supply of owner-occupied units.”
And finally, the owner-occupied vacancy rate is rising sharply. At 2.1%, the current rate is the highest on record. This is, of course, an unintentional consequence of speculators realizing there is no place to take a seat now that the music has stopped. “The fact that the homeownership and vacancy data tell the same story as the housing inventory data is significant … because they are based on entirely separate data sources,” Mr. Hatzius added. “This increases our confidence that the housing sector really is slowing substantially.”Link here.
Welcome to the Dead Zone.
The stories keep piling up. In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials. The message is clear. Five years of superheated price gains rescued America from stock market collapse, put billions in consumers’ pockets, and ignited a building boom that bolstered the nation’s economy. But it’s over. The great housing bubble has finally started to deflate.
You will not find that news in broad national statistics or the upbeat comments from the real estate industry. The latest official figures, for example, show both new and existing home sales rising in March, a mixed bag on prices – and a record number of new homes on the market. But Fortune’s on-the-ground reporting – in what up to now have been some of the nation’s hottest areas – paints a very different picture: Contracts are being canceled, deals are drying up, prices are starting to drop. The psychology is shifting even as thousands of new homes and condos join the for-sale listings each day – so the downward pressure will only get worse.
The vast expanse of America between the coasts was never touched by real estate mania and is in no danger of a meltdown. And even some overheated markets – including Manhattan, Los Angeles and California’s Orange County – are still simmering. But things are suddenly looking very chilly indeed in four coastal cities – Boston, Washington, Miami and San Diego – as well as three Western boomtowns – Phoenix, Las Vegas and Sacramento. So far this year, monthly sales have fallen 11% to 25% in Miami, Boston, northern Virginia and San Diego, according to local housing experts. The prognosis is even worse in Phoenix, and in Sacramento – where new-home sales plunged 57% in the first quarter vs. Q1 2005. And what is happening in these areas is a sign of what may be coming in the rest of the bubble zone – the two dozen or so mainly coastal cities and their suburbs that have seen prices soar in recent years and account for 60% of the nation’s residential real estate value.
The problem is as basic as beams and trusses: The triple threat of soaring prices, higher mortgage rates and relentlessly rising property taxes has drastically increased the cost of ownership and put many homes out of reach for a huge number of potential buyers. With houses hovering beyond the reach of most potential purchasers, formerly frantic markets grow eerily calm. People who rush to list their homes, hoping to grab a fat gain just before prices break, take them off the market. Sales shrink as buyers float low-ball offers, and sellers refuse them. Realtors and mortgage brokers find other jobs. The bubble areas turn into Dead Zones.
Right now the ratio of home values to incomes in the bubble zones is about 40% above its historical average. So the only question is how much of the adjustment will come from rising incomes and how much from falling prices. If the economy keeps chugging along, housing prices could drop 10 to 15% in the bubble zone over the next 12 months, then remain flat for maybe four more years while incomes catch up. But for the past few years the housing boom has driven the economy, adding jobs in construction, remodeling, and real estate services. And consumers gorged on the equity in their homes, taking out a total of $2 trillion via loans, refinancings, and sales over the past five years. Those powerful stimulants, which added a full point to annual GDP growth, will soon vanish. If some other force does not come along to pick up the slack, we could go into a recession that would cut income growth to zero. Then inflated housing prices would have to shoulder the entire, wrenching adjustment, falling 30% or more over several years.Link here.
A chill is in the air for sellers.
Many Americans who planned on real estate as their path to wealth are beginning to find that there are limits to how high is up. Blame market forces. As higher interest rates dampen demand in cities and suburbs that only a year ago were battlegrounds for fierce bidding wars among numerous buyers, sellers are grudgingly lowering their prices to drum up interest. A house at 57 Marina Boulevard in San Rafael, across the bay from San Francisco, was originally listed at $1.45 million. The owner recently dropped the price to $949,000 when a competing house on the same street lowered its price to $959,000, from $989,000. In Marin County, the prices of about a quarter of all listings have been reduced. County records show that 57 Marina Boulevard was sold in February for $700,000, so the owner, Dan Marr, is unlikely to lose money even at the lower price, though he may not make as much as he had hoped. “I don’t want to talk about it,” he said.
It is getting tough out there for sellers. What is happening in Marin County is being repeated in cities and suburbs across the U.S. Nearly a year after the sales of homes peaked, buyers are wresting control from sellers in many areas as inventories of unsold homes have grown, in some markets doubling. Few people are losing money after the run-up in housing prices in the last 10 years, but the air is coming out of the market.
For the first time in nearly a decade, you can smell the anxiety. The listing agent for a four-bedroom home on Scripps Trail in San Diego informed other agents in the multiple-listing service that a “very, very motivated seller will entertain all reasonable offers” and “will help with closing costs.” The house was listed in September at $810,000. After a previous price cut, the seller is now willing to entertain offers as low as $685,000. The seller bought the house for $730,000 in 2005, according to county property records, for what the listing agent said were investment purposes.Link here.
The housing bubbleocrats are starting to feel the pain resulting from the bursting of the housing bubble. Bubbleocrats hoping for a kind word from Warren Buffett at his annual confab in the capital of capitalism in Omaha, Nebraska, were sorely disappointed. Buffett thinks that a “significant downward adjustment”, i.e., a crash, is a real possibility for real estate prices.
Housing bubbleocrats should not dismiss Buffet’s opinions without due consideration. Buffet’s Berkshire Hathaway has numerous businesses that give him a direct eye into housing markets, including manufactured home builder Clayton Homes, paint producer Benjamin Moore, roofing and insulation manufacturer Johns Manville, furniture makers Nebraska Furniture Mart, Jordan’s Furniture and crucially, real estate brokerage, mortgage, title and homeowner’s insurance firm HomeServices of America. Buffet, then, has no negative axe to grind in the continuing national debate regarding housing prices.
Nonetheless, we know that housing bubbleocrats are unlikely to be convinced by such arguments. Behavioral finance tells us that belief in a point of view, even if irrational, will always trump logic until it is too late. For these true believers then, we present “Toll Brothers orders fall 32%” and “Sold – or Not: When home buyers walk”, stories from the Wall Street Journal and the Washington Post that should shake housing bubbleocrats from their complacency about the danger in elevated housing prices. Toll Brothers, referenced in the WSJ story is a leading builder of luxury homes and is squarely in the eye of the gathering housing storm. CEO Robert Toll, in reporting quarterly results, said “we are entering our ninth month of slower sales in most of our markets.” Nonetheless, Toll remains sanguine and hopeful and believes that the current slowdown is temporary. The gradient of Toll’s order slowdown in 2006 suggests that the CEO’s optimism is based on the triumph of hope over reality. Toll’s second quarter order decline is confirmation of even grimmer portents for prices and the first signs of a coming debacle in housing. To us Toll’s order book looks to be in a meltdown.
