Jaguar Inflation

Mises Daily by Robert R. Prechter, Jr. | Posted on 2/19/2009 12:00:00 AM

[The original version of this article appeared in the February 20, 2004 issue of The Elliott Wave Theorist, a year before the housing-credit bubble burst. An MP3 audio file of this article, read by Dr. Floy Lilley, is available for download.]

I am tired of hearing economists argue that government and the Fed should expand credit for the good of the economy. Sometimes an analogy clarifies a subject, so let's try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible.

To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing production with tax money. To everyone's delight, it offers these luxury cars for sale at 50% off the old price. People flock to the showrooms and buy.

Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores to buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars.

Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving, the economy will stop. So the government announces "stimulus" programs and begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don't care if they're free. They can't find a use for them. Production of Jaguars ceases.

It takes years to work through the overhanging supply of Jaguars. The factories close, unemployment soars and tax collections collapse. The economy is wrecked. People can't afford repairs or gasoline, so many of the Jaguars rust away to worthlessness. The number of Jaguars — at best — returns to the level it was before the program began.

The same thing can happen with credit.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible.

To facilitate that goal, it begins operating credit-production plants all over the country — called Federal Reserve Banks, Federal Home Loan Banks, Fannie Mae, Sallie Mae, and Freddie Mac, all subsidized by monopoly powers or government guarantees — to funnel credit to the public through banks. To everyone's delight, banks begin reducing collateral requirements and thereby offering credit for sale at below-market rates. People flock to the banks and buy.

Later, sales slow down, so banks cut the price again. More people rush in and buy. Sales again slow, so lenders lower the price to 1% with no collateral and no money down. People return to the banks to buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats, and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit.

Alas, sales slow again, and government and banks start to panic. They must move more credit, or, according to its theory — ironically now made fact — the economy will recede. People are working three days a week just to pay the interest on their debt to the banks so the banks can keep offering more credit. If credit stops moving, the economy will stop. So the government announces "stimulus" programs and begins giving credit away, at 0% interest. A few more loans move through the tellers' windows, but then it ends. Nobody wants any more credit. They don't care if it's free. They can't find a use for it. Production of credit ceases.

It takes years to work through the overhanging supply of credit. Banks close, unemployment soars and tax collections collapse. The economy is wrecked. People can't afford to pay interest on their debts, so many IOUs deteriorate to worthlessness. The value of credit — at best — returns to the level it was before the program began.

See how it works?

Is the analogy perfect? No. The idea of pushing credit on people is far more dangerous than the idea of pushing Jaguars on them. In the credit scenario, debtors and even most creditors lose everything in the end. In the Jaguar scenario, at least everyone ends up with a garage full of cars. Of course, the Jaguar scenario is impossible, because the government can't produce value. It can, however, reduce values.

A government that imposes a central bank monopoly, for example, can reduce the incremental value of credit. A monopoly credit system also allows for fraud and theft on a far bigger scale. Instead of government appropriating citizens' labor openly by having them produce cars, monopoly banking and credit machines do so clandestinely by stealing stored labor from citizens' bank accounts by inflating the supply of credit, thereby reducing the value of savings.

Twentieth-century macroeconomic theory — both Keynesian and monetarist — championed the idea that a growing economy needs easy credit. But this is a false theory. Credit should be supplied by the free market, in which case it will almost always be offered intelligently, primarily to producers, not consumers.

Print $17

Audio $25

"Let's go back to using real money."

Would lesser availability of consumer credit mean that fewer people would own a house or a car? Quite the opposite. Only the timeline would be different. Initially it would take a few years longer for the same number of people to save enough to own houses and cars — actually own them, not rent them from banks. Prices would be lower because credit would not be competing with money to bid up these goods. And, because banks would not be appropriating so much of people's labor and wealth, the economy as a whole would grow much faster. Eventually, the extent of home and car ownership — actual ownership — would eclipse that in an easy-credit society. Moreover, people would keep their homes and cars because banks would not be foreclosing on them. As a bonus, there would be no devastating across-the-board collapse of the banking system, which, as history has repeatedly demonstrated, is inevitable under a system of central banking and other government-created credit factories.

Jaguars, anyone? More credit? Here's a better idea: let's go back to using real money.

 

Yield Spread

The Yield spread in the US along with REITs has blown out to all time highs.
With the government spending program in place, and the strong possibility that REITs are about to put in a multi month low, I have gone short long bonds and long US REITs.
I put the trade on yesterday with the chart looking as below.
Fortunately there was significant weakness in the bond market and strength in REITs so it looks like our timing might have been spot on.

(for some reason the legend says it is bonds vs SAPY- this is an error as it is vs US)

IS THE SUN STILL SHINING ON S.AFRICA

I have marvelled for some time how SA and SA listed property in particular has side-stepped the world financial crisis, and the emerging market turmoil more particularly.
In the last few days I have watched a stream of negative economic data flow through my inbox in relation to SA's now clearly faltering economy.

The relative trade displayed below is once again an indicator for an excellent high probability profitable trade.

Short South Africa go Long Australia

I have been saying for some time that South African REITs are way too expensive.

One only has to look at their respective valuations against the worlds leading 1st world REITs to start asking questions. In South Africa you still have certain companies trading on historical yields below the long bond yield, history has proved this relationship should not exist and I have no doubt the necessary reversions will set in place before too long.
It wasn't along time ago when this phenomenon existed in the major REIT markets only to blow out well past the historical mean, and I mean well past.

I also get the familiar argument that the South African economy is stronger than many of the 1st world countries, which is currently reflected in the low vacancies and high (double digit) distribution growth numbers. Do not forget that the USA, Australia and other regions were also displaying similar fundamental strength preceding their respective swan dives into the abyss.

Do not be fooled by the fact that due to South Africa's relatively closed economy that it has been able to avoid much of the problems that have entwined the world financial system and in so doing buried the decoupling debate far below the average South African gold mine. Remember that SA is after all a 3rd world country with unemployment and crime at unacceptable levels. Remember that South Africa needs to export a lot of its resources to a shrinking world market, remember that South Africa's current account deficit is dependent on foreign capital inflows. Remember that South African politics is in complete disarray with alarming stories of corruption. Remember that South Africa is only able to grow its GDP in the 2 - 3% region far lower than the level needed to maintain and increase jobs. Before you get carried away with the growth story of South Africa's emerging black middle class, remember that China is growing at above 10% per annum and has a far larger emerging middle class, yet its share market is off 70% from its peak. Remember the World Cup was discounted into the share market years ago, and remember it was done so in an environment where the world traded on one of the lowest risk premiums in history. As the lustre begins to fade and the reality of the less than spectacular World Cup numbers come to pass and the many new white elephants that litter the metropolis and not the game farms, the markets may play catch up on the downside at a speed which will make the Rand's demise in 2001 a walk in the park.

So in conclusion wouldn't you prefer to own Westfield with its prime assets in Australia, UK & USA with low gearing paying a 10% dividend with muted growth if any than a Hyprop or Resilient with more debt on the balance sheet, in Africa, paying 7.5% with 10% growth for now with no real chance of maintaining this growth well into the future. (I haven't researched the numbers in the sentence above but are approximations used to illustrate my point).

