Wealth International, Limited (trustprofessionals.com) : Where There’s W.I.L., There’s A Way

W.I.L. Finance Digest :: July 2009, Part 3

This Week’s Entries :


Fear seems to be nearly absent from the markets right now, the players apparently having tired of worrying about whether the numbers add up. They don’t, of course.

Bears are experiencing that familiar same old déjà vu all over again. Stocks are going up despite the fact that they “shouldn’t.’ And they look overvalued.

This cognitive dissonance stems from the theory that the stock market is rational in some sense. There is no evidence for that. An alternative hypothesis, suggested by Rick Ackerman here, is that the stock market is “deaf, dumb and blind; Indeed, if it were a dog, it could not detect a lamb chop tied to its neck. It is not prescience that makes stocks go up and down ... but rather the ebb and flow of fear and greed as they play out in broad cycles.” Sounds reasonable to us, and less crazy-making.

Ackerman points out that the market can go another 50% higher from here – unlikely, but possible (anything is possible) – without breaking the long-term bear case.

Just because there are a dozen great reasons to hate stocks right now does not necessarily mean they cannot go much higher. Not only that, the bear rally could continue for quite a while – until 2011 and beyond, even – without distorting the bearish look of the long-term charts one bit. Take a look at the monthly chart below, which shows 10 years14 worth of price action in the S&P 500 futures. Nine of those years have seen a bear market brought on by the collapse of tech stocks in 2000. But notice how, when the major bear phase ended 2 1/2 years later, the S&P embarked on a rally that lasted five years and which recouped 80% of the losses. It is categorized as a bear rally nonetheless, rather than as a bull market, simply because it failed to exceed the all-time high recorded in 2000. If a similar rally is under way now in the S&P 500, it would imply that the S&P futures, currently trading around 934, will hit 1407 by mid-2014. Our speculative price bars (in red) show how the rally would look if it reached 1407 somewhat sooner, in early 2012.

We think this is extremely unlikely, given the disastrous state of the economy. Where some optimists purport to see green shoots of recovery, we see the early stages of a collapse that eventually will be recognized as a full-blown depression. Under the circumstances, it is more likely that, come 2014, the S&Ps will be trading closer to 400 than to 1400. Even so, we cannot rule out the possibility that the irrational surge begun in March will go significantly higher than anyone believes it “should” before sputtering out and reversing with a vengeance. The rally presumably would occur even as state and local governments slip deeper into bankruptcy and unemployment pushes above 15%.

Deaf, Dumb and Blind

While it might seem implausible that stocks could stage a gigantic rally as the economy slips into coma, we learned long ago that the two are not connected in a way that makes them act logically, much less predictably, relative to each other. Popular wisdom has it that the stock market, all-knowing and prescient, looks ahead and sniffs out a recovery well before it becomes apparent statistically. Our interpretation is a bit different. We see the stock market as deaf, dumb and blind; Indeed, if it were a dog, it could not detect a lamb chop tied to its neck. It is not prescience that makes stocks go up and down, we would argue, but rather the ebb and flow of fear and greed as they play out in broad cycles.

Fear seems to be nearly absent from the markets right now, the players apparently having tired of worrying about whether the numbers add up. They don’t, of course, and the profits that banks have been reporting lately are just a mirage. But we should not be surprised if millions of investors continue to believe for yet a while that the mirage is real, especially when this point of view is the sum and substance of coverage each day by the relentless likes of CNBC and other advertising-driven purveyors of news.


Last week we looked at gold as we would a house or an insurance policy. Now I want to present it as a core investment relative to your overall strategy.

Chuck Cohen’s 3-part opening volley on Rick Ackerman’s website was featured in the previous W.I.L. Finance Digest. Here he follows that up by starting to build a fundamental bullish case for gold. The previous emphasis was on the concept of gold as insurance. That notion is far from dropped here, but the primary focus is on the actual investment case for gold – and not just as some speculative fringe “alternative investment” but as an anchor.

Recently I discussed some of the reasons investors often fall short [see here]. Today I want to help bring clarity to your investment goals and also explain why gold should hold a central place in your portfolio. If you succeed in these two areas, you will not only prosper, you will also be prepared for the incredible changes and shocks that I believe are coming.

As Richard Russell always stresses, succeeding in the stock market is a lifetime learning process. At age 84 or so, he is still working diligently at it. As we have all learned, making money in the stock market is not as easy as the hucksters would have us believe. Success comes not just from market knowledge but from learning from our mistakes. And it is critical to acknowledge that we all make mistakes. To succeed also includes knowing ourselves, especially the emotions which often rule our decisions. It can be just as important to avoid a disaster or to get out of a potential one than to have a successful trade. Just as in baseball, we aim to have a high batting average and to avoid deep slumps. And as an aside, (speaking from experience), this invariably means making sure your spouse is comfortable with your finances.

Because of these issues, we need to lay a foundation from which we can look at the markets, especially gold, intelligently and dispassionately. Once we have done so, we will get into more detail. Please excuse any overlaps or repeats as we go along. Some might be intentional, some not.

Gold as a Core Investment

When I began contributing essays to Rick’s Picks recently, I did not know how familiar readers were with gold, particularly the idiosyncrasies of various mining companies. Judging from the e-mails and comments I received, however, I have inferred that many of you are fairly knowledgeable and active in bullion. Even so, let us review some fundamentals.

As I mentioned earlier, gold does not require an all-or-nothing commitment, and it need not be a stand-alone investment. However, it should hold an essential position in these uneasy and uncertain times. It must be considered within the overall economic landscape that also includes your personal situation plus your other investments.

Last week we looked at gold as we would a house or an insurance policy. Now I want to present it as a core investment relative to your overall strategy. We will also consider gold as a speculative vehicle. In future articles I will continue to underscore that we now live in a period vastly different from all others before us. The financial and geopolitical ground around us is shifting, and before long, great, irrevocable changes will arrive. Therefore, our approach to our lives, and especially to our finances, must stress preparedness so that we can adapt to these changes. What has been successful in the past is not likely to work in the future. Having witnessed the decimation of such hallowed financial institutions as Bear Stearns, Lehman Brothers and AIG, can we logically assume the worst is behind us? Surely not. Let us look at four factors that should deepen our commitment to gold.

I. The World Landscape Is Shifting

Despite the spin from Washington and the financial media that things will somehow work out, this requires the kind of faith that I – and probably many of you – just do not have. Given the tumultuousness of the last decade, only an ostrich would buy into this sunny assumption.

A quick list of our problems is not meant to be depress you so that you cannot sleep. But it reflects the hard reality of our nation’s condition, to wit:
  1. Unlike China, we have no savings set aside, either by households or by government at all levels. Meanwhile, we are trying to induce a debt strapped-consumer to spend even more by going deeper into hock;
  2. revenues and tax collections at all levels of governments are collapsing;
  3. infrastructure is deteriorating and in dire need of rebuilding;
  4. Social Security and Medicare are drastically underfunded even as Baby Boomers approach retirement;
  5. corporations face vast unfunded pension liabilities;
  6. all of these problems will contribute to a bleak employment outlook; and,
  7. our only solution at this point has been to stimulate through the injection of trillions of paper dollars. This cannot hide the fact that America is technically bankrupt.
The dollar, once the world’s great currency, is under close scrutiny by overseas creditors. They are considering a shift away from dollars, which would result in either a profound dollar weakness, dramatically higher interest rates, or both. It is almost unimaginable that the once great creditor nation of the United States is now at the mercy of, what were until recently considered, underdeveloped countries. Please read Julian Phillips’ latest article on China, the yuan and the dollar. He is a very perceptive observer.

My point is this: Is it logical that we will somehow muddle through our mess, and by faith believe that these problems can, through the issuance of money out of thin air, be solved or just disappear? I do not think so. A more reasonable conclusion is that America is on a elongated down slope. As a consequence, the price of gold will continue to increase, and most likely accelerate.

II. Personal Financial Risk Is Increasing

What is your personal financial situation, and what are your expectations? How might these things be affected by your age, health and family considerations? These issues affect how you can approach gold. We will get into many of these at a later date.

III. Gold Alternatives Have Soured

I assume that you have some savings invested in different vehicles. Let us look very briefly at some of them.

Most investors still believe that stocks, bonds and even real estate are the safest and best places to be for the long-term. Because this reflects the popular wisdom and is reinforced constantly by the financial media, we tend to continue to stay where we feel most comfortable.

But in retrospect, the past 10 years have been unkind to stocks and real estate. The terrific returns that were quoted back in 2000 have collapsed and we sense that things will get worse before they get better. Indeed, just because stocks and real estate have been severely hit, can we assume, as most analysts do, that the worst must be over? Or are we in a period like 1930-31, when it appeared that the stock market was righting itself, only to fall to a full decline of 90%?

And bonds? They have fared much better in this decade, but given the very extraordinary infusion of monetary easing and the immense financing that will be required in Bailout Nation, is it not likely that rates are about to rise? In the 1970s, in a similar monetary environment, the bond market was a disaster, with short term rates soaring to over 20%. To reiterate: The key to success is to understand the big picture, to position oneself accordingly and to try to be prepared for the unexpected. The recent historic monetary events show that sudden shocks strike without any warning.

IV. Brace for the Worst

Finally, I must include a huge “What if?” By this I mean the financial equivalent of 9/11. This is hardly a stretch when we consider how quickly Bear Stearns vanished in the mire of financial derivatives. Recall that the firm was alive and kicking at $62 on March 10, 2008; four days later it was gone. I believe that the next shock may come with even less warning, and this time with no safety net. This is where the insurance and potential upward explosion of gold really is critical.


