Ishrc � Discussion Threads

[simon gordon] 19/2/2008 18:07

Anthony Hilton in the Mail - 19/2/08:

'Whether or not the nationalisation of Northern Rock turns out to be a good idea or a financial disaster hinges very much on what is going to happen to house prices.

If they plunge and the bank's bad debts soar, the losses will be huge.

If stability returns, the current slowdown will not matter too much because Rock will be able to trade its way through, although it will have to shrink a bit.

The real problem is not what happens in the next few months but whether the whole trend of rising house prices is going into reverse. Two independent studies published last week produced in their different ways other more fundamental reasons to worry about house prices.

However, they are not concerned with a downturn induced by the short-term problems of the economy. Their analyses point to a fundamental shift in economic conditions, which could mean that the great long-term upward trend in housing is about to turn the other way.

The first case was made by Tim Bond of Barclays Capital in his annual Equity Gilt Study. Although he took most of his data from the US, much of what he concluded is equally applicable to the UK. Having studied long-run trends in house prices, he concluded that the only reason people were prepared to pay as much as they did was that they expected further increases.

Homebuyers probably don't need an economist to spell this out for them, but it does underline how prices have lost touch with the underlying economic reality. Bond highlights how people had only been able to enter this world of unreal pricing because of the exceptional conditions in world markets - the def lationary pressure from China, the glut of world savings and the willingness of central banks to cut interest rates at any sign of an economic slowdown. This has allowed the huge rise in personal debt that has driven the surge in house prices.

But the party is now over because global economic conditions have changed. Global inflation is back, and with it volatility. Central banks can no longer indulge the world's borrowers with easy money at low rates. The prop under the housing market has been removed and prices must fall.

The ABN Amro/London Business School produces the other analysis in its annual Global Investment Returns yearbook, also published last week. One section dealt with momentum investing - where investors buy what is going up and sell what is falling. It shows how the public's willingness to buy houses depends on whether prices are rising or not and on the availability of bank finance.

If they look good, people will take on more debt, and then small changes in the amount people are allowed to borrow, say from 75% to 80% of the property's value, have a massive impact on prices. Indeed, the authors reckon a 7% change in loan-to-value ratios causes a doubling of house prices.

The corollary is that as banks tighten up and the money is no longer available, as is now happening, the prices go into reverse. And just as they went up far more than you would expect, so too will they fall.

A harsh lesson in stock-picking

If in 2000 a stock-market investor had been asked to decide which industries or sectors would dominate the first decade of the new century, he or she would probably have gone for computer hardware and software and fixed and mobile telecommunications, with an outside bet on the media.

They would then have learned a harsh lesson. Thanks to the Global Investment Returns yearbook, we can see they would have lost 95% of their money on computer hardware; 88% on software, 67% on fixed-line telecoms, 62% on mobile telecoms and 53% on the media.

There was a sector in 2000 where you could have made almost 10 times your money in the next seven years. But who would ever have chosen tobacco, up 960%? It was followed more rationally by mining, up 667%, personal goods, up 521%and presumably reflecting the debt-fuelled consumer boom, and household goods, up 400%.

As Professor Elroy Dimson, one of the three professors at London Business School who compile the yearbook put it, this is the long-run triumph of the boring. It reflects the thinking of Warren Buffett, the world's most successful investor who avoids the new, the fashionable, the revolutionary and anything that promises transformational change.

Buffett's view is that investors should never confuse innovation with the opportunity to make money. He avoids new industries because they attract so many entrants that no one makes any money. Picking the handful that will survive and prosper from the many more that will go out of business is a question of luck not judgment, and that is no way to invest.'

[simon gordon] 18/2/2008 07:50

From the Telegraph - `8/2/08:

'Basket case Britain must rebuild its credibility
By Ambrose Evans-Pritchard

Britons cling to a comforting notion that overpopulated islands with a shortage of land can never suffer a sharp fall in house prices. Such illusions are often at the root of the most extreme asset bubbles.

Some of the most spectacular property crashes over the last 60 years occurred in the Pacific rim islands during the 1990s. Tokyo land prices fell 80pc in Japan's deflation. Property prices fell 63pc in Hong Kong, and 56pc in Taiwan. Each is a more crowded island than Britain. In each, the bust followed rampant misuse of debt leverage. Closer to home, we see a crunch in Ireland. Dublin property prices fell roughly 10pc in 2007. A study by Trinity College Dublin said values may halve before the excesses of the credit boom are fully purged.

Caveat Lector. The UK is not my beat. Any views are those of an "outsider", returning after a quarter-century abroad. So let me be clear. The British economy has been recklessly mismanaged for over five years.

Indictment One: the UK current account deficit reached 5.7pc of GDP in the third quarter of last year, the worst of any major country in the world, bar Spain. "This is approaching Banana Republic status," said Albert Edwards from Société Générale. "Years of macro-mismanagement have dragged the UK economy to the edge of a precipice. The household sector is borrowing at a cyclically unprecedented 4pc of GDP. Basing economic growth on unsustainable asset price bubbles was always a recipe for disaster," he said.