As Buffett noted at his Omaha confab, “When you have speculation-type holdings and Internet day traders moving into the day-trade of condos, then you get a market that can move in a big way.” Even as prices begin to descend into their death spiral and eventual collapse, bubble prices are catalyzing demographic trends as Americans uproot their lives get at their piece of the housing bubble. William H. Frey, a University of Michigan demographer says there are vast regions of the country that have been “locked off” – meaning, unaffordable – due to high housing prices. Consequently, they have now given up on these markets and have moved to areas beyond exurbs to areas that were previously too rural and distant to be considered for residential housing. Americans having lost faith in the stock markets and experiencing stagnant wages now believe that the path to riches lies in owning a 5-bedroom McMansion.
Today, the greatest benefit of living in our democratic, capitalist society is not the right to vote or the right to free speech but the right to this delusional dream of vast wealth through speculation – the right to be a bubbleocrat. In the U.S., speculation has replaced the once quintessential ethic of hard work, thrift, fiscal prudence and generational progress. Now all we aspire to is to get rich by being at the forefront of the next asset bubble. The U.S. has successfully transitioned itself to a bubbleocracy where speculation is central activity of the economy. The rich and wealthy speculate through hedge funds and private equity, the middle and upper class through real estate and stocks and the working class through lottery tickets and gambling.
However, the most populous economic strata in society is the middle class and hence the primary path to being a bubbleocrat has been through speculation in real estate. For those still looking for jackpots through the housing bubble, it is dark days ahead. The window on this speculation has closed. What is left to come is the ugly political aftermath and the resulting social convulsions. For homeowners uninterested in speculation, but accidentally caught in the cross hairs of the real estate bubble’s back draft, there is some good news. The Chicago Mercantile Exchange, Chicago Board Options Exchange and International Real Estate Exchange are readying products that will track home values by cities and regions. Most homeowners will not use these financial “innovations” to protect themselves because most believe there is no bubble. However, we hope that at least a few will use these financial instruments to counter declining prices.Link here.
FINDING COMFORT (AND NEW FRIENDS) IN GOLD
It is a splendid spring day in Connecticut’s horse country and James E. Sinclair, perhaps the best-known gold speculator of his era, is sitting before his trading terminal, contemplating the upward thrust of gold on his trader’s chart. The sun, bursting through the bay windows, catches the glint of gold that is everywhere in Mr. Sinclair’s home office – on the coins near his computer, on his chunky Rolex watch, on the rings on three of his fingers, on the cuff links on his monogrammed shirt, and – could it be? – a hint of it in his one working eye. “I love gold, O.K.?” he said, his voice rising in excitement. “Gold has made me wealthy. It feels nice. It’s exchangeable. It’s money.”
With gold trading at $683.80 an ounce, a 25-year high, it is a good time to be a gold bug like Mr. Sinclair, especially if, like him, you own a gold exploration company (his is in Tanzania) and were a buyer when the metal sank as low as $250 an ounce in 2001. Now Wall Street, traditionally a laggard when it comes to making the investment case for gold, has jumped on Mr. Sinclair’s bandwagon. Investment banks are putting out bullish research notes, retail investors are heavy buyers through exchange-traded funds and hedge funds, and the trading desks of investment banks have been piling into the market – especially in the last week.
For Mr. Sinclair, who rode the last bull market in gold to its peak, in 1980, the surging price of his beloved metal is sending out clear signals that take him back to the 1970’s, when inflation, a weak dollar and an oil spike driven by turmoil in the Middle East propelled gold to a high of $875 an ounce, or more than $1,800 in current dollars after adjusting for inflation. His ultimate price target now is not far from that: $1,650 an ounce, assuming that things become really bad. For more than two decades, the apocalyptic lament of Mr. Sinclair and other gold bugs has been largely dismissed as the U.S. has experienced – aside from a few hiccups – a 25-year bull market in a range of assets, from stocks and bonds to real estate and art. But now, with gold making a run for $700, dedicated gold investors are getting a wider hearing.
Given gold’s sharp recent climb, a correction would not be surprising. Is it another asset bubble … the latest investment fad? For Mr. Sinclair and a small clutch of other self-exiled Wall Streeters, the metal’s recent climb is just deserts for their unwavering, if not mystical, devotion to gold as an investment, an adornment, a means of exchange and, more than anything else, a moral bulwark in a corrupting sea of paper money, credit and what they see as insidious financial instruments. Mr. Sinclair, who in the 1970’s ran his own trading firm, achieved his renown by selling 900,000 ounces of gold at an average price 0f $810 in early 1980. That was when the metal was capping a decade-long bull market that commenced in 1971, when President Richard M. Nixon severed once and for all the dollar’s link to gold.Link here.
The Thin Gold Line
A very thin line separates inflation from deflation, perhaps as thin as the line that separates hate from love … or as thin as the line that separates gold-hating from gold-loving. We do not know what the Fates hold in store for the U.S. economy. We do not know whether inflationary trends will continue to gain momentum, or whether deflationary influences will begin to take hold. But under either scenario we do not hold out much hope for the U.S. dollar. On the one hand, high-priced energy can force companies to pass on their costs via higher prices, which is inflationary. On the other hand, high-priced energy acts as a brake on economic activity, which is arguably deflationary. The same double-sided inflationary-deflationary coin applies to commodities in general. Last but not least, the same coin applies to globalization itself. Developing world demand has driven copper and other commodities to unseen heights. But while the price of raw materials climbs higher, the margin on finished goods falls ever lower, thanks to the deflationary effects of distance-shrinking technology and an expanding global labor pool.
Global growth really got rolling over the past few years, courtesy of rapid emerging market growth, Americans’ voracious appetite for debt-financed consumption and mass generation-low interest rates from the Fed. On top of all that, the U.S. dollars flowing out at record pace – to pay for oil and Asian imports on credit – were recycled back into U.S. Treasuries, keeping long-term interest rates low and goosing growth even more. The problem, of course, is that too much of a good thing inevitably becomes a bad thing. When sound, high-quality growth mutates into rampant, speculative growth, inflation throws everything out of whack.
The Federal Reserve realized it was necessary to slow things down, lest the whole global financial system shake itself to pieces. That realization came 375 basis points ago, under Alan Greenspan’s reign. It is now up to Bernanke to finish the job. The trick that Bernanke must pull off, of course, is attempting to slow things down, but not too much. If Gentle Ben throttles down too quickly, friction and gravity threaten to take over. That would be bad. Once the global growth falls below a critical threshold, it becomes harder and harder to get things moving again. Worse still, if investors give in to sudden panic, the effect could be like a massive yank on the emergency brake – from full speed ahead to dead stop, with global financial markets tumbling head over heels as a result. The discussion is a bit theoretical, but the consequences are very real.
An unspoken, yet widely accepted reality is that the U.S. will have to massively debase its currency to deal with the fiscal mess it has created. A weaker dollar means more competitive U.S. exports and more expensive foreign imports, both of which are meant to counter the growing trade deficit. It also means big losses over time for any foreign financial institution with significant dollar reserves. The elephant in the room is whether or not the greenback’s managed decline will turn into a downside blowout. The soaring gold price suggests that the world’s dollar-holders are becoming a little nervous. The endgame for the Fed comes down to a Hobson’s choice: destroy the economy or destroy the currency. Is there any doubt which option Ben Bernanke would chose?Link here (scroll down to piece by Justice Litle).
The road to gold $3,000.