The more we delve into the world economic and political landscape, the more attractive gold becomes and the more we might wish to expand and deepen our involvement. A corollary is that you may wish to reapportion some of the alternatives. I believe in spite of sharp stock rallies and declines, bouts of market optimism and pessimism, one thing is certain: We are in uncharted water. Fiscal problems that used to be reckoned in billions now tally into the trillions. As a result, no one can predict what the outcome will be.

The next article in Cohen’s series, “Junior Golds Offer ‘Ridiculous’ Leverage,” is featured in the next Finance Digest.


All eyes are on China.

The analysis of Doug Noland, editor of the PrudentBear.com column Credit Bubble Bulletin, appears to be particularly pertinent at this juncture. Policy makers the world over are pulling out all the reflation stops in order to create a new bubble – they might not use those terms! – that will stop the pain from the old one’s collapse. Are they being successful? This needs to be tracked in close to real time.

From the tea leaves Noland is reading the answer appears to be basically yes, with Asia leading the way and the U.S. lagging. The massive increase in U.S. government debt, as he sees it, is driving massive dollar flows to China, Asia and the emerging markets which are largely absorbed by the central banks. “And as economies recover and inflationary distortions reemerge, these enormous dollar flows can be expected to foment increasing policymaker angst. Asian reflation is poised to take on a wild life of its own, forcing policymakers at some point to confront today’s reality that dollar flows are destabilizing and unmanageable. China, in particular, faces tough choices when it comes both to managing its bubble and the massive accumulation of IOUs of deteriorating quality.”

May we live in interesting times.

Key indicators of global reflation were released this week. China official reserve holdings jumped to a record $2.132 trillion. Importantly, second quarter reserve growth surged to a record $178 billion. This was up dramatically from Q1 2009’s $7.7 billion increase and Q4 2008’s growth of $40.0 billion. It is worth also noting that the most recent quarter exceeded even the $154 billion increase near the height of the “hot money” bubble period back in early 2007. China began 2004 with $400 billion of reserves.

China is central to my macro global reflation thesis. And I believe the “core to periphery” (i.e., dollar outflows to China, Asia and emerging markets) flow of funds dynamic will fundamentally shape unfolding reflationary dynamics. I view the enormous increase in China’s reserves as confirmation both that global speculative flows have been largely rejuvenated and that China and the emerging markets retain the most robust inflationary bias. On the margin, speculative flows will prefer Asia to the U.S. – providing reflationary crosscurrents/headwinds here at home. Meanwhile, things that Asia needs and wants will demonstrate upward price pressures over time.

There were also a slew of strong economic reports out of China this week. Second quarter growth was reported at a stronger-than-expected 7.9% rate, boosting China’s first-half expansion to an impressive 7.1%. Fixed investment was up 33.6% y-o-y during the quarter, while industrial production rose 10.7%. First-half steel production increased to a record. Another report had China’s fiscal spending up 21.5% y-o-y in June, with receipts up 19.6%. Accounts have it that real estate prices are bubbling again. June M2 money supply expanded at a 28.5% pace. And after posting a 75% gain so far this year, Chinese stocks have again surpassed Japan’s to take second place globally in terms of market capitalization. Economists are quickly raising second-half and 2010 growth estimates.

The emerging markets and commodities rallied strongly this week. The EMBI+ emerging market bond index traded this week to a record high. The Goldman Sachs Commodities Index surged 6.3%, increasing 2009 gains to 23.3%. Brazilian dollar bond yields dropped to 5.80%. Copper jumped 9.6% this week, silver was up 5.7%, and gold rallied 2.7%. It is also worth nothing that the Indonesian rupiah declined only 2/3 of 1% following today’s terrorist attacks.

The massive scope of China’s bank lending and “hot money” inflows ensures a historic policy challenge.

The massive scope of China’s bank lending and “hot money” inflows ensures a historic policy challenge. There are indications that Chinese monetary authorities (People’s Bank of China) are now attempting to tap the brake a bit, as somewhat reduced inter-bank liquidity pressures short-term borrowing costs higher. But do not expect central bank tinkering to have much more impact in China than it did here at home during the 2004-2007 bubble period. I would expect the rejuvenated Chinese boom to be largely impervious to cautious policymaking. Or, stated differently, bubble dynamics would seem to dictate that increasingly unwieldy financial and economic bubbles will keep policymakers on their heels and unwilling to decisively face growing risks. And as ultra-loose financial conditions in the U.S. and elsewhere spur a rebound in credit growth (and attendant financial flows), the Chinese predicament will turn even more problematic.

Financial reports here at home also confirm a rejuvenation of speculative and global reflation dynamics. Goldman Sachs reported record quarterly net revenues ($13.76 billion) and net earnings ($3.44 billion). “Net revenues in Trading and Principal Investments were $10.78 billion, 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009.” “Fixed Income, Currency and Commodities (FICC) generated record quarterly revenues. ... Equity underwriting produced record quarterly net revenues.” Investment Banking revenues were up 75% from the first quarter to $1.44 billion. Second quarter debt underwriting revenues of $336 million compare to Q1’s $248 million and the year ago $269 million. Second quarter equity underwriting revenues of $736 million compare to Q1’s $48 million and the year ago $616 million.

At JPMorgan Chase, “Record firmwide revenue of $27.7 billion.” Net Income of $2.721 billion was up 27% from the first quarter and 36% from the year ago period. “The investment bank reported record overall revenue for the first half of the year, which included record fees and Fixed Income.” “Fixed Income Markets revenue was a record $4.9 billion, up by $2.6 billion from the prior year, driven by strong results across all products.” “Extended approximately $150 billion in new credit to consumers, corporations, small businesses, municipalities, and non-profits.” JPMorgan approved 138,000 loan modifications during the second quarter.

While clearly struggling, Bank of America “funded $110.6 billion in first mortgages. ... credit extended during the quarter ... was more than $211 billion, compared to $183 billion in the first quarter.” BofA “earned” $3.4 billion in the quarter, “results driven by continued strong revenue performance in the wholesale capital markets businesses as well as in home loans.” “Bank of America Merrill Lynch ranked No. 1 in high-yield debt and leveraged loans.” “Sales and trading revenue ... rose to a record $6.7 billion.” BofA provided rate relief/modification to 150,000 customers.

Policymakers desperately need Goldman and JPMorgan to expand credit. There are clearly no two institutions better positioned to profit from ultra-loose financial conditions.

Of course, Goldman and JPMorgan benefit greatly from their competitors’ travails. But their greater advantage is that policymakers desperately need them to expand credit. With bank lending stagnant, domestic reflation today depends chiefly upon the revival of the capital markets. And there are clearly no two institutions better positioned to profit from ultra-loose financial conditions than Goldman and JPMorgan. One can argue that the concentration of financial power to a few Wall Street firms played a major role in the credit boom and bust. Ironically, reflationary policymaking is today fostering only greater concentration of power and market influence.

So far, I do not really see many surprising developments pertaining to reflation dynamics. Thing seem largely on track in Asia, while the struggling U.S. credit system is regaining some fire power. At this point I see little justification for revising my expectation for lagging U.S. asset markets and economic performance.

The makings of future bouts of acute fragility are evident.

At the same time, one can see the makings of future bouts of acute fragility. I see great risk in the system’s increasing reliance on capital markets as the primary source for credit expansion and liquidity creation. It is unfortunate – but not unexpected – that reflation requires a further concentration of financial power. Moreover, it is dangerous that Washington policymakers now completely hold sway over the credit markets. “Federal” credit – Treasury, agency, and GSE MBS – remains the vast majority of system credit creation. It is worth noting that May and June GSE MBS issuance totaled almost $450 billion (from Bloomberg). There is an enormous amount of mortgage credit and interest-rate risk being bundled and transferred to Washington – to a government that already has too much of it.

Asian reflation is poised to take on a wild life of its own, forcing policymakers at some point to confront today’s reality that dollar flows are destabilizing and unmanageable.

The problem only seems to get clearer. The maladjusted U.S. bubble economy is sustained by $2.0 to $2.5 trillion of new credit – credit that must largely be issued or guaranteed in Washington. This reflation (a.k.a. credit inflation/currency devaluation) drives massive flows to China, Asia and the emerging markets that have few takers other than the central banks. And as economies recover and inflationary distortions reemerge, these enormous dollar flows can be expected to foment increasing policymaker angst. Asian reflation is poised to take on a wild life of its own, forcing policymakers at some point to confront today’s reality that dollar flows are destabilizing and unmanageable. China, in particular, faces tough choices when it comes both to managing its bubble and the massive accumulation of IOUs of deteriorating quality.


“Too big to fail,” if it includes a trading operation, needs to be broken up. If Obama and Geithner were not getting their advice from Wall Street, they would already be preparing legislation to achieve this.

Ex-Enron president and much-villified Jeffrey Skilling had the idea of using price information available to Enron at energy distribution network nodes to make trading profits for the firm. The advent of the internet made real-time gathering of such information possible. The theory was not disproven by Enron’s demise, which was rather the fault of too much leverage (hidden by a formidable array of legal accounting tricks).

Martin Hutchinson points out that the theory differed only in market sector from the idea that “financial services could be made more efficient by taking loans off balance sheets through securitization, enabling home mortgages to be traded in bulk across New York trading desks and packaged to investors in Dusseldorf.” Measured by speads vs. Treasuries, that theory has ended up costing mortagees 20 basis points a year.