Indictment Two: we are a budget basket case as well, with a deficit of 3pc of GDP at the top the cycle. We enter slump without a fiscal shield. Even America is doing better. This deficit is beyond the legal limit of the Maastricht Treaty, not that Downing Street cares. Gordon Brown may have to care more about the bond vigilantes and currency traders who have sharper claws.

They may yet force him to raise taxes into a downturn, as Labour's Philip Snowden had to do in 1931, or as Latin America's big spenders have had to do with an IMF gun to their head. A hard landing will have a "catastrophic impact on UK public finances" as tax revenues dry up and dole costs soar, says Capital Economics. "A recession as deep as that in the early 1990s could push borrowing up to £150bn per annum," it said. In the ERM smash-up, Britain swung from a 2pc surplus to an 8pc deficit. That was the result of subcontracting monetary policy to the Bundesbank. This time we have our own bank, bruised though it may be. It can cut interest rates a long way.

Indictment Three: the state share of the economy has risen from 37pc to 45pc in eight years, on OECD figures. We have risen above Germany for the first time since the Schmidt-Callaghan era. Berlin has been trimming as we bloat fatter. So have the Swedes, Danes, Dutch, Belgians, Austrians, Italians, Spanish and Eastern Europeans. It is a matter of political taste whether you think Brown's largesse on doctors, nurses, schools, and roads has been well used, but there is no denying that we are now one of the most socialist/collectivist states in the world.

Indictment Four: household debt has reached 103pc of GDP, pushing the frontiers of irresponsibility into uncharted terrain. The Americans buckled at around 85pc. UK home equity withdrawals have reached £50bn a year. We are spending unrealised paper profits at a rate of 4pc of GDP per annum. Some 58pc of all home loans issued in Britain in 2006 were either sub-prime, buy-to-let, or other forms of "specialist lending". The effective cash and liquid assets ratio of the banks has fallen to zero.

Is it not disturbing that Northern Rock should have collapsed even before the housing market turned, and defaults had begun to soar? What happens now if UK house prices fall 5pc in 2008 as forecast by Merrill Lynch, or indeed further?

The most pernicious effect of this sorry tale is the impression that Britain might be better off in EMU, under the tutelage of the European Central Bank, which has handled the credit crunch with skill. It carried out a pre-emptive "rescue" of the euro-zone banks by showering the system with liquidity and accepting rubbish as collateral, but it had to do so because there is no clear-cut lender of last resort in EMU. It cannot risk a Northern Rock. Who bails out whom? That must never be tested.

Yes, Mervyn King's hair-shirt austerity was quixotic, and ill-judged, but at least he tried to fight moral hazard. Europe capitulated immediately. It did so because EMU is a dysfunctional monetary union, where the Latin and Germanic halves are moving further apart and so are the spreads on sovereign bonds. The gloss will come off Euroland in due course.

In Britain we must rebuild our smashed credibility. We face a decade of grinding debt deflation, like Japan. Thank you Mr Brown.'

[simon gordon] 12/2/2008 17:40

Barrons - 11/2/08:

This Credit Crisis Has a Long Way to Run

Interview with Jeremy Grantham, Chief Investment Strategist, GMO

ONE OF THE GRANDEST OF THINKERS AND MOST ELOQUENT of oracles, Jeremy Grantham has long been the voice of reason in an industry prone to excesses and embellishment. By taking the long view, blending quantitative strategies and technical analysis with sound and experienced judgment, Grantham, chairman of Boston-based GMO, consistently uncovers with his team the best values among a wide range of global asset classes.

[simon gordon] 09/2/2008 10:52

From Japan's Slump in 1990s, Lessons for U.S.

Published: February 9, 2008

In broad strokes, the parallels are alarming. After a long boom, the Japanese economy in the 1990s, as America's today, was jolted by a sharp plunge in the real estate market.

Could the American Economy Find Itself in a Lost Decade? In Tokyo, the government bankers and policy makers were slow to recognize the scope of the problem. Bad loans piled up. The financial troubles rippled through the economy as consumer spending and job growth fell.

The Japanese slump proved extraordinarily long-lived, ending only a few years ago, a stretch of stagnation known as Japan's lost decade. It was a humbling and lasting setback for a nation once feared and admired as a model of economic dynamism.

The shadow of Japan hangs over the American economy these days. The United States is sliding into a housing-driven downturn, economists say, just as it also appears to be losing some of its global edge from the productivity-enhancing gains driven by the technology investments of recent decades. For Japan, experts point out, the housing bubble burst just as the rise of China as an export power hurt Japanese manufacturers.

A lengthy slowdown, they say, could alter the economic psychology of America, echoing the Japanese pattern, as the nation enters a period of diminished confidence that restrains consumer spending and business investment.

"I think there are a lot more similarities than people are willing to admit," said Clyde V. Prestowitz, president of the Economic Strategy Institute, a Washington-based policy research organization that has long promoted American industry.

"The American economy is very fragile now," said Mr. Prestowitz, who was a trade negotiator with Japan in the Reagan administration.

But the extreme Japanese experience, most analysts agree, stands less as a prediction of America's fate than as a cautionary example. A Japan-style quagmire, they say, is an outcome that can be avoided in the United States with sound economic policy.

Japan's central bank and finance ministry, economists say, waited far too long - years - before taking steps to revive Japan's economy in the 1990s.