While awaiting that delightful Armageddon that might propel gold to $2,000 or $3,000 an ounce, we gold bulls will certainly endure a large number of “down days”. We will suffer through harrowing price declines that will produce large mark-to-market losses … and anguish. The True Believers among us will “buy the dips”, but many of our weaker brethren will panic and sell. Happily, there may be a middle road: Selling naked or “covered” options. Naked refers to selling options without any other related position, e.g., selling calls on Newmont Mining without also owning the stock. Selling covered options is selling calls on Newmont Mining while OWNING the stock.
Most individual investors simply buy puts or calls, as a means of leveraging their bets, while strictly limiting their potential losses. Indeed, winning option trades can produce sizeable gains, while losing options trades can produce no worse that the cost of the option itself. Buying stock options, therefore, is as sexy and thrilling as playing a Vegas craps table. And almost as dangerous. Some craps players win big, but the vast majority lose. Only the House wins consistently. The same is true in the options game. But the big difference between betting on a roll of the dice and betting on options is that in the options markets, any player can become “the House”. Any investor, in other words, can choose to SELL options rather than buy them.
Selling options is even sexier and even more thrilling than buying options, but can also be much more dangerous, which is why very few individual investors dare to attempt it. But selling options in limited quantities and in selective situations can reduce a portfolio’s overall risk. Option-selling strategies function best amidst very volatile market conditions. High volatility produces high option prices, which is exactly what an option-seller loves to see. The gold market has been quite volatile of late, which has created high volatility among gold stocks, and boosted the implied volatility of call options on gold stocks. In other words, the price of options on gold stocks is rising because the EXPECTED potential price movements of gold stocks is also rising.
Not surprisingly, therefore, placing a bullish bet on the HUI Index of gold stocks has become a very pricey proposition. The timorous gold bug could buy the HUI Index (or a comparable basket of gold stocks) and sell the September 400 calls. If gold stocks continue to rally, the option seller would make up to 11% in four months, but no more than that. On the other hand, if gold stocks faltered, the option seller would still keep his $38, as a partial protection against the loss on his falling gold stocks. A much gutsier – and much more dangerous – means of placing a bullish bet on gold stocks would be to SELL put options. We will merely point out to those who already execute such trades that put option prices on many gold stocks are quite high right now. Do with this information what you will … and Godspeed to you.
Throughout the 1990s, as many Rude readers may recall, the gold market was a tranquilized lion. The world’s central banks and bullion banks fired so many sell orders into the poor beast that it barely retained a pulse. But the tranquilizers are wearing off, and the sellers are running out of darts. As this ferocious feline continues shaking off her stupor, she will roar very loudly (and she might even maul those who have been holding her down). As the volatility increases, so will the opportunities to sell pricey options.Link here.
SOARING GOLF FEES SPARK BUBBLE FEARS IN JAPAN
The market value of some golf memberships in Japan, a keenly watched proxy for property prices and economic activity, has soared in recent months, sparking talk of a mini-bubble. The stirring of golf course membership fees after years in the deflationary bunker coincides with evidence that land prices, which have been falling since the economic bubble burst in 1990, could finally be rising again. According to Bank of Japan weighted-average estimates, released on Monday, the total value of land in the country rose 1.4% in calendar 2005, the first increase in 15 years.
Weekly Diamond, a business magazine, devoted a 102-page special in its early May issue to the sudden rally in golf membership fees, some of which rose 30% or more last month alone. Price rises had been concentrated around Tokyo and in more prestigious clubs, it said. Masaaki Kanno, economist at JPMorgan, said the spike, while not harmful in itself, could be symptomatic of a future bubble. “Once the direction changes in Japan, we tend to go too far, too fast,” he said, alluding to a new mood of optimism after years of gloom. The froth in parts of the property market has caught the attention of the BoJ, which is considering raising rates, long pinned at zero, as early as July.
Mr. Kanno said there was evidence that golf fees were being pushed up by profit-flush companies seeking memberships for their executives. That would contrast with the bubble years when golf memberships were frantically bought and sold by speculators, many of whom had no intention of ever gracing the fairway. Paul Shard, economist at Lehman Brothers, said it was ridiculous to worry about a jump in land prices, which he described as a wholly good sign that the economy was at long last reflating. “It really borders on the ridiculous to be talking about bubbles and overheating,” he said, referring to recent statements from the central bank about the perceived risks of inflation. The fact that land prices had fallen 87% from their 1990 peak meant any recovery was bound to bring a sharp rebound in percentage terms. But to worry about prices that were still not a quarter of their former value was a “very Calvinistic view of the world,” he said.Link here.
RISKY INVESTMENT TRENDS RAISE A RED FLAG
Is there such a thing as too much money? This is not a question addressed to you or me personally. Even if we are well-off, well-heeled, well-to-do or well-fixed, we are not awash in money. So it is difficult to understand a world that is. It is not easy to prepare for the consequences, either. But some of the best people in the investment business are suggesting just that: Too much money is chasing small opportunities with big risks.
One warning comes from Steve Leuthold, a portfolio strategist I frequently mention. Mr. Leuthold is taking most of his chips off the table. Some will dismiss him because he was embarrassingly early (i.e., years) on his call for caution before the 2000-02 wipeout. But he may be on to something. So let us listen to another voice, Bill Gross. Mr. Gross, master of the bond universe at Pacific Investment Management Co., or Pimco, writes a monthly commentary on the firm’s Web site. The heart of his April note was that so much money, much of it in hedge funds, is chasing so few opportunities that entire sectors of the global bond market are not worth investing in. Money managers and individuals alike are investing as though risk did not exist.
But the figures that really got my attention came from James Montier, director of global strategy at Dresdner Kleinwort Watterstein, based in London and Frankfurt. Some of Mr. Montier’s key observations: “Nasdaq stocks are trading at a nose-bleed high of 40 times trailing earnings. But short interest on the exchange-traded index fund (ETF) that tracks the Nasdaq (QQQQ) is less than two days of trading volume. Since investors sell short in hope of buying back later at a lower price, it’s clear that few are betting that Nasdaq stocks are overvalued at 40 times trailing earnings Trashy stocks are the ones investors are buying. Globally, stocks with high dividends have underperformed stocks with low dividends so far this year … stocks with high earnings stability are underperforming relative to stocks with low earnings stability.”
Mr. Montier reports that stocks ranked A+ by S&P have returned less than 5% year to date, while stocks ranked C, the lowest rank before succumbing to reorganization or liquidation, have returned more than 16% year to date. Investors are paying a premium for junk, Mr. Montier notes. While the A+ ranked stocks have historically sold at an average forward Price/Earnings ratio of 16.7, they are now selling at 14.6. The opposite is happening with lower-quality stocks. As a consequence, high-quality stocks are relatively cheap. Investors seem to have forgotten the pain of 2000-02.
Meanwhile, simple, no-risk, fixed-income investing is looming large as a competitor for stock investing. But no one cares. Viewed in terms of earnings yield (stock earnings per share divided by price), low-quality stocks at 18 times uncertain forward earnings have an earnings yield of 5.56 percent, slightly less than the earnings yield on 5-year Treasury Inflation-Protected Securities (TIPS). High-quality stocks, meanwhile, have an earnings yield of 6.85%, only a small premium over no-risk Treasury obligations. The year 2006 is developing a creepy resemblance to 1987, when both interest rates and stocks rose – until October, when stocks plunged 20% in two days.Link here.