Skilling understood the advantages of superior knowledge of market flows. Anyone with a trading mentality figures that out on day 1. Hutchinson cannot help but note that this idea applies in spades to Goldman Sachs and the IB arm of JP Morgan Chase. With the demise and hobbling of so much of the competition these two firms have a virtual duopoly on information about major investors’ trading moves. Thus the recent surge in the profitability of their trading desks. The selective bailout of Wall Street has increased market concentration and thereby increased the profitability of the Goldmans and JP Morgans while making it more difficult for small and medium-sized finance providers to compete.

As is his wont, Hutchinson objects to this market dominance backstopped by being “too big to fail.” (For greater development on this theme, see last week’s “Too Big to Take Risks”.) Heads I get market dominance, tails you bail me out. Not a bad deal. If Wall Street did not have an inside track to the Obama adminstration, remedies would have already been proposed.

The mammoth profits reported by Goldman Sachs and the investment banking end of JP Morgan Chase last week surprised markets and demonstrated once again the power of trading operations to earn spectacular returns, for their protagonists and even occasionally for investors. It was of course the theory of Jeff Skilling and the late lamented Enron that in the new wired world, business would increasingly be done from trading platforms to the great benefit of all. So was Enron not an obviously malevolent scam that deserved to get its top official a 25-year jail term, but a noble misunderstood pioneer of 21st century business?

The Enron thesis was an attractive one at first blush. Commodity and energy distribution is an expensive business, but the advent of Internet technology and efficient communications enabled costs to be taken out of it by making each stage of the distribution process tradable, with price discovery through open bidding rather than by wholesalers negotiating individually with utilities. Similarly, financial services could be made more efficient by taking loans off balance sheets through securitization, enabling home mortgages to be traded in bulk across New York trading desks and packaged to investors in Dusseldorf. Removing all those middlemen and shining the light of the market into obscure local operations should both normalize prices and reduce costs.

It all sounded very plausible when I heard Jeff Skilling expound it at a conference in April 2001, even as Enron’s stock prices had gone into unexpected freefall. Whatever the man’s failings, he gave a hell of a presentation.

We now know the fate of Enron and the home mortgage securitization market, which suggests there had to have been a flaw in Skilling’s glossy presentation, whether applied to energy or financial markets. Nevertheless, Goldman’s, JP Morgan’s and indeed Bank of America’s most recent earnings (the latter of which rested largely on good results at Merrill Lynch) suggest that 25-year jail sentences are not the inevitable outcome of practicing this theory; great wealth may also eventuate, at least for traders.

Trading is among the most intellectually opaque of all ways of making money. Modest analysis can uncover the secrets of profitability at almost all businesses, at least post facto, but not those of trading. Traders seem no cleverer than the rest of us, and rather less endowed with charm, although they clearly have excellent nerves. They are also unable to explain how they make money, or at least extremely unwilling to do so. Even books such as the excellent if annoyingly arrogant best-sellers of successful ex-traders such as Nassim Nicholas Taleb offer little further enlightenment beyond massive helpings of rather dubious philosophy.

One can understand “buy low and sell high.” But if it were as easy as that, why couldn’t everybody do it? Furthermore, why are the most successful traders almost all concentrated in the same houses? There appears to the naked eye very little difference between a trader at Goldman Sachs and a trader at a second-tier European bank, yet only the Goldman guy is likely to become seriously rich.

There are two major secrets to success as a trader. One is to figure out a methodology that works in the short term, even if it is likely to cause a gigantic disaster later on. Most of the money made in trading mortgage bonds resulted from this approach. The existence of fashionable, fallacious risk-management models such as “Value at Risk,” for example, enabled traders to pile on debt and thereby achieve attractive returns through huge leveraging of modest differentials between interest rates.

This strategy becomes particularly attractive if the Federal Reserve is forcing short-term interest rates down to levels far below long-term rates, as it has since 1995. Indeed, since long-term interest rates declined steadily from 1981 to December 2008, many traders in the debt area were able to spend their entire careers in an arena in which a modest level of profit, year after year, was built into the structure of their operations. Yes, there was the occasional year in which short-term and long-term interest rates backed up, but the last such year in which debt trading was economically unattractive was as long ago as 1994.

That works for debt products, but not so well for stocks, which are less attractive vehicles for leverage games because their prices bounce around too much, so that even the doziest risk managers will not let you borrow too much against them. However, during the glory years of 2003-07, trading desks found an attractive alternative means of generating steady leveraged gains, through their investments in privately held hedge funds and private equity funds, and complex untraded securitization structures.

These investments were justified as asset diversification, though in reality most were not “alternative” at all but heavily correlated to the stock or real estate markets. Their true attraction was that their value could be assessed only through the mathematical models of the trading desks themselves. Through the fashionable “mark to market accounting,” their book value could then be marked up by a moderate amount each year, and profits taken into earnings on which bonuses were based. Leveraged with debt at low interest rates, those moderate returns were sufficient to provide juicy bonuses to participants. Since many of these investments eventually produced losses in 2008 (and many others will eventually do so), the traders were essentially playing the same game as the Ponzi schemer Bernard Madoff – the difference being that at least some of them may have been unaware of the fundamental swindle of outside shareholders that was taking place.

While the intrinsic profitability of leveraged long bond positions in a secular 27-year bond bull market explains the sleek appearance of even regional bank debt traders in the last couple of decades, it does not explain the profitability of Goldman Sachs and JP Morgans today, as interest rates have been rising in 2009. Private equity and hedge funds have had quite good years so far, but that could not have been relied upon in advance. However, for the largest participants in each market, there is another source of trading profits: The ability of dealers to profit from insider information.

Trading on insider information about the operations of client companies was a major source of Pierpont Morgan’s original fortune, and of those of many London merchant bankers, but has been illegal since the 1930s, and prosecuted with gradually increasing ferocity by the Securities and Exchange Commission. Presumably, investment banks today profit from this kind of information only occasionally, although there will certainly be some leakage between the client side of the largest banks and their trading arms (and most of them also have research operations, whose information falls into a gray area).

However, there are many forms of inside information, in the sense of information that the general universe of investors does not have. Probably the most important, even more important than company operating information, is information about large investors’ moves into particular securities or markets. Armed with this knowledge, a trader can manipulate the market so that his positions always swim with the market current, never against it. In the less transparent markets, such as those for options, credit default swaps and many other derivatives, traders who are aware of a substantial portion of the money flows can manipulate prices, let alone the parameters such as volatility that serve as inputs to the ubiquitous mathematical valuation models.

This explains the recent sudden increase in the profitability of the largest trading desks. Bear Stearns and Lehman exited the market, and the number of large non-U.S. participants dabbling in U.S. markets is way down from two years ago. Hence the profitability of trading in general for the remaining houses has jumped, because their level of information on market activity has jumped. I would expect that to have been particularly the case in markets such as options and credit default swaps, in which prices are opaque and manipulation relatively straightforward (apart from the possibility in CDS markets of playing profitable games with actual defaults, the number of which has risen in the recession far above the long-term average).

That is why Goldman and JP Morgan were particularly keen to get away from Trouble Asset Relief Program funding, and reestablish their independence from government interference. The existence of hobbled competitors, such as Citigroup and Bank of America, who have not managed to escape from the government and whose management is in turmoil, doubtless gives Goldman and JP Morgan an additional advantage. A lengthy recession, with international banks licking their wounds from losses in the U.S. market, would be their ideal. In such an environment their trading market shares will remain dominant.

Skilling of course understood the advantages of superior knowledge of market flows. That is why he leveraged Enron to the hilt to gain market share (the leverage eventually proved fatal – it proved to be impossible to run a huge derivatives operation with a BBB credit rating). The supposed benefits to society of distribution migrating to trading desks were mostly flim-flam. The additional profits gained by such migration go almost entirely to the traders, not to society as a whole. Likewise in the home mortgage market, the migration from Jimmy Stewart making home mortgages directly to Wall Street securitizing them added about 20 basis points (0.20%) to the cost of a home mortgage, expressed as a margin over Treasury bond yields.

Both Enron’s and Wall Street’s trading operations were primarily rent-seeking exercises, and extremely successful ones. The selective bailout of Wall Street, by increasing market concentration, has increased the profitability of the Goldmans and JP Morgans, as well as made it even more difficult for small and even medium-sized finance providers to compete – I think it almost certain that the juicy second quarters at Goldman and J.P. Morgan will prove NOT to have been shared by the regional banks. (CIT’s bankruptcy or near-bankruptcy is another data item proving the same point; if credit provision itself had been profitable in 2009, CIT would now be laughing).

For the rest of us, there are clear antitrust implications. “Too big to fail,” if it includes a trading operation, needs to be broken up, to prevent the rent-seeking of market dominance (which comes at the expense of the rest of us). If President Obama and Treasury Secretary Tim Geithner were not getting their advice from Wall Street, they would already be preparing legislation to achieve this. As it is, such legislation will have to come from such anti-establishment figures as Rep. Ron Paul, R-Texas (sponsor of a bill to audit the Fed) and Rep. Maxine Waters, D-California (sponsor of a bill to ban credit default swaps).

Meanwhile, justice demands that they free poor Jeff Skilling, who was only a far-sighted pioneer of the new Wall Street.


How much should you risk on foreign stocks? Probably more than you are risking now.

Stocks traded outside of the U.S. are worth 59% of total value of global shares, yet the average American has only 11% of his stock holdings abroad. This constitutes a de facto attempt to beat “the market” by overweighting U.S. holdings. This does not sound like a winning formula to us, although one never knows. The fact that it has all the earmarks of nonthinking U.S. investor inertia stains the approach’s credibility further.