The Federal Reserve, while slow to see the credit crisis spilling into the broader economy last year, has acted much more decisively in recent weeks. The Fed has twice cut short-term interest rates sharply, lowering its benchmark rate to 3 percent, reflecting both the central bank's anxiety and its determination to try to lift the economy despite serious concerns about the risk of higher inflation.

Ben S. Bernanke, the Fed chairman, is a former professor at Princeton University and a student of Japan's policy missteps. And while a number of experts fault Mr. Bernanke for what they see as the Fed's poor communications with both Main Street and Wall Street, the central bank's recent moves suggest that he has taken those lessons to heart.

His past comments, however, indicate that Mr. Bernanke thinks that low interest rates alone are not enough to revive an ailing economy. In a 2003 speech in Tokyo, for example, he offered a prescription for Japan's malaise: a more aggressive monetary policy and "explicit, though temporary, cooperation between the monetary and fiscal authorities" to stimulate the economy.

Washington understands that message. Congress - America's fiscal authority - moved unexpectedly rapidly to approve a $168 billion stimulus plan that includes household tax rebates, temporary tax cuts and incentives for business investment.

"The United States is moving faster than the Japanese did," said Charles Yuji Horioka, a professor of economics at Osaka University. "So far, so good. But American policy makers have to be ready to take further steps as needed."

The American economy, many economists predict, will deteriorate further before things turn around. The government's report last week that employment fell in January, the first decline in more than four years, was the latest sign of trouble. The depth and duration of the downturn, economists say, will largely depend on how much more bad news is coming from banks and other financial institutions.

Nouriel Roubini, an economics professor at the Stern School of Business at New York University, warned that the roughly $100 billion in bad loans reported by banks to date could increase nearly tenfold, as the defaults spread beyond the subprime mortgage loans to consumer loans, credit cards and corporate lending.

In his view, the American economy is already in recession and faces a lengthy downturn of a year or more, before growth recovers.

Still, even Mr. Roubini sees scant chance of the United States following Japan's path. "I'm very pessimistic, but I don't think it will be anything like Japan," he said.

Compared with the boom-bust cycle in Japan, the American housing market looks positively sedate. In the major metropolitan regions of the United States, house prices rose 82 percent from the end of the last recession in November 2001 to their peak in June 2006, according to the Standard & Poor's Case-Shiller home price index. Since the peak, house prices have declined about 10 percent, and most economists expect a further decline of 10 to 15 percent.

Could the American Economy Find Itself in a Lost Decade? In Japan, housing prices in the major metropolitan regions nearly tripled from 1985 to 1991, then proceeded to lose two-thirds of their value over the next 14 years. Today, prices have risen slightly, according to Japanese government statistics. Still, Japanese house prices last year were only slightly higher than the level before the boom, more than two decades ago.

In Japan, government officials not only tolerated the housing price bubble, economists say, they actively encouraged it. Fearful that a strengthening yen was hurting Japanese exporters, the Ministry of Finance urged banks to lend to real estate developers so that a building boom and increased consumer spending would lift the economy.

Japan's post-bubble recession should have lasted from 1992 to 1994, according to Adam S. Posen, a senior fellow at the Peterson Institute for International Economics in Washington. But Japanese officials were too conservative and too protective of failing banks, he said, and thus prone to policy steps that were counterproductive, like the decision in 1997 to raise Japan's sales tax to 5 percent, from 3 percent.

"What kept Japan down was repeated macroeconomic policy mistakes," Mr. Posen observed.

Japan's close-knit business and government culture, economists say, slowed its response to the crisis and prolonged the slump. The industrial groups, or keiretsu, had tight links with banks, so when a bank got in trouble it was often quietly bailed out temporarily with loans or investments from other members of the corporate group. Japanese bank regulators, economists note, tended to be friendly and permissive.

Eventually, Japan experts say, banking regulation and disclosure rules were tightened up.

"In America, we force the bad news out faster than the Japanese did, and we deal with it faster," said Edward J. Lincoln, an economist and director of the Japan-U.S. Center for Business and Economic Studies at New York University. "That should limit the damage from the economic shock instead of drag it out, as they did in Japan."

Though not expected to reach the proportions it reached in Japan, the economic pain in America could be considerable, some analysts warn. They see disturbing parallels with Japan in that the depths of the financial troubles in United States are still not known, and the shock of the housing market slump may bring a lasting recalibration of the national mood, lowering expectations and confidence.

In Japan, the slump lasted longer than expected not just because of policy mistakes, notes Kenneth S. Rogoff, a professor of economics at Harvard University, but also because of some underlying global economic shifts. Starting in the 1990s, he said, Japan's exporters began facing stiffer competition from other nations in Asia, particularly China.

Mr. Rogoff sees a similar drag on the American economy from the slowdown in the rapid growth in productivity that began in the mid-1990s, often attributed to technology-driven gains. Last year, he said, the government revised its estimate of the productivity growth rate since 2003 down to about 1.6 percent a year, far lower than 2.5 percent average in the years before.

"It certainly appears that the U.S. productivity miracle is over," Mr. Rogoff said. "Our resilience as an economy is way down. So it looks like the United States will experience a milder version of the Japanese disease."