THE SEVEN-YEAR SWITCH
Americans love an underdog. We love pulling for the little guy. In fact, we have been pulling for the little guys for seven straight years … and for seven straight years they have been throttling the big guys. So maybe it is time to bet on the new underdogs: the big guys. The nearby chart depicts the relative performance of the Russell 2000 Index of small and mid-cap stocks, relative to the S&P 500 Index. Over the last seven years, the Russell has nearly doubled, while the S&P 500 has gained a mere 9%. The Russell’s remarkable performance over this time-frame has elicited many oohs and ahs, as well as a number of after-the-fact justifications from Wall Street.
We have no idea what has caused the spectacular small-cap rally of the last several years, but the we have some idea about the resulting effects. Specifically, small-cap stocks have become quite expensive, relative to their large-cap counterparts. Yet, despite their lofty valuations, seven years of straight-up price action has emboldened investors to continue buying them. Both of these characteristics suggest that small-caps are closer to a peak than a trough, at least relative to large caps. We know of no precise reason why small-caps must now begin to falter, but we can think of innumerable reasons why they SHOULD.
For starters, analyst Richard Rhodes, of the Rhodes Report, observes that small-cap stocks tend to perform well over seven-year cycles. Since 1999, Rhodes notes, the Russell 2000/S&P 500 ratio has been going straight up. “Generally,” he asserts, “the ratio runs in 7 year cycles, so given we are in the 8th year, perhaps the time has arrived to consider readjusting one’s portfolio. In fact, we believe the winds of change are forthcoming …” Valuation differentials would second the notion. At 41 times trailing annual earnings, the Russell 2000 sells for more than twice the valuation of the S&P 500. And even if we attempt to flatter the Russell by relying on estimated earnings, this pricey index would still sell for more than 26 times earnings, well above the S&P’s multiple of 17 times earnings.
Perhaps year eight will prove to be another winner for the small caps, but we would rather bet on the underdogs.Link here.
DOLLARS ON SALE, 30% OFF
The dollar was once the almighty dollar. It became the world reserve currency. Every investor and government wanted dollars over all other currencies. Those were the glory days for the economy but now it appears the U.S. has been running a trade deficit for so long that is so large, those glory days are nearing an end. It may be time to sell your dollars before the upcoming 30% off sale.
When the Federal Reserve cut short-term interest rates to 1%, the dollar vs. the euro adjusted down from 85 to 125. In retrospect, the decline in the dollar should have lowered the trade deficit – as foreign goods became more expensive in America, and American goods became cheaper abroad – but that did not happen. Instead, we took advantage of lower interest rates to borrow against our houses and spend more, so the trade deficit has just kept on growing! Americans now spend approximately $800 billion more than they make each year … a mind-numbing amount of money! To paraphrase an election slogan we remember hearing from former President Clinton, “It’s about the trade deficit, stupid”.
Currencies in every country need to adjust from time to time to close trade deficits. Trade deficits reflect more purchases (than sales) of goods and services abroad, and are financed by the flow of financial capital. Since Americans do not save, capital, as well as goods, must flow into our country to pay for the trade deficit. (Indeed, the trade deficit creates a financial deficit.) The fact that our federal government spends more than it taxes, adds to the problem. You may wonder where all the money comes from to pay for all those extra goods and services bought abroad by spendthrift Americans who do not save a penny, especially when this spending is not matched by earnings from selling America’s goods and services abroad.
To finance our trade deficit of 7 to 8% percent of GDP and encourage the buying of dollars worldwide, a form of “financial bribery” through interest rate differentials has been used. Up until now, it has worked like a charm. For instance, as the Fed raised interest rates well above those paid on euro and yen accounts, a lot of money was made by borrowing low-cost euros and yen, and then investing them in higher-yield dollar assets. It has taken a widening interest rate differential just to keep the dollar stable.
In addition, virtually every central bank in the world has been buying U.S. financial assets. Without this continued magnitude of buying, the dollar will fall. Why is there such enormous buying of dollars from world central banks? To start with, the Japanese, Chinese and Asian central banks have found it in their commercial interests to buy dollars to prevent their own currencies from appreciating. (China and Japan now hold about a $1 trillion each.) In addition, the U.S. government uses political blackmail and the arm-twisting of our allies and their foreign central banks, to buy dollars. We may see a slight shift in global trends in the form of a sell-off of the dollar as central banks worldwide seek a buffer from the burgeoning U.S. trade and budget deficits. More importantly, the G7 and the IMF have gone on record to say that currencies need an adjustment … a very big adjustment!
In order to fully understand what is really happening on the central bank front, Larry Summers is worth listening to, now that he is free of all the politics at Harvard. Mr. Summers who served in a series of senior policy positions – most notably as the secretary of the Treasury of the United States – specialized in the currency markets. Indeed, he was “the man” who successfully engineered foreign central bank gold sales to help hold the price of gold down and make the dollar look strong! Mr. Summers is now urging the poorer, smaller countries with excess dollar reserves, “to do something with them.” Perhaps his advice is to sanction foreign aid, but I suspect he may be encouraging these smaller central banks to swap out of dollars early before the big banks do. This would preserve the real value of their foreign exchange reserves, and save the IMF a lot of money down the road for not having to bail them out. When someone yells fire in the move theatre, you want to be sitting in the back row near the exit door. Larry Summers has just yelled “fire”.
The dollar is in grave danger because there are hundreds of billions of dollar assets funded by hedge funds that will be sold. Worldwide, central banks are beginning to buy fewer dollars at a time when the U.S. needs new buyers of dollar assets to fund our escalating trade deficit. If America, as a matter of policy, is going to let the dollar go, there are many investments you must not own as an investor or saver. One investment is dollar-denominated bonds. U.S. Stocks will fight the headwinds of inflation and may go up in dollar terms, but they will most likely not keep pace with inflation. So, if you truly value a good night’s sleep, and the thrills and terror of the stock market have you spinning, put your money in cash, just not dollar cash!Link here.
Asia is getting ready to dump the dollar peg.
Li Yong, China’s vice minister for finance, said he had heard a “rumor” that the U.S. dollar was headed for a 25% drop. If the gossip was true, the consequences would be “shocking”, he said. Li’s comment, which he made at a discussion on global financial imbalances last week at the annual meeting of the Asian Development Bank in the Indian city of Hyderabad, was aimed directly at fellow panelist Tim Adams, the U.S. Treasury undersecretary of international affairs. The unspoken message was, “Don’t try to talk the dollar down.” And Adams knew better than to ask, “Well, what are you going to do about it?” The answer to that question has already begun taking shape.
Asia may be getting ready to fix its currencies to a local anchor, dumping the region’s unofficial dollar peg. Even as they continue to pile up U.S. debt in their foreign exchange reserves to keep their currencies stable against the dollar, Asian nations, China among them, are preparing for a scenario where the dollar does indeed collapse under the weight of a record U.S. current account deficit. At the Hyderabad meeting, the 13-nation group said it would sponsor a research project, titled “Toward greater financial stability in the Asian region: Exploring steps to create regional monetary units.”