To us getting foreign holdings up to the market’s 41% weighting is the way to go. If you want to argue for overweighting overseas holdings we will not squawk either, although we would want to understand your thinking.

How will traumatized American investors respond to the recent global turmoil? With a wave of investment isolationism, predicts Linda Tesar, chairman of the University of Michigan’s economics department. Frank Warnock, a finance professor at the University of Virginia’s business school, expects the opposite.

These experts in foreign investing do not agree on what Americans will do, but they are in complete accord about what they should do: Invest more abroad.

Stocks traded outside of the U.S. are worth $14 trillion, or 59% of total value of global shares. (The figures are as of June 30.) Yet the average American has only 11% of his stock holdings abroad. Perhaps these savers rationalize that they will be spending dollars, not euros or yen, at the grocery store. But they are missing an opportunity for better diversification and returns.

In the 35 years through 2005 a stock portfolio that mimicked the weightings of world stock markets would have delivered an 11.2% annual return to a U.S. dollar investor. A purely domestic stock portfolio would have earned only 10.7% annually. That half-point advantage, compounded, turns into a big difference. The worldly investor who put down $100,000 at the outset of the period would have had $4.1 million at its end point, $600,000 more than the homebody.

Even if returns over the next 35 years are destined to be equal, there is a compelling reason to go global: diversification. Adding foreign shares should (on the presumption that foreign bourses do not move in lockstep with the U.S. market) reduce volatility in a stock portfolio. That has been the historical result. A hypothetical investor who had moved half his stock money abroad in 1970 would have suffered 12% less volatility risk than someone 100% in U.S. stocks.

Smoothing out the bumps is more than a way to get a good night’s sleep. Market experts point out that any given investor has only so much stomach for risk. Cut the risk they have to endure in stocks by diversifying abroad and investors become willing to own a larger portion of this risky asset class--and thus enjoy greater returns over the long term. On average stocks have outperformed long-term Treasury bonds by 4.1 percentage points annually since 1926. It is not, of course, foreordained that this phenomenon will continue or that it will work short-term. As Forbes pointed out recently (“The Case for Bonds”), you would have earned more in Treasurys the past two decades than in stocks.

Vanguard Group researcher Christopher Philips also cautions that stock markets in different countries have become more closely correlated over the past decade. If the global synchronicity persists, it will shrink the benefits of venturing abroad.

What about currency fluctuations? Short term these add to the risk of a foreign stock portfolio for a U.S. investor. Some foreign funds (such as Tweedy Browne Global Value and Longleaf Partners International) limit this hazard by buying currency hedges. However, currency shifts have a way of washing out, says the University of Michigan’s Tesar. In addition, countries with weakening currencies tend to have correspondingly higher nominal returns.

Given the uncertainties, even experts who consider Americans’ international stock holdings to be irrationally skimpy stop short of recommending that everyone align them with global market weightings. The greatest value in going global is reaped from the first 10% of a portfolio that is put abroad. Cranking up foreign holdings to 20% of a portfolio will add a smaller but still significant portion of excess risk-adjusted returns. After that the benefits diminish rapidly.

Approach the allocation question with a certain humility. “Any idea of an optimal portfolio is based on historical data, and the world changes,” says Warnock, the finance professor. A 20% or 25% share of your stock portfolio seems about right.

The next question is how to divvy up investments among countries and regions. The European market’s share of the world’s equity value is 30%, that of Japan’s long-suffering market is 10% and that of emerging markets roughly another 10%. These shares can change dramatically over time. Japan’s share during the bubble of the late 1980s was 25%.

The numbers do not mean that you should have 30% of a $1 million equity portfolio in Europe. Rather, the point is that if you have $100,000 in Europe, a $33,000 allocation to emerging economies (the category includes Russia, China, India and Latin America) is a good starting point.

The simplest way to allocate assets is to let a fund manager do it for you, either actively in a traditional mutual fund or passively in an index or exchange-traded fund. Pay attention to costs. A handful of actively managed foreign funds seem to earn their fees. Among them: Vanguard International Explorer, which Forbes awards an A in up markets and a B in down markets, and Harbor International-Inv, which gets a B in up markets and A in down markets.

If you think that striving after market-beating results is a futile task, then buy a passive fund – and get the cheapest one you can find. Among the bargains: Fidelity Spartan International Index (a mutual fund), which charges 0.1% a year, and the Vanguard European ETF, which charges 0.11%. The iShares MSCI European Monetary Union ETF, with a similar portfolio to the Vanguard ETF’s, dings investors for 0.52%.

Some mutual funds, including Vanguard’s FTSE All-World ex-U.S. Index, charge redemption fees if shares are bought and sold within a relatively short period, so do not think of them as trading vehicles. Exchange-traded funds do not charge redemption fees but will cost you brokerage commissions and bid/ask spreads; they are not suitable for frequent purchases, like monthly contributions to a 401(k).

If your international fund is in a taxable account, you can get back foreign withholding taxes by claiming them as a credit on your tax return. If the fund is in a retirement account, you receive no credit at home or refund abroad, so it might make sense to hold your shares in a taxable account.


Because of real estate’s battering, now is a once-in-a-generation chance to reload your property portfolio.

Step up to the plate contrarians, say various advisors, because the real estate bargains are here. For example, REITs are down 60% from their peak and yield an average of 7.3%.

What percent of your portfolio should be put in real estate? Ranges from 10% to 20% are offered here. The S&P 500’s exposure to property is about 1%.

By the way, these recommended exposures do not include your family home, which is a large consumer durable that nature is intent on turning to dust and compost. If you want to speculate on future rental rates be our guest but, again, you own home is not an investment. According the Yale economist and real estate solon Robert Shiller, when you adjust for expanding home sizes you find that real home prices have scarcely budged over the past 120 years.

The reputation of virtually every type of investment has been sullied over the past year, but no other asset class has come off looking quite as rotten as real estate.

The housing bubble was just the start. Shares of companies that own malls, office buildings, storage units and other properties fell a sickening 75% from their early 2007 peak to their low this March. Although they have rebounded since, real estate investment trusts are still down an average of 60%, which is a far sight worse than the 40% decline in the broader stock market. With house prices still falling, demand for commercial property weak and credit tight, more nasty surprises could be just around the corner.

All of which leaves investors to ponder how best to invest in this recently untrustworthy asset class – if at all. The counterintuitive answer: You should buy more. Despite real estate’s battering – no, because of it – now is a once-in-a-generation chance to reload your property portfolio.

With their low-cost mortgages expiring and banks unenthusiastic about extending fresh credit, owners of office buildings and other commercial properties are rushing to come up with fresh capital. REITs have done so by raising $14 billion in new equity so far this year and are using much of the capital to acquire properties at distressed prices. Investors intrepid enough to supply the capital are getting well compensated. Although the REIT industry has slashed dividends to conserve cash, its downtrodden shares are throwing off average dividend yields of 7.3%. That is about what you could earn from investment-grade bonds and double the yield on Treasurys.

The capital gains could be considerable, too. Cohen & Steers (CNS), a real estate money management firm, expects REITs’ acquisition binge to dovetail nicely with the low point of the real estate cycle.

Unconvinced by the market timing argument? There is still a strong case to be made for putting a sizable slice of your investable assets into real estate – namely, that it has historically offered a healthy hedge against the vagaries of stock-and-bond-heavy portfolios, as well as attractive returns.

How big a slice is right? Ibbotson Associates tried in late 2006 to come up with an answer. Based on the notion that the perfect real estate portfolio would be one that offered the maximum incremental risk-adjusted return, as implied by historical data, the Chicago financial research firm came up with an allocation of somewhere between 9% and 22%. Imprecise as that is, it would no doubt have to be adjusted considerably lower these days, given how dismally real estate has performed the past two years.

David Swensen, the highly successful manager of Yale University’s endowment, is another fervent advocate of real estate investing. In Unconventional Success, published in 2005, he recommended that individuals shun mutual funds and instead put up to 20% of their assets into real estate. In contrast, if you have 100% of your portfolio in the S&P 500, your exposure to property is on the order of 1%, based on its contribution to the total market value of the index’s component stocks.

Should you count your house in the equation? Probably not. A key lesson of the recent crash is that Americans need to return to a more old-fashioned way of thinking about real estate, argues Michael Kirby, a longtime industry analyst and founder of Green Street Advisors.

“You should own a house to provide shelter,” says Kirby. “In a way it is not an investment, and it is not part of your investment portfolio. It is really just a living expense. By owning a house you are prepaying rent.”

Regarding your house as shelter does not mean you need live in a hovel. Go ahead and buy something comfortable. But view it as an extravagance rather than as a retirement account.

That housing-as-consumption philosophy is supported by a growing body of evidence. The old real estate agent adage that investing in your home will inevitably pay off, provided you are prepared to wait long enough, has been damaged by the recent housing bust. Strip out inflation (and the fact that homes are much bigger than they used to be) and you find that home prices have scarcely budged over the past 120 years, according to Yale economist Robert Shiller.

Why REITs Make Sense

Property offers alluring prospects to bargain hunters these days. Real estate investment trusts are the best way to get in and out of the asset class.

While we are only intermittent fans of real estate, we are steady fans of using REITs to gain exposure to the investment class. Management costs are lower than when you join a real estate partnership or self-manage, the headaches are obviously far lower than with self-management, and liquidity on the way out is the same as the way in (99% of the time, anyway) for a given portfolio of properties. The people cited in this article are of a similar mind.