[simon gordon] 05/2/2008 10:59

Ken Murray at Blue Planet - 21/1/08:

American Banking System Perilously Close to Collapse

Ken Murray, Chief Executive of Blue Planet Investment Management, forecast on 3rd April 2007 that the credit cycle had turned and that bad debts in the US mortgage market were set to soar. He also said that this would lead to a recession in the US. On 17th August 2007 he made the following prediction "We are entering the worst banking crisis in decades and banks will go bust as they are overwhelmed by liquidity problems and a tsunami of bad debts". Since then Northern Rock has collapsed and other banks are set to follow suit.

In an update on events he comments:
"The banking crisis that is unfolding in the US is the worst since the Great Depression and as major economies, including those of the US and UK, move into recession matters will get much worse. The American banking system is perilously close to collapse."

The reasoning for his argument goes as follows: When banks have limited funds to lend, they demand good margins from the customers to whom they lend and they are very selective in their choice of customer. Conversely, when banks are awash with funds to lend, they soon exhaust the available supply of creditworthy loan proposals and many engage in ever riskier, poor quality lending. The greater the over-supply of cheap liquidity into the banking system and resulting credit, the greater the subsequent level of bad debts.

This is exactly what happened when the Federal Reserve flooded the banking market with cheap money in 2000 to 2003 in order, as it saw it, to avert a recession. In cutting interest rates from 6.25% to 1.5% it sowed the seeds of a much more serious crisis – a crisis that has brought the US banking system perilously close to collapse.

It is not clear whether the Federal Reserve simply failed to understand the consequences of its actions, or whether it underestimated the level of bad debts that would arise from its policy. No matter which one of these interpretations is the case, one thing is for sure: the Federal Reserve is responsible for the crisis that now threatens the American and global banking systems. Even more worrying is that their response to the current crisis engulfing the US banking system seems to show that they have learnt little from their mistakes. Once again they are embarking on a path of cutting interest rate cuts in the hope of stimulating consumption and averting a recession – at least that appears to be their public position. With inflation rising all over the world this looks like a very dangerous strategy that may ultimately lead to higher interest rates. That would only serve to exacerbate the situation and increase the total amount of bad debts to be borne by the banking system in the long run.

The only way to address the current problems being faced by the banking system is to encourage banks to raise equity so that they can absorb the losses that are already in the system, while the Central Bank simultaneously keeps credit expansion and, most importantly, inflation under tight control so that future bad debts and interest rates are kept to the minimum. This may mean that the Fed has to accept a recession.

On the basis of its public pronouncements the Fed shows no signs of following such a prudent course of action and appears obsessed with economic growth at all costs. However, such statements by Central Banks are often no more than smoke screens particularly when the stability of individual banks or the banking system is concerned. The public explanation given by the Fed for its actions needs to be seen in this context. The reality is that the Fed is currently engaged in a desperate battle to stave off the collapse of the American banking system – a battle that carries grave risks for inflation and financial markets. Despite the seriousness of the risks arising from it's "print more money" policy it is clear that the Fed fears the short term risks to the US banking market more and it's primary concern is now to slow down the rate of growth in bad debts before they bring down banks.

Those that believe the Fed's policy of reducing interest rates will bring a return to the boom times are going to be sorely disappointed. Policies aimed at cutting interest rates in order to stimulate credit expansion, consumption and economic activity become increasingly ineffective as consumers exhaust their ability to borrow. This has now all but happened in the US and the UK as demonstrated by rising levels of bad debts. The US consumer, now one of the most indebted in the world, is a spent force and can no longer drive the US economy. This is important as personal consumption makes up approximately 70% of US GDP and any fall in it has a profound effect on the US economy. Put simply, interest rate cuts are not going to stimulate consumption in the way that they did in the early part of this millennium when people had "balance sheets" that could support additional borrowings. They will buy time and slow the rate of growth in bad debts in the short term but ultimately they are also likely to produce more inflation and bad debts.

Consumers can only consume at the rate of growth in their incomes in the absence of credit or a fall in the savings ratio. Consumption has been well above the rate of growth in consumers incomes in recent years and has been financed by borrowings and by consumers reducing the amount of their incomes they save. These elevated levels of consumption have increased economic activity and led to the boom of recent years. However consumers now have to service that debt and with property prices falling they can no longer rely on that source of "savings" and will have to revert to more conventional means of saving i.e. they will have to increase the proportion of their incomes they actually save. The upshot is that consumption will now fall below the rate of growth in consumers' incomes and economic activity will fall with it. Consequently, a recession is inevitable. This is the future we face.

The current situation in the US banking market is without precedent. Never before in a time of near full employment and record corporate profitability have we seen such huge levels of bad debts. By our own estimates bad debts in the US mortgage market alone will be between $150bn and $300bn. Other estimates set the figure much higher. This is important because the bad debts that have been incurred so far are entirely due to poor underwriting as opposed to a downturn in economic activity. However, a downturn in economic activity is now occurring and, if the US economy is heading for recession as we forecast on 3rd April 2007, it will give rise to a huge layer of additional bad debts. It is perfectly conceivable that bad debts may rise to somewhere in the order of $250bn to $500bn. To put the scale of these losses into perspective the total equity of the US's top 100 banks stood at $800bn at the end of the third quarter 2007. At $250bn the losses would wipe out 31% of their capital at $500bn they would wipe out 63%. If the losses were spread equally amongst the banks it would leave a very large number of them unable to meet their minimum capital requirements under Basle II and push up their cost of funding. But of course the losses will not be spread evenly across all banks, some will be affected more than others. It is likely that some banks will simply fold under the pressure of such write-offs. So far only about $97bn has been provided for so we are nowhere near the bottom of this cycle.