At the end of the day the words used above are merely trying to explain the chart on the left which to me tells the whole story. Short South Africa and go long Australia, it is a no brainer.

Excitement vs Regret

Monday, February 23, 2009

I attended a workshop a couple of weeks ago (Van Tharp) and one of the exercises we did was examine where we may have conflict within ourselves.
One of the conflicts I brought up is the uneasy relationship between "excitement" which I usually associate with large positions and "regret".

What is interesting is that both emotions have positive intentions, in my case excitement is there to take me out of my comfort zone, to strive for more, to achieve my goals. Regret also has the positive intention of wishing to prevent feelings of I wish I never did that or I am such an idiot. What is clear from examining these 2 emotions is that they need not be apart and work against one another, rather if regret becomes a part of excitement in that certain ground rules are laid then there can be no cause for disharmony but rather on the contrary there should be better harmony.

How does one achieve this. The secret is to do ones homework and establish that in fact there is a suitable risk reward setup to place the larger trade. If in fact there is this payoff profile then regret has no place as the excitement is duly being rewarded for this increased risk. On the other hand if I am not going to do my homework then regret is correct in staying apart and that conflict should remain until such time as I am able to bring them together.

Trading Rules - Dennis Gartman

It is amazing how simple and brilliant these rules are, my only point of debate is reconciling these principles with a contrarian approach to trading.

If I have understood these rules correctly, Dennis is saying that you cannot trade contrarian profitably. You can have contrarian views, however, it seems according to him you need to wait for the new trend to take effect.

I need to give this more thought, however, those rules aside I think the rest make for a must when trading.


The "Not-So-Simple" (But Really Utterly So) Rules of Trading

The world of investing/treading, even at the very highest levels, where we are supposed to believe that wisdom prevails and profits abound, is littered with the wreckage of wealth that has hit the various myriad rocks that exist just beneath the tranquil surface of the global economy. It matters not what level of supposed wisdom, or education, that the money managers or individuals in question have. We can make a list of wondrously large financial failures that have come to flounder upon these rocks for the very same reasons. Let us, for a bit, have a moment of collective silence for Long Term Capital Management; for Baring's Brothers; for Sumitomo Copper... and for the tens of thousands of individuals each year who follow their lead into financial oblivion.

I've been in the business of trading since the early 1970s as a bank trader, as a member of the Chicago Board of Trade, as a private investor, and as the writer of The Gartman Letter, a daily newsletter I've been producing for primarily institutional clientele since the middle 1980s. I've survived, but often just barely. I've made preposterous errors of judgment. I've made wondrously insightful "plays." I've understood, from time to time, basis economic fundamentals that should drive prices--and then don't. I've misunderstood other economic fundamentals that, in retrospect, were 180 degrees out of logic and yet prevailed profitably. I've prospered; I've almost failed utterly. I've won, I've lost, and I've broken even.

As I get older, and in my mid-50s, having seen so much of the game--for a game it is, with bad players who get lucky; great players who get unlucky; mediocre players who find their slot in the lineup and produce nice, steady results over long periods of time; "streak-y" players who score big for a while and lose big at other times--I have distilled what it is that we do to survive into a series of "Not-So-Simple" Rules of Trading that I try my best to live by every day ... every week ... every month. When I do stand by my rules, I prosper; when I don't, I don't. I am convinced that had Long Term Capital Management not listened to its myriad Nobel Laureates in Economics and had instead followed these rules, it would not only still be extant, it would be enormously larger, preposterously profitable and an example to everyone. I am convinced that had Nick Leeson and Barings Brothers adhered to these rules, Barings too would be alive and functioning. Perhaps the same might even be said for Mr. Hamanaka and Sumitomo Copper.

Now, onto the Rules:

NEVER ADD TO A LOSING POSITION

R U L E # 1
Never, ever, under any circumstance, should one add to a losing position ... not EVER!

Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

R U L E # 2
Never, ever, under any circumstance, should one add to a losing position ... not EVER!

We trust our point is made. If "location, location, location" are the first three rules of investing in real estate, then the first two rules of trading equities, debt, commodities, currencies, and so on are these: never add to a losing position.

INVEST ON THE SIDE THAT IS WINNING

R U L E # 3
Learn to trade like a mercenary guerrilla.

The great Jesse Livermore once said that it is not our duty to trade upon the bullish side, nor the bearish side, but upon the winning side. This is brilliance of the first order. We must indeed learn to fight/invest on the winning side, and we must be willing to change sides immediately when one side has gained the upper hand.

Once, when Lord Keynes was appearing at a conference he had spoken to the year previous, at which he had suggested an investment in a particular stock that he was now suggesting should be shorted, a gentleman in the audience took him to task for having changed his view. This gentleman wondered how it was possible that Lord Keynes could shift in this manner and thought that Keynes was a charlatan for having changed his opinion. Lord Keynes responded in a wonderfully prescient manner when he said, "Sir, the facts have changed regarding this company, and when the facts change, I change. What do you do, Sir?" Lord Keynes understood the rationality of trading as a mercenary guerrilla, choosing to invest/fight upon the winning side. When the facts change, we must change. It is illogical to do otherwise.

DON'T HOLD ON TO LOSING POSITIONS

R U L E # 4
Capital is in two varieties: Mental and Real, and, of the two, the mental capital is the most important.

Holding on to losing positions costs real capital as one's account balance is depleted, but it can exhaust one's mental capital even more seriously as one holds to the losing trade, becoming more and more fearful with each passing minute, day and week, avoiding potentially profitable trades while one nurtures the losing position.

GO WHERE THE STRENGTH IS

R U L E # 5
The objective of what we are after is not to buy low and to sell high, but to buy high and to sell higher, or to sell short low and to buy lower.

We can never know what price is really "low," nor what price is really "high." We can, however, have a modest chance at knowing what the trend is and acting on that trend. We can buy higher and we can sell higher still if the trend is up. Conversely, we can sell short at low prices and we can cover at lower prices if the trend is still down. However, we've no idea how high high is, nor how low low is.

Nortel went from approximately the split-adjusted price of $1 share back in the early 1980s, to just under $90/share in early 2000 and back to near $1 share by 2002 (where it has hovered ever since). On the way up, it looked expensive at $20, at $30, at $70, and at $85, and on the way down it may have looked inexpensive at $70, and $30, and $20--and even at $10 and $5. The lesson here is that we really cannot tell what is high and/or what is low, but when the trend becomes established, it can run far farther than the most optimistic or most pessimistic among us can foresee.

R U L E # 6
Sell markets that show the greatest weakness; buy markets that show the greatest strength.

Metaphorically, when bearish we need to throw our rocks into the wettest paper sack for it will break the most readily, while in bull markets we need to ride the strongest wind for it shall carry us farther than others.

Those in the women's apparel business understand this rule better than others, for when they carry an inventory of various dresses and designers they watch which designer's work moves off the shelf most readily and which do not. They instinctively mark down the work of those designers who sell poorly, recovering what capital then can as swiftly as they can, and use that capital to buy more works by the successful designer. To do otherwise is counterintuitive. They instinctively buy the "strongest" designers and sell the "weakest." Investors in stocks all too often and by contrast, watch their portfolio shift over time and sell out the best stocks, often deploying this capital into the shares that have lagged. They are, in essence, selling the best designers while buying more of the worst. A clothing shop owner would never do this; stock investors do it all the time and think they are wise for doing so!