This is no innocuous academic exercise. Regional monetary units are a euphemism for a parallel Asian currency, an idea that has been around since the 1997-98 financial crisis and is now, for the first time, entering the realm of policy making. Both Japan and China are extremely serious about it and are vying to take ownership of the project. An Asian Currency Unit, or ACU, will be an index that seeks to capture the value of a hypothetical Asian currency by taking a weighted average of several of them. What is the big deal with the ACU? Given the data, anyone can set up an index. It is not that Asia is talking about replacing its national currencies with the ACU. A European-style single currency in Asia is at least decades away. The ACU will start making a difference when it becomes the fulcrum of exchange-rate management in Asia. There is some sign that Asian nations want to do just that.
The ACU may well emerge as a viable currency for denominating export invoices, bank loans and bond issuances if the dollar is no longer perceived as a safe storage of value. So far, Japan has been driving the ACU concept. Now China has taken control. While China continues to exhort the U.S. not to follow weak- dollar policies, it, like everyone else, can only guess about the longevity of the present global imbalances. The idea behind the ACU is to buy some insurance, however inadequate, against a sudden collapse in the dollar.
With its “my currency is your problem” attitude, the U.S. has made a negotiated settlement of global imbalances a diplomatic non-starter. China is not willing to consider the U.S. argument that quicker appreciation of the yuan may prevent a costly adjustment later. Once again in Hyderabad, Undersecretary Adams tried valiantly to get this message across to Chinese Vice Finance Minister Li. He was wasting his breath. Li, as Adams noted wryly, “knows all my talking points.”Link here.
HAWKISH FED MAY NOT SHOO AWAY DOLLAR BEARS
Investors’ bearish sentiment toward the dollar has become so entrenched that even a hint from the Fed that it will not pause in raising U.S. interest rates may fail to stop the greenback’s slide. Uncertainty over what the Federal Reserve’s post-meeting statement may say has given the dollar some respite recently from the aggressive selling that has pounded it to 1-year lows against the euro and an 8-month low against the yen.
The Fed is widely expected to raise its benchmark federal funds rate by a quarter percentage point to 5%, its 16th straight such increase. The few remaining dollar bulls in the market are hoping the statement will signal the U.S. economy is growing fast enough to warrant more successive increases, thereby shoring up the currency. But most observers agree that the Fed is nearing the end of its nearly 2-year-long campaign to tighten monetary policy, while the European Central Bank is expected to keep raising rates this year and the Bank of Japan is also expected to raise short-term rates for the first time in six years. So the unfolding dollar-negative rate differential story is playing into that painted by the longer-term structural issues such as the massive U.S. trade deficit.
In testimony to the Joint Economic Committee of Congress last month, Fed Chairman Ben Bernanke said a pause in monetary tightening may be warranted even if data show inflation is on the rise, which sent the dollar barreling to one-year lows against the euro.Link here.
Living on the Fed-ge.
Exactly 169 years ago today, the U.S. economy endured one of the worst economic catastrophes in its history: the Panic of 1837, when nearly half of the nation’s lending institutions went bust and closed their doors to existing customers, sparking the worst levels of unemployment ever and a 5-year long depression. For many, the event seems like an ancient history when powerful men wore white powdered wigs and carried pouches of gold and silver coins for currency. Above all the differences, though, THEN the country was fragmented into 850 separate banks with no conductor, a flailing body without a head, a scarecrow sans the brain we have in place today … the Federal Reserve Bank.
In case you are new to the scene – according to Wall Street, the U.S. Central Bank is the central nervous system of the nation’s economy AND holds in its hands the monetary controls to maintain price stability, contain inflation, and sustain growth. Further is the notion that triggers more parsing of Fed policy statements than of Celebrity Pre-Nup papers: That the end of long strings of interest rate hikes sparks the beginning of even longer strings of stock market spikes.
Which makes days like May 10, 2006 so darn interesting – the date of the Federal Open Market Committee’s interest rate decision. No surprise to anyone, Ben and company chose to take things up another quarter percentage point for the 16th straight rate hike in a row since June of 2004. That said, traders were still fixed to the event like Lincoln on a penny to catch any signs of how much further the Fed has until it stops. In the words of the mainstream “experts”, “one and done” will give the bull the legs it needs to run.
The problem is, history offers no proof supporting such a scenario. Our analysts calculated the average DJIA price action in the months after the completion of the 16 previous Fed rate tightening cycles since 1920. By our calculations, the average mean return six months later is -4.9%, while 12 months later, it is –3.87% – solid evidence that “an end of a series of raising rates does not necessarily provide a tailwind for equities.” Also of interest was the average date of the Dow’s major turns of trend relative to the Fed’s final rate hike: they occurred about two months PRIOR to the end of the Fed’s tightening cycle, corroborating our thesis that the market leads, and the Fed follows.
Following up the series of historical data up with a compelling close-up of how stock prices consistently responded to a Federal Funds discount rate of 6% or higher over the last 80 years: Even a cursory glance at a chart makes it obvious that some of the most important trend changes of the previous century occurred while the discount rate was at these levels. FYI: On May 10, the Fed also lifted the discount rate to 6%. Bottom line: The central bank’s actions of May 10 offer one more piece of historical evidence to indicate that a gale-force wind is forming in the face of one kind of move in stocks.Elliott Wave International May 10 lead article.
The little-noticed “yet” in the Fed’s statement.
What a powerful word “yet” can be in the hands of Federal Reserve officials. The Federal Open Market Committee yesterday raised its overnight lending rate target by a quarter-percentage point, to 5%, as everyone expected. It was in the statement explaining what may come next that “yet” appeared, signaling that after boosting the target at 16 consecutive meetings the committee probably will take a pass late next month. After the previous meeting on March 28, the statement said, “The committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance.” Yesterday it read, “The committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.”
In March, the FOMC did not want to say flatly that it intended to raise rates at its next meeting. On the other hand, that was what it wanted financial markets to anticipate, and they did. This time, saying that “some policy firming may yet be needed” is intended to tell the market two things. First, the committee does not think, at this point, that a rate increase will be needed on June 29. Second, even if there were no move then, it would not rule out one or more increases later in the year.
The other part of that key sentence regarding “policy firming” was equally important. There the committee was emphasizing that a decision on raising rates will depend on how the Fed’s assessment of the economic outlook changes as a result of new data. Earlier in the statement, the committee noted that economic growth has been “quite strong so far this year.” Still, growth is “likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effect of increases in interest rates and energy prices.” A bad inflation number for a month, or a large gain in payrolls this month would not, by themselves, do the trick, as some analysts seem to think.
So far, the statement said, “the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained.” All this is exactly in line with Chairman Ben S. Bernanke’s April 27 congressional testimony. As a Fed official might explain, “Yes, there is concern about the risk of rising inflation, though we do not know how serious those risks are. After all, higher oil prices and falling unemployment have been around for an extended period and have not pushed core inflation much higher. Now we would like to have some more data to help us evaluate those risks before we raise rates again.”Link here.
Bank of England signals interest rates rise.