Banks are under unprecedented pressures. Generally they go bust for one of two reasons, either because of a lack of liquidity or because their capital is wiped out by bad debts.

The activities of Central Banks can stave off the first of these but they have no direct powers to prevent the second cause of insolvency and it is this that will bring down banks.

Central Banks have been injecting billions of dollars of liquidity into the banking system. This conveys a message but it is one that few in equity markets seem to understand. It is that banks are becoming increasingly insolvent. This loss of liquidity is a result of the market for securitised bank assets and syndicated loans drying up. So assets that were previously sold on for cash now have to be retained on balance sheet. Bizarrely, many stockmarket investors see these increasingly massive injections of liquidity as positive. Time and time again the market spikes up on their announcement. The fact that banks NEED all this liquidity is a clear and unequivocal sign that banks are becoming increasing insolvent and that the problems they face are getting worse. Indeed many would now be insolvent were it not for the support of Central Banks. If the ailing banks were seen in human terms, as a patient requiring increasingly large transfusions of blood to stay alive instead of capital I wonder how many investors would conclude that the patient's health was improving. Well this is what is happening to banks.

Be that as it may, Central Banks can probably deal with this liquidity problem and money market yields are returning to more normal levels but they have much less power to stop the rapidly escalating problem of bad debts. This is a problem that their loose monetary policy has created and it can only be addressed either through equity injections into the banking system, or by banks shrinking the amount of loans outstanding (not practical in the short time available) or a combination of the two. It is not by any means clear that investors will supply the amount of equity required to deal with this problem. If they do not, then banks will go bust and the day of reckoning on this front is fast approaching.

Bad debts in the US rose very sharply in the fourth quarter of 2007 and are likely to keep on this steep upward trend for some time to come. They are spreading from the housing market into consumer finance as HSBC, Citigroup, Wells Fargo and JP Morgan have recently reported and will soon spread into commercial property and private equity/LBO lending in the coming months - areas that have historically resulted in big losses for the banks. This deterioration in credit quality will happen as economies slide into recession and it will result in substantial further losses for banks. Despite this, equity markets show very little signs of understanding the seriousness of the situation or just how far and how fast corporate earnings in all sectors, not just in the banking sector, will fall.

This lack of understanding is illustrated not just by the market's reaction to the growing liquidity requirements of banks but also by its reaction to Citigroup's and UBS's recent capital raisings. The fact that these banks, amongst the largest in the World, agreed to pay such penal rates for capital should have sent a clear signal to the markets about the gravity of the situation faced by them.

The DJ Eurostoxx 50 Index stands at 4,140, that is roughly 9% percent below its five year high and 124% above its 5 year low. It is difficult to see how this properly prices in the downside risks that currently face investors. Indeed, it is about as bad an attempt at pricing risk as that made by US mortgage and investment banks in the subprime market in 2005/6. We believe that if future falls in earnings and the unprecedented risks that currently exist to the financial system are properly priced in then the DJ Eurostoxx 50 Index should be between 25% and 40% below current levels.

Blue Planet has warned of these mounting problems for some time now and has built up liquidity in its funds to very high levels, hedged its long positions and concentrated its investments in banks located in economies that are growing rapidly and whose earnings should be largely unaffected by the growing banking crisis in the West. It has no investments in the US or UK banking sectors.

Ken Murray its Chief Executive says:
"Once this crisis has blown over it will present opportunities for us to profit from the banking sector's recovery and we fully expect to make the sort of huge returns we made for investors during the last upswing in the credit cycle but you need to know what you are doing in this sector and I believe that we have demonstrated our proficiency over the years both by the huge returns we have generated for our investors and by correctly forecasting events that affect markets. The greatest risk for investors is that they entrust their money to managers who are not experts in this complex sector. There will still be large losses made before matters start to improve. The trick is to know when and where it is safe to invest and for that you need in depth sector knowledge."

[insipiens] 04/2/2008 20:46

yes, its a bit like a car crash - you know, everything slows down and you watch as it happens.

Its sickening to see the perpetuation of errors we all saw coming and knowing that there will be no happy ending.

The worst is it will hurt everyone to a degree.

BoE should be counteracting M3 growth not inflation IMO - monetarist that I am....

Back to the gold standard and little growth I say, stick my money in 2% bonds just like the victorians did :)

[insipiens] 04/2/2008 08:54

"John Train reckons that in an Infaltionary bust one should invest in Short Term Debt and Gold - both of these have been outperforming."

yes, I have the precious metals EFT AIGP from etfs and have some investment in UGY for this reason.

Also Agricultural ETF AIGA

[simon gordon] 03/2/2008 14:00

Avner again:

'Hold on tight, the consequences of this bubble bursting have only just begun:

One advantage of having grey hair (aside from still having hair) is that it comes with memories (a.k.a. experience), and few need them more than money managers. Especially in hairy times like these, when a big bubble has just burst - real estate speculation financed by unpayable (a.k.a. subprime) debt.