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MAKING "LOGICAL" PLAYS IS COSTLY

R U L E # 7
In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral.

Rule 6 addresses what might seem like a logical play: selling out of a long position after a sharp rush higher or covering a short position after a sharp break lower--and then trying to play the market from the other direction, hoping to profit from the supposedly inevitable correction, only to see the market continue on in the original direction that we had gotten ourselves exposed to. At this point, we are not only losing real capital, we are losing mental capital at an explosive rate, and we are bound to make more and more errors of judgment along the way.

Actually, in a bull market we can be neutral, modestly long, or aggressively long--getting into the last position after a protracted bull run into which we've added to our winning position all along the way. Conversely, in a bear market we can be neutral, modestly short, or aggressively short, but never, ever can we--or should we--be the opposite way even so slightly.

Many years ago I was standing on the top step of the CBOT bond-trading pit with an old friend Bradley Rotter, looking down into the tumult below in awe. When asked what he thought, Brad replied, "I'm flat ... and I'm nervous." That, we think, says it all...that the markets are often so terrifying that no position is a position of consequence.

R U L E # 8
"Markets can remain illogical far longer than you or I can remain solvent."

I understand that it was Lord Keynes who said this first, but the first time I heard it was one morning many years ago when talking with a very good friend, and mentor, Dr. A. Gary Shilling, as he worried over a position in U.S. debt that was going against him and seemed to go against the most obvious economic fundamentals at the time. Worried about his losing position and obviously dismayed by it, Gary said over the phone, "Dennis, the markets are illogical at times, and they can remain illogical far longer than you or I can remain solvent." The University of Chicago "boys" have argued for decades that the markets are rational, but we in the markets every day know otherwise. We must learn to accept that irrationality, deal with it, and move on. There is not much else one can say. (Dr. Shilling's position shortly thereafter proved to have been wise and profitable, but not before further "mental" capital was expended.)

R U L E # 9
Trading runs in cycles; some are good, some are bad, and there is nothing we can do about that other than accept it and act accordingly.

The academics will never understand this, but those of us who trade for a living know that there are times when every trade we make (even the errors) is profitable and there is nothing we can do to change that. Conversely, there are times that no matter what we do--no matter how wise and considered are our insights; no matter how sophisticated our analysis--our trades will surrender nothing other than losses. Thus, when things are going well, trade often, trade large, and try to maximize the good fortune that is being bestowed upon you. However, when trading poorly, trade infrequently, trade very small, and continue to get steadily smaller until the winds have changed and the trading "gods" have chosen to smile upon you once again. The latter usually happens when we begin following the rules of trading again. Funny how that happens!

THINK LIKE A FUNDAMENTALIST;
TRADE LIKE A TECHNICIAN

R U L E # 10
To trade/invest successfully, think like a fundamentalist; trade like a technician.

It is obviously imperative that we understand the economic fundamentals that will drive a market higher or lower, but we must understand the technicals as well. When we do, then and only then can we, or should we, trade. If the market fundamentals as we understand them are bullish and the trend is down, it is illogical to buy; conversely, if the fundamentals as we understand them are bearish but the market's trend is up, it is illogical to sell that market short. Ah, but if we understand the market's fundamentals to be bullish and if the trend is up, it is even more illogical not to trade bullishly.

R U L E # 11
Keep your technical systems simple.

Over the years we have listened to inordinately bright young men and women explain the most complicated and clearly sophisticated trading systems. These are systems that they have labored over; nurtured; expended huge sums of money and time upon, but our history has shown that they rarely make money for those employing them. Complexity breeds confusion; simplicity breeds an ability to make decisions swiftly, and to admit error when wrong. Simplicity breeds elegance.

The greatest traders/investors we've had the honor to know over the years continue to employ the simplest trading schemes. They draw simple trend lines, they see and act on simple technical signals, they react swiftly, and they attribute it to their knowledge gained over the years that complexity is the home of the young and untested.

UNDERSTAND THE ENVIRONMENT

R U L E # 12
In trading/investing, an understanding of mass psychology is often more important than an understanding of economics.

Markets are, as we like to say, the sum total of the wisdom and stupidity of all who trade in them, and they are collectively given over to the most basic components of the collective psychology. The dot-com bubble was indeed a bubble, but it grew from a small group to a larger group to the largest group, collectively fed by mass mania, until it ended. The economists among us missed the bull-run entirely, but that proves only that markets can indeed remain irrational, and that economic fundamentals may eventually hold the day but in the interim, psychology holds the moment.

And finally the most important rule of all:

THE RULE THAT SUMS UP THE REST

R U L E # 13
Do more of that which is working and do less of that which is not.

This is a simple rule in writing; this is a difficult rule to act upon. However, it synthesizes all the modest wisdom we've accumulated over thirty years of watching and trading in markets. Adding to a winning trade while cutting back on losing trades is the one true rule that holds--and it holds in life as well as in trading/investing.

If you would go to the golf course to play a tournament and find at the practice tee that you are hitting the ball with a slight "left-to-right" tendency that day, it would be best to take that notion out to the course rather than attempt to re-work your swing. Doing more of what is working works on the golf course, and it works in investing.

If you find that writing thank you notes, following the niceties of life that are extended to you, gets you more niceties in the future, you should write more thank you notes. If you find that being pleasant to those around you elicits more pleasantness, then be more pleasant.

And if you find that cutting losses while letting profits run--or even more directly, that cutting losses and adding to winning trades works best of all--then that is the course of action you must take when trading/investing. Here in our offices, as we trade for our own account, we constantly ask each other, "What's working today, and what's not?" Then we try to the very best of our ability "to do more of that which is working and less of that which is not." We've no set rule on how much more or how much less we are to do, we know only that we are to do "some" more of the former and "some" less of the latter. If our long positions are up, we look at which of those long positions is doing us the most good and we do more of that. If short positions are also up, we cut back on that which is doing us the most ill. Our process is simple.

We are certain that great--even vast--holes can and will be proven in our rules by doctoral candidates in business and economics, but we care not a whit, for they work. They've proven so through time and under pressure. We try our best to adhere to them.

This is what I have learned about the world of investing over three decades. I try each day to stand by my rules. I fail miserably at times, for I break them often, and when I do I lose money and mental capital, until such time as I return to my rules and try my very best to hold strongly to them. The losses incurred are the inevitable tithe I must make to the markets to atone for my trading sins. I accept them, and I move on, but only after vowing that "I'll never do that again."

WHAT SEEMS LIKE AN ETERNITY

I have stated in my last 2 newsletters that I expect the November lows to be broken.
Well almost 3 months later we are about to witness this happening. No matter how firm ones conviction there is always the fear of being wrong. From my perspective I was never planning on betting the farm on this trade as the risk reward for being short this trade in size didnt permit excessive risk taking.