The Bank of England signaled the next move in interest rates was likely to be up as the U.S. Federal Reserve raised its main interest rate to 5%. The Bank’s quarterly inflation projections indicated inflation would overshoot its 2% target if it failed to raise rates. The Fed’s move was the 16th in a row since June 2004 and was accompanied by a statement indicating that it may have to raise rates further, although future moves would not be automatic. With the Bank of England now expected to raise rates, all the world’s important central banks are tilted towards tightening. The inflation report shows inflation on target in two years’ time if rates rise by close to 0.5 percentage points over the period, reflecting a reassessment of the cost and price pressures in the UK economy.Link here.
SARBANES-OXLEY MAKES AN IPO “MISSION IMPOSSIBLE”
Tom Cruise’s character in Mission: Impossible III had his hands full dodging explosions and bullets. Analytical Graphics Inc.’s CFO William Broderick faces another impossible mission: going public under the burden of Section 404 of the Sarbanes-Oxley Act, the internal controls provision of the investor protection law. At a Congressional hearing last week held by the House Committee on Small Business, Broderick testified that 404 compliance for small companies “has the effect of being penny-wise but pound-foolish,” because the current regulations lack reasonable cost-benefit analysis. Instead of protecting shareholders, investors are “significantly harmed” from a shareholder value perspective.
Using a back-of-the envelope calculation, he figured that some 7,400 small companies would lose an aggregate $60 billion in equity valuation on a permanent basis by complying with 404 in its current form. He bases his numbers on a report issued in April by the SEC. In the report, the SEC estimated that for companies with market caps between $75 million and $700 million, compliance with 404 averages $900,000 annually. Thus, as a percentage of revenue, the cost is 16 times greater for small companies than for larger ones.
Hefty Sarbox compliance bills are the main reason AGI did not issue an IPO in 2004, says Broderick. Because the investor was eager to cash out, AGI liquidated the venture company’s full stake by taking on $15 million in bank debt and using $13 million in cash. The capital drain, says Broderick, makes investment in advanced research and development “difficult”. It also squelches other growth objectives, such as investments into sales and marketing and business development. Further, low cash reserves forces the software maker to operate much more conservatively, a competitive disadvantage in the high-tech industry.
Broderick’s ideas for a Sarbox fix are simple, but controversial. Auditors and others who oppose a scaling back of Sarbox for small companies argue that if companies want to be in the public company game, they have to follow public company rules. Comments like that are made in a vacuum, says Broderick, contending that the notion lacks common sense, fundamental cost-benefit analysis, and business judgment. “The big misperception,” contends Broderick, “is that small companies don’t have any controls, and that is just not the case.”Link here.
SHORT-SIDE UTILITIES CHOICES FOR WHEN THEY SHUT DOWN THE POWER
When I first wrote to you about the weakness I saw in the Dow Jones Utilities Average, the index was testing its 200-day moving average. Since that time, the Dow Utilities has risen and fallen. As I write this column (in late March), the index is once again challenging its key 200-day long-term support line. The ups and downs of the last month have resulted in this averaging trace out the right shoulder of a head and shoulders chart pattern. The neckline of the head and shoulders pattern is roughly in the area of the 200-day moving average. This sector is weak! It might bounce again. But I am telling you, a good stiff market wind is likely to shut the power off on this corner of the equities world.
If you do not know how to attempt to profit from the potential weakness in this sector, let me give you some different trading or investment approaches to consider. First, you can simply buy a put option contract on the index itself. That is the purest play. But if you are not an options player – or if you do not find these options that attractive (they are not that liquid) – there are a number of other avenues you could consider. One approach is to short one or more of the stocks of the 15 companies that comprise the Dow Utilities. If shorting is not your game – or if you would like the leverage or clearly limited risk offered by the options market – you could buy puts on one or more of these stocks. All of them offer options.
If you are seeking more of a play on the entire utilities industry – where you can take a position in a single instrument that closely replicates the performance of the sector – there are a number of other possibilities you can choose from. One of these securities is what is known as a HOLDRS – which stands for Holding Company Depository Receipts. These Depository Receipts are designed to replicate the performance of specific companies within a particular industry, sector, or group in one security. According to the American Stock Exchange’s website, there are currently seventeen different HOLDRS traded. These HOLDRS are liquid and are actively traded. One of these securities is the Utilities HOLDRS (AMEX: UTH). The UTH consists of the stocks of 19 companies, most of which are also part of the DJUI. You may simply take a short position in the Utilities HOLDRS itself. Unlike stocks that trade on the New York Stock Exchange, it is not necessary to wait for an uptick in the price of the security for your open short order in UTH to be executed. Again, if you are not comfortable with the concept of shorting, or the theoretical unlimited risk inherent in this method of trading and investing, you can purchase a put option – on the UTF itself or on any of the individual UTH components.
Yet another way to bet on the downside in utilities involves Exchange Traded Funds (ETFs). Unlike the Utilities HOLDRS, which is composed of a fixed list of stocks, the companies contained in an ETF change over time. Thus, these securities are is more analogous to a mutual fund than a market index. As with the HOLDRS, ETFs related to the utilities sector may be shorted without an uptick. All these ETFs have options. One series of ETFs is known as iShares. One of these iShares is the Dow Jones U.S. Utilities Sector Index Fund (IDU). If your intent is to find a security that most closely tracks the performance of the Dow Utilities, the IDU is probably your ticket. Another popular ETF created to track utilities industry stocks is the Utilities Select Sector SPDR (XLU). Two other ETFs intended to reflect the general performance of stocks in the utilities industry are the PowerShares Dynamic Portfolio (PUI) and the Vanguard Utilities VIPERs (VPU). Both have options, but have much lighter volume than the securities mentioned above – and thus lack the liquidity of the alternatives described earlier. So, you would be better off sticking with other, more actively traded investment vehicles.
Just decide upon the method with which you are most comfortable, pick a good entry point, choose you risk threshold, and select a profit target. Then, go after it – before they shut the power on these utilities stocks.Link here.
IN A POST-DOLLAR WORLD
On our way to a post-collapse, post-dollar world, Asia will likely transition from a de jure dollar standard to a de facto gold standard. This will happen in stages as the dollar crumbles. Asian countries and consumers will accumulate gold reserves surreptitiously at first, and may eventually formalize the transition through some sort of pan-Asian IMF-type arrangement. Asia has the “second mover advantage” of being privy to all the Western World’s mistakes. They are able to see where profligacy and runaway entitlement programs have led. Their top-down orientation will enable them to rein in expensive entitlement programs or, better yet, curtail young ones before they grow bigger. Not being as mentally and emotionally tied to the workings of empire and the capitalist welfare mentality, Asia will successfully cut the cord faster.
In doing so, Asia will also rely on its citizens’ natural propensity to trust precious metals and hoard them as a store of value in the first place. Last but not least, Asia’s relative lack of capital market structure – its underdeveloped backbone of lending networks – will make a de facto gold standard that much more attractive. By going straight to gold, Asians get the “trust” that is already built into the metal. They can skip all the financial engineering, or get to working it in later.