Yes, value investors are supposed to buy when times are tough. But - to be blunt about it - the tough times have probably not even started. I have witnessed several big bubbles over the years, but few as big as this. And because buying prematurely in a bubble can be hazardous to your financial health, the first thing you must understand is its nature.

So, let me try to make sure you understand how big this one is, and how long it can take to mend. First, you should distinguish between localized small bubbles that only damage speculators in a specific market, and large bubbles that spill over into Main Street.

The gold and silver runup of the early 1980s was of the first type. Another such one was the stock market runup of 1987 that ended with a market crash, but caused little economic damage. Even the junk bonds bubble of the late eighties that fuelled takeovers - a mini-mini version of today's unpayable debt mountain - ended quickly, and U.S. Federal Reserve Board money-printing soon had the economy humming. The more serious bubble comparable to today's debt mountain, is Japan of the eighties. (In fact, in 1990 Gordon Capital sent me and another partner to Japan to see whether Gordon should open an office there, to benefit from the boom. "No way," we said. "It's a bubble.")

In those days, Japanese banks lent money at 0.5 per cent, which Japanese companies used to create cheap, unprofitable products. Other companies used the free money to speculate in real estate. The resulting debt mountain could never be repaid; and so Japan slid into a decade-long stagnation/recession.

A smaller, more recent bubble was the tech runup of the late nineties. That one, ending in the Nasdaq crash, took three years to unravel. And now we face the subprime bubble - a huge landfill of unpayable debt, of a size comparable to the U.S. gross domestic product, bringing frantic calls to the Fed to print away the problem.

Can it be done? Probably not. Because of its size, this debt problem will probably last longer than the tech bubble's three years, though shorter than Japan's decade, and will likely make the next few years resemble that far-gone decade, the seventies. Remember them?

In the early seventies I was reading both the International Herald Tribune and Le Monde in Paris, where I was working as an apprentice engineer fresh out of university, waiting for my immigration visa to Canada, and skimping so I could take my girlfriend to Le Petit Choux, my favourite restaurant.

From the newspapers I soon realized that those who understood how money worked could take their girlfriends out more often, so I began reading the economic sections, too. I learned that American tourists were having their U.S. dollars refused because the U.S. dollar was plunging, and that President Richard Nixon had liberated gold from its fixed price, and so the gold price was rising. A year later, when I was already in Canada, I read that Arab countries jacked up the price of oil (following the Yom Kippur war), and that the Fed was printing money fast to pay for the oil and for the Vietnam war, and as a result, the economy stagnated even as prices rose.

Sounds familiar? Sure does. Based on what we see in our research daily, the same thing is happening today. It's called stagflation: stagnation plus inflation. In the seventies, the Fed tried to cure the first part - stagnation - by printing even more money. This is what it's also trying to do today. In the seventies, it only made things worse - the economy shrank, inflation spiked, and the market fell.

The Fed (under President Ronald Reagan) then realized that the second part - inflation - must be cured first, and in the early 1980s this is what Fed chairman Paul Volker did, which resulted in the awful recession of 1980-1982. Will this repeat? Unhappily, it very probably might.

First, we must suffer the ravages of stagnation - starting now - then suffer the economic tourniquet applied by the new U.S. administration to squeeze inflation out.

Can we have some relief on the way? Probably a little, as tax cuts may create false spike-ups, but they cannot cure the debt problem. It is simply too big.

Are things entirely similar to the seventies? Of course not. One big difference is that the world today is much faster. In those days you gave an order to your broker who called it in, and it was executed by hand. (The Toronto Stock Exchange used to have boards where trainees actually wrote prices by hand.) Today, you can click and buy, so panic can be magnified and transformed into legally binding orders. This, if anything, may lengthen the bubble.

What is the solution, then? Make sure you keep spare cash, are well diversified, as well as long and short - and do not act in a hurry, because your emotions may trip you. Better still, consult those with grey hair who have been active in the seventies, because that decade may just be coming back.'

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Wiki on Stagfaltion:

'Stagflation, a portmanteau of the words stagnation and inflation, is a macroeconomics term used to describe a period of inflation combined with stagnation (that is, slow economic growth and rising unemployment, possibly including recession). The term stagflation is generally attributed to United Kingdom Chancellor of the Exchequer Iain MacLeod, who coined the term in a speech to Parliament in 1965. "Stag" comes from the first syllable of "stagnation", a reference to a sluggish economy, while "flation" comes from the second and third syllables of "inflation", a reference to an upward spiral in consumer prices.

Stagflation came to be recognized as a potentially important macroeconomic problem in the 1970s, when it afflicted many countries in the developed and developing world. Prior to the 1970s, the prevailing Keynesian school of macroeconomics assumed that inflation and stagnation were unlikely to occur together. Macroeconomists at that time believed that stagnation could typically be cured by expansionary monetary or fiscal policies, while inflation could be cured by contractionary monetary or fiscal policies. When both stagnation and inflation occurred at the same time, this called into question existing macroeconomic theories and also posed a dilemma for the standard policy remedies that had been used to stabilize the economy in the past.