The question of course is how much further will this wave take us. In markets like Australia we have been beneath November for some time so the possibility of Aussie leading the recovery is quite high. This is the reason why I continue to purchase the Australian REITs despite the shocking news coming daily from their most recent quarter financial releases.
I continue to level out our short position as I anticipate a massive buying opportunity as a medium term bottom is formed. So in short what I am saying is that although this last leg of the selloff has good profit potential the risk of not being well positioned in the coming weeks for the mother of all buying opportunities is the basis for my continued buying into weakness.

MARKET VIEWS

I attach a chart of the Australian listed property trust sector (AREITs) over the last 5 years.

After enjoying what seemed to be a fantastic bull market, we have seen a precipitous fall that has no doubt caught most investors on the wrong foot.

One can certainly make the argument that this is no different to the performance of REITs across the globe, but the fact is this is only partly true, as yes global markets have suffered a similar fate yet Australia on a relative basis has fared worse. In the chart that follows you will see that over the last 5 years the relative performance has been steadily dropping and is close to 2 std-deviations from its mean; despite the attempt in the 4^th quarter of 08 to march ahead.

My simple explanation for this relative underperformance is due to the fact that Australia through its forced savings legislation (Super) amassed a pool of capital for investment that was far greater than the investment opportunities in Australia itself. As we know that money burns a hole in our pockets, the investment managers we placed our faith in clearly failed to heed this age old lesson and plunged head first into every conceivable investment venture around the globe. I am focusing on real estate but the same can be said for other asset classes. I recall being amazed at the statistics a few years ago when reading research reports that Australia was the 2^nd largest and in some countries the largest foreign investors in real estate.

I recall the main theme of NAREIT end of 2004 (I haven't checked the date) was the subject of the JV model, whereby US REITs would sell a few assets into an SPV which would be capitalised by typically an Australian fund whereby the newly capitalised SPV would then go on a spending spree. The beauty for the US REIT was they got to earn management fees on the properties they sold to the SPV plus all the new ones bought. This JV model I believe gave what used to be regarded as modest income growth stocks a fuel injection that led multiples to levels that were destined to fail.

The question we need to ask ourselves is for how much longer will Australia choke on its excessive offshore investments.

Knee Jerk Reaction

I have come to realise that the majority of people, even those with the knowledge to act differently, seem to act in the same way when we are confronted with certain circumstances.

I must confess this 1 dimensional thinking irritates me in its simplistic understanding of the complexity of the stock market. Let me explain what I mean.

You will find that around specific news events many people and I have one particular fund manager in mind when I write this will think that if the FOMC is about to announce a rate decision tomorrow they will wait until tomorrow and then place their trade on, in the expectation that the market will then go up if it is a rate cut or go down if it is a rate hike. The statistics will tell us the market behaves very noisily around news events which means the behaviour is typically random, and of course the market has long been discounted what the news event is likely to produce.

It therefore irks me when people say I am waiting to buy the market after the cut tomorrow. We have been witness to an increasing amount of market behaviour that has been contrary to these news events, such as major stimulus injection announcements and rate cuts, etc.

Volatility is Smiling

The volatility picture that I see is a sell off in volatility that is about to pick up as the IYR makes new lows. I do not foresee new highs in volatility, this ties in well with a 5th wave new low.

To play it particularly safe in the short term I am applying a delta neutral strategy by buying both calls and puts at spot, hoping that there will be an increase in Volatility.

Mr Gauss gets Killed by a Fat Tail

After spending a lot of time on my own and with the quiet to reflect I look back on this last year and draw the most satisfaction from the way our kids have adapted and thrived in their new environment. Ever the libertarian I was adamant that the kids adapt in their own time. Now for those believers in the Gaussian Distribution or better known "Normal" distribution of the Bell Shaped Curve I want you to know there is nothing normal about it. Just like the financial wizards and mainstream economists who believed the economy and the stock market behaved according to this "Normal" Distribution curve were unceremoniously killed by the bear markets "fat tail"; so do we make the mistake in believing kids/people develop according to a normal distribution. This distribution curve is nothing more than an elegant statistical equation which groups people in probabilities based on an observed historical sample. Unfortunately the formulae hopelessly fails to capture the reality in which a far greater proportion of the statistical outliers occur within the main body of the bell than the statistics would have us believe. What am I saying? I am saying that the world doesn't exist in an orderly patterned way, yes nature may present some order on the surface but beneath the veneer is a chaotic process developing in a manner that is far from normal. Take the current financial malaise, according to many Nobel winning economists this type of event should only happen once every few million years, but history shows us that it happens surprisingly frequently. Noted French Mathematician Bernard Mandlebroit published a book a few years ago where he provided excellent scientific proof refuting the normal distribution, so if you want to understand what I said more eloquently turn there for guidance. So Berman what is your theory now that you have bashed one of the most relied on, trusted, statistical tools the world has ever known.

 

If we as a people develop chaotically or as I would prefer us to believe, in patterned chaos (no this is not a contradiction, far greater mathematicians can prove patterns within Chaos Theory) then we need to provide broader scope in our categorization of what seems to the narrow thinking mind as normal. If a child achieves mastery of mathematics at 10 instead of 8 is that abnormal? If a child develops their 1st friendship at 8 instead of 5 is that abnormal? Yes I am speaking from an idealistic perspective as we as humans are  part of society and within society there are norms. It isn't well accepted for a 20year old to be in grade 7 I take the point, and it does a child no favours emotionally to be in a class that they are not coping with, and by the same token a child a lot older than his or her peers is not done any favours either as their emotional self worth is challenged by the school scoring system and the perception of their intelligence. The same theory applies to those positive outliers. For instance there are some kids who develop far quicker physically or mentally than others, by teaching them that they are special often backfires when the laws of nature slow down this early growth to more normal levels and the kid who was so special becomes average. This too leads to emotional baggage.  What we as parents need to accept is that societies ranking system of what is generally considered as normal is far from accurate and furthermore we as parents need to tap into the patterned chaos that provides us with the most accurate clues in our most precious assets development and potential.

 

As a libertarian committed to a free market my views on letting the kids develop in their own way needs to be tempered with the reality that kids are not fully comprehending participants of the game called life, and we as parents have the unfair advantage of experience which we need to use to coach these bundles of energy/potential. To achieve this balance one needs to almost be like a composer of a complex orchestral score. Where I lean too far to the left Ilana balances the equation with her exquisite intuition to the right,and when the discipline components sees me too far to the right she balances me to the left. Together this year we have made music, as our kids have developed at school, made friends and gained in health, albeit at a pace much slower than "normal" but quick enough to make a parent more happy than any material possession could achieve.

 

Simplicity and Causality

Friday, 5 December 2008 - 4:22 AM (journal:Daily Journal[2008\12\05+042254734])
Simplicity and Causality

We are living through a time of financial turmoil; what I find startling are the fancy theories "experts" are using to explain the solutions to our current situation. To my mind the fact that we find ourselves in this financial mess was so glaringly obvious to all, not just a few, it was greed that blinded us to believe that the show will carry on. We were all scared to miss the boat in case this time things were different or our neighbours would somehow enjoy more of the largesse than we would. There is a cliché my father taught me that is so apt for the current malaise, "easy come easy go".