Michael Gunzenhaeuser, a 59-year-old semiretired obstetrician in Mansfield, Ohio, has heard his share of real estate horror stories lately. Friends who own rental apartments grousing about plumbers’ bills and endless tenant bellyaching. A son who lives nearby on the verge of unloading his home at a big loss. Golfing buddies near his winter home in Naples, Florida taking a bath on preconstruction condominiums they bought on spec.

For his part, Gunzenhaeuser never liked the idea of owning property directly. “Too much work," he snorts.

Instead, the doctor has 1/10 of his 7-figure net worth in real estate investment trusts – companies that take care of the hassles of owning property and whose shares can be bought or sold for a $9 commission.

Given the way property has performed recently, why own it at all? Precisely because its recent pummeling may offer an attractive entry point into an asset class that, over the long haul, has added a nice boost to stocks and bonds (see “Property Poor” [immediately above]). Why REITs? Because unless you are planning to make a career out of property management, or someone is offering you rental real estate for a boatload less than it will cost you to own it, the hassles of becoming a landlord are likely to outweigh the advantages (see “The Landlord Game” [below]).

If you invest in stocks, you probably have a smattering of real estate exposure already. McDonald’s (MCD) and Sears Holdings (SHLD) own many of their stores. Plum Creek Timber controls 7 million acres of woodlands. Home builders like Toll Brothers usually bank land, too. Then there are land-development specialists, like St. Joe Co. It recently received permission to build 45,000 homes and 13 million square feet of commercial space on some of its 586,000-acre portfolio.

All these companies offer ways to invest in property without having to field calls from tenants with overflowing toilets. The highest-yielding stocks in the real estate universe are property-owning REITs, which are in business to collect rent and pass the money along to shareholders. (If they are careful in distributing their taxable income, they pay no corporate income tax.) There are 113 listed in the U.S. Some specialize in apartment buildings. Others own collections of shopping malls, office buildings, self-storage facilities, warehouses, mobile home lots or anything else that attracts rent-paying tenants. Average yield: 7.3%.

All REITs have the same basic objective: Buy property and put it to “higher and better use.” That means fitting in more tenants (or higher-paying ones) or redeveloping the property for more lucrative purposes. In addition to the hassles you avoid by not owning property outright, following are considerations for prospective REIT investors.

Timing: The next few years could be tough on commercial real estate, REITs included. For those willing to hang in, it is worth noting that REITs are trading at 13 times what industry researcher Green Street Advisors projects to be their “adjusted funds from operations” – that is net income plus depreciation minus any reserve needed for fix-ups – over the coming year. That is down from a multiple of 25 times during the real estate craze.

Scale: REITs own dozens of properties. This heft gives them an edge in purchasing supplies and offering tenants choices. They can usually ride out with relative ease the bankruptcy of a big tenant or economic troubles in certain cities.

Smarts: You may be a savvy investor, but you are probably no David Simon. His Simon Property Group (SPG) in Indianapolis has assembled the world’s largest shopping mall collection. Shares sell for precisely their underlying net asset value (as estimated by Green Street). Simon’s genius is thrown in for free. [Note: He does not provide this genius for free.]

Cost: Buy a $100,000 property and closing costs can easily run $3,000. Assuming you put down $20,000, that represents a one-way drag of 15%. Sell and your Realtor is likely to skim off a 6% commission. REIT operators absorb some of these same costs, but at least you can get in and out of their shares at their prevailing market value. The Simon REIT runs up overhead of 0.8% of assets annually; this is on top of operating costs (like janitors’ salaries) of the sort that any property owner incurs.

Debt: Even at the height of the recent real estate boom REITs on average had debts equal to only 43% of the fair market value of their holdings. (A glaring exception was Chicago shopping mall owner General Growth Properties, now in bankruptcy.)

When property values began to fall, REITs scrambled to raise equity and pay down debt. Even though REIT shares have been clobbered, 18 of the top operators have managed to keep debt at no more than 55% of the value of their properties, according to Green Street Advisors. By contrast, most private real estate funds and partnerships have debts up to 80% of property value.

Taxes: Your REIT dividend is a mix of ordinary income (taxed at up to 35% and not eligible for the temporary reduction on corporate dividends) and a so-called return of capital – essentially the depreciation that reduces taxable income but does not reduce the amount of cash available to dish out. Mack-Cali Realty (CLI) paid out distributions of $2.56 a share last year; $2.08 was ordinary income, and virtually all of the other $0.48 was a return of capital. It reduced the cost basis of the shares and had no immediate tax consequence but will increase the capital gain when Mack-Cali shareholders sell.

Investor clout: Since REITs retain so little of their earnings, they are constantly scrounging for new capital and must treat shareholders, analysts and lenders well. A REIT manager caught self-dealing, making questionable loans to family or wasting capital on ego-building projects is likely to soon run out of capital – and find his REIT has become takeover bait for better-managed, and capitalized, rivals.

Performance: Gunzenhaeuser, the ob-gyn, chuckles at how poorly he fared in his only direct property investments. He recently lowered the asking price on his 4-bedroom Tudor house, which he built on 1.5 acres in 1983. If he manages to get the $385,000 he is now listing it at, the house will have returned 1.5% a year, not even keeping up with inflation. REITs generated average annual total returns of 9% over the same period.

For a list of attractive REITs and mutual funds that own REITs, see the tables [included in the article].

The Landlord Game

The days of flipping houses for profit are over. But in many cities you can make money another way: by collecting rent.

Thinking of trying to make money the old-fashioned way in real estate, by earning it? It can be done if the price is right. If rent minus all costs give you a reasonable cash-on-cash return for whatever amount of leverage you use, then the possibility is there. These days you might want to be conservative by leaving room for price stagnation or depreciation in assessing the total return potential. On the other hand, if severe price inflation shows up you should have some nominal price gains.

Scott Patterson had his faith in the stock market severely shaken over the past year, so he decided to look around for something more solid in which to invest his retirement savings. The 43-year-old owner of a gutter-cleaning business settled last month on a three-bedroom house in Athens, Georgia, which over the years has attracted a steady stream of renters from the nearby University of Georgia campus. Patterson put down 20% of the $127,000 sale price, or $25,400. After debt service, taxes, insurance and an allowance for repairs he will clear $3,500 this year. That is a 12% return on the capital he invested (including closing costs). Depreciation deductions can shelter a good part of this from taxes.

“This just seems like a better bet right now than adding money to the IRA or SEP,” he says of his retirement account alternatives.

Until the housing bubble filled investors’ heads with the notion that real estate is a way to get rich quickly, the nation was populated by millions of investors, like Patterson, who valued properties based on the rent they could earn. With real estate prices down 50% or more in some areas, the landlord game is back in vogue. And like Patterson, many potential players are carefully comparing it with the returns they could reasonably expect by sticking their money in other places.

Blue-chip stocks? A $100,000 stake invested in the S&P 500 10 years ago would have shriveled to $63,000, including reinvested dividends. Alas, even after a dismal decade stocks are far from cheap in relation to their near-term earnings prospects.

In many metropolitan markets, by contrast, returns from rental properties are at the high end of historic ranges. One standard measure is the capitalization rate, which is calculated by dividing the operating income from a property (annual rent minus upkeep, insurance and management costs) by the sale price. This is comparable with the dividend yield on a stock. For real estate almost anywhere in the U.S., cap rates are better than the current 2.4% yield on the stock market.

The cap-rate calculation assumes an all-cash buyer. You should look closely at the ratio – even if you will, like most buyers, get a mortgage.

Start with the annual rental income, which in Patterson’s case is expected to be $13,800. Now subtract costs, beginning with the 10% that a rental management agent would charge, even though you might be doing this work yourself. (By all means be a do-it-yourselfer if you have the stomach for it, but do not kid yourself about the return on an investment as opposed to a return on labor.)

Maintenance, property taxes and insurance eat up an average of 35% of rental income, judging by the income statement of Equity Residential, a real estate investment trust that owns apartments. Patterson thinks he can squeak by with less “ only 25% of his gross income.

Subtract another 5% for vacancy – you will have revenue-free months between tenants or while you are evicting a deadbeat. In his mental spreadsheet, Patterson allows nothing here. Realistically, though, a home like Patterson’s is going to generate only $9,660 a year out of a $13,800 asking rent. Divide this by the $127,000 purchase price and you get a 7.6% cap rate. It is out of this return – before income taxes but after all cash outlays – that you pay the mortgage.

Before plunging in, investors should think about (a) the low liquidity and (b) all the unpleasant surprises that come with real estate ownership. Stocks or bonds can be unloaded with a mouse click; selling a building might take months, and transaction costs are high. You might also be woken up at 3 a.m. with word of a toaster fire. Walter Charnoff, who has owned nearly 50 investment properties, was summoned by tenants in the middle of the night to deal with broken toilet pipes and fried air conditioners.

“Trying to manage properties on my own was my biggest mistake,” he says. “You don’t think about how often you have to be on standby to talk to your tenants about stuff that breaks.”

For an apartment building, figure on spending between $600 and $1,000 annually per unit, depending on the age of the building, on things like exterior paint, wall repair and appliances, says Alexander Goldfarb, associate director of equity REIT research at Sandler O’Neill & Partners. He assumes that capital spending on things like water heaters, boilers and roofing will cost equally as much.

Jeffrey Nimmer, 32, owns a lone one-bedroom apartment in Greensboro, North Carolina that rents for $900 a month. In the past two years he has replaced the dishwasher ($500) and microwave oven ($100) and paid to have the chimney cleaned ($150). A deep cleaning, needed to attract new tenants, runs $250. “When you are a landlord, you come to expect things will go wrong. Badly wrong,” he says.