Economists today typically offer two main explanations of stagflation. First, stagflation can occur when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.[5] Second, both stagnation (recession) and inflation can be caused by inappropriate macroeconomic policies: for example, if the central banks are prompted by a desire to fend off a recession, they can cause inflation by permitting excessive growth of the money supply, and the government can cause stagnation by excessive regulation of goods markets and labor markets. The global stagflation of the 1970s is often blamed on both causes: it was largely started by a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to try to avoid the resulting recession (stagnation,) causing a runaway wage-price spiral.'

[simon gordon] 02/2/2008 17:29

Avner Mandelman's take on this Bear market - 2/2/08:

'The market is down a lot, the Fed cut rates twice, and brave contrarians come out of the woodwork telling you to buy. Should you? Short term you may catch a bounce, perhaps even a good one, but don't stay in long. We are in a bear market and it has probably just begun.

Yes, I know the best time to buy for the long term is when the market plunges. And I also know that the most dangerous words in the market are: "This time it's different." But this time it probably is. Why? Because the enormous damage done by speculation in real estate, financed by subprime bonds, is of a scale far larger than any we have seen since the 1970s, and therefore would likely take far longer to mend.

Now, money destruction by itself is not the issue. Most bear markets start with a meltdown of capital, after a mass of financial lemmings lose their common sense and buy tulip bulbs on credit. When the tulips (or dot-coms, or unneeded homes) crash, the debt must be written off - which causes a slowdown or a recession, such as the one we are in now.

How sure am I we are in a recession? Quite sure, based on what we see in our due diligence. On top, one of Giraffe's clients is a diamond merchant, and he tells us that for the last 25 years, a sales slump in high grade stones always coincided with a recession - and a month or two ago a deep recession began. Just how deep? To answer this we have to estimate the size of the capital destruction. Here's how:

When a company writes off a failed investment, it does so via the income statement. A country's income statement is the gross domestic product, and capital destroyed by speculation reduces the GDP.

How big a reduction is required to cause a recession (a GDP decline of at least two quarters)? Let's see. The United States' annual GDP is about $14-trillion (U.S.)., growing at between 2 per cent and 3 per cent a year, or 0.25 per cent to 0.75 per cent per quarter.

Therefore a damage of, say, $200-billion, or 1.5 per cent of GDP, is enough to tumble two or more quarters into negative. Stock speculation, such as the 1990's dot-com mania, is of such a scale, and so is a standard recession caused by inventory accumulation.

But bond speculation is a beast of an entirely different ferocity. Bond speculation to stock speculation is like nuclear bomb to TNT - its awfulness is of a different order. That's because the bond market is 10 times the size of the stock market. So when you mess up stocks, in a year or two it can be fine. But if you mess up bonds, you're likely to botch the economy for several years.

Japan suffered a decade's recession in the '90s, after its '80s stock market speculation spilled into real estate and bonds. Even the minor U.S. junk bond speculation of the late '80s caused a bad economic hangover in 1990-1991.

What of today's subprime debt recession? I'm afraid this mess is far bigger than previous messes, because this time the speculator has been the U.S. government itself.

Years ago, the U.S. government got suckered into insuring home mortgages via two federal mortgage insurers, Fannie Mae and Freddie Mac. As a result, home ownership came to be seen as near-riskless investment - but it really only transferred the risk to the U.S. government via its agencies F&F - which today own more than $5-trillion of mortgages - or a third of the U.S. GDP - with arguably an almost equal amount of other obligations and mortgage derivatives off balance sheet, for a total of two-thirds of the GDP.

These holdings are likely worth far less than what they are carried at. How much less? Well, private mortgage insurers like MBIA whose portfolios were marked to market saw declines of 15 per cent, 20 per cent, and more. If F&Fs similarly marked their holdings to market, it would imply a writeoff of about $1.5- to $2-trillion, or 10 to 15 per cent of the U.S. GDP! This is a scary number, far bigger than the dot-com hangover, far bigger than the 1990-91 junk bonds problem, and can only be compared - maybe - to Japan's 1990s. Such a big hole almost dictates a deep recession of two to three years à la 1982, or a Japanese-style on-off recession of perhaps half a decade.

But, you may ask, can't the government fill this hole by cutting rates even more? How about cutting more taxes? Or handing out even more money? My view is that this time the government cannot fix things, since, for the first time ever, the hole is of GDP scale. Just see what happened after the Fed cut rates - nothing. Heck, after the second cut, the market actually fell.

What then should you do, if it's indeed a bear market? Two things.

First, you should recognize that in a bear market, bear rules apply. Whereas in a bull market you buy the dips, in a bear market you sell (or short) the rallies. Sure, some sectors will do well - those representing scarcity, necessity, or special situations; but the market as a whole won't be up.

Second, in a bull market you can afford to invest mostly by yourself, because most stocks go up. But in a bear market, you should let a pro handle your money - and better find one who can go both long and short. This way you'd sleep well while the pro sweats for you. Because in the next two to three years, if I am right, there'll be plenty to sweat about.'

[simon gordon] 01/2/2008 12:25

You are right.

It is probable that the FTSE100 could be trading between 5,000 and 7,000 in the next five to ten years. It is still where it was in 1997.