Markets have existed in some shape or form alongside man for 1,000's of years. Yes innovation has allowed the pattern of market behaviour to develop in different ways often tricking us into believing this time is different; but the axis on which the wheels of the market turn are the same - supply and demand remain. All that changes is our interpretation or quantification of supply and demand. For those of you who like economic history like I do "The phrase "supply and demand" was first used by James Denham-Steuart (http://en.wikipedia.org/wiki/James_Denham-Steuart) in his Inquiry into the Principles of Political Economy (http://en.wikipedia.org/w/index.php?title=Inquiry_into_the_Principles_of_Political_Economy&action=edit&redlink=1), published in 1767. Adam Smith (http://en.wikipedia.org/wiki/Adam_Smith) used the phrase in his 1776 book The Wealth of Nations (http://en.wikipedia.org/wiki/The_Wealth_of_Nations), and David Ricardo (http://en.wikipedia.org/wiki/David_Ricardo) titled one chapter of his 1817 work Principles of Political Economy and Taxation (http://en.wikipedia.org/wiki/Principles_of_Political_Economy_and_Taxation) "On the Influence of Demand and Supply on Price".

I recently spent some time in the US; sitting on an airplane observing a 20yr old girl next to me feverishly texting as if she were sending an SOS to save the world it dawned on me how far we have strayed from the basics. It is a simple fact of life that you cannot always get what you want (great song). It is not a sin or something to be embarrassed about it is a simple fact. However, financial engineers in all their many disguises would like us to believe that most things are attainable. What a load of rubbish, and we believe it because we want to. Lets face it some of us will earn enough money to buy the $2m house and gas guzzling SUV, but most of us wont. Lets not fall for it will only cost us $10k a month bull when we are only earning $12k.

There is no rocket science we are a society that is living way beyond our means. How can we expect to build lasting wealth when we are consuming more than we have. Adam Smith that famous economist who coined the free market term of the "invisible hand" spent far more time examining mans moral behaviour ("The Theory of Moral Sentiments") than economics as we think of it today as represented by Marshall and Walras's demand and supply curves. What I am saying is that we don't have an economic problem but rather a moral one, TARP or SHMARP are not the answer, the answers are very simple but are we ready to face them?

What has been put on the table by political and business leaders infuriates me, we haven't seen lasting solutions, all we get is political soothsaying and the part that angers me most is that the so called intellectuals have bought this crap. Lets just try and think about this logically. The leaders have all agreed the mess we find ourselves in today is because of a housing and credit bubble, yes this is part of the reason, ok so lets work within this framework. How can the solution be more easy credit via lower interest rates and propping up bad mortgages with government purchases, surely someone must pay for the mistakes?

The equation is very simply "easy come easy go". The perceived wealth we experienced over the last few decades is quickly evaporating and there is nothing we can do about it because there was nothing really there. No government or business can stop the process of easy come easy go it is a law of nature, and until such time as nature has taken its course we are at the mercy of civilization grappling with "fair value".

Is it reasonable to think that the engineers of the problem are likely to be able to fix it? I think not when the tools being used are infected with disease. Ludwig von Mises the great Austrian Economist and his disciples Murry Rothbard and Ron Paul clearly explain that our banking and monetary system are flawed. They in fact go much further and claim we are being extorted by government in a massive fraud. You should all do yourself a favour and buy Congressmen Ron Paul's book "Pillars of Prosperity" for a lucid critique and solution to many of today's problems. Let me simply say that a system that enables a government to create money out of thin air
can only result in an erosion of the value of this money through inflation. Giving government a free reign on the printing press will always lead to the solutions we are currently witnessing whereby more and more money is added magically to the system so that government is able to inflate away the costs of its debt. The system is flawed, the system is corrupt and the system will die.

The many solutions the Fed and Treasury have put to work clearly demonstrate that the powers that be are far from ready to relinquish their grip on society and far from the free market principles the founding fathers of the USA constitution envisaged. We live in a time of increased intervention and government interference. Nobody from government is shouting about what was allowed to develop, it is very hard to shout at oneself. Government and its market interference is to blame for today's financial crisis and until such time as policy makers stop bailing out protagonists and rather step back to allow the market to heal itself we are going to continue to witness booms and busts on the grand scale we are currently experiencing.

You are probably saying to yourself what the hell does this guy know, we have the greatest minds in the world working on a solution. If you are thinking this then you don't get it. The system is the problem and the people telling you they are working on a solution are part of that system so until the system dies there are no solutions only further problems disguised as a way out. This isn't a conspiracy theory, we are currently living in a massive economic experiment and I am sad to say we are the null hypothesis.

I have probably upset most of you with what I have said but the sooner you start accepting that you have to live within ones means and that a consumption society will inevitably self-destruct the sooner will a solution develop to lead us forward. We all know the folklore of the shoe shine boy trading tips at the time of the Great Depression and the hairdresser, etc trading tips during the dot.com bubble well I feel that today we are currently witnessing the same thing in reverse. Everyone has an opinion today on what is going on in the financial crisis. From the cab driver to the au pere. We clearly have a long way to go on the downside with all this market interest. As Robert Prechter says we will know we are near a lasting bottom when stocks and all things economic are reviled. When people want nothing to do with the stock market and fancy schemes. At the moment people are scared and panicked but I have not yet seen disgust. I believe we are years away from a lasting bottom, as the economies continue to misfire due to their band-aid solutions. Inevitably we will see true change. Not the kind of change Barrack Obama has in mind but change of the whole system. There is likely to be unrest with this change and I foresee a surge in civil unrest as people lose hope in a system that has no hope.

If you haven't pressed delete already I am going to throw out one last controversial theory that I believe drives the process of economics. This is not my theory it is Robert Prechter Jnr, and it relates to the causality of economics and the market. We have all been taught that the stock market is forward looking in that it discounts what it forecasts the economy to do in the future. So a falling market using this theory would imply that the market is anticipating a weakening economy. This is what I was taught in university and it is what every mainstream market commentator believes. I would go as far to say that 99.9% of people who have a view on the fundamentals of stock market valuation would believe this link. Prechter turns this theory on its head and explains the causality link as follows: the stock market behaves endogenously based on its participants collective moods and the economy in turn is reflective of this mood expressed in the stock market. So if the market is going down, this reflects a negative mood and the resulting downturn in the economy isn't reflective of a discounting process but more profoundly by the causal link of negative sentiment (pretty neat).

So where are we in this cycle? Clearly the mood is extremely negative and if you are one who believes that the pattern of mood behaviour can be forecast on a probability scale then it is likely that the mood will get far worse. We are starting to see the manifestation in the real economy of this negative mood. For those of you not inclined to patterns but staying with the more esoteric, psychology teaches us that mood operates through feedback loops and both positive and negative inputs have the ability to drive perceptions beyond their underlying reality. This is an extremely foreboding insight into the road ahead.

Comparisons with the Great Depression have thus far been restricted to economic comparisons, if we want to get a real insight into how severe the current financial meltdown is likely to be we need to start comparing the collective mood we are experiencing now and what pervaded society in the lead up to and during the Great Depression. Economics is not about financial engineering and measuring utils, it is about understanding mans moral makeup and the collective psychology of man acting in groups.