While Keynesians see the rise of gold as temporary – and will continue to assert their naysayer views as gold rises further – it will soon come to light that the “world reserve currency” idea was the temporary thing, an anachronism of the industrial age. The world reserve currency concept is tied to the notion of a single all-powerful superpower. That is a 20th-century idea that is going away. It is also tied to the idea of a single economic powerhouse striding atop the rest of the world. That idea is going away too. Even if China becomes the new manufacturing Boss Hoss of the 21st century, it will not wield the same economic heft as America did in the 20th or Britain did in the 19th. There are too many competitors for that now. The agglomeration of industrial and political power seen in the 20th century will likely vanish into the pages of history. The concept of “world reserve currency” may well vanish with it.
Gold is also a contender because the alternatives for replacing the dollar look so weak. The euro has its own set of long-term problems, in some ways more severe than those of the dollar. Nor is the yen ready for prime time, with Japan’s economic behavior erratic and the Bank of Japan viewed as incompetent. China’s yuan is not yet supported by a fully functional financial infrastructure and has too long been pegged to the dollar to suddenly go it alone. Gold, on the other hand, steps up with a number of advantages. It can function without the need for a complex financial system to guide and regulate transactions. Asia could well be the vanguard for a new gold standard because of internal dynamics. China is exemplary in this regard in that Chinese citizens regularly save as much as 40% of their personal income. Many of China’s less-connected citizens seem as likely to bury their wealth in a shoebox as put it in a bank. This mindset strongly favors a physical, storable asset, like gold.
In today’s world, the edge is in getting smaller and leaner, outsourcing nonessential tasks and jettisoning excess baggage entirely. This will apply to governments as much as companies in the long run. In the new post-collapse environment, the number of competitive jurisdictions will thus multiply as large governments lose their capital accumulation edge to smaller ones. Successful governments in this hyper-competitive environment will be customer service providers rather than shakedown operations. They will have to provide more value for money as capital flows become all the more mobile and hard to pin down. This shift will naturally favor sound money.
Sound money naysayers argue that a gold standard cannot work in today’s modern global economy. They declare the gold straitjacket too fiscally restrictive. They warn that there is not enough gold in the world to properly grease the wheels of commerce. But the naysayers wrongly assume that a gold-based system cannot contain leverage. The use of leverage itself is not a bad thing except when abused. Governments cannot be trusted to apply leverage responsibly, but private entities could – under the watchful eye of investors and deposit holders. A sound money system policed by private creditors – without the moral hazard of government influence – could make use of leverage responsibly and well, without undue political pressures.Link here (scroll down to piece by Justice Litle).
The floozy currency begins a new chapter in her tawdry life.
The dollar has been too easy with her favors. And now, her best years are behind her. Her last beau, Alan Greenspan, took a lot out of her – reducing her street value by half. And yesterday, the end of the rate increases signaled the beginning of a new and tawdry chapter in the life of the floozy currency. For the last two years, the Fed has been raising rates … in tiny, “baby steps” of one-fourth a point each time. And yesterday, the Fed did so again. But this time, let it be known that it had reached the end of the line. From here on out, future rate increases will be “data dependent”, meaning the Fed will raise or lower rates depending on which way it thinks the wind is blowing.
It is only these rate increases that have helped the dollar maintain a little dignity. The imperial currency has been getting a little shopworn. She has been showing signs of decay, degeneration, degradation, and corruption. But each quarter point from the pimps at the Fed has checked caddish speculators from dumping the old girl. They figured they would hang around as long as rates were rising – why not? Now, the dollar is tumbling. Everyone says so. And everyone approves. It is the only way to restore “balance” in the world financial system, they say. Besides, who cares? Neither the president, nor her current protector. Neither of the two seem interested in her anymore.
The rest of the world shows neither sympathy nor concern. Following the Fed announcement, the dollar wobbled again – especially against her archrival, gold. “She brought it on herself,” say insensitive investors. “She threw herself at every man who walked down the street, you know, practically giving herself away to anyone who asked. She just a girl who couldn’t say ‘no’. What do you expect?” Meanwhile, gold hit a quarter-century high, with June contracts selling for $705 an ounce.
The yellow metal, buyers noticed, is everything the dollar is not. While the dollar could never say “no”, gold says nothing else: No to debt. No to new spending schemes. No to improving the world. No to re-electing scoundrels. No to bubbles. No to foreign wars. No to trade deficits. No, no, no, no, no. While the dollar was a good-time girl for everyone, gold barely said a word. She never lost her head, never held a press conference, and never made any promises. Not surprisingly, it was Dame Dollar that crowds called for. It was she whose telephone rang. It was she who got invited out, and she who showed up at every party.
That was then. This is now. Martin Feldstein writes in the Wall Street Journal that the dollar can perfectly well fall down. And why should we care? We will be better off with a cheaper dollar. Ben Bernanke says he can manage without a strong dollar. And Larry Summers is going around the world telling small nations to get rid of their dollars before it is too late: “Do something with them,” he advises. So now what for the poor dollar? Who wants her? That, dear reader, is what we are about to find out. The surprise will be that she will not go down gently, or gracefully. Instead, like a brothel Madame with a good diary, she will take a lot of people with her.Link here.
“A REALLY HIGH GOLD PRICE”
On Tuesday, the Ben Bernanke hiked short-term interest rates to 5% – the 16th straight quarter-point increase – and promised to continue hiking rates “if the data warrant.” Over the ensuing three days, global stock markets have stumbled, the dollar has dropped 2% and the gold price has skyrocketed more than $50. These financial data are probably not the sort of “data” that Bernanke had in mind, but they are exactly the sort that might warrant a 17th or 18th or 25th rate hike – as a desperate effort to defend the U.S. dollar. “Anybody have Paul Volcker’s phone number?” joked futures trader Richard Morrow. “We need help sooner rather than later. The Fed needs to step up and defend the dollar. So far, that’s a no-go as it would bust asset prices. The Fed is in a really tough position. … The wild spending orgy from the Republicans in D.C. is finally beginning to hurt.”
Republicans, alone, are not to blame for the U.S. dollar’s precarious footing. American’s of all political, or apolitical, persuasions have mastered the art of spending money that belongs to someone else. Our world-beating consumerism has plunged our personal savings rate into the red while elevating our current account deficit to an astounding 7% of GDP. Against these imposing macroeconomic forces, Bernanke’s little interest rate would seem to stand very little chance of defending the dollar. “Bernanke is not inheriting the best of situations,” former Fed Chairmen, Paul Volcker, recently remarked. “How would you like to be responsible for an economy that’s dependent upon $700 billion of foreign money every year? I don’t know what I would do about it, but he’s going to have to do something about it sooner or later.”
Mr. Volcker, of course, knows something about rugged economic situations. When he assumed the chairmanship of the Federal Reserve in 1979, he inherited the inflationary, “Carter-era” economy that produced 14% inflation rates and $800 gold. The dollar’s esteem plunged to such depths during that time-frame that the U.S. Treasury temporarily issued “Carter bonds”, denominated in foreign currencies. Volcker responded to this crisis by rapidly hiking short-term interest rates to 20%. Predictably, the U.S. economy lurched into a deep recession. But within two years time, the inflation rate tumbled and the dollar strengthened. Not coincidentally, the stock and bond markets also stabilized and began what would become two-decade-long bull markets.