Fire and liability insurance for a landlord will cost around $900 per year for an apartment building with up to four units, says Julie Parsons, vice president of Allstate’s consumer household unit.

Rent Out Your Home, Cut Your Taxes

Leasing out an unwanted home can provide a little cash flow – and a hefty tax advantage.

Thanks to the generous treatment of real estate by the Internal Revenue Code it may make sense to rent out an under-water real estate investment rather than blow it out at a loss – assuming you do not want to live in the place. The experts cited make the usual good advice: Make sure the deal works without the tax benefits. The later is just the proverbial icing on the cake.

Cherie Kerr wants out of her home. The 65-year-old comedian and public speaking coach paid $590,000 for a 1,150-square-foot Los Angeles condo two and a half years ago – only to find the construction so flimsy that her upstairs neighbor woke her up by dropping a coin on the wooden floor.

“A defect hell,” fumes Kerr of her newly built abode. She has moved back into a suburban home she still owns and would love to unload the apartment, but housing values have fallen so far that she figures such a move would lock in a $200,000 loss.

The good news is that Kerr is anything but stuck. A real estate agent recently informed her that the condo can fetch $3,300 a month in rent. That is enough to cover her mortgage and property taxes. So Kerr has decided to lease out her condo until values rebound. While she no longer harbors visions of becoming rich off the downtown L.A. property, things could be a lot worse.

“It’ll be a tax writeoff,” she says.

Kerr has lots of company these days. No less a financier (and former do-it-yourself tax preparer) than Treasury Secretary Timothy Geithner is leasing out his Mamaroneck, New York home after failing to get for it a bid he was willing to accept. If you are one of the horde suffering real estate buyer’s remorse, you too may be able to turn a modest profit renting out your albatross of a residence. How can that be? Thank the trove of tax breaks for residential landlords.

The first step in figuring out whether renting makes sense is to find out how much your place is worth. A professional appraisal is best, but written statements from a few Realtors will do as long as they agree on the value and stipulate how much is attributable to land and how much to the building. (The appraisal, as you will see later, is essential for two separate tax calculations.)

The next step is to see how much the property will fetch in monthly rent and weigh that against the costs and tax consequences. As a landlord, you cannot claim mortgage interest as an itemized deduction on Schedule A of your tax return. Instead, you deduct interest costs, plus property taxes, monthly condo fees, insurance and anything you pay to a property manager (most charge 10% of rent) against rental income on Schedule E. You can also expense travel and other costs you personally incur to look after the property.

The other big tax deduction for landlords is depreciation. The tax code allows you to divide the value of your building (but not the land) by 27.5 and to claim the result as an annual depreciation expense. Here is the first place that the current appraisal comes in. When you convert to a rental, your depreciation is based on the cost of the property plus improvements or its market value at the time of conversion – whichever is less.

In Kerr’s case she must use the $390,000 fair market value of her condo, not the $590,000 she paid. Assuming that 10% of the $390,000 is attributable to land under her building, the depreciation expense comes to $12,764 annually (and reduces her cost basis by the same amount). Add in Kerr’s other expenses and the total is likely to exceed her $39,600 gross annual rental revenue. Almost any residential landlord with a mortgage is going to be in that boat.

The amount by which expenses exceed rent is a tax loss that can be used to shelter up to $25,000 in other income – say, from your salary – if your adjusted gross income is $100,000 or less. (The same cutoff applies to both singles and couples.) Above $100,000 the break is phased out, and it disappears completely at $150,000.

The one and only time you get to use a passive loss to shelter active income.

“It is the one and only time you get to use a passive loss to shelter active income,” says Sacramento tax attorney Roni L. Deutch.

If you happen to be a real estate professional – defined as someone spending at least 750 hours a year, and at least 50% of his working time, in the business – then your career managing property becomes an “active” one and your losses are fully deductible against other income. If you fail the income test or to qualify as a pro, your rental losses do not go entirely to waste. The net loss gets carried forward and deducted if and when you dispose of the loser real estate or you have gains from passive investments. These gains could be from selling the property in question at a capital gain or from owning other passive investments, like oil wells.

Note that “passive” is a term of art in the Internal Revenue Code and does not cover portfolio investing (stocks and bonds). So if you collect $30,000 from stock dividends and have a $30,000 loss on Schedule E, you cannot net one against the other. But you can wise up, sell the stocks and use the proceeds to pay off the mortgage. At that point you are probably out of the loss column on the rental and pulling real cash out of the property. A good part of the cash return will be sheltered from taxes by your depreciation deduction.

How are gains taxed when you sell a converted property? A lot depends on timing. If you lived in the property for at least two years and then rented it out for less than three, you may be able to use the provision that excludes $500,000 in gains from the sale of a principal residence, per couple, from tax. (You will still owe gains tax on the amount claimed as depreciation.) If you sell at a loss, the only deductible portion is the loss occurring after you converted the house from personal to income-producing use. The appraisal is crucial here.

Kerr hopes that sales prices will rebound in two years. Assume instead that they slide and she clears only $340,000, or $50,000 less than what her Realtors said her condo was worth when she converted it to a rental. Her tax basis in the property will be $364,500 (the $390,000 minus $25,500 for two years of depreciation). She would be left with a $24,500 capital loss she can use to shelter taxable gains on other investments. Also, she could then claim any passive losses she could not use before.

Renting does present problems. You must either maintain a property yourself or pay someone else to do it. Tax and real estate experts warn against hanging on to real estate if rent falls far short of your pretax, out-of-pocket costs. In other words, look to the tax benefits to sweeten the deal, not drive it, says tax accountant William Fleming of PricewaterhouseCoopers.


“If you don’t lever up in good times, you won’t be hamstrung in bad times.”

Stephens Inc. is a privately-held investment banking firm headquartered in Little Rock, Arkansas. Highly respected within the industry, they are not well known by the public. The public would do well to pay attention to the company’s business practices, however.

Unlike Goldman Sachs and its late Wall Street brethren, Stephens is built to last without need for bailouts. While typical Wall Street firms leverage their equity 30-to-1 Stephens is leveraged just 2-to-1. That means they have to earn a decent return on their investments to earn a decent return on the company’s equity. This means supporting quality businesses. They handled Wal-Mart’s IPO in 1970. No highly leveraged bets which depend on the yield curve or foreign exchange rates staying benign, or on alleged hedges with nameless counterparties working like the rocket science formulas say they will. Needless to say this is a nice position to be in come heart-palpitating times. While many were worried about survival last fall Stephens was looking to scoop up bargains.

Mind you, the Stephens men are not choir boys. Their insider contacts include a fair share of politicians such as the likes of Bill Clinton. The good ol’ boy network is not a pure meritocracy. CEO Warren Stephens was a McCain supporter. But watch their business practices and learn.

When Lehman Brothers collapsed last September, Warren Stephens sat down in his Little Rock, Arkansas office and wrote a memo to his staff. He reassured them that while much of Wall Street was leveraged 30-to-1, Stephens Inc. is leveraged just 2-to-1, with more than half of its assets consisting of government securities. He wrote, “One thing I know for sure, this crisis will not affect Stephens Inc.”

But the crisis is affecting this investment banking, asset management and brokerage firm. It is creating opportunities.

Stephens and his right-hand man, Chief Operating Officer Curt F. Bradbury, are busy expanding during the recession. In the last year Stephens Inc. has boosted its ranks of investment bankers from 84 to 100 and is opening a Houston office. The firm aims to double its roster of retail brokers to 200 and hire more analysts and portfolio managers. It is expanding in property/casualty insurance, which in three years has grown from 13 employees to 300 and $321 million in annualized premiums. Stephens will probably pick up a trust business and a bank (a business the family got out of 15 years ago).

Warren’s uncle W.R. (Witt) Stephens founded the company in 1933 on $15,000 in borrowed money and a bet that Arkansas highway bonds, then trading at 10 cents on the dollar, would be redeemed at par. Witt began to buy, trade and underwrite muni bonds across the South. Brother Jack (Warren’s dad) joined in 1946. In 1953 they paid $5.4 million for Arkansas-Oklahoma Gas, which produced natural gas and piped it into homes and businesses. Stephens Production Co. owns natural gas fields and has paid an estimated $1 billion to the family in dividends over the years. The gas money has made it possible for the affiliated Stephens Capital Partners to amass private equity stakes worth some $1 billion. Broker-dealer Stephens Inc. has $100 million in capital. Both firms are wholly owned by Stephens, 52.

The Stephens brothers were masters at good ol’ boy networking, which they practiced on the golf course. Jack was host of the Masters Tournament at Augusta National 1991-98; Warren hired Tom Fazio to design the course at his exclusive Alotian Club, which sits on 300 rolling acres overlooking Lake Maumelle outside Little Rock.

Jack and Witt underwrote countless municipal bond issues and backed politicians as diverse as Orval Faubus (Arkansas governor from 1955-67) and Bill Clinton. Sam Walton and Jack Stephens were quail-hunting buddies; in 1970 Stephens handled the initial stock offering for Walton’s tiny ($32 million in revenues) retail chain, Wal-Mart (WMT). Stephens underwrote offerings for Tyson Foods (TSN) and Alltel (AT).

It is on the golf course and occasionally inside the firm’s four private jets that Stephens bankers make deals. The name of the game is cross-pollination. The 100 brokers have client assets of $6.5 billion and generate annual fees and commissions of some $500,000 apiece. That compares with $340,000 on average for regional firms and $550,000 on average for Merrill’s 22,000 brokers. Stephens’s clients have been a fertile source for firms that need financing. Since 2003 Stephens’s bankers have advised on $100 billion in deals

With no publicly traded stock, Stephens rewards bankers with the opportunity to take subsidized stakes in his private equity deals. An executive might put in $50,000 and the firm will add $100,000. If the investment works, the exec keeps the return on both contributions. If it is a dog, he suffers a loss only on his own money. There is no preassigned annual amount – it is a good incentive for finding worthy targets.