Good luck

Michael Berman

when will we learn

That’s what Australia said about their Listed Property Trusts 65% ago.
In Australia vacancy in retail is 0% office is very low. Growth is still coming through at around 5% in a 1.5% inflationary economy, gearing is low, interest rates have dropped with 3 rate cuts, Australia's main trading partners are the Asian tigers, China in particular, so fundamentals in Australia are far stronger. The economy here runs a budget surplus not like SA's 7.8% budget deficit of GDP.

I don’t buy it, when a lot of people try and exit a very small door it gets nasty. In SA nobody in property stocks is prepared to be the 1st to exit with a big knock, but the knock is coming...................

-----Original Message-----
From: Brian Azizollahoff [mailto:briana@redefine.co.za]
Sent: Thursday, 13 November 2008 7:18 PM
To: Michael Berman; aazizol@attglobal.net
Subject: RE:

Maybe it's today...

The thing is that fundamentals here are still ok so growth outlook is
positive. This is keeping share prices up.

Regret and Placing Trades

I have discussed this many times before, once I have made up my mind about a specific trade I become increasingly tense that I may not get my trade on. Over the years I have come to accept that for my personality and my style of trading, i.e. I tend to take longer term views typically in the months and some times years, that it is of little relevance to get in on the trade at the "best/lowest if long" price if you run the risk of missing the trade completely.

What I have learnt through deep introspection is that not placing the trade and the following feelings of regret far outweigh the pain of being early and withstanding short term movements against my trade position. My approach to minimize the effects of being early is to stagger my entry. I typically place a 3rd or quarter of my desired position on the 1st trade, this allows me to have a position if the market takes off in my anticipated direction.

Another point making up my entry approach is that as a contrarian investor I need to buy when the market is falling and sell when the market is rising. This approach goes against the conventional trend following wisdom which dominates the investment landscape. Following the trend is a very acceptable means of investing, as it reflects the herd and as many people will tell you "the market always knows best". For the large part this is correct; however, it is at inflection/turning points that the market in fact gets it wrong.

As JP Morgan said during the Great Depression, "you need to buy when there is blood on the street" and as Warren Buffet recently said, " you need to buy when there is maximum fear, and sell when there is maximum greed".

If we know that markets trend for far longer periods than reversals, why don't I trade the trend. The answer is one of probability and psychology. Depending on ones view of market randomness the continuation of the trend following a random walk theory (majority academic view) is not something one can forecast with any degree of certainty other than a random view. (This is not my view, my views are more complex). This still doesn't answer the question. My answer is that I do trade the trend as I do believe markets follow a non random pattern, albeit with a certain degree of randomness interspersed. My problem with trading the trend and staying with the trend is that most systems only pick up a change in the trend after a substantial trend reversal which invariably leads to large draw downs. This brings me to my initial answer of psychology.

I find that I am able to stay with a particular trade an endure the discomfort of a period of loss only by providing my psyche with the mental accounting of having bought something cheaply or sold it expensively. So my answer is actually quite simple. If the markets do possess a high degree of randomness this means that our forecasts are likely to incorporate a reasonable degree of randomness even if one believes it is possible to forecast the future based on probability. With this in mind the ability to position ones mind psychologically to withstand the buffeting of the short term randomness allows me to withstand the volatility knowing that I have as a security the fact that I bought something cheap or that I sold short something expensively.

Australian Economy - Greed Always Comes Back To Bite

I think this article is well worth reading. In the midst of the current financial crisis it is important to realize that the Australian public are still highly leveraged, and will need to go through the process of mending their balance sheets. It is sad but a fact. It is important not to think that rallies in the short term spell the end of this financial malaise but rather a long arduous slog to get things balanced again.
Mike “Bearman”
Greed a deadly sin for the economy
Paul Sheehan
October 20, 2008
On July 30 Hans Redeker, head of foreign exchange strategy at BNP Paribas, Europe's biggest investment bank, predicted: "The Aussie is going down, big time."
Back then - it already seems like a long time ago - the Australian dollar was sitting majestically at 97 cents to the US dollar, which was taking a battering. But the Aussie did, indeed, go down, big time. Within three months it had crashed by 33 per cent to US65.5 cents. Now Redeker has issued another warning to Australia. We'll get to that. But first, let's look at his track record.
December 2006: Redeker predicted a sharp recession in the United States, saying the condition of its housing market was worse than the experts were stating and the flow-on effects would be much worse than predicted. That was almost two years ago. He was right.
January 2008: he predicted the Aussie dollar was facing two years of decline, and expected to see it fall to 66 cents. He was right. He also predicted a rise in financial market volatility, higher inflation worldwide, higher interest rates in Asia, weakening demand for Australia's minerals exports from China, and a weaker sharemarket in China, all of which would drive down the Australian dollar. Since then, the Shanghai sharemarket has crashed 50 per cent from its peak.
October 2008: two weeks ago Redeker repeated his claim that abundant foreign money had been available to Australia and too much of it had been spent on real estate, creating a speculative bubble: "The easy money went straight into real estate c Australia will now have to generate 4 per cent of GDP to meet payments to foreign holders of its assets. This is twice as high as the burden faced by the US."
After the Australian Reserve Bank slashed key interest rates by 1 per cent, Redeker also told London's Telegraph that he was concerned about what the Australian Government may do: "Yes, Australia has a fiscal surplus, but that does not offer as much protection as people think. If the Government boosts spending further, the current account deficit will spiral out of control." (my emphasis – Mike)
And what has the Rudd Government just done? Boost spending.
There was certainly no discussion of the current account deficit spinning out of control, or Australia's excessive debt, when the Prime Minister, Kevin Rudd, launched his $10 billion economic stimulus package last week, nor any from the Opposition Leader, Malcolm Turnbull, who offered in-principle bipartisan support.
It gets worse. Redeker continued: "There is a risk, however remote, that Australia could face some of the foreign funding difficulties we have seen in Iceland."
Iceland! Iceland was the most leveraged economy in the developed world when it became the first economy to be bankrupted by the credit crisis. You do not want to be mentioned in the same sentence as Iceland unless the discussion is fishing or blondes.
After quoting Redeker, the Telegraph's global business columnist, Ambrose Evans-Pritchard, weighed in with his own commentary: "The immediate problem for Australia's banks is that they gorged on offshore US dollar markets to fund expansion because the interest costs were lower. They were playing c on a huge scale with leverage c European banks face much the same problem as dollar liabilities come back to haunt, but Australian lenders have pushed their luck even further."
Gabriel Stein, of Lombard Street Research, weighed in with this, after noting that Australian household debt had reached 177 per cent of gross domestic product, almost a world record: "It is amazing that in the midst of the biggest commodity boom ever seen they have still been unable to get a current account surplus. They have been living beyond their means for 10 years. What worries me is that productivity growth has been very low: they have been coasting after their reforms in the 1990s."
The global financial world is watching the Australian dollar because it holds a key to the great unanswered question of this uncertain era: will the global market punish a currency for its declining interest yield? Or will it reward a currency because of the soundness of its economy? Central banks are acutely interested in the answer.
Evans-Pritchard thinks the early signs are hopeful that the answer is the good one, that nations will be rewarded for having sound economies. But he does not believe Australia can escape the consequences of excess: "Australia has allowed its net foreign liabilities to reach 60 per cent of GDP during a decade-long boom, twice the level of the US. The country will, in effect, have to pay 4 per cent of GDP in the form of rents to foreign asset-holders as the bill for such extravagance falls due." (my emphasis – Mike)
The bill is falling due. Earlier in the year Australians travelling in Europe would have paid about $1.50 for every euro spent. Today they need $2.10. The Aussie dollar is weak again, despite all the luck of the China boom. This raises a number of awkward questions. Did the lucky country became the greedy country? Did it fail to sufficiently embark on a program of nation-building during the resources boom? Was most of the bonus redistributed as tax cuts, which were spent chasing bigger mortgages, bigger homes, new cars and general consumption, stimulating short-term economic growth but not enough on long-term productivity and higher savings?
During 17 years of unbroken economic expansion and a 10-year commodities boom, it took a lot of people, borrowing a lot of money, taking a lot of unproductive risk, to get to where we are today: a nation with excessive debt and excessive vulnerability to external circumstances barely within our control.
This story was found at: http://www.smh.com.au/articles/2008/10/19/1224351052160.html