Bravo for Volcker! But will history repeat itself? Probably not, but it is rhyming already. At $730 an ounce, the gold price has reached its highest level since the beginning of the Volcker era. But beyond this superficial connection, the two eras possess very few obvious similarities, “obvious” being the operative word. Based on the prevailing economic, Volcker faced a far more dire situation than Bernanke faces. But we fear that the reality is exactly the opposite. Volker’s chalice, by comparison was brimming with milk and honey. In 1979, America produced a current account surplus and boasted a national savings rate of nearly 10%. Today, both of these essential balance sheet line-items are in the red. Meanwhile, we have amassed a few trillion dollars of government debt since the Volcker era. Our crippled national balance sheet, therefore, raises the risk of serious economic crisis, should the dollar’s slump become a rout.
And now that the dollar is slumping, while gold is soaring, the unimaginable rout of the dollar is becoming a bit too imaginable. “How much longer can the dollar’s supremacy last?” Paul Volker wondered aloud at the Grant’s Interest Rate Observer Conference last month. “And what’s the endgame?” Implicit in Volcker’s musing was the clear suggestion that the dollar’s days are numbered. “Does this go on forever?” he asked rhetorically about the financing of American consumption by foreign creditors. “What kind of pyramid can you build? There seem to me to be a lot of unknowns that are facing this de facto world currency called the U.S. dollar and its increasing importance in the world,” Volcker concluded. “Does that increase in importance have some natural limit? And if so, what is the endgame?”
“In response to the question posed by Paul Volcker,” James Grant remarked, “not a few of the Grant’s conference attendees had an answer at the ready: ‘A really high gold price.’”Link here (scroll down to piece by Eric J. Fry).
THE CHURCH OF BUFFETT AND MUNGER
This year about 24,000 made the pilgrimage to see the Oracle of Omaha and his witty, if reticent, wingman Charlie Munger. The two did not disappoint, as they dished out generous amounts of their folksy wisdom and humor. This was my first year here, my first close encounter with the Church of Buffett and Munger. Many of the people that come here are … well, how can I put this kindly? Sheep. They are mindless followers. They laugh hysterically at every corny joke. They laugh at every tired, worn-out aphorism. They say sappy, syrupy, sentimental and silly things about these two old billionaires. And when it is time for the Q&A, they ask fawning pointless questions. Of course, only after they are done saying how wonderful Buffett is and how wonderful Munger is and how they are a beacon of some kind or another and … well, you get the picture. Maybe it’s just me.
Anyway … Buffett and Munger had lots of interesting things to say, and not all the rabble that lined up to ask questions were sheep. For example, some of the good questions focused on drawing out their thinking on the current investment climate and in specific areas such as commodities, newspaper stocks, South America and more. Some value investors have been digging around in the market’s discard pile and coming up with newspaper stocks. Many of the nation’s once great franchises are suffering and their stocks are making new lows. Advertising revenue is falling. Readership is declining.
What does Buffett, a long-time newspaper investor think? Buffett thinks the current woes are part of a longer-term trend that is not likely to reverse. And valuations on newspaper stocks do not reflect this. As he says, there is always somebody who thinks he sees a robin and the first day of spring. Instead, newspaper stocks face a long, perhaps permanent, winter. He said he was wrong in thinking newspapers were a bulletproof franchise. It is clear they are not. Bulletproof franchises are a rarity in the investment world. Nearly all businesses face long-term competitive pressures. But the idea of bulletproof franchises reflects Buffett and Munger’s basic desire to own businesses where the fundamentals will not change, or are not likely to change, over a 5-10-year span.
Buffett cited the telecom industry as an example where substantial change is likely. And he also talked about Intel, which Buffett said he could not figure out at its birth and cannot figure out now. That is another business that is likely to face a lot of change in the future. Indeed, a good part of Berkshire’s success over the years is in sticking to what they know. Munger added, “We know the edges of our competency better than other people know theirs.” This helps limit – although not eliminate – mistakes. One of the great pieces of advice Buffett and Munger gave was in how they would manage a small amount of money – say, several million, instead of tens of billions: Go to your best idea and measure everything against that. In the real world, you have to go with the best ideas you have. And they may not, and are probably not, the best ideas you will eventually uncover. Things change.
Buffett sprinkled his talk with lots of other investment wisdom, too. In another instance, he invoked one of the key ideas of his famed mentor, Benjamin Graham: You are right because your facts and reasoning are right and not because somebody agrees with you. This goes back to the idea that you cannot let the market sway you. “Make the market serve you,” Buffett advised, “it’s not there to instruct you.” And this is one key difference between a bottoms-up (micro) investor and a top-down (macro) approach. The top-down, macro approach takes its cues from the market – hence, the common use of charts.
Buffett said investors should focus on things that are important and knowable. One attendee asked Buffett and Munger a big-picture question involving currencies, interest rates and current account deficits. “We don’t play big trends. That’s a bit too macro for us,” he said. Asked about the viability of ethanol as a fuel additive and as an investment, Buffett said it was easier figuring out if more people were going to drink Coca-Cola and eat more See’s Candies. Plus, the fact that ethanol is so hot right now is a deterrent to Berkshire getting involved. Munger opined that since it takes more energy to produce ethanol than ethanol itself delivers, he did not think it was a good idea. He also rolled out his oft-used concept of three buckets. “At Berkshire we have three buckets,” he said, “Yes, no and too hard.” Ethanol goes in the “too hard” bucket. You do not have to investigate everything, or have an opinion on everything. Some investment ideas are just too hard, too difficult, too complex to forge a good, safe investment opinion.
On the question of whether or not commodities were in a bubble, the famed duo had some wise advice. Buffett said, excluding agricultural products, they do see something of a bubble in metals (especially copper) and oil. He said, like most trends, the fundamentals drive it in the beginning. And what the wise man does at the beginning, the fool does at the end. As trends form and gather momentum, they attract a speculative element. Eventually, that element takes over, and then you are in the danger zone. “We are seeing that in the commodity area,” Buffett opined. How high is it all going to go? Nobody knows. But commodities, Buffett concluded, were a “speculative football”.
What about South America? Buffett said the problem is they have to put a lot of money to work to move the needle at Berkshire, and that greatly limits the number of countries they can invest in. Brazil, for example, is a big country and is not off limits, but they would have to get a lot of money in a business that they understand at a price lower than comparable U.S. stocks. What about Russia? “Not interested.”
I would say the only thing that irritates me about this pair is when they talk politics. For example, is there any more ridiculous spectacle than a billionaire (in this case, Buffett) complaining about how he pays fewer taxes as a percentage of his income than the secretary in his office? My message to Warren: Nobody is stopping you from writing a bigger check to Uncle Sam anytime you feel you want to pay more. Sheesh, a billionaire whining about how he wants to pay more taxes! The other dopey thing Buffett said was about Social Security. When Buffett praises it as “the most successful program in the history of our government,” I can feel the hairs rise up on the back of my neck. And I wonder what he is drinking besides a can of Coca-Cola. Social Security is a disaster that is bankrupting this country. The sooner people realize that, the better. It also proves the point that genius in one area (in this case, investing) does not necessarily translate into other areas.
Of course, I forgive him for such transgressions. At the end of the day, he and Munger taught us all a lot about investing over the years. Serious investors will study their careers as long as there are markets.Link here (scroll down to piece by Chris Mayer).
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