So instead of the market tanking, it could just trade sideways.

The Financial Services sector which is a large weighting of Index trackers will suffer, as they shrink their balance sheets and find it difficult to devise readily accepted products like SIV's and CDO's.

If this is the case then the place to make money will be:

-Softs.
-Metals.
-Oil & Gas.
-Clean Energy.
-Water.
-Infrastructure

I suppose a bundle of ETF's covering these would be a sound way of making profits in the low teens, per year.

iShares cover some of the above and Eclectica have an Agri fund.

Still, for the risk the reward ain't too chunky.

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Looking for the next bubble after TMT, Property, Credit and Private Equity - how about inflation?

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John Train reckons that in an Infaltionary bust one should invest in Short Term Debt and Gold - both of these have been outperforming.

[insipiens] 31/1/2008 07:34

seems that guy doesn't understand the impact of fiat currencies. When you can just print money.....

[insipiens] 30/1/2008 01:38

yep, when they get really depressed will be the time to start to look for value.

I heard an interview where they said that if you had a January sale and you could buy goods at 20-30% off would you wait for the price to go up before buying? Then why in a bear market do investors sell only to wait for the market to go back up before piling in.

True enough I suppose.

[simon gordon] 24/1/2008 20:36

From Alphavile - 7/1/08:

THE FIVE STAGES OF MARKET MISERY

We spent much of the second half of last year bandying around the word "denial." Lots of people were in such a state, or so it seemed: equity investors; Northern Rock investors; Northern Rock management; the Chancellor of the Exchequer; anyone with money in the Chinese stock market.

But it has taken Barry Ritholtz at the Big Picture to extrapolate this into a fully formed market psyche. After sceptically reading commentary from pundits on the present macro environment, he's realised why it all seems slightly familiar.

The five stages of grief - as introduced by Elisabeth Kübler-Ross in her 1969 book "On Death and Dying":

1. Denial
2. Anger
3. Bargaining
4. Depression
5. Acceptance

Number one is easy, summed by the "subprime is contained" camp.

We saw the same denial steps in inflation, consumer spending, and job creation. The denial transition went from: a) No slowdown; to b) Slowdown, but no impact; to c) Impact, but contained; to d) Broad impact already reflected in stock prices.

Ritholtz thinks we've also seen some anger now, citing (who else?) Jim Cramer. Anger we'd say seems to be continuing, and is being directed ever-more-broadly across banks, rating agencies, central banks, and, of course, the media. If anything, the comments and emails coming to FT Alphaville HQ are getting angrier.

How about bargaining?

I believe we are now at the bargaining stage. This is reflected in the increased expectations of a 50 bps rate cut (If the Fed cuts aggressively, stocks will be fine). Buying falling knives is a form of bargaining (If I avoid momentum plays and only buy cheap stocks, I'm okay).
We have yet, he reckons, to reach stages four and five: depression and acceptance. The former is self-explanatory; the latter is when hope is extinguished and you get out of the market. That's then a good time to buy.

One Big Picture commenter applauds the parallel, but reminds us that bouncing between stages is not uncommon - there's still time to bounce back to denial with a strong Fed-led rally.

Different groups, or individuals, may also find their own route through the stages. Economists - according to a Nouriel Roubini post on the annual meetings of the American Economic Association - may have given up bargaining and be heading further into the depressive abyss: a recession is a given; now how bad is it going to be? Equity strategists, back in bargaining mode, are still looking for a way out.

[insipiens] 23/1/2008 04:25

I agree with you that we need to get the bear market over and done with, and that the plunge team is counter productive but I feel that they can only slow the inevitable on a daily basis.

Mervyn is right and as we depend on world trade it matters less what happens to UK interest rates (matters to Brits but not the world economy) than what happens in the US.

[simon gordon] 22/1/2008 10:40

I think Global growth will continue as markets integrate into a more closely aligned trading system. The BRIC's, Eastern Europe and Africa.

The view that I am picking up from all the data I read is that Q1 is going to be a dog and then the reflation trade will lift equity markets.

Last week I picked up some EAGA. I think that EAGA has upside potential to £5.00, over a three to five year view.

I am hoping the market crashes and that I can pick up EAGA for a quid.

[insipiens] 22/1/2008 10:30

Simon, I think you might like the sentiment of this show. Ok it is Californian but if you can get over that they do make a little sense if rather extremely gold biased.



One thing I found, since living in the US, is that almost everyone has a bias/opinion, to the degree that they will not consider the other point of view - no wonder they get into such a mess.

[insipiens] 22/1/2008 10:20

hmmmm, some stocks beginning to look more attractive than bonds.....have shifted accumulation strategy accordingly. Still, further downleg required in indices - this was the shock movement (omg recession!) next comes the depression movement (omg shares make only losses). Asset bubbles. Just like almost 20 years ago :/ who said history doesn't repeat itself....

Steady accumulation over the next 4 years of stagnation should serve me well. ^^

Whats your take Simon? ftse drifts/goes to 4800 in a years time is my bet, then slow recovery....

If you fancy a giggle see my thread on CSUZ - talk about an ill timed fund....but perhaps(?)

[insipiens] 10/1/2008 11:41

I agree with that. Should bode well for my gold ETCs