Financial Advisors - The Blind Lead the Blind

Hi Fonz,
Excellent email and something I strongely endorse.
My quick comment, as a fund manager trading through a “Black Swan” moment; don’t think your tools that you have calibrated so exquisitely over the last number of years are going to do the job in this market. By doing more of the same you are allowing in fact more randomness into what many call a randomly performing industry.
In times like these one needs to listen to the wise counsel of those that have encountered the truly ugly Black Swan.
My only advice to colleagues and friends not just in these times but through all times, never “blow up”. Look after your capital, don’t let any financial advisor tell you it is impossible to time the markets so you must just grin and bare it. No, you need to define in your mind before the game begins what you consider is a “blow up” once you have that stated objective in mind, it is up to you with your advisor to ensure that it never happens.
The advisors I am encountering are all reactionary and hide behind the relative performance baloney by telling their clients that they lost a little bit less than such and such a fund, but what about the persons overall wealth. If the investor is down 50% he or she needs to return 100% in the future to make them whole. What about advisors taking a holistic look and saying your wealth at time 0 was X and now at time 1 it is Y, if things carry on like this you are going to lose more wealth lets rather do the following.
The industry has been due a shake up, and just like the free market even with all the government intervention will expose all the weak spots in the economy so to will this financial maelstrom clean up the financial advisement industry that for all its regulation is an example of the blind leading the blind, and conflicted in all the wrong places.
Catch you later have a good fast.
Mickson

From: The Peer Effect [mailto:info@thepeereffect.com.au]
Sent: Wednesday, 8 October 2008 9:45 AM
To: michael@velocity-trading.com
Subject: Ideas Email No. 32 - It's not business as usual
If you are a LOTUS NOTES user or are having problems viewing this email click here (http://clients.easyemailmarketing.com/ch/1dczjrw/548165/8aef0100mk.html)












Dear Mickson,
Over the last few weeks I've had the opportunity to speak with several advisers to canvass how they are reacting to today's dramatic financial environment. Almost to a person they have replied 'business as usual' or something similar. They tell me that their clients understand what's happening, that their clients are invested for the long term; that they have educated their clients in anticipation of just such a scenario.
Is this possible? Is this panic a media event? Are most investors, particularly your clients, sitting pretty waiting for the shake-out to end? I doubt it. Human nature is what it is. We are prone to doubt ourselves when faced with adversity. We are programmed to swing between greed and fear. We are strongly influenced by common wisdom and the action of the herd.
I understand the importance of a brave face and confident demeanour at these times. The last thing your clients want to hear is a quaver in your voice and uncertainty in your words. But it is definitely not business as usual. By all means show a steely resolve, but it's time for action.
Here are some ideas...
Your Clients
You should be in regular contact with your Segment 'A' clients. They are hearing and reading things that challenge the messages that you have given them. You may have clients who prefer to ignore what's happening. That's fine and you can cross them off your list. But many will seek your reassurance.
Before you telephone a client, jot down three key points that you want to communicate. These points should be relevant to the current situation, not an 'invest for the long term' mantra. Your clients want to know that you are abreast with current developments and have an opinion.
There is a lot of thoughtful opinion and commentary that can be attached to emails. Use email to augment your Segment 'A' contact and as an efficient way to communicate with the rest of your client base.
You need to be careful that this increased communication (although sorely wanted by many clients) does not suggest any panic on your end. Use phrases like 'I'm going to be in contact with you more often while this market volatility lasts. We all know that it will end but I appreciate that the journey can be a bit scary'.
Manage your centres of influence in the same way you do your Segment 'A' clients.
Your Staff
Make no mistake. Your staff are feeling the strain. They may have money invested themselves. They may have introduced family and friends to your practice and are worried that relationships may be damaged. And most of all, many young people and new entrants to our industry may have never experienced an environment like this. They may be entertaining doubts about the value they provide and even whether they have made the correct career choice.
Make some time for one-on-one chats. Deal with issues before they flare up. I wouldn't suggest any group activity here - any negativity can be magnified and there's always the possibility that sensitive issues aren't communicated.
Yourself
By all means show your clients and staff your nothing-can-rattle-me visage. But be honest with yourself. I have a few very close friends in funds management and I can see the strain they're going through. At least they have business-to-business relationships. These are usually a lot more practical. You have mainly business-to-client relationships which are more emotional.
Here are some specific actions that will enable you to manage these times:
Drink more water. Stress releases toxins. These create fatigue and illness. Water assists your body to flush out toxins. Don't skip meals. Now is not the time to neglect your physical well-being.
Share your feelings with a close friend or confidant. Our mind is capable of creating all kinds of nightmarish scenarios. And most of our self-talk is negative. Verbalising and sharing your thoughts often puts things in perspective.
Do some exercise every day - even if this is just a ten minute walk outside your office. Try and get some time in the sun. Sunshine releases brain chemicals which improve your mood.
Redo your budget. Unless you planned for the scenario we are going through, you are well behind your objectives for this year. I spoke with an ex-colleague of mine last week and he remarked that he was 'only 65% of budget'. This can only be demotivating and stressful. So rework your own plan and those of your staff (or if you do not have the time at least communicate that we are going through challenging times and in these circumstances missing targets is understandable).
The collective wisdom of the group...



The Ideas Email is much more than a weekly email. As a subscriber you are part of a virtual community of financial advisers and people who work with advisers. Up until now I have done all the talking. I'd like this to change. If only for one powerful reason: so that you can access the collective wisdom of the group.
I would like you to share any action that you are currently taking to manage today's challenges that has produced great results. Please email this to me and I will consolidate your replies and report back in next week's Ideas Email.



It is not business as usual in the financial services industry. These are epochal times. Let us recognise this and act accordingly.
I wish you great success in your business.
All the best,

Changing the Rules in the middle of the Game - shame on you.

It is a sad time for me as a trader in what I always believed to be a free market system. Yes I am a libertarian and strongly believe that government intervention in the market is not only wrong, it makes matters worse. But my exposure to government intervention was more from an economic point of view, whereby fiscal stimulus package either by tax cuts or government spending had a direct impact on the economy which would feed its way into the market place in an indirect way. Also the Fed which has the powers of monetary policy could also play a role in the markets but once again they are limited to the creation or cancellation of liquidity. So why is it such a sad day for me this Monday morning?