Corporate finance managing director E.H. (Skip) Clemmons recently persuaded Warren Stephens to buy into Sexing Technologies, a Texas biotech company that helps cattle farmers engineer the gender of calves by mechanically sorting bull semen – with 93% accuracy. The investment came after Sexing contacted Clemmons to help raise capital for an acquisition. Stephens’s 90 portfolio companies – which also tend to be Stephens investment banking clients – include Viking Range, maker of kitchen appliances, and StyleMark, a sunglasses company.

One of Stephens’ private equity investments is a conglomeration of 40 newspapers, including the Las Vegas Review Journal and the North Little Rock Times. It is not a lovely business these days, but it has side benefits. Warren, a McCain supporter, last year penned an editorial in his Las Vegas paper condemning Democrats’ plans to raise taxes on the wealthy. With no debt, Stephens says, the papers are in no danger of going under. “If you don’t lever up in good times, you won’t be hamstrung in bad times,” he says.


European banks have the potential to create significant risk for the entire worldwide system.

John Mauldin takes a look at the banking situation in Europe. The view is eye-popping. As reckless and feckless as the conduct of the U.S. banking system regulators and management was, Europe was even worse – much worse. And the “conservative” Swiss were the worst of all. Leverage was allowed to go far high than in the U.S., and their lending was equally bubble-thinking addled. When they did not join in the U.S. subprime lending party, they dumped money on emerging European and other economies, in effect repeating the mistakes made by the U.S. money center banks in the 1970s.

Too bad for Europe, you say? The trouble is we are all interconnected now. When the European bank ice cream hits the fan we will all get splattered ... again.

We have avoided Armageddon, at least for now. The cost to the U.S. taxpayer has been a few trillion. Some in the media are loudly announcing the end of the recession. But we are not out of the woods yet. There are a few more bumps in the road. Actually, some of them are quite steep hills. As big as the subprime problem? Maybe.

When asked a few weeks ago what was my biggest short-term concern, I quickly replied, “European banks have the potential to create significant risk for the entire worldwide system.” This week we will glance “over the pond” to see what gives me cause for concern. Then we briefly look at a few of the bumps I mentioned, which are likely to stretch out any recovery, and maybe even dip us back into recession. ...

Europe on the Brink

Globalization is a two-edged sword. On balance, it has brought prosperity to those who have embraced it, with rising lifestyles, better health, longer lives, and more. The more we need each other, the less likely it is that we will shoot each other. Shooting your customers is not a good business strategy. And while the growth has not been even or smooth, only a Luddite would want to return to the early 1800s or 1900s, or even 1975.

The other edge of that sword? We are connected in so very many ways, far more than most of the world suspected. Who thought that insane lending policies at U.S. mortgage banks would bring the world financial system to its knees, increasing unemployment and leading to a global recession? World trade is down 20% or more. U.S. railroad shipments are down more than 20% year-over-year. Chinese (and Asian) factories have seen their orders drop, as U.S. consumers have gone on strike. The U.S. trade deficit was just $25 billion last month; and while our exports are still dropping, our imports are dropping more. Oil is becoming a bigger and bigger share of imports, and that does not come from Asian exporters.

Europe as a whole is as economically important to the world as the U.S. What happens in Europe makes a difference in the U.S.

The U.S. is far and away the country with the largest gross domestic product (GDP). California would be the 7th largest country, but few think of California in such terms. For this letter, at least, I would like to think of Europe as a whole rather than as 27 countries. From that perspective, Europe is as economically important to the world as the U.S. What happens in Europe makes a difference in the U.S.

Last week we looked at the precarious position of Japan, the 2nd largest economy (or 3rd if you think of Europe as a whole). It was a sobering letter. When you realize the extent to which Japan has funded Asian expansion, what is happening there cannot be good for the world.

But Europe’s banks have been much more aggressive in funding emerging-market expansion than U.S. or Japanese banks. Western European banks have lent $4.5 trillion to various emerging-market countries, businesses, and consumers. Many Eastern European businesses borrowed in low-interest-rate euros. New homeowners in Hungary and the rest of Eastern Europe borrowed in Swiss francs and euros, and as their currencies have collapsed they now find they owe more on their homes than they are worth.

Europe’s banking system is in far worse shape than the U.S. system.

And here is the problem. Europe’s banking system is in far worse shape than the U.S. system. The losses may be bigger, and their capital to meet those losses is certainly less. Let’s look at some charts. Remove sharp objects or pour another adult beverage.

As I noted last week, one of the real benefits of writing this letter is that I get to see a lot of really interesting information from readers and meet with very savvy investment professionals. I recently had the privilege of sitting with a team of analysts from Hayman Capital here in Dallas. Hayman runs a global macro hedge fund, so they spend a lot of time thinking about how all the different aspects of the global markets fit together. This week we again look at some of their analysis. There was a lot of work (as in months) done here; and Kyle Bass, the founder of the firm, graciously allowed me to share some of it with you (and kudos to Wes Swank, who pulled this together). The graphs are theirs, and my discussion about them is certainly informed by our meeting; but I am using the material as a launching point, so they are not responsible for my conclusions and interpretations.

And Then There Was Leverage

In the first few years of the G.W. Bush administration, the banking authorities decided it would be OK to allow five banks to increase their leverage from 12:1 up to 30:1. Which five banks, you ask? Bear Stearns, Lehman, Merrill Lynch, JPMorgan, and Goldman Sachs. How did that work out, just five years later? Three are gone and two survived with large dollops of taxpayer money.

(Sidebar: Is it really any surprise that Goldman and JPMorgan are making record profits on the underwriting and trading side of the business? Hell, if I could eliminate 50% of my competition, my profits would grow too! JPMorgan’s consumer credit, credit card, and other business groups are losing money big-time.)

30 times leverage means that if you lose 3.3%, you wipe out all your capital. And we watched as banks too big to fail were bailed out with taxpayer dollars. Slowly, banks are buying time, writing down assets. Remember, this month is the 2nd anniversary of the onset of the credit crisis. I wrote back then that the strategy would be to stretch this out as long as possible. Time heals a lot of bad debts, especially at a 0% Fed Funds rate.

Banks that are reporting so far this quarter seem to be saying that the write-offs will start to level off in about two quarters, although banking expert Chris Whalen says that the level may stay higher than we think for longer than we think. There are a lot of assets to write off, and they are just now getting to the commercial real estate problems. This is going to take time. (For an interesting interview on CNBC with Maine fishing buddy Chris Whalen, click here.)

The point, before we get to Europe, is that here there was a central bank and a government that not only could step in but was willing to. I know former Treasury Secretary Paulson had his critics, but I am not one of them. Did he do some things that in hindsight he might like to take a “mulligan” on? Sure. But he dealt with the problems in the best manner he could. The time to have taken action was when we were making liar and no-doc loans and calling then AAA, or allowing banks to go to 30:1 leverage. Paulson had to deal with eggs that were already broken. That the system did not crater is to his credit. Securitizing what he and everyone else should have known would be garbage while he was head of Goldman Sachs is not to his credit. But I digress.

I am going to give you four charts showing the leverage of banks in the U.S., the United Kingdom, the Eurozone, and Switzerland. The bottom, blue portion is assets to common and preferred stock; the red is assets to common equity, which can include good will; and the purple is assets to tangible common equity.

Tangible common equity is all the rage, and that is what the recent “stress tests” measured, as opposed to tier 1 capital, which includes preferred stock (which would basically be the blue portion.) TCE only includes common shares. Now, let’s start with the U.S. These graphs show leverage. The average leverage of tier 1 capital of the five largest banks is in the range of 12:1, and is actually down from 10 years ago. (By the way, a very good and simple explanation of all this can be found here.)

While the TCE has obviously been rising and taking total leverage to rather lofty levels in the mid-40s, banks are raising capital, and over time leverage will come back down. It helps if you can borrow money at almost nothing and lend it out at much higher rates. Now, let’s turn to the United Kingdom. This is uglier.

Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1 and with TCE is around 55. The assets of UK banks are about five times as large as UK GDP. By comparison, for the U.S. the ratio is barely 2:1.

Think about that for a second. The UK has banking assets which are five times as large as the annual domestic output of the country. They also had a housing bubble. They have their own bailouts to deal with, which are massive and will potentially get much larger. But at least they have a central bank and government that can try to fix the problems.

But as the commercial says, “But wait, there’s more!” Let’s look at the Eurozone.

Leverage is now 35:1 and with TCE is almost 55. How did 35:1 work out for the U.S.? Given the massive credit problems that Eurozone banks have with emerging markets (plus Spain’s housing bubble, which is every bit as bad as that of the U.S.), will this not end up in wailing and weeping?

Too Big To Save

And here is the real issue. They have no Paulson and Bernanke. Now some of my Austrian-economist friends will say, “Good, they should all be allowed to die;” but that is a very cavalier attitude when you start talking about actually increasing the unemployment rate to something like 20%. I agree that management should be changed (as well as the regulators: 35:1 to 1 – really? What were they thinking?) and shareholders wiped out, but I do not want the system to collapse. And this is a global risk, not just localized to Ireland or Spain or Austria. Sure, the pain might be worse in the local region, but we will all feel it.

The European Central Bank, at least as of now, cannot step in and start saving individual banks. How do you save a Spanish bank and not an Austrian bank? Austria’s banks have made large loans to Eastern Europe, in euros and Swiss francs, and are going to have large losses, far more than 3%, which would wipe out their capital. But bank assets in Austria are 4 times GDP. What we have are banks that are too big to save for relatively small Austria. And for Italy, Spain, Greece, et al. More on this below. For now, let us turn our eyes to Switzerland.

Those Wild and Crazy Swiss

We think of Switzerland as a stodgy, by-the-numbers, clockwork type of banking country. I have done business with Swiss private bankers, and they are conservative. But somewhere, somehow, UBS and Credit Suisse ran up a little leverage. Before the crisis, they were over 40:1. And now they are nearly at a nosebleed-high 70!

As an aside, I was in Switzerland about two years ago, meeting with some very well-known Swiss, let us call them dignitaries. In a very off-the-record conversation, they told me UBS was technically bankrupt. As it turns out, there were a lot of banks around the world that were technically bankrupt.

Now, the next graph underscores the problem of “too big to save.” Let’s say the U.S. will eventually pump $1 trillion into the banking system (in taxpayer losses). That is about 7% of U.S. GDP. We may not like it, but it does not stop the game. U.S. bank assets are only twice U.S. GDP. Switzerland and Ireland are over 7 times, the UK is over 5, and the Eurozone is at 4 times. And so it goes.

If Eurozone bank losses were just 5% of the portfolio (an optimistic assumption), it would be 20% of Eurozone GDP.

Eurozone banks are already reeling from losses from U.S. subprime-related problems. They are now getting ready to deal with even deeper losses from their own lending portfolios. If the losses were just 5% of the portfolio (an optimistic assumption), it would be 20% of Eurozone GDP. But each country is responsible for its own banks. While it is thought Germany will be able to handle its problems, the prognostication for Austria and Italy is not so sanguine. Italy is already running a massive deficit, and has no central bank to monetize its debt. The same goes for Portugal, Spain, Greece, and Ireland. 5% loan losses in Ireland would be 40% of GDP, the equivalent for my fellow U.S. citizens of about $5 trillion. Where does Europe find a few trillion dollars?

I was writing in late 2006 that the subprime lending market would end in tears. And I think the European banking crisis that is on the horizon has the potential to be every bit as big a problem as subprime loans. The world depended on Europeans banks for much of the lending that allowed for growth and development. Like their counterparts in the U.S., they are going to have to reduce their loan portfolios. Deleveraging is not fun.

It takes time to build up a banking infrastructure that can raise the capital necessary to make and process loans. A lot of time. Europe is a big customer of the U.S. and Asia. Their businesses are going to be hit hard by the lack of capital, which is of course no good for employment, etc. We are all connected. What happens in Rome no longer stays in Rome.

Let me reprint a graph from last week. Burn it into your mind. The world is going to need to find $5 trillion to finance government debt issuance. And we need to fund private business and consumer debt. Where is all this money going to come from? “If you lend me $5 trillion today, I will gladly repay you Tuesday.”


Forget about an end the financial oligarchy rule that led us down our road to ruin.

iTulip.com’s Eric Janszen believes the rule of the “financial oligarchs” has brought our economy to its current woeful state. Will the people rise up an rebel against this regime? Not if Great Depression era precedent holds. A 25% unemployment rate did not light a fire under a population struggling to survive in an economy brought to its knees by the excesses of an unregulated financial class then. What does it take?

J P Morgan Chase head honcho and financial oligarch Jamie Dimon “amid the disgrace of his industry has emerged as President Obama’s favorite banker,” according to über-establishment rag the New York Times. Dimon is getting “a good return on what Mr. Dimon has labeled his company’s ‘seventh line of business’ – government relations,” according to the Times.

Great. In Washington, failure is no obstacle to policy-making.

As we work out the intersection of our era’s monetary orthodoxy, economic politics, and markets, an offering from my collection of 1930s magazines I picked up from Hugo’s Used Books on Newbury Street in Boston in 1999, before the internet put them out of business.

Ten years ago I promised readers I would post a few pages of these documents here as they became relevant to the echo of that past that was destined to return.

Readers who remain hopeful that a drawn-out economic crisis will motivate the American people to action to end the financial oligarchy rule that led us down our road to ruin, who pray for a restoration of the U.S. to a vibrant multi-party democratic system, may want to skip over this post.

You have been warned.


According to the New York Times, on Wednesday [July 22] American financial oligarch Jamie Dimon, the head of J P Morgan Chase, held a meeting of his board in the nation’s capital for the first time. White House chief of staff, Rahm Emanuel, attended.
WASHINGTON – Mr. Emanuel’s appearance would underscore the pull of Mr. Dimon, who amid the disgrace of his industry has emerged as President Obama’s favorite banker, and in turn, the envy of his Wall Street rivals. It also reflects a good return on what Mr. Dimon has labeled his company’s “seventh line of business” – government relations.

The business of better influencing Washington, begun in late 2007, was jump-started just as the financial crisis hit and the capital displaced New York as the nation’s money center. Then Mr. Obama’s election brought to power Chicago Democrats well-known to Mr. Dimon from his recent years running a bank there.

“It’s a very nice thing for the board to have happen,” said the chief of a major financial company. “But you’d have to have a lot of influence to pull it off.”
The influence of America’s top financial firm, Goldman Sachs, widened its influence over the White House when on Friday the Times reported, “Goldman Executive Named as Obama Adviser.”
President Obama said Friday he would nominate Robert Hormats, a vice chairman of Goldman Sachs International, to a top economic position at the State Department. Mr. Hormats, 66, will be under secretary of state for economic, energy and agricultural affairs. He was deputy trade representative from 1979 through 1981 and held other posts at the State Department throughout his career. Hillary Rodham Clinton, the secretary of state, said in a speech on Wednesday that she hoped to make economic policy and trade a larger part of United States diplomacy.
Banker’s board meetings in Washington with White House staff in attendance? Will our legislature dispense with the formality of drafting FIRE Economy friendly legislation and simply allow the banks’ law firms to draft legislation for them? How could this happen in the United States of America?



May 1931, in the second year of an economic depression that later devolved to become known as The Great Depression, Mauritz A. Hallgren published “Third Party Fantasy.”

The article argues that neither the socialistic nor anti-statist independent parties of the day could effectively field a third party candidate in the 1932 presidential election, despite a glaring need for political change.

If a 25% unemployment rate does not light a fire under behinds of a population struggling to survive in an economy brought to its knees by the excesses of an unregulated financial class, what will?

But it didn’t.

Change a few names and you will find the opening page of Hallgren’s article disagreeably familiar.

Keep in mind that in those days the term “Liberal” in the U.S. referred to proponents of minimal and non-invasive government, the platform currently occupied by Libertarians, while “Progressive” referred to a broad range of anti-establishment positions, including both Libertarian and the redistributionist and statist views promoted by Progressives today.

The author goes on to say that building a viable third party to restore democracy to America requires that Progressive intellectualsóLibertarians in modern parlance – roll up their pant legs, climb down from the Ivory Tower, and wade into the gutter of American politics.

What do you think?


Adios from a Trader

Making money has nothing to do with right or wrong. If you followed your system you did right, win of lose.

I will have to say that it has been fun meeting a whole new group of people. ... The chat room has been filled with grumbles of late claiming conspiracy theories. Goldman Sachs has become the giant conspirator and the government and all of its agencies remain the great Satan. There always seems to be someone or something that is doing you dirt. Why don’t you take a look at how this can be your edge? My philosophy has always been follow the money. I do not care if it is GS or the Fed. Let them run it any way they want; I will just get on board and take my little piece of the pie. I am not greedy.

So I don’t care if gold goes to $1300 or back to $350, I will take my piece of the action and leave the rest to others. ... You should be able to consider the market as your private ATM machine and tap it any time that you need some extra money. There are loses. I know that I am not perfect and I know that the only one that is going to cost me money is me, not GS, the Fed or anyone on the floor of any of the exchanges. Once you learn to accept the full reponsibility for your actions you will find it a lot easier to trade successfully because you will not be looking for someone to blame for everything that goes wrong with your account. Each night you should go over your trades and see what you did right and what you did wrong. Making money has nothing to do with right or wrong. If you followed your system you did right, win of lose. Rick [Ackerman] will make mistakes and bad calls and I will make mistakes and bad calls. If you don’t do anything you cannot make a mistake, and that is the greatest mistake of all.

I read a book once about the Swiss bankers and how they became rich. They followed the simple economic cycles that keep repeating themselves. Growth, Inflation, restricted growth, recession, and then growth again. Where are we now in that cycle and what can you expect out of each part of the cycle. Take one part of the circle. Recession, lower interest rates, growth stable interest rates, Inflation rising interest rates, reduction of growth and inflation, lower interest rates and then it starts all over again. So if you lay out the business cycle and a plan of action and just trade the bonds and notes you can do very well. There are people that have made fortunes just trading one item. There are those that just trade soy beans, or the crush. There are others that just trade the corn wheat spread. How many have made a lot of money just trading Apple or Google? There are those on this list that just trade gold and do very well.

For the beginners, try to digest everything that is put forth in this forum. Take the parts that suit your system of trading and your personality. Put together a system that you are comfortable with and that produces profits. Chart your account and see how it does graphically. It is the same as any other chart. Once it starts down, stop trading and figure out what you are doing different now that you were not doing before. Always be on the alert for something that will enhance your system and trading style and keep it as simple as you can.

So set your prejudices and biases aside and just trade what you see on the charts.

Best of luck and good trading to all. Adios. Ira