I tell you why, although I strongly disagree with the policies of intervention discussed above; at least I knew the rules of the game when signing up. With the recent banning of short selling on financial stocks in the US and Europe and now the banning of all shorting in Australia, the authorities have effectively entered the ring well into the fight and tied our hands behind our back. This is just not fair play.

One can argue that I am squealing because I am going to lose or lost money, in my case I am fortunately not going to lose too much money, although I will lose. I am more troubled by the fact that the authorities have decided to lay the blame of the current malaise at the foot of an industry that to a large part ensures efficient market pricing. To believe that the reason for the dramatic sell off in financial stocks is because of the hedge fund industry is naïve in the extreme. I don't have all the facts and figures but I believe that around 4 or 5% of the total equity market is out on loan which means that the hedge fund industry and its respective shorts are just tiny and hardly the cause of the damage being laid at them.

There is an overwhelming loss of confidence in a sector that has cooked up a brew of artificial wealth, and this potion has finally proved lethal to its manufacturers and consumers. This realization is at the foot of the problem, and there is no where to hide. The bankruptcies and bad loans need to flush themselves through the system, and the "entrepreneurs" who incorrectly forecasted profits from these institutions need to accept the consequences.

Clearly this is not going to happen, as government authorities do not have the luxury if you can call it that of sitting back and letting the business cycle correct its mistakes. Instead they will try and do "something". On the surface these aggressive steps will provide the system with a degree of comfort that the whole pack of cards will not come tumbling down. However, as soon as the "relief" passes, and the players in the system realize that the rescue is not a real rescue but a system of bringing people who were safe from the devastation into the game, we will encounter a force of revulsion and fear that may blow up in the architects of this systems face.

What they are hoping for is to avoid the death spiral of deflation and reliquify the system to inflate away the debt the government is taking on. This will ultimately destroy the value of the dollar, which already is a currency that is suffering from an identity crisis. Just because a weaker dollar makes sense now do not think a dollar short is a guaranteed trade, as we may still see a flight to safety in Treasuries and Bonds which will keep the dollar alive and probably lose the fight against inflation right now.

Dr Bernanke is a great student of the 2 depression era's in the 20th century, and he is determined to learn from the mistakes made then with his highly aggressive stimulus type package, remember he is the man who said they will drop money from helicopters if they need to. The powers that be long understood where this economy was heading and were sure to employ a man who they believe was/is best placed to fight the deflation monster.

Now I don't know Ben but I wonder how much he understands about crowd psychology, and if my instincts are correct, he is grossly under estimating the risk aversion forces that are spreading across the globe. So yes government holding your hand and saying we will help you get out of this mess can provide some relief, but when you realize the "thing" holding your hand is the actual monster that got you into this mess, you will be reluctant to obey the orders they give. In fact you may actually turn against them.

So yes I am reluctantly holding onto my deflationary views, but I do believe the deflation we are currently experiencing and will experience will be relatively short lived as the seeds for massive inflation have been planted and will sprout. However, given all the action over the last couple of weeks and months, I am forced to take a less bold approach into my trading as I realize I am fighting a battle with my hands tied behind my back, and more importantly against opponents who don't hold by the original rules of the game. I also need to factor in the fact that the relief rally may last longer than what is rational.

At times like these it would be more sensible to lower my exposure to the markets as I fundamentally and technically still believe we should see prices much lower, but I need to factor in the quantum of the "relief" that is likely to continue to manifest from the latest set of stimulation.

It is time for Lehman to Die

It has almost become the catch phrase for so many business headlines lately, "Too Big to Fail". By the Fed intervening like it did with Bear Sterns and now the Treasury more recently with Fannie and Freddie (although here congress messed up way back when it gave the implicit guarantee not actually when Paulson made it real) the threat of moral hazard has become something we have all become weary of.

Is it right for the good people, i.e. those that save and or run profitable companies to have to come in and subsidize the risk takers who have been rewarded way in excess of the norm. I suspected that because of the earlier intervention there was no way government or its agencies could be seen to help Lehman in its current crisis.

As a libertarian I feel strongly that Lehman and the financial markets need to sort out their own mess, even if it has devastating consequences. This business of borrowing from tomorrow in order to smooth things for today is not right, it is in fact theft. The bible does say however, that we pay for the sins of our fathers so I suppose the behaviour that takes us to this point is not unnatural, but it doesn't mean it is right.

What will it mean if Lehman and others are left to falter. Before I answer that question I think the fact that nobody has bought Lehman in any shape or form and whoever sits at the table has walked away without a bid tells me that something is seriously wrong. Now back to the worst case scenario.

Should Lehman go bankrupt, it will send the entire financial market into chaos, as all the derivative players try and establish what in fact is owed by who and to whom. There will of course be further tightening in credit standards and the cost of borrowing will sky-rocket, irrespective of where the Fed drops rates to, they only have 200bps to play with any way. All this uncertainty will have a major impact on confidence and many more companies and individuals will follow the bankruptcy route thus placing further downward pressure on asset prices. The deflationary spiral will take hold. Already because of the Fannie and Freddie commitment by congress the tax payer will be burdened for decades to come with spiralling government expenditure financed in part directly by the tax payer but indirectly through major credit creation from the Fed and Treasury printing press, where the US Dollar will bear the ultimate pain with this inflationary bailout. So from a massive unemployment and decade long depression will come dollar wealth destruction causing massive inflation and then a further economic depression.

Ultimately from all this pain will emerge a stronger more robust financial system, whereby its participants will no longer trust the promises of government to perpetuate the fiat fraud and fraction reserve banking.

Predictably Irrational

I am currently reading a most thought provoking book called Predictably Irrational, by Dan Ariely. He is a professor at MIT if I remember correctly. He crosses into Behavioral Finance and all things psychological as they affect the market place, i.e. mainly from a consumers point of view.

This is a highly entertaining book, and certainly provides one with some remarkable insights into the complexity of the human mind. Especially when aroused or subject to stimulation.

The number of books coming out with terrific insights is quite fantastic, the only problem I have with a lot of these books, in fact most of them is that they alert us to the problem but so few of them offer solutions how to counteract the innate drives of the human decision making brain.

I look forward to doing some work in this regard that works to counteract these strong forces that seem to work counter intuitively and cause us more harm in a financial context.

Sep 14 Weekend View

After going through all my usual news letter writers and observing the market action over the last week, I am left with the conclusion that the probability remains that we are going to see a major sell-off in the blue chip indexes with the US REIT market primed to follow in step.

I am expecting to see some short term strength in the EUR and AUD or said better USD weakness. This should last a week or so and then we should see continued Dollar strength.

I remain well positioned to the short side, with my major shorts being the US but I am short UK and SA REITs as well. My only long remains Australian REITs which I believe offer relative value.

South Africa continues to hold up despite the fact that its currency has recently faltered, its economy is stuttering and emerging markets in general have been sold aggressively. I am convinced South Africa is a bi-polar investment case. I will describe more fully another time.